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Section 1: 10-K

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 

FORM 10-K

(Mark One)

 

 

 

x

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2014
OR

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

FOR THE TRANSITION PERIOD FROM   TO  
COMMISSION FILE NUMBER: 000-11486

ConnectOne Bancorp, Inc.
(Exact name of registrant as specified in its charter)

 

 

 

New Jersey
(State or other jurisdiction of
incorporation or organization)

 

52-1273725
(IRS Employer Identification Number)

301 Sylvan Avenue Englewood Cliffs,
New Jersey
(Address of principal executive offices)

 

07632
(Zip Code)

201-816-8900
(Registrant’s telephone number, including area code)

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE EXCHANGE ACT:

 

 

 

Title of each class

 

Name of each exchange on
which registered

Common Stock, no par value

 

Nasdaq

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE EXCHANGE ACT:
None

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No x

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o  No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Regulation S-T (232,405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant has required to submit and post such files.)  Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934.
Large accelerated filer  
o  Accelerated filer   x  Non-accelerated  o  Smaller reporting company  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)
Yes 
o or No x

The aggregate market value of the voting and nonvoting common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold or the average bid and ask price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter—$302.8 million

Shares Outstanding on March 3, 2015
Common Stock, no par value: 29,864,602 shares

DOCUMENTS INCORPORATED BY REFERENCE
Definitive proxy statement in connection with the 2015 Annual Stockholders Meeting to be filed with the Commission pursuant to Regulation 14A will be incorporated by reference in Part III

 

 


 

CONNECTONE BANCORP, INC.

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

Page

PART I

Item 1.

 

Business

 

 

 

1

 

Item 1A.

 

Risk Factors

 

 

 

14

 

Item 1B.

 

Unresolved Staff Comments

 

 

 

25

 

Item 2.

 

Properties

 

 

 

25

 

Item 3.

 

Legal Proceedings

 

 

 

27

 

Item 3A.

 

Executive Officers of the Registrant

   

Item 4.

 

Mine Safety Disclosures

 

 

 

27

 

PART II

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

 

28

 

Item 6.

 

Selected Financial Data

 

 

 

30

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

34

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

53

 

Item 8.

 

Financial Statements and Supplementary Data:

 

 

 

54

 

 

 Reports of Independent Registered Public Accounting Firms

 

 

 

55

 

 

 

 Consolidated Statements of Condition

 

 

 

59

 

 

 Consolidated Statements of Income

 

 

 

60

 

 

 

 Consolidated Statements of Comprehensive Income

 

 

 

61

 

 

 Consolidated Statements of Changes in Stockholders’ Equity

 

 

 

62

 

 

 

 Consolidated Statements of Cash Flows

 

 

 

63

 

 

 Notes to Consolidated Financial Statements

 

 

 

65

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

 

 

117

 

Item 9A.

 

Controls and Procedures

 

 

 

117

 

Item 9B.

 

Other Information

 

 

 

118

 

PART III

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

 

 

119

 

Item 11.

 

Executive Compensation

 

 

 

119

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

 

119

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

 

 

119

 

Item 14.

 

Principal Accounting Fees and Services

 

 

 

119

 

PART IV

Item 15.

 

Exhibits, Financial Statements Schedules

 

 

 

120

 

 

Signatures

 

 

 

123

 

Information included in or incorporated by reference in this Annual Report on Form 10-K, other filings with the Securities and Exchange Commission, the Corporation’s press releases or other public statements, contain or may contain forward looking statements. Please refer to a discussion of the Corporation’s forward looking statements and associated risks in “Item 1—Business—Historical Development of Business” and “Item 1A—Risk Factors” in this Annual Report on Form 10-K.


 

CONNECTONE BANCORP, INC.
FORM 10-K

PART I

Item 1. Business

Historical Development of Business

This report, in Item 1, Item 7 and elsewhere, includes forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, that involve inherent risks and uncertainties. These forward-looking statements concern the financial condition, results of operations, plans, objectives, future performance and business of ConnectOne Bancorp, Inc. and its subsidiaries, including statements preceded by, followed by or that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) competitive pressures among depository institutions may increase significantly; (2) changes in the interest rate environment may reduce interest margins; (3) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions may vary substantially from period to period; (4) general economic conditions may be less favorable than expected; (5) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions may adversely affect the businesses in which ConnectOne Bancorp, Inc. is engaged; (7) changes and trends in the securities markets may adversely impact ConnectOne Bancorp, Inc.; (8) a delayed or incomplete resolution of regulatory issues could adversely impact our planning; (9) difficulties in integrating any businesses that we may acquire, which may increase our expenses and delay the achievement of any benefits that we may expect from such acquisitions; (10) the impact of reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; and (11) the outcome of any future regulatory and legal investigations and proceedings may not be anticipated. Further information on other factors that could affect the financial results of ConnectOne Bancorp, Inc. are included in Item 1A of this Annual Report on Form 10-K and in ConnectOne Bancorp’s other filings with the Securities and Exchange Commission. These documents are available free of charge at the Commission’s website at http://www.sec.gov and/or from ConnectOne Bancorp, Inc. ConnectOne Bancorp, Inc. assumes no obligation to update forward-looking statements at any time.

ConnectOne Bancorp, Inc., (the “Company” and with ConnectOne Bank, “we” or “us”) a one-bank holding company, was incorporated in the state of New Jersey on November 12, 1982 as Center Bancorp, Inc. and commenced operations on May 1, 1983 upon the acquisition of all outstanding shares of capital stock of Union Center National Bank, its then principal subsidiary.

On January 20, 2014, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with ConnectOne Bancorp, Inc., a New Jersey corporation (“Legacy ConnectOne”). Effective July 1, 2014, the Company completed the merger contemplated by the Merger Agreement (the “Merger”) with Legacy ConnectOne merging with and into the Company, with the Company as the surviving corporation. Also at closing, the Company changed its name to “ConnectOne Bancorp, Inc.” and changed its NASDAQ trading symbol to “CNOB”. Immediately following the consummation of the Merger, Union Center Bank merged with and into ConnectOne Bank, a New Jersey-chartered commercial bank (“ConnectOne Bank” or the “Bank”) and a wholly-owned subsidiary of Legacy ConnectOne, with ConnectOne Bank continuing as the surviving bank. Subject to the terms and conditions of the Merger Agreement, each share of common stock, no par value per share, of Legacy ConnectOne was converted into 2.6 shares of the Company’s common stock.

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The Company’s primary activity, at this time, is to act as a holding company for the Bank and its other subsidiaries. As used herein, the term “Parent Corporation” shall refer to the Company on an unconsolidated basis.

The Company owns 100% of the voting shares of Center Bancorp, Inc. Statutory Trust II, through which it issued trust preferred securities. The trust exists for the exclusive purpose of (i) issuing trust securities representing undivided beneficial interests in the assets of the trust; (ii) investing the gross proceeds of the trust securities in $5.2 million of junior subordinated deferrable interest debentures (subordinated debentures) of the Company; and (iii) engaging in only those activities necessary or incidental thereto. These subordinated debentures and the related income effects are not eliminated in the consolidated financial statements as the statutory business trust is not consolidated in accordance with Financial Accounting Standards Board (“FASB”) FASB ASC 810-10 “Consolidation of Variable Interest Entities.” Distributions on the subordinated debentures owned by the subsidiary trust have been classified as interest expense in the Consolidated Statements of Income. See Note 11 of the Consolidated Financial Statements.

Except as described above, the Company’s wholly-owned subsidiaries are all included in the Company’s consolidated financial statements. These subsidiaries include an advertising subsidiary; an insurance subsidiary offering annuity products, property and casualty, life and health insurance, and various investment subsidiaries which hold, maintain and manage investment assets for the Company. The Company’s subsidiaries also include two real estate investment trust subsidiaries (the “REIT” subsidiaries) which hold a portion of the Company’s real estate loan portfolio. All subsidiaries mentioned above are directly or indirectly wholly owned by the Company, except that the Company owns less than 100% of the preferred stock of the REIT subsidiaries. A REIT must have 100 or more shareholders to qualify as a REIT. The REIT subsidiaries have issued less than 20% of its outstanding non-voting preferred stock to individuals, primarily Bank personnel and directors.

On August 1, 2012, the Bank assumed all of the deposits and certain other liabilities and acquired certain assets of Saddle River Valley Bank, a New Jersey State-chartered bank, pursuant to the terms of a Purchase and Assumption Agreement, dated as of February 1, 2012, among the Bank, Saddle River Valley Bank and Saddle River Valley Bancorp.

SEC Reports and Corporate Governance

The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments thereto available on its website at www.connectonebank.com without charge as soon as reasonably practicable after filing or furnishing them to the SEC. Also available on the website are the Company’s corporate code of ethics that applies to all of the Company’s employees, including principal officers and directors, and charters for the Audit Committee, Compensation Committee and Nominating Committee.

Additionally, the Company will provide without charge, a copy of its Annual Report on Form 10-K to any shareholder by mail. Requests should be sent to ConnectOne Bancorp, Inc., Attention: Shareholder Relations, 301 Sylvan Avenue, Englewood Cliffs, New Jersey 07632.

Narrative Description of the Business

We offer a broad range of deposit and loan products and services to the general public and, in particular, to small and mid-sized businesses, local professionals and individuals residing, working and shopping in our trade area.

Prior to the Merger, we had concentrated on organic growth, through opening new branches and offering new technology and product delivery channels to acquire new customers. We expect to take an opportunistic approach to acquisitions, considering opportunities to purchase whole institutions, branches or lines of business that complement our existing strategy in the future, we expect the bulk of our future growth to be organic. Our goal is to open new offices in the counties contained in our broader trade area discussed below. However, we do not believe that we need to establish a physical location in each market that we serve. We believe that advances in technology have created new delivery channels which allow us to service customers and maintain business

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relationships without a physical presence, and that these customers can also be serviced through a regional office. We believe the key to customer acquisition and retention is establishing quality teams of lenders and business relationship officers who will frequently go to the customer, rather than having the customer come into the branch.

We emphasize superior customer service and relationship banking. The Bank offers high-quality service by minimizing personnel turnover and by providing more direct, personal attention than we believe is offered by competing financial institutions, the majority of which are branch offices of banks headquartered outside our primary trade area. By emphasizing the need for a professional, responsive and knowledgeable staff, we offer a superior level of service to our customers. As a result of senior management’s availability for consultation on a daily basis, we believe we offer customers a quicker response on loan applications and other banking transactions than competitors, whose decisions may be made in distant headquarters. We believe that this response time results in a pricing advantage to us, in that we frequently may exceed competitors’ loan pricing and still win customers. We also provide state-of-the-art banking technology, including remote deposit capture, internet banking and mobile banking, to provide our customers with the most choices and maximum flexibility. We believe that this combination of quick, responsive and personal service and advanced technology provides the Bank’s customers with a superior banking experience.

The Bank, through its subsidiary, Center Financial Group LLC, provides financial services, including brokerage services, insurance and annuities, mutual funds and financial planning.

Our Market Area

Our banking offices are located in Bergen, Union, Morris, Essex, Hudson, Mercer and Monmouth Counties in New Jersey, which include some of the most affluent markets in the United States. In addition, we are in the process of obtaining regulatory approvals to open a branch office in the borough of Manhattan in New York City. The New York City branch is expected to open for business during the second quarter of 2015. We also attract business and customers from a broader region, including northern New Jersey, the five boroughs of New York City, and Westchester and Nassau counties in New York State.

Products and Services

We derive substantially all of our income from our net interest income (i.e., the difference between the interest we receive on our loans and securities and the interest we pay on deposits and other borrowings). We offer a broad range of deposit and loan products. In addition, to attract the business of consumer and business customers, we also provide a broad array of other banking services. Products and services provided include personal and business checking accounts, retirement accounts, money market accounts, time and savings accounts, credit cards, wire transfers, access to automated teller services, internet banking, Treasury Direct, ACH origination, lockbox services and mobile banking by phone. In addition, we offer safe deposit boxes. The Bank also offers remote deposit capture banking for both retail and business customers, providing the ability to electronically scan and transmit checks for deposit, reducing time and cost.

Checking account products consist of both retail and business demand deposit products. Retail products include Totally Free checking and, for businesses, both interest-bearing accounts, which require a minimum balance, and non-interest bearing accounts. NOW accounts consist of both retail and business interest-bearing transaction accounts that have minimum balance requirements. Money market accounts consist of products that provide a market rate of interest to depositors but have limited check writing capabilities. Our savings accounts consist of both passbook and statement type accounts. Time deposits consist of certificates of deposit, including those held in IRA accounts, generally with initial maturities ranging from 7 days to 60 months and brokered certificates of deposit, which we use for asset liability management purposes and to supplement other sources of funding. CDARS/ICS Reciprocal deposits are offered based the Bank’s participation in Promontory Interfinancial Network, LLC. Customers who are FDIC insurance sensitive are able to place large dollar deposits with the Company and the Company uses CDARS to place those funds into certificates of deposit issued by other banks in the Network. This occurs in increments of less than

3


 

the FDIC insurance limits so that both the principal and interest are eligible for complete FDIC insurance coverage. The FDIC currently considers these funds as brokered deposits.

Deposits serve as the primary source of funding for our interest-earning assets, but also generate non-interest revenue through insufficient funds fees, stop payment fees, safe deposit rental fees, card income, including foreign ATM fees and credit and debit card interchange, gift card fees, and other miscellaneous fees. In addition, the Bank generates additional non-interest revenue associated with residential loan origination and sale, loan servicing, late fees and merchant services.

We offer personal and commercial business loans on a secured and unsecured basis, revolving lines of credit, commercial mortgage loans, and residential mortgages on both primary and secondary residences, home equity loans, bridge loans and other personal purpose loans. However, we are not and have not historically been a participant in the sub-prime lending market.

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 Board of Directors has approved a loan policy granting designated lending authorities to specific officers of the Bank. Those officers are comprised of the Chief Executive Officer, Chief Lending Officer, Chief Credit Officer, Team Leader and the Consumer Loan Officer. All loan approvals require the signatures of a minimum of two officers. The Senior Lending Group (Chief Executive Officer, Chief Lending Officer and Chief Credit Officer) can approve loans up to $25 million in aggregate loan exposure not exceed 65% of the Legal Lending Limit of the Bank (currently $46.4 million as of December 31, 2014 for most loans), provided that (i) the credit does not involve an exception to policy greater than $7.5 million or $20 million in the aggregate, (ii) the credit does not exceed certain dollar amount thresholds set forth in our policy, which varies by loan type, and (iii) the credit is not extended to an insider of the Bank. The Board Loan Committee (which includes the Chief Executive Officer and four other Board members) approves credits that are both exceptions to policy and are above prescribed amounts related to loan type and collateral. Loans to insiders must be approved by the entire Board.

The Bank’s lending policies generally provide for lending inside of our primary trade area. However, the Bank will make loans to persons outside of our primary trade area when we deem it prudent to do so. In an effort to promote a high degree of asset quality, the Bank focuses primarily upon offering secured loans. However, the Bank does make short-term unsecured loans to borrowers with high net worth and income profiles. The Bank generally requires loan customers to maintain deposit accounts with the Bank. In addition, the Bank generally provides for a minimum required rate of interest in its variable rate loans. We believe that having senior management on-site allows for an enhanced local presence and rapid decision-making that attracts borrowers. The Bank’s legal lending limit to any one borrower is 15% of the Banks’s capital base (defined as tangible equity plus the allowance for loan losses) for most loans ($46.4 million) and 25% of the capital base for loans secured by readily marketable collateral ($77.4 million). At December 31, 2014, the Bank’s largest committed relationship (to several affiliated borrowers) totaled $37.0 million. The Bank’s largest single loan outstanding at December 31, 2014 was $19.9 million.

Our business model includes using industry best practices for community banks, including personalized service, state-of-the-art technology and extended hours. We believe that this will generate deposit accounts with somewhat larger average balances than are found at many other

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financial institutions. We also use pricing techniques in our efforts to attract banking relationships having larger than average balances.

Competition

The banking business is highly competitive. We face substantial immediate competition and potential future competition both in attracting deposits and in originating loans. We compete with numerous commercial banks, savings banks and savings and loan associations, many of which have assets, capital and lending limits larger than those that we have. Other competitors include money market mutual funds, mortgage bankers, insurance companies, stock brokerage firms, regulated small loan companies, credit unions and issuers of commercial paper and other securities.

Our larger competitors have greater financial resources to finance wide-ranging advertising campaigns.

Additionally, we endeavor to compete for business by providing high quality, personal service to customers, customer access to our decision-makers and competitive interest rates and fees. We seek to hire and retain quality employees who desire greater responsibility than may be available working for a larger employer. Additionally, the local real estate and other business activities of our Directors help us develop business relationships by increasing our profile in our communities.

SUPERVISION AND REGULATION

The banking industry is highly regulated. Statutory and regulatory controls increase a bank holding company’s cost of doing business and limit the options of its management to deploy assets and maximize income. The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on the Company or the Bank. It is intended only to briefly summarize some material provisions.

Bank Holding Company Regulation

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (the “Holding Company Act”). As a bank holding company, the Company is supervised by the Board of Governors of the Federal Reserve System (“FRB”) and is required to file reports with the FRB and provide such additional information as the FRB may require. The Company and its subsidiaries are subject to examination by the FRB.

The Holding Company Act prohibits the Company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to subsidiary banks, except that it may, upon application, engage in, and may own shares of companies engaged in, certain businesses found by the FRB to be so closely related to banking “as to be a proper incident thereto.” The Holding Company Act requires prior approval by the FRB of the acquisition by the Company of more than 5% of the voting stock of any other bank. Satisfactory capital ratios and Community Reinvestment Act ratings and anti-money laundering policies are generally prerequisites to obtaining federal regulatory approval to make acquisitions. The policy of the FRB provides that a bank holding company is expected to act as a source of financial strength to its subsidiary bank and to commit resources to support the subsidiary bank in circumstances in which it might not do so absent that policy.

As a New Jersey-charted commercial bank and an FDIC-insured institution, acquisitions by the Bank require approval of the New Jersey Department of Banking and Insurance (the “Banking Department”) and the FDIC, an agency of the federal government. The Holding Company Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies. The Gramm-Leach-Bliley Act, discussed below, allows the Company to expand into insurance, securities, merchant banking activities, and other activities that are financial in nature, in certain circumstances.

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Regulation of Bank Subsidiary

The operations of the Bank are subject to requirements and restrictions under federal law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted, and limitations on the types of investments that may be made and the types of services which may be offered. Various consumer laws and regulations also affect the operations of the Bank. There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, which govern the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its holding company’s non-bank subsidiaries and affiliates. Under federal law, a bank subsidiary may only make loans or extensions of credit to, or investment in the securities of, its parent or the non-bank subsidiaries of its parent (other than direct subsidiaries of such bank which are not financial subsidiaries) or to any affiliate, or take their securities as collateral for loans to any borrower, upon satisfaction of various regulatory criteria, including specific collateral loan to value requirements.

