Attached files

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EX-31.1 - PERSONAL CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - ConnectOne Bancorp, Inc.connect3203971-ex311.htm
EX-32 - PERSONAL CERTIFICATION OF THE CEO AND THE CFO - ConnectOne Bancorp, Inc.connect3203971-ex32.htm
EX-31.2 - PERSONAL CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - ConnectOne Bancorp, Inc.connect3203971-ex312.htm
EX-23.1 - CONSENT OF CROWE HORWATH LLP - ConnectOne Bancorp, Inc.connect3203971-ex231.htm
EX-21.1 - SUBSIDIARIES OF THE REGISTRANT - ConnectOne Bancorp, Inc.connect3203971-ex211.htm
EX-12.1 - STATEMENT OF RATIOS OF EARNINGS TO FIXED CHARGES - ConnectOne Bancorp, Inc.connect3203971-ex121.htm

Table of Contents 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)  

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

For the Fiscal Year Ended December 31, 2016

OR

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

For the Transition Period from         to

Commission File Number: 000-11486

 

ConnectOne Bancorp, Inc.

(Exact name of registrant as specified in its charter)

New Jersey   52-1273725

(State or Other Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification Number)

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)

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class   Name of each exchange on which registered
Common Stock, no par value   NASDAQ

Securities registered pursuant to Section 12(g) of the Exchange Act: None

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

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

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

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

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

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

Large Accelerated Filer ¨ Accelerated Filer x Non-Accelerated ¨ Small Reporting Company  ¨

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

The aggregate market value of the voting and nonvoting common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold or the average bid and ask price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter - $368.0 million.

Shares Outstanding on March 10, 2017
Common Stock, no par value: 31,973,356 shares

DOCUMENTS INCORPORATED BY REFERENCE

Definitive proxy statement in connection with the 2017 Annual Stockholders Meeting to be filed with the Commission pursuant to Regulation 14A will be incorporated by reference in Part III

 

 

CONNECTONE BANCORP, INC.

TABLE OF CONTENTS

    Page
PART I
Item 1. Business 3
Item 1A. Risk Factors 12
Item 1B. Unresolved Staff Comments 19
Item 2. Properties 20
Item 3. Legal Proceedings 20
Item 4. Mine Safety Disclosures 20
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 21
Item 6. Selected Financial Data 23
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 44
Item 8. Financial Statements and Supplementary Data: 44
  Report of Independent Registered Public Accounting Firms 45
  Consolidated Statements of Condition 46
  Consolidated Statements of Income 47
  Consolidated Statements of Comprehensive Income 48
  Consolidated Statements of Changes in Stockholders’ Equity 49
  Consolidated Statements of Cash Flows 50
  Notes to Consolidated Financial Statements 52
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 109
Item 9A. Controls and Procedures 109
Item 9B. Other Information 109
PART III
Item 10. Directors, Executive Officers and Corporate Governance 110
Item 11. Executive Compensation 110
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 110
Item 13. Certain Relationships and Related Transactions, and Director Independence 110
Item 14. Principal Accounting Fees and Services 110
PART IV
Item 15. Exhibits, Financial Statements Schedules 111
  Signatures 114

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

 

 

 

CONNECTONE BANCORP, INC.

FORM 10-K

PART I

Item 1. Business

Historical Development of Business

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

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

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

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

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

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

 

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SEC Reports and Corporate Governance

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

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

Narrative Description of the Business

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

While we expect to take an opportunistic approach to acquisitions, considering opportunities to purchase or merge with whole institutions, branches or lines of business that complement our existing strategy, the bulk of our future growth may be organic. Our goal is to open new offices in the counties contained in our broader trade area discussed below. However, we do not believe that we need to establish a physical location in each market that we serve. We believe that advances in technology have created new delivery channels which allow us to service customers and maintain business relationships without a physical presence, and that these customers can also be serviced through a regional office. We believe the key to customer acquisition and retention is establishing quality business relationship officers who will frequently go to the customer, rather than having the customer come into the branch.

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

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

Our Market Area

Our banking offices are located in Bergen, Union, Morris, Essex, Hudson, Mercer and Monmouth Counties in New Jersey and in the borough of Manhattan, in New York City, which include some of the most affluent markets in the United States. We also attract business and customers from broader regions, including the other boroughs of New York City as well as Westchester County and Long Island in New York State.

Products and Services

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

Noninterest demand deposit products include “Totally Free Checking” and “Simply Better Checking” for retail clients and “Small Business Checking” and “Analysis Checking” for commercial clients. Interest-bearing checking accounts require minimum balances for both retail and commercial clients and include “Consumer Interest Checking” and “Business Interest Checking”. Money market accounts consist of products that provide a market rate of interest to depositors but offer a limited number of preauthorized withdrawals. Our savings accounts consist of statement type accounts. Time deposits consist of certificates of deposit, including those held in IRA accounts, generally with initial maturities ranging from 7 days to 60 months and brokered certificates of deposit, which we use for asset liability management purposes and to supplement other sources of funding.  CDARS/ICS Reciprocal deposits are offered based the Bank’s participation in Promontory Interfinancial

 

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Network, LLC.  Customers who are FDIC insurance sensitive are able to place large dollar deposits with the Company and the Company uses CDARS to place those funds into certificates of deposit issued by other banks in the Network. This occurs in increments of less than the FDIC insurance limits so that both the principal and interest are eligible for FDIC insurance coverage in amounts larger than the standard dollar amount. The FDIC currently considers these funds as brokered deposits.

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

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

Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, taxi medallions, inventory and equipment, and liens on commercial and residential real estate. As of December 31, 2016, the carrying value of our taxi medallion portfolio totaled $65.6 million, all of which is designated as held-for-sale, reflecting management’s intent to sell the portfolio. All of our taxi medallion loans are secured by New York City taxi medallions.

Commercial construction loans are loans to finance the construction of commercial or residential properties secured by first liens on such properties. Commercial real estate loans include loans secured by first liens on completed commercial properties, including multi-family properties, to purchase or refinance such properties. Residential mortgages include loans secured by first liens on 1-4 family residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Home equity loans and lines of credit include loans secured by first or second liens on residential real estate for primary or secondary residences. Consumer loans are made to individuals who qualify for auto loans, cash reserve, credit cards and installment loans.

The Board of Directors has approved a loan policy granting designated lending authorities to specific officers of the Bank. Those officers are comprised of the Chief Executive Officer, Chief Lending Officer, Chief Credit Officer, Team Leaders and the Consumer Loan Officers. All loan approvals require the signatures of a minimum of two officers. The Senior Lending Group (Chief Executive Officer, Chief Lending Officer and Chief Credit Officer) can approve loans up to $25 million in aggregate loan exposure and which do not exceed 65% of the Legal Lending Limit of the Bank (currently $69.3 million as of December 31, 2016 for most loans), provided that (i) the credit does not involve an exception to policy and a principal balance greater than $7.5 million or $20 million in all credit outstanding to the borrower in the aggregate, (ii) the credit does not exceed certain dollar amount thresholds set forth in our policy, which varies by loan type, and (iii) the credit is not extended to an insider of the Bank. The Board Loan Committee (which includes the Chief Executive Officer and four other Board members) approves credits that are both exceptions to policy and are above prescribed amounts related to loan type and collateral. Loans to insiders must be approved by the entire Board.

The Bank’s lending policies generally provide for lending within our primary trade area. However, the Bank will make loans to persons outside of our primary trade area when we deem it prudent to do so. In an effort to promote a high degree of asset quality, the Bank focuses primarily upon offering secured loans. However, the Bank does make short-term unsecured loans to borrowers with high net worth and income profiles. The Bank generally requires loan customers to maintain deposit accounts with the Bank. In addition, the Bank generally provides for a minimum required rate of interest in its variable rate loans. We believe that having senior management on-site allows for an enhanced local presence and rapid decision-making that attracts borrowers. The Bank’s legal lending limit to any one borrower is 15% of the Bank’s capital base (defined as tangible equity plus the allowance for loan and lease losses) for most loans ($69.3 million) and 25% of the capital base for loans secured by readily marketable collateral ($115.5 million). At December 31, 2016, the Bank’s largest committed relationship (to several affiliated borrowers) totaled $59.9 million. The Bank’s largest single loan outstanding at December 31, 2016 was $31.0 million.

Our business model includes using industry best practices for community banks, including personalized service, state-of-the-art technology and extended hours. We believe that this will generate deposit accounts with somewhat larger average balances than are found at many other financial institutions. We also use pricing techniques in our efforts to attract banking relationships having larger than average balances.

Competition

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

 

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Our larger competitors have greater financial resources to finance wide-ranging advertising campaigns. Additionally, we endeavor to compete for business by providing high quality, personal service to customers, customer access to our decision-makers and competitive interest rates and fees. We seek to hire and retain quality employees who desire greater responsibility than may be available working for a larger employer.

SUPERVISION AND REGULATION

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

Bank Holding Company Regulation

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

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

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

 Regulation of Bank Subsidiary

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

The Dodd-Frank Act

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

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

 

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  The Consumer Financial Protection Bureau (“Bureau”).   The Dodd-Frank Act created the Bureau. The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against state-chartered institutions. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Institutions with $10 billion or less in assets, such as the Bank, will continue to be examined for compliance with the consumer laws by their primary bank regulators.
  Deposit Insurance.   The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits. Amendments to the Federal Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance premiums paid to the Deposit Insurance Fund (“DIF”) will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity during the assessment period. Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. In December 2010, the FDIC increased the designated reserve ratio to 2.0%.
  Shareholder Votes.  The Dodd-Frank Act requires publicly traded companies like the Company to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments in certain circumstances. The Dodd-Frank Act also authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. The SEC has not yet adopted such rules.

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

Regulation W

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

  to an amount equal to 10% of the bank’s capital and surplus, in the case of covered transactions with any one affiliate; and
  to an amount equal to 20% of the bank’s capital and surplus, in the case of covered transactions with all affiliates

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

  a loan or extension of credit to an affiliate;
  a purchase of, or an investment in, securities issued by an affiliate;

 

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  a purchase of assets from an affiliate, with some exceptions;
  the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and
  the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.

