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UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the Quarterly Period Ended June 30, 2014

 

OR

 

  £ 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 26-1998619
(State or Other Jurisdiction of
Incorporation or Organization)
(IRS Employer
Identification No.)

 

301 Sylvan Avenue

Englewood Cliffs, New Jersey 07632

(Address of Principal Executive Offices) (Zip Code)

 

201-816-8900

(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 S  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 S  No £

 

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 S 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  S

 

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: 29,825,658, shares
(Title of Class) (Outstanding as of August 11, 2014)
 

Table of Contents

 

    Page
     
PART I – FINANCIAL INFORMATION
     
Item 1. Financial Statements  
  Consolidated Statements of Condition at June 30, 2014 (unaudited) and December 31, 2013 3
  Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013 (unaudited) 4
  Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013 (unaudited) 5
  Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2014 and 2013 (unaudited) 6
  Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013 (unaudited) 7
  Notes to Consolidated Financial Statements 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 34
     
Item 3. Qualitative and Quantitative Disclosures about Market Risks 50
     
Item 4. Controls and Procedures 51
     
PART II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 51
     
Item 1a. Risk Factors 51
     
Item 6. Exhibits 52
   
SIGNATURES 53

 

2

 

Item 1. Financial Statements

 

CONNECTONE BANCORP, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF CONDITION

 

(in thousands, except for share and per share data)  June 30,
2014
   December 31,
2013
 
   (Unaudited)     
ASSETS          
Cash and due from banks  $92,617   $82,692 
Investment securities:          
Available-for-sale   266,959    323,070 
Held-to-maturity (fair value of $222,503 and $210,958)   218,159    215,286 
Loans held for sale   483     
Loans   1,006,256    960,943 
Less: Allowance for loan losses   10,825    10,333 
Net loans   995,431    950,610 
Investment in restricted stock, at cost   11,289    8,986 
Premises and equipment, net   14,013    13,681 
Accrued interest receivable   6,414    6,802 
Bank-owned life insurance   36,245    35,734 
Goodwill and other intangible assets   16,815    16,828 
Other real estate owned   220    220 
Due from brokers for investment securities       8,759 
Other assets   7,164    10,414 
Total assets  $1,665,809   $1,673,082 
           
LIABILITIES          
Deposits:          
Non-interest bearing  $238,138   $227,370 
Interest-bearing:          
Time deposits $100 and over   112,616    99,444 
Interest-bearing transaction, savings and time deposits less than $100   923,866    1,015,191 
Total deposits   1,274,620    1,342,005 
Borrowings   196,000    146,000 
Subordinated debentures   5,155    5,155 
Accounts payable and accrued liabilities   11,756    11,338 
Total liabilities   1,487,531    1,504,498 
           
STOCKHOLDERS’ EQUITY          
Preferred stock, $1,000 liquidation value per share, authorized 5,000,000 shares; issued and outstanding 11,250 shares of Series B preferred stock at June 30, 2014 and December 31, 2013; total liquidation value of $11,250,000 at June 30, 2014 and December 31, 2013   11,250    11,250 
Common stock, no par value, authorized 50,000,000 shares; issued 18,477,412 shares at June 30, 2014 and December 31, 2013; outstanding 16,413,490 shares at June 30, 2014 and 16,369,012 at December 31, 2013   110,056    110,056 
Additional paid-in capital   5,380    4,986 
Retained earnings   67,108    61,914 
Treasury stock, at cost (2,063,922 common shares at June 30, 2014 and 2,108,400 at December 31, 2013)   (16,717)   (17,078)
Accumulated other comprehensive income (loss)   1,201    (2,544)
Total stockholders’ equity   178,278    168,584 
Total liabilities and stockholders’ equity  $1,665,809   $1,673,082 

 

See accompanying notes to unaudited consolidated financial statements.

 

3
 

CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
(in thousands, except for share and per share data)  2014   2013   2014   2013 
                 
Interest income                    
Interest and fees on loans  $10,461   $9,892   $20,572   $19,815 
Interest and dividends on investment securities:                    
Taxable   2,909    2,885    5,925    5,857 
Tax-exempt   895    1,081    1,951    2,157 
Dividends   136    121    290    252 
Interest on federal funds sold and other short-term investments               2 
Total interest income   14,401    13,979    28,738    28,083 
Interest expense                    
Interest on certificates of deposit $100 or more   203    220    410    459 
Interest on other deposits   1,098    1,063    2,207    2,108 
Interest on borrowings   1,432    1,468    2,843    2,918 
Total interest expense   2,733    2,751    5,460    5,485 
Net interest income   11,668    11,228    23,278    22,598 
Provision for loan losses   284        909     
Net interest income after provision for loan losses   11,384    11,228    22,369    22,598 
Other income                    
Service charges, commissions and fees   469    451    966    857 
Annuities and insurance commissions   105    146    205    246 
Bank-owned life insurance   256    274    511    839 
Loan related fees   214    114    395    253 
Net gains on sale of loans held for sale   43    91    79    229 
Other   63    31    100    209 
Other-than-temporary impairment losses on investment securities               (24)
Net gains on sales of investment securities   574    600    1,989    943 
Total other income   1,724    1,707    4,245    3,552 
Other expense                    
Salaries and employee benefits   3,184    3,335    6,516    6,825 
Occupancy and equipment   816    811    1,896    1,717 
FDIC insurance   288    208    588    521 
Professional and consulting   306    230    561    449 
Stationery and printing   88    78    172    163 
Marketing and advertising   27    62    67    163 
Computer expense   373    343    718    696 
Other real estate owned, net   1    107    3    126 
Merger expenses   729        1,789     
All other   932    902    1,930    1,954 
Total other expense   6,744    6,076    14,240    12,614 
Income before income tax expense   6,364    6,859    12,374    13,536 
Income tax expense   1,986    1,936    3,598    3,689 
Net Income   4,378    4,923    8,776    9,847 
Less: Preferred stock dividends   28    28    56    84 
Net income available to common stockholders  $4,350   $4,895   $8,720   $9,763 
Earnings per common share                    
Basic  $0.27   $0.30   $0.53   $0.60 
Diluted  $0.26   $0.30   $0.53   $0.60 
Weighted average common shares outstanding                    
Basic   16,372,885    16,348,915    16,361,596    16,348,567 
Diluted   16,430,376    16,375,774    16,422,339    16,375,028 
Dividend per common share  $0.075   $0.055   $0.150   $0.130 

 

See accompanying notes to unaudited consolidated financial statements. 

 

4

 

CONNECTONE BANCORP, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
(in thousands)  2014   2013   2014   2013 
Net income  $4,378   $4,923   $8,776   $9,847 
Other comprehensive (loss) income, net of tax:                    
Unrealized gains and losses on securities available-for-sale:                    
Unrealized holding (losses) gains on available-for-sale securities   3,311    (11,702)   6,827    (11,154)
Tax effect   (1,276)   4,689    (2,466)   4,489 
Net of tax amount   2,035    (7,013)   4,361    (6,665)
Reclassification adjustment of OTTI losses included in income               24 
Tax effect               (6)
Net of tax amount               18 
Reclassification adjustment for net gains arising during the period   (574)   (600)   (1,989)   (943)
Tax effect   179    167    559    257 
Net of tax amount   (395)   (433)   (1,430)   (686)
Amortization of unrealized holding gains on securities transferred from available-for-sale to held-to-maturity   54    88    99    74 
Tax effect   (23)   (33)   (43)   (28)
Net of tax amount   31    55    56    46 
Pension plan:                    
Actuarial gains           1,281     
Tax effect           (523)    
Net of tax amount           758     
Total other comprehensive (loss) income   1,671    (7,391)   3,745    (7,287)
Total comprehensive (loss) income  $6,049   $(2,468)  $12,521   $2,560 

 

See accompanying notes to unaudited consolidated financial statements. 

 

5
 

CONNECTONE BANCORP, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

 

(in thousands, except for share and per share data)  Preferred
Stock
   Common
Stock
   Additional
Paid In
Capital
   Retained
Earnings
   Treasury
Stock
   Accumulated
Other
Comprehensive
Income (Loss)
   Total
Stockholders’
Equity
 
Balance as of January 1, 2013  $11,250   $110,056   $4,801   $46,753   $(17,232)  $5,063   $160,691 
Net income                  9,847              9,847 
Other comprehensive loss, net of tax                            (7,287)   (7,287)
Dividend on series B preferred stock                  (113)             (113)
Issuance cost of common stock                  (6)             (6)
Cash dividends declared on common stock ($0.13 per share)                  (2,125)             (2,125)
Issuance of restricted stock awards (18,829 shares)             91         152         243 
Stock issued for options exercised (1,000 shares)             8         2         10 
Stock-based compensation expense             25                   25 
Balance as of June 30, 2013  $11,250   $110,056   $4,925   $54,356   $(17,078)  $(2,224)  $161,285 
Balance as of January 1, 2014  $11,250   $110,056   $4,986   $61,914   $(17,078)  $(2,544)  $168,584 
Net income                  8,776              8,776 
Other comprehensive income, net of tax                            3,745    3,745 
Dividend on series B preferred stock                  (56)             (56)
Issuance cost of common stock                  (7)             (7)
Cash dividends declared on common stock ($0.15 per share)                  (3,519)             (3,519)
Stock issued for options exercised (44,478 shares)             119         361         480 
Tax benefit of options exercised             241                   241 
Stock-based compensation expense             34                   34 
Balance as of June 30, 2014  $11,250   $110,056   $5,380   $67,108   $(16,717)  $1,201   $178,278 

 

 

See accompanying notes to unaudited consolidated financial statements. 