The Dodd-Frank Act

The Dodd-Frank Act, adopted in 2010, will continue to have a broad impact on the financial services industry, as a result of the significant regulatory and compliance changes made by the Dodd-Frank Act, including, among other things, (i) enhanced resolution authority over troubled and failing banks and their holding companies; (ii) increased capital and liquidity requirements; (iii) increased regulatory examination fees; (iv) changes to assessments to be paid to the FDIC for federal deposit insurance; and (v) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the FRB, the Office of the Comptroller of the Currency and the FDIC. A summary of certain provisions of the Dodd-Frank Act is set forth below:

 

 

Minimum Capital Requirements. The Dodd-Frank Act requires new capital rules and the application of the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies. In addition to making bank holding companies subject to the same capital requirements as their bank subsidiaries, these provisions (often referred to as the Collins Amendment to the Dodd-Frank Act) were also intended to eliminate or significantly reduce the use of hybrid capital instruments, especially trust preferred securities, as regulatory capital. The Dodd-Frank Act also requires banking regulators to seek to make capital standards countercyclical, so that the required levels of capital increase in times of economic expansion and decrease in times of economic contraction. See “New Capital Rules” for a description of new capital requirements adopted by U.S. federal banking regulators in 2013 and the treatment of trust preferred securities under such rules.

 

 

The Consumer Financial Protection Bureau (“Bureau”). The Dodd-Frank Act created the Bureau within the FRB. The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against state-chartered institutions. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Institutions with $10 billion or less in assets, such as the Bank, will continue to be examined for compliance with the consumer laws by their primary bank regulators.

 

 

Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits. Amendments to the Federal Deposit Insurance Act also revise the

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assessment base against which an insured depository institution’s deposit insurance premiums paid to the Deposit Insurance Fund (“DIF”) will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity during the assessment period. Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15 percent to 1.35 percent of the estimated amount of total insured deposits and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. In December 2010, the FDIC increased the designated reserve ratio to 2.0 percent.

 

 

Shareholder Votes. The Dodd-Frank Act requires publicly traded companies like the Company to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments in certain circumstances. The Dodd-Frank Act also authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. The SEC has not yet adopted such rules.

Although a significant number of the rules and regulations mandated by the Dodd-Frank Act have been finalized, many of the new requirements called for have yet to be implemented and will likely be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements (which, in turn, could require the Company and the Bank to seek additional capital) or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

Regulation W

Regulation W codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank. The Company is considered to be an affiliate of the Bank. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates:

 

 

to an amount equal to 10% of the bank’s capital and surplus, in the case of covered transactions with any one affiliate; and

 

 

to an amount equal to 20% of the bank’s capital and surplus, in the case of covered transactions with all affiliates

In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A “covered transaction” includes:

 

 

a loan or extension of credit to an affiliate;

 

 

a purchase of, or an investment in, securities issued by an affiliate;

 

 

a purchase of assets from an affiliate, with some exceptions;

 

 

the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and

 

 

the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.

Further, under Regulation W:

 

 

a bank and its subsidiaries may not purchase a low-quality asset from an affiliate;

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covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and

 

 

with some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by certain types of collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the FRB decides to treat these subsidiaries as affiliates.

Capital Adequacy Guidelines

The FRB has adopted risk-based capital guidelines. These guidelines establish minimum levels of capital and require capital adequacy to be measured in part upon the degree of risk associated with certain assets. Under these guidelines all banks and bank holding companies must have a core or Tier 1 capital to risk-weighted assets ratio of at least 4% and a total capital to risk-weighted assets ratio of at least 8%. At December 31, 2014, the Company’s Tier 1 capital to risk-weighted assets ratio and total capital to risk-weighted assets ratio were 10.44% and 10.94%, respectively.

In addition, the FRB and the FDIC have approved leverage ratio guidelines (Tier 1 capital to average quarterly assets, less goodwill) for bank holding companies such as the Company. These guidelines provide for a minimum leverage ratio of 3% for bank holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other holding companies are required to maintain a leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis points. The Company’s leverage ratio was 9.37% at December 31, 2014.

Under FDICIA, federal banking agencies have established certain additional minimum levels of capital. See “FDICIA”. See also “New Capital Rules” for a description of capital requirements adopted by federal regulators in July 2013.

FDICIA

Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), each federal banking agency has promulgated regulations, specifying the levels at which an insured depository institution such as the Bank would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution. To qualify to engage in financial activities under the Gramm-Leach-Bliley Act, all depository institutions must be “well capitalized.”

The FDIC’s regulations implementing these provisions of FDICIA provide that an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, and (iv) meets certain other requirements. An institution will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 4.0 percent, (iii) has a Tier 1 leverage ratio of (a) at least 4.0 percent or (b) at least 3.0 percent if the institution was rated 1 in its most recent examination, and (iv) does not meet the definition of “well capitalized.” An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, or (iii) has a Tier 1 leverage ratio of (a) less than 4.0 percent or (b) less than 3.0 percent if the institution was rated 1 in its most recent examination. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 3.0 percent, or (iii) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower

8


 

capitalization category if it receives an unsatisfactory examination rating. The requirements for certain of these categories have recently been revised. See “New Capital Rules.”

In addition, significant provisions of FDICIA required federal banking regulators to impose standards in a number of other important areas to assure bank safety and soundness, including internal controls, information systems and internal audit systems, credit underwriting, asset growth, compensation, loan documentation and interest rate exposure.

New Capital Rules

In December 2010 and January 2011, the Basel Committee on Banking Supervision (the “Basel Committee”) published the final texts of reforms on capital and liquidity generally referred to as “Basel III.” In July 2013, the FRB, the FDIC and the Comptroller of the Currency adopted final rules (the “New Rules”), which implement certain provisions of Basel III and the Dodd-Frank Act. The New Rules replace the general risk-based capital rules of the various banking agencies with a single, integrated regulatory capital framework. The New Rules require higher capital cushions and more stringent criteria for what qualifies as regulatory capital.

For banks and bank holding companies like the Company and the Bank, January 1, 2015 is the start date for compliance with the revised minimum regulatory capital ratios and for determining risk-weighted assets under what the New Rules call a “standardized approach.”

As of January 1, 2015, the Company and the Bank will be required to maintain the following minimum capital ratios, expressed as a percentage of risk-weighted assets:

 

 

Common Equity Tier 1 Capital Ratio of 4.5% (this is a new concept and requirement, and is referred to as the “CET1”);

 

 

Tier 1 Capital Ratio (CET1 capital plus “Additional Tier 1 capital”) of 6.0%; and

 

 

Total Capital Ratio (Tier 1 capital plus Tier 2 capital) of 8.0%.

In addition, the Company and the Bank will be subject to a leverage ratio of 4% (calculated as Tier 1 capital to average consolidated assets as reported on the consolidated financial statements).

The New Rules also require a “capital conservation buffer.” When fully phased in on January 1 2019, the Company and the Bank will be required to maintain a 2.5% capital conservation buffer, which is composed entirely of CET1, on top of the minimum risk-weighted asset ratios described above, resulting in the following minimum capital ratios:

 

 

CET1 of 7%;

 

 

Tier 1 Capital Ratio of 8.5%; and

 

 

Total Capital Ratio of 10.5%.

The purpose of the capital conservation buffer is to absorb losses during periods of economic stress. Banking institutions with a CET1, Tier 1 Capital Ratio and Total Capital Ratio above the minimum set forth above but below the capital conservation buffer will face constraints on their ability to pay dividends, repurchase equity and pay discretionary bonuses to executive officers, based on the amount of the shortfall.

The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level, and increase by 0.625% on each subsequent January 1 until it reaches 2.5% on January 1, 2019.

The New Rules provide for several deductions from and adjustments to CET1, which will be phased in between January 1, 2015 and January 1, 2018. For example, mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in common equity issued by nonconsolidated financial entities must be deducted from CET1 to the extent that any one of those categories exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.

Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under the

9


 

New Rules, the effects of certain accumulated other comprehensive income items are not excluded; however, banking organizations such as the Company and the Bank may make a one-time permanent election to continue to exclude these items effective as of January 1, 2015.

While the New Rules generally require the phase-out of non-qualifying capital instruments such as trust preferred securities and cumulative perpetual preferred stock, holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, may permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in Additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.

The New Rules prescribe a standardized approach for calculating risk-weighted assets that expands the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. Government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories. In addition, the New Rules provide more advantageous risk weights for derivatives and repurchase-style transactions cleared through a qualifying central counterparty and increase the scope of eligible guarantors and eligible collateral for purposes of credit risk mitigation.

Consistent with the Dodd-Frank Act, the New Rules adopt alternatives to credit ratings for calculating the risk-weighting for certain assets.

With respect to the Bank, the New Rules revise the “prompt corrective action” regulations under Section 38 of the Federal Deposit Insurance Act by (i) introducing a CET1 ratio requirement at each capital quality level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital to risk weighted assets ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being 8% (as compared to the current 6%); and (iii) requiring a leverage ratio of 5% to be well-capitalized, no change from the current requirement. The New Rules do not change the total risk-based capital requirement for any “prompt corrective action” category. When the capital conservation buffer is fully phased in, the capital ratios applicable to depository institutions under the New Rules will exceed the ratios to be considered well-capitalized under the prompt corrective action regulations.

The Company believes that as of December 31, 2014, the Company and the Bank would meet all capital requirements under the New Rules on a fully phased-in basis, if such requirements were currently in effect.

Federal Deposit Insurance and Premiums

Substantially all of the deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF.

The FDIC has approved a rule to change the assessment base from adjusted domestic deposits to average consolidated total assets minus average tangible equity, as required by the Dodd-Frank Act. These new assessment rates began in the second quarter of 2011 and were paid at the end of September 2011. Since the new base is larger than the prior base, the FDIC’s rule lowered total base assessment rates to between 2.5 and 9 basis points for banks in the lowest risk category, and 30 to 45 basis points for banks in the highest risk category. The Company paid $1.6 million in total FDIC assessments in 2014, as compared to $1.1 million in 2013.

Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (DRR), that is, the ratio of the DIF to insured deposits. The FDIC has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. The FDIC has not yet announced how it will implement this offset.

10


 

In addition to deposit insurance assessments, the FDIC is required to continue to collect from institutions payments for the servicing of obligations of the Financing Corporation (“FICO”) that were issued in connection with the resolution of savings and loan associations, so long as such obligations remain outstanding. The Bank paid a FICO premium of $134,000 in 2014.

The Gramm-Leach-Bliley Financial Services Modernization Act of 1999

The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the “Modernization Act”):

 

 

allows bank holding companies meeting management, capital, and Community Reinvestment Act standards to engage in a substantially broader range of non-banking activities than previously was permissible, including insurance underwriting and making merchant banking investments in commercial and financial companies, if the bank holding company elects to become a financial holding company, it files a certification, effective in 30 days, and thereafter may engage in certain financial activities without further approvals;

 

 

allows insurers and other financial services companies to acquire banks;

 

 

removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies; and

 

 

establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.

The Modernization Act also modified other financial laws, including laws related to financial privacy and community reinvestment. The Company has elected not to become a financial holding company.

Community Reinvestment Act

Under the Community Reinvestment Act (“CRA”), as implemented by FDIC regulations, an insured depository institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection with its examination of every bank, to assess the bank’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such bank.

USA PATRIOT Act

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) gives the federal government powers to address terrorist threats through domestic security measures, surveillance powers, information sharing, and anti-money laundering requirements. By way of amendments to the Bank Secrecy Act, the USA PATRIOT Act encourages information-sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of the USA PATRIOT Act impose affirmative obligations on a broad range of financial institutions, including banks, thrift institutions, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.

Among other requirements, the USA PATRIOT Act imposes the following requirements with respect to financial institutions:

 

 

All financial institutions must establish anti-money laundering programs that include, at a minimum: (i) internal policies, procedures, and controls; (ii) specific designation of an anti-money laundering compliance officer; (iii) ongoing employee training programs; and (iv) an independent audit function to test the anti-money laundering program.

11


 

 

 

The Secretary of the Department of Treasury, in conjunction with other bank regulators, is authorized to issue regulations that provide for minimum standards with respect to customer identification at the time new accounts are opened.

 

 

Financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) are required to establish appropriate, specific and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering.

 

 

Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain record keeping obligations with respect to correspondent accounts of foreign banks.

 

 

Bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.

The United States Treasury Department has issued a number of implementing regulations which address various requirements of the USA PATRIOT Act and are applicable to financial institutions such as the Bank. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers.

TARP and SBLF

In January 2009, the Company issued $10.0 million of its nonvoting non-convertible senior preferred stock (the “TARP Preferred Stock”) to the United States Treasury pursuant to Congress’ Troubled Asset Relief Program (“TARP”).

On September 15, 2011, the Company issued to the Treasury a total of 11,250 shares of the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “SBLF Preferred Stock”), having a liquidation value of $1,000 per share, for a total purchase price of $11,250,000 as part of the Treasury’s Small Business Lending Fund program (“SBLF”).

The SBLF Preferred Stock qualifies as Tier 1 capital. Non-cumulative dividends are payable quarterly on January 1, April 1, July 1 and October 1 for the SBLF Preferred Stock, commencing on January 1, 2012. The dividend rate is calculated as a percentage of the aggregate liquidation value of the outstanding SBLF Preferred Stock and is based on changes in the level of “Qualified Small Business Lending” or “QSBL” by the Bank The dividend rate on the SBLF Preferred Stock was set at five percent for the initial dividend period.

For the second through tenth calendar quarters after the closing of the SBLF Program transaction, the dividend rate will fluctuate between one percent and five percent to reflect the amount of change in the Bank’s level of QSBL more specifically, if the Bank’s QSBL at the end of a quarter has increased as compared to the baseline, then the dividend rate payable on the SBLF Preferred Stock would change as follows:

 

 

 

Relative Increase in QSBL to Baseline

 

Dividend Rate
(for each of the 2
nd – 10th Dividend Periods)

0% or less

 

5%

More than 0%, but less than 2.5%

 

5%

2.5% or more, but less than 5%

 

4%

5% or more, but less than 7.5%

 

3%

7.5% or more, but less than 10%

 

2%

10% or more

 

1%

From the eleventh through the eighteenth calendar quarters and that portion of the nineteenth calendar quarter which ends immediately prior to the date that is the four and one half years anniversary of the closing of the SBLF Program transaction, the dividend rate on the SBLF Preferred Stock will be fixed at between one percent and seven percent based on the level of QSBL at that time, as compared to the baseline in accordance with the chart below. If any SBLF Preferred

12


 

Stock remains outstanding after four and one half years following the closing of the SBLF Program transaction, the dividend rate will increase to nine percent.

 

 

 

0% or less

 

 

 

7

%

 

More than 0%, but less than 2.5%

 

 

 

5

%

 

2.5% or more, but less than 5%

 

 

 

4

%

 

5% or more, but less than 7.5%

 

 

 

3

%

 

7.5% or more, but less than 10%

 

 

 

2

%

 

10% or more

 

 

 

1

%

 

The SBLF Preferred Stock is non-voting, except in limited circumstances that could impact the SBLF investment, such as (i) authorization of senior stock, (ii) charter amendments adversely affecting the SBLF Preferred Stock and (iii) extraordinary transactions such as mergers, asset sales, share exchanges and the like (unless the SBLF Preferred Stock remains outstanding and the rights and preferences thereof are not impaired by such transaction).

In the event the Company misses five dividend payments, whether or not consecutive, the holder of the SBLF Preferred Stock will have the right, but not the obligation, to appoint a representative as an “observer” on the Company’s Board of Directors.

Further, the SBLF Preferred Stock may be redeemed by the Company at any time, at a redemption price of 100% of the liquidation amount plus accrued but unpaid dividends for the then current Dividend Period, subject to the approval of the Company’s federal banking regulator.

The SBLF Preferred Stock is not subject to any contractual restrictions on transfer and thus the Secretary may sell, transfer, exchange or enter into other transactions with respect to the SBLF Preferred Stock without the Company’s consent.

The Company used the proceeds from the issuance of the SBLF Preferred to redeem from the Treasury all shares issued by the Company pursuant to TARP, for a redemption price of $10,041,667, including accrued but unpaid dividends up to the date of redemption.

Loans to Related Parties

The Company’s authority to extend credit to its directors and executive officers, as well as to entities controlled by such persons, is currently governed by the requirements of the Sarbanes-Oxley Act of 2002 and Regulation O promulgated by the FRB. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, the Bank’s Board of Directors must approve extensions of credit in excess of certain limits.

Dividend Restrictions

The Parent Corporation is a legal entity separate and distinct from the Bank. Virtually all of the revenue of the Parent Corporation available for payment of dividends on its capital stock will result from amounts paid to the Parent Corporation by the Bank. All such dividends are subject to the laws of the State of New Jersey, the Banking Act, the Federal Deposit Insurance Act (“FDIA”) and the regulation of the New Jersey Department of Banking and Insurance and of the FDIC.

Under the New Jersey Corporation Act, the Parent Corporation is permitted to pay cash dividends provided that the payment does not leave us insolvent. As a bank holding company under the BHCA, we would be prohibited from paying cash dividends if we are not in compliance with any capital requirements applicable to us. However, as a practical matter, for so long as our major operations consist of ownership of the Bank, the Bank will remain our source of dividend payments, and our ability to pay dividends will be subject to any restrictions applicable to the Bank.

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Under the New Jersey Banking Act of 1948, as amended, dividends may be paid by the Bank only if, after the payment of the dividend, the capital stock of the Bank will be unimpaired and either the Bank will have a surplus of not less than 50% of its capital stock or the payment of the dividend will not reduce the Bank’s surplus. The payment of dividends is also dependent upon the Bank’s ability to maintain adequate capital ratios pursuant to applicable regulatory requirements.

The terms of the SBLF Preferred Stock discussed above impose limits on the Company’s ability to pay dividends on and repurchase shares of its common stock and other securities. More specifically, if the Company fails to declare and pay dividends on the SBLF Preferred Stock in a given quarter, then during such quarter and for the next three quarters following such missed dividend payment, the Company may not pay dividends on, or repurchase, any common stock or any other securities that are junior to (or in parity with) the SBLF Preferred Stock, except in very limited circumstances.

Also under the terms of the SBLF Preferred Stock, the Company may declare and pay dividends on its common stock or any other stock junior to the SBLF Preferred Stock, or repurchase shares of any such stock, only if after payment of such dividends or repurchase of such shares, the Company’s Tier 1 Capital would be at least equal to the so-called Tier 1 Dividend Threshold, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock.

The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs asset quality and overall financial condition. FRB regulations also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Under the prompt corrective action laws, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized, and under regulations implementing the Basel III accord, a bank holding company’s ability to pay cash dividends may be impaired if it fails to satisfy certain capital buffer requirements. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

Item 1A. Risk Factors

An investment in our common stock involves risks. Stockholders should carefully consider the risks described below, together with all other information contained in this Annual Report on Form 10-K, before making any purchase or sale decisions regarding our common stock. If any of the following risks actually occur, our business, financial condition or operating results may be harmed. In that case, the trading price of our common stock may decline, and stockholders may lose part or all of their investment in our common stock.