Further, under Regulation W:

  a bank and its subsidiaries may not purchase a low-quality asset from an affiliate;
  covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and
  with some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by certain types of collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit

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

FDICIA

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

The FDIC’s regulations implementing these provisions of FDICIA provide that an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0%, (ii) has a Tier 1 risk-based capital ratio of at least 8.0%, (iii) has a Tier 1 leverage ratio of at least 5.0%, (iv) has a common equity Tier 1 capital ratio of at least 6.5%, and (v) meets certain other requirements. An institution will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0%, (ii) has a Tier 1 risk-based capital ratio of at least 6.0%, (iii) has a Tier 1 leverage ratio of at least 4.0%, has a common equity Tier 1 capital ratio of at least 4.5%, and (v) does not meet the definition of “well capitalized.” An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0%, (ii) has a Tier 1 risk-based capital ratio of less than 6.0%, (iii) has a Tier 1 leverage ratio of less than 4.0%, or (iv) has a common equity Tier 1 capital ratio of less than 4.5%. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0%, (ii) has a Tier 1 risk-based capital ratio of less than 4.0%, (iii) has a Tier 1 leverage ratio of less than 3.0%, or (iv) has a common equity Tier 1 capital ratio of less 3.0%. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0%. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating.

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

Capital Adequacy Guidelines

In December 2010 and January 2011, the Basel Committee on Banking Supervision (the “Basel Committee”) published the final texts of reforms on capital and liquidity generally referred to as “Basel III.” In July 2013, the FRB, the FDIC and the Comptroller of the Currency adopted final rules (the “New Rules”), which implement certain provisions of Basel III and the Dodd-Frank Act. The New Rules replaced the existing general risk-based capital rules of the various banking agencies with a single, integrated regulatory capital framework. The New Rules require higher capital cushions and more stringent criteria for what qualifies as regulatory capital. The New Rules were effective for the Bank and the Company on January 1, 2015.  

Under the New Rules, the Company and the Bank are required to maintain the following minimum capital ratios, expressed as a percentage of risk-weighted assets: 

  · Common Equity Tier 1 Capital Ratio of 4.5% ( the “CET1”);
  · Tier 1 Capital Ratio (CET1 capital plus “Additional Tier 1 capital”) of 6.0%; and
  · Total Capital Ratio (Tier 1 capital plus Tier 2 capital) of 8.0%.

 

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

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

  · CET1 of 7%;
  · Tier 1 Capital Ratio of 8.5%; and
  · Total Capital Ratio of 10.5%.

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

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

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

Under the New Rules, banking organizations such as the Company and the Bank may make a one-time permanent election regarding the treatment of accumulated other comprehensive income items in determining regulatory capital ratios. Effective as of January 1, 2015, the Company and the Bank elected to exclude accumulated other comprehensive income items for purposes of determining regulatory capital.

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

The New Rules prescribe a standardized approach for calculating risk-weighted assets. Depending on the nature of the assets, the risk categories generally range from 0% for U.S. Government and agency securities, to 600% for certain equity exposures, and result in higher risk weights for a variety of asset categories. In addition, the New Rules provide more advantageous risk weights for derivatives and repurchase-style transactions cleared through a qualifying central counterparty and increase the scope of eligible guarantors and eligible collateral for purposes of credit risk mitigation.

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

Federal Deposit Insurance and Premiums

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

The assessment base for deposit insurance premiums is an institution’s average consolidated total assets minus average tangible equity. In connection with adopting this assessment base calculation, the FDIC lowered total base assessment rates to between 2.5 and 9 basis points for banks in the lowest risk category, and 30 to 45 basis points for banks in the highest risk category. The Company paid $2.4 million in total FDIC assessments in 2016, as compared to $1.9 million in 2015.

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

In addition to deposit insurance assessments, the FDIC is required to continue to collect from institutions payments for the servicing of obligations of the Financing Corporation (“FICO”) that were issued in connection with the resolution of savings and loan associations, so long

 

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as such obligations remain outstanding. The Bank paid a FICO premium of $209 thousand in 2016, versus approximately $143 thousand in 2015.

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

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

  · allows bank holding companies meeting management, capital, and Community Reinvestment Act standards to engage in a substantially broader range of non-banking activities than previously was permissible, including insurance underwriting and making merchant banking investments in commercial and financial companies, if the bank holding company elects to become a financial holding company, it files a certification, effective in 30 days, and thereafter may engage in certain financial activities without further approvals;  
  · allows insurers and other financial services companies to acquire banks;  
  · removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies; and  
  · establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.

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

Community Reinvestment Act

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

USA PATRIOT Act

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

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

  · All financial institutions must establish anti-money laundering programs that include, at a minimum: (i) internal policies, procedures, and controls; (ii) specific designation of an anti-money laundering compliance officer; (iii) ongoing employee training programs; and (iv) an independent audit function to test the anti-money laundering program.
  · The Secretary of the Department of Treasury, in conjunction with other bank regulators, is authorized to issue regulations that provide for minimum standards with respect to customer identification at the time new accounts are opened.
  · Financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) are required to establish appropriate, specific and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering.
  · Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain record keeping obligations with respect to correspondent accounts of foreign banks.

 

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

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

Loans to Related Parties

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

Dividend Restrictions

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

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

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

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

 

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Item 1A. Risk Factors

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

Risks Applicable to Our Business:

Our growth-oriented business strategy could be adversely affected if we are not able to attract and retain skilled employees or if we lose the services of our senior management team.

We may not be able to successfully manage our business as a result of the strain on our management and operations that may result from growth. Our ability to manage growth will depend upon our ability to continue to attract, hire and retain skilled employees. The loss of members of our senior management team, including those officers named in the summary compensation table of our proxy statement, could have a material adverse effect on our results or operations and ability to execute our strategic goals. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our employees.

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

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

We have a significant concentration in commercial real estate loans.

Our loan portfolio is made up largely of commercial real estate loans. These types of loans generally expose a lender to a higher degree of credit risk of non-payment and loss than do residential mortgage loans because of several factors, including dependence on the successful operation of a business or a project for repayment, and loan terms with a balloon payment rather than full amortization over the loan term. In addition, commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to four-family residential mortgage loans. Underwriting and portfolio management activities cannot completely eliminate all risks related to these loans. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us.

At December 31, 2016, we had $2.7 billion of commercial real estate loans, including commercial construction loans, which represented 77.4% of loans receivable. Concentrations in commercial real estate are also monitored by regulatory agencies and subject to scrutiny. Guidance from these regulatory agencies includes all commercial real estate loans, including commercial construction loans, in calculating our commercial real estate concentration, but excludes owner-occupied commercial real estate loans. Based on this regulatory definition, our commercial real estate loans represented 532% of total risk-based capital.

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

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

 

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

If we are limited in our ability to originate loans secured by commercial real estate we may face greater risk in our loan portfolio

If, because of our concentration of commercial real estate loans, or for any other reasons, we are limited in our ability to originate loans secured by commercial real estate, we may incur greater risk in our loan portfolio. For example, we may seek to originate commercial and industrial loans, including both secured and unsecured commercial and industrial loans. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses and personal guarantees. Secured commercial and industrial loans are generally collateralized by accounts receivable, inventory, equipment or other assets owned by the borrower and typically include a personal guaranty of the business owner. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed. Therefore, we may be exposed to greater risk of loss on these credits.

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

Given the significant growth in our loan portfolio, many of our commercial real estate loans are unseasoned, meaning that they were originated relatively recently. As of December 31, 2016, we had $2.2 billion in commercial real estate loans outstanding. Approximately 62% of the loans, or $1.4 billion, had been originated in the past three years. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of our loan portfolio. These loans may have delinquency or charge-off levels above our expectations, which could negatively affect our performance.

Our portfolio of loans secured by New York City taxi medallions could expose us to credit losses.

We maintain a significant credit exposure ($65.6 million carrying value as of December 31, 2016) of loans secured by New York City taxi medallions. The taxi industry in New York City is facing significant competition and pressure from technology based ride share companies such as Uber and Lyft. This has resulted in volatility in the pricing of medallions, and has impacted the earnings of many medallion holders, including our borrowers. The majority of the taxi medallion portfolio ($63.0 million, or 96%) was designated as nonaccrual, and the entire portfolio has been designated as loans held-for-sale, reflecting management’s intent to sell the portfolio. Any further deterioration in the value of New York City taxi medallions, or in the medallion taxi industry in New York City, could expose us to additional losses through a lower sale price for these loans, or, if we are unable to sell all or a portion of this portfolio, additional write downs on these loans.

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

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

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

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

 

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

During the last seven years it has been the policy of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, yields on securities we have purchased, and to a lesser extent, market rates on the loans we have originated, have been at levels lower than were available prior to 2008. Consequently, the average yield on our interest-earning assets has decreased during the recent low interest rate environment. Our ability to lower our interest expense is limited at these interest rate levels, while the average yield on our interest-earning assets may continue to decrease. Accordingly, our net interest income may decrease, which may have an adverse effect on our profitability. For information with respect to changes in interest rates, see “Risk Factors-Changes in interest rates may adversely affect or our earnings and financial condition.”

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

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

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

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

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

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

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

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

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

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

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

Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to market factors or an adverse regulatory action against us. In addition, our ability to use alternate deposit originations channels could be substantially impaired if we fail to remain “well capitalized”. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. The liquidity issues have been particularly acute for regional and community banks, as many of the larger financial institutions have significantly curtailed their lending to regional and community banks to reduce their exposure to the risks of

 

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other banks. In addition, many of the larger correspondent lenders have reduced or even eliminated federal funds lines for their correspondent customers. Furthermore, regional and community banks generally have less access to the capital markets than do the national and super-regional banks because of their smaller size and limited analyst coverage. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.

Declines in the value of our investment securities portfolio may adversely impact our results.

As of December 31, 2016, we had approximately $353.3 million in investment securities, available-for-sale. We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information on investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio in future periods. If an impairment charge is significant enough, it could affect the ability of the Bank to upstream dividends to the Company, which could have a material adverse effect on our liquidity and our ability to pay dividends to shareholders and could also negatively impact our regulatory capital ratios.

