Attached files

file filename
EX-32.1 - ConnectOne Bancorp, Inc.c79152_ex32-1.htm
EX-31.2 - ConnectOne Bancorp, Inc.c79152_ex31-2.htm
EX-32.2 - ConnectOne Bancorp, Inc.c79152_ex32-2.htm
EX-31.1 - ConnectOne Bancorp, Inc.c79152_ex31-1.htm
EXCEL - IDEA: XBRL DOCUMENT - ConnectOne Bancorp, Inc.Financial_Report.xls

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 September 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   52-1273725
(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: 29,665,075 shares
(Title of Class) (Outstanding as of November 10, 2014)
 

Table of Contents

 

    Page
     
PART I – FINANCIAL INFORMATION  
     
Item  1. Financial Statements  
  Consolidated Statements of Condition at September 30, 2014 (unaudited) and December 31, 2013 3
  Consolidated Statements of Income for the three and nine months ended September 30, 2014 and 2013 (unaudited) 4
  Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2013 (unaudited) 5
  Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2014 (unaudited) and for the year ended December 31, 2013 6
  Consolidated Statements of Cash Flows for the nine months ended September 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 39
     
Item  3. Qualitative and Quantitative Disclosures about Market Risks 53
     
Item  4. Controls and Procedures 54
     
PART II – OTHER INFORMATION  
     
Item  1. Legal Proceedings 54
     
Item 1a. Risk Factors 54
     
Item  6. Exhibits 55
   
SIGNATURES 56

 

2

 

Item 1. Financial Statements

 

CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

 

(in thousands, except for share data)  September 30,
2014
   December 31,
2013
 
   (Unaudited)     
ASSETS          
Cash and due from banks  $41,041   $82,692 
Interest-bearing deposits with banks   96,972     
Cash and cash equivalents   138,013    82,692 
           
Investment securities:          
Available-for-sale   307,502    323,070 
Held-to-maturity (fair value of $222,393 and $210,958)   217,567    215,286 
Loans held for sale   920     
           
Loans receivable   2,426,765    960,943 
Less: Allowance for loan losses   12,118    10,333 
Net loans receivable   2,414,647    950,610 
           
Investment in restricted stock, at cost   17,922    8,986 
Bank premises and equipment, net   20,900    13,681 
Accrued interest receivable   10,976    6,802 
Bank-owned life insurance   51,999    35,734 
Other real estate owned   1,442    220 
Due from brokers for investment securities       8,759 
Goodwill   145,909    16,804 
Core deposit intangibles   5,070    24 
Other assets   23,390    10,414 
Total assets  $3,356,257   $1,673,082 
           
LIABILITIES          
Deposits:          
Noninterest-bearing  $471,151   $227,370 
Interest-bearing   1,998,017    1,114,635 
Total deposits   2,469,168    1,342,005 
Borrowings   420,960    146,000 
Subordinated debentures   5,155    5,155 
Other liabilities   19,135    11,338 
Total liabilities   2,914,418    1,504,498 
           
COMMITMENTS AND CONTINGENCIES          
           
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 September 30, 2014 and December 31, 2013; total liquidation value of $11,250,000 at September 30, 2014 and December 31, 2013   11,250    11,250 
Common stock, no par value, authorized 50,000,000 shares; issued 31,728,997 shares at September 30, 2014 and 18,477,412 at December 31, 2013; outstanding 29,665,075 shares at September 30, 2014 and 16,369,012 at December 31, 2013   374,287    110,056 
Additional paid-in capital   5,818    4,986 
Retained earnings   66,623    61,914 
Treasury stock, at cost (2,063,922 common shares at September 30, 2014 and 2,108,400 at December 31, 2013)   (16,717)   (17,078)
Accumulated other comprehensive income (loss)   578    (2,544)
Total stockholders’ equity   441,839    168,584 
Total liabilities and stockholders’ equity  $3,356,257   $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
September 30,
   Nine Months Ended
September 30,
 
(in thousands, except for share data)  2014   2013   2014   2013 
                 
Interest income                    
Interest and fees on loans  $28,098   $10,148   $48,670   $29,963 
Interest and dividends on investment securities:                    
Taxable   2,916    3,116    8,840    8,973 
Tax-exempt   892    1,151    2,840    3,308 
Dividends   349    126    639    378 
Interest on federal funds sold and other short-term investments   88        88    2 
Total interest income   32,343    14,541    61,077    42,624 
Interest expense                    
Deposits   2,725    1,330    5,343    3,897 
Borrowings   2,072    1,489    4,914    4,407 
Total interest expense   4,797    2,819    10,257    8,304 
Net interest income   27,546    11,722    50,820    34,320 
Provision for loan losses   1,300        2,209     
Net interest income after provision for loan losses   26,246    11,722    48,611    34,320 
Noninterest income                    
Service charges, commissions and fees   315    780    1,645    1,890 
Annuities and insurance commissions   94    92    299    338 
Bank-owned life insurance   401    265    912    1,104 
Net gains on sale of loans held for sale   65    26    144    255 
Net gains on sales of investment securities   111    343    2,100    1,286 
Other income   187    37    322    222 
Total other income   1,173    1,543    5,422    5,095 
Noninterest expense                    
Salaries and employee benefits   6,243    3,247    13,153    10,072 
Occupancy and equipment   1,781    839    3,658    2,556 
FDIC insurance   504    283    1,092    804 
Professional and consulting   530    352    1,289    801 
Marketing and advertising   209    94    276    257 
Data processing   902    362    1,761    1,058 
Merger expenses   8,784        10,573     
Loss on extinguishment of debt   4,550        4,550     
Amortization of core deposit intangible   248    6    260    19 
Other expenses   1,649    1,022    3,028    3,252 
Total other expense   25,400    6,205    39,640    18,819 
Income before income tax expense   2,019    7,060    14,393    20,596 
Income tax expense   253    1,966    3,851    5,655 
Net Income   1,766    5,094    10,542    14,941 
Less: Preferred stock dividends   28    28    84    112 
Net income available to common stockholders  $1,738   $5,066   $10,458   $14,829 
Earnings per common share                    
Basic  $0.06   $0.31   $0.50   $0.91 
Diluted   0.06    0.31    0.49    0.91 
Weighted average common shares outstanding                    
Basic   29,636,001    16,349,480    20,819,241    16,348,875 
Diluted   30,108,103    16,385,155    21,285,452    16,380,970 
Dividends per common share  $0.075   $0.075   $0.225   $0.185 

