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:
The ongoing COVID-19 pandemic and measures intended to prevent its spread could have a material adverse effect on our business, results of operations and financial condition, and such effects will depend on future developments, which are highly uncertain and are difficult to predict.
Global health concerns relating to the COVID-19 outbreak and related government actions taken to reduce the spread of the virus, including the initial closure of non-essential business and stay at home orders, and continuing restrictions on certain businesses, such as bars restaurants and gyms, have been weighing on the macroeconomic environment in our New Jersey/New York metropolitan market trade area, and the outbreak has significantly increased economic uncertainty and reduced economic activity. The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. Such measures, even as certain of them have been eased, have significantly contributed to rising unemployment and negatively impacted consumer and business spending. The United States government has taken steps to attempt to mitigate some of the more severe anticipated economic effects of the virus, including the passage of the CARES Act and the Economic Aid Act, but there can be no assurance that such steps will be effective or achieve their desired results in a timely fashion.
The outbreak has adversely impacted and is likely to further adversely impact our workforce and operations and the operations of our borrowers, customers and business partners. In particular, we may experience financial losses due to a number of operational factors impacting us or our borrowers, customers or business partners, including but not limited:
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to credit losses resulting from financial stress being experienced by our borrowers as a result of the outbreak and related governmental actions, particularly in the hospitality, energy, retail and restaurant industries, but across other industries as well. As of December 31, 2020, the Bank had approximately $207 million of outstanding loans on deferral for customers facing financial stress due to the COVID-19 pandemic. Although many of the loans receiving deferrals during 2020 have returned to normal repayment cycles, we can give you no assurance that these borrowers will be able to sustain repayment of their credits, or that other borrowers will need/seek payment deferrals;
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declines in collateral values;
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third party disruptions, including outages at network providers and other suppliers;
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increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruption, given increased online and remote activity; and
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operational failures due to changes in our normal business practices necessitated by the outbreak and related governmental actions.
These factors may remain prevalent for a significant period of time and may continue to adversely affect our business, results of operations and financial condition even after the COVID-19 outbreak has subsided.
The spread of COVID-19 has caused us to modify our business practices (including restricting employee travel, and developing work from home and social distancing plans for our employees), and we may take further actions as may be required by government authorities or as we determine are in the best interests of our employees, customers and business partners. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or will otherwise be satisfactory to government authorities.
The extent to which the coronavirus outbreak impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future.
There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. However, the effects could have a material impact on our results of operations and heighten many of our known risks described in this “Risk Factors” section.
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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. 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.
As of December 31, 2020, we had $4.4 billion of commercial real estate loans, including commercial construction loans, which represented 70.6% 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 442% of the Bank’s total risk-based capital as of December 31, 2020.
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.
The impact of the COVID-19 pandemic on the metropolitan New York area commercial real estate market is uncertain, with rents in certain core urban markets declining.Many other factors, including the exchange rate for the U.S. dollar, potential international trade tariffs,and changes in federal tax laws affecting the deductibility of state and local taxes and mortgage interest could negatively impact 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, 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 credit 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.
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.
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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 are and may continue to seek to further increase our growth rate in 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, 2020, we had $3.9 billion in commercial real estate loans outstanding. Approximately 48.4% of the loans, or $1.9 billion, had been originated in the past three years. In addition, as part of the Bancorp of New Jersey merger, we acquired $0.8 billion in loans from Bancorp of New Jersey. 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 credit exposure ($24.7 million carrying value as of December 31, 2020) 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, as well as from the impact of the COVID-19 pandemic and the trend toward working from home as a mitigant to the pandemic. This has resulted in volatility in the pricing of medallions, and has impacted the earnings of many medallion holders, including our borrowers. 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 additional write downs on these loans.
We expect that the implementation of Current Expected Credit Loss (“CECL”), which will require us to record an allowance for credit losses in excess of our existing allowance for loan losses, could cause increased volatility in our financial condition and results of operation.