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

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

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

We may incur impairment to goodwill.

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

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

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

·potential exposure to unknown or contingent liabilities of banks and businesses we acquire;
·exposure to potential asset quality issues of the acquired bank or related business;
·difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and
·the possible loss of key employees and customers of the banks and businesses we acquire. 

 

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

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

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

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

Risks Applicable to the Banking Industry Generally:

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

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

·Net interest income, the difference between interest earned on our interest earning assets and interest paid on interest-bearing liabilities, represents a significant portion of our earnings. Both increases and decreases in the interest rate environment may reduce our profits. We expect that we will continue to realize income from the spread between the interest we earn on loans, securities and other interest-earning assets, and the interest we pay on deposits, borrowings and other interest-bearing liabilities. The net interest spread is affected by the differences between the maturity and repricing characteristics of our interest-earning assets and interest-bearing liabilities. Our interest-earning assets may not reprice as slowly or rapidly as our interest-bearing liabilities.
·The market value of our securities portfolio may decline and result in other than temporary impairment charges. The value of securities in our portfolio is affected by factors that impact the U.S. securities market in general as well as specific financial sector factors and entities. Recent uncertainty in the market regarding the financial sector has negatively impacted the value of securities within our portfolio. Further declines in these sectors may result in future other than temporary impairment charges.
·Asset quality may deteriorate as borrowers become unable to repay their loans.

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

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

Although we believe that our allowance for loan and lease losses is adequate to cover known and probable incurred losses included in the portfolio, we cannot assure you that we will not further increase the allowance for loan and lease losses or that our regulators will not require us to increase this allowance. Either of these occurrences could adversely affect our earnings.

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

Our net income depends primarily upon our net interest income. Net interest income is the difference between interest income earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and borrowed funds. The level of net interest income is primarily a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-bearing liabilities which, in turn, are impacted by such external factors as the local economy,

 

 - 16 - 
   

 

competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board of Governors (the “FOMC”), and market interest rates.

A sustained increase in market interest rates could adversely affect our earnings if our cost of funds increases more rapidly than our yield on our earning assets, and compresses our net interest margin. In addition, the economic value of portfolio equity would decline if interest rates increase. For example, we estimate that as of December 31, 2016, a 200 basis point increase in interest rates would have resulted in our economic value of portfolio equity declining by approximately $42.1 million or 8.0%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Sensitivity Analysis.”

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

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

The banking business is subject to significant government regulations.

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

For example, the Dodd-Frank Act may result in substantial new compliance costs. The Dodd-Frank Act was signed into law on July 21, 2010. Generally, the Dodd-Frank Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law, many of which will not become effective until various Federal regulatory agencies have promulgated rules implementing the statutory provisions. In addition, as a result of the 2016 elections, certain provisions of The Dodd-Frank Act may be repealed or modified. Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact either on the financial services industry as a whole, or on our business, results of operations and financial condition.

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

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

 

 - 17 - 
   

 

·Tier 1 capital treatment for “hybrid” capital items like trust preferred securities is eliminated subject to various grandfathering and transition rules.
·The prohibition on payment of interest on demand deposits was repealed, effective July 21, 2011.
·Deposit insurance is permanently increased to $250,000.
·The deposit insurance assessment base calculation now equals the depository institution’s total assets minus the sum of its average tangible equity during the assessment period.
·The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35% of estimated annual insured deposits or assessment base; however, the FDIC is directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion.

In addition, in order to implement Basel III and certain additional capital changes required by the Dodd-Frank Act, on July 9, 2013, the Federal banking agencies, including the FDIC, the Federal Reserve and the Office of the Comptroller of the Currency, approved, as an interim final rule, the regulatory capital requirements for U.S. insured depository institutions and their holding companies. This regulation requires financial institutions to maintain higher capital levels and more equity capital.

These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, may impact the profitability of our business activities and may change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially and adversely affect our business, financial condition and results of operations.

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

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

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

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

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

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

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

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

·Telecommunications;
·Data processing;
·Automation;

 

 - 18 - 
   

 

·Internet-based banking, including personal computers, mobile phones and tablets;
·Debit cards and so-called “smart cards”; and
·Remote deposit capture.

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

Item 1B. Unresolved Staff Comments

None.

 

 - 19 - 
   

Item 2. Properties

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

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

Branch Location   Term
301 Sylvan Avenue, Englewood Cliffs, NJ   Term expires November 2028; renewable at the Bank’s option
12 East Palisade Avenue, Englewood, NJ   Term expires July 2022; renewable at the Bank’s option
1 Union Avenue, Cresskill, NJ   Term expires June 2026; renewable at the Bank’s option
899 Palisade Avenue, Fort Lee, NJ   Term expires April 2017; renewable at the Bank’s option
142 John Street, Hackensack, NJ   Term expires December 2021; renewable at the Bank’s option
171 East Ridgewood Avenue, Ridgewood, NJ   Term expires April 2019 renewable at the Bank’s option
71 East Allendale Road, Saddle River, NJ   Term expires May 2032, unless canceled or extended by the Bank
356 Chestnut Street, Union, NJ   Term expires in May 2027; renewable at the Bank’s option
104 Ely Place, Boonton, NJ   Term expires August 2021; renewable at the Bank’s option
300 Main Street, Madison, NJ   Term expires May 2021; renewable at the Bank’s option
545 Morris Avenue, Summit, NJ   Term expires January 2024; renewable at the Bank’s option
217 Chestnut Street, Newark, NJ   Term expires February 2019
5914 Park Avenue, West New York, NJ   Term expires September 2018; renewable at the Bank’s option
344 Nassau Street, Princeton, NJ   Term expires May 2019; renewable at the Bank’s option
963 Holmdel Road, Holmdel, NJ   Term expires July 2021; renewable at the Bank’s option
551 Madison Ave, Suite 202, New York, NY   Term expires March 2023

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

Item 3. Legal Proceedings

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

Item 4. Mine Safety Disclosures

Not applicable.

 

 - 20 - 
   

 

PART II

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

Security Market Information

The common stock of the Company is traded on the NASDAQ Global Select Market under the symbol “CNOB”. As of December 31, 2016, the Company had 500 stockholders of record, excluding beneficial owners for whom CEDE & Company or others act as nominees. On December 31, 2016, the closing sale price was $25.95.

The following table sets forth the high and low closing sales price, and the dividends declared, on a share of the Company’s common stock for the years ended December 31, 2016 and 2015. 

   Common Stock Price         
   2016   2015   Common Dividends
Declared
 
   High   Low   High   Low   2016   2015 
Fourth Quarter  $26.50   $17.78   $19.51   $17.50   $0.075   $0.075 
Third Quarter   18.86    15.22    22.27    18.50    0.075    0.075 
Second Quarter   17.30    15.12    21.88    19.00    0.075    0.075 
First Quarter   18.63    15.17    19.50    17.85    0.075    0.075 
Total                      $0.300   $0.300 

Share Repurchase Program

Historically, repurchases have been made from time to time as, in the opinion of management, market conditions warranted, in the open market or in privately negotiated transactions. Shares repurchased were used for stock dividends and other issuances. No repurchases were made of the Company’s common stock during 2016 or 2015.

Dividends

Federal laws and regulations contain restrictions on the ability of the Parent Corporation and the Bank to pay dividends. For information regarding restrictions on dividends, see Part I, Item 1, “Business” and Part II, Item 8, “Financial Statements and Supplementary Data”, Note 20 of the Notes to Consolidated Financial Statements.”

Stockholders Return Comparison

Set forth on the following page is a line graph presentation comparing the cumulative stockholder return on the Parent Corporation’s common stock, on a dividend reinvested basis, against the cumulative total returns of the NASDAQ Composite and the KBW Bank Index for the period from December 31, 2011 through December 31, 2016.

 

 - 21 - 
   

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

 

 

Assumes $100 Invested on December 31, 2011, with Dividends Reinvested
Year Ended December 31, 2016

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

   Fiscal Year Ending 
Company/Index/Market  12/31/11   12/31/12   12/31/13   12/31/14   12/31/15   12/31/16 
ConnectOne Bancorp, Inc.   100.00    120.27    197.54    203.22    203.11    285.27 
NASDAQ   100.00    117.70    164.65    188.87    202.25    220.13 
KBW Bank Index   100.00    132.78    182.44    199.28    200.25    255.90 

 

 - 22 - 
   

 

Item 6. Selected Financial Data

The following tables set forth selected consolidated financial data as of the dates and for the periods presented. The selected consolidated statement of financial condition data as of December 31, 2016 and 2015 and the selected consolidated summary of income data for the years ended December 31, 2016, 2015 and 2014 have been derived from our audited consolidated financial statements and related notes that we have included elsewhere in this Annual Report. The selected consolidated statement of financial condition data as of December 31, 2014, 2013, 2012 and the selected consolidated summary of income data for the years ended December 31, 2013 and 2012 have been derived from audited consolidated financial statements that are not presented in this Annual Report.