Risks Applicable to Our Business:

If we do not successfully complete all aspects of the integration of ConnectOne Bank and Union Center National Bank, our results of operation may be adversely affected.

We consummated the Merger effective July 1, 2014. Since that time, we have focused on integrating the cultures, business, operations and systems of both companies. If we do not successfully manage the integration of the cultures and personnel of the two banks, we may suffer customer defections and other business disruptions. We cannot assure you that we will be able to successfully manage the complete integration of the two banks, and any difficulties we encounter in connection with this integration may adversely affect our results of operations.

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Nationwide economic weakness may adversely affect our business by reducing real estate values in our trade area and stressing the ability of our customers to repay their loans.

Our trade area, like the rest of the United States, is currently experiencing weak economic conditions. In addition, the financial services industry is a major employer in our trade area. The financial services industry has been adversely affected by current economic and regulatory factors. As a result, many companies have experienced reduced revenues and have laid off employees. These factors have stressed the ability of both commercial and consumer customers to repay their loans, and may result in higher levels of non-accrual loans. In addition, real estate values have declined in our trade area. Since the number of our loans secured by real estate represents a material segment of our overall loan portfolio, declines in the market value of real estate impact the value of the collateral securing our loans, and could lead to greater losses in the event of defaults on loans secured by real estate.

Our recent growth has substantially increased our expenses and impacted our results of operations.

As a strategy, we have focused on growth by aggressively pursuing organic business development opportunities and we closed a significant merger transaction on July 1, 2014. Our assets have grown from $1.7 billion at December 31, 2013, to $3.4 billion at December 31, 2014, more than doubling our assets. We intend to continue to focus on growth. Although we believe that our growth strategy will support our long-term profitability and franchise value, the expense associated with our growth, including compensation expense for the employees needed to support this growth and leasehold and other expenses associated with our locations, has and may continue to negatively affect our results. In addition, in order for our most recently opened branches to contribute to our long-term profitability, we will need to be successful in attracting and maintaining cost efficient deposits at these locations. In order to successfully manage our growth, we need to adopt and effectively implement policies, procedures and controls to maintain our credit quality and oversee our operations. We can give you no assurance that we will be successful in this strategy.

Our growth-oriented business strategy could be adversely affected if we are not able to attract and retain skilled employees.

We may not be able to successfully manage our business as a result of the strain on our management and operations that may result from growth. Our ability to manage growth will depend upon our ability to continue to attract, hire and retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our employees.

We may need to raise additional capital to execute our growth oriented business strategy.

In order to continue our growth, we will be required to maintain our regulatory capital ratios at levels higher than the minimum ratios set by our regulators. In light of current economic conditions, our regulators have been seeking higher capital bases for insured depository institutions experiencing strong growth. In addition, the implementation of certain new regulatory requirements, such as the Basel III accord and the Dodd-Frank Act, may establish higher tangible capital requirements for financial institutions. These developments may require us to raise additional capital in the future. We can offer you no assurances that we will be able to raise capital in the future, or that the terms of any such capital will be beneficial to our existing security holders. In the event we are unable to raise capital in the future, we may not be able to continue our growth strategy.

We have a significant concentration in commercial real estate loans and commercial business loans.

Our loan portfolio is made up largely of commercial real estate loans and commercial business loans. These types of loans generally expose a lender to a higher degree of credit risk of non-payment and loss than do residential mortgage loans because of several factors, including dependence on the successful operation of a business or a project for repayment, the collateral

15


 

securing these loans may not be sold as easily as residential real estate, and loan terms with a balloon payment rather than full amortization over the loan term. In addition, commercial real estate and commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to four-family residential mortgage loans. Underwriting and portfolio management activities cannot completely eliminate all risks related to these loans. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us.

At December 31, 2014, we had $1.6 billion of commercial real estate loans, which represented 64.4% of our total loan portfolio. Our commercial real estate loans include loans secured by multi-family, owner occupied and non-owner occupied properties for commercial uses. In addition, we make both secured and unsecured commercial and industrial loans. At December 31, 2014, we had $499.8 million of commercial business loans, which represented 19.7% of our total loan portfolio. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses. Secured commercial and industrial loans are generally collateralized by accounts receivable, inventory, equipment or other assets owned by the borrower and typically include a personal guaranty of the business owner. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed.

Loans secured by owner-occupied real estate and commercial and industrial loans are both reliant on the operating businesses to provide cash flow to meet debt service obligations, and as a result they are more susceptible to the general impact on the economic environment affecting those operating companies as well as the real estate.

Although the economy in our market area generally, and the real estate market in particular, is improving, we can give you no assurance that it will continue to grow or that the rate of growth will accelerate. We can give you no assurance that it will continue to grow or that the rate of growth will accelerate to historical levels. Many factors, including continuing European economic difficulties could reduce or halt growth in our local economy and real estate market. Accordingly, it may be more difficult for commercial real estate borrowers to repay their loans in a timely manner in the current economic climate, as commercial real estate borrowers’ ability to repay their loans frequently depends on the successful development of their properties. The deterioration of one or a few of our commercial real estate loans could cause a material increase in our level of nonperforming loans, which would result in a loss of revenue from these loans and could result in an increase in the provision for loan losses and/or an increase in charge-offs, all of which could have a material adverse impact on our net income. We also may incur losses on commercial real estate loans due to declines in occupancy rates and rental rates, which may decrease property values and may decrease the likelihood that a borrower may find permanent financing alternatives. Given the continued weaknesses in the commercial real estate market in general, there may be loans where the value of our collateral has been negatively impacted. Any weakening of the commercial real estate market may increase the likelihood of default of these loans, which could negatively impact our loan portfolio’s performance and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, we could incur material losses. Any of these events could increase our costs, require management time and attention, and materially and adversely affect us.

Federal banking agencies have issued guidance regarding high concentrations of commercial real estate loans within bank loan portfolios. The guidance requires financial institutions that exceed certain levels of commercial real estate lending compared with their total capital to maintain heightened risk management practices that address the following key elements: board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. If there is any deterioration in our commercial real estate portfolio or if our regulators conclude that we have not implemented appropriate risk management practices, it could adversely affect our business, and could result in the requirement to maintain increased capital levels. Such

16


 

capital may not be available at that time, and may result in our regulators requiring us to reduce our concentration in commercial real estate loans.

The nature and growth rate of our commercial loan portfolio may expose us to increased lending risks.

Given the significant growth in our loan portfolio, many of our commercial real estate loans are unseasoned, meaning that they were originated relatively recently. As of December 31, 2014, we had $1.6 billion in commercial real estate loans outstanding. Approximately 69.6% of the loans, or $1.1 billion, had been originated in the past three years. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of our loan portfolio. These loans may have delinquency or charge-off levels above our expectations, which could negatively affect our performance.

The small to medium-sized businesses that the Bank lends to may have fewer resources to weather a downturn in the economy, which may impair a borrower’s ability to repay a loan to the Bank that could materially harm our operating results.

The Bank targets its business development and marketing strategy primarily to serve the banking and financial services needs of small to medium-sized businesses. These small to medium-sized businesses frequently have smaller market share than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience significant volatility in operating results. Any one or more of these factors may impair the borrower’s ability to repay a loan. In addition, the success of a small to medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay a loan. Economic downturns and other events that negatively impact our market areas could cause the Bank to incur substantial credit losses that could negatively affect our results of operations and financial condition.

Regulatory changes allowing the payment of interest on commercial accounts may negatively impact our core deposit strategy and our net interest income.

Our current core deposit strategy includes continuing to increase our noninterest-bearing commercial accounts in order to lower our cost of funds. Recent changes effected by the Dodd-Frank Act, however, permit the payment of interest on such accounts, which was previously prohibited. If our competitors begin paying interest on commercial accounts, this may increase competition from other financial institutions for these deposits and negatively affect our ability to continue to increase commercial deposit accounts, may require us to consider paying interest on such accounts, or may otherwise require us to revise our core deposit strategy, any of which could increase our interest expense and therefore our cost of funds and, as a result, decrease our net interest income which would adversely impact our results of operations.

The loss of our Chairman and Chief Executive Officer could hurt our operations.

We rely heavily on our Chairman and Chief Executive Officer, Frank Sorrentino III. Mr. Sorrentino has served as Chief Executive Officer of the Bank for eight years. It was Mr. Sorrentino who originally conceived of the business idea of organizing the Bank, and he spearheaded the efforts to organize the Bank in 2005. The loss of Mr. Sorrentino could have a material adverse effect on us, as he is central to virtually all aspects of our business operations and management. In addition, as a community bank, we have fewer management-level personnel who are in position to succeed and assume the responsibilities of Mr. Sorrentino.

17


 

Our lending limit may restrict our growth.

We are limited in the amount we can loan to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. Based upon our current capital levels, the amount we may lend is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our lending limit from doing business with us. We accommodate larger loans by selling participations in those loans to other financial institutions, but his strategy may not always be available.

We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.

We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results may be materially adversely affected.

Historically low interest rates may adversely affect our net interest income and profitability.

During the last seven years it has been the policy of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, yields on securities we have purchased, and to a lesser extent, market rates on the loans we have originated, have been at levels lower than were available prior to 2008. Consequently, the average yield on our interest-earning assets has decreased during the recent low interest rate environment. As a general matter, our interest-bearing liabilities re-price or mature more quickly than our interest-earning assets, which have contributed to increases in net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) in the short term. However, our ability to lower our interest expense is limited at these interest rate levels, while the average yield on our interest-earning assets may continue to decrease. The FRB has indicated its intention to maintain low interest rates for the foreseeable future, with no rate increases likely until at least the second half of 2015. Accordingly, our net interest income may decrease, which may have an adverse effect on our profitability. For information with respect to changes in interest rates, see “Risk Factors—Changes in interest rates may adversely affect or our earnings and financial condition.”

Anti-takeover provisions in our corporate documents and in New Jersey corporate law may make it difficult and expensive to remove current management.

Anti-takeover provisions in our corporate documents and in New Jersey law may render the removal of our existing board of directors and management more difficult. Consequently, it may be difficult and expensive for our stockholders to remove current management, even if current management is not performing adequately.

Competition from other financial institutions in originating loans and attracting deposits may adversely affect our profitability.

We face substantial competition in originating loans. This competition comes principally from other banks, savings institutions, mortgage banking companies, credit unions and other lenders. Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that we originate and the interest rates we may charge on these loans.

18


 

In attracting deposits, we face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations.

These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations, which may increase our cost of funds.

We also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, insurance companies and governmental organizations, which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our operations. As a result, such non-bank competitors may have advantages over us in providing certain products and services. This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our earnings and financial condition.

External factors, many of which we cannot control, may result in liquidity concerns for us.

Liquidity risk is the potential that the Bank may be unable to meet its obligations as they come due, capitalize on growth opportunities as they arise, or pay regular dividends because of an inability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances.

Liquidity is required to fund various obligations, including credit commitments to borrowers, mortgage and other loan originations, withdrawals by depositors, repayment of borrowings, operating expenses, capital expenditures and dividend payments to shareholders.

Liquidity is derived primarily from deposit growth and retention; principal and interest payments on loans; principal and interest payments on investment securities; sale, maturity and prepayment of investment securities; net cash provided from operations, and access to other funding sources. In addition, in recent periods we have substantially increased our use of alternate deposit origination channels, including brokered deposits and the use of internet listing services and reciprocal deposit services.

Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to market factors or an adverse regulatory action against us. In addition, our ability to use alternate deposit originations channels could be substantially impaired if we fail to remain “well capitalized”. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. The liquidity issues have been particularly acute for regional and community banks, as many of the larger financial institutions have significantly curtailed their lending to regional and community banks to reduce their exposure to the risks of other banks. In addition, many of the larger correspondent lenders have reduced or even eliminated federal funds lines for their correspondent customers. Furthermore, regional and community banks generally have less access to the capital markets than do the national and super-regional banks because of their smaller size and limited analyst coverage. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.

Declines in value may adversely impact our investment portfolio.

As of December 31, 2014, we had approximately $289.5 million in available for sale investment securities. We may be required to record impairment charges on our investment securities if they

19


 

suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information on investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio in future periods. If an impairment charge is significant enough, it could affect the ability of the Bank to upstream dividends to the Company, which could have a material adverse effect on our liquidity and our ability to pay dividends to shareholders and could also negatively impact our regulatory capital ratios.

The Bank’s ability to pay dividends is subject to regulatory limitations, which, to the extent that the Company requires such dividends in the future, may affect the Company’s ability to honor its obligations and pay dividends.

As a bank holding company, the Company is a separate legal entity from the Bank and its subsidiaries and does not have significant operations. We currently depend on the Bank’s cash and liquidity to pay our operating expenses and to fund dividends to shareholders. We cannot assure you that in the future the Bank will have the capacity to pay the necessary dividends and that we will not require dividends from the Bank to satisfy our obligations. Various statutes and regulations limit the availability of dividends from the Bank. It is possible, depending upon our and the Bank’s financial condition and other factors, that bank regulators could assert that payment of dividends or other payments by the Bank are an unsafe or unsound practice. In the event that the Bank is unable to pay dividends, we may not be able to service our obligations, as they become due, or pay dividends on our capital stock. Consequently, the inability to receive dividends from the Bank could adversely affect our financial condition, results of operations, cash flows and prospects.

In addition, as described under “Business—Supervision and Regulation—New Capital Rules,” beginning in 2016, banks and bank holding companies will be required to maintain a capital conservation buffer on top of minimum risk-weighted asset ratios. When fully phased in on January 1, 2019, the capital conservation buffer will be 2.5%. Banking institutions which do not maintain capital in excess of the capital conservation buffer will face constraints on the payment of dividends, equity repurchases and compensation based on the amount of the shortfall. Accordingly, if the Bank fails to maintain the applicable minimum capital ratios and the capital conservation buffer, distributions to the Company may be prohibited or limited.

We may incur impairment to goodwill.

We review our goodwill at least annually. Significant negative industry or economic trends, reduced estimates of future cash flows or disruptions to our business, could indicate that goodwill might be impaired. Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely on projections of future operating performance. We operate in a competitive environment and projections of future operating results and cash flows may vary significantly from actual results. Additionally, if our analysis results in an impairment to our goodwill, we would be required to record a non-cash charge to earnings in our financial statements during the period in which such impairment is determined to exist. Any such charge could have a material adverse effect on our results of operations and our stock price.

If we pursue acquisitions, we may heighten the risks to our operations and financial condition.

To the extent that we undertake acquisitions or new branch openings, we may experience the effects of higher operating expenses relative to operating income from the new operations, which may have a material adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business. To the extent that we grow through acquisitions and branch openings, we cannot assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses involve similar risks to those commonly associated with branching, but may also involve additional risks, including:

20


 

 

 

potential exposure to unknown or contingent liabilities of banks and businesses we acquire;

 

 

exposure to potential asset quality issues of the acquired bank or related business;

 

 

difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and

 

 

the possible loss of key employees and customers of the banks and businesses we acquire.

Attractive acquisition opportunities may not be available to us in the future.

We expect that other banking and financial service companies, many of which have significantly greater resources than us, will compete with us in acquiring other financial institutions if we pursue such acquisitions. This competition could increase prices for potential acquisitions that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators will consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and shareholders’ equity per share of our common stock.

Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.

Hurricanes and other weather events can disrupt our operations, result in damage to our properties and negatively affect the local economies in which we operate. In addition, these weather events may result in a decline in value or destruction of properties securing our loans and an increase in delinquencies, foreclosures and loan losses.

Risks Applicable to the Banking Industry Generally:

The financial services industry is undergoing a period of great volatility and disruption.

Beginning in mid-2007, there has been significant turmoil and volatility in global financial markets. Recent market uncertainty regarding the financial sector has increased. In addition to the impact on the economy generally, changes in interest rates, in the shape of the yield curve, or in valuations in the debt or equity markets or disruptions in the liquidity or other functioning of financial markets, all of which have been seen recently, could directly impact us in one or more of the following ways:

 

 

Net interest income, the difference between interest earned on our interest earning assets and interest paid on interest bearing liabilities, represents a significant portion of our earnings. Both increases and decreases in the interest rate environment may reduce our profits. We expect that we will continue to realize income from the spread between the interest we earn on loans, securities and other interest-earning assets, and the interest we pay on deposits, borrowings and other interest-bearing liabilities. The net interest spread is affected by the differences between the maturity and repricing characteristics of our interest-earning assets and interest-bearing liabilities. Our interest-earning assets may not reprice as slowly or rapidly as our interest-bearing liabilities.

 

 

The market value of our securities portfolio may decline and result in other than temporary impairment charges. The value of securities in our portfolio is affected by factors that impact the U.S. securities market in general as well as specific financial sector factors and entities. Recent uncertainty in the market regarding the financial sector has negatively impacted the value of securities within our portfolio. Further declines in these sectors may result in future other than temporary impairment charges.

 

 

Asset quality may deteriorate as borrowers become unable to repay their loans.

21


 

Our allowance for loan losses may not be adequate to cover actual losses.

Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and nonperformance. The process for determining the amount of the allowance is critical to our financial results and condition. It requires difficult, subjective and complex judgments about the future, including the impact of national and regional economic conditions on the ability of our borrowers to repay their loans. If our judgment proves to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio. Further, state and federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses and may require an increase in our allowance for loan losses.

At December 31, 2014, our allowance for loan losses as a percentage of total loans was 0.56% and as a percentage of total non-accrual loans was 122.0%. Although we believe that our allowance for loan losses is adequate to cover known and probable incurred losses included in the portfolio, we cannot assure you that we will not further increase the allowance for loan losses or that our regulators will not require us to increase this allowance. Either of these occurrences could adversely affect our earnings.

Changes in interest rates may adversely affect our earnings and financial condition.

Our net income depends primarily upon our net interest income. Net interest income is the difference between interest income earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and borrowed funds. The level of net interest income is primarily a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest- bearing liabilities which, in turn, are impacted by such external factors as the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board of Governors (the “FOMC”), and market interest rates.

A sustained increase in market interest rates could adversely affect our earnings if our cost of funds increases more rapidly than our yield on our earning assets, and compresses our net interest margin. In addition, the economic value of portfolio equity would decline if interest rates increase. For example, we estimate that as of December 31, 2014, a 200 basis point increase in interest rates would have resulted in our economic value of portfolio equity declining by approximately $62.7 million or 15.0%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity Analysis.”

Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience gaps in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could reduce our net interest income. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, deflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets.

We also attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate sensitive assets and interest rate sensitive liabilities. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect our results of operations and financial performance.

The banking business is subject to significant government regulations.