 

6
 

CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 (in thousands)  Six Months Ended
June 30,
 
   2014   2013 
Cash flows from operating activities:          
Net income  $8,776   $9,847 
Adjustments to reconcile net income to net cash provided by operating activities:          
Amortization of premiums and accretion of discounts on investment securities, net   941    1,841 
Depreciation and amortization   428    429 
Provision for loan losses   909     
Stock-based compensation   34    25 
Other-than-temporary impairment losses on investment securities       24 
Gains on sales of investment securities, net   (1,989)   (943)
Net loss on sale of other real estate owned       75 
Loans originated for resale   (2,821)   (12,351)
Proceeds from sale of loans held for sale   2,417    13,486 
Gains on sale of loans held for sale   (79)   (229)
Decrease (increase) in accrued interest receivable   388    (1)
Decrease in prepaid FDIC insurance assessments       811 
Increase in cash surrender value of bank-owned life insurance   (511)   (548)
Life insurance death benefit       (291)
Decrease (increase) in other assets   2,545    (3,215)
(Decrease) increase in other liabilities   (645)   1,185 
Net cash provided by operating activities   10,393    10,145 
Cash flows from investing activities:          
Investment securities available-for-sale:          
Purchases   (10,487)   (119,749)
Sales   66,738    78,911 
Maturities, calls and principal repayments   14,486    29,583 
Investment securities held-to-maturity:          
Purchases   (8,310)   (6,104)
Maturities and principal repayments   5,068    2,803 
Net (purchases) redemption of restricted investment in bank stocks   (2,303)   (22)
Net increase in loans   (45,730)   (13,421)
Purchases of premises and equipment   (747)   (304)
Proceeds from bank-owned life insurance death benefits       592 
Proceeds from sale of other real estate owned       1,230 
Net cash provided by (used in) investing activities   18,715    (26,481)
Cash flows from financing activities:          
Net (decrease) increase in deposits   (67,385)   (26,028)
Net increase in borrowings   50,000     
Cash dividends on preferred stock   (56)   (84)
Cash dividends on common stock   (2,456)   (1,978)
Issuance of restricted stock awards       243 
Issuance cost of common stock   (7)   (6)
Tax benefit of options exercised   241     
Proceeds from exercise of stock options   480    10 
Net cash used in financing activities   (19,183)   (27,843)
Net change in cash and cash equivalents   9,925    (44,179)
Cash and cash equivalents at beginning of period   82,692    106,138 
Cash and cash equivalents at end of period  $92,617   $61,959 
Supplemental disclosures of cash flow information:          
Cash payments for:          
Interest paid on deposits and borrowings  $5,425   $5,548 
Income taxes   2,553    1,630 
Supplemental disclosures of non-cash investing activities:          
Transfer of loans to other real estate owned       236 
Dividends declared, not paid   1,063      
Transfer of investment securities available-for-sale to investment securities held-to-maturity       75,694 

 

See accompanying notes to unaudited consolidated financial statements. 

 

7
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Nature of Operations and Principles of Consolidation

 

The consolidated financial statements of ConnectOne Bancorp, Inc. (the “Parent Corporation”) are prepared on an accrual basis and include the accounts of the Parent Corporation and its wholly-owned subsidiary, ConnectOne 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.

 

The Bank is a community-based, full-service New Jersey-chartered commercial bank that was founded in 2005. The Bank operates from its headquarters located at 301 Sylvan Avenue in the Borough of Englewood Cliffs, Bergen County, New Jersey, and following consummation of the merger on July 1, 2014, through its twenty-three other banking offices. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from business operations. There are no significant concentrations of loans to any one industry or customer. However, the customers’ ability to repay their loans is dependent on the cash flows, real estate and general economic conditions in the area.

 

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 and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014, or for any other interim period. The Company’s 2013 Annual Report on Form 10-K, should be read in conjunction with these 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 dates 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, the other-than-temporary impairment evaluation of securities, the evaluation of the impairment of goodwill and the evaluation 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. Recent Accounting Pronouncements

 

FASB ASU 2014-04: Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure. EITF Issue 13-E sought to define “in substance repossession or foreclosure” because of the diversity in practice regarding when entities were reclassifying loans receivable to other real estate owned instead of as a loan receivable. The timing of loan reclassifications to OREO may be qualitatively significant to regulators and other financial statement users. “In substance repossession or foreclosure” is clarified by the ASU. A creditor is considered to have received physical possession (resulting from an in substance repossession) of residential real estate property collateralizing a consumer mortgage loan only upon the occurrence of either of the following: a) The creditor obtains legal title to the residential real estate property upon completion of a foreclosure. A creditor may obtain legal title to the residential real estate property even if the borrower has redemption rights that provide the borrower with a legal right for a period of time after a foreclosure to reclaim the real estate property by paying certain amounts specified by law. b) The borrower conveys all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The deed in lieu of foreclosure or similar legal agreement is completed when agreed-upon terms and conditions have been satisfied by both the borrower and the creditor. The ASU is effective for fiscal years beginning after December 15, 2014, and interim periods therein. Early adoption is permitted. The Corporation will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

 

FASB ASU No. 2014-09: Revenue from Contracts with Customers. In May 2014, the FASB issued an update creating FASB Topic 606, Revenue from Contracts with Customers. The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

 

8
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

FASB ASC ASU No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. In June 2014, the FASB issued an update impacting FASB ASC 860, Transfers and Servicing. The amendments in this update change the accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements. The amendments also require new disclosures. An entity is required to disclose information on transfers accounted for as sales in transactions that are economically similar to repurchase agreements. An entity must also provide additional information about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The amendments in this update become effective for the first interim or annual period beginning after December 15, 2014. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

FASB ASC ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. In June 2014, the FASB issued an update impacting FASB ASC 860, Transfers and Servicing. Generally, an award with a performance target also requires an employee to render service until the performance target is achieved. In some cases, however, the terms of an award may provide that the performance target could be achieved after an employee completes the requisite service period. The amendments in this update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. An entity should apply guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period for which the service has already been rendered. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

Note 3. Subsequent Event – Completion of Merger

 

On January 20, 2014, the Parent Corporation entered into an Agreement and Plan of Merger (the “Merger Agreement”) with ConnectOne Bancorp, Inc., a New Jersey corporation (“ConnectOne Bancorp”). Effective July 1, 2014 (the “Effective Time”), the Parent Corporation completed the merger contemplated by the Merger Agreement (the “Merger”) with legacy ConnectOne Bancorp, Inc., a New Jersey corporation (“Legacy ConnectOne”). At closing, Legacy ConnectOne merged with and into the Parent Corporation, with the Parent Corporation as the surviving corporation. Also at closing, the Parent Corporation changed its name from “Center Bancorp, Inc.” to “ConnectOne Bancorp, Inc.” and changed its NASDAQ trading symbol to “CNOB” from “CNBC.”

 

Pursuant to the Merger Agreement, holders of Legacy ConnectOne common stock, no par value per share (the “Legacy ConnectOne Common Stock”), received 2.6 shares of common stock of the Parent Corporarion, no par value per share (the “Company Common Stock”), for each share of Legacy ConnectOne Common Stock held immediately prior to the effective time of the Merger, with cash to be paid in lieu of fractional shares. Each outstanding share of Company Common Stock remained outstanding and was unaffected by the Merger. Each option granted by Legacy ConnectOne to purchase shares of Legacy ConnectOne Common Stock was converted into an option to purchase Company Common Stock on the same terms and conditions as were applicable prior to the Merger (taking into account any acceleration or vesting by reason of the consummation of the Merger and its related transactions), subject to adjustment of the exercise price and the number of shares of Company Common Stock issuable upon exercise of such option based on the 2.6 exchange ratio.

 

Immediately following the Merger, Union Center National Bank, a bank organized pursuant to the laws of the United States, and a wholly owned subsidiary of the Parent Corporation (“UNCB”), merged (the “Bank Merger”) with and into ConnectOne Bank, a New Jersey state-chartered commercial bank and a wholly owned subsidiary of Legacy ConnectOne, with ConnectOne Bank as the surviving entity (the “Bank”). The Bank will now conduct business only in the name of and under the brand of ConnectOne.