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

 

 - 23 - 
   

 

SUMMARY OF SELECTED STATISTICAL INFORMATION AND FINANCIAL DATA

   For the Years Ended December 31, 
   2016   2015   2014   2013   2012 
(dollars in thousands, except share data)    
Selected Statement of Financial Condition Data                         
Total assets  $4,426,348   $4,015,909   $3,448,572   $1,673,082   $1,629,082 
Loans receivable   3,475,832    3,009,007    2,538,641    960,943    889,672 
Allowance for loan and lease losses   25,744    26,572    14,160    10,333    10,237 
Securities – available-for-sale   353,290    195,770    289,532    323,070    496,815 
Securities – held-to-maturity   -    224,056    224,682    215,286    58,064 
Goodwill and other intangible assets   148,997    149,817    150,734    16,828    16,858 
Borrowings   476,280    671,587    495,553    146,000    146,000 
Subordinated debt (net of issuance costs)   54,534    54,343    5,155    5,155    5,155 
Deposits   3,344,271    2,790,966    2,475,607    1,342,005    1,306,922 
Tangible common stockholders’ equity(1)   325,127    316,277    284,235    168,584    160,691 
Total stockholders’ equity   531,032    477,344    446,219    168,584    160,691 
Average total assets   4,236,758    3,661,306    2,520,524    1,633,270    1,538,473 
Average common stockholders’ equity   491,110    456,036    301,004    153,775    138,464 
Dividends                         
Cash dividends paid on common stock  $9,067   $8,996   $6,940   $4,254   $2,778 
Dividend payout ratio   29.19%   21.84%   37.60%   21.50%   16.13%
Cash dividends per share                         
Cash dividends  $0.300   $0.300   $0.300   $0.280   $0.195 
                          
Selected Statement of Income Data                         
Interest income  $161,241   $140,967   $94,207   $57,268   $55,272 
Interest expense   (31,096)    (23,814)   (14,808)   (11,082)    (11,776)
Net interest income   130,145    117,153    79,399    46,186    43,496 
Provision for loan and lease losses   (38,700)    (12,605)   (4,683)   (350)   (325)
Net interest income after provision for loan losses   91,445    104,548    74,716    45,836    43,171 
Noninterest income   9,920    11,173    7,498    6,851    7,210 
Noninterest expense   (58,507)    (54,484)   (54,804)   (25,278)   (25,197)
Income before income tax expense   42,858    61,237    27,410    27,409    25,184 
Income tax expense   (11,776)    (19,926)    (8,845)   (7,484)   (7,677) 
Net income  $31,082   $41,311   $18,565   $19,925   $17,507 
Preferred stock dividends   (22)    (112)   (112)   (141)   (281)
Net income available to common stockholders  $31,060   $41,199   $18,453   $19,784   $17,226 

__________________________

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

 

 - 24 - 
   

 

   At or for the Years Ended December 31, 
(dollars in thousands, except share data)  2016   2015   2014   2013   2012 
Per Common Share Data                         
Basic  $1.02   $1.37   $0.80   $1.21   $1.05 
Diluted   1.01    1.36    0.79    1.21    1.05 
Book value per common share   16.62    15.49    14.65    9.61    9.14 
Tangible book value per common share (1)   11.96    10.51    9.57    8.58    8.11 
                          
Selected Performance Ratios                         
Return on average assets   0.73%   1.13%   0.74%   1.22%   1.14%
Return on average common stockholders’ equity   6.30    9.03    6.13    12.87    12.44 
Net interest margin   3.38    3.55    3.57    3.30    3.32 
                          
Selected Asset Quality Ratios as a % of loans receivable:                         
Nonaccrual loans (excluding loans held-for sale)   0.16%   0.67%   0.46%   0.33%   0.41%
Loans 90 days or greater past due and still accruing (non-PCI)   -    -    0.05    -    0.01 
Loans 90 days or greater past due and still accruing (PCI)   0.15    -    -    -    - 
Performing TDRs   0.38    2.77    0.07    0.60    0.77 
Allowance for loan and lease losses   0.74    0.86    0.56    1.08    1.15 
                          
Nonperforming assets(2)  to total assets   1.57%   0.58%   0.37%   0.20%   0.30%
Allowance for loan and lease losses to nonaccrual loans (excluding loans held-for-sale   449.0    128.1    122.0    329.4    283.1 
Net loan charge-offs (recoveries) to average loans(3)   1.18    0.01    0.05    0.03    (0.04)
                          
Capital Ratios                         
Leverage ratio   9.29%   9.07%   9.37%   9.69%   9.02%
Common equity Tier 1 risk-based ratio   9.74    9.14    n/a    n/a    n/a 
Risk-based Tier 1 capital ratio   9.87    9.61    10.44    12.10    11.39 
Risk-based total capital ratio   11.78    11.77    10.94    12.90    12.22 
Tangible common equity to tangible assets (1)   8.93    8.18    8.62    8.48    8.22 

__________________________

(1)These measures are not measures recognized under generally accepted accounting principles in the United States (“GAAP”), and are therefore considered to be non-GAAP financial measures. See –“Notes to Selected Financial Data” for a reconciliation of these measurers to their most comparable GAAP measures.
(2)Nonperforming assets are defined as nonaccrual loans, nonaccrual loans held-for-sale, and other real estate owned.
(3)Charge-offs in 2016 included $36.7 million related to the transfer of our taxi medallion portfolio to loans held-for-sale.

 

 - 25 - 
   

 

Notes to Selected Financial Data

   As of the year ended December 31, 
   2016   2015   2014   2013   2012 
(dollars in thousands, except per share data)    
Tangible common equity and tangible common equity/tangible assets                         
Common stockholders’ equity  $531,032   $466,094   $434,969   $157,334   $149,441 
Less: goodwill and other intangible assets   148,997    149,817    150,734    16,828    16,858 
Tangible common stockholders’ equity  $382,035   $316,277   $284,235   $140,506   $132,583 
                          
Total assets  $4,426,348   $4,015,909   $3,448,572   $1,673,082   $1,629,765 
Less: goodwill and other intangible assets   148,997    149,817    150,734    16,828    16,858 
Tangible assets  $4,277,351   $3,866,092   $3,297,838   $1,656,254   $1,612,907 
                          
Tangible common equity ratio   8.93%   8.18%   8.62%   8.48%   8.22%
                          
Tangible book value per common share                         
Book value per common share  $16.62   $15.49   $14.65   $9.61   $9.14 
Less: goodwill and other intangible assets   4.66    4.98    5.08    1.03    1.03 
Tangible book value per common share  $11.96   $10.51   $9.57   $8.58   $8.11 

 

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

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

Cautionary Statement Concerning Forward-Looking Statements

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

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to our audited consolidated financial statements contains a summary of our significant accounting policies. Management believes our policy with respect to the methodology for the determination of the allowance for loan and lease losses involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and our Board of Directors.

Business Combinations 

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

Allowance for Loan and Lease Losses and Related Provision

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

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

The allowance for loan and lease losses is established through a provision for loan and lease losses charged to expense. Management believes that the current allowance for loan and lease losses will be adequate to absorb probable incurred loan and lease losses on existing loans and leases that may become uncollectible based on the evaluation of known and inherent risks in the originated loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect our borrowers’ ability to pay. The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. Various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan and lease losses. Such agencies may require us to make additional provisions for loan losses based upon information available to them at the time of their examination. All of the factors considered in the analysis of the adequacy of the allowance for loan and lease losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods. Additional information can be found in Note 1 of the Notes to Consolidated Financial Statements.

 

 - 27 - 
   

 

Income Taxes

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

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

Goodwill

The Company has adopted the provisions of FASB ASC 350-10-05, which requires that goodwill be reported separate from other intangible assets in the Consolidated Statements of Condition and not be amortized but tested for impairment annually or more frequently if indicators arise for impairment. No impairment charge was deemed necessary for the years ended December 31, 2016, 2015 and 2014.

Fair Value of Investment Securities

The Company relies upon the guidance in FASB ASC 820-10-65 when determining fair value for the Company’s pooled trust preferred securities and private issue corporate bond. See Note 22 of the Notes to Consolidated Financial Statements, Fair Value Measurements and Fair Value of Financial Instruments, for further discussion.

Overview and Strategy

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

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

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

General

The following discussion and analysis presents the more significant factors affecting the Company’s financial condition as of December 31, 2016 and 2015 and results of operations for each of the years in the three-year period ended December 31, 2016. The MD&A should be read in conjunction with the consolidated financial statements, notes to consolidated financial statements and other information contained in this report.

 

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Operating Results Overview

Net income for the year ended December 31, 2016 was $31.1 million, a decrease of $10.2 million, or 24.8%, compared to net income of $41.3 million for 2015. Net income available to common shareholders for the year ended December 31, 2016 was $31.1 million, a decrease of $10.1 million, or 24.6%, compared to net income available to common shareholders of $41.2 million for 2015. Diluted earnings per share were $1.01 for 2016, a 25.7% decrease from $1.36 for 2015.

The change in net income from 2015 to 2016 was attributable to the following:

·Increased net interest income of $13.0 million primarily due to organic growth,
·Increased provision for loan and lease losses of $26.1 million primarily due to an increase in additional reserves specifically allocated to the Company’s taxi medallion portfolio, resulting from the transfer of the portfolio to loans held-for-sale,
·Decrease in noninterest income of $1.3 million primarily resulting from a prior year insurance recovery ($2.2 million), offset by current year increases in BOLI income ($0.8 million),
·Noninterest expense increased approximately $4.0 million primarily due to an increase in salaries and employee benefits ($3.4 million), occupancy and equipment ($1.0 million), FDIC insurance ($0.8 million), data processing ($0.4 million) and other expenses ($0.6 million), offset by a prior year loss on extinguishment of debt ($2.4 million), and
·Decreased income tax expense of $8.2 million resulting from decrease in income before taxes.

Net income for the year ended December 31, 2015 was $41.3 million, an increase of $22.7 million, or 123.4%, compared to net income of $18.6 million for 2014. Net income available to common shareholders for the year ended December 31, 2015 was $41.2 million, an increase of $22.7 million, or 123.3%, compared to net income available to common shareholders of $18.5 million for 2014. Diluted earnings per share were $1.36 for 2015, a 72.2% increase from $0.79 for 2014.

The change in net income from 2014 to 2015 was attributable to the following:

·Increased net interest income of $37.8 million primarily due to the impact of the Merger and organic growth,
·Increased provision for loan and lease losses of $7.9 million primarily due to an increase in organic loan growth during 2015, higher levels of specific reserves including $4.5 million related to the taxi medallion portfolio and $1.3 million related to the Union Center’s former operations center that was repositioned as a lease financing receivable and the maturity and extension of acquired portfolio loans,
·Increased noninterest income of $3.7 million primarily resulting from an insurance recovery ($2.2 million) and an increase in net gains on sale of investment securities ($1.1 million),
·Noninterest expense remained relatively flat due to an increase in salaries and employee benefits ($8.9 million), occupancy and equipment ($2.3 million), and professional and consulting ($1.3 million), offset by impact of the Merger (including direct merger charges of $12.4 million in 2014), and
·Increased income tax expense of $11.1 million resulting from higher pretax income in 2015 offset by nondeductible merger-related expenses incurred in 2014.