We are subject to extensive governmental supervision, regulation and control. These laws and regulations are subject to change, and may require substantial modifications to our operations or

22


 

may cause us to incur substantial additional compliance costs. In addition, future legislation and government policy could adversely affect the commercial banking industry and our operations. Such governing laws can be anticipated to continue to be the subject of future modification. Our management cannot predict what effect any such future modifications will have on our operations. In addition, the primary focus of Federal and state banking regulation is the protection of depositors and not the shareholders of the regulated institutions.

For example, the Dodd-Frank Act may result in substantial new compliance costs. The Dodd-Frank Act was signed into law on July 21, 2010. Generally, the Dodd-Frank Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law, many of which will not become effective until various Federal regulatory agencies have promulgated rules implementing the statutory provisions. Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact either on the financial services industry as a whole, or on our business, results of operations and financial condition.

The following aspects of the financial reform and consumer protection act are related to the operations of the Bank:

 

 

A new independent consumer financial protection bureau was established within the Federal Reserve, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. However, smaller financial institutions, like the Bank, are subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws.

 

 

The act also imposes new obligations on originators of residential mortgage loans, such as the Bank. Among other things, originators must make a reasonable and good faith determination based on documented information that a borrower has a reasonable ability to repay a particular mortgage loan over the long term. If the originator cannot meet this standard, the loan may be unenforceable in foreclosure proceedings. The act contains an exception from this ability to repay rule for “qualified mortgages”, which are deemed to satisfy the rule, but does not define the term, and left authority to the Consumer Financial Protection Bureau (“CFPB”) to adopt a definition. A rule issued by the CFPB in January 2013, and effective January 10, 2014, sets forth specific underwriting criteria for a loan to qualify as a Qualified Mortgage Loan. The criteria generally exclude loans that are interest- only, have excessive upfront points or fees, have negative amortization features or balloon payments, or have terms in excess of 30 years. The underwriting criteria also impose a maximum debt to income ratio of 43%. If a loan meets these criteria and is not a “higher priced loan” as defined in FRB regulations, the CFPB rule establishes a safe harbor preventing a consumer from asserting as a defense to foreclosure the failure of the originator to establish the consumer’s ability to repay. However, this defense will be available to a consumer for all other residential mortgage loans. Although the majority of residential mortgages historically originated by the Bank would qualify as Qualified Mortgage Loans, the Bank has also made, and may continue to make in the future, residential mortgage loans that will not qualify as Qualified Mortgage Loans. These loans may expose the Bank to greater losses, loan repurchase obligations, or litigation related expenses and delays in taking title to collateral real estate, if these loans do not perform and borrowers challenge whether the Bank satisfied the ability to repay rule on originating the loan.

 

 

Tier 1 capital treatment for “hybrid” capital items like trust preferred securities is eliminated subject to various grandfathering and transition rules.

 

 

The prohibition on payment of interest on demand deposits was repealed, effective July 21, 2011.

 

 

Deposit insurance is permanently increased to $250,000.

 

 

The deposit insurance assessment base calculation now equals the depository institution’s total assets minus the sum of its average tangible equity during the assessment period.

23


 

 

 

The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent of estimated annual insured deposits or assessment base; however, the FDIC is directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion.

In addition, 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. This regulation will require financial institutions to maintain higher capital levels and more equity capital.

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.

Our management is actively reviewing the provisions of the Dodd-Frank Act and Basel III, many of which are to be phased-in over the next several months and years, and assessing the probable impact on our operations. However, the ultimate effect of these changes on the financial services industry in general, and us in particular, is uncertain at this time.

The laws that regulate our operations are designed for the protection of depositors and the public, not our shareholders.

The federal and state laws and regulations applicable to our operations give regulatory authorities extensive discretion in connection with their supervisory and enforcement responsibilities, and generally have been promulgated to protect depositors and the Deposit Insurance Fund and not for the purpose of protecting shareholders. These laws and regulations can materially affect our future business. Laws and regulations now affecting us may be changed at any time, and the interpretation of such laws and regulations by bank regulatory authorities is also subject to change.

We can give no assurance that future changes in laws and regulations or changes in their interpretation will not adversely affect our business. Legislative and regulatory changes may increase our cost of doing business or otherwise adversely affect us and create competitive advantages for non-bank competitors.

The potential impact of changes in monetary policy and interest rates may negatively affect our operations.

Our operating results may be significantly affected (favorably or unfavorably) by market rates of interest that, in turn, are affected by prevailing economic conditions, by the fiscal and monetary policies of the United States government and by the policies of various regulatory agencies. Our earnings will depend significantly upon our interest rate spread (i.e., the difference between the interest rate earned on our loans and investments and the interest raid paid on our deposits and borrowings). Like many financial institutions, we may be subject to the risk of fluctuations in interest rates, which, if significant, may have a material adverse effect on our operations.

We cannot predict how changes in technology will impact our business; increased use of technology may expose us to service interruptions or breaches in security.

The financial services market, including banking services, is increasingly affected by advances in technology, including developments in:

 

 

Telecommunications;

24


 

 

 

Data processing;

 

 

Automation;

 

 

Internet-based banking, including personal computers, mobile phones and tablets;

 

 

Telephone banking;

 

 

Debit cards and so-called “smart cards”; and

 

 

Remote deposit capture.

Our ability to compete successfully in the future will depend, to a certain extent, on whether we can anticipate and respond to technological changes. We offer electronic banking services for our consumer and business customers via our website, www.cnob.com, including Internet banking and electronic bill payment, as well as mobile banking by phone. We also offer check cards, ATM cards, credit cards, and automatic and ACH transfers. The successful operation and further development of these and other new technologies will likely require additional capital investments in the future. In addition, increased use of electronic banking creates opportunities for interruptions in service or security breaches, which could expose us to claims by customers or other third parties. We cannot assure you that we will have sufficient resources or access to the necessary proprietary technology to remain competitive in the future, or that we will be able to maintain a secure electronic environment.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The Bank operates eight banking offices in Bergen County, NJ, consisting of one office each in Englewood Cliffs, Englewood, Cresskill, Fort Lee, Hackensack, Oakland, Ridgewood and Saddle River; nine banking offices in Union County, NJ, consisting of five offices in Union Township, and one office each in Springfield Township, Berkeley Heights, Vauxhall and Summit; three banking offices in Morris County, NJ, consisting of one office each in Boonton, Madison and Morristown; one office in Newark in Essex County, NJ; one office in West New York in Hudson County, NJ; one office in Princeton in Mercer County, NJ, and one office in Holmdel in Monmouth County, NJ. The Bank is also in the process of obtaining regulatory approvals to open a branch office in the borough of Manhattan in New York City. The Bank’s principal office is located at 301 Sylvan Avenue, Englewood Cliffs, NJ. The principal office is a three-story leased building constructed in 2008.

25


 

The following table sets forth certain information regarding the Bank’s leased locations.

 

 

 

Branch Location

 

Term

301 Sylvan Avenue, Englewood Cliffs, NJ

 

Term expires November 30, 2028; renewable at the Bank’s option

12 East Palisade Avenue, Englewood, NJ

 

Term expires July 31, 2022; renewable at the Bank’s option

1 Union Avenue, Cresskill, NJ

 

Term expires June 30, 2026; renewable at the Bank’s option

899 Palisade Avenue, Fort Lee, NJ

 

Term expires April 30, 2017; renewable at the Bank’s option

142 John Street, Hackensack, NJ

 

Term expires December 31, 2016; renewable at the Bank’s option

3 Allerman Road, Oakland, NJ

 

Term expires April 30, 2028; renewable at the Bank’s option

171 East Ridgewood Avenue, Ridgewood, NJ

 

Term expired December 31, 2013, on a month-to-month basis

71 East Allendale Road, Saddle River, NJ

 

Term expires May 31, 2032, unless terminated or extended by the Bank

356 Chestnut Street, Union, NJ

 

Term expires in 2028; renewable at the Bank’s option

Career Center Branch located in Union High School, Union, NJ

 

Term expires August 31, 2015

2933 Vauxhall Road, Vauxhall, NJ

 

Term expires January 31, 2020; renewable at the Bank’s option

104 Ely Place, Boonton, NJ

 

Term expires August 29, 2021; renewable at the Bank’s option

300 Main Street, Madison, NJ

 

Term expires May 31, 2016; renewable at the Bank’s option

545 Morris Avenue, Summit, NJ

 

Term expires January 31, 2024; renewable at the Bank’s option

217 Chestnut Street, Newark, NJ

 

Term expires February 28, 2019

5914 Park Avenue, West New York, NJ

 

Term expires September 30, 2018; renewable at the Bank’s option

344 Nassau Street, Princeton, NJ

 

Term expires May 31, 2016; renewable at the Bank’s option

963 Holmdel Road, Holmdel, NJ

 

Term expires July 31, 2021; renewable at the Bank’s option

The Bank operates a Drive In/Walk Up located at 2022 Stowe Street, Union, NJ.

The Bank executed a lease agreement with 551 Madison Property, LLC, with respect to certain premises located at 551 Madison Avenue, New York, NY.

On October 9, 2004, the Bank opened a 19,555 square foot office facility on Springfield Road in Union, NJ, which served as the Bank’s operations and data center until 2010. During the second quarter of 2010, the Bank entered into a lease of its former operations facility under a direct financing lease. The lease has a 15-year term with no renewal options. According to the terms of the lease, the lessee has an obligation to purchase the property underlying the lease in either year seven, ten or fifteen at predetermined prices for those years as provided in the lease. The structure of the minimum lease payments and the purchase prices as provided in the lease provide an inducement to the lessee to purchase the property in year seven.

26


 

Item 3. Legal Proceedings

There are no significant pending legal proceedings involving the Company other than those arising out of routine operations. None of these matters would have a material adverse effect on the Company or its results of operations if decided adversely to the Company.

Item 4. Mine Safety Disclosures

Not applicable.

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PART II

Item 5. Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities

Security Market Information

The common stock of the Company is traded on the NASDAQ Global Select Market under the symbol “CNOB”. As of December 31, 2014, the Company had 511 stockholders of record, excluding beneficial owners for whom CEDE & Company or others act as nominees. On December 31, 2014, the closing sale price was $19.00.

The following table sets forth the high and low closing sales price, and the dividends declared, on a share of the Company’s common stock for the years ended December 31, 2014 and 2013.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock Price

 

Common Dividends Declared

 

2014

 

2013

 

High

 

Low

 

High

 

Low

 

2014

 

2013

Fourth Quarter

 

 

$

 

19.15

 

 

 

$

 

18.86

 

 

 

$

 

19.67

 

 

 

$

 

13.96

 

 

 

$

 

0.075

 

 

 

$

 

0.075

 

Third Quarter

 

 

 

19.09

 

 

 

 

18.93

 

 

 

 

15.24

 

 

 

 

12.95

 

 

 

 

0.075

 

 

 

 

0.075

 

Second Quarter

 

 

 

19.38

 

 

 

 

18.93

 

 

 

 

13.23

 

 

 

 

11.50

 

 

 

 

0.075

 

 

 

 

0.075

 

First Quarter

 

 

 

19.11

 

 

 

 

18.73

 

 

 

 

12.82

 

 

 

 

11.62

 

 

 

 

0.075

 

 

 

 

0.055

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

$

 

0.300

 

 

 

$

 

0.280

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share Repurchase Program

Historically, repurchases have been made from time to time as, in the opinion of management, market conditions warranted, in the open market or in privately negotiated transactions. Shares repurchased were used for stock dividends and other issuances. No repurchases were made of the Company’s common stock during 2014 or 2013.

Dividends

Federal laws and regulations contain restrictions on the ability of the Parent Corporation and the Bank to pay dividends. For information regarding restrictions on dividends, see Part I, Item 1, “Business” and Part II, Item 8, “Financial Statements and Supplementary Data”, Note 19 of the Notes to Consolidated Financial Statements.”

Stockholders Return Comparison

Set forth on the following page is a line graph presentation comparing the cumulative stockholder return on the Parent Corporation’s common stock, on a dividend reinvested basis, against the cumulative total returns of the NASDAQ and the KBW Bank Index for the period from December 31, 2009 through December 31, 2014.

28


 

COMPARE 5-YEAR CUMULATIVE TOTAL RETURN
AMONG CONNECTONE BANCORP INC.,
NASDAQ AND KBW BANK INDEX

Assumes $100 invested on December 31, 2009
Assumes dividends reinvested
Year ended December 31, 2014

COMPARISON OF CUMULATIVE TOTAL RETURN OF ONE OR MORE
COMPANIES, PEER GROUPS, INDUSTRY INDEXES AND/OR BROAD MARKETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Company/Index/Market

 

Fiscal Year Ending

 

12/31/09

 

12/31/10

 

12/31/11

 

12/31/12

 

12/31/13

 

12/31/14

ConnectOne Bancorp, Inc.

 

 

 

100.00

 

 

 

 

92.76

 

 

 

 

112.61

 

 

 

 

135.57

 

 

 

 

223.85

 

 

 

 

230.45

 

NASDAQ

 

 

 

100.00

 

 

 

 

118.00

 

 

 

 

117.08

 

 

 

 

137.80

 

 

 

 

192.78

 

 

 

 

221.15

 

KBW Bank Index

 

 

 

100.00

 

 

 

 

123.27

 

 

 

 

94.87

 

 

 

 

125.84

 

 

 

 

172.91

 

 

 

 

188.88

 

29


 

Item 6. Selected Financial Data

The following tables set forth selected consolidated financial data as of the dates and for the periods presented. The selected consolidated statement of financial condition data as of December 31, 2014 and 2013 and the selected consolidated summary of income data for the years ended December 31, 2014, 2013 and 2012 have been derived from our audited consolidated financial statements and related notes that we have included elsewhere in this Annual Report. The selected consolidated statement of financial condition data as of December 31, 2012, 2011 and 2010 and the selected consolidated summary of income data for the years ended December 31, 2011 and 2010 have been derived from audited consolidated financial statements that are not presented in this Annual Report.

The selected historical consolidated financial data as of any date and for any period are not necessarily indicative of the results that may be achieved as of any future date or for any future period. You should read the following selected statistical and financial data in conjunction with the more detailed information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes that we have presented elsewhere in this Annual Report.

On July 1, 2014, the Merger was completed. See Note 4—Business Combinations of the Notes to the Consolidated Financial Statements.

30


 

SUMMARY OF SELECTED STATISTICAL INFORMATION AND FINANCIAL DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Years Ended December 31,

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

(Dollars in thousands, except share data)

SELECTED STATEMENT OF FINANCIAL CONDITION DATA

 

 

 

 

 

 

 

 

 

 

Total assets

 

 

$

 

3,448,572

 

 

 

$

 

1,673,082

 

 

 

$

 

1,629,082

 

 

 

$

 

1,432,738

 

 

 

$

 

1,207,385

 

Loans receivable

 

 

 

2,538,641

 

 

 

 

960,943

 

 

 

 

889,672

 

 

 

 

754,992

 

 

 

 

708,111

 

Allowance for loan losses

 

 

 

14,160

 

 

 

 

10,333

 

 

 

 

10,237

 

 

 

 

9,602

 

 

 

 

8,867

 

Securities—available for sale

 

 

 

289,532

 

 

 

 

323,070

 

 

 

 

496,815

 

 

 

 

414,507

 

 

 

 

378,080

 

Goodwill and other intangible assets

 

 

 

150,734

 

 

 

 

16,828

 

 

 

 

16,858

 

 

 

 

16,902

 

 

 

 

16,959

 

Borrowings

 

 

 

495,553

 

 

 

 

146,000

 

 

 

 

146,000

 

 

 

 

161,000

 

 

 

 

212,855

 

Deposits

 

 

 

2,475,607

 

 

 

 

1,342,005

 

 

 

 

1,306,922

 

 

 

 

1,121,415

 

 

 

 

860,332

 

Tangible common stockholders’ equity(1)

 

 

 

284,235

 

 

 

 

168,584

 

 

 

 

160,691

 

 

 

 

135,916

 

 

 

 

120,957

 

Total stockholders’ equity

 

 

 

446,219

 

 

 

 

168,584

 

 

 

 

160,691

 

 

 

 

135,916

 

 

 

 

120,957

 

Average total assets

 

 

 

2,520,524

 

 

 

 

1,633,270

 

 

 

 

1,538,473

 

 

 

 

1,321,262

 

 

 

 

1,184,482

 

Average common stockholders’ equity

 

 

 

301,004

 

 

 

 

153,775

 

 

 

 

138,464

 

 

 

 

119,363

 

 

 

 

101,477

 

Dividends

 

 

 

 

 

 

 

 

 

 

Cash dividends on common stock

 

 

$

 

6,940

 

 

 

$

 

4,254

 

 

 

$

 

2,778

 

 

 

$

 

1,955

 

 

 

$

 

1,800

 

Dividend payout ratio

 

 

 

37.60

%

 

 

 

 

21.50

%

 

 

 

 

16.13

%

 

 

 

 

14.92

%

 

 

 

 

28.02

%

 

Cash dividends per share

 

 

 

 

 

 

 

 

 

 

Cash dividends

 

 

$

 

0.300

 

 

 

$

 

0.280

 

 

 

$

 

0.195

 

 

 

$

 

0.120

 

 

 

$

 

0.120

 

SELECTED INCOME STATEMENT DATA

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

$

 

94,207

 

 

 

$

 

57,268

 

 

 

$

 

55,272

 

 

 

$

 

51,927

 

 

 

$

 

48,714

 

Interest expense

 

 

 

14,808

 

 

 

 

11,082

 

 

 

 

11,776

 

 

 

 

12,177

 

 

 

 

14,785

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

79,399

 

 

 

 

46,186

 

 

 

 

43,496

 

 

 

 

39,750

 

 

 

 

33,929

 

Provision for loan losses

 

 

 

4,683

 

 

 

 

350

 

 

 

 

325

 

 

 

 

2,448

 

 

 

 

5,076

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

 

 

 

74,716

 

 

 

 

45,836

 

 

 

 

43,171

 

 

 

 

37,302

 

 

 

 

28,853

 

Noninterest income

 

 

 

7,498

 

 

 

 

6,851

 

 

 

 

7,210

 

 

 

 

7,478

 

 

 

 

2,472

 

Noninterest expense

 

 

 

54,804

 

 

 

 

25,278

 

 

 

 

25,197

 

 

 

 

23,443

 

 

 

 

24,099

 

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

 

 

27,410

 

 

 

 

27,409

 

 

 

 

25,184

 

 

 

 

21,337

 

 

 

 

7,226

 

Income tax expense

 

 

 

8,845

 

 

 

 

7,484

 

 

 

 

7,677

 

 

 

 

7,411

 

 

 

 

222

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

$

 

18,565

 

 

 

$

 

19,925

 

 

 

$

 

17,507

 

 

 

$

 

13,926

 

 

 

$

 

7,004

 

 

 

 

 

 

 

 

 

 

 

 

Net income available to common stockholders

 

 

$

 

18,453

 

 

 

$

 

19,784

 

 

 

$

 

17,226

 

 

 

$

 

13,106

 

 

 

$

 

6,423

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

 

These measures are not measures recognized under generally accepted accounting principles in the United States (“GAAP”), and are therefore considered to be non-GAAP financial measures. See—“Non-GAAP Financial Measures” for a reconciliation of these measurers to their most comparable GAAP measures.

