ConnectOne Bancorp, Inc. - FORM 10-Q

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EX-32.1 - ConnectOne Bancorp, Inc.	v221406_ex32-1.htm
EX-31.1 - ConnectOne Bancorp, Inc.	v221406_ex31-1.htm
EX-32.2 - ConnectOne Bancorp, Inc.	v221406_ex32-2.htm
EX-31.2 - ConnectOne Bancorp, Inc.	v221406_ex31-2.htm

UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended March 31, 2011

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

CENTER BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

New Jersey	52-1273725
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)

2455 Morris Avenue

Union, New Jersey 07083-0007

(Address of Principal Executive Offices) (Zip Code)

(908) 688-9500

(Registrant’s Telephone Number, Including Area Code)

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 ¨

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 Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨ Not applicable to the Registrant.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer ¨

Accelerated filer x

Non-accelerated filer ¨

(Do not check if smaller

reporting company)

Smaller reporting company ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, no par value:	16,290,700 shares
(Title of Class)	(Outstanding as of April 30, 2011)

Table of Contents

		Page

PART I – FINANCIAL INFORMATION		1

Item 1.	Financial Statements	2
	Consolidated Statements of Condition at March 31, 2011 and December 31, 2010 (unaudited)	2
	Consolidated Statements of Income for the three months ended March 31, 2011 and 2010 (unaudited)	3
	Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2011 and 2010 (unaudited)	4
	Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010 (unaudited)	5
	Notes to Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

Item 3.	Qualitative and Quantitative Disclosures about Market Risks	45

Item 4.	Controls and Procedures	46

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	46

Item 1A.	Risk Factors	46

Item 6.	Exhibits	47

SIGNATURES		48

PART I – FINANCIAL INFORMATION

The following unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and, accordingly, do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2011, or for any other interim period. The Center Bancorp, Inc. 2010 Annual Report on Form 10-K, should be read in conjunction with these financial statements.

Item 1. Financial Statements

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

(Unaudited)

(in thousands, except for share data)	March 31, 2011			December 31, 2010

ASSETS
Cash and due from banks	$	80,129		$	37,497
Investment securities		410,376			378,080
Loans		716,096			708,444
Less: Allowance for loan losses		9,591			8,867
Net loans		706,505			699,577
Restricted investment in bank stocks, at cost		9,146			9,596
Premises and equipment, net		12,747			12,937
Accrued interest receivable		4,756			4,134
Bank-owned life insurance		28,165			27,905
Goodwill and other intangible assets		16,942			16,959
Prepaid FDIC assessments		3,109			3,582
Other assets		16,771			17,118
Total assets	$	1,288,646		$	1,207,385
LIABILITIES
Deposits:
Non interest-bearing	$	154,910		$	144,210
Interest-bearing:
Time deposits $100 and over		165,596			119,651
Interest-bearing transaction, savings and time deposits $100 and less		614,140			596,471
Total deposits		934,646			860,332
Short-term borrowings		35,917			41,855
Long-term borrowings		161,000			171,000
Subordinated debentures		5,155			5,155
Accounts payable and accrued liabilities		27,344			8,086
Total liabilities		1,164,062			1,086,428
STOCKHOLDERS’ EQUITY
Preferred stock, $1,000 liquidation value per share, authorized 5,000,000 shares; issued 10,000 shares		9,721			9,700
Common stock, no par value, authorized 25,000,000 shares; issued 18,477,412 shares; outstanding 16,290,700 shares at March 31, 2011 and 16,289,832 shares at December 31, 2010		110,056			110,056
Additional paid-in capital		4,949			4,941
Retained earnings		24,015			21,633
Treasury stock, at cost (2,186,712 common shares at March 31, 2011 and 2,187,580 common shares at December 31, 2010)		(17,691	)		(17,698	)
Accumulated other comprehensive loss		(6,466	)		(7,675	)
Total stockholders’ equity		124,584			120,957
Total liabilities and stockholders’ equity	$	1,288,646		$	1,207,385

See accompanying notes to consolidated financial statements.