 

Given the initial accounting for this business combination is incomplete, management is not yet able to disclose the preliminary fair value of the assets acquired and liabilities assumed.

 

9
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 4. Earnings per Common Share

 

Basic earnings per common share (“EPS”) is computed by dividing income available to common stockholders 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 restricted stock awards outstanding using the Treasury Stock Method, which are not included in the calculation of basic EPS. Anti-dilutive stock option and restricted stock award shares outstanding were 19,174 and 19,377, respectively, for the three and six months ended June 30, 2014, and anti-dilutive stock option shares outstanding were 67,451 for both the three and six months ended June 30, 2013.

 

Earnings per common share have been computed as follows:

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
(in thousands, except per share amounts)  2014   2013   2014   2013 
Net income  $4,378   $4,923   $8,776   $9,847 
Preferred stock dividends   (28)   (28)   (56)   (84)
Net income available to common stockholders  $4,350   $4,895    8,720   $9,763 
Basic weighted average common shares outstanding   16,373    16,349    16,362    16,349 
Plus: effect of dilutive options   57    27    61    26 
Diluted weighted average common shares outstanding   16,430    16,376    16,423    16,375 
Earnings per common share:                    
Basic  $0.27   $0.30   $0.53   $0.60 
Diluted  $0.26   $0.30   $0.53   $0.60 

 

Note 5. Investment Securities

 

The Corporation’s investment securities are classified as available-for-sale and held-to-maturity at June 30, 2014 and December 31, 2013. 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.

 

Transfers of debt securities from the available-for-sale category to the held-to-maturity category are made at fair value at the date of transfer. The unrealized holding gain or loss at the date of transfer remains in accumulated other comprehensive income and in the carrying value of the held-to-maturity investment security. Premiums or discounts on investment securities are amortized or accreted using the effective interest method over the life of the security as an adjustment of yield. Unrealized holding gains or losses that remain in accumulated other comprehensive income are amortized or accreted over the remaining life of the security as an adjustment of yield, offsetting the related amortization of the premium or accretion of the discount.

 

10
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following tables present information related to the Corporation’s investment securities at June 30, 2014 and December 31, 2013.

 

   June 30, 2014 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
   (dollars in thousands) 
Investment Securities Available-for-Sale:                    
U.S. Treasury and agency securities  $9,608   $   $(136)  $9,472 
Federal agency obligations   22,643    116    (111)   22,648 
Residential mortgage pass-through securities   44,369    1,563    (13)   45,919 
Commercial mortgage pass-through securities   3,072        (51)   3,021 
Obligations of U.S. states and political subdivisions   6,303    200        6,503 
Trust preferred securities   16,085    490    (239)   16,336 
Corporate bonds and notes   132,401    6,969    (43)   139,327 
Asset-backed securities   15,010    166        15,176 
Certificates of deposit   2,099    38    (5)   2,132 
Equity securities   376        (83)   293 
Mutual funds and money market funds   6,232        (100)   6,132 
Total  $258,198   $9,542   $(781)  $266,959 
                     
Investment Securities Held-to-Maturity:                    
U.S. Treasury and agency securities  $28,159   $257   $   $28,416 
Federal agency obligations   22,039    166    (19)   22,186 
Residential mortgage pass-through securities   2,049    14        2,063 
Commercial mortgage pass-through securities   4,341    77    (18)   4,400 
Obligations of U.S. states and political subdivisions   123,646    3,327    (410)   126,563 
Corporate bonds and notes   37,925    950        38,875 
Total  $218,159   $4,791   $(447)  $222,503 
Total investment securities  $476,357   $14,333   $(1,228)  $489,462 

 

11
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

   December 31, 2013 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
   (dollars in thousands) 
Investment Securities Available-for-Sale:                    
U.S. Treasury and agency securities  $14,344   $   $(825)  $13,519 
Federal agency obligations   20,567    29    (655)   19,941 
Residential mortgage pass-through securities   48,312    791    (229)   48,874 
Commercial mortgage pass-through securities   7,145    3    (157)   6,991 
Obligations of U.S. states and political subdivisions   30,804    711    (55)   31,460 
Trust preferred securities   19,763    150    (510)   19,403 
Corporate bonds and notes   154,182    4,930    (482)   158,630 
Asset-backed securities   15,733    246        15,979 
Certificates of deposit   2,250    32    (20)   2,262 
Equity securities   376        (89)   287 
Mutual funds and money market funds   5,671    68    (15)   5,724 
Total  $319,147   $6,960   $(3,037)  $323,070 
Investment Securities Held-to-Maturity:                    
U.S. Treasury and agency securities  $28,056   $   $(1,019)  $27,037 
Federal agency obligations   15,249    23    (389)   14,883 
Residential mortgage-backed securities   2,246        (64)   2,182 
Commercial mortgage-backed securities   4,417    41    (62)   4,396 
Obligations of U.S. states and political subdivisions   127,418    1,303    (3,688)   125,033 
Corporate bonds and notes   37,900    149    (622)   37,427 
Total  $215,286   $1,516   $(5,844)  $210,958 
Total investment securities  $534,433   $8,476   $(8,881)  $534,028 

 

The following table presents information for investment securities available-for-sale at June 30, 2014, based on scheduled maturities. Actual maturities can be expected to differ from scheduled maturities due to prepayment or early call options of the issuer.

 

   June 30, 2014 
   Amortized
Cost
   Fair Value 
   (in thousands) 
Investment Securities Available-for-Sale:    
Due in one year or less  $9,384   $9,499 
Due after one year through five years   45,331    46,591 
Due after five years through ten years   112,083    117,869 
Due after ten years   37,351    37,635 
Residential mortgage pass-through securities   44,369    45,919 
Commercial mortgage pass-through securities   3,072    3,021 
Equity securities   376    293 
Mutual funds and money market funds   6,232    6,132 
Total  $258,198   $266,959 
Investment Securities Held-to-Maturity:          
Due in one year or less  $2,052   $2,054 
Due after one year through five years   12,932    13,203 
Due after five years through ten years   68,506    69,838 
Due after ten years   128,279    130,945 
Residential mortgage-backed securities   2,049    2,063 
Commercial mortgage pass-through securities   4,341    4,400 
Total  $218,159   $222,503 
           
Total investment securities  $476,357   $489,462 

 

12
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

For the six months ended June 30, 2014, proceeds of available-for-sale investment securities sold amounted to approximately $66.7 million.

 

All residential mortgage and commercial mortgage pass-through securities are issued by government sponsored agencies.

 

Gross gains and losses from the sales of investment securities for the three-month and six-month periods ended June 30, 2014 and 2013 were as follows:

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
(in thousands)  2014   2013   2014   2013 
Gross gains on sales of investment securities  $579   $600   $2,011   $1,032 
Gross losses on sales of investment securities   5        22    89 
Net gains on sales of investment securities  $574   $600   $1,989   $943 

 

The following summarizes OTTI charges for the periods indicated.

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(in thousands)  2014   2013   2014   2013 
Other than temporary impairment charges  $   $   $   $ 
Principal losses on a variable rate CMO               24 
Total other-than-temporary impairment charges  $   $   $   $24 

 

The Corporation performs regular analysis on all its investment securities to determine whether a decline in fair value indicates that an investment is other-than-temporarily impaired in accordance with FASB ASC 320-10. FASB ASC 320-10 requires companies to record OTTI charges through earnings if they have the intent to sell, or if it is more likely than not that they will be required to sell an impaired debt security before recovery of its amortized cost basis. If the Corporation intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its estimated fair value at the balance sheet date. If the Corporation does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

 

The Corporation’s assessment of whether an impairment is other than temporary includes factors such as whether the issuer has defaulted on scheduled payments, announced a restructuring and/or filed for bankruptcy, has disclosed severe liquidity problems that cannot be resolved, disclosed a deteriorating financial condition or sustained significant losses. The Corporation maintains a watch list for the identification and monitoring of securities experiencing problems that require a heightened level of review. This could result from credit rating downgrades.

 

13
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table presents detailed information for each trust preferred security held by the Corporation at June 30, 2014 which has at least one rating below investment grade.