31


 

 

 

 

 

 

 

 

 

 

 

 

 

 

At or for the Years Ended December 31,

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

(Dollars in thousands, except share data)

PER COMMON SHARE DATA

 

 

 

 

 

 

 

 

 

 

Basic

 

 

$

 

0.80

 

 

 

$

 

1.21

 

 

 

$

 

1.05

 

 

 

$

 

0.80

 

 

 

$

 

0.43

 

Diluted

 

 

 

0.79

 

 

 

 

1.21

 

 

 

 

1.05

 

 

 

 

0.80

 

 

 

 

0.43

 

Book value per common share

 

 

 

14.65

 

 

 

 

9.61

 

 

 

 

9.14

 

 

 

 

7.63

 

 

 

 

6.83

 

Tangible book value per common share(1)

 

 

 

9.57

 

 

 

 

8.58

 

 

 

 

8.11

 

 

 

 

6.60

 

 

 

 

5.79

 

Basic

 

 

 

23,029,813

 

 

 

 

16,349,204

 

 

 

 

16,340,197

 

 

 

 

16,295,761

 

 

 

 

15,025,870

 

Diluted

 

 

 

23,479,074

 

 

 

 

16,385,692

 

 

 

 

16,351,046

 

 

 

 

16,314,899

 

 

 

 

15,027,159

 

SELECTED PERFORMANCE RATIOS

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

 

 

0.74

%

 

 

 

 

1.22

%

 

 

 

 

1.14

%

 

 

 

 

1.05

%

 

 

 

 

0.59

%

 

Return on average common stockholders’ equity

 

 

 

6.13

%

 

 

 

 

12.87

%

 

 

 

 

12.44

%

 

 

 

 

10.98

%

 

 

 

 

6.33

%

 

Net interest margin

 

 

 

3.57

%

 

 

 

 

3.30

%

 

 

 

 

3.32

%

 

 

 

 

3.53

%

 

 

 

 

3.30

%

 

SELECTED ASSET QUALITY RATIOS

 

 

 

 

 

 

 

 

 

 

Nonaccrual loans to loans receivable

 

 

 

0.46

%

 

 

 

 

0.33

%

 

 

 

 

0.41

%

 

 

 

 

0.91

%

 

 

 

 

1.58

%

 

Nonaccrual loans and loans past due 90 days and still accruing

 

 

 

0.50

%

 

 

 

 

0.33

%

 

 

 

 

0.41

%

 

 

 

 

1.05

%

 

 

 

 

1.68

%

 

Nonperforming assets(2) to total assets

 

 

 

0.37

%

 

 

 

 

0.20

%

 

 

 

 

0.30

%

 

 

 

 

0.52

%

 

 

 

 

0.93

%

 

Allowance for loan losses to loans receivable

 

 

 

0.56

%

 

 

 

 

1.08

%

 

 

 

 

1.15

%

 

 

 

 

1.27

%

 

 

 

 

1.25

%

 

Allowance for loan losses to nonaccrual loans

 

 

 

122.0

%

 

 

 

 

329.4

%

 

 

 

 

283.1

%

 

 

 

 

139.7

%

 

 

 

 

79.4

%

 

Net loan charge-offs (recoveries) to average loans

 

 

 

0.05

%

 

 

 

 

0.03

%

 

 

 

 

(0.04

)%

 

 

 

 

0.24

%

 

 

 

 

0.69

%

 

CAPITAL RATIOS

 

 

 

 

 

 

 

 

 

 

Leverage ratio

 

 

 

9.37

%

 

 

 

 

9.69

%

 

 

 

 

9.02

%

 

 

 

 

9.29

%

 

 

 

 

9.90

%

 

Risk-based Tier 1 capital ratio

 

 

 

10.44

%

 

 

 

 

12.10

%

 

 

 

 

11.39

%

 

 

 

 

12.00

%

 

 

 

 

13.28

%

 

Risk-based total capital ratio

 

 

 

10.94

%

 

 

 

 

12.90

%

 

 

 

 

12.22

%

 

 

 

 

12.89

%

 

 

 

 

14.29

%

 

Tangible common equity to tangible assets(1)

 

 

 

8.62

%

 

 

 

 

8.48

%

 

 

 

 

8.22

%

 

 

 

 

7.61

%

 

 

 

 

7.92

%

 

 

 

(1)

 

These measures are not measures recognized under generally accepted accounting principles in the United States (“GAAP”), and are therefore considered to be non-GAAP financial measures. See—“Non-GAAP Financial Measures” for a reconciliation of these measurers to their most comparable GAAP measures.

 

(2)

 

Nonperforming assets are defined as nonaccrual loans plus other real estate owned.

32


 

Notes to Selected Financial Data

 

 

 

 

 

 

 

 

 

 

 

 

 

As of the year ended December 31,

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

(Dollars in thousands, except per share data)

Tangible common equity and tangible common equity/tangible assets

 

 

 

 

 

 

 

 

 

 

Common stockholders’ equity

 

 

$

 

434,969

 

 

 

$

 

157,334

 

 

 

$

 

149,441

 

 

 

$

 

124,666

 

 

 

$

 

111,257

 

Less: goodwill and other intangible assets

 

 

 

150,734

 

 

 

 

16,828

 

 

 

 

16,858

 

 

 

 

16,902

 

 

 

 

16,959

 

 

 

 

 

 

 

 

 

 

 

 

Tangible common stockholders’ equity

 

 

$

 

284,235

 

 

 

$

 

140,506

 

 

 

$

 

132,583

 

 

 

$

 

107,764

 

 

 

$

 

94,298

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

 

$

 

3,448,572

 

 

 

$

 

1,673,082

 

 

 

$

 

1,629,765

 

 

 

$

 

1,432,738

 

 

 

$

 

1,207,385

 

Less: goodwill and other intangible assets

 

 

 

150,734

 

 

 

 

16,828

 

 

 

 

16,858

 

 

 

 

16,902

 

 

 

 

16,959

 

 

 

 

 

 

 

 

 

 

 

 

Tangible assets

 

 

$

 

3,297,838

 

 

 

$

 

1,656,254

 

 

 

$

 

1,612,907

 

 

 

$

 

1,415,836

 

 

 

$

 

1,190,426

 

 

 

 

 

 

 

 

 

 

 

 

Tangible common equity ratio

 

 

 

8.62

%

 

 

 

 

8.48

%

 

 

 

 

8.22

%

 

 

 

 

7.61

%

 

 

 

 

7.92

%

 

Tangible book value per common share

 

 

 

 

 

 

 

 

 

 

Book value per common share

 

 

$

 

14.65

 

 

 

$

 

9.61

 

 

 

$

 

9.14

 

 

 

$

 

7.63

 

 

 

$

 

6.83

 

Less: goodwill and other intangible assets

 

 

 

5.08

 

 

 

 

1.03

 

 

 

 

1.03

 

 

 

 

1.03

 

 

 

 

1.04

 

 

 

 

 

 

 

 

 

 

 

 

Tangible book value per common share

 

 

$

 

9.57

 

 

 

$

 

8.58

 

 

 

$

 

8.11

 

 

 

$

 

6.60

 

 

 

$

 

5.79

 

 

 

 

 

 

 

 

 

 

 

 

33


 

Item 7. Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Company’s results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document.

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

See Item 1 of this Annual Report on Form 10-K for information regarding forward-looking statements.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on 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 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.

BUSINESS COMBINATIONS

The Company accounts for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that we believe to be reasonable, and whenever necessary, include assistance from independent third-party appraisal and valuation firms.

ALLOWANCE FOR LOAN LOSSES AND RELATED PROVISION

The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Company’s Consolidated Statements of Condition.

The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.

The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb loan losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes

34


 

in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect our borrowers’ ability to pay. The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. 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. All of the factors considered in the analysis of the adequacy of the allowance for loan losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods. Additional information can be found in Note 1 of the Notes to Consolidated Financial Statements.

INCOME TAXES

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s consolidated financial statements or tax returns.

Fluctuations in the actual outcome of these future tax consequences could impact the Company’s consolidated financial condition or results of operations. Notes 1 (under the caption “Use of Estimates”) and 12 of the Notes to Consolidated Financial Statements include additional discussion on the accounting for income taxes.

GOODWILL

The Company has adopted the provisions of FASB ASC 350-10-05, which requires that goodwill be reported separate from other intangible assets in the Consolidated Statements of Condition and not be amortized but tested for impairment annually or more frequently if impairment indicators arise for impairment. No impairment charge was deemed necessary for the years ended December 31, 2014, 2013 and 2012.

FAIR VALUE OF INVESTMENT SECURITIES

The Company relies upon the guidance in FASB ASC 820-10-65 when determining fair value for the Company’s pooled trust preferred securities and private issue corporate bond. See Note 21 of the Notes to Consolidated Financial Statements, Fair Value Measurements and Fair Value of Financial Instruments, for further discussion.

Overview and Strategy

We serve as a holding company for the Bank, which is our primary asset and only operating subsidiary. We follow a business plan that emphasizes the delivery of customized banking services in our market area to customers who desire a high level of personalized service and responsiveness. The Bank conducts a traditional banking business, making commercial loans, consumer loans and residential and commercial real estate loans. In addition, the Bank offers various non-deposit products through non-proprietary relationships with third party vendors. The Bank relies upon deposits as the primary funding source for its assets. The Bank offers traditional deposit products.

Many of our customer relationships start with referrals from existing customers. We then seek to cross sell our products to customers to grow the customer relationship. For example, we will frequently offer an interest rate concession on credit products for customers that maintain a non-interest bearing deposit account at the Bank. This strategy has lowered our funding costs and helped slow the growth of our interest expense even as we have substantially increased our total deposits. It has also helped fuel our significant loan growth. We believe that the Bank’s significant growth and increasing profitability demonstrate the need for and success of our brand of banking.

35


 

Our results of operations depend primarily on our net interest income, which is the difference between the interest earned on our interest-earning assets and the interest paid on funds borrowed to support those assets, primarily deposits. Net interest margin is the difference between the weighted average rate received on interest-earning assets and the weighted average rate paid to fund those interest-earning assets, which is also affected by the average level of interest-earning assets as compared with that of interest-bearing liabilities. Net income is also affected by the amount of non-interest income and non-interest expenses.

General

The following discussion and analysis presents the more significant factors affecting the Company’s financial condition as of December 31, 2014 and 2013 and results of operations for each of the years in the three-year period ended December 31, 2013. The Merger was effective July 1, 2014, which significantly impacts comparisons to earlier periods. The MD&A should be read in conjunction with the consolidated financial statements, notes to consolidated financial statements and other information contained in this report. On July 1, 2014, the combined company changed its name to ConnectOne.

Operating Results Overview

Net income for the year ended December 31, 2014 was $18.6 million, a decrease of $1.4 million, or 6.8%, compared to net income of $19.9 million for 2013. Net income available to common shareholders for the year ended December 31, 2014 was $18.5 million, a decrease of $1.3 million, or 6.7%, compared to net income available to common shareholders of $19.8 million for 2013. Diluted earnings per share were $0.79 for 2014, a 34.7% decrease from $1.21 for 2013.

The decrease in net income from 2013 to 2014 was attributable to the following:

 

 

Increased net interest income of $33.2 million primarily due to the impact of the Merger and including net favorable purchase accounting adjustments of $5.3 million,

 

 

A higher loan loss provision of $4.3 million largely due to organic loan growth during 2014, the maturity and extension of acquired portfolio loans during the second half of 2014 and an increase in net loan charge-offs,

 

 

A $29.5 million increase in non-interest expense principally due to the impact of the Merger (including direct merger charges of $12.4 million), a $4.6 million loss on the extinguishment of debt and a $2.4 million charge on a fraudulent wire transfer, and

 

 

Increased income tax expense of $1.4 million resulting from nondeductible merger-related expenses incurred in 2014.

Net income for the year ended December 31, 2013 was $19.9 million, an increase of $2.4 million, or 13.8%, compared to net income of $17.5 million for 2012. Net income available to common shareholders for the year ended December 31, 2013 was $19.8 million, an increase of $2.6 million, or 14.9%, compared to net income available to common shareholders of $17.2 million for 2012. Diluted earnings per share were $1.21 for 2013, a 13.2% increase from $1.05 for 2012.

The increase in net income from 2012 to 2013 was resulted primarily from increased net interest income, which grew $2.7 million to $46.2 million in 2013.

Net Interest Income

Fully taxable equivalent net interest income for 2014 totaled $81.8 million, an increase of $33.1 million, or 67.9%, from 2013. The increase in net interest income was due to an increase in average interest-earning assets, which grew by 54.9% to $2.3 billion principally as a result of the Merger, as well as a 27 basis-point widening of the net interest margin to 3.57% due to net accretion of purchase accounting fair value adjustments recognized on acquired loans, securities, time deposits and borrowings and a reduction in the average rate paid on borrowings resulting from a $70 million debt extinguishment and subsequent refinancing accomplished at the end of the third quarter of 2014. Average total loans increased by 86.7% to $1.7 billion in 2014 from $908.8 million in 2013.

36


 

Fully taxable equivalent net interest income for 2013 totaled $48.7 million, an increase of $3.3 million, or 7.3%, from 2012. The increase in net interest income was primarily due to an increase in average interest-earning assets, principally loans, which increased by 11.4% to $908.8 million in 2013 from $815.5 million in 2012 partially offset by a two basis-point decline in the net interest margin to 3.30% in 2013.

Average Balance Sheets

The following table sets forth certain information relating to our average assets and liabilities for the years ended December 31, 2014, 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Tax-Equivalent Basis)

 

Years Ended December 31,

 

2014

 

2013

 

2012

 

Average
Balance

 

Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Income/
Expense

 

Yield/
Rate

 

 

(Dollars in Thousands)

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities(1)(2)

 

 

$

 

508,024

 

 

 

$

 

18,148

 

 

 

 

3.57

%

 

 

 

$

 

559,454

 

 

 

$

 

19,108

 

 

 

 

3.42

%

 

 

 

$

 

541,339

 

 

 

$

 

17,780

 

 

 

 

3.28

%

 

Loans receivable(2)(3)(4)

 

 

 

1,696,977

 

 

 

 

77,669

 

 

 

 

4.58

%

 

 

 

 

908,784

 

 

 

 

40,281

 

 

 

 

4.43

%

 

 

 

 

815,501

 

 

 

 

38,921

 

 

 

 

4.77

%

 

Restricted investment in bank stocks

 

 

 

14,946

 

 

 

 

636

 

 

 

 

4.26

%

 

 

 

 

8,983

 

 

 

 

407

 

 

 

 

4.53

%

 

 

 

 

9,120

 

 

 

 

452

 

 

 

 

4.96

%

 

Federal funds sold and interest-earnings deposits with banks

 

 

 

68,152

 

 

 

 

138

 

 

 

 

0.20

%

 

 

 

 

351

 

 

 

 

2

 

 

 

 

0.57

%

 

 

 

 

2,766

 

 

 

 

8

 

 

 

 

0.29

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

 

 

2,288,099

 

 

 

 

96,591

 

 

 

 

4.22

%

 

 

 

 

1,477,572

 

 

 

 

59,798

 

 

 

 

4.05

%

 

 

 

 

1,368,726

 

 

 

 

57,161

 

 

 

 

4.18

%

 

Noninterest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

 

(14,267

)

 

 

 

 

 

 

 

 

(10,235

)

 

 

 

 

 

 

 

 

(9,972

)

 

 

 

 

 

Non-interest earning assets

 

 

 

246,692

 

 

 

 

 

 

 

 

165,933

 

 

 

 

 

 

 

 

179,719

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

 

$

 

2,520,524

 

 

 

 

 

 

 

$

 

1,633,270

 

 

 

 

 

 

 

$

 

1,538,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES & STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, NOW, money market, interest checking

 

 

$

 

1,121,148

 

 

 

 

4,152

 

 

 

 

0.37

%

 

 

 

$

 

895,532

 

 

 

 

3,637

 

 

 

 

0.41

%

 

 

 

$

 

842,515

 

 

 

 

3,507

 

 

 

 

0.42

%

 

Time deposits

 

 

 

424,603

 

 

 

 

4,108

 

 

 

 

0.97

%

 

 

 

 

172,444

 

 

 

 

1,582

 

 

 

 

0.92

%

 

 

 

 

189,060

 

 

 

 

1,901

 

 

 

 

1.01

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing deposits

 

 

 

1,545,751

 

 

 

 

8,260

 

 

 

 

0.53

%

 

 

 

 

1,067,976

 

 

 

 

5,219

 

 

 

 

0.49

%

 

 

 

 

1,031,575

 

 

 

 

5,408

 

 

 

 

0.52

%

 

Borrowings

 

 

 

288,798

 

 

 

 

6,301

 

 

 

 

2.18

%

 

 

 

 

146,425

 

 

 

 

5,705

 

 

 

 

3.90

%

 

 

 

 

156,905

 

 

 

 

6,200

 

 

 

 

3.95

%

 

Subordinated debentures

 

 

 

5,155

 

 

 

 

156

 

 

 

 

3.03

%

 

 

 

 

5,155

 

 

 

 

158

 

 

 

 

3.06

%

 

 

 

 

5,155

 

 

 

 

168

 

 

 

 

3.26

%

 

Capital lease obligation

 

 

 

1,528

 

 

 

 

91

 

 

 

 

5.96

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing liabilities

 

 

 

1,841,232

 

 

 

 

14,808

 

 

 

 

0.80

%

 

 

 

 

1,219,556

 

 

 

 

11,082

 

 

 

 

0.91

%

 

 

 

 

1,193,635

 

 

 

 

11,776

 

 

 

 

0.99

%

 

Noninterest bearing deposits

 

 

 

350,310

 

 

 

 

 

 

 

 

233,835

 

 

 

 

 

 

 

 

182,642

 

 

 

 

 

Other liabilities

 

 

 

16,728

 

 

 

 

 

 

 

 

14,854

 

 

 

 

 

 

 

 

12,482

 

 

 

 

 

Stockholders’ equity

 

 

 

312,254

 

 

 

 

 

 

 

 

165,025

 

 

 

 

 

 

 

 

149,714

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

 

$

 

2,520,524

 

 

 

 

 

 

 

$

 

1,633,270

 

 

 

 

 

 

 

$

 

1,538,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income/interest rate spread(5)

 

 

 

 

$

 

81,783

 

 

 

 

3.42

%

 

 

 

 

 

$

 

48,716

 

 

 

 

3.14

%

 

 

 

 

 

$

 

45,385

 

 

 

 

3.19

%

 

Tax-equivalent adjustment

 

 

 

 

 

(2,384

)

 

 

 

 

 

 

 

 

(2,530

)

 

 

 

 

 

 

 

 

(1,889

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income as reported

 

 

 

 

$

 

79,399

 

 

 

 

 

 

 

$

 

46,186

 

 

 

 

 

 

 

$

 

43,496

 

 

 

Net interest margin(6)

 

 

 

 

 

 

 

3.57

%

 

 

 

 

 

 

 

 

3.30

%

 

 

 

 

 

 

 

 

3.32

%

 

 

 

(1)

 

Average balances for available-for-sale securities are based on amortized cost.