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended March 31,
(in thousands, except for share data)	2011			2010
Interest income
Interest and fees on loans	$	9,217		$	9,368
Interest and dividends on investment securities:
Taxable interest		3,378			3,009
Tax-exempt interest		88			117
Dividends		184			178
Total interest income		12,867			12,672
Interest expense
Interest on certificates of deposit $100 or more		265			414
Interest on other deposits		1,002			1,264
Interest on borrowings		1,655			2,485
Total interest expense		2,922			4,163
Net interest income		9,945			8,509
Provision for loan losses		878			940
Net interest income after provision for loan losses		9,067			7,569
Other income
Service charges, commissions and fees		449			430
Annuities and insurance commissions		6			93
Bank-owned life insurance		260			264
Other		116			108
Other-than-temporary impairment losses on investment securities		(95	)		(7,767	)
Portion of losses recognized in other comprehensive income, before taxes		—			3,377
Net other-than-temporary impairment losses on investment securities		(95	)		(4,390	)
Net gains on sale of investment securities		861			1,046
Net investment securities gains (losses)		766			(3,344	)
Total other income (loss)		1,597			(2,449	)
Other expense
Salaries and employee benefits		2,867			2,657
Occupancy and equipment		866			889
FDIC insurance		528			618
Professional and consulting		241			274
Stationery and printing		101			84
Marketing and advertising		21			93
Computer expense		339			340
Other real estate owned		(1	)		—
Loss on fixed assets, net		—			(10	)
Repurchase agreement termination fee		—			594
Other		973			853
Total other expense		5,935			6,392
Income (loss) before income tax expense (benefit)		4,729			(1,272	)
Income tax expense (benefit)		1,711			(1,553	)
Net Income		3,018			281
Preferred stock dividends and accretion		146			145
Net income available to common stockholders	$	2,872		$	136
Earnings per common share
Basic	$	0.18		$	0.01
Diluted	$	0.18		$	0.01
Weighted Average Common Shares Outstanding
Basic		16,290,391			14,574,832
Diluted		16,300,604			14,579,871

See accompanying notes to consolidated financial statements.

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(in thousands, except for share data)	Preferred Stock		Common Stock		Additional Paid In Capital		Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balance—December 31, 2009	$	9,619	$	97,908	$	5,650	$	17,068		$	(17,720	)	$	(10,776	)	$	101,749
Comprehensive income:
Net income								281									281
Other comprehensive loss, net of tax														3,087			3,087
Total comprehensive income																	3,368
Accretion of discount on preferred stock		20						(20	)								—
Cash dividends on preferred stock								(125	)								(125	)
Cash dividends declared on common stock ($0.03 per share)								(438	)								(438	)
Restricted stock awarded (2,083 shares)						3					22						25
Taxes related to stock-based compensation						8											8
Stock-based compensation expense						16											16

Balance—March 31, 2010	$	9,639	$	97,908	$	5,677	$	16,766		$	(17,698	)	$	(7,689	)	$	104,603

Balance—December 31, 2010	$	9,700	$	110,056	$	4,941	$	21,633		$	(17,698	)	$	(7,675	)	$	120,957
Comprehensive income:
Net income								3,018									3,018
Other comprehensive income, net of tax														1,209			1,209
Total comprehensive income																	4,227
Accretion of discount on preferred stock		21						(21	)								—
Issuance cost of common stock								(1	)								(1	)
Cash dividends on preferred stock								(125	)								(125	)
Cash dividends declared on common stock ($0.03 per share)								(489	)								(489	)
Stock issued for options exercise											7						7
Stock-based compensation expense						8											8

Balance—March 31, 2011	$	9,721	$	110,056	$	4,949	$	24,015		$	(17,691	)	$	(6,466	)	$	124,584

See accompanying notes to consolidated financial statements.