The Financial Accounting Standards Board (“FASB”) has adopted a new accounting standard, CECL. The effective date for the Company of CECL has been delayed by the Economic Aid Act until January 1, 2022, although earlier adoption is permitted. CECL will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, other financial instruments and other commitments to extend credit and provide for the expected credit losses as allowances for credit losses. However, the Company has decided to adopt CECL as of January 1, 2021. This will change the current method of providing allowances for loan losses that are probable, which will require us to record an allowance for credit losses as of January 1, 2021 in excess of our existing allowance for loan losses, and will greatly increase the data we will need to collect and review to determine the appropriate level of the allowance for credit losses. Although we expect the Bank and the Parent Corporation will continue to meet all capital adequacy requirements to which they are subject following recording of the impact of adoption to stockholders’ equity, future provisioning for expected credit losses under CECL may have a material adverse effect on our financial condition and results of operations.
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.
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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.
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.
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 in originating loans and attracting deposits may adversely affect our profitability.
We face substantial competition in originating loans. This competition currently 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.
We have also been active in competing for New York and New Jersey governmental and municipal deposits. As of December 31, 2020, governmental and municipal deposits accounted for approximately $693.1 million in deposits. The governor of New Jersey has proposed that the state form and own a bank in which governmental and municipal entities would deposit their excess funds, with the state-owned bank then financing small businesses and municipal projects in New Jersey. Although this proposal is in the very early stages, should this proposal be adopted and a state-owned bank formed, it could impede our ability to attract and retain governmental and municipal 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.
In addition, the banking industry in general has begun to face competition for deposit, credit and money management products from non-bank technology firms, or fintech companies, which my offer products independently or through relationships with insured depository institutions.
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.
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Liquidity is derived primarily from deposit growth and retention; principal and interest payments on loans; prepayment and maturities of 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 origination 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. 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, 2020, we had approximately $488.0 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 below their amortized cost basis that is considered credit related. 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,” banks and bank holding companies are be required to maintain a capital conservation buffer on top of minimum risk-weighted asset ratios. The capital conservation buffer is 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.
We have grown and may continue to grow through acquisitions.
Since January 1, 2019, we have acquired GHB, BoeFly, LLC and BNJ. To be successful as a larger institution, we must successfully integrate the operations and retain the customers of acquired institutions, attract and retain the management required to successfully manage larger operations, and control costs.
Future results of operations will depend in large part on our ability to successfully integrate the operations of the acquired institutions and retain the customers of those institutions. If we are unable to successfully manage the integration of the separate cultures, customer bases
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and operating systems of the acquired institutions, and any other institutions that may be acquired in the future, our results of operations may be adversely affected.
In addition, to successfully manage substantial growth, we may need to increase non-interest expenses through additional personnel, leasehold and data processing costs, among others. In order to successfully manage growth, we may need to adopt and effectively implement policies, procedures and controls to maintain credit quality, control costs and oversee our operations. No assurance can be given that we will be successful in this strategy.
We may be challenged to successfully manage our business as a result of the strain on management and operations that may result from growth. The ability to manage growth will depend on our ability to continue to attract, hire and retain skilled employees. Success will also depend on the ability of officers and key employees to continue to implement and improve operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage employees.
Finally, substantial growth may stress regulatory capital levels, and may require us to raise additional capital. No assurance can be given that we will be able to raise any required capital, or that it will be able to raise capital on terms that are beneficial to stockholders.
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 target companies 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 or health related 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. Finally, health related events, such as a viral pandemic, could adversely affect the business of our customers and our local economies, thereby adversely affecting our results of operations.
We may be adversely affected by changes in Federal tax laws.
Our business may be adversely affected by changes in tax laws. For example, changes in tax laws contained in The Tax Cuts and Jobs Act, enacted in December 2017, include a number of provisions that have an impact on the banking industry, borrowers and the market for single-family residential real estate. Changes include (i) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (ii) the elimination of interest deductions for home equity loans, (iii) a limitation on the deductibility of business interest expense and (iv) a limitation on the deductibility of property taxes and state and local income taxes.
The changes in the tax laws may have an adverse effect on the market for, and valuation of, residential properties, and on the demand for such loans in the future and could make it harder for borrowers to make their loan payments. In addition, these changes may also have a disproportionate effect on taxpayers in states with high residential home prices and high state and local taxes, such as New Jersey and New York. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of the properties securing loans in the loan portfolio may be adversely impacted as a result of the changing economics of home ownership, which could require an increase in the provision for loan losses, which would reduce profitability and could have a material adverse effect on the Company’s business, financial condition and results of operations.