 

Deal Name  Single
Issuer or
Pooled
  Class/
Tranche
   Amortized
Cost
   Fair
Value
   Gross
Unrealized
Gain (Loss)
   Lowest
Credit
Rating
Assigned
  Number of
Banks
Currently
Performing
   Deferrals
and Defaults
as % of
Original
Collateral
  Expected
Deferral/Defaults
as % of
Remaining
Performing
Collateral
   (dollars in thousands)
Countrywide Capital IV  Single   n/a   $1,771   $1,819   $48   BB+   1   None  None
Countrywide Capital V  Single   n/a    2,747    2,858    111   BB+   1   None  None
Countrywide Capital V  Single   n/a    250    260    10   BB+   1   None  None
Nationsbank Cap Trust III  Single   n/a    1,574    1,335    (239)  BB+   1   None  None
Morgan Stanley Cap Trust IV  Single   n/a    2,500    2,515    15   BB+   1   None  None
Morgan Stanley Cap Trust IV  Single   n/a    1,743    1,759    16   BB+   1   None  None
Goldman Sachs  Single   n/a    1,000    1,139    139   BB+   1   None  None
Stifel Financial  Single   n/a    4,500    4,651    151   BBB-   1   None  None
Total          $16,085   $16,336   $251               

 

Credit Loss Portion of OTTI Recognized in Earnings on Debt Securities

 

   Six Months
Ended
June 30,
2014
   Year
Ended
December 31,
2013
 
   (in thousands) 
Balance of credit-related OTTI at January 1,  $   $4,450 
Addition:          
Credit losses on investment securities for which other-than-temporary impairment was not previously recognized       652 
Reduction:          
Credit losses on investment securities sold during the period       (5,102)
Balance of credit-related OTTI at period end  $   $ 

 

14
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Temporarily Impaired Investments

 

For all securities, the Corporation does not believe that the unrealized losses, which were comprised of 81 investment securities as of June 30, 2014, represent an other-than-temporary impairment. The gross unrealized losses of $1.2 million associated with U.S. Treasury and agency securities, federal agency obligations, mortgage-backed securities, corporate bonds, tax-exempt securities, mutual funds and equity securities are not considered to be other than temporary because these unrealized losses are related to changes in interest rates and do not affect the expected cash flows of the underlying collateral or issuer.

 

Factors affecting the market price include credit risk, market risk, interest rates, economic cycles, and liquidity risk. The magnitude of any unrealized loss may be affected by the relative concentration of the Corporation’s investment in any one issuer or industry. The Corporation has established policies to reduce exposure through diversification of concentration of the investment portfolio including limits on concentrations to any one issuer. The Corporation believes the investment portfolio is prudently diversified.

 

The decline in value is related to a change in interest rates and subsequent change in credit spreads required for these issues affecting market price. All issues are performing and are expected to continue to perform in accordance with their respective contractual terms and conditions. Short to intermediate average durations and in certain cases monthly principal payments should reduce further market value exposure to increases in rates.

 

The Corporation evaluates all securities with unrealized losses quarterly to determine whether the loss is other than temporary. Unrealized losses in the corporate debt securities category consists primarily of senior unsecured corporate debt securities issued by large financial institutions, insurance companies and other corporate issuers and single issuer corporate trust preferred securities. None of the corporate issuers have defaulted on interest payments. The unrealized loss in equity securities consists of losses on other bank equities. The decline in fair value is due in large part to the lack of an active trading market for these securities, changes in market credit spreads and rating agency downgrades. Management concluded that these securities were not other-than-temporarily impaired at June 30, 2014. Future deterioration in the credit quality of these large financial institution issuers of TRUP debt securities could result in impairment charges in the future.

 

In determining that the securities giving rise to the previously mentioned unrealized losses were not other-than-temporary, the Corporation evaluated the factors cited above, which the Corporation considers when assessing whether a security is other-than-temporarily impaired. In making these evaluations the Corporation must exercise considerable judgment. Accordingly there can be no assurance that the actual results will not differ from the Corporation’s judgments and that such differences may not require the future recognition of other-than-temporary impairment charges that could have a material effect on the Corporation’s financial position and results of operations. In addition, the value of, and the realization of any loss on an investment security are subject to numerous risks as cited above.

 

15
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following tables indicate gross unrealized losses not recognized in income and fair value, aggregated by investment category and the length of time individual securities have been in a continuous unrealized loss position at June 30, 2014 and December 31, 2013:

 

   June 30, 2014 
   Total   Less than 12 Months   12 Months or Longer 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
   (in thousands) 
Investment Securities Available-for-Sale:                              
U.S. Treasury and agency securities  $9,472   $(136)  $   $   $9,472   $(136)
Federal agency obligations   8,093    (111)   3,949    (37)   4,144    (74)
Residential mortgage pass-through securities   3,698    (13)   448    (1)   3,250    (12)
Commercial mortgage pass-through securities   3,021    (51)           3,021    (51)
Trust preferred securities   1,335    (239)           1,335    (239)
Corporate bonds and notes   7,410    (43)   5,445    (25)   1,965    (18)
Certificates of deposit   217    (5)   217    (5)        
Equity securities   294    (83)           294    (83)
Mutual funds and money market funds   5,401    (100)   4,413    (89)   988    (11)
Total   38,941    (781)   14,472    (157)   24,469    (624)
Investment Securities Held-to-Maturity:                              
U.S. Treasury and agency securities  $   $   $   $   $   $ 
Federal agency obligations   1,757    (19)   1,757    (19)        
Residential mortgage pass-through securities                        
Commercial mortgage pass-through securities   1,409    (18)           1,409    (18)
Obligations of U.S. states and political subdivisions   33,586    (410)   13,955    (48)   19,631    (362)
Total   36,752    (447)   15,712    (67)   21,040    (380)
Total Temporarily Impaired Securities  $75,693   $(1,228)  $30,184   $(224)  $45,509   $(1,004)

 

16
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

   December 31, 2013 
   Total   Less than 12 Months   12 Months or Longer 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
   (in thousands) 
Investment Securities Available-for-Sale:                              
U.S. Treasury and agency securities  $13,519   $(825)  $13,519   $(825)  $   $ 
Federal agency obligation   17,200    (655)   17,200    (655)        
Residential mortgage pass-through securities   18,293    (229)   18,293    (229)        
Commercial mortgage pass-through securities   2,924    (157)   2,924    (157)        
Obligations of U.S. states and political subdivisions   4,199    (55)   4,199    (55)        
Trust preferred securities   5,306    (510)   4,031    (211)   1,275    (299)
Corporate bonds and notes   32,498    (482)   30,533    (448)   1,965    (34)
Certificates of deposit   552    (20)   552    (20)        
Equity securities   287    (89)           287    (89)
Mutual funds and money market funds   985    (15)           985    (15)
Total   95,763    (3,037)   91,251    (2,600)   4,512    (437)
Investment Securities Held-to-Maturity:                              
U.S. Treasury and agency securities  $27,037   $(1,019)  $27,037   $(1,019)  $   $ 
Federal agency obligation   13,492    (389)   13,197    (388)   295    (1)
Residential mortgage pass-through securities   2,182    (64)   2,182    (64)        
Commercial mortgage pass-through securities   1,395    (62)   1,395    (62)        
Obligations of U.S. states and political subdivisions   66,034    (3,688)   57,072    (2,957)   8,962    (731)
Corporate bonds and notes   27,210    (622)   27,210    (622)        
Total   137,350    (5,844)   128,093    (5,112)   9,257    (732)
Total Temporarily Impaired Securities  $233,113   $(8,881)  $219,344   $(7,712)  $13,769   $(1,169)

 

Investment securities having a carrying value of approximately $140.0 million and $109.3 million at June 30, 2014 and December 31, 2013, respectively, were pledged to secure public deposits, borrowings, and Federal Home Loan Bank advances and for other purposes required or permitted by law.

 

Note 6. 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. Past due status is based on the contractual terms of the loan. 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.

 

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 the 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 and are in the process of collection), 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.

 

17
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 and six months of payments have been received to demonstrate that the borrower can continue to meet the loan terms. 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. 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.

 

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. The Corporation has defined its population of impaired loans to include all classes of non-accrual and troubled debt restructuring (“TDR”) loans. As part of the evaluation of impaired loans, the Corporation individually reviews for impairment all non-homogeneous loans (in each instance, above an established dollar threshold of $200,000) internally classified as substandard or below. Generally, smaller impaired non-homogeneous loans and impaired homogeneous loans are collectively evaluated for impairment.

 

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), 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.

 

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 for loan losses and the reserve for unfunded commitments (the “Unfunded Commitments”).

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for probable incurred credit 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 Corporation’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.

 

18
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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.

 

Composition of Loan Portfolio

 

The following table sets forth the composition of the Corporation’s loan portfolio, including net deferred fees and costs, at June 30, 2014 and December 31, 2013:

 

   June 30,   December 31,
   2014    2013  
   (in thousands)
Commercial and industrial  $245,930   $229,688 
Commercial real estate   565,397    536,539 
Construction   46,705    42,722 
Residential mortgage   147,128    150,571 
Installment   617    1,084 
Subtotal   1,005,777    960,604 
Net deferred loan costs   479    339 
Total loans  $1,006,256   $960,943 

 

At June 30, 2014 and December 31, 2013, loans to executive officers and directors aggregated approximately $19,949,000 and $20,365,000, respectively. During the six months ended June 30, 2014, the Corporation made new loans and advances to executive officers and directors in the amount of $1,319,000. Payments and payoffs by such persons during the six months ended June 30, 2014 aggregate $1,735,000.