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)	Three Months Ended March 31,
	2011			2010
Cash flows from operating activities:
Net income	$	3,018		$	281
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of premiums and accretion of discounts on investment securities, net		1,056			339
Depreciation and amortization		241			312
Stock-based compensation		8			16
Provision for loan losses		878			940
Provision for deferred taxes		—			193
Net other-than-temporary impairment losses on investment securities		95			4,390
Gains on sales of investment securities, net		(861	)		(1,046	)
Loans originated for resale		(2,449	)		—
Proceeds from sale of loans held for sale		2,481			—
Gains on sale of loans held for sale		(32	)		—
Net gain on sales and dispositions of premises and equipment		—			(10	)
Increase in accrued interest receivable		(622	)		(35	)
Decrease in prepaid FDIC insurance assessments		473			374
Increase in cash surrender value of bank-owned life insurance		(260	)		(264	)
Decrease in other assets		349			1,697
Increase (decrease) in other liabilities		418			(960	)
Net cash provided by operating activities		4,793			6,227
Cash flows from investing activities:
Investment securities available-for-sale:
Purchases		(109,956	)		(153,302	)
Sales		76,551			141,511
Maturities, calls and principal repayments		20,867			16,663
Net redemption of restricted investment in bank stocks		450			121
Net decrease (increase) in loans		(7,797	)		4,189
Purchases of premises and equipment		(35	)		(59	)
Increase in principal portion of lease		(9	)		—
Proceeds from sale of premises and equipment		—			1
Net cash (used in) provided by investing activities		(19,929	)		9,124
Cash flows from financing activities:
Net increase (decrease) in deposits		74,314			(21,195	)
Net decrease in short-term borrowings		(5,938	)		(5,892	)
Repayments of long-term borrowings		(10,000	)		(10,039	)
Cash dividends on preferred stock		(125	)		(125	)
Cash dividends on common stock		(489	)		(438	)
Issuance cost of common stock		(1	)		—
Issuance cost of restricted stock award		—			25
Proceeds from exercise of stock options		7			—
Taxes related to stock based awards		—			8
Net cash provided by (used in) financing activities		57,768			(37,656	)
Net change in cash and cash equivalents		42,632			(22,305	)
Cash and cash equivalents at beginning of period		37,497			89,168
Cash and cash equivalents at end of period	$	80,129		$	66,863
Supplemental disclosures of cash flow information:
Cash payments for:
Interest paid on deposits and borrowings	$	3,006		$	4,310
Income taxes		—			40
Supplemental disclosures of non-cash investing activities:
Trade date accounting settlements for investments, net	$	17,892		$	27,624

See accompanying notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The consolidated financial statements of Center Bancorp, Inc. (the “Parent Corporation”) are prepared on the accrual basis and include the accounts of the Parent Corporation and its wholly-owned subsidiary, Union Center National Bank (the “Bank” and, collectively with the Parent Corporation and the Parent Corporation’s other direct and indirect subsidiaries, the “Corporation”). All significant intercompany accounts and transactions have been eliminated from the accompanying consolidated financial statements.

In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and that affect the results of operations for the periods presented. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to change in the near term relate to the determination of the allowance for loan losses, other-than-temporary impairment evaluation of securities, the evaluation of the impairment of goodwill and the valuation of deferred tax assets.

The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”).

Note 2. Earnings per Common Share

Basic earnings per common share (“EPS”) is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding. Diluted EPS includes any additional common shares as if all potentially dilutive common shares were issued (e.g., stock options). The Corporation’s weighted- average common shares outstanding for diluted EPS include the effect of stock options and warrants outstanding using the Treasury Stock Method, which are not included in the calculation of basic EPS.

Earnings per common share have been computed based on the following:

	Three Months Ended March 31,
(in thousands, except per share amounts)	2011			2010
Net income	$	3,018		$	281
Preferred stock dividends and accretion		(146	)		(145	)
Net income available to common shareholders	$	2,872		$	136
Basic weighted average common shares outstanding		16,290			14,575
Plus: effect of dilutive options and warrants		11			5
Diluted weighted average common shares outstanding		16,301			14,580
Earning per common share:
Basic	$	0.18		$	0.01
Diluted	$	0.18		$	0.01

Note 3. Stock-Based Compensation

The Corporation maintains two stock-based compensation plans from which new grants could be issued. The Corporation’s stock option plans permit Parent Corporation common stock to be issued to key employees and directors of the Corporation and its subsidiaries. The options granted under the plans are intended to be either incentive stock options or non-qualified options. Under the 2009 Equity Incentive Plan, a total of 394,417 shares are available for issuance. Under the 2003 Non-Employee Director Stock Option Plan, a total of 431,003 shares remain available for grant under the plan as of March 31, 2011 and are authorized for issuance. Such shares may be treasury shares, newly issued shares or a combination thereof.

Options have been granted to purchase common stock principally at the fair market value of the stock at the date of grant. Options are exercisable over a three year vesting period starting one year after the date of grant and generally expire ten years from the date of grant.

Stock-based compensation expense for all share-based payment awards granted after December 31, 2005 is based on the grant date fair value estimated in accordance with the provisions of FASB ASC 718-10-10. The Corporation recognizes these compensation costs net of a forfeiture rate and recognizes the compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of 3 years. The Corporation estimated the forfeiture rate based on its historical experience during the preceding seven fiscal years.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Stock-Based Compensation—(continued)

For the three months ended March 31, 2011, the Corporation’s income before income taxes and net income were reduced by $8,000 and $5,000, respectively, as a result of the compensation expense related to stock options. For the three months ended March 31, 2010, the Corporation’s income before income taxes and net income were reduced by $16,000 and $10,000, respectively, as a result of the compensation expense related to stock options.