 

See accompanying notes to unaudited consolidated financial statements.

 

4

CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
(in thousands)  2014   2013   2014   2013 
Net income  $1,766   $5,094   $10,542   $14,941 
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   (1,171)   383    5,656    (10,771)
Tax effect   584    (118)   (1,882)   4,371 
Net of tax amount   (587)   265    3,774    (6,400)
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   (111)   (343)   (2,100)   (1,286)
Tax effect   42    96    601    353 
Net of tax amount   (69)   (247)   (1,499)   (933)
Amortization of unrealized holding gains on securities transferred from available-for-sale to held-to-maturity   57    (42)   156    32 
Tax effect   (24)   15    (67)   (13)
Net of tax amount   33    (27)   89    19 
Pension plan:                    
Actuarial gains           1,281     
Tax effect           (523)    
Net of tax amount           758     
Total other comprehensive (loss) income   (623)   (9)   3,122    (7,296)
Total comprehensive income  $1,143   $5,085   $13,664   $7,645 

 

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               19,925            19,925 
Other comprehensive loss, net of tax                       (7,607)   (7,607)
Dividend on series B preferred stock               (169)           (169)
Issuance cost of common stock               (13)           (13)
Cash dividends declared on common stock ($0.260 per share)               (4,581)           (4,581)
Issuance of restricted stock awards (18,829 shares)           91        152        243 
Dividend on restricted stock declared               (1)           (1)
Stock issued for options exercised (2,268 shares)           19        2        21 
Stock-based compensation             75                   75 
Balance as of December 31, 2013   11,250    110,056    4,986    61,914    (17,078)   (2,544)   168,584 
Net income               10,542             10,542 
Other comprehensive income, net of tax                       3,122    3,122 
Dividend on series B preferred stock               (84)           (84)
Issuance cost of common stock               (7)           (7)
Cash dividends declared on common stock ($0.225 per share)               (5,742)           (5,742)
Stock issued for options exercised (74,911 shares)           424        361        785 
Stock issued (13,221,152 shares) and options acquired (783,732 shares) in acquisition of Legacy ConnectOne       264,231                    264,231 
Stock-based compensation           408                408 
Balance as of September 30, 2014  $11,250   $374,287   $5,818   $66,623   $(16,717)  $578   $441,839 

 

See accompanying notes to unaudited consolidated financial statements.

 

6

CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

(in thousands)  Nine Months Ended
September 30,
 
   2014   2013 
Cash flows from operating activities:          
Net income  $10,542   $14,941 
Adjustments to reconcile net income to net cash provided by operating activities:          
Amortization of premiums and accretion of discounts on investment securities, net   1,966    2,665 
Depreciation and amortization   1,717    650 
Provision for loan losses   2,209     
Stock-based compensation (excluding tax benefit)   51    41 
Other-than-temporary impairment losses on investment securities       24 
Gains on sales of investment securities, net   (2,100)   (1,286)
Net loss on sale of other real estate owned   23    75 
Loans originated for resale   (7,316)   (14,045)
Proceeds from sale of loans held for sale   6,730    15,690 
Gains on sale of loans held for sale   (144)   (255)
Decrease in accrued interest receivable   296    277 
Increase in cash surrender value of bank-owned life insurance   (912)   (813)
Life insurance death benefit       (291)
Decrease (increase) in other assets   1,128    (2,351)
(Decrease) increase in other liabilities   (3,791)   2,446 
Net cash provided by operating activities   10,399    17,768 
           
Cash flows from investing activities:          
Investment securities available-for-sale:          
Purchases   (31,550)   (137,152)
Sales   66,738    90,773 
Maturities, calls and principal repayments   20,951    38,634 
Investment securities held-to-maturity:          
Purchases   (8,310)   (23,531)
Maturities and principal repayments   6,235    3,248 
Net (purchases) redemption of restricted investment in bank stocks   4,710    (22)
Net increase in loans   (167,314)   (68,099)
Purchases of premises and equipment   (2,199)   (535)
Proceeds from bank-owned life insurance death benefits       592 
Proceeds from sale of other real estate owned   1,562    1,230 
Cash acquired in acquisition of Legacy ConnectOne   70,318     
Net cash used in investing activities    (38,859)   (94,862)
           
Cash flows from financing activities:          
Net increase in deposits   75,821    7,395 
Net increase in borrowings   11,590     
Cash dividends on preferred stock   (84)   (112)
Cash dividends paid on common stock   (4,681)   (3,025)
Issuance of restricted stock awards       243 
Issuance cost of common stock   (7)   (9)
Tax benefit of options exercised   357     
Proceeds from exercise of stock options   785    21 
Net cash provided by financing activities   83,781    4,513 
Net change in cash and cash equivalents   55,321    (72,581)
Cash and cash equivalents at beginning of period   82,692    106,138 
           
Cash and cash equivalents at end of period  $138,013   $33,557 
                 
Supplemental disclosures of cash flow information:                
Cash payments for:                
Interest paid on deposits and borrowings   $ 10,222     $ 8,357  
Income taxes   $ 4,653     $ 2,195  

 

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, 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 nine months ended September 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 Corporation’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”). Some items in the prior year financial statements were reclassified to conform with current presentation. Reclassifications had not effect on prior year net income for stockholders’ equity.

 

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; or 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, but it is not expected to have a material impact.

 

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

FASB ASC ASU No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. In September 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 September 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.

 

FASB issued ASU 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. This update requires the creditors to reclassify loans that are within the scope of the ASU to “other receivables” upon foreclosure, rather than reclassifying them to other real estate owned. The separate other receivable recorded upon foreclosure is to be measured based on the amount of the loan balance (principal and interest) the creditor expects to recover from the guarantor. The new guidance is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The impact of adoption of this ASU by the Corporation is not expected to be material.

 

Note 3. Acquisition

 

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 (“Legacy ConnectOne”). Effective July 1, 2014 (the “Effective Time”), the Parent Corporation completed the merger contemplated by the Merger Agreement (the “Merger”) with 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 Corporation, 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 now conducts business only in the name of and under the brand of ConnectOne.

 

9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible, were recorded at their fair values as of July 1, 2014 based on management’s best estimate using the information available as of the Merger date. The application of the acquisition method of accounting resulted in the recognition of goodwill of $129,105,000 and a core deposit intangible of $5,308,000. As of July 1, 2014, Legacy ConnectOne had assets with a carrying value of approximately $1.5 billion, including loans with a carrying value of approximately $1.2 billion, and deposits with a carrying value of approximately $1.1 billion. The table below summarizes the amounts recognized as of the Merger date for each major class of assets acquired and liabilities assumed, the estimated fair value adjustments and the amounts recorded in the Corporation’s financial statements at fair value at the Merger date (in thousands):

 

Consideration paid through Center Bancorp, Inc. common stock issued to Legacy ConnectOne shareholders and fair value of stock options acceleration was $264,231  
                   
   Legacy
ConnectOne
carrying value
   Fair value
adjustments
   As recorded
at
acquisition
 
                
Cash and cash equivalents  $70,318   $   $70,318 
Investment securities   28,436     16  (a)   28,452 
Restricted stock   13,646        13,646 
Loans held for sale   190        190 
Loans   1,304,600     (5,316)  (b)   1,299,284 
Bank owned life insurance   15,481        15,481 
Premises and equipment   7,380     (905)  (c)   6,475 
Accrued interest receivable   4,470        4,470 
Core deposit and other intangibles        5,308  (d)   5,308 
Other real estate owned   2,455        2,455 
Other assets   10,636    3,650  (e)   14,286 
Deposits   (1,049,666)    (1,676)  (f)   (1,051,342)
FHLB borrowings   (262,046)    (1,324)  (g)   (263,370)
Other liabilities   (10,527)       (10,527)
Total identifiable net assets  $135,373   $(247)  $135,126 
                
Goodwill recorded in the Merger            $129,105 

 

The following provides an explanation of certain fair value adjustments presented in the above table:

 

a)Represents the fair value adjustment on investment securities held to maturity.
b)Represents the elimination of Legacy ConnectOne’s allowance for loan losses, deferred fees, deferred costs and an adjustment of the amortized cost of loans to estimated fair value, which includes an interest rate mark and credit mark.
c)Represent an adjustment to reflect the fair value of below-market rent on leased premises. The below market rent intangible asset will be amortized on a straight-line basis over the remaining term of the leases.
d)Represents intangible assets recorded to reflect the fair value of core deposits and below market rent leased premises. The core deposit asset was recorded as an identifiable intangible asset and will be amortized on an accelerated basis over the estimated average life of the deposit base.
e)Consist primarily of adjustments in net deferred tax assets resulting from the fair value adjustments related to acquired assets, liabilities assumed and identifiable intangibles recorded.
f)Represents fair value adjustment on time deposits as the weighted average interest rates of time deposits assumed exceeded the costs of similar funding available in the market at the time of the Merger, as well as the elimination of fees paid on brokered time deposits.
g)Represents the fair value adjustment on FHLB borrowings as the weighted average interest rate of FHLB borrowings assumed exceeded the cost of similar funding available in the market at the time of the Merger.

 

The amount of goodwill recorded reflects the increased market share and lending capabilities; greater access to best-in-class banking technology, and related synergies that are expected to result from the acquisition, and represents the excess purchase price over the estimated fair value of the net assets acquired by ConnectOne.

 

10

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Except for collateral dependent loans with deteriorated credit quality, the fair values for loans acquired from Legacy ConnectOne were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted by estimated future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. For collateral dependent loans with deteriorated credit quality, fair value was estimated by analyzing the value of the underlying collateral, assuming the fair values of the loan were derived from the eventual sale of the collateral. These values were discounted using marked derived rate of returns, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral. There was no carryover of Legacy ConnectOne allowance for loan losses associated with the loans that were acquired, as the loans were initially recorded at fair value on the date of the Merger.

 

The acquired loan portfolio subject to purchased credit impairment accounting guidance (ASC 310-30) as of July 1, 2014 was comprised of collateral dependent loans with deteriorated credit quality as follows (in thousands):

 

   ASC 310-30
Loans
 
Contractual principal and accrued interest at acquisition  $23,284 
Principal not expected to be collected (non-accretable discount)   (6,942)
Expected cash flows at acquisition   16,342 
Interest component of expected cash flows (accretable discount)   (5,013)
Fair value of acquired loans  $11,329 

 

The core deposit intangible asset recognized is being amortized over its estimated useful life of approximately 10 years utilizing the accelerated method. Other intangibles consist of below market rents, which are amortized over the remaining life of each lease using the straight-line method.

 

Goodwill is not amortized for book purposes; however, it is reviewed at least annually for impairment and is not deductible for tax purposes.

 

The fair value of retail demand and interest bearing deposit accounts was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was estimated by discounting the contractual future cash flows using market rates offered for time deposits of similar remaining maturities. The fair value of borrowed funds was estimated by discounting the future cash flows using market rates for similar borrowings.

 

Direct acquisition and integration costs of the Merger were expensed as incurred and totaled $10.6 million. These items were recorded as merger-related expenses on the statement of operations.

 

The following table presents selected unaudited pro forma financial information reflecting the Merger assuming it was completed as of January 1, 2014 and January 1, 2013. The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the financial results of the combined companies had the Merger actually been completed at the beginning of the periods presented, nor does it indicate future results for any other interim or full fiscal year period. Pro forma basic and diluted earnings per common share were calculated using the Corporation’s actual weighted average shares outstanding for the periods presented, plus the incremental shares issued, assuming the Merger occurred at the beginning of the periods presented. The unaudited pro forma information is based on the actual financial statements of the Corporation for the periods presented, and on the actual financial statements of the Corporation for the 2013 period presented and in 2014 until the date of the Merger, at which time Legacy ConnectOne’s results of operations were included in the Corporation’s financial statements.

 

The unaudited pro forma information, for the nine months ended September 30, 2014 and 2013, set forth below reflects the adjustments related to (a) purchase accounting fair value adjustments; (b) amortization of core deposit and other intangibles; and (c) adjustments to interest income and expense due to amortization of premiums and accretion discounts. The unaudited pro forma information give effect to the Merger as if it occurred on January 1, 2014 with respect to the pro forma information for the nine months ended September 30, 2014 and on January 1, 2013 with respect to the pro forma information for the nine months ended September 30, 2013. In the table below, merger-related expenses of $13.5 million were excluded from pro forma non-interest expenses for the nine months ended September 30, 2014. Income taxes were also adjusted to exclude income tax benefits of $3.9 million related to the merger expenses for the nine months ended September 30, 2014. Furthermore, the unaudited pro forma information does not reflect management’s estimate of any revenue enhancement opportunities or anticipated cost savings.

 

11

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

   Pro Forma for the Nine
Months Ended September
30,
 
   2014   2013 
   (in thousands, except per
share amounts)
 
Net interest income  $78,872   $71,091 
Noninterest income   6,168    5,948 
Noninterest expense   (41,073)   (34,352)
Net income   26,490    26,125 
           
Pro forma earnings per share from continuing operations:          
Basic  $0.89   $0.91 
Diluted   0.88    0.90 

 

The Corporation has determined that it is impractical to report the amounts of revenue and earnings of legacy ConnectOne since the acquisition date, July 1, 2014.  The back-office systems conversion of the combined entity took place on July 21, 2014.  Accordingly, reliable and separate complete revenue and earnings information are no longer available. In addition, such amounts would require significant estimates related to the proper allocation of merger cost saves that cannot be objectively made.

 

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.

 

Earnings per common share have been computed as follows:

 

   Three Months Ended
September 30,
   Nine Months Ended
 September 30,
 
(in thousands, except share amounts)  2014   2013   2014   2013 
Net income  $1,766   $5,094   $10,542   $14,941 
Preferred stock dividends   (28)   (28)   (84)   (112)
Net income available to common stockholders  $1,738   $5,066   $10,458   $14,829 
Basic weighted average common shares outstanding   29,636,001    16,349,480    20,819,241    16,348,875 
Effect of dilutive options   472,102    35,675    466,211    32,095 
                     
Diluted weighted average common shares outstanding   30,108,103    16,385,155    21,285,452    16,380,970 
                     
Earnings per common share:                    
Basic  $0.06   $0.31   $0.50   $0.91 
Diluted   0.06    0.31    0.49    0.91 

 

Note 5. Investment Securities

 

The Corporation’s investment securities are classified as available-for-sale and held-to-maturity at September 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 7 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.

 

12

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

   September 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  $11,517   $   $(132)  $11,385 
Federal agency obligations   33,110    75    (193)   32,992 
Residential mortgage pass-through securities   58,459    1,332    (100)   59,691 
Commercial mortgage pass-through securities   3,057        (41)   3,016 
Obligations of U.S. states and political subdivisions   8,204    225        8,429 
Trust preferred securities   16,085    465    (236)   16,314 
Corporate bonds and notes   129,550    6,300    (10)   135,840 
Asset-backed securities   21,603    151    (1)   21,753 
Certificates of deposit   2,098    32    (6)   2,124 
Equity securities   376        (87)   289 
Mutual funds and money market funds   15,808        (139)   15,669 
Total  $299,867   $8,580   $(945)  $307,502 
                     
Investment Securities Held-to-Maturity:                    
U.S. Treasury and agency securities  $28,212   $251   $   $28,463 
Federal agency obligations   21,119    112    (74)   21,157 
Residential mortgage pass-through securities   2,616    7        2,623 
Commercial mortgage pass-through securities   4,304    38    (19)   4,323 
Obligations of U.S. states and political subdivisions   123,379    3,914    (151)   127,142 
Corporate bonds and notes   37,937    762    (14)   38,685 
Total  $217,567   $5,084   $(258)  $222,393 
                     
Total investment securities  $517,434   $13,664   $(1,203)  $529,895 

 

13

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 September 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.

 

   September 30, 2014 
   Amortized
Cost
   Fair Value 
   (in thousands) 
Investment Securities Available-for-Sale:   
Due in one year or less  $14,395   $14,543 
Due after one year through five years   43,153    44,425 
Due after five years through ten years   110,494    115,594 
Due after ten years   54,125    54,275 
Residential mortgage pass-through securities   58,459    59,691 
Commercial mortgage pass-through securities   3,057    3,016 
Equity securities   376    289 
Mutual funds and money market funds   15,808    15,669 
Total  $299,867   $307,502 
Investment Securities Held-to-Maturity:          
Due in one year or less  $7,059   $7,140 
Due after one year through five years   7,907    8,056 
Due after five years through ten years   69,114    70,359 
Due after ten years   126,567    129,892 
Residential mortgage-backed securities   2,616    2,623 
Commercial mortgage pass-through securities   4,304    4,323 
Total  $217,567   $222,393 
           
Total investment securities  $517,434   $529,895 

 

14

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

For the nine months ended September 30, 2014, proceeds of available-for-sale investment securities sold amounted to approximately $67.0 million.

 

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

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
(in thousands)  2014   2013   2014   2013 
Gross gains on sales of investment securities  $111   $343   $2,122   $1,375 
Gross losses on sales of investment securities           22    89 
Net gains on sales of investment securities   111    343    2,100    1,286 
Less: tax provision on gross gains   42    96    601    353 
Gross gains on sales of investments, net of tax  $69   $247   $1,499   $933 

 

The following summarizes OTTI charges for the periods indicated.

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 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.

 

15

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

Issuer  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   $1,813    42   BB   1   None  None
Countrywide Capital V  Single  n/a   2,747    2,827    80   BB   1   None  None
Countrywide Capital V  Single  n/a   250    257    7   BB   1   None  None
Nationsbank Cap Trust III  Single  n/a   1,575    1,339    (236)  BB   1   None  None
Morgan Stanley Cap Trust IV  Single  n/a   2,500    2,517    17   BB   1   None  None
Morgan Stanley Cap Trust IV  Single  n/a   1,742    1,760    18   BB   1   None  None
Goldman Sachs  Single  n/a   1,000    1,137    137   BB   1   None  None
Stifel Financial  Single  n/a   4,500    4,664    164   BBB-   1   None  None
Total        $16,085   $16,314    229               

 

Credit Loss Portion of OTTI Recognized in Earnings on Debt Securities

 

   Nine Months
Ended
September 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  $   $ 

 

16

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 84 investment securities as of September 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, asset-backed 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 September 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-temporarily impaired, 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.

 

17

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 September 30, 2014 and December 31, 2013:

 

   September 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  $9,488   $(132)  $4,744   $(57)  $4,744   $(75)
Federal agency obligations   22,682    (193)   18,601    (113)   4,081    (80)
Residential mortgage pass-through securities   16,327    (100)   16,327    (100)        
Commercial mortgage pass-through securities   3,016    (41)           3,016    (41)
Trust preferred securities   1,338    (236)           1,338    (236)
Corporate bonds and notes   3,002    (10)   3,002    (10)        
Asset-backed securities   1,952    (1)   1,952    (1)        
Certificates of deposit   216    (6)   216    (6)        
Equity securities   289    (87)           289    (87)
Mutual funds and money market funds   11,361    (139)   10,379    (122)   982    (17)
Total   69,671   $(945)  $55,221   $(409)  $14,450   $(536)
Investment Securities Held-to-Maturity:                              
Federal agency obligations  $8,325   $(74)  $8,325   $(74)  $   $ 
Commercial mortgage pass-through securities   1,392    (19)           1,392    (19)
Obligations of U.S. states and political subdivisions   14,789    (151)   3,336    (4)   11,453    (147)
Corporate bonds and notes   2,700    (14)   2,700    (14)        
Total   27,206    (258)   14,361    (92)   12,845    (166)
Total Temporarily Impaired Securities  $96,877   $(1,203)  $69,582   $(501)  $27,295   $(702)

 

18

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 $232.9 million and $109.3 million at September 30, 2014 and December 31, 2013, respectively, were pledged to secure public deposits, borrowings, Federal Reserve Discount Window, and Federal Home Loan Bank advances and for other purposes required or permitted by law.

 

At September 30, 2014 and December 31, 2013, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

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.

 

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

 

19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 (including lease financing), commercial real estate, commercial construction, residential real estate (including home equity) and consumer.

 

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, troubled debt restructuring (“TDR”) loans and loans with a specific reserve. As part of the evaluation of impaired loans, the Corporation individually reviews for impairment all non-homogeneous loans internally classified as substandard or below. Generally, smaller impaired non-homogeneous loans and impaired homogeneous loans are collectively evaluated for impairment.

 

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 nine 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 reflects management’s best estimate of probable losses within the existing loan portfolio. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risk inherent in the loan portfolio. Additions to the allowance for loan losses are made by charges to the provision for loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.

 

The Corporation’s allowance for loan losses includes (1) specific valuation allowances for impaired loans evaluated in accordance with FASB Codification Topic 310: Receivables; (2) formulaic allowances based on historical loss experience by loan category, adjusted, as necessary, to reflect the impact of current conditions; and (3) unallocated general valuation allowances determined in accordance with FASB Codification Topic 450: Contingencies based on general economic conditions and other qualitative risk factors both internal and external to the Corporation.

 

20

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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.

 

Purchase Credit Impaired Loans

 

The Corporation purchases individual loans and groups of loans, some of which have shown evidence of credit deterioration since origination. These purchased credit impaired loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses.

 

Such purchased credit impaired loans are accounted for individually. The Corporation estimates the amount and timing of expected cash flows for each loan or pool, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).

 

Over the life of the loan , expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

 

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 September 30, 2014 and December 31, 2013:

 

   September 30,   December 31, 
   2014   2013 
   (in thousands) 
Commercial  $470,510   $229,688 
Commercial real estate   1,570,854    536,539 
Construction   141,844    42,722 
Residential real estate   241,387    150,571 
Consumer   2,640    1,084 
Subtotal   2,427,235    960,604 
Net deferred loan (fees) costs   (470)   339 
Loans receivable  $2,426,765   $960,943 

 

At September 30, 2014 and December 31, 2013, loan balances of approximately $987.5 million and $564.7 million, respectively, were pledged to secure borrowings from the Federal Home Loan Bank of New York.

 

21

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Purchase Credit Impaired Loans

 

The Corporation holds purchased loans for which there was, at their acquisition date, evidence of deterioration of credit quality since their origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans is as follows at September 30, 2014 and December 31, 2013.

 

   September 30,   December 31, 
   2014   2013 
   (in thousands) 
Commercial  $7,255   $ 
Commercial real estate   1,835     
Construction        
Residential real estate   2,262     
Consumer        
Total carrying amount  $11,352   $ 

 

For those purchased loans disclosed above, the Corporation did not increase the allowance for loan losses for the nine months ended September 30, 2014, nor did it increase the allowance for loan losses for purchased impaired loans during the nine months ended September 30, 2013.

 

The accretable yield, or income expected to be collected, on the purchased loans above is as follows at September 30, 2014 and December 31, 2013.

 

   September 30,     
   2014     
Balance at July 1  $5,013     
New loans purchased         
Accretion of income   (76)     
Reclassifications from non-accretable difference         
Disposals         
Balance at September 30  $4,937      

 

22

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

Loans Receivable on Non-Accrual Status        
         
   September 30, 2014   December 31, 2013 
   (in thousands) 
Commercial  $634   $753 
Commercial real estate   3,765    744 
Residential real estate   1,684    1,640 
Total loans receivable on non-accrual status  $6,083   $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 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. The following table presents information, excluding net deferred costs, about the Corporation’s loan credit quality at September 30, 2014 and December 31, 2013:

 

Credit Quality Indicators

 

   September 30, 2014 
   Pass   Special Mention   Substandard   Doubtful   Total 
   (in thousands) 
Commercial  $449,688   $15,447   $5,073   $302   $470,510 
Commercial real estate   1,533,499    17,521    19,834        1,570,854 
Construction   140,365        1,479        141,844 
Residential real estate   238,516        2,871        241,387 
Consumer   2,534        106        2,640 
                          
Total loans  $2,364,602   $32,968   $29,363   $302   $2,427,235 
                          
   December 31, 2013 
   Pass   Special Mention   Substandard   Doubtful   Total 
   (in thousands) 
Commercial  $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 real estate   147,379    978    2,214        150,571 
Consumer   964        120        1,084 
Total loans  $925,527   $17,241   $17,164   $672   $960,604 

 

23

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

   September 30, 2014 
   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
 
   (in thousands) 
No Related Allowance Recorded    
Commercial  $890   $663   $ 
Commercial real estate   5,005    5,654     
Residential real estate   1,957    2,288     
Consumer   106    106     
Total  $7,958   $8,711     
                
With An Allowance Recorded               
Commercial real estate  $3,600   $3,600   $323 
Total  $3,600   $3,600   $323 
Total               
Commercial  $890   $663   $ 
Commercial real estate   8,605    9,254     
Residential real estate   1,957    2,288     
Consumer   106    106     
Total  $11,558   $12,311   $323 

 

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

 

24

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 nine months ended September 30, 2014 and 2013.

 

   Three Months Ended September 30,   Nine Months Ended September 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  $897   $   $   $   $778   $30   $   $ 
Commercial real estate   5,046    31    1,275    19    5,313    74    1,275    57 
Residential real estate   1,975    0            2,044    31         
Consumer   106    2            106    5         
                                         
Total  $8,024    32   $1,275   $19   $8,241   $140   $1,275   $57 
                                         
Impaired loans with an allowance recorded:                                        
                                         
Commercial  $   $   $   $   $   $   $   $ 
Commercial real estate   3,600    37    175        3,600    122    2,302    68 
Residential real estate           1,226    10            1,226    31 
Consumer                                 
                                         
Total  $3,600   $37   $1,401   $10   $3,600   $122   $3,428   $99 
                                         
Total impaired loans:                                        
                                         
Commercial  $897   $   $   $   $778   $30   $   $ 
Commercial real estate   8,646    68    1,450    19    8,913    196    3,477    125 
Residential real estate   1,975    0    1,226    10    2,044    31    1,226    31 
Consumer   106    2            106    5         
                                         
Total  $11,624   $69   $2,676   $29    11,841   $262   $4,703   $156 

 

Included in impaired loans at September 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.