 

19
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

At June 30, 2014 and December 31, 2013, loan balances of approximately $503.3 million and $564.7 million, respectively, were pledged to secure borrowings from the Federal Home Loan Bank of New York.

 

The following table presents information about the recorded investment loan receivables on non-accrual status by class at June 30, 2014 and December 31, 2013:

 

Loans Receivable on Non-Accrual Status      
   June 30,
2014
    December 31,
2013
 
    (in thousands)
Commercial and industrial  $775   $753 
Commercial real estate   1,427    744 
Residential mortgage   1,830    1,640 
Total loans receivable on non-accrual status  $4,032   $3,137 

 

Non-accrual loans and loans past due 90 days still on accrual include both smaller balance homogenous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

The amount of interest income that would have been recorded on non-accrual loans during the six months ended June 30, 2014, the year ended December 31, 2013 and six months ended June 30, 2013, had payments remained in accordance with the original contractual terms, was $109,000, $104,000 and $58,000, respectively.

 

The Corporation continuously monitors the credit quality of its loans receivable. In addition to its 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, excluding net deferred costs, about the Corporation’s loan credit quality at June 30, 2014 and December 31, 2013:

 

Credit Quality Indicators                         
   June 30, 2014 
   Pass   Special Mention    Substandard   Doubtful   Total 
    (in thousands) 
Commercial and industrial  $242,914   $1,621   $1,080   $315   $245,930 
Commercial real estate   542,940    14,438    8,019        565,397 
Construction   45,316        1,389        46,705 
Residential mortgage   143,704    969    2,455        147,128 
Installment   506        111        617 
Total loans  $975,380   $17,028   $13,054   $315   $1,005,777 
                          

   December 31, 2013 
   Pass   Special Mention   Substandard   Doubtful   Total 
   (in thousands) 
Commercial and industrial  $226,013   $1,719   $1,284   $672   $229,688 
Commercial real estate   509,679    14,544    12,316        536,539 
Construction   41,492        1,230        42,722 
Residential mortgage   147,379    978    2,214        150,571 
Installment   964        120        1,084 
Total loans  $925,527   $17,241   $17,164   $672   $960,604 

 

20
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table provides an analysis of the impaired loans, by class, at June 30, 2014 and December 31, 2013:

 

  June 30, 2014
  Recorded
Investment
  Unpaid
Principal
Balance
Related
Allowance
 
  (in thousands)
No Related Allowance Recorded
Commercial and industrial $1,000  $1,301  $ 
Commercial real estate  3,083   3,384    
Residential mortgage  1,900   2,054    
Installment  111   111    
Total $6,094  $6,850    
             
With An Allowance Recorded               
Commercial real estate $3,600  $3,600  $335 
Total $3,600  $3,600  $335 
Total            
Commercial and industrial $1,000  $1,301  $ 
Commercial real estate  6,683   6,984   335 
Residential mortgage  1,900   2,054    
Installment  111   111    
Total (including related allowance) $9,694  $10,450  $335 

 

  December 31, 2013
  Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
 
(in thousands) 
No Related Allowance Recorded            
Commercial and industrial $449  $449  $ 
Commercial real estate  10,482   10,783    
Residential mortgage  1,858   2,000    
Installment  120   120    
Total $12,909  $13,352  $ 
             
With An Allowance Recorded             
Commercial and industrial $672  $672  $300 
Commercial real estate  4,344   4,344   115 
Total $5,016  $5,016  $415 
Total            
Commercial and industrial $1,121  $1,121  $300 
Commercial real estate  14,826   15,127   115 
Residential mortgage  1,858   2,000    
Installment  120   120    
Total (including related allowance) $17,925  $18,368  $415 

 

21
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

(Unaudited)

 

The following table provides an analysis related to the average recorded investment and interest income recognized on impaired loans by class as of and for the three and six months ended June 30, 2014 and 2013.

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2014   2013   2014   2013 
   Average Recorded Investment   Interest Income Recognized   Average Recorded Investment   Interest Income Recognized   Average Recorded Investment   Interest Income Recognized   Average Recorded Investment   Interest Income Recognized 
                                 
Impaired loans with no related allowance recorded:                                        
                                         
Commercial and industrial  $1,357   $16   $   $   $1,370   $30   $   $ 
Commercial real estate   3,112    42    1,450    19    3,123    43    1,450    38 
Residential mortgage   2,229    24            2,280    31         
Installment   113    1            115    3         
Total  $6,811    83   $1,450   $19   $6,888   $107   $1,450   $38 
                                         
Impaired loans with an allowance recorded:                                        
                                         
Commercial real estate  $3,600   $43   $3,908   $34   $3,600   $85   $4,087   $68 
Residential mortgage           1,244    11            1,244    21 
Total  $3,600   $43   $5,152   $45   $3,600   $85   $5,331   $89 
                                         
Total impaired loans:                                        
                                         
Commercial and industrial  $1,357   $16   $   $   $1,370   $30   $   $ 
Commercial real estate   6,712    85    5,358    53    6,723    128    5,537    106 
Residential mortgage   2,229    24    1,244    11    2,280    31    1,244    21 
Installment   113    1            115    3         
Total  $10,411   $126   $6,602   $64   $10,488   $192   $6,781   $127 

 

Included in impaired loans at June 30, 2014 are loans that are deemed troubled debt restructurings. The recorded investment in loans include accrued interest receivable and other capitalized costs such as real estate taxes paid on behalf of the borrower and loan origination fees, net, when applicable.

 

Cash basis interest and interest income recognized on accrual basis approximate each other.

 

22

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table provides an analysis of the aging of the recorded investment of loans, excluding net deferred costs that are past due at June 30, 2014 and December 31, 2013 by class:

 

Aging Analysis

 

   June 30, 2014 
   30-59 Days
Past Due
   60-89 Days
Past Due
   90 Days or
Greater Past Due
   Total Past
Due
   Current   Total Loans
Receivable
   Loans
Receivable > 90
Days Past Due
and Accruing
 
   (in thousands) 
Commercial and Industrial  $911   $1,831   $775   $3,517   $242,413   $245,930   $ 
Commercial Real Estate   990    1,647    1,427    4,064    561,333    565,397     
Construction                   46,705    46,705     
Residential Mortgage   775    791    1,974    3,540    143,588    147,128    144 
Installment   4            4    613    617     
Total  $2,680   $4,269   $4,176   $11,125   $994,652   $1,005,777   $144 

 

   December 31, 2013 
   30-59 Days
Past Due
   60-89 Days
Past Due
   90 Days or
Greater Past Due
   Total Past
Due
   Current   Total Loans
Receivable
   Loans
Receivable > 90
Days Past Due
and Accruing
 
   (in thousands) 
Commercial and Industrial  $18   $   $753   $771   $228,917   $229,688   $ 
Commercial Real Estate   221        744    965    535,574    536,539     
Construction                   42,722    42,722     
Residential Mortgage   990    258    1,640    2,888    147,683    150,571     
Installment   5            5    1,079    1,084     
Total  $1,234   $258   $3,137   $4,629   $955,975   $960,604   $ 

 

The following table details the amount of loans receivable that are evaluated individually, and collectively, for impairment (excluding net deferred costs), and the related portion of the allowance for loan loss that is allocated to each loan portfolio class:

 

23
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Allowance for loan and lease losses

 

   June 30, 2014 
   Commercial & Industrial   Commercial
Real Estate
   Construction   Residential Mortgage   Installment   Unallocated   Total 
   (in thousands) 
Allowance for loan and lease losses:                                   
Individually evaluated for impairment  $   $335   $   $   $   $   $335 
Collectively evaluated for impairment   2,142    5,406    504    1,011    63    1,364    10,490 
Total  $2,142   $5,741   $504    1,011   $63   $1,364   $10,825 
                                    
Loans Receivable                                   
Individually evaluated for impairment  $1,000   $6,683   $   $1,900   $111   $   $9,694 
Collectively evaluated for impairment   242,915    544,960    45,316    132,955    387        966,533 
Loans acquired with discounts related to credit quality   2,015    13,754    1,389    12,273    119        29,550 
Total  $245,930   $565,397   $46,705   $147,128   $617   $   $1,005,777 

 

Allowance for loan and lease losses

 

   December 31, 2013 
   Commercial & Industrial   Commercial
Real Estate
   Construction   Residential Mortgage   Installment   Unallocated   Total 
   (in thousands) 
Allowance for loan and lease losses:                                   
Individually evaluated for impairment  $300   $115   $   $   $   $   $415 
Collectively evaluated for impairment   1,398    5,631    362    990    146    1,391    9,918 
Total  $1,698   $5,746   $362   $990   $146   $1,391   $10,333 
                                    
Loans Receivable                                   
Individually evaluated for impairment  $1,121   $14,826   $   $1,858   $120   $   $17,925 
Collectively evaluated for impairment   226,450    505,361    41,493    135,031    839        909,174 
Loans acquired with discounts related to credit quality   2,117    16,352    1,229    13,682    125        33,505 
Total  $229,688   $536,539   $42,722   $150,571   $1,084   $   $960,604 

 

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, 2013.