Under the principal option plans, the Corporation may also grant restricted stock awards to certain employees. Restricted stock awards are non-vested stock awards. Restricted stock awards are independent of option grants and are generally subject to forfeiture if employment terminates prior to the release of the restrictions. Such awards generally vest within 30 days to five years from the date of grant. During that period, ownership of the shares cannot be transferred. Restricted stock has the same cash dividend and voting rights as other common stock and is considered to be currently issued and outstanding. The Corporation expenses the cost of restricted stock awards, which is determined to be the fair market value of the shares at the date of grant, ratably over the period during which the restrictions lapse. There were no restricted stock awards outstanding at March 31, 2011 and 2010.

There were 30,564 and 38,203 shares of common stock underlying granted options for the three months ended March 31, 2011 and 2010, respectively. The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model with the following assumptions and weighted average fair values at the time the grants were awarded:

	Three Months Ended March 31,
	2011			2010
Weighted average fair value of grants	$	1.89		$	2.16
Risk-free interest rate		2.19	%		2.29	%
Dividend yield		1.32	%		1.41	%
Expected volatility		22.25	%		28.6	%
Expected life in months		65			62

Activity under the principal option plans as of March 31, 2011 and changes during the three months ended March 31, 2011 were as follows:

	Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Outstanding at December 31, 2010		198,946		$	9.75
Granted		30,564			8.28
Exercised		(3,648	)		1.83
Forfeited/cancelled/expired		(12,857	)		11.75
Outstanding at March 31, 2011		213,005		$	9.56		5.56	$	173,071
Exercisable at March 31, 2011		144,408		$	9.78		3.98	$	114,313

The aggregate intrinsic value of options above represents the total pre-tax intrinsic value (the difference between the Corporation’s closing stock price on the last trading day of the first quarter of 2011 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2011. This amount changes based on the fair value of the Corporation’s stock.

As of March 31, 2011, there was approximately $89,000 of total unrecognized compensation expense relating to unvested stock options. These costs are expected to be recognized over a weighted average period of 1.6 years.

Note 4. Recent Accounting Pronouncements

ASU 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, will help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolio by expanding credit risk disclosures.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure.

The amendments in this Update apply to all public and nonpublic entities with financing receivables. Financing receivables include loans and trade accounts receivable. However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments.

In December 2010, the FASB issued ASU No. 2010-28, "When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." Under GAAP, the evaluation of goodwill impairment is a two-step test. In Step 1, an entity must assess whether the carrying amount of a reporting unit exceeds its fair value. If it does, an entity must perform Step 2 of the goodwill impairment test to determine whether goodwill has been impaired and to calculate the amount of that impairment. The provisions of this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The provisions of this ASU are effective for the Corporation's reporting period ended March 31, 2011. As of March 31, 2011, the Corporation had no reporting units with zero or negative carrying amounts or reporting units where there was a reasonable possibility of failing Step 1 of the goodwill impairment test. As a result, the adoption of this ASU did not have a material impact on the Corporation's statements of income and condition.

In January 2011, the FASB issued ASU No. 2011-01, "Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20." The provisions of ASU No. 2010-20 required the disclosure of more granular information on the nature and extent of troubled debt restructurings and their effect on the Allowance for the period ended March 31, 2011. The amendments in this ASU defer the effective date related to these disclosures, enabling creditors to provide those disclosures after the FASB completes its project clarifying the guidance for determining what constitutes a troubled debt restructuring. As the provisions of this ASU only defer the effective date of disclosure requirements related to troubled debt restructurings, the adoption of this ASU will have no impact on the Corporation's statements of income and condition.

In April 2011, the FASB issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.” The provisions of ASU No. 2011-02 provide additional guidance related to determining whether a creditor has granted a concession, include factors and examples for creditors to consider in evaluating whether a restructuring results in a delay in payment that is insignificant, prohibit creditors from using the borrower’s effective rate test to evaluate whether a concession has been granted to the borrower, and add factors for creditors to use in determining whether a borrower is experiencing financial difficulties. A provision in ASU No. 2011-02 also ends the FASB’s deferral of the additional disclosures about trouble debt restructuring as required by ASU No. 2010-20. The provisions of ASU No. 2011-02 are effective for the Corporation’s reporting period ending September 30, 2011. The adoption of ASU No. 2011-02 is not expected to have a material impact on the Company’s statements of income and condition.