Net Interest Income

Fully taxable equivalent net interest income for 2016 totaled $133.0 million, an increase of $13.3 million, or 11.1%, from 2015. The increase in net interest income was due to an increase in average interest-earning assets, which grew by 16.7% to $3.9 billion. Partially offsetting the increase in interest-earning assets was a 17 basis-point contraction in the net interest margin. The decrease in the net interest margin was attributed to higher levels of cash held at the Federal Reserve Bank, lower accretion of purchase accounting adjustments related to the Merger, long-term subordinated debt issued in June 2016, and an increase in rates paid on deposits. Average total loans increased by 20.1% to $3.4 billion in 2016 from $2.8 billion in 2015.

Fully taxable equivalent net interest income for 2015 totaled $119.7 million, an increase of $37.9 million, or 46.4%, from 2014. The increase in net interest income was due to an increase in average interest-earning assets, which grew by 47.3% to $3.4 billion principally as a result of the Merger, which was effective on July 1, 2014. Partially offsetting the increase in interest-earning assets was a 2 basis-point contraction in the net interest margin. During 2015, the Bank’s funding costs were higher due to an increase in longer-term funding, including time deposits and subordinated debt. Average total loans increased by 64.6% to $2.8 billion in 2015 from $1.7 billion in 2014.

 

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Average Balance Sheets

The following table sets forth certain information relating to our average assets and liabilities for the years ended December 31, 2016, 2015 and 2014 and reflect the average yield on assets and average cost of liabilities for the periods indicated. Such yields are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown.

   Years Ended December 31, 
   2016   2015   2014 
(Tax-Equivalent Basis)  Average
Balance
   Income/
Expense
   Yield/
Rate
   Average
Balance
   Income/
Expense
   Yield/
Rate
   Average
Balance
   Income/
Expense
   Yield/
Rate
 
   (dollars in thousands) 
ASSETS                                             
Interest-earning assets:                                             
Investment securities (1) (2)  $396,622   $13,153    3.32%  $482,703   $16,128    3.34%  $508,024   $18,148    3.57%
Loans (2) (3) (4)   3,355,452    148,755    4.43%   2,793,952    126,133    4.51%   1,696,977    77,669    4.58%
Federal funds sold and interest-earnings deposits with banks   152,397    756    0.50%   65,513    178    0.27%   68,152    138    0.20%
Restricted investment in bank stocks   28,439    1,410    4.96%   27,335    1,081    3.95%   14,946    636    4.26%
Total interest-earning assets   3,932,910    164,074    4.17%   3,369,503    143,520    4.26%   2,288,099    96,591    4.22%
Noninterest-earning assets:                                             
Allowance for loan and lease losses   (32,554)              (17,905)              (14,267)           
Noninterest-earning assets   336,402              309,708              246,692           
Total assets  $4,236,758             $3,661,306             $2,520,524           
                                              

LIABILITIES & STOCKHOLDERS’ EQUITY

                                             
Savings, NOW, money market, interest checking  $1,544,838    6,754    0.44%  $1,279,663    4,972    0.39%  $1,121,148    4,152    0.37%
Time deposits   923,114    11,913    1.29%   752,380    8,784    1.17%   424,603    4,108    0.97%
Total interest-bearing deposits   2,467,952    18,667    0.76%   2,032,043    13,756    0.68%   1,545,751    8,260    0.53%
                                              
Borrowings   571,626    9,013    1.58%   565,408    8,181    1.45%   288,798    6,301    2.18%
Subordinated debentures (5)   55,155    3,246    5.89%   30,497    1,700    5.57%   5,155    156    3.03%
Capital lease obligation   2,829    170    6.01%   2,946    177    6.01%   1,528    91    5.96 
Total interest-bearing liabilities   3,097,562    31,096    1.00%   2,630,894    23,814    0.91%   1,841,232    14,808    0.80%
Noninterest-bearing deposits   624,731              537,287              350,310           
Other liabilities   21,203              25,839              16,728           
Stockholders’ equity   493,262              467,286              312,254           
Total liabilities and stockholders’ equity  $4,236,758             $3,661,306             $2,520,524           
                                              

Net interest income/interest rate spread (6)

       $132,978    3.17%       $119,706    3.35%       $81,783    3.42%
Tax-equivalent adjustment        (2,833)             (2,553)              (2,384)      
Net interest income as reported       $130,145             $117,153             $79,399      
Net interest margin (7)             3.38%             3.55%             3.57%

__________________________

(1) Average balances are based on amortized cost.
(2) Interest income is presented on a tax equivalent basis using 35% federal tax rate.
(3) Includes loan fee income.
(4) Loans include nonaccrual loans.
(5) Amount does not reflect netting of debt issuance costs of $621, $812 and $ - as of December 31, 2016, December 31, 2015 and December 31, 2014, respectively.
(6) Represents difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and is presented on a tax equivalent basis.
(7) Represents net interest income on a tax equivalent basis divided by average total interest-earning assets

 

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Rate/Volume Analysis

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

   2016/2015
Increase (Decrease)
Due to Change in:
   2015/2014
Increase (Decrease)
Due to Change in:
 
   Average
Volume
   Average
Rate
   Net
Change
   Average
Volume
   Average
Rate
   Net
Change
 
   (dollars in thousands) 
Interest income:                              
Investment securities:  $(2,855)   $(120)  $(2,975)  $(846)  $(1,174)  $(2,020)
Loans receivable and loans held-for-sale   24,893    (2,271)   22,622    49,523    (1,059)   48,464 
Federal funds sold and interest-earnings deposits with banks   431    147    578    (7)   47    40 
Restricted investment in bank stocks   55    274    329    490    (45)   445 
Total interest income:  $22,524   $(1,970)  $20,554   $49,160   $(2,231)  $46,929 
                               
Interest expense:                              
Savings, NOW, money market, interest checking  $1,294   $488   $1,622   $632   $188   $820 
Time deposits   2,203    926    3,289    3,827    849    4,676 
Borrowings and subordinated debentures   1,549    829    2,378    5,415    (1,991)   3,424 
Capital lease obligation   (7)   -    (7)    85    1    86 
Total interest expense:  $5,039   $2,243   $7,282   $9,959   $(953)  $9,006 
                               
Net interest income:  $17,485   $(4,213)   $13,272   $39,201   $(1,278)  $37,923 

Provision for Loan and Lease Losses

In determining the provision for loan and lease losses, management considers national and local economic trends and conditions; trends in the portfolio including orientation to specific loan types or industries; experience, ability and depth of lending management in relation to the complexity of the portfolio; effects of changes in lending policies, trends in volume and terms of loans; levels and trends in delinquencies, impaired loans and net charge-offs and the results of independent third party loan and lease review.

For the year ended December 31, 2016, the provision for loan and lease losses was $38.7 million, an increase of $26.1 million, compared to the provision for loan and lease losses of $12.6 million for 2015. The increase was largely attributable to an increase in reserves allocated to the Bank’s taxi medallion portfolio of approximately $27.7 million resulting from the transfer of the portfolio to loans held-for-sale, offset by a reduction in reserves of $1.5 million related to the movement of loans from the acquired portfolio into loans held-for-investment.

For the year ended December 31, 2015, the provision for loan and lease losses was $12.6 million, an increase of $7.9 million, compared to the provision for loan and lease losses of $4.7 million for the same period in 2014. The increase resulted from an increase in organic loan growth during 2015, higher levels of specific reserves including $4.5 million related to the taxi medallion portfolio and $1.3 million related to the Union Center’s former operations center that was repositioned as a lease financing receivable and the maturity and extension of acquired portfolio loans.

Noninterest Income

Noninterest income for the full-year 2016 decreased by $1.3 million, or 11.2% to $9.9 million from $11.2 million in 2015. The decrease was primarily the result of a 2015 insurance recovery of $2.2 million, offset by an increase in BOLI income of $0.8 million and higher net investment securities gains, increasing by $0.3 million to $4.2 million for the year ended December 31, 2016 from $3.9 million for the year ended December 31, 2015.

 

 - 31 - 
   

 

Noninterest income for the full-year 2015 increased by $3.7 million, or 49.0% to $11.2 million from $7.5 million in 2014. The increase was primarily the result of a 2015 insurance recovery of $2.2 million and higher net investment securities gains, increasing by $1.1 million to $3.9 million for the year ended December 31, 2015 from $2.8 million for the year ended December 31, 2014, partially offset by a slight decline in deposit, loan and other income of $0.1 million to $2.7 million and a decline in annuities and insurance commissions of $0.2 million to $0.2 million for the year ended December 31, 2015.

Noninterest Expense

Noninterest expenses for the full-year 2016 increased by $4.0 million, or 7.4% to $58.5 million from $54.5 million in 2015.  The increase was primarily attributable to an increased level of business and staff resulting from organic growth. Salary and employee benefits increased by $3.3 million, occupancy and equipment expenses increased by $1.0 million, FDIC insurance increased by $0.8 million, data processing increased by $0.4 million, marketing and advertising increased by $0.2 million and other expenses increased by $0.6 million, offset by a 2015 loss on an extinguishment of debt for $2.4 million.

Noninterest expenses for the full-year 2015 decreased by $0.3 million, or 0.6% to $54.5 million from $54.8 million in 2014.  The decrease was a result of merger-related charges of $12.4 million in 2014, offset by increases attributable to the Merger (2015 reflected a full-year of combined company expenses whereas 2014 reflected those expenses only during the second half) as well as an increased level of business and staff resulting from organic growth. Salary and employee benefits increased by $8.9 million, occupancy and equipment expenses increased by $2.3 million and professional and consulting fees increased by $1.3 million.

Income Taxes

Income tax expense was $11.8 million for the full-year 2016 compared to $19.9 million for the full-year 2015 and $8.8 million for the full-year 2014. The effective tax rates were 27.5% for 2016 and 32.5% for 2015 and 32.3% for 2014.  The effective tax rate in 2016 from 2015 decreased due to a decrease in the proportion of income subject to income taxes. The effective tax rate in 2015 from 2014 remained relatively flat.