 

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

 

   Three Months Ended June 30, 2014 
   Commercial & Industrial   Commercial
Real Estate
   Construction   Residential Mortgage   Installment   Unallocated   Total 
   (in thousands) 
Balance at April 1,  $2,225   $5,384   $434   $1,004   $79   $1,507   $10,633 
                                    
Charge offs               (90)   (4)       (94)
                                    
Recoveries               1    1        2 
                                    
Provision   (83)   357    70    96    (13)   (143)   284 
                                    
Balance at June 30,  $2,142   $5,741   $504   $1,011   $63   $1,364   $10,825 

 

24
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

   Six Months Ended June 30, 2014 
   Commercial & Industrial   Commercial
Real Estate
   Construction   Residential Mortgage   Installment   Unallocated   Total 
   (in thousands) 
Balance at January 1,  $1,698   $5,746   $362   $990   $146   $1,391   $10,333 
                                    
Charge offs   (333)           (90)   (7)       (430)
                                    
Recoveries               11    2        13 
                                    
Provision   777    (5)   142    100    (78)   (27)   909 
                                    
Balance at June 30,  $2,142   $5,741   $504   $1,011   $63   $1,364   $10,825 

 

   Three Months Ended June 30, 2013 
   Commercial & Industrial   Commercial
Real Estate
   Construction   Residential Mortgage   Installment   Unallocated   Total 
   (in thousands) 
Balance at April 1,  $2,083   $5,353   $284   $1,378   $103   $1,031   $10,232 
                                    
Charge offs       (50)           (11)       (61)
                                    
Recoveries   21    8            2        31 
                                    
Provision   318    22    34    (37)   (65)   (272)    
                                    
Balance at June 30,  $2,422   $5,333   $318   $1,341   $29   $759   $10,202 

 

   Six Months Ended June 30, 2013 
   Commercial & Industrial   Commercial
Real Estate
   Construction   Residential Mortgage   Installment   Unallocated   Total 
   (in thousands) 
Balance at January 1,  $2,424   $5,323   $313   $1,532   $113   $532   $10,237 
                                    
Charge offs       (50)           (16)       (66)
                                    
Recoveries   21    8            2        31 
                                    
Provision   (23)   52    5    (191)   (70)   227     
                                    
Balance at June 30,  $2,422   $5,333   $318   $1,341   $29   $759   $10,202 

 

At June 30, 2014, 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, or whose terms have been modified in troubled debt restructurings.

 

25
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The policy of the Corporation generally is to grant commercial, mortgage and installment loans to 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. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

 

Loans modified in a troubled debt restructuring totaled $2.7 million at June 30, 2014, of which $1.1 million were on non-accrual status. The remaining loans modified were current and have complied with the terms of their restructure agreement. At December 31, 2013, loans modified in a troubled debt restructuring totaled $6.6 million, of which $826,000 were on non-accrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement. The Corporation has allocated $0 of specific allocations with respect to loans whose loan terms had been modified in troubled debt restructurings as of June 30, 2014 and December 31, 2013.

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the six months ended June 30, 2014 (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

Number of
Loans

 

Pre-Modification
Outstanding
Recorded
Investment

 

Post-Modification
Outstanding
Recorded
Investment

Troubled debt restructurings:

 

 

 

 

 

 

Commercial and industrial

 

 

 

1

 

 

 

$

 

672

 

 

 

$

 

315

 

Commercial real estate

 

 

 

 

 

 

 

 

 

 

 

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

 

 

1

 

 

 

 

53

 

 

 

 

51

 

Installment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

2

 

 

 

$

 

725

 

 

 

$

 

366

 

 

 

 

 

 

 

 

 

The Corporation had a $333,000 charge-off in connection with a loan modification at the time of modification during the six months ended June 30, 2014. There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the six months ended June 30, 2014.

 

On April 30, 2014, a $4.1 million performing troubled debt restructuring was upgraded to pass status.

 

There were no troubled debt restructurings that occurred during the year ended December 31, 2013. The Corporation had no loans charged-off in connection with a loan modification at the time of the modification during the year ended December 31, 2013. There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the year ended December 31, 2013.

 

In an effort to proactively manage delinquent loans, the Corporation has selectively extended to certain borrowers concessions such as rate reductions, extension of maturity dates, principal or interest forgiveness, adjusted repayment terms, forbearance agreements, or combinations of two or more of these concessions. As of June 30, 2014, loans on which concessions were made with respect to adjusted repayment terms amounted to $1.4 million. Loans on which combinations of two or more concessions were made amounted to $1.3 million. The concessions granted included principal concessions, rate reduction, adjusted repayment, extended maturity and payment deferral.

 

Note 7. Fair Value Measurements and Fair Value of Financial Instruments

 

Fair Value Measurements

 

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. The estimated fair value amounts have been measured as of March 31, 2014 and December 31, 2013, and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period end.

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

 

·Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
   
·Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
   
·Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

26

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Investment Securities Available-for-Sale

 

Where quoted prices are available in an active market, investment securities are classified in Level 1 of the valuation hierarchy. Level 1 inputs include investment securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy, include municipal bonds and certain agency collateralized mortgage obligations. In certain cases where there is limited activity in the market for a particular instrument, assumptions must be made to determine its fair value and it is classified as Level 3. Due to the inactive condition of the markets amidst the financial crisis, the Corporation treated certain investment securities as Level 3 assets in order to provide more appropriate valuations. For assets in an inactive market, the infrequent trades that do occur are not a true indication of fair value. When measuring fair value, the valuation techniques available under the market approach, income approach and/or cost approach are used. The Corporation’s evaluations are based on market data and the Corporation employs combinations of these approaches for its valuation methods depending on the asset class. In certain cases where there were limited or less transparent information provided by the Corporation’s third-party pricing service, fair value was estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

 

On a quarterly basis, management reviews the pricing information received from the Corporation’s third-party pricing service. This review process includes a comparison to non-binding third-party broker quotes, as well as a review of market-related conditions impacting the information provided by the Corporation’s third-party pricing service.

 

Management primarily identifies investment securities which may have traded in illiquid or inactive markets by identifying instances of a significant decrease in the volume and frequency of trades, relative to historical levels, as well as instances of a significant widening of the bid-ask spread in the brokered markets. Investment securities that are deemed to have been trading in illiquid or inactive markets may require the use of significant unobservable inputs. For example, management may use quoted prices for similar investment securities in the absence of a liquid and active market for the securities being valued. As of June 30, 2014 and December 31, 2013, management made no adjustments to prices provided by the third-party pricing service as a result of illiquid or inactive markets.

 

The Corporation determined that an income approach valuation technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at the prior measurement dates. As a result, the Corporation used the discount rate adjustment technique to determine fair value.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2014 and December 31, 2013 are as follows: 

 

27

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

       Fair Value Measurements at
Reporting Date Using
 
Assets Measured at Fair Value on a Recurring Basis  June 30,
2014
   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
U.S. Treasury & agency securities  $9,472   $9,472   $   $ 
Federal agency obligations   22,648        22,648     
Residential mortgage pass-through securities   45,919        45,919     
Commercial mortgage pass-through securities   3,021        3,021     
Obligations of U.S. states and political subdivisions   6,503        6,503     
Trust preferred securities   16,336        16,336     
Corporate bonds and notes   139,327        139,327     
Asset-backed securities   15,176        15,176     
Certificates of deposit   2,132        2,132     
Equity securities   293    293         
Mutual funds and money market funds   6,132    6,132         
Investment securities available-for-sale  $266,959   $15,897   $251,062   $ 

 

       Fair Value Measurements at
Reporting Date Using
 
Assets Measured at Fair Value on a Recurring Basis  December 31,
2013
   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
U.S. Treasury and agency securities  $13,519   $13,519   $   $ 
Federal agency obligations   19,941        19,941     
Residential mortgage pass-through securities   48,874        48,874     
Commercial mortgage pass-through securities   6,991        6,991     
Obligations of U.S. states and political subdivisions   31,460        31,460     
Trust preferred securities   19,403        19,403     
Corporate bonds and notes   158,630        158,630     
Asset-backed securities   15,979        15,979     
Certificates of deposit   2,262        2,262     
Equity securities   287    287         
Mutual funds and money market funds   5,724    5,724         
Securities available-for-sale  $323,070   $19,530   $303,540   $ 

 

The fair values used by the Corporation are obtained from an independent pricing service and represent either quoted market prices for the identical securities (Level 1 inputs) or fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2).