Note 5 — Loans and the Allowance for Loan Losses

Loans are stated at their principal amounts inclusive of net deferred loan origination fees. Interest income is credited as earned except when a loan becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued. Loans that are past due 90 days or more that are both well secured and in the process of collection will remain on an accruing basis. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In July 2010, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2010-20, "Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses," which requires that the Corporation provide a greater level of disaggregated information about the credit quality of the Corporation’s loans and leases and the allowance for loan and lease losses (the "Allowance"). This ASU also requires the Corporation to disclose on a prospective basis, additional information related to credit quality indicators, non-accrual loans and leases, and past due information. The Corporation adopted the provisions of this ASU in preparing the Consolidated Financial Statements as of and for the year ended December 31, 2010. As this ASU amends only the disclosure requirements for loans and leases and the Allowance, the adoption of this ASU for the quarter and year ended March 31, 2011 and December 31, 2010, respectively, had no impact on the Corporation’s statements of income and condition. The required disclosures are presented in the following tables and related discussion later in this Note.

Portfolio segments are defined as the level at which an entity develops and documents a systematic methodology to determine its Allowance. Management has determined that the Corporation has two portfolio segments of loans and leases (commercial and consumer) in determining the Allowance. Both quantitative and qualitative factors are used by management at the portfolio segment level in determining the adequacy of the Allowance for the Corporation. Classes of loans and leases are a disaggregation of a Corporation's portfolio segments. Classes are defined as a group of loans and leases which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. Management has determined that the Corporation has five classes of loans and leases (Commercial and industrial (including lease financing), Commercial – real estate, Construction, Residential mortgage (including home equity) and Installment.

Generally, all classes of commercial and consumer loans and leases are placed on non-accrual status upon becoming contractually past due 90 days or more as to principal or interest (unless loans and leases are adequately secured by collateral, are in the process of collection, and are reasonably expected to result in repayment), when terms are renegotiated below market levels, or where substantial doubt about full repayment of principal or interest is evident.. For certain installment loans the entire outstanding balance on the loan is charged-off when the loan becomes 60 days past due.

Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected. Loan origination fees and certain direct loan origination costs are deferred and recognized over the life of the loan as an adjustment to the loan’s yield using the level yield method.

Impaired Loans

The Corporation accounts for impaired loans in accordance with FASB ASC 310-10-35 (previously SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosures”). The value of impaired loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or at the fair value of the collateral if the loan is collateral dependent.

The Corporation has defined its population of impaired loans to include all non-accrual and troubled debt restructuring loans. As part of the evaluation, the Corporation reviews all non-homogeneous loans for impairment internally classified as substandard or below, in each instance above an established dollar threshold of $200,000. Smaller impaired non-homogeneous loans and impaired homogeneous loans are not measured for specific reserves and are covered under the Corporation’s general reserve.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will not be able to collect all amounts due from the borrower in accordance with the contractual terms of the loan, including scheduled interest payments. Impaired loans include all classes of commercial and consumer non-accruing loans and all loans modified in a troubled debt restructuring ("TDR").

When a loan has been identified as being impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral-dependent. If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net of deferred loan fees or costs and unamortized premiums or discounts), an impairment is recognized by creating or adjusting an existing allocation of the Allowance, or by recording a partial charge-off of the loan to its fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income may be accrued or recognized on a cash basis.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans Modified in a Troubled Debt Restructuring

Loans are considered to have been modified in a TDR when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

Reserve for Credit Losses

The Corporation's reserve for credit losses is comprised of two components, the Allowance and the reserve for unfunded commitments (the "Unfunded Commitments").

Allowance for Loan Losses

The allowance for loan losses (“allowance”) is maintained at a level determined adequate to provide for probable loan losses. The allowance is increased by provisions charged to operations and reduced by loan charge-offs, net of recoveries. The allowance is based on management’s evaluation of the loan portfolio considering economic conditions, the volume and nature of the loan portfolio, historical loan loss experience and individual credit situations.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.

The ultimate collectability of a substantial portion of the Bank’s loan portfolio is susceptible to changes in the real estate market and economic conditions in the State of New Jersey and the impact of such conditions on the creditworthiness of the borrowers.

Management believes that the allowance for loan losses is adequate. Management uses available information to recognize loan losses; however, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examinations.

Reserve for Unfunded Commitments

The reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities and is included in other liabilities in the consolidated statements of condition. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, and credit risk. Net adjustments to the reserve for unfunded commitments are included in other expense.