In addition, the incoming Biden administration has discussed raising corporate income tax rates. Any increase in our federal income tax rates could adversely impact our results of operations.
Recent New Jersey legislative changes may increase our tax expense.
In 2019, New Jersey adopted legislation that will increase our state income tax liability and could increase our overall tax expense. The legislation imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and of 1.5% for tax years beginning on or after January 1, 2020 through December 31, 2021. However, in 2020, this surtax was extended through December 31, 2023, at the 2.5% level. The legislation also required combined filing for members of an affiliated group for tax years beginning on or after January 1, 2019, changing New Jersey’s current status as a separate return state, and limits, to varying degrees related to the Company’s size, operating area and organizational structure, the deductibility of dividends received. These changes are not temporary. Although regulations implementing the legislative changes have not yet
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been issued, it is possible that the Company will lose the benefit of at least certain of its tax management strategies, and, if so, our total tax expense will likely increase.
The Company will be subject to heightened regulatory requirements if total assets exceed $10 billion.
The Company’s total assets were $7.5 billion as of December 31, 2020. Banks with assets in excess of $10 billion are subject to requirements imposed by the Dodd-Frank Act and its implementing regulations, including: the examination authority of the Consumer Financial Protection Bureau to assess compliance with Federal consumer financial laws, imposition of higher FDIC premiums, and reduced debit card interchange fees all of which increase operating costs and reduce earnings.
As the Company approaches $10 billion in total consolidated assets, additional costs have been incurred to prepare for the implementation of these imposed requirements. The Company may be required to invest more significant management attention and resources to evaluate and continue to make any changes necessary to comply with the new statutory and regulatory requirements under the Dodd-Frank Act. Further, Federal financial regulators may require accelerated actions and investments to prepare for compliance before $10 billion in total consolidated assets is exceeded, and may suspend or delay certain regulatory actions, such as approving a merger agreement, if preparations are deemed inadequate. Upon reaching this threshold, the Company faces the risk of failing to meet these requirements, which may negatively impact results of operations and financial condition. While the effect of any presently contemplated or future changes in the laws or regulations or their interpretations would have been unpredictable, these changes could be materially adverse to the Company’s investors.
Reforms to and uncertainty regarding LIBOR may adversely affect the business.
In 2017, a committee of private-market derivative participants and their regulators convened by the Federal Reserve, the Alternative Reference Rates Committee, or “ARRC”, was created to identify an alternative reference interest rate to replace LIBOR. The ARRC announced Secured Overnight Financing Rate, or “SOFR”, a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, as its preferred alternative to LIBOR. The Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced its intention to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. Subsequently, the Federal Reserve Bank announced final plans for the production of SOFR, which resulted in the commencement of its published rates by the Federal Reserve Bank of New York on April 2, 2018. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question and the future of LIBOR at this time is uncertain. The uncertainty as to the nature and effect of such reforms and actions and the political discontinuance of LIBOR may adversely affect the value of and return on the Company’s financial assets and liabilities that are based on or are linked to LIBOR, the Company’s results of operations or financial condition. In addition, these reforms may also require extensive changes to the contracts that govern these LIBOR based products, as well as the Company’s systems and processes.
Risks Applicable to the Banking Industry Generally:
Our allowance for loan losses and allowance for credit losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan losses and allowance for credit 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 may not be sufficient to cover losses in our loan portfolio. Further, state and federal regulatory agencies, as an integral part of their examination process, review our loans and allowance and may require an increase in our allowance for loan losses and allowance for credit losses.
Further increases to the allowance 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, 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, 2020, a 200-basis point increase in interest rates would have resulted in our economic value of portfolio equity declining by approximately $74.7 million or 7.8%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Sensitivity Analysis.”
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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. 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, financial institutions with less than $10.0 billion in total assets, 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.
•
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.
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•
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;
•
Internet-based banking, including personal computers, mobile phones and tablets;
•
Debit cards and so-called “smart cards”; and
•
Remote deposit capture.
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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 and damage our reputation. 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.