 

28

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following tables present the changes in investment securities available-for-sale with significant unobservable inputs (Level 3) for the three months ended June 30, 2014 and 2013.

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
   (in thousands) 
Balance, beginning of the period  $   $44   $   $36 
Interest payment deferrals       15        29 
Principal repayments                
Total net losses included in net income                
Total net unrealized (losses) gains       13        7 
Balance, end of the period      $72       $72 

 

For the six months ended June 30, 2014, there were no transfers of investment securities available-for-sale into or out of Level 1, Level 2, or Level 3 assets.

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

For assets measured at fair value on a non-recurring basis, the unobservable inputs used to derive fair value measurements at June 30, 2014 and December 31, 2013 were as follows:

 

Impaired Loans   Valuation Techniques   Range of Unobservable Inputs
Residential   Appraisals of collateral value   Adjustment for age of comparable sales, generally a decline of 0% to 25%
Commercial   Discounted cash flow model   Discount rate from 0% to 6%
Commercial real estate   Appraisals of collateral value   Market capitalization rates between 8% to 12%. Market rental rates for similar properties
Construction   Appraisals of collateral value   Adjustment for age comparable sales. Generally a decline of 0% to 5%
         
Other Real Estate Owned        
Residential   Appraisals of collateral value   Adjustment for age of comparable sales, generally a decline of 0% to 25%
Commercial   Appraisals of collateral value   Adjustment for age of comparable sales, generally a decline of 0% to 15%

 

          Fair Value Measurements at Reporting Date Using  
Assets Measured at Fair Value on a Non-Recurring Basis  

June 30,

2014

   

Quoted

Prices

in Active

Markets for

Identical

Assets

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

 

Impaired Loans

(in thousands)  
 Commercial real estate   $ 3,265   $                      $   $   3,265  

 

Other Real Estate Owned

                               
 Residential     220                   220  

 

 

 

                               
          Fair Value Measurements at Reporting Date Using  
Assets Measured at Fair Value on a Non-Recurring Basis   December 31,
2013
   

Quoted

Prices

in Active

Markets for

Identical

Assets

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

 

Impaired Loans

(in thousands)  
Commercial and industrial   $ 372     $     $     $ 372  
Commercial real estate     4,229                   4,229  

 

Other Real Estate Owned

Residential

    220                   220  
                                   

 

 

29

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following methods and assumptions were used to estimate the fair values of the Corporation’s assets measured at fair value on a non-recurring basis at June 30, 2014 and December 31, 2013.

 

Impaired Loans. The value of an impaired loan is measured based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan is collateral dependent. Smaller balance homogeneous loans that are collectively evaluated for impairment, such as residential mortgage loans and installment loans, are specifically excluded from the impaired loan portfolio. The Corporation’s impaired loans are primarily collateral dependent. Impaired loans are individually assessed to determine that each loan’s carrying value is not in excess of the fair value of the related collateral or the present value of the expected future cash flows. Impaired loans at June 30, 2014 that required a valuation allowance during 2014 were $3.6 million with a related valuation allowance of $335,000 compared to $5.0 million with a related valuation allowance of $415,000 at December 31, 2013. Additional provision for loan losses of $110,000 and $222,000 for the second quarter and first six months of 2014, respectively, were recorded.

 

Other Real Estate Owned. Other real estate owned (“OREO”) is measured at fair value less costs to sell, generally a decline of 0% to 25% for residential OREO and a decline of 0% to 15% for commercial OREO. The Corporation believes that the fair value component in its valuation follows the provisions of FASB ASC 820-10-05. The fair value of OREO is determined by sales agreements or appraisals by qualified licensed appraisers approved and hired by the Corporation. Costs to sell associated with OREO are based on estimation per the terms and conditions of the sales agreements or appraisals.

 

Cash and due from banks and interest bearing deposits: The carrying amounts of cash and short-term instruments approximate fair values and care classified as Level 1.

 

Investment in Restricted Stock: It is not practical to determine the fair value of FHLB Stock due to restrictions placed on its transferability.

 

Fair Value of Financial Instruments

 

FASB ASC 825-10 requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Corporation, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in FASB ASC 825-10. Many of the Corporation’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Corporation’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities except for loans held-for-sale and investment securities available-for-sale. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Corporation for the purposes of this disclosure.

 

Investment Securities Held-to-Maturity. The fair value of the Corporation’s investment securities held-to-maturity was primarily measured using information from a third-party pricing service. If quoted prices were not available, fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. In cases where there may be limited or less transparent information provided by the Corporation’s third-party pricing service, fair value may be estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

 

Loans Held-for-Sale. Fair value is estimated using the prices of the Corporation’s existing commitments to sell such loans and/or the quoted market price for commitments to sell similar loans.

 

Loans. The fair value of the Corporation’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were segregated by types such as commercial, residential and consumer loans. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

 

Non-Interest-Bearing Deposits. The fair value for non-interest-bearing deposits is equal to the amount payable on demand at the reporting date.

 

Interest-Bearing Deposits. The fair values of the Corporation’s interest-bearing deposits were estimated using discounted cash flow analyses. The discounted rates used were based on rates currently offered for deposits with similar remaining maturities. The fair values of the Corporation’s interest-bearing deposits do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

 

Term Borrowings and Subordinated Debentures. The fair value of the Corporation’s long-term borrowings and subordinated debentures were calculated using a discounted cash flow approach and applying discount rates currently offered based on weighted remaining maturities.

 

Accrued Interest Receivable/Payable. The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

 

30

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Corporation’s financial instruments as of June 30, 2014 and December 31, 2013.

 

           Fair Value Measurements 
   Carrying
Amount
   Fair Value   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
June 30, 2014                    
Financial assets                         
Cash and due from banks  $92,617   $92,617   $92,617   $   $ 
Investment securities available-for-sale   266,959    266,959    15,897    251,062     
Investment securities held-to-maturity   218,159    222,503    28,416    175,210    18,877 
Investment in restricted stock   11,289    n/a    n/a    n/a    n/a 
Net loans   995,431    992,632            992,632 
Accrued interest receivable   6,414    6,414    89    3,568    2,757 
                          
Financial liabilities                         
Non interest-bearing deposits   238,138    238,138    238,138         
Interest-bearing deposits   1,036,482    1,043,230        1,043,230     
Borrowings   196,000    209,075        209,075     
Subordinated debentures   5,155    4,923        4,923     
Accrued interest payable   998    998        998     
                          
December 31, 2013                         
Financial assets                         
Cash and due from banks  $82,692   $82,692   $82,692   $   $ 
Investment securities available-for-sale   323,070    323,070    19,530    303,540     
Investment securities held-to-maturity   215,286    210,958    27,037    164,940    18,981 
Investment in restricted stock   8,986    n/a    n/a    n/a    n/a 
Net loans   950,610    948,606            948,606 
Accrued interest receivable   6,802    6,802    102    4,034    2,666 
                          
Financial liabilities                         
Non interest-bearing deposits   227,370    227,370    227,370         
Interest-bearing deposits   1,114,635    1,115,781        1,115,781     
Long-term borrowings   146,000    157,440        157,440     
Subordinated debentures   5,155    5,143        5,143     
Accrued interest payable   963    963        963     

 

31

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 8. Accumulated Other Comprehensive Income

 

Accumulated other comprehensive income (loss) at June 30, 2014 and December 31, 2013 consisted of the following:

 

     June 30,
2014
    December 31,
2013
 
     (in thousands) 
  Net unrealized gain on investment securities available-for-sale, net of tax  $5,304   $2,374 
  Unamortized component of securities transferred from available-for-sale to held-to-maturity, net of tax   (1,368)   (1,425)
  Defined benefit pension and post-retirement plans, net of tax   (2,735)   (3,493)
  Total accumulated other comprehensive income (loss)  $1,201   $(2,544)

 

Note 9. Stock-Based Compensation

 

The Corporation maintains two stock-based compensation plans from which new grants could be issued. The Corporation’s stock-based compensation 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 363,081 shares are available for grant and issuance as of June 30, 2014. Under the 2003 Non-Employee Director Stock Option Plan, a total of 380,644 shares remain available for grant and issuance under the plan as of June 30, 2014. 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 share-based payment awards is based on the grant date fair value estimated on the date of grant. The Corporation recognizes compensation costs for 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 three years. The Corporation estimates the forfeiture rate based on its historical experience during the preceding seven fiscal years.

 

For the six months ended June 30, 2014, the Corporation’s income before income taxes and net income were reduced by $34,000 and $20,000, respectively; as a result of the compensation expense related to stock options and restricted stock awards. For the six months ended June 30, 2013, the Corporation’s income before income taxes and net income were reduced by $25,000 and $15,000, respectively, as a result of the compensation expense related to stock options.