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

Financial Condition Overview

At December 31, 2016, the Company’s total assets were $4.4 billion, an increase of $410 million from December 31, 2015. Total loans (including loans held-for-sale) were $3.6 billion, an increase of $455 million from December 31, 2015. Deposits were $3.3 billion, an increase of $553 million from December 31, 2015.

At December 31, 2015, the Company’s total assets were $4.0 billion, an increase of $568 million from December 31, 2014. Loans receivable were $3.1 billion, an increase of $560 million from December 31, 2014. Deposits were $2.8 billion, an increase of $315 million from December 31, 2014.

Loan Portfolio

The Bank’s lending activities are generally oriented to small-to-medium sized businesses, high net worth individuals, professional practices and consumer and retail customers living and working in the Bank’s market area of Bergen, Union, Morris, Essex, Hudson, Mercer and Monmouth counties, New Jersey, as well as NYC’s five boroughs. The Bank has not made loans to borrowers outside of the United States. The Bank believes that its strategy of high-quality customer service, competitive rate structures and selective marketing have enabled it to gain market share.

Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, inventory and equipment and liens on commercial and residential real estate. Commercial construction loans are loans to finance the construction of commercial or residential properties secured by first liens on such properties. Commercial real estate loans include loans secured by first liens on completed commercial properties, including multi-family properties, to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Home equity loans and lines of credit include loans secured by first or second liens on residential real estate for primary or secondary residences. Consumer loans are made to individuals who qualify for auto loans, cash reserve, credit cards and installment loans.

During 2016 and 2015, loan portfolio growth was positively impacted in several ways including (i) an increase in demand for small business lines of credit, and business term loans as economic conditions have stabilized and begun to improve, (ii) industry consolidation and lending restrictions involving larger competitors allowing the Bank to gain market share, (iii) an increase in refinancing strategies employed by borrowers during the current low rate environment, and (iv) the Bank’s success in attracting highly experienced commercial loan officers with substantial local market knowledge.

 

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Total gross loans at December 31, 2016 totaled $3.5 billion, an increase of $378 million, or 12.2%, over gross loans at December 31, 2015 of $3.1 billion. As of December 31, 2016, the Bank had transferred $77.8 million of loans to loans held-for-sale, consisting primarily of $65.6 million of taxi medallion loans (part of commercial loans), $7.7 million of commercial real estate loans and $4.5 million in non-taxi commercial loans. Excluding this transfer, total gross loans at December 31, 2016 increased by $455 million, or 14.7% over gross loans at December 31, 2015. The increase in gross loans was attributable to organic loan growth.

The largest component of our loan portfolio at December 31, 2016 and December 31, 2015 was commercial real estate loans. Our commercial real estate loans (including multifamily loans) at December 31, 2016 totaled $2.2 billion, an increase of $238 million, or 12.1%, over commercial real estate loans at December 31, 2015 of $2.0 billion. Our commercial loans totaled $553.6 million at December 31, 2016, a decrease of $16.5 million, or 2.9%, over commercial loans at December 31, 2015 of $570.1 million. The decrease was the result of a transfer of the entire taxi medallion portfolio ($65.6 million) to loans held-for-sale as of December 31, 2016. Excluding this transfer of the taxi medallion portfolio, the commercial loan portfolio increased by $49.1 million, or 8.7% over commercial loans at December 31, 2015.

Our commercial construction loans at December 31, 2016 totaled $486.2 million, an increase of $157.4 million, or 47.9%, over commercial construction loans at December 31, 2015 of $328.8 million. Our residential real estate loans totaled $232.5 million at December 31, 2016, a decrease of $1.1 million, or 0.5%, over residential real estate loans at December 31, 2015 of $233.7 million. Our consumer loans at December 31, 2016 totaled $2.4 million, a decrease of $0.1 million, 3.0%, over consumer loans of $2.5 million at December 31, 2015. The growth in our loan portfolio reflects the success of our business strategy, in particular emphasizing high-quality customer service, which has led to continued customer referrals.

The following table sets forth the classification of our loans by loan portfolio segment for the periods presented.

    December 31,  
    2016   2015   2014   2013   2012  
    (dollars in thousands)  
Commercial   $ 553,576   $ 570,116   $ 499,816   $ 229,688   $ 181,682  
Commercial real estate     2,204,710     1,966,696     1,634,510     536,539     497,392  
Commercial construction     486,228     328,838     167,359     42,722     40,277  
Residential real estate     232,547     233,690     234,967     150,571     169,094  
Consumer     2,380     2,454     2,879     1,084     1,104  
Gross loans     3,479,441     3,101,794     2,539,531     960,604     889,549  
Net deferred (fees) loan costs     (3,609)     (2,787)     (890)     339     123  
Loans receivable     3,475,832     3,099,007     2,538,641     960,943     889,672  
Allowance for loan and lease losses     (25,744)     (26,572)     (14,160)      (10,333)     (10,237)  
Net loans receivable   $ 3,450,088   $ 3,072,435   $ 2,524,481   $ 950,610   $ 879,435  

The following table sets forth the classification of our gross loans by loan portfolio segment and by fixed and adjustable rate loans as of December 31, 2016 in term of contractual maturity.

    At December 31, 2016, Maturing  
    In
One Year
or Less
  After
One Year
through
Five Years
  After
Five Years
  Total  
    (dollars in thousands)  
Commercial   $ 228,442   $ 185,982   $ 139,152   $ 553,576  
Commercial real estate     201,193     622,184     1,381,333     2,204,710  
Commercial construction     428,177     58,051     -     486,228  
Residential real estate     5,224     33,878     193,445     232,547  
Consumer     805     813     762     2,380  
Total   $ 863,841   $ 900,908   $ 1,714,692   $ 3,479,441  
Loans with:                          
Fixed rates   $ 180,994   $ 538,599   $ 523,755   $ 1,243,348  
Variable rates     682,847     362,309     1,190,937     2,236,093  
Total   $ 863,841   $ 900,908   $ 1,714,692   $ 3,479,441  

For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.

 

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Asset Quality

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

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

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

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans for which the terms have been modified as a concession to the borrower due to the borrower experiencing financial difficulties are considered troubled debt restructurings (“TDR”) and are classified as impaired. Loans considered to be TDRs can be categorized as nonaccrual or performing. The impairment of a loan can be measured at (1) the fair value of the collateral less costs to sell, if the loan is collateral dependent, (2) at the value of expected future cash flows using the loan’s effective interest rate, or (3) at the loan’s observable market price. Generally, the Bank measures impairment of such loans by reference to the fair value of the collateral less costs to sell. Loans that experience minor payment delays and payment shortfall generally are not classified as impaired.

Loans $250,000 and over, as well as all TDRs, are individually evaluated for impairment. If a loan that is identified as impaired and the individual test results in an impairment, a portion of the allowance is allocated so that the loan is reported, net, at the fair value of collateral less costs to sell if repayment is expected solely from the collateral or at the present value of estimated future cash flows using the loan’s existing rate if the loan is dependent on cash flow. Loans with balances less than $250,000 (with the exception of TDRs) are collectively evaluated for impairment, and accordingly, are not separately identified for impairment disclosures.

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

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

 

 - 34 - 
   

 

A bank’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by Federal bank regulators which can order the establishment of additional general or specific loss allowances. The Federal banking agencies have adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management analyze all significant factors that affect the collectability of the portfolio in a reasonable manner; and that management establish acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Our management believes that, based on information currently available, our allowance for loan and lease losses is maintained at a level which covers all known and probable incurred losses in the portfolio at each reporting date. However, actual losses are dependent upon future events and, as such; further additions to the level of allowances for loan losses may become necessary.

The table below sets forth information on our classified loans and loans designated as special mention (excluding loans held-for-sale) as of the dates presented:

   December 31, 
   2016   2015 
(dollars in thousands)    
Classified Loans:          
Substandard  $35,693   $130,253 
Doubtful   -    239 
Loss   -    - 
Total classified loans   35,693    130,492 
Special Mention Loans   37,816    31,412 
Total classified and special mention loans  $73,509   $161,904 

During the year ended December 31, 2016, “substandard” loans, which include lower credit quality loans which possess higher risk characteristics than special mention assets, decreased from $130.3 million, or 4.2% of total loans receivable, at December 31, 2015 to $35.7 million, or 1.0% of total loans, at December 31, 2016.  The decrease is primarily attributable to the entire taxi medallion portfolio moving to the loans held-for-sale category. At December 31, 2015, approximately $80.3 million of taxi medallion loans were reported as “substandard”. In addition, a relationship totaling $10.4 million (consisting of two commercial loans and one lease financing receivable) that was reported as “substandard” as of December 31, 2015 was paid off during the third quarter of 2016.

Nonperforming Loans, Troubled Debt Restructurings, Past Due Loans and OREO

Nonperforming loans include nonaccrual loans and accruing loans which are contractually past due 90 days or greater. Nonaccrual loans represent loans on which interest accruals have been suspended. The Company considers charging off loans, or a portion thereof, when they become contractually past due ninety days or more as to interest or principal payments or when other internal or external factors indicate that collection of principal or interest is doubtful. Troubled debt restructurings represent loans on which a concession was granted to a borrower, such as a reduction in interest rate to a rate lower than the current market rate for new debt with similar risks, and which are currently performing in accordance with the modified terms. The Company previously reported performing troubled debt restructured loans as a component of nonperforming assets. For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.

 

 - 35 - 
   

 

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

   At December 31, 
   2016   2015   2014   2013   2012 
   (dollars in thousands) 
Nonaccrual loans  $5,734   $20,737   $11,609   $3,137   $3,616 
Nonaccrual loans (held-for-sale)   63,044    -    -    -    - 
OREO   626    2,549    1,108    220    1,300 
Total nonperforming assets(1)  $69,404   $23,286   $12,717   $3,357   $4,916 
                          
Performing TDRs  $13,338   $85,925   $1,763   $5,746   $6,813 
Loans 90 days or greater past due and still accruing (non-PCI)  $-   $-   $-   $-   $- 
Loans 90 days or greater past due and still accruing (PCI)  $5,293   $-   $-   $-   $- 
(1)Nonperforming assets are defined as nonaccrual loans, nonaccrual loans held-for-sale, and other real estate owned.