Item 2. Properties
The Bank operates nine banking offices in Bergen County, NJ, in Fort Lee, Englewood Cliffs, Englewood, Hackensack, Cliffside Park, Cresskill, Haworth, Ridgewood and Saddle River; five banking offices in Union County, NJ, consisting of two offices in Union Township, and one office each in Springfield Township, Berkeley Heights, and Summit; one banking office in Morristown in Morris County, NJ; 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; one office in Holmdel in Monmouth County, one banking office in the borough of Manhattan in New York City, one office in Melville, Nassau County on Long Island, one in Astoria, Queens and six branches in the Hudson Valley, including in White Plains and Tarrytown, in Westchester County, New York, Bardonia and Blauvelt, in Rockland County, New York and in Middletown, and Warwick, in Orange County, New York. 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.
Banking Office Location Term
301 Sylvan Avenue, Englewood Cliffs, NJ Term expires November 2028
12 East Palisade Avenue, Englewood, NJ Term expires July 2022
1 Union Avenue, Cresskill, NJ Term expires June 2026
899 Palisade Avenue, Fort Lee, NJ Term expires August 2022
142 John Street, Hackensack, NJ Term expires December 2021
171 East Ridgewood Avenue, Ridgewood, NJ Term expires April 2024
71 East Allendale Road, Saddle River, NJ Term expires May 2032
356 Chestnut Street, Union, NJ Term expires May 2027
545 Morris Avenue, Summit, NJ Term expires February 2024
217 Chestnut Street, Newark, NJ Term expires December 2024
5914 Park Avenue, West New York, NJ Term expires September 2023
344 Nassau Street, Princeton, NJ Term expires July 2022
963 Holmdel Road, Holmdel, NJ Term expires July 2021
551 Madison Avenue, Suite 202, NY, NY Term expires October 2028
48 South Service Rd, 2nd Fl, Melville, NY Term Expires July 2025
36-19 Broadway, Astoria, NY Term Expires August 2028
485 Schutt Rd, Middletown, NY Term Expires October 2025
62 Main St., Warwick, NY Term Expires January 2024
715 Route 304, Bardonia NY Term Expires August 2028
567 North Broadway, White Plains NY Term Expires December 2028
155 White Plains Rd., Tarrytown NY Term Expires December 2026
170 East Erie St, Blauvelt NY Term Expires February 2028
354 Palisades Avenue, Cliffside Park, NJ Term Expires July 2021
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.
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PART II
Item 5. Market for the Registrant’s Common Equity, 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, 2020, the Company had 729 stockholders of record, excluding beneficial owners for whom Cede & Company or others act as nominees.
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.
In March 2019, the Board of Directors of the Company approved a share repurchase program for up to 1,200,000 shares. The Company may repurchase shares from time to time in the open market, in privately negotiated share purchases or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission and applicable federal securities laws. The share repurchase plan does not obligate the Company to acquire any particular amount of common stock, and it may be modified or suspended at any time at the Company's discretion. During the year ended December 31, 2020, the Company repurchased a total of 54,693 shares. As of December 31, 2020, shares remaining for repurchase under the program were 605,289.
The following table details share repurchases for the year 2020:
During the first quarter of 2020, the Company suspended its share repurchase program due to the potential risks of COVID-19. On January 26, 2021, the Board of Directors lifted such suspension.
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, 2015 through December 31, 2020.
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COMPARE 5-YEAR CUMULATIVE TOTAL RETURN
AMONG CONNECTONE BANCORP INC.
NASDAQ AND KBW BANK INDEX
Assumes $100 Invested on December 31, 2015, with Dividends Reinvested
Year Ended December 31, 2020
COMPARISON OF CUMULATIVE TOTAL RETURN OF ONE OR MORE
COMPANIES, PEER GROUPS, INDUSTRY INDEXES AND/OR BROAD MARKETS
Fiscal Year Ending
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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, 2020 and 2019 and the selected consolidated summary of income data for the years ended December 31, 2020, 2019 and 2018 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, 2018, 2017, 2016 and the selected consolidated summary of income data for the years ended December 31, 2017 and 2016 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.