 

Under the principal stock-based compensation plans, the Corporation may also grant stock awards to certain employees. Stock awards are independent of option grants and are generally subject to forfeiture if employment terminates prior to the release of any applicable restrictions. Unless fully vested at the time of grant, 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 and stock awards that are fully vested at the time of grant have the same cash dividend and voting rights as other common stock and are considered to be currently issued and outstanding. The Corporation expenses the cost of 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 any restrictions lapse.

 

There were 18,829 restricted stock awards outstanding at June 30, 2014 and June 30, 2013. These awards were issued with an award price equal to the market price of the Corporation’s common stock on the award date and with a five year vesting period. Forfeiture provisions exist for personnel that separate employment before the vesting period expires. During the first sixth months of 2014, none of the shares of restricted stock were vested. All shares of restricted stock were fully vested on July 1, 2014.

 

32

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

There were 0 and 31,257 shares of common stock underlying options that were granted during the three and six months ended June 30, 2014 and 2013, 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:

 

   Six Months Ended
June 30,
 
   2014  2013 
Weighted average fair value of grants   n/a   $2.50 
Risk-free interest rate   n/a    1.86%
Dividend yield   n/a    1.76%
Expected volatility   n/a    23.21%
Expected life in months   n/a    69 

 

Activity under the stock-based compensation plans as of June 30, 2014 and changes during the sixth months ended June 30, 2014 were as follows:

 

   Shares   Weighted-
Average
Exercise
Price
   Weighted-
Average
Remaining
Contractual
Term (Years)
   Aggregate
Intrinsic
Value
 
Outstanding at December 31, 2013   214,263   $10.59           
Granted – options                   
Exercised   44,478   $10.78           
Canceled/expired                   
Forfeited                   
Outstanding at June 30, 2014   169,785   $10.54    5.96   $1,474,951 
Exercisable at June 30, 2014   120,343   $10.05    5.01   $1,105,335 

 

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 second quarter of 2014 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 June 30, 2014. This amount changes based on the fair value of the Corporation’s stock.

 

As of June 30, 2014, there was approximately $117,000 of total unrecognized compensation expense relating to unvested stock options. These costs are expected to be recognized over a weighted average period of 2.5 years. As of June 30, 2014, there was approximately $194,000 of total unrecognized compensation expense relating to unvested restricted stock awards. These costs are expected to be recognized over a weighted average period of 5.0 years.

 

Note 10. Components of Net Periodic Pension Cost

 

The Corporation maintained a non-contributory defined benefit pension plan for substantially all of its employees until September 30, 2007, at which time the Corporation froze the plan. The following table sets forth the net periodic pension cost of the Corporation’s pension plan for the periods indicated.

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2014   2013   2014   2013 
   (in thousands) 
Interest cost  $144   $132   $288   $264 
Expected return on plan assets   (149)   (148)   (298)   (244)
Net amortization and deferral   56    94    112    188 
Net periodic pension cost  $51   $78   $102   $208 

 

Contributions

 

The Corporation presently estimates that it will contribute $400,000 to its Pension Trust for 2014. The trust is established to provide retirement and other benefits for eligible employees and their beneficiaries. No part of the trust assets may be applied to any purpose other than providing benefits under the plan and for defraying expenses of administering the plan and the trust.

 

33
 

Item 2. Management’s Discussion and Analysis 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 Corporation’s results of operations for the periods presented herein and financial condition as of June 30, 2014 and December 31, 2013. In order to fully understand this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing elsewhere in this report.

 

Cautionary Statement Concerning Forward-Looking Statements

 

This report 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. This report contains certain forward-looking statements with respect to 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, sovereign debt problems, 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 is engaged, including, without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010; (7) changes and trends in the securities markets may adversely impact ConnectOne Bancorp; (8) a delayed or incomplete resolution of regulatory issues could adversely impact planning by ConnectOne Bancorp; (9) the impact on reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; and (10) the outcome of regulatory and legal investigations and proceedings may not be anticipated. Further information on other factors that could affect the financial results of ConnectOne Bancorp is included in Item 1A. of ConnectOne Bancorp’s 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.

 

Critical Accounting Policies and Estimates

 

The accounting and reporting policies followed by ConnectOne Bancorp, Inc. and its subsidiaries (collectively, the “Corporation”) conform, in all material respects, to U.S. generally accepted accounting principles. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and for the periods indicated in the consolidated statements of operations. Actual results could differ significantly from those estimates.

 

The Corporation’s accounting policies are fundamental to understanding Management’s Discussion and Analysis (“MD&A”) of financial condition and results of operations. The Corporation has identified the determination of the allowance for loan losses, the other-than-temporary impairment evaluation of securities, the evaluation of the impairment of goodwill and the evaluation of deferred tax assets to be critical because management must make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available. Additional information on these policies is provided below.

 

Allowance for Loan Losses and Related Provision

 

The allowance for loan losses represents management’s estimate of probable credit 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, individual credit situation 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 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.

 

34
 

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 in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect the 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. 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.

 

Other-Than-Temporary Impairment of Investment Securities

 

Investment securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. FASB ASC 320-10-65 clarifies the interaction of the factors that should be considered when determining whether a debt security is other–than-temporarily impaired. For debt securities, management assesses whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery.

 

In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

 

Fair Value of Investment Securities

 

FASB ASC 820-10-35 clarifies the application of the provisions of FASB ASC 820-10-05 in an inactive market and how an entity would determine fair value in an inactive market. The Corporation applies the guidance in FASB ASC 820-10-35 when determining fair value for the Corporation’s private label collateralized mortgage obligations, pooled trust preferred securities and single name corporate trust preferred securities. See Note 8 of the Notes to Consolidated Financial Statements for further discussion.

 

FASB ASC 820-10-65 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10-05 when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

 

Goodwill

 

The Corporation adopted the provisions of FASB ASC 350-10, which requires that goodwill be reported separate from other intangible assets in the Consolidated Statements of Condition and not be amortized but rather tested for impairment annually or more frequently if impairment indicators arise. No impairment charge was deemed necessary for the three and six months ended June 30, 2014 and 2013.

 

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 Corporation’s consolidated financial statements or tax returns.

 

Fluctuations in the actual outcome of these future tax consequences could impact the Corporation’s consolidated financial condition or results of operations. Note 12 of the 2013 Form 10-K of the Notes to Consolidated Financial Statements includes additional discussion on the accounting for income taxes.

 

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Operating Results Overview

 

Net income available to common stockholders for the three months ended June 30, 2014 amounted to $4.4 million compared to $4.9 million for the comparable three-month period ended June 30, 2013. The Corporation recorded earnings per diluted common share of $0.26 for the three months ended June 30, 2014 as compared with earnings of $0.30 per diluted common share for the same three months in 2013. The annualized return on average assets was 1.06% for the three months ended June 30, 2014, compared to 1.22% for the three months ended June 30, 2013. The annualized return on average stockholders’ equity was 9.92% for the three-month period ended June 30, 2014, compared to 11.84% for the three months ended June 30, 2013.

 

Net income available to common stockholders for the six months ended June 30, 2014 amounted to $8.7 million compared to $9.8 million for the comparable six-month period ended June 30, 2013. The Corporation recorded earnings per diluted common share of $0.53 for the six months ended June 30, 2014 as compared with earnings of $0.60 per diluted common share for the same six months in 2013. The annualized return on average assets was 1.05% for the six months ended June 30, 2014, compared to 1.22% for six months ended June 30, 2013. The annualized return on average stockholders’ equity was 9.97% for the six-month period ended June 30, 2013, compared to 11.96% for the six months ended June 30, 2013.

 

Net Interest Income and Margin

 

Net interest income is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets. Net interest income is presented on a tax-equivalent basis by adjusting tax-exempt income (primarily interest earned on obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues. Net interest margin is defined as net interest income on a tax-equivalent basis as a percentage of total average interest-earning assets.

 

The following table presents the components of net interest income on a tax-equivalent basis for the periods indicated.

 

Net Interest Income

(tax-equivalent basis)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
(dollars in thousands)  2014   2013   Increase
(Decrease)
   Percent
Change
   2014   2013   Increase
(Decrease)
   Percent Change 
Interest income:                                        
Investment securities AFS  $2,288   $3,521   $(1,233)   (35.02)%  $4,957   $7,410   $(2,453)   (33.10)%
Investment securities HTM   2,037    1,048    989    94.37    4,050    1,810    2,240    123.76 
Loans, including net costs   10,563    9,892    671    6.78    20,750    19,815    935    4.72 
Restricted investment in bank stocks, at cost   97    99    (2)   (2.02)   210    207    3    1.45 
Other interest-bearing deposits                       2    (2)   (100.00)
Total interest income   14,985    14,560    425    2.92    29,967    29,244    723    2.47 
Interest expense: