Attached files

file filename
EX-32.2 - ConnectOne Bancorp, Inc.c82943_ex32-2.htm
EX-31.2 - ConnectOne Bancorp, Inc.c82943_ex31-2.htm
EX-32.1 - ConnectOne Bancorp, Inc.c82943_ex32-1.htm
EX-31.1 - ConnectOne Bancorp, Inc.c82943_ex31-1.htm

UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

  (Mark One)    
       
  x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
       
    For the Quarterly Period Ended September 30, 2015  
       
    OR  
       
  o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
       
    For the transition period from                 to                 
       
    Commission File Number:  000-11486  

 

 

ConnectOne Bancorp, Inc.

(Exact Name of Registrant as Specified in Its Charter) 

 

New Jersey 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 x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to 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 x No o

 

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 o Accelerated filer x Non-accelerated filer o
(Do not check if smaller
reporting company)
Smaller reporting company o

 

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

 

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

 

Common Stock, no par value: 30,084,744 shares
(Title of Class) (Outstanding as of November 9, 2015)
 

Table of Contents 

 

  Page
   
PART I – FINANCIAL INFORMATION  
   
Item 1. Financial Statements  
  Consolidated Statements of Condition at September 30, 2015 (unaudited) and December 31, 2014 3
  Consolidated Statements of Income for the three and nine months ended September 30, 2015 and 2014 (unaudited) 4
  Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and 2014 (unaudited) 5
  Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2015 (unaudited) and for the year ended December 31, 2014 6
  Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014 (unaudited) 7
  Notes to Consolidated Financial Statements 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 41
     
Item 3. Qualitative and Quantitative Disclosures about Market Risks 54
     
Item 4. Controls and Procedures 55
     
PART II – OTHER INFORMATION  
   
Item 1. Legal Proceedings 56
     
Item 1a. Risk Factors 56
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 56
     
Item 3. Defaults Upon Senior Securities 56
     
Item 4. Mine Safety Disclosures 56
     
Item 5. Other Information 56
     
Item 6. Exhibits 57
     
SIGNATURES  

 

2

 

Item 1. Financial Statements

 

ConnectOne Bancorp, inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CONDITION

 

(in thousands, except for share data)   September 30,
2015
    December 31,
2014
 
    (unaudited)        
ASSETS            
Cash and due from banks   30,100     $ 31,813  
Interest-bearing deposits with banks     128,421       95,034  
Cash and cash equivalents     158,521       126,847  
                 
Investment securities:                
Available-for-sale     224,214       289,532  
Held-to-maturity (fair value of $234,493 and $231,445)     227,221       224,682  
                 
Loans held for sale     990        
Loans receivable     2,953,381       2,538,641  
Less: Allowance for loan and lease losses     21,533       14,160  
Net loans receivable     2,931,848       2,524,481  
                 
Investment in restricted stock, at cost     30,362       23,535  
Bank premises and equipment, net     21,523       20,653  
Accrued interest receivable     11,662       11,700  
Bank-owned life insurance     53,681       52,518  
Other real estate owned     3,244       1,108  
Goodwill     145,909       145,909  
Core deposit intangibles     4,125       4,825  
Other assets     24,953       22,782  
Total assets   $ 3,838,253     $ 3,448,572  
LIABILITIES                
Deposits:                
Noninterest-bearing   $ 586,643     $ 492,515  
Interest-bearing     2,079,981       1,983,092  
Total deposits     2,666,624       2,475,607  
Borrowings     621,674       495,553  
Subordinated debentures     55,155       5,155  
Other liabilities     23,654       26,038  
Total liabilities     3,367,107       3,002,353  
                 
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, 2015 and December 31, 2014; total liquidation value of $11,250 at September 30, 2015 and December 31, 2014     11,250       11,250  
Common stock, no par value, authorized 50,000,000 shares; issued 32,261,541 shares at September 30, 2015 and 31,758,558 at December 31, 2014; outstanding 30,197,619 shares at September 30, 2015 and 29,694,636 at December 31, 2014     374,287       374,287  
Additional paid-in capital     8,315       6,015  
Retained earnings     97,321       72,398  
Treasury stock, at cost (2,063,922 common shares at September 30, 2015 and December 31, 2014)     (16,717 )     (16,717 )
Accumulated other comprehensive loss     (3,310 )     (1,014 )
Total stockholders’ equity     471,146       446,219  
Total liabilities and stockholders’ equity   $ 3,838,253     $ 3,448,572  

 

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 and per share data)   2015     2014     2015     2014  
                         
Interest income                        
Interest and fees on loans   $ 32,276     $ 28,098       91,807     $ 48,670  
Interest and dividends on investment securities:                                
Taxable     2,669       2,916       8,340       8,840  
Tax-exempt     901       892       2,666       2,840  
Dividends     297       349       797       639  
Interest on federal funds sold and other short-term investments     43       88       127       88  
Total interest income     36,186       32,343       103,737       61,077  
Interest expense                                
Deposits     3,655       2,725       9,980       5,343  
Borrowings     2,804       2,072       7,060       4,914  
Total interest expense     6,459       4,797       17,040       10,257  
Net interest income     29,727       27,546       86,697       50,820  
Provision for loan and lease losses     4,175       1,300       7,550       2,209  
Net interest income after provision for loan and lease losses     25,552       26,246       79,147       48,611  
Noninterest income                                
Annuities and insurance commissions     77       94       210       299  
Bank-owned life insurance     388       401       1,162       912  
Net gains on sale of loans held for sale     63       65       276       144  
Deposit, loan and other income     1,224       502       2,145       1,967  
Insurance recovery                 2,224        
Net gains on sales of investment securities     2,067       111       2,793       2,100  
Total noninterest income     3,819       1,173       8,810       5,422  
Noninterest expenses                                
Salaries and employee benefits     6,905       6,243       20,480       13,153  
Occupancy and equipment     1,916       1,781       5,785       3,658  
FDIC insurance     535       504       1,535       1,092  
Professional and consulting     836       530       2,045       1,289  
Marketing and advertising     247       209       634       276  
Data processing     957       902       2,686       1,761  
Merger-related expenses           8,784             10,573  
Loss on extinguishment of debt           4,550       2,397       4,550  
Amortization of core deposit intangible     217       248       700       260  
Other expenses     1,688       1,649       4,643       3,028  
Total noninterest expenses     13,301       25,400       40,905       39,640  
Income before income tax expense     16,070       2,019       47,052       14,393  
Income tax expense     5,228       253       15,309       3,851  
Net income     10,842       1,766       31,743       10,542  
Less: Preferred stock dividends     28       28       84       84  
Net income available to common stockholders   $ 10,814     $ 1,738       31,659     $ 10,458  
                                 
Earnings per common share:                                
Basic   $ 0.36     $ 0.06       1.06     $ 0.50  
Diluted   $ 0.36     $ 0.06       1.04     $ 0.49  
Weighted average common shares outstanding:                                
Basic     30,045,818       29,636,001       29,786,374       20,819,241  
Diluted     30,335,571       30,108,103       30,323,376       21,285,452  
Dividend per common share   $ 0.075     $ 0.075       0.225     $ 0.225  

 

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)   2015     2014     2015     2014  
Net income   $ 10,842     $ 1,766     $ 31,743     $ 10,542  
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     108       (1,171 )     (1,196 )     5,656  
Tax effect     (39 )     584       485       (1,882 )
Net of tax amount     69       (587 )     (711 )     3,774  
Reclassification adjustment for realized gains arising during this period     (2,067 )     (111 )     (2,793 )     (2,100 )
Tax effect     794       42       1,091       601  
Net of tax amount     (1,273 )     (69 )     (1,702 )     (1,499 )
Amortization of unrealized holding losses on securities transferred from available-for-sale to held-to-maturity     37       57       165       156  
Tax effect     (15 )     (24 )     (67 )     (67 )
Net of tax amount     22       33       98       89  
Unrealized losses on cash flow hedges     (855 )           (1,153 )      
Tax effect     349             471        
Net of tax amount     (506 )           (682 )      
Pension plan:                                
Actuarial gains     183             1,186       1,281  
Tax effect     (75 )           (485 )     (523 )
Net of tax amount     108             701       758  
Total other comprehensive (loss) income     (1,580 )     (623 )     (2,296 )     3,122  
Total comprehensive income   $ 9,262     $ 1,143     $ 29,447     $ 13,664  

 

See accompanying notes to unaudited consolidated financial statements.

 

5

 

ConnectOne Bancorp, inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)

 

(dollars in thousands, except for 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, 2014   $ 11,250     $ 110,056     $ 4,986     $ 61,914     $ (17,078 )   $ (2,544 )   $ 168,584  
Net income                       18,565                   18,565  
Other comprehensive income, net of tax                                   1,530       1,530  
Dividend on series B preferred stock                       (112 )                 (112 )
Issuance cost of common stock                       (7 )                 (7 )
Cash dividends declared on common stock ($0.300 per share)                       (7,962 )                 (7,962 )
Exercise of 100,911 stock options                 806             361             1,167
Stock issued (13,221,152 shares) and options acquired (783,732 shares) in acquisition of Legacy ConnectOne           264,231                               264,231  
Stock-based compensation expense                 223                         223  
Balance as of December 31, 2014     11,250       374,287       6,015       72,398       (16,717 )     (1,014 )     446,219  
Net income                       31,743                   31,743  
Other comprehensive loss, net of tax                                   (2,296 )     (2,296 )
Dividend on series B preferred stock                       (84 )                 (84 )
Cash dividends declared on common stock ($0.225 per share)                       (6,736 )                 (6,736 )
Exercise of stock options (340,492 shares)                 1,424                         1,424  
Restricted stock and performance units grants (162,491 shares)                                          
Stock-based compensation expense                 876                         876  
Balance as of September 30, 2015   $ 11,250     $ 374,287     $ 8,315     $ 97,321     $ (16,717 )   $ (3,310 )   $ 471,146  

 

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,
 
    2015     2014  
Cash flows from operating activities:            
Net income   $ 31,743     $ 10,542  
Adjustments to reconcile net income to net cash provided by operating activities:                
Amortization of premiums and accretion of discounts on investment securities, net     1,442       1,966  
Depreciation and amortization     2,420       1,717  
Provision for loan losses     7,550       2,209  
Stock-based compensation     876       51  
Gains on sales of investment securities, net     (2,793 )     (2,100 )
Net loss on sale of other real estate owned     112       23  
Loans originated for resale     (18,004 )     (7,316 )
Proceeds from sale of loans held for sale     17,290       6,730  
Gains on sale of loans held for sale     (276 )     (144 )
Decrease in accrued interest receivable     38       296  
Increase in cash surrender value of bank-owned life insurance     (1,163 )     (912 )
(Increase) decrease in other assets     (3,324 )     1,128  
Increase (decrease) in other liabilities     294       (3,791 )
Net cash provided by operating activities     36,205       10,399  
Cash flows from investing activities:                
Investment securities available-for-sale:                
Purchases     (34,796 )     (31,550 )
Sales     44,397       66,738  
Maturities, calls and principal repayments     53,542       20,951  
Investment securities held-to-maturity:                
Purchases     (17,531 )     (8,310 )
Maturities and principal repayments     14,702       6,235  
Net (purchases) redemptions of restricted investment in bank stocks     (6,827 )     4,710  
Net increase in loans     (417,291 )     (167,314 )
Purchases of premises and equipment     (2,590 )     (2,199 )
Cash acquired in acquisition of Legacy ConnectOne           70,318  
Proceeds from sale of other real estate owned     126       1,562  
Net cash (used in) provided by investing activities     (366,268 )     (38,859 )
Cash flows from financing activities:                
Net increase in deposits     191,017       75,821  
Increase in subordinated debt     50,000        
Advances of FHLB borrowings     625,000       11,590  
Repayments of FHLB borrowings     (482,879 )      
Net decrease in repurchase agreements     (16,000 )      
Cash dividends on preferred stock     (84 )     (84 )
Cash dividends paid on common stock     (6,741 )     (4,681 )
Issuance cost of common stock           (7 )
Tax benefit of options exercised           357  
Proceeds from exercise of stock options     1,424       785  
Net cash provided (used in) by financing activities     361,737       83,781  
Net change in cash and cash equivalents     31,674       55,321  
Cash and cash equivalents at beginning of period     126,847       82,692  
                 
Cash and cash equivalents at end of period   $ 158,521     $ 138,013  
Supplemental disclosures of cash flow information:                
Cash payments for:                
Interest paid on deposits and borrowings   $ 15,940     $ 10,222  
Income taxes     17,045       4,653  
Supplemental disclosures of non-cash investing activities:                
Transfer of loans to other real estate owned     2,374        
Dividends declared, not paid     (5 )     1,063  

 

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 “Company”). All significant intercompany accounts and transactions have been eliminated from the accompanying consolidated financial statements.

 

The Bank is a community-based, full-service New Jersey-chartered commercial bank that was founded in 2005. The Bank operates from its headquarters located at 301 Sylvan Avenue in the Borough of Englewood Cliffs, Bergen County, New Jersey and through its twenty-one 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 client. However, the clients’ 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 months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2015, or for any other interim period. The Company’s 2014 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.

 

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 to current presentation. Reclassifications had no effect on prior year net income or stockholders’ equity.

 

Note 2. New Authoritative Accounting Guidance

 

ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs” requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in the ASU No. 2015-03. ASU No. 2015-03 will be effective for reporting periods (including interim periods) beginning after December 15, 2015. ASU No. 2015-03 became effective for the Company on January 1, 2015 and did not have a significant impact on its consolidated financial statements.

 

Note 3. Business Combinations

 

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 Company (“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 Company. 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.

 

8

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 3. Business Combinations – (continued)

 

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 Company’s financial statements at fair value at the Merger date (in thousands):

 

Consideration paid through Parent Corporation 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 and lease 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 above-market rent on leased premises. The above-market rent adjustment will be amortized on a straight-line basis over the remaining term of the respective leases.
d)Represents intangible assets recorded to reflect the fair value of core deposits. 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 represents the excess purchase price over the estimated fair value of the net assets acquired by the Company and reflects the economies of scale, 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.

 

9

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 3. Business Combinations – (continued)

 

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 loans were derived from the eventual sale of the collateral. These values were discounted using market derived rates 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 and lease 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 $12.4 million for the full year 2014. These items were recorded as merger-related expenses on the statement of operations.

 

Note 4. Earnings per Common Share

 

Basic earnings per common share 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 Company’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 per share amounts)  2015   2014   2015   2014 
Net income  $10,842   $1,766   $31,743   $10,542 
Less: preferred stock dividends   (28)   (28)   (84)   (84)
Net income available to common stockholders  $10,814   $1,738    31,659    10,458 
Basic weighted average common shares outstanding   30,046    29,636    29,786    20,819 
Plus: effect of dilutive options and awards   290    472    537    466 
Diluted weighted average common shares outstanding   30,336    30,108    30,323    21,285 
Earnings per common share:                    
Basic  $0.36   $0.06   $1.06   $0.50 
Diluted   0.36    0.06    1.04    0.49 

 

10

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 5. Investment Securities

 

The Company’s investment securities are classified as available-for-sale and held-to-maturity at September 30, 2015 and December 31, 2014. 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 as of September 30, 2015. Fair value is based upon either quoted market prices, or in certain cases where there is limited activity in the market for a particular instrument, assumptions are made to determine their fair value. See Note 8 of the Notes to Consolidated Financial Statements for a further discussion.

 

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

 

The following tables present information related to the Company’s investment securities at September 30, 2015 and December 31, 2014.

 

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair
Value
 
   September 30, 2015 
   (in thousands) 
Investment securities available-for-sale                    
Federal agency obligations  $30,474   $438   $(7)  $30,905 
Residential mortgage pass-through securities   46,943    1,162    (14)   48,091 
Commercial mortgage pass-through securities   2,996    59        3,055 
Obligations of U.S. states and political subdivisions   8,191    191        8,382 
Trust preferred securities   16,087    385    (150)   16,322 
Corporate bonds and notes   76,049    2,418    (81)   78,386 
Asset-backed securities   21,403    2    (275)   21,130 
Certificates of deposit   1,896    27    (3)   1,920 
Equity securities   376        (38)   338 
Other securities   15,715    67    (97)   15,685 
Total  $220,130   $4,749   $(665)  $224,214 
Investment securities held-to-maturity                    
U.S. Treasury and agency securities  $28,419   $1,328   $   $29,747 
Federal agency obligations   35,519    642    (47)   36,114 
Residential mortgage-backed securities   4,240    19    (1)   4,258 
Commercial mortgage-backed securities   4,150    97        4,247 
Obligations of U.S. states and political subdivisions   118,877    4,470    (46)   123,301 
Corporate bonds and notes   36,016    888    (78)   36,826 
Total  $227,221   $7,444   $(172)  $234,493 
                     
Total investment securities  $447,351   $12,193   $(837)  $458,707 

 

11

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 5. Investment Securities – (continued)

 

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair
Value
 
   December 31, 2014 
   (in thousands) 
Investment securities available-for-sale                    
Federal agency obligations  $32,650   $217   $(50)  $32,817 
Residential mortgage pass-through securities   58,836    1,531    (11)   60,356 
Commercial mortgage pass-through securities   3,042    4        3,046 
Obligations of U.S. states and political subdivisions   8,201    205        8,406 
Trust preferred securities   16,086    489    (269)   16,306 
Corporate bonds and notes   119,838    5,950    (11)   125,777 
Asset-backed securities   27,393    140    (31)   27,502 
Certificates of deposit   2,098    27    (2)   2,123 
Equity securities   376        (69)   307 
Other securities   12,941    33    (82)   12,892 
Total  $281,461   $8,596   $(525)  $289,532 
Investment securities held-to-maturity                    
U.S. Treasury and agency securities  $28,264   $920   $   $29,184 
Federal agency obligations   27,103    322    (28)   27,397 
Residential mortgage-backed securities   5,955    28        5,983 
Commercial mortgage-backed securities   4,266    50        4,316 
Obligations of U.S. states and political subdivisions   120,144    4,512    (60)   124,596 
Corporate bonds and notes   38,950    1,026    (7)   39,969 
Total  $224,682   $6,858   $(95)  $231,445 
                     
 Total investment securities  $506,143   $15,454   $(620)  $520,977 

 

The following table presents information for investment securities at September 30, 2015, 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, 2015 
   Amortized
Cost
   Fair
Value
 
   (in thousands) 
Investment securities available-for-sale:          
Due in one year or less  $16,296   $16,443 
Due after one year through five years   30,271    31,401 
Due after five years through ten years   55,740    56,953 
Due after ten years   51,793    52,248 
Residential mortgage pass-through securities   46,943    48,091 
Commercial mortgage pass-through securities   2,996    3,055 
Equity securities   376    338 
Other securities   15,715    15,685 
Total  $220,130   $224,214 
Investment securities held-to-maturity:          
Due in one year or less  $   $ 
Due after one year through five years   13,571    13,888 
Due after five years through ten years   76,126    78,980 
Due after ten years   129,134    133,120 
Residential mortgage-backed securities   4,240    4,258 
Commercial mortgage-backed securities   4,150    4,247 
Total  $227,221   $234,493 
Total investment securities  $447,351   $458,707 

 

12

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 5. Investment Securities – (continued)

 

Gross gains and losses from the sales, calls and maturities of investment securities for the three-month and nine-month periods ended September 30, 2015 and 2014 were as follows:

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
(in thousands)  2015   2014   2015   2014 
Proceeds  $32,125   $2,303   $44,397   $66,738 
Gross gains on sales of investment securities   2,067    111    2,793    2,122 
Gross losses on sales of investment securities               (22)
Net gains on sales of investment securities  $2,067   $111   $2,793   $2,100 
Less: tax provision on net gains   794    42    1,091    601 
Total  $1,273   $69   $1,702   $1,499 

 

The Company performs regular analysis on the securities portfolio 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 other-than-temporary impairment (“OTTI”) charges, through earnings, if they have the intent to sell, or more likely than not will be required to sell, an impaired debt security before recovery of its amortized cost basis. If the Company 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, less any current period credit loss, 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 Company does not intend to sell the security and it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period loss, and as such, it determines that a decline in fair value is other than temporary, 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 Company maintains a watch list for the identification and monitoring of securities experiencing problems that require a heightened level of review. This could include credit rating downgrades.

 

The Company’s assessment of whether an impairment in the portfolio is other than temporary includes factors such as whether the issuer has defaulted on scheduled payments, announced restructuring and/or filed for bankruptcy, has disclosed severe liquidity problems that cannot be resolved, disclosed deteriorating financial condition or sustained significant losses.

 

The following table presents detailed information for each single issuer trust preferred security held by the Company at September 30, 2015, of which all but one has at least one rating below investment grade (in thousands):

 

               Lowest
           Gross   Credit
   Amortized   Fair   Unrealized   Rating
Issuer  Cost   Value   Gain (Loss)   Assigned
                   
Countrywide Capital IV  $1,771   $1,804   $33   BB+
Countrywide Capital V   2,747    2,829    82   BB+
Countrywide Capital V   250    257    7   BB+
Nationsbank Cap Trust III   1,576    1,426    (150)  BB+
Morgan Stanley Cap Trust IV   2,500    2,537    37   BB
Morgan Stanley Cap Trust IV   1,743    1,775    32   BB
Goldman Sachs   1,000    1,149    149   BB
Stifel Financial   4,500    4,545    45   BBB-
Total  $16,087   $16,322   $235    

 

13

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 5. Investment Securities – (continued)

 

Temporarily Impaired Investments

 

The Company does not believe that the unrealized losses, for all securities, which were comprised of 57 and 54 investment securities as of September 30, 2015 and December 31, 2014, respectively, represent an other-than-temporary impairment. The gross unrealized losses associated with U.S. Treasury and agency securities, federal agency obligations, mortgage-backed securities, corporate bonds, tax-exempt securities, asset-backed securities, trust preferred 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 Company’s investment in any one issuer or industry. The Company has established policies to reduce exposure through diversification of concentration of the investment portfolio including limits on concentrations to any one issuer. The Company 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 Company evaluates all securities with unrealized losses quarterly to determine whether the loss is other than temporary. Unrealized losses in the corporate debt securities category consist primarily of senior unsecured corporate debt securities issued by large financial institutions, insurance companies and other corporate issuers. Single issuer corporate trust preferred securities are also included, and in the case of one holding the market valuation loss is largely based upon the floating rate coupon and corresponding market valuation. Neither that trust preferred issuer, nor any other 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, 2015.

 

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

 

14

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 5. Investment Securities – (continued)

 

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, 2015 and December 31, 2014:

 

   September 30, 2015 
   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:                              
Federal agency obligation  $3,743   $(7)  $3,478   $(5)  $265   $(2)
Residential mortgage pass-through securities   2,283    (14)   2,162    (13)   121    (1)
Trust preferred securities   1,426    (150)           1,426    (150)
Corporate bonds and notes   8,389    (81)   6,437    (58)   1,952    (23)
Asset-backed securities   19,628    (275)   18,359    (235)   1,269    (40)
Certificates of deposit   220    (3)   220    (3)        
Equity securities   338    (38)           338    (38)
Other securities   5,597    (97)           5,597    (97)
Total  $41,624   $(665)  $30,656   $(314)  $10,968   $(351)
                               
Investment securities held-to-maturity:                              
Federal agency obligation  $5,443   $(47)  $4,614   $(47)  $829   $ 
Residential mortgage pass-through securities   438    (1)   391    (1)   47     
Obligations of U.S. states and political subdivisions   7,313    (46)   7,313    (46)        
Corporate bonds and notes   2,670    (78)   2,670    (78)        
Total  $15,864   $(172)  $14,988   $(172)  $876   $ 
                               
Total temporarily impaired securities  $57,488   $(837)  $45,644   $(486)  $11,844   $(351)

 

15

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 5. Investment Securities – (continued)

 

   December 31, 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:                              
Federal agency obligation  $6,755   $(50)  $2,770   $(9)  $3,985   $(41)
Residential mortgage pass-through securities   5,694    (11)   5,694    (11)        
Trust preferred securities   1,307    (269)           1,307    (269)
Corporate bonds and notes   1,961    (11)   1,961    (11)        
Asset-backed securities   9,773    (31)   9,773    (31)        
Certificates of deposit   369    (2)   369    (2)        
Equity securities   307    (69)           307    (69)
Other securities   5,417    (82)   1,978    (21)   3,439    (61)
Total  $31,583   $(525)  $22,545   $(85)  $9,038   $(440)
                               
Investment securities held-to-maturity:                              
Federal agency obligation  $3,228   $(28)  $3,228   $(28)  $   $ 
Obligations of U.S. states and political subdivisions   8,341    (60)   1,401    (3)   6,940    (57)
Corporate bonds and notes   993    (7)   993    (7)        
Total  $12,562   $(95)  $5,622   $(38)  $6,940   $(57)
Total temporarily impaired securities  $44,145   $(620)  $28,167   $(123)  $15,978   $(497)

 

Investment securities having a carrying value of approximately $142.8 million and $224.7 million at September 30, 2015 and December 31, 2014, 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.

 

As of September 30, 2015 and December 31, 2014, 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 - Derivatives

 

The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swap does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.

 

Interest rate swaps were entered into on August 24, 2015, October 15, 2014 and December 30, 2014, each with a respective notional amount of $25.0 million and were designated as a cash flow hedge of a Federal Home Loan Bank advance. The swaps were determined to be fully effective during the period presented and therefore no amount of ineffectiveness has been included in net income while the aggregate fair value of the swaps is recorded in other assets (liabilities) with changes in fair value recorded in other comprehensive income (loss). The amount included in accumulated other comprehensive income (loss) would be reclassified to current earnings should the hedges no longer be considered effective. The Company expects the hedges to remain fully effective during the remaining term of the swaps.

 

16

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 6 – Derivatives – (continued)

 

Summary information about the interest rate swaps designated as cash flow hedges as of September 30, 2015 and 2014 and December 31, 2014 is presented in the following table.

 

(dollars in thousands)  September 30,
2015
   December 31,
2014
   September 30,
2014
 
Notional amount  $75,000   $50,000   $ 
Weighted average pay rates   1.56%   1.58%   %
Weighted average receive rates   0.30%   0.24%   %
Weighted average maturity   4.1 years    4.4 years     
Fair value  $(1,105)  $48   $ 

 

Interest expense recorded on these swap transactions totaled approximately $165 thousand and $528 thousand for the three and nine months ended September 30, 2015, respectively. There were no related expenses during the nine months ended September 30, 2014.

 

Cash Flow Hedge

 

The following table presents the net gains (losses), recorded in other comprehensive income and the Consolidated Statements of Income relating to the cash flow derivative instruments for the nine months ended September 30, 2015:

 

   2015 
(in thousands)  Amount of loss
recognized
in OCI (Effective
Portion)
   Amount of loss
reclassified
from OCI to
interest income
   Amount of loss
recognized in other
Non-interest income
(Ineffective Portion)
 
Interest rate contracts  $(1,153)  $   $ 

 

There were no net gains (losses) recorded in accumulated other comprehensive income or in the Consolidated Statement of Income relating to cash flow derivative instruments for the nine months ended September 30, 2014.

 

17

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan and lease losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

 

Loan segments 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 Company has five segments of loans and leases: commercial (including lease financing), commercial real estate, commercial construction, residential real estate (including home equity) and consumer.  

 

Interest income on commercial, commercial real estate, commercial construction and residential loans are discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is moved to nonaccrual status in accordance with the Company’s policy, typically after 90 days of non-payment.

 

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

The policy of the Company is to generally grant commercial, residential 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 Company. The Company is therefore subject to risk of loss. The Company believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan and lease losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for a large majority of the Company’s loans.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses is a valuation allowance for probable incurred credit losses. Losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan and lease loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.

 

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (“TDRs”) and classified as impaired. As part of the evaluation of impaired loans, the Company individually reviews for impairment all non-homogeneous loans internally classified as substandard or below. Generally, smaller impaired non-homogeneous loans and impaired homogeneous loans are collectively evaluated for impairment.

 

The Bank has defined its population of impaired loans to include all loans on nonaccrual status; all troubled debt restructuring loans; and all loans (above an established dollar threshold of $250,000) internally classified as “Special Mention” or below that require a specific reserve.

 

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

18

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan and lease losses.

 

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience, the primary factor, is determined by loan class and is based on the actual loss history experienced by the Bank over an actual three year rolling calculation. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. This actual loss experience is supplemented with the exogenous factor adjustments based on the risks present for each loan category. These exogenous factors (nine total) include consideration of the following: concentrations of credit; delinquency & nonaccrual trends; economic & business conditions including evaluation of the national and regional economies and industries with significant loan concentrations; external factors including legal, regulatory or competitive pressures that may impact the loan portfolio; changes in the experience, ability, or size of the lending staff, management, or board of directors that may impact the loan portfolio; changes in underwriting standards, collection procedures, charge-off practices, or other changes in lending policies and procedures that may impact the loan portfolio; loss and recovery trends; changes in portfolio size and mix; and trends in problem loans.

 

Purchased Credit-Impaired Loans

 

The Company purchases groups of loans in conjunction with mergers, 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 and lease losses.  After acquisition, losses are recognized by an increase in the allowance for loan and lease losses.

 

Such purchased credit impaired loans are accounted for individually.  The Company estimates the amount and timing of expected cash flows for each loan 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.

 

Composition of Loan Portfolio

 

The following table sets forth the composition of the Company’s loan portfolio, including net deferred loan fees, at September 30, 2015 and December 31, 2014:

 

   September 30,
2015
   December 31, 2014 
   (in thousands) 
Commercial  $569,605   $499,816 
Commercial real estate   1,873,714    1,634,510 
Commercial construction   283,623    167,359 
Residential real estate   225,158    234,967 
Consumer   3,569    2,879 
Gross loans   2,955,669    2,539,531 
Net deferred loan fees   (2,288)   (890)
Total loans receivable  $2,953,381   $2,538,641 

 

At September 30, 2015 and December 31, 2014, loan balances of approximately $1.6 billion and $1.0 billion, respectively, were pledged to secure borrowings from the Federal Home Loan Bank of New York.

 

19

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

Purchased Credit-Impaired Loans

 

The Company 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, 2015 and December 31, 2014.

 

   September 30,
2015
   December 31, 2014 
   (in thousands) 
Commercial  $7,046   $7,199 
Commercial real estate   1,799    1,816 
Residential real estate   323    806 
Total carrying amount  $9,168   $9,821 

 

For those purchased loans disclosed above, the Company did not increase the allowance for loan and lease losses for the nine months ended September 30, 2015.

 

The accretable yield, or income expected to be collected, on the purchased loans disclosed above for the nine months ended September 30, 2015 is as follows (in thousands):

 

    Three Months
Ended
September 30,
2014
    Three Months
Ended
September 30,
2015
    Nine Months
Ended
September 30,
2015
 
Beginning balance   $ 5,013     $ 4,678     $ 4,805  
New loans purchased                  
Accretion of income     (76 )    (53)     (180 )
Reclassifications from nonaccretable difference                 
Disposals                  
Ending balance   $ 4,937     $ 4,625    $ 4,625  

 

 

The following table presents information about the recorded investment in loan receivables on nonaccrual status by segment at September 30, 2015 and December 31, 2014:

 

Loans Receivable on Nonaccrual Status

 

   September 30,
2015
   December 31, 2014 
   (in thousands) 
Commercial  $5,051   $616 
Commercial real estate   3,467    8,197 
Commercial construction   1,479     
Residential real estate   2,891    2,796 
Total loans receivable on nonaccrual status  $12,888   $11,609 

 

Nonaccrual 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.

 

20

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

The Company continuously monitors the credit quality of its loans receivable. In addition to its internal staff, the Company 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 Company’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 loan fees, about the Company’s loan credit quality at September 30, 2015 and December 31, 2014: 

 

   September 30, 2015 
   Pass   Special Mention   Substandard   Doubtful   Total 
   (in thousands) 
Commercial  $476,142   $80,516   $12,696   $251   $569,605 
Commercial real estate   1,827,412    25,189    21,113        1,873,714 
Commercial construction   282,144        1,479        283,623 
Residential real estate   222,370        2,788        225,158 
Consumer   3,482        87        3,569 
                          
Total loans  $2,811,550   $105,705   $38,163   $251   $2,955,669 

 

   December 31, 2014 
   Pass   Special Mention   Substandard   Doubtful   Total 
   (in thousands) 
Commercial  $481,638   $3,686   $14,203   $289   $499,816 
Commercial real estate   1,596,606    14,140    23,764        1,634,510 
Commercial construction   165,880    1,479            167,359 
Residential real estate   230,772        4,195        234,967 
Consumer   2,778        101        2,879 
                          
Total loans  $2,477,674   $19,305   $42,263   $289   $2,539,531 

 

21

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

The following table provides an analysis of the impaired loans, by loan segment, at September 30, 2015 and December 31, 2014:

 

   September 30, 2015 
   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
 
No related allowance recorded   (in thousands) 
Commercial  $690    735     
Commercial real estate   4,830    5,233      
Commercial construction   1,479    1,479      
Residential real estate   3,164    3,518      
Consumer   95    87      
Total  $10,258    11,052      
                
With an allowance recorded               
Commercial  $79,724   $79,494   $3,001 
                 
Total               
Commercial  $80,414   $80,229   $3,001 
Commercial real estate   4,830    5,233     
Commercial construction   1,479    1,479     
Residential real estate   3,164    3,518     
Consumer   95    87     
Total  $ 89,982   $90,546   $3,001 

 

   December 31, 2014 
   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
 
No related allowance recorded  (in thousands)
Commercial  $481   $527     
Commercial real estate   5,890    6,587      
Residential real estate   3,072    3,407      
Consumer   109    101      
Total  $9,552   $10,622      
                
With an allowance recorded               
Commercial  $387   $390   $111 
Commercial real estate   3,520    3,520    151 
Total  $3,907   $3,910   $262 
                
Total               
Commercial  $868   $917   $111 
Commercial real estate   9,410    10,107    151 
Residential real estate   3,072    3,407     
Consumer   109    101     
Total  $13,459   $14,532   $262 

 

22

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

The following table provides an analysis related to the average recorded investment and interest income recognized on impaired loans by segment as of and for the three and nine months ended September 30, 2015 and 2014 (in thousands):

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
   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  $712   $   $897   $   $707   $   $778   $30 
Commercial real estate   4,869    15    5,046    31    4,905    46    5,313    74 
Commercial construction   1,479                1,479            31 
Residential real estate   3,221    7    1,975        3,251    12    2,044    5 
Consumer   100    1    106    2    102    4    106     
Total  $10,381    23   $8,024    33   $10,444   $62   $8,241   $140 
                                         
Impaired loans with an allowance recorded:                                        
                                         
Commercial  $79,732   $722   $   $   $45,747   $1,206   $   $ 
Commercial real estate             3,600    37            3,600    122 
Total  $79,732   $722   $3,600   $37   $45,747   $1,206   $3,600   $122 
                                         
Total impaired loans:                                        
                                         
Commercial  $80,444   $712   $897   $   $46,454   $1,206   $778   $30 
Commercial real estate   4,869    15    8,646    68    4,905    46    8,913    196 
Commercial construction   1,479                1,479             
Residential mortgage   3,221    7    1,975        3,251    12    2,044    31 
Consumer   100    1    106    2    102    4    106    5 
Total  $90,113   $745   $11,624   $70     56,191   $1,268   $11,841   $262 

 

Included in impaired loans at September 30, 2015, December 31, 2014 and 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.

 

23

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

The following table provides an analysis of the aging of the recorded investment of loans, excluding net deferred loan fees that are past due at September 30, 2015 and December 31, 2014 by segment:

 

Aging Analysis      

 

   September 30, 2015 
   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 or Greater
Past Due and

Accruing
 
   (in thousands) 
Commercial  $   $9,726   $5,020   $14,746   $554,859   $569,605   $ 
Commercial real estate   782    1,365    3,232    5,379    1,868,335    1,873,714     
Commercial construction           1,479    1,479    282,144    283,623     
Residential real estate   922    1,308    3,244    5,474    219,684    225,158    268 
Consumer                   3,569    3,569      
Total  $1,704   $12,399   $12,975   $27,078   $2,928,591   $2,955,669   $268 

 

Aging Analysis

 

   December 31, 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 or Greater
Past Due and
Accruing
 
   (in thousands) 
Commercial  $6,060   $   $662   $6,722   $493,094   $499,816   $45 
Commercial real estate   4,937    638    5,961    11,535    1,622,975    1,634,510    609 
Commercial construction                   167,359    167,359     
Residential real estate   1,821    210    3,200    5,231    229,736    234,967    557 
Consumer   30    1        31    2,848    2,879     
Total  $12,848   $849   $9,823   $23,520   $2,516,011   $2,539,531   $1,211 

 

24

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

The following table details, at the period presented, the amount of loans receivable that are evaluated individually, and collectively, for impairment (excluding net deferred loan fees), acquired, and the related portion of the allowance for loan and lease losses that are allocated to each loan portfolio segment:

 

   September 30, 2015 
   Commercial   Commercial real estate   Commercial construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Allowance for loan and lease losses                                   
Individually evaluated for impairment  $3,001   $   $   $   $   $   $3,001 
Collectively evaluated for impairment   4,122    10,274    2,646    1,012    4    474    18,532 
Acquired with deteriorated credit quality                            
Total  $7,123   $10,274   $2,646   $1,012   $4   $474   $21,533 
                                    
Loans receivable                                   
Individually evaluated for impairment  $80,414   $4,830   $1,479   $3,164   $95   $   $89,982 
Collectively evaluated for impairment   482,145    1,867,085    282,144    221,671    3,474        2,856,519 
Acquired with deteriorated credit quality   7,046    1,799        323            9,168 
Total  $569,605   $1,873,714   $283,623   $225,158   $3,569   $   $2,955,669 

 

The table above includes approximately $0.9 billion of acquired loans for the period ended September 30, 2015 reported as collectively evaluated for impairment.

 

The following table, at the period presented, details the amount of loans that are evaluated individually, and collectively, for impairment (excluding net deferred loan fees), acquired, and the related portion of the allowance for loan and lease losses that are allocated to each loan portfolio segment:

 

   December 31, 2014 
   Commercial   Commercial real estate   Commercial construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Allowance for loan and lease losses                                   
Individually evaluated for impairment  $111   $151   $   $   $   $   $262 
Collectively evaluated for impairment   2,972    7,648    1,239    1,113    7    919    13,898 
Acquired with deteriorated credit quality                            
Total  $3,083   $7,799   $1,239   $1,113   $7   $919   $14,160 
                                    
Loans receivable                                   
Individually evaluated for impairment  $868   $9,410   $   $3,072   $109   $   $13,459 
Collectively evaluated for impairment   491,749    1,623,284    167,359    231,089    2,770        2,516,251 
Acquired with deteriorated credit quality   7,199    1,816        806            9,821 
Total  $499,816   $1,634,510   $167,359   $234,967   $2,879   $   $2,539,531 

 

The table above includes approximately $1.2 billion of acquired loans for the period ended December 31, 2014 reported as collectively evaluated for impairment.

 

25

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

The Company’s allowance for loan and lease 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 and lease losses methodology as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

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

 

   Three Months Ended September 30, 2015 
   Commercial   Commercial real estate   Commercial construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Balance at June 30, 2015  $4.633   $9,195   $1,945   $1,161   $7   $535   $17,480 
                                    
Charge-offs       (124)                   (124)
                                    
Recoveries   2                        2 
                                    
Provision   2,488    1,203    701    (149)   (3)   (61)   4,175 
                                    
Balance at September 30, 2015  $7,123   $10,274   $2,646   $1,012   $4   $474   $21,533 

 

   Three Months Ended September 30, 2014 
   Commercial   Commercial real estate   Commercial construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Balance at June 30, 2014  $2,412   $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, 2014  $2,478   $7,022   $524   $1,052   $5   $1,037   $12,118 

 

26

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

   Nine Months Ended September 30, 2015 
   Commercial   Commercial real estate   Commercial construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Balance at December 31, 2014  $3,083   $7,799   $1,239   $1,113   $7   $919   $14,160 
                                    
Charge-offs   (100)   (406)           (13)       (519)
                                    
Recoveries   12    327        2    1        342 
                                    
Provision   4,128    2,554    1,407    (103)   9    (445)   7,550 
                                    
Balance at September 30, 2015  $7,123   $10,274   $2,646   $1,012   $4   $474   $21,533 

 

   Nine Months Ended September 30, 2014 
   Commercial   Commercial real estate   Commercial construction   Residential real estate   Consumer   Unallocated   Total 
   (in thousands) 
Balance at December 31, 2013  $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, 2014  $2,478   $7,022   $524   $1,052   $5   $1,037   $12,118 

 

27

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

Trouble Debt Restructurings

 

At September 30, 2015, there were no commitments to lend additional funds to borrowers whose loans were on nonaccrual 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 Company 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 Company. The Company is therefore subject to risk of loss. The Company believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan and lease 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 $77.1 million at September 30, 2015, of which $1.1 million were on nonaccrual status. The remaining loans modified were current and have complied with the terms of their restructure agreement. At December 31, 2014, loans modified in a troubled debt restructuring totaled $2.8 million, of which $1.0 million were on nonaccrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement. The Company has allocated $2.0 million in specific allocations with respect to loans whose loan terms had been modified in troubled debt restructurings as of September 30, 2015. There were no specific allocations with respect to troubled debt restructurings as of September 30, 2014. The TDRs presented as of September 30, 2015 increased the allowance for loan and lease losses by $2.0 million for the three and nine months ended September 30, 2015. The TDRs presented as of September 30, 2014 did not increase the allowance for loan and lease losses for the three and nine months ended September 30, 2014.

 

The $2.0 million in specific allocations associated with taxi medallion lending referred to above was calculated based on the present value of estimated cash flows, including contractual debt interest service through maturity and principal repayments based on the fair value of the collateral, and excludes any consideration for the personal guarantees of borrowers, which provides an additional source of repayment but cannot be relied upon. The valuation per corporate medallion used for the calculation at September 30, 2015 was $814,000. A specific allocation was required at September 30, 2015 due to a decline in the valuation of taxi medallions from June 30, 2015, when there was no specific allocation required.

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2015 (dollars in thousands):

 

       Pre-Modification   Post-Modification 
       Outstanding   Outstanding 
   Number of   Recorded   Recorded 
   Loans   Investment   Investment 
Troubled debt restructurings:               
Commercial   47   $75,363   $75,363 
Commercial real estate            
Commercial construction            
Residential real estate            
Consumer            
                
Total   47   $75,363   $75,363 

 

The increase in TDRs was due to loans secured by New York City taxi medallions that were modified during the second quarter of 2015. The modifications consisted of a deferral of principal amortization from approximately 25-30 year amortization to interest-only. There was no extension of the loans’ contractual maturity dates, there was no forgiveness of principle, and the interest rates on these loans were increased from approximately 3%-3.25% to 3.75%. These loans were accruing prior to modification and remained in accrual status post-modification.

 

There were no charge-offs in connection with a loan modification at the time of modification during the nine months ended September 30, 2015. 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, 2015.

 

28

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 7. Loans and the Allowance for Loan and Lease Losses – (continued)

 

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            
Commercial construction            
Residential real estate   1    53    51 
Consumer            
                
Total   2   $725   $366 

 

The Company 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.

 

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments

 

ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

 

    Level 1:   Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
     
   

Level 2:   Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

    Level 3:   Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (for example, supported with little or no market activity).

 

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.

 

29

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments – (continued)

 

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at September 30, 2015 and December 31, 2014:

 

Securities available-for-sale - Where quoted prices are available in an active market, securities are classified with Level 1 of the valuation hierarchy. Level 1 inputs include securities that have quoted prices in active markets for identical assets. Level 1 securities held include:  US Treasury securities, publicly traded equity securities, mutual funds and overnight money market funds. 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 their fair value and are classified as Level 3. Due to the inactive condition of the markets amidst the financial crisis, the Company treated certain securities as Level 3 securities 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 Company’s evaluations are based on market data and the Company employs combinations of these approaches for its valuation methods depending on the asset class.

 

Derivatives - The fair value of derivatives are based on valuation models using observable market data as of the measurement date (level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rate, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

 

Loans held for sale - Loans held for sale are carried at the lower of cost or fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions.

 

Loans receivable - The fair value of performing loans, except residential mortgages, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risks inherent in the loan. The estimate of maturity is based on the historical experience of the Bank with prepayments for each loan classification, modified as required by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources adjusted to reflect differences in servicing and credit costs.

 

Off-balance sheet financial instruments - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current market levels of interest rate and the committed rates.

 

The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties.

 

30

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments – (continued)

 

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, 2015 and December 31, 2014 are as follows: 

 

       September 30, 2015  
       Fair Value Measurements at Reporting Date Using 
       Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
(in thousands)                    
Recurring fair value measurements:                    
Assets                    
Investment securities:                    
Available-for-sale:                    
Federal agency obligations  $30,905   $   $30,905   $ 
Residential mortgage pass-through securities   48,091        48,091     
Commercial mortgage pass-through securities   3,055        3,055     
Obligations of U.S. states and political subdivision   8,382        8,382     
Trust preferred securities   16,322        16,322     
Corporate bonds and notes   78,386        78,386     
Asset-backed securities   21,130        21,130     
Certificates of deposit   1,920        1,920     
Equity securities   338    338         
Other securities   15,685    15,685         
Total available-for-sale   224,214    16,023    208,191     
Loans held for sale   990        990     
Total assets  $225,204   $16,023   $209,181   $ 
Liabilities                    
Derivatives  $1,105   $   $1,105   $ 
                     
Total liabilities  $1,105   $   $1,105   $ 

 

31

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments – (continued)

 

       December 31, 2014 
       Fair Value Measurements at Reporting Date Using 
       Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
(in thousands)                    
Recurring fair value measurements:                     
Assets                     
Investment securities:                    
Available-for-sale:                    
Federal agency obligations  $32,817   $   $32,817   $ 
Residential mortgage pass-through securities   60,356        60,356     
Commercial mortgage pass-through securities   3,046        3,046     
Obligations of U.S. states and political subdivision   8,406        8,406     
Trust preferred securities   16,306        16,306     
Corporate bonds and notes   125,777        125,777     
Asset-backed securities   27,502        27,502     
Certificates of deposit   2,123        2,123     
Equity securities   307    307         
Other securities   12,892    12,892         
Total available-for-sale   289,532    13,199    276,333     
Derivatives   48        48     
Total assets  $289,580   $13,199   $276,381   $ 

 

For the nine months ended September 30, 2015, 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, 2015 and December 31, 2014 were as follows:

 

Impaired loans   Valuation Techniques   Range of Unobservable Inputs
Commercial   Appraisals of collateral value   Adjustment for age of comparable sales, generally a decline of 0% to 15%
         
Commercial real estate   Appraisals of collateral value   Market capitalization rates between 8% and 12%. Market rental rates for similar properties

 

32

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments – (continued)

 

       Fair Value Measurements at Reporting Date Using  
Assets measured at fair value on a nonrecurring basis:  September 30, 2015   Quoted
Prices
in Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 
                    
Impaired loans  (in thousands)  
Commercial  $3,360   $   $   $ 3,360  

 

 

       Fair Value Measurements at Reporting Date Using 
Assets Measured at Fair Value on a Non-Recurring Basis  December 31,
2014
   Quoted
Prices
in Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
                 
Impaired loans  (in thousands) 
Commercial  $276   $   $   $276 
Commercial real estate   3,369            3,369 

 

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis at September 30, 2015 and December 31, 2014.

 

Impaired loans - Impaired loans at September 30, 2015 that required a valuation allowance during 2015 were $4.4 million with a related valuation allowance of $1,001,000 compared to $3.9 million with a related valuation allowance of $262,000 at December 31, 2014. Additional provision for loan and lease losses of $211,000 and $840,000 for the three and nine months ending September 30, 2015, respectively, and $0 and $210,500 three and nine months ending September 30, 2014, respectively, were recorded.

 

33

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments – (continued)

 

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 Company, 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 Company’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 Company’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 Company for the purposes of this disclosure.

 

Cash and cash equivalents - The carrying amounts of cash and short-term instruments approximate fair values.

 

FHLB 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 Company’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 Company’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 - The fair value of the Company’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 non-interest-bearing deposits is equal to the amount payable on demand at the reporting date.

 

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

 

Borrowings and subordinated debentures - The fair value of the Company’s 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.

 

34

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments – (continued)

 

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of September 30, 2015 and December 31, 2014.

 

           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, 2015                         
Financial assets                         
Cash and cash equivalents  $158,521   $158,521   $158,521   $   $ 
Investment securities available-for-sale   224,214    224,214    16,023    208,191     
Investment securities held-to-maturity   227,221    234,493    29,747    186,133    18,613 
Investments in restricted stock, at cost   30,362     n/a     n/a     n/a     n/a 
Loans held for sale   990    990        990     
Net loans receivable   2,931,848    2,929,939            2,929,939 
Accrued interest receivable   11,662    11,662    221    2,631    8,810 
                          
Financial liabilities                         
Noninterest-bearing deposits   586,643    586,643    586,643         
Interest-bearing deposits   2,079,981    2,084,440        2,084,440     
Borrowings   621,674    627,399        627,399     
Subordinated debentures   55,155    55,007        55,007     
Derivatives   1,105    1,105        1,105     
Accrued interest payable   5,198    5,198        5,198     
                          

 

           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, 2014                    
Financial assets                         
Cash and cash equivalents  $126,847   $126,847   $126,847   $   $ 
Investment securities available-for-sale   289,532    289,532    13,199    276,333     
Investment securities held-to-maturity   224,682    231,445    29,184    183,489    18,772 
Investments in restricted stock, at cost   23,535    n/a    n/a    n/a    n/a 
Net loans receivable   2,524,481    2,538,415            2,538,415 
Derivatives   48    48        48     
Accrued interest receivable   11,700    11,700    68    3,674    7,958 
                          
Financial liabilities                         
Noninterest-bearing deposits   492,516    492,516    492,516         
Interest-bearing deposits   1,983,091    1,990,484        1,990,484     
Borrowings   495,553    505,641        505,641     
Subordinated debentures   5,155    4,768    &md