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SUMMARY OF SELECTED STATISTICAL INFORMATION AND FINANCIAL DATA
As of or For the Years Ended December 31,
(dollars in thousands, except share data)
Selected Statement of Financial Condition Data
Dividends
Selected Statement of Income Data
Preferred stock dividends - - - - (22 )
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As of or For the Years Ended December 31,
(dollars in thousands, except share data)
Per Common Share Data
Selected Performance Ratios
Selected Asset Quality Ratios as a % of Loans Receivable:
Company Capital Ratios
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Non-GAAP Reconciliation Table
As of December 31,
(dollars in thousands, except per share data)
Tangible common equity and tangible common equity/tangible assets
Tangible book value per common share
Return on average tangible common equity
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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. Accounting policies considered critical to our financial results include the allowance for loan losses and related provision, income taxes, goodwill and business combinations. For information on our significant accounting policies, see Note 1a in the Notes to Consolidated Financial Statements.
Allowance for Loan Losses and Related Provision
The allowance for loan losses represents management’s estimate of probable incurred loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated 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 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 losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb probable incurred loan losses on existing loans 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 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 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 1a of the Notes to Consolidated Financial Statements.
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. Note 1 (under the caption “Use of Estimates”) and Note 11 of the Notes to Consolidated Financial Statements include additional discussion on the accounting for income taxes.
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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. The goodwill impairment evaluation involves significant estimates and subjective assumptions, which requires Management’s judgment on factors such as discount rate, prospective financial information, earnings retention rate and peer group market data. Changes in these estimates and assumptions could have a significant impact on the conclusions reached regarding whether impairment occurred and the amount of impairment. No impairment charge was deemed necessary for the years ended December 31, 2020, 2019 and 2018.
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.
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 present the more significant factors affecting the Company’s financial condition as of December 31, 2020 and 2019 and results of operations for each of the years in the three-year period ended December 31, 2020. 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, 2020 was $71.3 million, a decrease of $2.1 million, or 2.9%, compared to net income of $73.4 million for 2019. Diluted earnings per share were $1.79 for 2020, a 13.5% decrease from $2.07 for 2019.
The change in net income from 2019 to 2020 was attributable to the following:
•
Increased provision for loan losses of $32.9 million was primarily due to the continued economic uncertainties associated with the COVID-19 pandemic.
•
Increase in noninterest expenses of $28.8 million, primarily due to an increase in salaries and employee benefits of $9.9 million, merger expenses of $5.7 million, occupancy and equipment expense of $4.2 million and professional and consulting expenses of $1.9 million. These increases are mainly attributable to the acquisition of BNJ. Additionally, the Company saw an increase in value of acquisition price of $2.3 million related to its BoeFly acquisition.
•
Increased net interest income of $51.7 million primarily due to the acquisition of BNJ and an 11-basis point widening of the net interest margin.
•
Increase in noninterest income of $6.4 million primarily resulting from an increase in deposit, loan, and other income, increase in bank owned life insurance and net gains on sale of loans held-for-sale.
•
Decrease in income tax expense of $1.5 million resulting primarily from a decrease in income from taxable sources.
Net income for the year ended December 31, 2019 was $73.4 million, an increase of $13.0 million, or 21.6%, compared to net income of $60.4 million for 2018. Diluted earnings per share were $2.07 for 2019, an 11.3% increase from $1.86 for 2018.
The change in net income from 2018 to 2019 was attributable to the following:
•
Increased net interest income of $29.1 million primarily due to the acquisition of GHB.
•
Decreased provision for loan losses of $13.0 million primarily due to $17.0 million increase in specific reserves (then concurrently charged-off) within the taxi medallion loan portfolio in 2018.
•
Increase in noninterest income of $2.6 million primarily resulting from an increase in deposit, loan, and other income, which included higher overdrafts fees, and income related to the operations of BoeFly.
•
Increase in noninterest expenses of $21.8 million, primarily due to an increase in salaries and employee benefits of $9.6 million, merger expenses of $7.6 million and professional and consulting expenses of $1.9 million. The increases are mainly attributable to the acquisition of GHB.
•
Increase in income tax expense of $9.8 million resulting primarily from an increase in income from taxable sources.
Net Interest Income
Fully taxable equivalent net interest income for 2020 totaled $239.9 million, an increase of $51.9 million, or 27.6%, from 2019. The increase in net interest income was due to an increase in average interest-earning assets, which grew by 23.6% to $6.9 billion and a widening of 11 basis-points in the net interest margin. The widening of the net interest margin was mainly attributable to lower cost of funds, offset by higher average cash balances and lower yields on loans and securities. Average total loans, which includes loans held-for-sale, increased by 22.8% to $6.2 billion in 2020 from $5.0 billion in 2019. The increase in average total loans is primarily attributable to the acquisition of BNJ.