Nonaccrual loans (excluding loans held-for-sale) to total loans receivable   0.16%    0.67%    0.46%    0.33%    0.41% 
Nonperforming assets to total assets   1.57%    0.58%    0.37%    0.20%    0.30% 
Nonperforming assets, performing TDRs, and loans 90 days or greater past due and still accruing to total loans(2)   2.48%    3.52%    0.62%    0.95%    1.32% 
(2)Includes loans held-for-sale.

The decrease in performing TDRs was mainly attributable to the entire taxi medallion portfolio being moved to loans held-for-sale as of December 31, 2016. As of December 31, 2015, $78.5 of taxi medallion loans were reported as performing TDRs. In addition, prior to the taxi medallion loans being moved to the loans held-for-sale category, $63.0 million of taxi medallion loans (net of a $36.7 charge-off) were designated as nonaccrual.

Allowance for Loan and Lease Losses and Related Provision

The allowance for loan and lease losses is a reserve established through charges to earnings in the form of a provision for loan and lease losses. We maintain an allowance for loan and lease losses at a level considered adequate to provide for all known and probable incurred losses in the portfolio. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited. Our officers analyze risks within the loan portfolio on a continuous basis and through an external independent loan review function, and the results of the loan review function are also reviewed by our Audit Committee. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly and, as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to our allowance for loan and lease losses.

At December 31, 2016, the allowance for loan and lease losses was $25.7 million, a decrease of $0.8 million or 3.1%, from $26.6 million for the year ended December 31, 2015. The decrease in the allowance for loan and lease losses was primarily attributable to net charge-offs of $39.5 million, of which $36.7 million were for the nonperforming taxi medallion portfolio, offset by provisioning of $38.7 million, of which $32.2 million were related to the nonperforming taxi medallion portfolio. The remaining provision was mainly attributable to organic loan growth.

 

 - 36 - 
   

 

Net charge-offs totaled $39.5 million during 2016 and $0.2 million for 2015. The allowance for loan and lease losses as a percentage of loans receivable was 0.74% at December 31, 2016 and 0.86% at December 31, 2015. The increase in net charge-offs and the decrease in the percentage were attributable to the aforementioned charges against the taxi medallion portfolio.

 

Five-Year Statistical Allowance for Loan and Lease Losses

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

   Years Ended December 31, 
   2016   2015   2014   2013   2012 
   (dollars in thousands) 
Balance at the beginning of year  $26,572   $14,160   $10,333   $10,237   $9,602 
Charge-offs:                         
Commercial-other   1,446    507    777    132    57 
Commercial-taxi medallions   36,750    -    -    -    - 
Commercial-lease financing receivable   1,147    -    -    -    - 
Commercial real estate   107    -    -    -    - 
Residential real estate   94    -    159    175    454 
Consumer   29    31    -    22    16 
Total charge-offs   39,573    538    936    329    527 
Recoveries:                         
Commercial-other   4    340    50    69    620 
Commercial real estate   35    -    -    -    - 
Residential real estate   3    2    19    -    210 
Consumer   3    3    11    6    7 
Total recoveries   45    345    80    75    837 
Net charge-offs (recoveries)   39,528    193    856    254    (310)
Provision for loan and lease losses   38,700    12,605    4,683    350    325 
Balance at end of year  $25,744   $26,572   $14,160   $10,333   $10,237 
Ratio of net charge-offs (recoveries) during the year to average loans outstanding during the year   1.18%   0.01%   0.05%   0.03%   (0.04)%
Allowance for loan and lease losses as a percentage of loans receivable at end of year   0.74%   0.86%   0.56%   1.08%   1.15%

For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.

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

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

    Commercial     Residential real estate     Consumer     Unallocated          
    Amount of
Allowance
     Loans to
Total
Loans
%
     Amount of
Allowance
     Loans to
Total
Loans
%
     Amount of
Allowance
     Loans to
Total
Loans
%
     Amount of
Allowance
     Total Allowance  
    (dollars in thousands)  
2016   $ 24,005       93.2     $ 957       6.7     $ 3       0.1     $ 779     $ 25,744  
2015     25,127       92.4       977       7.5       4       0.1       464       26,572  
2014     12,121       90.6       1,113       9.3       7       0.1       919       14,160  
2013     7,806       84.2       990       15.7       146       0.1       1,391       10,333  
2012     7,944       80.9       1,528       19.0       114       0.1       651       10,237  

 

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Investments

For the year ended December 31, 2016, the average volume of investment securities decreased by $86.1 million to approximately $396.6 million or 10.1% of average earning assets, from $482.7 million on average, or 14.3% of average earning assets, in 2015. The decrease in investment securities resulted from a focus on funding new loan originations and sale of investments. At December 31, 2016, the total investment portfolio amounted to $353.3 million, a decrease of $66.5 million from December 31, 2015. At December 31, 2016, the principal components of the investment portfolio are U.S. Treasury and Government Agency Obligations, Federal Agency Obligations including mortgage-backed securities, Obligations of U.S. states and political subdivision, corporate bonds and notes, and other debt and equity securities.

Transfers of debt securities from the held-to-maturity category to the available-for-sale category are made at fair value at the date of transfer.  The unrealized holding gain or loss at the date of the transfer is recognized in accumulated other comprehensive income, net of applicable taxes. During the quarter ended September 30, 2016 the Company transferred all securities previously categorized as held-to-maturity to available-for-sale classification. The transfer resulted in an increase of approximately $210 million in amortized cost basis of securities and resulted in a net increase to accumulated other comprehensive income of $7.4 million, net of tax. This transfer will enhance liquidity and increase flexibility with regard to asset-liability management and balance sheet composition.

During the year ended December 31, 2016, volume related factors decreased investment revenue by $2.9 million. The tax-equivalent yield on investments decreased by 2 basis points to 3.32% from a yield of 3.34% during the year ended December 31, 2015. This was caused by the Company decreasing the size of its investment portfolio in an effort to deploy excess cash into loans.

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

At December 31, 2016, the net unrealized gain carried as a component of accumulated other comprehensive income and included in stockholders’ equity, net of tax, amounted to $0.9 million as compared with a net unrealized gain of $0.6 million at December 31, 2015, resulting from changes in market conditions and interest rates at December 31, 2016. For additional information regarding the Company’s investment portfolio, see Note 4, Note 17 and Note 22 of the Notes to the Consolidated Financial Statements.

During 2016, securities sold from the Company’s available-for-sale portfolio amounted to $85.3 million, as compared with $65.2 million in 2015 and $80.4 million in 2014. The gross realized gains on securities sold, called or matured amounted to approximately $4.2 million in 2016, $3.9 million in 2015 and $2.8 million in 2014, while there were no gross realized losses in 2016 and 2015 and there were losses of $19 thousand in 2014. There were no impairment charges in 2016 or 2015 as compared to $740 thousand in 2014.

The table below illustrates the maturity distribution and weighted average yield on a tax-equivalent basis for investment securities at December 31, 2016, on a contractual maturity basis.

   Due in 1 year or less   Due after 1 year
through 5 years
   Due after 5 years
through 10 years
   Due after 10 years   Total 
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Market
Value
 
(dollars in thousands)                                            
Investment Securities Available-for-Sale                                                       
Federal Agency Obligations  $-    -%  $3,324    1.79%  $3,987    2.49%  $45,515    2.43%  $52,826    2.39%  $52,837 
Residential Mortgage Pass-through Securities   -    -    983    2.37    6,435    2.09    65,504    2.58    72,922    2.53    72,497 
Commercial Mortgage Pass-through Securities   -    -    -    -    4,186    2.40    -    -    4,186    2.40    4,209 
Obligations of U.S. States and Political Subdivisions   1,818    4.65    6,637    4.20    26,855    4.49    113,437    4.61    148,747    4.57    150,605 
Trust Preferred   -    -    -    -    -    -    5,575    5.33    5,575    5.33    5,666 
Corporate Bonds and Notes   2,797    2.86    21,607    2.79    12,313    3.70    -    -    36,717    3.10    36,928 
Asset-backed Securities   38    1.39    -    -    7,417    1.68    7,412    1.56    14,867    1.62    14,583 
Certificates of Deposit   350    1.92    477    2.38    146    1.94    -    -    973    2.15    983 
Equity Securities   -    -    -    -    -    -    376    0.48    376    0.48    568 
Other Securities   -    -    -    -    -    -    14,739    0.02    14,739    0.02    14,414 
Total Investment Securities  $5,003    3.43%  $33,028    2.95%  $61,339    3.46%  $252,558    3.34%  $351,928    3.33%  $353,290 

For information regarding the carrying value of the investment portfolio, see Note 4, Note 17 and Note 22 of the Notes to the Consolidated Financial Statements.

 

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The securities listed in the table above are either rated investment grade by Moody’s and/or Standard and Poor’s or have shadow credit ratings from a credit agency supporting an investment grade and conform to the Company’s investment policy guidelines. There were no municipal securities, or corporate securities, of any single issuer exceeding 10% of stockholders’ equity at December 31, 2016. Equity securities and other securities do not have a contractual maturity and are included in the “Due after ten years” maturity in the table above.

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

   2016   2015   2014 
   (dollars in thousands) 
Investment Securities Available-for-Sale:               

 

Federal agency obligations

  $52,837   $29,146   $32,817 
Residential mortgage pass-through securities   72,497    44,910    60,356 
Commercial mortgage pass-through securities   4,209    2,972    3,046 
Obligations of U.S. States and political subdivisions   150,605    8,357    8,406 
Trust preferred securities   5,666    16,255    16,306 
Corporate bonds and notes   36,928    53,976    125,777 
Asset-backed securities   14,583    19,725    27,502 
Certificates of deposit   983    1,905    2,123 
Equity securities   568    374    307 
Other securities   14,414    18,150    12,892 
Total  $353,290   $195,770   $289,532 
Investment Securities Held-to-Maturity:               
U.S. treasury & agency securities  $-   $28,471   $28,264 
Federal agency obligations   -    33,616    27,103 
Residential mortgage pass-through securities   -    3,805    5,955 
Commercial mortgage-backed securities   -    4,110    4,266 
Obligations of U.S. States and political subdivisions   -    118,015    120,144 
Corporate bonds and notes   -    36,039    38,950 
Total  $-   $224,056   $224,682 
Total investment securities  $353,290   $418,676   $514,214 

For other information regarding the Company’s investment securities portfolio, see Note 4 and Note 22 of the Notes to the Consolidated Financial Statements.

Interest Rate Sensitivity Analysis

The principal objective of our asset and liability management function is to evaluate the interest-rate risk included in certain balance sheet accounts; determine the level of risk appropriate given our business focus, operating environment, and capital and liquidity requirements; establish prudent asset concentration guidelines; and manage the risk consistent with Board approved guidelines. We seek to reduce the vulnerability of our operations to changes in interest rates, and actions in this regard are taken under the guidance of the Bank’s Asset Liability Committee (the “ALCO”). The ALCO generally reviews our liquidity, cash flow needs, maturities of investments, deposits and borrowings, and current market conditions and interest rates.

We currently utilize net interest income simulation and economic value of equity (“EVE”) models to measure the potential impact to the Bank of future changes in interest rates. As of December 31, 2016 and December 31, 2015 the results of the models were within guidelines prescribed by our Board of Directors. If model results were to fall outside prescribed ranges, action, including additional monitoring and reporting to the Board, would be required by the ALCO and Bank’s management.

The net interest income simulation model attempts to measure the change in net interest income over the next one-year period, and over the next three-year period on a cumulative basis, assuming certain changes in the general level of interest rates.

Based on our model, which was run as of December 31, 2016, we estimated that over the next one-year period a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 5.79%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 2.93%. As of December 31, 2015, we estimated that over the next one-year period, a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 5.65%, while a 100 basis-point instantaneous decrease in the general level of interest rates would decrease our net interest income by 3.62%.

Based on our model, which was run as of December 31, 2016, we estimated that over the next three years, on a cumulative basis, a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 6.65%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 4.43%. As of December 31, 2015, we estimated that over

 

 - 39 - 
   

 

the next three years, on a cumulative basis, a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 6.66%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 5.59%.

An EVE analysis is also used to dynamically model the present value of asset and liability cash flows with instantaneous rate shocks of up 200 basis points and down 100 basis points. The economic value of equity is likely to be different as interest rates change. Our EVE as of December 31, 2016, would decline by 7.97% with an instantaneous rate shock of up 200 basis points, and increase by 2.96% with an instantaneous rate shock of down 100 basis points.  Our EVE as of December 31, 2015, would decline by 15.02% with an instantaneous rate shock of up 200 basis points, and increase by 13.65% with an instantaneous rate shock of down 100 basis points. 

Interest Rates Estimated Estimated Change in
EVE
  Interest Rates Estimated Estimated Change in NII  
(basis points) EVE Amount %   (basis points) NII Amount %  
+300  $459,528  $(69,110) (13.1)   +300  $143,818  $11,115 8.4  
+200  486,530  (42,108) (8.0)   +200  140,388  7,685 5.8  
+100  510,733  (17,905) (3.4)   +100  136,676  3,973 3.0  
0  528,638  - 0.0   0  132,703  - 0.0  
-100  544,300  15,662 3.0   -100  128,199  (3,884) (2.9)  

Estimates of Fair Value

The estimation of fair value is significant to certain assets of the Company, including available-for-sale investment securities. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, expected cash flows, credit quality, discount rates, or market interest rates. Fair values for most available-for-sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. See Note 22 of the Notes to Consolidated Financial Statements for additional discussion.

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

Impact of Inflation and Changing Prices

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

Liquidity

Liquidity is a measure of a bank’s ability to fund loans, withdrawals or maturities of deposits, and other cash outflows in a cost-effective manner. Our principal sources of funds are deposits, scheduled amortization and prepayments of loan principal, maturities of investment securities, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flow and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.

At December 31, 2016, the amount of liquid assets remained at a level management deemed adequate to ensure that, on a short and long-term basis, contractual liabilities, depositors’ withdrawal requirements, and other operational and client credit needs could be satisfied. As of December 31, 2016, liquid assets (cash and due from banks, interest-bearing deposits with banks and unencumbered investment securities) were $428.2 million, which represented 9.7% of total assets and 11.2% of total deposits and borrowings, compared to $466.8 million at December 31, 2015, which represented 11.6% of total assets and 13.5% of total deposits and borrowings on such date.

 

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The Bank is a member of the Federal Home Loan Bank of New York and, based on available qualified collateral as of December 31, 2016, had the ability to borrow $1.3 billion. In addition, at December 31, 2016, the Bank had in place borrowing capacity of $25 million through correspondent banks. The Bank also has a credit facility established with the Federal Reserve Bank of New York for direct discount window borrowings with capacity based on pledged collateral of $12.6 million. At December 31, 2016, the Bank had aggregate available and unused credit of approximately $781 million, which represents the aforementioned facilities totaling $1.3 billion net of $521 million in outstanding borrowings and letters of credit. At December 31, 2016, outstanding commitments for the Bank to extend credit were $603 million.

Cash and cash equivalents totaled $200.4 million on December 31, 2016, decreasing by $0.5 million from $200.9 million at December 31, 2015.  Operating activities provided $49.7 million in net cash.  Investing activities used $427.7 million in net cash, primarily reflecting an increase in loans, which was offset in part by cash flow from the securities portfolio.  Financing activities provided $377.5 million in net cash, primarily reflecting a net increase of $553.5 million in deposits and proceeds from the issuance of common stock of $38.4 million offset by a net decrease of $195.0 million in borrowings (consisting of $375.0 million in new borrowings offset by notional repayments of $570.0 million) and the redemption of $11.3 million of preferred stock associated with the Small Business Lending Fund.

Deposits

Deposits are our primary source of funds. Average total deposits increased $523.4 million, or 20.4% to $3.1 billion in 2016 from $2.6 billion in 2015 and increased $673.3 million, or 35.5% to $2.6 billion in 2015 from 2014. Growth in 2014 was partially due to the merger. During 2016 we saw substantial increases in demand accounts, money market accounts and time deposits. This was due to several promotional items as well as increased efforts to attract new customers.

The following table sets forth the year-to-date average balances and weighted average rates for various types of deposits for 2016, 2015 and 2014.

   2016  2015  2014
   Balance   Rate      Balance   Rate      Balance   Rate
(dollars in thousands)                     
Demand, noninterest-bearing  $     624,731   --  $    537,287   --  $    350,310   --
Demand, interest-bearing & NOW   530,169   0.33%   450,359   0.36%   339,707   0.43%
Money market accounts   802,839   0.54%   609,797   0.45%   584,586   0.41%
Savings   211,830   0.29%   219,507   0.28%   196,855   0.16%
Time   923,114   1.29%   752,380   1.17%   424,603   1.13%
                         
Total Deposits  $ 3,092,683   0.60%  $ 2,569,330   0.54%  $ 1,896,061   0.47%

The following table sets forth the distribution of total deposit accounts, by account types for each of the periods indicated.

   December 31, 2016  December 31, 2015
   Amount   % of
total
       Amount   % of
total
(dollars in thousands)              
Demand, noninterest-bearing  $     694,977   20.78%  $   650,775   23.32%
Demand, interest-bearing & NOW   563,740   16.86%   490,380   17.57%
Money market accounts   911,867   27.27%   658,695   23.60%
Savings   205,551   6.15%   216,399   7.75%
Time   968,136   28.94%   774,717   27.76%
                 
Total Deposits  $  3,344,271   100.00%  $  2,790,966   100.00%

 

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The following table summarizes the maturity distribution of time deposits in denomination of $100,000 or more:

  (dollars in thousands)                      December 31,
2016
     December 31,
2015
 
         
3 months or less    $107,350   $60,950 
Over 3 to 6 months   72,972    55,690 
Over 6 to 12 months   158,890    118,576 
Over 12 months   228,201    164,278 
           
Total  $567,413     $399,494 

Borrowings

Borrowings consist of long and short term advances from the Federal Home Loan Bank and securities sold under agreements to repurchase. Federal Home Loan Bank advances are secured, under the terms of a blanket collateral agreement, primarily by commercial mortgage loans. As of December 31, 2016, the Company had $476.3 million in notes outstanding at a weighted average interest rate of 1.69%. As of December 31, 2015, the Company had $671.6 million in notes outstanding at a weighted average interest rate of 1.37%.

Contractual Obligations and Other Commitments

The following table summarizes contractual obligations at December 31, 2016 and the effect such obligations are expected to have on liquidity and cash flows in future periods.

    Total   Less than 1
year
  1 – 3 years   4 – 5 years   Over 5
years
 
December 31, 2016   (dollars in thousands)  
Contractual obligations:                                
Operating lease obligations     $ 16,099     $ 2,149     $ 4,134     $ 3,416     $ 6,400  
Other long-term liabilities/long-term debt:                                
Time Deposits     968,136     534,946     406,590     26,600     -  
Federal Home Loan Bank advances and repurchase agreements     476,280     246,280     165,000     65,000     -  
Capital lease     2,763     292     615     642     1,214  
Subordinated debentures     54,534     -     -     -     54,534  
Total other long-term liabilities/long-term debt     1,501,713     781,518     572,205     92,242     55,748  
Other commercial commitments – off balance sheet:                                
Commitments under commercial loans and lines of credit     267,865     221,148     29,177     10,914     6,626  
Home equity and other revolving lines of credit     52,788     26,428     5,157     14,477     6,726  
Outstanding commercial mortgage loan commitments     263,395     254,755     8,640     -     -  
Standby letters of credit     18,331     18,051     280     -     -  
Overdraft protection lines     733     384     12     -     337  
Total off balance sheet arrangements and contractual obligations     603,112     520,766     43,266     25,391     13,689  
Total contractual obligations and other commitments   $