The following table sets forth the composition of the Corporation’s loan portfolio including net deferred fees and costs, at March 31, 2011 and December 31, 2010:

	March 31,		December 31,
	2011		2010
	(Dollars in Thousands)
Commercial and industrial	$	127,131	$	121,034
Commercial real estate		386,241		372,001
Construction		44,944		49,744
Residential mortgage		157,455		165,154
Installment		325		511
Total loans	$	716,096	$	708,444

Included in the loan balances above are net deferred loan costs of $207,000 and $258,000 at March 31, 2011 and December 31, 2010, respectively.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At March 31, 2011 and December 31, 2010, loans to officers and directors aggregated approximately $3,504,000 and $5,456,000, respectively. During the period ended March 31, 2011, the Corporation made no new loans to officers and directors; payments by such persons during 2011 aggregated $1,952,000.

Management is of the opinion that the above loans were made on the same terms and conditions as those prevailing for comparable transactions with non-related borrowers.

At March 31, 2011 and December 31, 2010, loan balances of approximately $391.9 million and $435.9 million, respectively, were pledged to secure short term borrowings from the Federal Reserve Bank of New York and Federal Home Loan Bank Advances.

The following table presents information about loan receivables on non-accrual status at March 31, 2011 and December 31, 2010:

Loans Receivable on Non-Accrual Status

	March 31, 2011		December 31, 2010
	(Dollars in Thousands)
Commercial and Industrial	$	—	$	456
Commercial Real Estate		3,532		3,563
Construction		6,303		5,865
Residential Mortgage		2,501		1,290
Total loans receivable on non-accrual status	$	12,336	$	11,174

The Corporation continuously monitors the credit quality of its loans receivable. In addition to the internal staff, the Corporation utilizes the services of a third party loan review firm to rate the credit quality of its loans receivable. Credit quality is monitored by reviewing certain credit quality indicators. Assets classified “Pass” are deemed to possess average to superior credit quality, requiring no more than normal attention. Assets classified as “Special Mention” have generally acceptable credit quality yet possess higher risk characteristics/circumstances than satisfactory assets. Such conditions include strained liquidity, slow pay, stale financial statements, or other conditions that require more stringent attention from the lending staff. These conditions, if not corrected, may weaken the loan quality or inadequately protect the Corporation’s credit position at some future date. Assets are classified “Substandard” if the asset has a well defined weakness that requires management’s attention to a greater degree than for loans classified special mention. Such weakness, if left uncorrected, could possibly result in the compromised ability of the loan to perform to contractual requirements. An asset is classified as “Doubtful” if it is inadequately protected by the net worth and/or paying capacity of the obligor or of the collateral, if any, that secures the obligation. Assets classified as doubtful include assets for which there is a “distinct possibility” that a degree of loss will occur if the inadequacies are not corrected. All loans past due 90 days or more and all impaired loans are included in the appropriate category below. The following table presents information about the loan credit quality at March 31, 2011 and December 31, 2010:

Credit Quality Indicators
	March 31, 2011
	(Dollars in Thousands)
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial and industrial	$	122,369	$	3,224	$	1,538	$	—	$	127,131
Commercial real estate		348,263		22,036		15,942		—		386,241
Construction		38,642		—		4,025		2,277		44,944
Residential mortgage		152,965		—		4,490		—		157,455
Installment		325		—		—		—		325
Total loans	$	662,564	$	25,260	$	25,995	$	2,277	$	716,096

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Credit Quality Indicators
	December 31, 2010
	(Dollars in Thousands)
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial and industrial	$	116,741	$	1,929	$	2,364	$	—	$	121,034
Commercial real estate		345,096		15,383		11,522		—		372,001
Construction		43,879		—		3,588		2,277		49,744
Residential mortgage		161,558		—		3,596		—		165,154
Installment		511		—		—		—		511
Total loans	$	667,785	$	17,312	$	21,070	$	2,277	$	708,444

The following table provides an analysis of the impaired loans at March 31, 2011 and December 31, 2010:


Impaired Loans

	At or for the three months ended March 31, 2011
No Related Allowance Recorded	(Dollars in Thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial and industrial	$	908	$	908	$	—	$	908	$	11
Commercial real estate		3,953		4,594		—		3,966		5
Construction		2,277		5,054		—		2,277		—
Residential mortgage		—		—		—		—		—
Total	$	7,138	$	10,556	$	—	$	7,151	$	16

With An Allowance Recorded
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial real estate	$	4,180	$	4,180	$	609	$	4,180	$	34
Construction		4,025		4,025		413		4,036		—
Residential mortgage		1,354		1,354		14		1,354		14
Total	$	9,559	$	9,559	$	1,036	$	9,570	$	48