Fully taxable equivalent net interest income for 2019 totaled $188.0 million, an increase of $28.8 million, or 18.1%, from 2018. The increase in net interest income was due to an increase in average interest-earning assets, which grew by 15.7% to $5.6 billion and a widening of 7 basis-points in the net interest margin. The widening of the net interest margin was mainly attributable to increases in both rates and the volume of loans, offset by higher cost of funds. Average total loans, which includes loans held-for-sale, increased by 16.6% to $5.0 billion in 2019 from $4.3 billion in 2018. The increase in average total loans is primarily attributable to the acquisition of GHB.
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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, 2020, 2019 and 2018 and reflects 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,
(dollars in thousands)
ASSETS
Interest-earning assets:
Noninterest-earning assets:
LIABILITIES & STOCKHOLDERS’ EQUITY
(1) Average balances are based on amortized cost.
(3) Includes loan fee income and accretion of purchase accounting adjustments.
(4) Loans include nonaccrual loans.
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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.
Average Volume Average Rate Net Change Average Volume Average Rate Net Change
(dollars in thousands)
Interest income:
Interest expense:
Capital lease obligation (11 ) - (11 ) (9 ) - (9 )
Provision for Loan Losses
In determining the provision for loan 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 review.
For the year ended December 31, 2020, the provision for loan losses was $41.0 million, an increase of $32.9 million, compared to the provision for loan losses of $8.1 million for 2019. The increase was due to the continued economic uncertainties associated with the COVID-19 pandemic and increases to specific reserves within our commercial portfolio.
For the year ended December 31, 2019, the provision for loan losses was $8.1 million, a decrease of $13.0 million, compared to the provision for loan losses of $21.1 million for 2018. The decline was due primarily to specific reserves (and concurrent charge-offs) of $17.0 million related to the taxi medallion loans in 2018.
With the adoption of CECL beginning on January 1, 2021, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance. See Note 1b to our audited financial statements included herein.
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Noninterest Income
Noninterest income for the full-year 2020 increased by $6.4 million, or 79.2%, to $14.4 million from $8.0 million in 2019. The increase was primarily the result of a $3.0 million increase in deposit, loan and other income. This increase was largely attributable to loan referral fee income of $2.3 million generated by BoeFly as a result of its participation in the PPP program. Additionally, increases in net gains on sale of loans held-for-sale of $1.6 million and increases in bank owned life insurance of $1.5 million contributed to the overall increase in noninterest income.
Noninterest income for the full-year 2019 increased by $2.6 million, or 46.8%, to $8.0 million from $5.5 million in 2018. The increase was primarily the result of a $1.4 million increase in deposit, loan and other income. This increase was mainly attributable to higher overdraft fees and income related to the operations of BoeFly. Increase in net gains on sale of loans held-for-sale of $0.5 million was mainly attributable to increases in gains on mortgage loan sales of $0.3 million and net gains on the sale of a pool of commercial real estate loans during the third quarter 2019 of $0.2 million. Other increases in noninterest income include an increase of $0.4 million in BOLI and increase of $0.6 million in net gains on equity securities, offset by net losses in sales of securities available-for-sale of $0.3 million.
Noninterest Expense
Noninterest expenses for the full-year 2020 increased by $28.8 million, or 31.2%, to $121.0 million from $92.2 million in 2019. The increase was primarily attributable to increases in salaries and employee benefits of $9.9 million, merger expenses of $5.7 million, occupancy and equipment of $4.2 million, increase in value of acquisition price of $2.3 million, FDIC insurance expense of $2.0 million, professional and consulting of $1.9 million and amortization of core deposit intangibles of $1.1 million. These increases were mainly the result of the acquisition of BNJ.
Noninterest expenses for the full-year 2019 increased by $21.8 million, or 30.9%, to $92.2 million from $70.5 million in 2018. The increase was primarily attributable to increases in salaries and employee benefits of $9.6 million, merger expenses of $7.6 million, professional and consulting of $1.9 million, and occupancy and equipment of $1.4 million. These increases were mainly the result of the acquisitions of GHB and BNJ. In addition, the Bank had a loss on extinguishment of debt of $1.0 million during the second quarter of 2019. Lastly, there was a decrease in FDIC expense of $1.1 million that was attributable to the Bank receiving a small bank credit of approximately $1.3 million during the second quarter of 2019.