 

25

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 September 30, 2014 and December 31, 2013 by class:

 

Aging Analysis

 

   September 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  $405   $   $752   $1,157   $469,353   $470,510   $ 
Commercial real estate   951    2,044    4,020    7,015    1,563,839    1,570,854     
Construction                   141,844    141,844     
Residential real estate   347    1,763    3,403    5,513    235,874    241,387     
Consumer   17            17    2,623    2,640      
Total  $1,720   $3,807   $8,175   $13,702   $2,413,533   $2,427,235   $ 

 

   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  $18   $   $753   $771   $228,917   $229,688   $ 
Commercial Real Estate   221        744    965    535,574    536,539     
Construction                   42,722    42,722     
Residential real estate   990    258    1,640    2,888    147,683    150,571     
Consumer   5            5    1,079    1,084      
Total  $1,234   $258   $3,137   $4,629   $955,975   $960,604   $ 

 

26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

   September 30, 2014 
   Commercial   Commercial
real estate
   Construction   Residential
real estate
   Consumer   Unallocated   Total 
   (in thousands) 
Allowance for loan and lease losses:                                   
Individually evaluated for impairment  $   $323   $   $   $   $   $323 
Collectively evaluated for impairment   2,478    6,699    524    1,052    5    1,037    11,795 
Acquired with deteriorated credit quality                            
Total  $2,478   $7,022   $524   $1,052   $5   $1,037   $12,118 
                                    
Loans Receivable                                   
Individually evaluated for impairment  $68   $5,983   $   $1,733   $106   $   $7,890 
Collectively evaluated for impairment   463,187    1,563,036    141,844    237,391    2,534        2,407,992 
Acquired with deteriorated credit quality   7,255    1,835        2,263            11,353 
Total  $470,510   $1,570,854   $141,844   $241,387   $2,640   $   $2,427,235 

 

The tables above include approximately $1,275,000,000 of acquired loans for the period ended September 30, 2014 reported as collectively evaluated for impairment.

 

   December 31, 2013 
   Commercial   Commercial
real estate
   Construction   Residential
real estate
   Consumer   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   228,567    521,713    42,722    148,713    964        942,679 
Total  $229,688   $536,539   $42,722   $150,571   $1,084   $   $960,604 

 

The tables above include approximately $34,000,000 of acquired loans for the period ended December 31, 2013 reported as collectively evaluated for impairment.

 

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 September 30, 2014 
   Commercial   Commercial
real estate
   Construction   Residential
real estate
   Consumer   Unallocated   Total 
   (in thousands) 
Balance at July 1,  $2,142   $5,741   $504   $1,011   $63   $1,364   $10,825 
                                    
Charge offs                   (18)       (18)
                                    
Recoveries                   11        11 
                                    
Provision   336    1,281    20    41    (51)   (327)   1,300 
                                    
Balance at September 30,  $2,478   $7,022   $524   $1,052   $5   $1,037   $12,118 

 

27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

   Nine Months Ended September 30, 2014 
   Commercial   Commercial real estate   Construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Balance at January 1,  $1,698   $5,746   $362   $990   $146   $1,391   $10,333 
                                    
Charge offs   (333)           (108)   (7)       (448)
                                    
Recoveries               11    13        24 
                                    
Provision   1,113    1,276    162    159    (147)   (354)   2,209 
                                    
Balance at September 30,  $2,478   $7,022   $524   $1,052   $5   $1,037   $12,118 
                                    
   Three Months Ended September 30, 2013 
   Commercial   Commercial
real estate
   Construction   Residential
real estate
   Consumer   Unallocated   Total 
   (in thousands) 
Balance at July 1,  $2,422   $5,333   $318   $1,341   $29   $759   $10,202 
                                    
Charge offs   (6)               (4)       (10)
                                    
Recoveries                   2        2 
                                    
Provision   (702)   455    51    (37)   67    166     
                                    
Balance at September 30,  $1,714   $5,788   $369   $1,304   $94   $925   $10,194 
                                    
   Nine Months Ended September 30, 2013 
   Commercial   Commercial real estate   Construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Balance at January 1,  $2,424   $5,323   $313   $1,532   $113   $532   $10,237 
                                    
Charge offs   (6)   (50)           (20)       (76)
                                    
Recoveries   21    8            4        33 
                                    
Provision   (725)   507    56    (228)   (3)   393     
                                    
Balance at September 30,  $1,714   $5,788   $369   $1,304   $94   $925   $10,194 

 

28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Troubled Debt Restructurings

 

At September 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.

 

The policy of the Corporation generally is to grant commercial, mortgage and consumer 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 a recorded investment of $2.8 million at September 30, 2014, of which $1.0 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 was 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 no specific allocations with respect to loans whose loan terms had been modified in troubled debt restructurings as of September 30, 2014 and December 31, 2013.

 

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

 

       Pre-Modification  Post-Modification
       Outstanding  Outstanding
   Number of   Recorded  Recorded
   Loans   Investment  Investment
Troubled debt restructurings:            
Commercial   1  $672  $315
Commercial real estate   1   136   93
Construction         
Residential real estate   2   275   273
             
Total   4  $1,083  $681

 

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

 

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 September 30, 2014, loans on which concessions were made with respect to adjusted repayment terms amounted to $2.0 million, and deemed troubled debt restructurings. 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. 

 

29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. The estimated fair value amounts have been measured as of September 30, 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.

 

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 valuations 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 September 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.

 

30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 September 30, 2014 and December 31, 2013 are as follows: 

 

       Fair Value Measurements at
Reporting Date Using
 
Assets Measured at Fair Value on a Recurring Basis  September 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  $11,385   $11,385   $   $ 
Federal agency obligations   32,992        32,992     
Residential mortgage pass-through securities   59,691        59,691     
Commercial mortgage pass-through securities   3,016        3,016     
Obligations of U.S. states and political subdivisions   8,429        8,429     
Trust preferred securities   16,314        16,314     
Corporate bonds and notes   135,840        135,840     
Asset-backed securities   21,753        21,753     
Certificates of deposit   2,124        2,124     
Equity securities   289    289         
Mutual funds and money market funds   15,669    15,669         
                     
Investment securities available-for-sale  $307,502   $27,343   $280,159   $ 

 

       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         
                     
Investment securities available-for-sale  $323,070   $19,530   $303,540   $ 

 

31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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).