Total
Commercial and industrial	$	908	$	908	$	—	$	908	$	11
Commercial real estate		8,133		8,774		609		8,146		39
Construction		6,302		9,079		413		6,313		—
Residential mortgage		1,354		1,354		14		1,354		14
Total (including related allowance)	$	16,697	$	20,115	$	1,036	$	16,721	$	64

Impaired Loans

	At or for the year ended December 31, 2010
No Related Allowance Recorded	(Dollars in Thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial and industrial	$	1,364	$	1,908	$	—	$	1,933	$	87
Commercial real estate		3,984		4,625		—		4,274		78
Construction		5,865		8,642		—		6,855		112
Residential mortgage		1,462		1,765		—		1,711		27
Total	$	12,675	$	16,940	$	—	$	14,773	$	304

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

With An Allowance Recorded
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial real estate	$	4,180	$	4,180	$	618	$	4,181	$	204
Residential mortgage		1,354		1,354		21		1,356		76
Total	$	5,534	$	5,534	$	639	$	5,537	$	280

Total
Commercial and industrial	$	1,364	$	1,908	$	—	$	1,933	$	87
Commercial real estate		8,164		8,805		618		8,455		282
Construction		5,865		8,642		—		6,855		112
Residential mortgage		2,816		3,119		21		3,067		103
Total (including related allowance)	$	18,209	$	22,474	$	639	$	20,310	$	584

The Corporation defines an impaired loan as a loan for which it is probable, based on information available at the determination date, that the Corporation will not collect all amounts due under the contractual terms of the loan. At March 31, 2011 impaired loans were primarily collateral dependent, and totaled $16.7 million. Specific allowance for loan loss of $1.04 million was assigned to impaired loans of $9.6 million. Loans in the amount of $7.1 million had no specific allowance allocation.

Loans are considered to have been modified in a troubled debt restructuring when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a troubled debt restructuring remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status. Included in impaired loans at March 31, 2011 are loans that are deemed troubled debt restructurings. Of these loans, $7.0 million, 99% of which are included in the tables above, are performing under the restructured terms and are accruing interest.

The following table provides an analysis of the age of loans that are past due at March 31, 2011 and December 31, 2010:

Aging Analysis

	March 31, 2011
	(Dollars in Thousands)
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans Receivable > 90 Days And Accruing
Commercial and Industrial	$	579	$	177	$	224	$	980	$	126,151	$	127,131	$	224
Commercial Real Estate		2,080		857		3,532		6,469		379,772		386,241		—
Construction		—		—		6,303		6,303		38,641		44,944		—
Residential Mortgage		3,081		626		2,964		6,671		150,784		157,455		463
Installment		11		—		—		11		314		325		—
Total	$	5,751	$	1,660	$	13,023	$	20,434	$	695,662	$	716,096	$	687

	December 31, 2010
	(Dollars in Thousands)
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans Receivable > 90 Days And Accruing
Commercial and Industrial	$	1,509	$	476	$	456	$	2,441	$	118,593	$	121,034	$	—
Commercial Real Estate		4,290		2,229		3,563		10,082		361,919		372,001		—
Construction		170		449		5,865		6,484		43,260		49,744		—
Residential Mortgage		1,814		309		2,004		4,127		161,027		165,154		714
Installment		9		—		—		9		502		511		—
Total	$	7,792	$	3,463	$	11,888	$	23,143	$	685,301	$	708,444	$	714

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table details the amount of loans receivable that are evaluated individually, and collectively, for impairment, and the related portion of the allowance for loan loss that is allocated to each loan portfolio segment:

Allowance for loan and lease losses

	March 31, 2011
	(Dollars in Thousands)
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	609	$	413	$	14	$	—	$	—	$	1,036
Collectively evaluated for impairment		1,378		5,574		487		938		51		127		8,555
Total	$	1,378	$	6,183	$	900	$	952	$	51	$	127	$	9,591

Loans Receivable
Individually evaluated for impairment	$	2,010	$	16,182	$	6,302	$	1,354	$	—	$	—	$	25,848
Collectively evaluated for impairment		125,121		370,059		38,642		156,101		325		—		690,248
Total	$	127,131	$	386,241	$	44,944	$	157,455	$	325	$	—	$	716,096

Allowance for loan and lease losses

	December 31, 2010
	(Dollars in Thousands)
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	618	$	—	$	21	$	—	$	—	$	639
Collectively evaluated for impairment		1,272		5,097		551		1,017		52		239		8,228
Total	$	1,272	$	5,715	$	551	$	1,038	$	52	$	239	$	8,867