37


 

 

(2)

 

Interest income is presented on a tax equivalent basis using 35% Federal tax rate.

 

(3)

 

Includes loan fee income.

 

(4)

 

Loans receivable include nonaccrual loans.

 

(5)

 

Represents difference between the average yield on interest earnings assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.

 

(6)

 

Represents net interest income on a fully taxable equivalent basis divided by average total interest-earning assets.

Rate/Volume Analysis

The following table presents, by category, the major factors that contributed to the changes in net interest income. Changes due to both volume and rate have been allocated in proportion to the relationship of the dollar amount change in each.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2014/2013
Increase (Decrease)
Due to Change in:

 

2013/2012
Increase (Decrease)
Due to Change in:

 

Average
Volume

 

Average
Rate

 

Net
Change

 

Average
Volume

 

Average
Rate

 

Net
Change

 

 

(Dollars in Thousands)

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities:

 

 

$

 

(1,918

)

 

 

 

$

 

958

 

 

 

$

 

(960

)

 

 

 

$

 

1,224

 

 

 

$

 

104

 

 

 

$

 

1,328

 

Loans receivable

 

 

 

36,034

 

 

 

 

1,354

 

 

 

 

37,388

 

 

 

 

4,320

 

 

 

 

(2,960

)

 

 

 

 

1,360

 

Restricted investment in bank stocks

 

 

 

252

 

 

 

 

(23

)

 

 

 

 

229

 

 

 

 

(7

)

 

 

 

 

(38

)

 

 

 

 

(45

)

 

Federal funds sold and interest-earnings deposits with banks

 

 

 

136

 

 

 

 

 

 

 

 

136

 

 

 

 

(6

)

 

 

 

 

 

 

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

 

$

 

34,504

 

 

 

$

 

2,289

 

 

 

$

 

36,793

 

 

 

$

 

5,531

 

 

 

$

 

(2,894

)

 

 

 

$

 

2,637

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

Savings, NOW, money market, interest checking

 

 

$

 

792

 

 

 

$

 

(277

)

 

 

 

$

 

515

 

 

 

$

 

231

 

 

 

$

 

(101

)

 

 

 

$

 

130

 

Time deposits

 

 

 

2,435

 

 

 

 

91

 

 

 

 

2,526

 

 

 

 

(160

)

 

 

 

 

(159

)

 

 

 

 

(319

)

 

Borrowings and subordinated debentures

 

 

 

1,089

 

 

 

 

(495

)

 

 

 

 

594

 

 

 

 

(409

)

 

 

 

 

(96

)

 

 

 

 

(505

)

 

Capital lease obligation

 

 

 

91

 

 

 

 

 

 

 

 

91

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest expense

 

 

$

 

4,407

 

 

 

$

 

(681

)

 

 

 

$

 

3,726

 

 

 

$

 

(338

)

 

 

 

$

 

(356

)

 

 

 

 

(694

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in net interest income

 

 

$

 

30,097

 

 

 

$

 

2,970

 

 

 

 

33,067

 

 

 

$

 

5,869

 

 

 

$

 

(2,538

)

 

 

 

$

 

3,331

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

For the year ended December 31, 2014, the provision for loan losses was $4.7 million, an increase of $4.3 million, compared to the provision for loan losses of $0.4 million for the same period in 2013. This increase resulted from organic loan growth during 2014, the maturity and extension of acquired portfolio loans during the second half of 2014 and an increase in net loan charge-offs.

For the year ended December 31, 2013, the provision for loan losses was $350,000, an increase of $25,000, compared to the provision for loan losses of $325,000 for the same period in 2012. The provision remained relatively flat reflective of the low level of net loan charge-offs and a decline in nonaccrual loans during 2013.

38


 

Noninterest Income

Noninterest income for the full-year 2014 increased by $0.6 million, or 9.4% to $7.5 million from $6.9 million in 2013. The increase was primarily the result of higher net investment securities gains, increasing by $1.1 million to $2.8 million for the year ended December 31, 2014 from $1.7 million for the year ended December 31, 2013, partially offset by a slight decline in deposit, loan and other income of $0.2 million to $2.8 million and a decline in annuity and insurance commissions of $0.1 million to $0.4 million for the year ended December 31, 2014.

The decline in fee income was the result of the Company de-emphasizing service charges, focusing instead on customer growth and retention. This strategy was particularly important during the Merger conversion process as the implementation of certain fees and other charges were intentionally delayed or waived.

For the year 2013, noninterest income decreased $0.4 million compared to the same period in 2012, primarily as a result of lower net securities gains of $0.3 million and $0.9 million related to a bargain gain on Saddle River acquisition in 2012, offset in part by increased service charges, commissions and fees on deposit accounts, annuity and insurance commissions, bank owned life insurance and loan related fees.

Noninterest Expense

Noninterest expenses for the full-year 2014 increased by $29.5 million, or 116.8% to $54.8 million from $25.3 million in 2013. The increase was primarily due to the impact of the Merger, including merger-related charges of $12.4 million. In addition, at the end of the third quarter of 2014, the Company repurchased $70.0 million of putable Federal Home Loan Bank advances which resulted in a loss on debt extinguishment of $4.6 million. The repurchase is expected to reduce interest expense and improve the Bank’s interest rate risk profile in future periods.

Noninterest expenses were largely unchanged in 2013 from 2012, increasing 0.3%. Excluding the repurchase agreement prepayment and termination fee and merger-related expenses recognized in 2012, noninterest expenses increased $1.6 million or 6.6%, primarily related to a growth in salaries and employee benefits, occupancy and equipment expense and advertising and promotion expense resulting from the operation of the Saddle River, Oakland and Englewood branches for all of 2013.

Income Taxes

Income tax expense was $8.8 million for the full-year 2014 compared to $7.5 million for the full-year 2013 and $7.7 million for the full-year 2012. The effective tax rates were 32.3% for 2014, 27.3% for 2013 and 30.5% for 2012. The increased effective tax rate in 2014 from 2013 resulted from nondeductible merger-related expenses incurred in 2014 as well as an increase in income subject to state taxes, while the decline in the effective tax rate in 2013 from 2012 was largely due to higher levels of tax-exempt income and lower income subject to state taxes.

For a more detailed description of income taxes see Note 12 of the Notes to Consolidated Financial Statements.

Financial Condition Overview

At December 31, 2014, the statement of financial condition reflected the Merger. The Company’s total assets were $3.4 billion, an increase of $1.8 billion from December 31, 2013. Loans were $2.5 billion, an increase of $1.6 billion from December 31, 2013. Deposits were $2.5 billion, an increase of $1.1 billion from December 31, 2013.

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 Bergen, Union, Morris, Essex, Hudson, Mercer and Monmouth counties, New Jersey. The Bank has not made loans to borrowers outside of the United States. The Bank

39


 

believes that its strategy of high-quality customer service, competitive rate structures and selective marketing have enabled it to gain market share.

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.

During 2014 and 2013, loan portfolio growth was positively impacted in several ways including (i) an increase in demand for small business lines of credit, and business term loans as economic conditions have stabilized and begun to improve, (ii) industry consolidation and lending restrictions involving larger competitors allowing the Bank to gain market share, (iii) an increase in refinancing strategies employed by borrowers during the current low rate environment, and (iv) the Bank’s success in attracting highly experienced commercial loan officers with substantial local market knowledge.

Gross loans at December 31, 2014 totaled $2.5 billion, an increase of $1.6 billion, or 164.4%, over gross loans at December 31, 2013 of $960.6 million. The increase in gross loans was mostly attributed to the Merger, as Legacy ConnectOne loans totaled $1.3 billion at acquisition. The remaing increase was the result of organic loan growth of $0.3 million. The largest component of our loan portfolio at December 31, 2014 and December 31, 2013 was commercial real estate loans. Our commercial real estate loans at December 31, 2014 were $1.6 billion, an increase of $1.1 billion, or 204.6%, over commercial real estate loans at December 31, 2013 of $536.5 million. Our commercial loans were $499.8 million at December 31, 2014, an increase of $270.1 million, or 117.6%, over commercial loans at December 31, 2013 of $229.7 million. Our commercial construction loans at December 31, 2014 were $167.4 million, an increase of $124.6 million, or 291.7%, over commercial construction loans at December 31, 2013 of $42.7 million. Our residential real estate loans were $234.7 million at December 31, 2014, an increase of $84.1 million, or 55.9%, over residential real estate loans at December 31, 2013 of $150.6 million. Our consumer loans at December 31, 2014 were $2.9 million, an increase of $1.8 million, 165.6%, over consumer loans of $1.1 million at December 31, 2013. The growth in our loan portfolio reflects the success of our business strategy, in particular emphasizing high-quality customer service strategy, which has led to continued customer referrals.

The following table sets forth the classification of our loans by loan portfolio class as of December 31, 2014, 2013, 2012, 2011 and 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

(Dollars in Thousands)

Commercial

 

 

$

 

499,816

 

 

 

$

 

229,688

 

 

 

$

 

181,682

 

 

 

$

 

146,711

 

 

 

$

 

121,043

 

Commercial real estate

 

 

 

1,634,510

 

 

 

 

536,539

 

 

 

 

497,392

 

 

 

 

408,164

 

 

 

 

371,983

 

Commercial construction

 

 

 

167,359

 

 

 

 

42,722

 

 

 

 

40,277

 

 

 

 

39,388

 

 

 

 

49,467

 

Residential real estate

 

 

 

234,967

 

 

 

 

150,571

 

 

 

 

169,094

 

 

 

 

159,753

 

 

 

 

164,847

 

Consumer

 

 

 

2,879

 

 

 

 

1,084

 

 

 

 

1,104

 

 

 

 

959

 

 

 

 

513

 

 

 

 

 

 

 

 

 

 

 

 

Gross loans

 

 

 

2,539,531

 

 

 

 

960,604

 

 

 

 

889,549

 

 

 

 

754,975

 

 

 

 

707,853

 

Net deferred loan (income) costs

 

 

 

(890

)

 

 

 

 

339

 

 

 

 

123

 

 

 

 

17

 

 

 

 

258

 

 

 

 

 

 

 

 

 

 

 

 

Total loans

 

 

 

2,538,641

 

 

 

 

960,943

 

 

 

 

889,672

 

 

 

 

754,992

 

 

 

 

708,111

 

Less: allowance for loan losses

 

 

 

14,160

 

 

 

 

10,333

 

 

 

 

10,237

 

 

 

 

9,602

 

 

 

 

8,867

 

 

 

 

 

 

 

 

 

 

 

 

Net loans

 

 

$

 

2,524,481

 

 

 

$

 

950,610

 

 

 

$

 

879,435

 

 

 

$

 

745,390

 

 

 

$

 

699,244

 

 

 

 

 

 

 

 

 

 

 

 

40


 

The following table sets forth the classification of our loans by loan portfolio class and by fixed and adjustable rate loans as of December 31, 2014 and 2013 in term of contractual maturity.

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2014, Maturing

 

In
One Year
or Less

 

After
One Year
through
Five Years

 

After
Five Years

 

Total

 

 

(Dollars in Thousands)

Commercial

 

 

$

 

212,548

 

 

 

$

 

213,491

 

 

 

$

 

73,776

 

 

 

$

 

499,815

 

Commercial real estate

 

 

 

112,705

 

 

 

 

283,242

 

 

 

 

1,238,563

 

 

 

 

1,634,510

 

Commercial construction

 

 

 

116,035

 

 

 

 

43,824

 

 

 

 

7,500

 

 

 

 

167,359

 

Residential real estate

 

 

 

4,922

 

 

 

 

47,100

 

 

 

 

182,945

 

 

 

 

234,967

 

Consumer

 

 

 

689

 

 

 

 

1,450

 

 

 

 

741

 

 

 

 

2,880

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

446,899

 

 

 

$

 

589,107

 

 

 

$

 

1,503,525

 

 

 

$

 

2,539,531

 

 

 

 

 

 

 

 

 

 

Loans with:

 

 

 

 

 

 

 

 

Fixed rates

 

 

$

 

134,524

 

 

 

$

 

352,660

 

 

 

$

 

385,996

 

 

 

$

 

873,180

 

Variable rates

 

 

 

312,375

 

 

 

 

236,447

 

 

 

 

1,117,529

 

 

 

 

1,666,351

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

446,899

 

 

 

$

 

589,107

 

 

 

$

 

1,503,525

 

 

 

$

 

2,539,531

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2013, Maturing

 

In
One Year
or Less

 

After
One Year
through
Five Years

 

After
Five Years

 

Total

 

 

(Dollars in Thousands)

Commercial and industrial

 

 

$

 

121,628

 

 

 

$

 

52,219

 

 

 

$

 

55,841

 

 

 

$

 

229,688

 

Commercial real estate

 

 

 

22,910

 

 

 

 

108,786

 

 

 

 

404,843

 

 

 

 

536,539

 

Construction

 

 

 

31,994

 

 

 

 

10,728

 

 

 

 

 

 

 

 

42,722

 

Residential mortgage

 

 

 

911

 

 

 

 

9,594

 

 

 

 

140,066

 

 

 

 

150,571

 

Installment

 

 

 

745

 

 

 

 

225

 

 

 

 

114

 

 

 

 

1,084

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

178,188

 

 

 

$

 

181,552

 

 

 

$

 

600,864

 

 

 

$

 

960,604

 

 

 

 

 

 

 

 

 

 

Loans with:

 

 

 

 

 

 

 

 

Fixed rates

 

 

$

 

36,203

 

 

 

$

 

119,477

 

 

 

$

 

133,678

 

 

 

$

 

289,358

 

Variable rates

 

 

 

141,985

 

 

 

 

62,075

 

 

 

 

467,186

 

 

 

 

671,246

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

178,188

 

 

 

$

 

181,552

 

 

 

$

 

600,864

 

 

 

$

 

960,604

 

 

 

 

 

 

 

 

 

 

For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.

Asset Quality

General. One of our key objectives is to maintain a high level of asset quality. When a borrower fails to make a scheduled payment, we attempt to cure the deficiency by making personal contact with the borrower. Initial contacts typically are made 15 days after the date the payment is due, and late notices are sent approximately 15 days after the date the payment is due. In most cases, deficiencies are promptly resolved. If the delinquency continues, late charges are assessed and additional efforts are made to collect the deficiency. All loans which are delinquent 30 days or more are reported to the board of directors of the Bank on a monthly basis.

On loans where the collection of principal or interest payments is doubtful, the accrual of interest income ceases (“non-accrual” loans). Except for loans that are well secured and in the process of collection, it is our policy to discontinue accruing additional interest and reverse any interest accrued on any loan that is 90 days or more past due. On occasion, this action may be taken earlier if the financial condition of the borrower raises significant concern with regard to his/her ability to service the debt in accordance with the terms of the loan agreement. Interest income is not accrued on these loans until the borrower’s financial condition and payment record demonstrate an ability to service the debt.

41


 

Real estate acquired as a result of foreclosure is classified as OREO until sold. OREO is recorded at the lower of cost or fair value less estimated selling costs. Costs associated with acquiring and improving a foreclosed property are usually capitalized to the extent that the carrying value does not exceed fair value less estimated selling costs. Holding costs are charged to expense. Gains and losses on the sale of OREO are charged to operations, as incurred.

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. As part of the evaluation of impaired loans, the Company individually reviews for impairment all non-homogeneous loans internally classified as substandard or below. Generally, smaller impaired non-homogeneous loans and impaired homogeneous loans are collectively evaluated for impairment.

In limited situations we will modify or restructure a borrower’s existing loan terms and conditions. A restructured loan is considered a troubled debt restructuring (“TDR”) when, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession to the borrower in modifying or renewing a loan that the institution would not otherwise consider. We had six TDRs totaling $1.8 million, which, as of December 31, 2014, were currently performing under their restructured terms. We had five TDRs totaling $5.7 million, which, as of December 31, 2013, were currently performing under their restructured terms.

Asset Classification. Federal regulations and our policies require that we utilize an internal asset classification system as a means of reporting problem and potential problem assets. We have incorporated an internal asset classification system, substantially consistent with Federal banking regulations, as a part of our credit monitoring system. Federal banking regulations set forth a classification scheme for problem and potential problem assets as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention.”

When an insured institution classifies one or more assets, or portions thereof, as “substandard” or “doubtful,” it is required that a general valuation allowance for loan losses be established for loan losses in an amount deemed prudent by management. General valuation allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies one or more assets, or portions thereof, as “loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.

A bank’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by Federal bank regulators which can order the establishment of additional general or specific loss allowances. The Federal banking agencies have adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management analyze all significant factors that affect the collectability of the portfolio in a reasonable manner; and that management establish acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Our management

42


 

believes that, based on information currently available, our allowance for loan losses is maintained at a level which covers all known and probable incurred losses in the portfolio at each reporting date. However, actual losses are dependent upon future events and, as such; further additions to the level of allowances for loan losses may become necessary.

The table below sets forth information on our classified assets designated special mention at the dates indicated.

 

 

 

 

 

 

 

2014

 

2013

 

 

(dollars in thousands)

Classified Assets:

 

 

 

 

Substandard

 

 

$

 

42,262

 

 

 

$

 

17,164

 

Doubtful

 

 

 

289

 

 

 

 

672

 

Loss

 

 

 

 

 

 

 

 

 

 

 

 

 

Total classified assets

 

 

 

42,551

 

 

 

 

17,836

 

Special Mention Assets

 

 

 

19,305

 

 

 

 

17,241

 

 

 

 

 

 

Total classified and special mention assets

 

 

$

 

61,856

 

 

 

$

 

35,077

 

 

 

 

 

 

Nonperforming and Past Due Loans and OREO

Nonperforming loans include nonaccrual loans and accruing loans which are contractually past due 90 days or more. Nonaccrual loans represent loans on which interest accruals have been suspended. It is the Company’s general policy to consider the charge-off of loans, or a portion thereof, when they become contractually past due ninety days or more as to interest or principal payments or when other internal or external factors indicate that collection of principal or interest is doubtful. Troubled debt restructurings represent loans on which a concession was granted to a borrower, such as a reduction in interest rate to a rate lower than the current market rate for new debt with similar risks, and which are currently performing in accordance with the modified terms. The Company previously reported performing troubled debt restructured loans as a component of nonperforming assets. For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.

The following table sets forth, as of the dates indicated, the amount of the Company’s nonaccrual loans, accruing loans past due 90 days or more, other real estate owned (“OREO”) and troubled debt restructurings.

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31,

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

(Dollars in Thousands)

Nonaccrual loans

 

 

$

 

11,609

 

 

 

$

 

3,137

 

 

 

$

 

3,616

 

 

 

$

 

6,871

 

 

 

$

 

11,174

 

OREO

 

 

 

1,108

 

 

 

 

220

 

 

 

 

1,300

 

 

 

 

591

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming assets

 

 

$

 

12,717

 

 

 

$

 

3,357

 

 

 

$

 

4,916

 

 

 

$

 

7,462

 

 

 

$

 

11,174

 

 

 

 

 

 

 

 

 

 

 

 

Troubled debt restructuring—performing

 

 

$

 

1,763

 

 

 

$

 

5,746

 

 

 

$

 

6,813

 

 

 

$

 

7,459

 

 

 

$

 

7,035

 

 

 

 

 

 

 

 

 

 

 

 

Loans past due 90 days and still accruing

 

 

$

 

1,211

 

 

 

$

 

 

 

 

$

 

55

 

 

 

$

 

1,029

 

 

 

$

 

714

 

 

 

 

 

 

 

 

 

 

 

 

Nonaccrual loans to total loans

 

 

 

0.46

%

 

 

 

 

0.33

%

 

 

 

 

0.41

%

 

 

 

 

0.91

%

 

 

 

 

1.58

%

 

Nonaccrual loans and loans past due 90 days and still accruing to total loans

 

 

 

0.50

%

 

 

 

 

0.33

%

 

 

 

 

0.41

%

 

 

 

 

1.05

%

 

 

 

 

1.68

%

 

Nonperforming assets to total assets

 

 

 

0.37

%

 

 

 

 

0.20

%

 

 

 

 

0.30

%

 

 

 

 

0.52

%

 

 

 

 

0.93

%

 

Allowance for Loan Losses and Related Provision

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. We maintain an allowance for loan losses at a level considered adequate to provide for all known and probable incurred losses in the portfolio. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited. Our officers analyze risks within the loan portfolio on a continuous basis and through an

43


 

external independent loan review function, and the results of the loan review function are also reviewed by our Audit Committee. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly and, as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to our allowance for loan losses.

At December 31, 2014, the allowance for loan losses was $14.2 million, an increase of $3.8 million or 37.0%, from $10.3 million for the year ended December 31, 2013. Net charge-offs totaled $0.9 million during 2014 and $0.3 million for 2013. The allowance for loan losses as a percentage of loans receivable was 0.56% at December 31, 2014 and 1.08% at December 31, 2013. The decrease in this percentage was due to the Merger, as Legacy ConnectOne loans were recorded at fair value, including a credit risk discount. In purchase accounting, any allowance for loan losses on an acquired loan portfolio is reversed and a credit risk discount is applied directly to the acquired loan balances.

Five-Year Statistical Allowance for Loan Losses

The following table reflects the relationship of loan volume, the provision and allowance for loan losses and net charge-offs for the past five years.

 

 

 

 

 

 

 

 

 

 

 

 

 

Years Ended December 31,

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

(Dollars in Thousands)

Balance at the beginning of year

 

 

$

 

10,333

 

 

 

$

 

10,237

 

 

 

$

 

9,602

 

 

 

$

 

8,867

 

 

 

$

 

8,711

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

777

 

 

 

 

132

 

 

 

 

57

 

 

 

 

1,985

 

 

 

 

3,348

 

Residential real estate

 

 

 

159

 

 

 

 

175

 

 

 

 

454

 

 

 

 

23

 

 

 

 

1,552

 

Consumer

 

 

 

 

 

 

 

22

 

 

 

 

16

 

 

 

 

20

 

 

 

 

40

 

 

 

 

 

 

 

 

 

 

 

 

Total charge-offs

 

 

 

936

 

 

 

 

329

 

 

 

 

527

 

 

 

 

2,028

 

 

 

 

4,940

 

 

 

 

 

 

 

 

 

 

 

 

Recoveries:

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

50

 

 

 

 

69

 

 

 

 

620

 

 

 

 

255

 

 

 

 

13

 

Residential real estate

 

 

 

19

 

 

 

 

 

 

 

 

210

 

 

 

 

53

 

 

 

 

1

 

Consumer

 

 

 

11

 

 

 

 

6

 

 

 

 

7

 

 

 

 

7

 

 

 

 

6

 

 

 

 

 

 

 

 

 

 

 

 

Total recoveries

 

 

 

80

 

 

 

 

75

 

 

 

 

837

 

 

 

 

315

 

 

 

 

20

 

 

 

 

 

 

 

 

 

 

 

 

Net charge-offs (recoveries)

 

 

 

856

 

 

 

 

254

 

 

 

 

(310

)

 

 

 

 

1,713

 

 

 

 

4,920

 

Provision for loan losses

 

 

 

4,683

 

 

 

 

350

 

 

 

 

325

 

 

 

 

2,448

 

 

 

 

5,076

 

 

 

 

 

 

 

 

 

 

 

 

Balance at end of year

 

 

$

 

14,160

 

 

 

$

 

10,333

 

 

 

$

 

10,237

 

 

 

$

 

9,602

 

 

 

$

 

8,867

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of net charge-offs (recoveries) during the year to average loans outstanding during the year

 

 

 

0.05

%

 

 

 

 

0.03

%

 

 

 

 

(0.04

)%

 

 

 

 

0.24

%

 

 

 

 

0.69

%

 

Allowance for loan losses as a percentage of total loans at end of year

 

 

 

0.56

%

 

 

 

 

1.08

%

 

 

 

 

1.15

%

 

 

 

 

1.27

%

 

 

 

 

1.25

%

 

For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements

Implicit in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made, the creditworthiness of the borrower and prevailing economic conditions. The allowance for loan losses has been allocated in the table below according to the estimated amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at December 31, for each of the past five years.

44


 

The table below shows, for three types of loans, the amounts of the allowance allocable to such loans and the percentage of such loans to total loans.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

Residential real estate

 

Consumer

 

Unallocated

 

Amount of
Allowance

 

Loans to
Total
Loans
%

 

Amount of
Allowance

 

Loans to
Total
Loans
%

 

Amount of
Allowance

 

Loans to
Total
Loans
%

 


Amount of
Allowance

 

Total

 

 

(Dollars in Thousands)

2014

 

 

$

 

12,121

 

 

 

 

90.6

 

 

 

 

1,113

 

 

 

 

9.3

 

 

 

 

7

 

 

 

 

0.1

 

 

 

 

919

 

 

 

 

14,160

 

2013

 

 

 

7,806

 

 

 

 

84.2

 

 

 

 

990

 

 

 

 

15.7

 

 

 

 

146

 

 

 

 

0.1

 

 

 

 

1,391

 

 

 

 

10,333

 

2012

 

 

 

7,944

 

 

 

 

80.9

 

 

 

 

1,528

 

 

 

 

19.0

 

 

 

 

114

 

 

 

 

0.1

 

 

 

 

651

 

 

 

 

10,237

 

2011

 

 

 

8,206

 

 

 

 

78.7

 

 

 

 

1,263

 

 

 

 

21.2

 

 

 

 

51

 

 

 

 

0.1

 

 

 

 

82

 

 

 

 

9,602

 

2010

 

 

 

7,538

 

 

 

 

76.6

 

 

 

 

1,038

 

 

 

 

23.3

 

 

 

 

52

 

 

 

 

0.1

 

 

 

 

239

 

 

 

 

8,867

 

Investment Portfolio

For the year ended December 31, 2014, the average volume of investment securities decreased by $51.4 million to approximately $508.0 million or 22.2% of average earning assets, from $559.4 million on average, or 37.9% of average earning assets, in 2013. At December 31, 2014, the total investment portfolio amounted to $514.2 million, a decrease of $24.1 million from December 31, 2013. At December 31, 2014, the principal components of the investment portfolio are U.S. Treasury and Government Agency Obligations, Federal Agency Obligations including mortgage-backed securities, Obligations of U.S. states and political subdivision, corporate bonds and notes, and other debt and equity securities.

During the year ended December 31, 2014, volume related factors decreased investment revenue by $1.9 million. The tax-equivalent yield on investments increased by 15 basis points to 3.6% from a yield of 3.4% during the year ended December 31, 2013. The decrease in the investment portfolio resulted from a focus for asset growth primarily towards funding to loan volumes. This caused the Corporation to prudently decrease the size of its investment portfolio in an effort to deploy excess cash into loans.

During 2013, the Company reclassified at fair value approximately $138.3 million in available-for-sale investment securities to the held-to-maturity category. The related after-tax losses of approximately $1.5 million (on a pre-tax basis of $2.6 million) remained in accumulated other comprehensive income and will be amortized over the remaining life of the securities as an adjustment of yield, offsetting the related amortization of the premium or accretion of the discount on the transferred securities. No gains or losses were recognized at the time of reclassification. Management considers the held- to-maturity classification of these investment securities to be appropriate as the Company has the positive intent and ability to hold these securities to maturity. There were no reclassifications any securities in 2014.

There were no holdings of any trust preferred security (“Pooled TRUPS”) in 2014. The Company owned one pooled trust preferred security in 2013, which consisted of securities issued by financial institutions and insurance companies. The Company held the mezzanine tranche of these securities. Senior tranches generally are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches, with senior tranches having the greatest protection and mezzanine tranches subordinated to the senior tranches. During 2013, a Pooled TRUP, ALESCO VII, incurred its eighteenth interruption of cash flow payments to date. Management reviewed the expected cash flow analysis and credit support to determine if it was probable to that all principal and interest would be repaid, and recorded an other-than-temporary impairment charge of $628,000 for the twelve months ended December 31, 2013. The new cost basis for this security had been written down to $260,000. This security was sold effective December 31, 2013 at the new cost basis

At December 31, 2014, the Company did not own any private label mortgage backed securities which required evaluation for impairment. The Company owned one variable rate private label collateralized mortgage obligation (CMO) in 2013, which was evaluated for impairment, which was

45


 

subsequently sold. The Company recorded $24,000 in principal losses in 2013. The Company recorded $318,000 in principal losses and $484,000 other-than-temporary charge on this bond in 2012.

Securities available-for-sale are a part of the Company’s interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk, liquidity management and other factors. The Company continues to reposition the investment portfolio as part of an overall corporate-wide strategy to produce reasonable and consistent margins where feasible, while attempting to limit risks inherent in the Company’s balance sheet.

At December 31, 2014, the net unrealized gain carried as a component of accumulated other comprehensive income and included in stockholders’ equity, net of tax, amounted to a net unrealized gain of $4.9 million as compared with a net unrealized gain of $2.4 million at December 31, 2013, resulting from changes in market conditions and interest rates at December 31, 2014. As a result of the inactive condition of the markets amidst the financial crisis, the Company elected to treat certain securities under a permissible alternate valuation approach at December 31, 2013. No alternative valuation approaches were used for any holdings at December 31, 2014. For additional information regarding the Company’s investment portfolio, see Note 5, Note 15, Note 20 and Note 21 of the Notes to the Consolidated Financial Statements.

During 2014, securities sold from the Company’s available-for-sale portfolio amounted to $91.6 million, as compared with $122.2 million in 2013. The gross realized gains on securities sold, called or matured amounted to approximately $2,837,000 in 2014 compared to $2,451,000 in 2013, while the gross realized losses were $19,000, with no impairment charges, in 2014 compared to $740,000 in 2013, which included impairment charges of $652,000. During 2013, the Company recorded an other-than-temporary charge of $628,000 on the Pooled TRUP, ALESCO VII, and $24,000 in principal losses on the same variable rate private label CMO. During 2012, the Company recorded an other-than-temporary charge of $68,000 on the Pooled TRUP, ALESCO VII, a $484,000 other-than-temporary charge on a variable rate private label CMO and $318,000 in principal losses on the same variable rate private label CMO.

The table below illustrates the maturity distribution and weighted average yield on a tax-equivalent basis for investment securities at December 31, 2014, on a contractual maturity basis.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Due in 1 year or less

 

Due after 1 year
through 5 years

 

Due after 5 years
through 10 years

 

Due after 10 years

 

Total

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Market
Value

 

 

(Dollars in thousands)

Investment Securities Available-for-Sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal Agency Obligations

 

 

$

 

7

 

 

 

 

0.69

%

 

 

 

$

 

3,330

 

 

 

 

1.72

%

 

 

 

$

 

786

 

 

 

 

2.69

%

 

 

 

$

 

28,527

 

 

 

 

2.21

%

 

 

 

$

 

32,650

 

 

 

 

2.17

%

 

 

 

$

 

32,817

 

Residential Mortgage Pass-through Securities

 

 

 

20

 

 

 

 

 

 

 

 

722

 

 

 

 

1.82

 

 

 

 

2,159

 

 

 

 

2.11

 

 

 

 

55,935

 

 

 

 

2.82

 

 

 

 

58,836

 

 

 

 

2.78

 

 

 

 

60,356

 

Commercial Mortgage Pass-through Securities

 

 

 

 

 

 

 

 

 

 

 

3,042

 

 

 

 

2.42

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,042

 

 

 

 

2.42

 

 

 

 

3,046

 

Obligations of U.S. States and Political Subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,259

 

 

 

 

4.51

 

 

 

 

2,942

 

 

 

 

5.75

 

 

 

 

8,201

 

 

 

 

4.95

 

 

 

 

8,406

 

Trust Preferred

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4,500

 

 

 

 

5.37

 

 

 

 

11,586

 

 

 

 

5.81

 

 

 

 

16,086

 

 

 

 

5.69

 

 

 

 

16,306

 

Corporate Bonds and Notes

 

 

 

12,896

 

 

 

 

2.72

 

 

 

 

32,492

 

 

 

 

3.44

 

 

 

 

74,450

 

 

 

 

4.31

 

 

 

 

 

 

 

 

 

 

 

 

119,838

 

 

 

 

3.90

 

 

 

 

125,777

 

Asset-backed Securities

 

 

 

 

 

 

 

 

 

 

 

5,165

 

 

 

 

0.79

 

 

 

 

8,303

 

 

 

 

1.19

 

 

 

 

13,925

 

 

 

 

0.86

 

 

 

 

27,393

 

 

 

 

0.95

 

 

 

 

27,502

 

Certificates of Deposit

 

 

 

 

 

 

 

 

 

 

 

1,381

 

 

 

 

1.93

 

 

 

 

495

 

 

 

 

2.12

 

 

 

 

222

 

 

 

 

2.62

 

 

 

 

2,098

 

 

 

 

2.05

 

 

 

 

2,123

 

Equity Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

376

 

 

 

 

0.48

 

 

 

 

376

 

 

 

 

0.48

 

 

 

 

307

 

Other Securities

 

 

 

 

 

 

 

 

 

 

 

8,467

 

 

 

 

2.31

 

 

 

 

 

 

 

 

 

 

 

 

4,474

 

 

 

 

1.12

 

 

 

 

12,941

 

 

 

 

1.90

 

 

 

 

12,892

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

12,923

 

 

 

 

2.71

%

 

 

 

$

 

54,599

 

 

 

 

2.79

%

 

 

 

$

 

95,952

 

 

 

 

4.03

%

 

 

 

$

 

117,987

 

 

 

 

2.74

%

 

 

 

$

 

281,461

 

 

 

 

3.19

%

 

 

 

$

 

289,532

 

Investment Securities Held-to-Maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and Agency Securities

 

 

$

 

 

 

 

 

%

 

 

 

$

 

 

 

 

 

%

 

 

 

$

 

28,264

 

 

 

 

2.50

%

 

 

 

$

 

 

 

 

 

%

 

 

 

$

 

28,264

 

 

 

 

2.50

%

 

 

 

$

 

29,184

 

Federal Agency Obligations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

45

 

 

 

 

4.34

 

 

 

 

27,058

 

 

 

 

2.63

 

 

 

 

27,103

 

 

 

 

2.63

 

 

 

 

27,397

 

Residential Mortgage Pass-through Securities

 

 

 

6

 

 

 

 

 

 

 

 

222

 

 

 

 

0.64

 

 

 

 

369

 

 

 

 

1.72

 

 

 

 

5,358

 

 

 

 

2.25

 

 

 

 

5,955

 

 

 

 

2.15

 

 

 

 

5,983

 

Commercial Mortgage Pass-through Securities

 

 

 

 

 

 

 

 

 

 

 

2,870

 

 

 

 

2.25

 

 

 

 

1,396

 

 

 

 

2.29

 

 

 

 

 

 

 

 

 

 

 

 

4,266

 

 

 

 

2.26

 

 

 

 

4,316

 

Obligations of U.S. States and Political Subdivisions

 

 

 

 

 

 

 

 

 

 

 

3,193

 

 

 

 

4.26

 

 

 

 

13,790

 

 

 

 

4.01

 

 

 

 

103,161

 

 

 

 

4.73

 

 

 

 

120,144

 

 

 

 

4.63

 

 

 

 

124,596

 

Corporate Bonds and Notes

 

 

 

5,001

 

 

 

 

4.19

 

 

 

 

6,019

 

 

 

 

1.40

 

 

 

 

27,930

 

 

 

 

3.80

 

 

 

 

 

 

 

 

 

 

 

 

38,950

 

 

 

 

3.48

 

 

 

 

39,969

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

5,007

 

 

 

 

4.18

%

 

 

 

$

 

12,304

 

 

 

 

2.33

%

 

 

 

$

 

71,794

 

 

 

 

3.29

%

 

 

 

$

 

135,577

 

 

 

 

4.21

%

 

 

 

$

 

224,682

 

 

 

 

3.81

%

 

 

 

$

 

231,445

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Investment Securities

 

 

$

 

17,930

 

 

 

 

3.12

%

 

 

 

$

 

66,903

 

 

 

 

2.71

%

 

 

 

$

 

167,746

 

 

 

 

3.71

%

 

 

 

$

 

253,564

 

 

 

 

3.53

%

 

 

 

$

 

506,143

 

 

 

 

3.46

%

 

 

 

$

 

520,977

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For information regarding the carrying value of the investment portfolio, see Note 5, Note 20 and Note 21 of the Notes to the Consolidated Financial Statements.

46


 

The securities listed in the table above are either rated investment grade by Moody’s and/or Standard and Poor’s or have shadow credit ratings from a credit agency supporting investment grade and conform to the Company’s investment policy guidelines. There were no municipal securities of any single issuer exceeding 10 percent of stockholders’ equity at December 31, 2014.

Equity securities and other securities do not have a contractual maturity and are included in the Due after ten years maturity in the table above.

The following table sets forth the carrying value of the Company’s investment securities, as of December 31 for each of the last three years.

 

 

 

 

 

 

 

 

 

2014

 

2013

 

2012

 

 

(Dollars in Thousands)

Investment Securities Available-for-Sale:

 

 

 

 

 

 

U.S. treasury & agency securities

 

 

$

 

 

 

 

$

 

13,519

 

 

 

$

 

11,909

 

Federal agency obligations

 

 

 

32,817

 

 

 

 

19,941

 

 

 

 

20,535

 

Residential mortgage pass-through securities

 

 

 

60,356

 

 

 

 

48,874

 

 

 

 

53,784

 

Commercial mortgage pass-through securities

 

 

 

3,046

 

 

 

 

6,991

 

 

 

 

9,969

 

Obligations of U.S. States and political subdivisions

 

 

 

8,406

 

 

 

 

31,460

 

 

 

 

107,714

 

Trust preferred securities

 

 

 

16,306

 

 

 

 

19,403

 

 

 

 

21,249

 

Corporate bonds and notes

 

 

 

125,777

 

 

 

 

158,630

 

 

 

 

237,405

 

Collateralized mortgage obligations

 

 

 

 

 

 

 

 

 

 

 

2,120

 

Asset-backed securities

 

 

 

27,502

 

 

 

 

15,979

 

 

 

 

19,742

 

Certificates of deposit

 

 

 

2,123

 

 

 

 

2,262

 

 

 

 

2,865

 

Equity securities

 

 

 

307

 

 

 

 

287

 

 

 

 

325

 

Other securities

 

 

 

12,892

 

 

 

 

5,724

 

 

 

 

9,198

 

 

 

 

 

 

 

 

Total

 

 

$

 

289,532

 

 

 

$

 

323,070

 

 

 

$

 

496,815

 

 

 

 

 

 

 

 

Investment Securities Held-to-Maturity:

 

 

 

 

 

 

U.S. treasury & agency securities

 

 

$

 

28,264

 

 

 

$

 

28,056

 

 

 

$

 

 

Federal agency obligations

 

 

 

27,103

 

 

 

 

15,249

 

 

 

 

4,178

 

Residential mortgage pass-through securities

 

 

 

5,955

 

 

 

 

2,246

 

 

 

 

 

Commercial mortgage-backed securities

 

 

 

4,266

 

 

 

 

4,417

 

 

 

 

5,501

 

Obligations of U.S. States and political subdivisions

 

 

 

120,144

 

 

 

 

127,418

 

 

 

 

48,385

 

Corporate bonds and notes

 

 

 

38,950

 

 

 

 

37,900

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

224,682

 

 

 

$

 

215,286

 

 

 

$

 

58,064

 

 

 

 

 

 

 

 

Total investment securities

 

 

$

 

514,214

 

 

 

$

 

538,356

 

 

 

$

 

554,879

 

 

 

 

 

 

 

 

For other information regarding the Company’s investment securities portfolio, see Note 5 and Note 21 of the Notes to the Consolidated Financial Statements.

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 equity (“EVE”) models to measure the potential impact to the Bank of future changes in interest rates. As of December 31, 2014 and December 31, 2013 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.

47


 

The net interest income simulation model attempts to measure the change in net interest income over the next one-year period, and over 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 December 31, 2014, we estimated that, over the next one-year period, a 200 basis-point increase in the general level of interest rates will increase our net interest income by 0.29%, while a 100 basis-point decrease in interest rates will also decrease net interest income by 3.41%. As of December 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 1.44%, while a 100 basis-point decrease in the general level of interest rates will decrease our net interest income by 0.89%.

In our model, which was run as of December 31, 2014, 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 2.76%, while a 100 basis-point decrease in interest rates will decrease net interest income by 6.54%. As of December 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 0.81%, while a 100 basis-point decrease in interest rates will decrease net interest income by 4.93%.

An EVE 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 EVE as of December 31, 2014, would decline by 15.02% with a rate shock of up 200 basis points, and increase by 13.65% with a rate shock of down 100 basis points. Our EVE as of December 31, 2013, would decline by 16.65% with a rate shock of up 200 basis points, and increase by 14.04% with a rate shock of down 100 basis points.

The following table reflects the Company’s net interest income sensitivity over a one-year period and economic value of equity sensitivity as of December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rates
(basis points)

 

Estimated
EVE

 

Estimated change in EVE

 

Estimated
NII

 

Estimated change in NII

 

Amount

 

Percent

 

Amount

 

Percent

(Dollars in thousands)

 

+300

 

 

 

$

 

315,759

 

 

 

$

 

(101,700

)

 

 

 

 

(24.4

)%

 

 

 

$

 

108,863

 

 

 

$

 

957

 

 

 

 

0.9

%

 

 

 

+200

 

 

 

 

354,737

 

 

 

 

(62,722

)

 

 

 

 

(15.0

)

 

 

 

 

108,223

 

 

 

 

317

 

 

 

 

0.3

 

 

+100

 

 

 

 

389,140

 

 

 

 

(28,319

)

 

 

 

 

(6.8

)

 

 

 

 

107,791

 

 

 

 

(115

)

 

 

 

 

(0.1

)

 

 

 

0

 

 

 

 

417,459

 

 

 

 

 

 

 

 

 

 

 

 

107,906

 

 

 

 

 

 

 

 

 

 

-100

 

 

 

 

474,459

 

 

 

 

57,000

 

 

 

 

13.8

 

 

 

 

104,231

 

 

 

 

(3,675

)

 

 

 

 

(3.4

)

 

Estimates of Fair Value

The estimation of fair value is significant to certain assets of the Company, including available-for-sale investment securities. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, expected cash flows, credit quality, discount rates, or market interest rates. Fair values for most available for sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. See Note 21 of the Notes to Consolidated Financial Statements for additional discussion.

These estimates are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Impact of Inflation and Changing Prices

The financial statements and notes thereto presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of

48


 

financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the operations; unlike most industrial companies, nearly all of the Company’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

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 December 31, 2014, 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 December 31, 2014, liquid assets (cash and due from banks, interest-bearing deposits with banks and unencumbered investment securities) were $418.2 million, which represented 12.1% of total assets and 16.9% of total deposits and borrowings, compared to $515.8 million at December 31, 2013, which represented 30.8% of total assets 34.5% of total deposits and borrowings on such date.

The Bank is a member of the Federal Home Loan Bank of New York and, based on available qualified collateral as of December 31, 2014, had the ability to borrow $771.6 million. In addition, at December 31, 2014, the Bank had in place borrowing capacity of $62.0 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 with approximate capacity based on pledged collateral of $112 million. At December 31, 2014, the Bank had aggregate available and unused credit of $482.1 million, which represents the aforementioned facilities totaling $945.6 million net of the $463.5 million in outstanding borrowings. At December 31, 2014, outstanding commitments for the Bank to extend credit were $489.8 milion.

Cash and cash equivalents totaled $126.8 million on December 31, 2014, increasing by $44.2 million or 53.4%, from $82.7 million at December 31, 2013. Operating activities provided $26.0 million in net cash. Investing activities used $144.4 million in net cash, primarily reflecting an increase in loans, which was offset in part by cash flow of from the securities portfolio. Financing activities provided $162.5 million in net cash, primarily reflecting a net increase of $82.3 million in deposits and $86.2 million in borrowings.

Deposits

Deposits are our primary source of funds. Average total deposits increased $594.3 million, or 45.6%, to $1.9 billion in 2014 from $1.3 billion in 2013, due to the impact of the Merger and a growth in core deposits, primarily in money market accounts deposits. Transaction and non-transaction (time) deposits have grown as the customer’s base has expanded.

49


 

The following table sets forth the average amount of various types of deposits for each of the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

2014 Average

 

2013 Average

 

2012 Average

 

Balance

 

Rate

 

Balance

 

Rate

 

Balance

 

Rate

 

 

(dollars in thousands)

Demand, non-interest bearing

 

 

$

 

350,310

 

 

 

 

 

 

 

$

 

233,835

 

 

 

 

 

 

 

$

 

182,642

 

 

 

 

 

Demand, interest bearing & NOW

 

 

 

339,707

 

 

 

 

0.43

%

 

 

 

 

298,530

 

 

 

 

0.40

%

 

 

 

 

279,631

 

 

 

 

0.42

%

 

Money market accounts

 

 

 

584,586

 

 

 

 

0.41

%

 

 

 

 

411,209

 

 

 

 

0.44

%

 

 

 

 

372,140

 

 

 

 

0.44

%

 

Savings

 

 

 

196,855

 

 

 

 

0.16

%

 

 

 

 

185,793

 

 

 

 

0.33

%

 

 

 

 

190,744

 

 

 

 

0.37

%

 

Time

 

 

 

424,604

 

 

 

 

1.13

%

 

 

 

 

172,444

 

 

 

 

0.92

%

 

 

 

 

189,060

 

 

 

 

1.01

%

 

 

 

 

 

 

 

 

 

 

 

 

Total Deposits

 

 

$

 

1,896,062

 

 

 

 

0.47

%

 

 

 

$

 

1,301,811

 

 

 

 

0.40

%

 

 

 

$

 

1,214,217

 

 

 

 

0.45

%

 

 

 

 

 

 

 

 

 

 

 

 

The following table summarizes the maturity distribution of time deposits in denomination of $250,000 or more:

 

 

 

 

 

 

 

December 31,
2014

 

December 31,
2013

 

 

(dollars in thousands)

3 months or less

 

 

$

 

12,089

 

 

 

$

 

7,127

 

3 to 6 months

 

 

 

14,804

 

 

 

 

19,465

 

6 to 12 months

 

 

 

50,885

 

 

 

 

10,411

 

Over 12 months

 

 

 

30,203

 

 

 

 

24,851

 

 

 

 

 

 

Total

 

 

$

 

107,981

 

 

 

$

 

61,854

 

 

 

 

 

 

Borrowings

Borrowings consist of long and short term advances from the Federal Home Loan Bank and securities sold under agreements to repurchase. Federal Home Loan Bank advances are secured, under the terms of a blanket collateral agreement, by commercial mortgage loans. As of December 31, 2014, the Company had $495.6 million in notes outstanding at a weighted average interest rate of 1.5%. As of December 31, 2013, the Company had $146.0 million in notes outstanding at a weighted average interest rate of 3.8%.

50


 

Contractual Obligations and Other Commitments

The following table summarizes contractual obligations at December 31, 2014 and 2013 and the effect such obligations are expected to have on liquidity and cash flows in future periods.

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

Less Than
1 Year

 

1 – 3 Years

 

4 – 5 Years

 

After
5 Years

 

 

(Dollars in Thousands)

December 31, 2014

 

 

 

 

 

 

 

 

 

 

Contractual Obligations:

 

 

 

 

 

 

 

 

 

 

Operating lease obligations

 

 

$

 

15,480

 

 

 

$

 

2,062

 

 

 

$

 

3,450

 

 

 

$

 

2,819

 

 

 

$

 

7,509

 

 

 

 

 

 

 

 

 

 

 

 

Total contracted cost obligations

 

 

 

15,480

 

 

 

 

2,062

 

 

 

 

3,450

 

 

 

 

2,819

 

 

 

 

7,509

 

 

 

 

 

 

 

 

 

 

 

 

Other Long-term Liabilities/Long-term Debt

 

 

 

 

 

 

 

 

 

 

Time Deposits

 

 

 

669,398

 

 

 

 

350,390

 

 

 

 

188,166

 

 

 

 

130,842

 

 

 

 

 

Federal Home Loan Bank advances and repurchase agreements

 

 

 

495,553

 

 

 

 

278,372

 

 

 

 

76,000

 

 

 

 

130,000

 

 

 

 

11,181

 

Capital lease

 

 

 

4,508

 

 

 

 

291

 

 

 

 

878

 

 

 

 

642

 

 

 

 

2,697

 

Subordinated debentures

 

 

 

5,155

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,155

 

 

 

 

 

 

 

 

 

 

 

 

Total Other Long-term Liabilities/Long-term Debt

 

 

 

1,174,614

 

 

 

 

629,053

 

 

 

 

265,044

 

 

 

 

261,484

 

 

 

 

19,033

 

 

 

 

 

 

 

 

 

 

 

 

Other Commercial Commitments—Off Balance Sheet:

 

 

 

 

 

 

 

 

 

 

Commitments under commercial loans and lines of credit

 

 

 

236,447

 

 

 

 

132,307

 

 

 

 

104,140

 

 

 

 

 

 

 

 

 

Home equity and other revolving lines of credit

 

 

 

56,031

 

 

 

 

21,892

 

 

 

 

34,139

 

 

 

 

 

 

 

 

 

Outstanding commercial mortgage loan commitments

 

 

 

169,043

 

 

 

 

141,089

 

 

 

 

27,954

 

 

 

 

 

 

 

 

 

Standby letters of credit

 

 

 

27,500

 

 

 

 

20,151

 

 

 

 

7,349

 

 

 

 

 

 

 

 

 

Overdraft protection lines

 

 

 

800

 

 

 

 

517

 

 

 

 

283

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total off balance sheet arrangements and contractual obligations

 

 

 

489,821

 

 

 

 

315,956

 

 

 

 

173,865

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total contractual obligations and other commitments

 

 

$

 

1,678,178

 

 

 

$

 

946,949

 

 

 

$

 

441,926

 

 

 

$

 

263,852

 

 

 

$

 

25,451

 

 

 

 

 

 

 

 

 

 

 

 

51


 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

Less Than
1 Year

 

1 – 3 Years

 

4 – 5 Years

 

After
5 Years

 

 

(Dollars in Thousands)

December 31, 2013

 

 

 

 

 

 

 

 

 

 

Contractual Obligations:

 

 

 

 

 

 

 

 

 

 

Operating lease obligations

 

 

$

 

11,543

 

 

 

$

 

920

 

 

 

$

 

1,735

 

 

 

$

 

1,599

 

 

 

$

 

7,289

 

 

 

 

 

 

 

 

 

 

 

 

Total contracted cost obligations

 

 

 

11,543

 

 

 

 

920

 

 

 

 

1,735

 

 

 

 

1,599

 

 

 

 

7,289

 

 

 

 

 

 

 

 

 

 

 

 

Other Long-term Liabilities/Long-term Debt

 

 

 

 

 

 

 

 

 

 

Time Deposits

 

 

 

151,953

 

 

 

 

102,106

 

 

 

 

45,437

 

 

 

 

4,410

 

 

 

 

 

Federal Home Loan Bank advances and repurchase agreements

 

 

 

146,000

 

 

 

 

 

 

 

 

50,000

 

 

 

 

56,000

 

 

 

 

40,000

 

Subordinated debentures

 

 

 

5,155

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,155

 

 

 

 

 

 

 

 

 

 

 

 

Total Other Long-term Liabilities/Long-term Debt

 

 

 

303,108

 

 

 

 

102,106

 

 

 

 

95,437

 

 

 

 

60,410

 

 

 

 

45,155

 

 

 

 

 

 

 

 

 

 

 

 

Other Commercial Commitments—Off Balance Sheet:

 

 

 

 

 

 

 

 

 

 

Commitments under commercial loans and lines of credit

 

 

 

109,661

 

 

 

 

109,661

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity and other revolving lines of credit

 

 

 

41,836

 

 

 

 

41,836

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding commercial mortgage loan commitments

 

 

 

48,129

 

 

 

 

39,568

 

 

 

 

8,561

 

 

 

 

 

 

 

 

 

Standby letters of credit

 

 

 

9,655

 

 

 

 

9,655

 

 

 

 

 

 

 

 

 

 

 

 

 

Performance letters of credit

 

 

 

21,844

 

 

 

 

21,844

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding residential mortgage loan commitments

 

 

 

1,858

 

 

 

 

1,858

 

 

 

 

 

 

 

 

 

 

 

 

 

Overdraft protection lines

 

 

 

5,273

 

 

 

 

5,273

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total off balance sheet arrangements and contractual obligations

 

 

 

238,256

 

 

 

 

229,695

 

 

 

 

8,561

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total contractual obligations and other commitments

 

 

$

 

552,907

 

 

 

$

 

332,721

 

 

 

$

 

105,733

 

 

 

$

 

62,009

 

 

 

$

 

52,444

 

 

 

 

 

 

 

 

 

 

 

 

Capital

The maintenance of a solid capital foundation continues to be a primary goal for the Company. Accordingly, capital plans and dividend policies are monitored on an ongoing basis. The most important objective of the capital planning process is to balance effectively the retention of capital to support future growth and the goal of providing stockholders with an attractive long-term return on their investment.

The Company’s Tier I leverage capital (defined as tangible stockholders’ equity for common stock and Trust Preferred Capital Securities) at December 31, 2014 amounted to $301.6 million or 9.4% of average total assets. At December 31, 2013, the Company’s Tier I leverage capital amounted to $159.4 million or 9.7% of average total assets. Tier I capital excludes the effect of FASB ASC 320-10-05, which amounted to $3.6 million of net unrealized gains, after tax, on securities available-for-sale at December 31, 2014 (and would be reported as a component of accumulated other comprehensive income which is included in stockholders’ equity), and is reduced by goodwill and intangible assets, which amounted to $150.7 million as of December 31, 2014. For information on goodwill and intangible assets, see Note 1 to the Consolidated Financial Statements.

United States bank regulators have issued guidelines establishing minimum capital standards related to the level of assets and off balance-sheet exposures adjusted for credit risk. Specifically, these guidelines categorize assets and off balance-sheet items into four risk-weightings and require banking institutions to maintain a minimum ratio of capital to risk-weighted assets. At December 31, 2014, the Company’s Tier I and total risk-based capital ratios were 9.4% and 10.9%, respectively. For information on risk-based capital and regulatory guidelines for the Parent Corporation and its bank subsidiary, see Note 15 to the Consolidated Financial Statements.

52


 

The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the bank regulators regarding capital components, risk weightings and other factors.

The company has reviewed the potential effect Basel III will have on capital balances. For information regarding Basel III, see Part I, Item 1, “Business”.

Subordinated Debentures

On December 19, 2003, Center Bancorp Statutory Trust II, a statutory business trust and wholly-owned subsidiary of the Parent Corporation issued $5.0 million of, MMCapS capital securities to investors due on January 23, 2034. The capital securities presently qualify as Tier I capital. The trust loaned the proceeds of this offering to the Company and received in exchange $5.2 million of the Parent Corporation’s subordinated debentures. The subordinated debentures are redeemable in whole or in part prior to maturity. The floating interest rate on the subordinate debentures is three-month LIBOR plus 2.85% and reprices quarterly. The rate at December 31, 2014 was 3.08%.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest Sensitivity

MARKET RISK

Interest rate risk management is our primary market risk. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operation—Interest Rate Sensitivity Analysis” herein for a discussion of our management of our interest rate risk.

53


 

8. Financial Statements and Supplementary Data

All Financial Statements:

The following financial statements are filed as part of this report under Item 8—“Financial Statements and Supplementary Data.”

 

 

 

 

 

Page

REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS

 

 

 

55

 

CONSOLIDATED STATEMENTS OF CONDITION

 

 

 

59

 

CONSOLIDATED STATEMENTS OF INCOME

 

 

 

60

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

61

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

 

 

62

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

63

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

65

 

54


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
ConnectOne Bancorp, Inc.
Englewood Cliffs, New Jersey

We have audited the accompanying consolidated statement of financial condition of ConnectOne Bancorp, Inc. (formerly known as Center Bancorp, Inc.) (“the Company”) as of December 31, 2014, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the year ended December 31, 2014. We also have audited the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting as disclosed in Item 9A. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United