 

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

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
       (in thousands)    
Balance, beginning of the period  $   $72   $   $36 
Interest payment deferrals       14        43 
Principal repayments                
Total net losses included in net income                
Total net unrealized (losses) gains       8        15 
Balance, end of the period      $94       $94 

 

For the nine months ended September 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 September 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
         
Other Real Estate Owned        
Residential   Appraisals of collateral value   Adjustment for age of comparable sales, generally a decline of 0% to 25%

 

      Fair Value Measurements at Reporting Date Using
Assets Measured at Fair Value on a Non-Recurring Basis  September 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)      
Impaired Loans             
Commercial real estate  $3,277   $   $    $3,277 
                      
Other Real Estate Owned                     
Residential   1,442             1,442 

 

32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

       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)
 
       (in thousands)     
Impaired Loans            
Commercial  $372   $   $   $372 
Commercial real estate   4,229            4,229 
                     
Other Real Estate Owned                    
Residential   220            220 

 

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 September 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 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 September 30, 2014 that required a valuation allowance during 2014 were $3.6 million with a related valuation allowance of $323,000 compared to $5.0 million with a related valuation allowance of $415,000 at December 31, 2013. Additional provision for loan losses of $0 and $210,500 for the third quarter and first nine months of 2014, respectively, were recorded. Additional provision for loan losses of $415,000 for the year ended December 31, 2013 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.

 

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.

 

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.

 

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.

 

33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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.

 

Noninterest-Bearing Deposits. The fair value for noninterest-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.

 

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Corporation’s financial instruments as of September 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) 
September 30, 2014                    
Financial assets:                         
Cash and cash equivalents  $138,013   $138,013   $138,013   $   $ 
Investment securities available-for-sale   307,502    307,502    27,343    280,159     
Investment securities held-to-maturity   217,567    222,393    28,463    175,105    18,825 
Investment in restricted stock, at cost   17,922    n/a    n/a    n/a    n/a 
Net loans   2,414,647    2,427,263            2,427,263 
Accrued interest receivable   10,976    10,976    278    3,176    7,522 
                          
Financial liabilities:                         
Noninterest-bearing deposits  $471,151   $471,151   $471,151   $   $ 
Interest-bearing deposits   1,998,017    2,004,084        2,004,084     
Borrowings   420,960    436,366        436,366     
Subordinated debentures   5,155    4,786        4,786     
Accrued interest payable   3,811    3,811        3,811     

 

34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           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) 
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, at cost   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:                         
Noninterest-bearing deposits   227,370    227,370    227,370         
Interest-bearing deposits   1,114,635    1,115,781        1,115,781     
Borrowings   146,000    157,440        157,440     
Subordinated debentures   5,155    5,143        5,143     
Accrued interest payable   963    963        963     

 

Note 8. Accumulated Other Comprehensive Income

 

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

 

   September 30,
2014
   December 31,
2013
 
   (in thousands) 
Net unrealized gain on investment securities available-for-sale, net of tax  $4,650   $2,374 
Unamortized component of securities transferred from available-for-sale to held-to-maturity, net of tax   (1,336)   (1,425)
Defined benefit pension and post-retirement plans, net of tax   (2,736)   (3,493)
Total accumulated other comprehensive income (loss)  $578   $(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 September 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 September 30, 2014. In addition, a total of 237,621 shares remain available for grant and issuance under Legacy ConnectOne equity plans. Options may be exercised with shares issued from Treasury shares, newly issued shares or a combination of both.

 

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.

 

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 nine months ended September 30, 2014 and September 30, 2013, total stock compensation (excluding tax benefit) was $51,000 and $60,000, respectively.

 

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 52,467 and 18,829 restricted stock awards outstanding at September 30, 2014 and September 30, 2013, respectively. 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 three year vesting period. Forfeiture provisions exist for personnel that separate employment before the vesting period expires. A total of 37,110 shares of restricted stock became fully vested on July 1, 2014.

 

There were 0 and 31,257 shares of common stock underlying options that were granted during the three and nine months ended September 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: 

 

    Nine Months Ended
September 30,
 
    2014     2013  
Weighted average fair value of grants     n/a     $ 3.34  
Risk-free interest rate     n/a       1.97 %
Dividend yield     n/a       1.32 %
Expected volatility     n/a       25.84 %
Expected life in months     n/a       74  

 

Activity under the stock-based compensation plans as of September 30, 2014 and changes during the ninth months ended September 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            
Options assumed in merger   783,732    4.73            
Exercised   (74,911)  $10.48            
Canceled/expired                    
Forfeited                    
Outstanding at September 30, 2014
   923,084   $5.58    3.12    $12,522,584 
Exercisable at September 30, 2014   923,084   $5.58    3.12    $12,522,584 

 

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

 

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

As of September 30, 2014, there was approximately $0 of total unrecognized compensation expense relating to unvested stock options. As of September 30, 2014, there was approximately $425,329 of total unrecognized compensation expense relating to unvested restricted stock awards. These costs are expected to be recognized over a weighted average period of 1.8 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
September 30,
   Nine Months Ended
 September 30,
 
   2014   2013   2014   2013 
   (in thousands) 
Interest cost  $143   $133   $429   $397 
Expected return on plan assets   (148)   (122)   (444)   (366)
Net amortization and deferral   55    93    165    281 
Net periodic pension cost  $50   $