Loans Receivable
Individually evaluated for impairment	$	2,748	$	11,960	$	5,865	$	1,354	$	—	$	—	$	21,927
Collectively evaluated for impairment		118,286		360,041		43,879		163,800		511		—		686,517
Total	$	121,034	$	372,001	$	49,744	$	165,154	$	511	$	—	$	708,444

The Corporation’s allowance for loan losses is analyzed quarterly. Many factors are considered, including growth in the portfolio, delinquencies, nonaccrual loan levels, and other factors inherent in the extension of credit. There have been no material changes to the allowance for loan loss methodology as disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A summary of the activity in the allowance for loan losses is as follows:

	March 31, 2011
	(Dollars in Thousands)
	C & I		Comm R/E		Construction		Res Mtge			Installment		Unallocated			Total

Balance at January 1,	$	1,272	$	5,715	$	551	$	1,038		$	52	$	239		$	8,867

Charge offs		165		—		—		23			3		—			191

Recoveries		35		—		—		—			2		—			37

Provision		236		468		349		(63	)		—		(112	)		878

Balance at March 31,	$	1,378	$	6,183	$	900	$	952		$	51	$	127		$	9,591

The amount of interest income that would have been recorded on non-accrual loans during the three months ended March 31, 2011, the year ended December 31, 2010 and the year ended December 31, 2009, had payments remained in accordance with the original contractual terms, was $215,000, $598,000 and $431,000, respectively.

At March 31, 2011, there were no commitments to lend additional funds to borrowers whose loans were on non-accrual status or were contractually past due in excess of 90 days and still accruing interest.

The policy of the Corporation is to generally grant commercial, mortgage and installment loans to New Jersey residents and businesses within its market area. The borrowers’ abilities to repay their obligations are dependent upon various factors, including the borrowers’ income and net worth, cash flows generated by the borrowers’ underlying collateral, value of the underlying collateral, and priority of the lender’s lien on the property. Such factors are dependent upon various economic conditions and individual circumstances beyond the control of the Corporation. The Corporation is therefore subject to risk of loss. The Corporation believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for virtually all loans.

Note 6. Comprehensive Income

Total comprehensive income includes all changes in equity during a period arising from transactions and other events and circumstances from non-owner sources. The Corporation’s other comprehensive income is comprised of unrealized holding gains and losses on investment securities available-for-sale, and actuarial losses of defined benefit plans, net of taxes.

Disclosure of comprehensive income for the three months ended March 31, 2011, and 2010 is presented in the Consolidated Statements of Changes in Stockholders’ Equity. The table below provides a reconciliation of the components of other comprehensive income (loss) to the data provided in the Consolidated Statements of Changes in Stockholders’ Equity.

The components of other comprehensive income (loss), net of tax, were as follows for the periods indicated:

	Three Months Ended March 31,
	2011			2010
	(in thousands)
Reclassification adjustment of OTTI losses included in income	$	(95	)	$	(4,390	)
Unrealized gains on available-for-sale securities		1,389			8,461
Reclassification adjustment for net gains arising during this period		861			1,046
Net unrealized gains		2,155			5,117
Tax effect		(861	)		(2,030	)
Net of tax amount		1,294			3,087
Change in minimum pension liability		(142	)		—
Tax effect		57			—
Net of tax amount		(85	)		—
Other comprehensive income, net of tax	$	1,209		$	3,087

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Accumulated other comprehensive loss at March 31, 2011 and December 31, 2010 consisted of the following:

	March 31, 2011			December 31, 2010
	(in thousands)
Investment securities available-for-sale, net of tax	$	(4,033	)	$	(5,327	)
Defined benefit pension and post-retirement plans, net of tax		(2,433	)		(2,348	)
Total accumulated other comprehensive loss	$	(6,466	)	$	(7,675	)

Note 7. Investment Securities

All of the Corporation’s investment securities are classified as available-for-sale at March 31, 2011 and December 31, 2010. Investment securities available-for-sale are reported at fair value with unrealized gains or losses included in equity, net of tax. Accordingly, the carrying value of such securities reflects their fair value at the balance sheet date. Fair value is based upon either quoted market prices, or in certain cases where there is limited activity in the market for a particular instrument, assumptions are made to determine their fair value. See Note 8 of the Notes to Consolidated Financial Statements for a further discussion.

The following tables present information related to the Corporation’s investment securities available-for-sale at March 31, 2011 and December 31, 2010.

March 31, 2011

(in thousands)

Amortized

Cost

Gross

Unrealized

Gains

Gross

Unrealized

Losses

Fair Value

ConnectOne Bancorp, Inc. - FORM 10-Q - May 10, 2011

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