Income Taxes
Income tax expense was $19.1 million for 2020 compared to $20.6 million for 2019 and $10.8 million for 2018. The slight decrease in income tax expense in 2020 when compared to 2019 was primarily the result of lower taxable income. The higher level of income tax expense in 2019 when compared to 2018 was primarily attributable to higher income before taxes and the negative impact of recent tax legislation in New Jersey. The effective tax rates were 21.1% in 2020, 21.9% in 2019 and 15.2% for 2018.
For a more detailed description of income taxes see Note 11 of the Notes to Consolidated Financial Statements.
Financial Condition Overview
As of December 31, 2020, the Company’s total assets were $7.5 billion, an increase of $1.4 billion from December 31, 2019. Total loans (including loans held-for-sale) were $6.2 billion, an increase of $1.1 billion from December 31, 2019. Deposits were $6.0 billion, an increase of $1.2 billion from December 31, 2019. These increases were primarily the result of the acquisition of BNJ.
As of December 31, 2019, the Company’s total assets were $6.2 billion, an increase of $712 million from December 31, 2018. Total loans (including loans held-for-sale) were $5.1 billion, an increase of $606 million from December 31, 2018. Deposits were $4.8 billion, an increase of $675 million from December 31, 2018. These increases were primarily the result of the acquisition of GHB.
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 clients living and working in the Bank’s metropolitan, New York market area, consisting of Bergen, Union, Morris, Essex, Hudson, Mercer and Monmouth counties, New Jersey, as well as NYC’s five boroughs, Nassau Rockland, Orange and Westchester counties, in New York. The Bank has not made loans to borrowers outside of the United States. The Bank believes that its strategy of high-quality client 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 clients 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.
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Gross loans as of December 31, 2020 totaled $6.3 billion, an increase of $1.2 billion, or 23.8%, over gross loans as of December 31, 2019 of $5.1 billion. The increase in gross loans was primarily attributable to the acquisition of BNJ.
The largest component of the gross loan portfolio as of December 31, 2020 and December 31, 2019 was commercial real estate loans. Commercial real estate loans as of December 31, 2020 totaled $3.8 billion, an increase of $742 million, or 24.4%, compared to commercial real estate loans as of December 31, 2019 of $3.0 billion. Commercial loans totaled $1.5 billion as of December 31, 2020, an increase of $392 million, or 34.7%, compared to commercial loans as of December 31, 2019 of $1.1 billion. Included in commercial loans were PPP loans of $397.5 million, contributing to the increase. Commercial construction loans as of December 31, 2020 totaled $618 million, a decrease of $5.6 million, or 0.9%, compared to construction loans as of December 31, 2019 of $623 million.
Residential real estate loans totaled $323 million as of December 31, 2020, an increase of $3 million, or 0.8%, compared to residential real estate loans as of December 31, 2019 of $320 million. Consumer loans as of December 31, 2020 totaled $2 million, a decrease of $1 million, or 44.3%, compared to consumer loans of $3 million as of December 31, 2019. The growth in our gross loans for 2020 was primarily attributable to the acquisition of BNJ.
The following table sets forth the classification of our loans by loan portfolio segment for the periods presented.
December 31,
(dollars in thousands)
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, 2020 by remaining contractual maturity.
As of December 31, 2020, Maturing
In One Year or Less After One Year through Five Years After Five Years Total
(dollars in thousands)
Loans with:
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 sending late notices, as well as making personal contact with the borrower. Typically, late notices are sent approximately 10 days after the date the payment is due, followed up by direct contact with the borrower approximately 15 days after 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. Total loans 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, unless the restructuring complies with the provisions of the CARES Act and regulatory guidance related to the COVID-19 pandamic. 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 shortfalls generally are not classified as impaired.
Generally, impaired loans consist of nonaccrual loans and performing troubled debt restructurings. Of this group of impaired loans, loans of $250,000 and over are individually evaluated for impairment, while loans with balances less than $250,000 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 losses must be established for loan 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.
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 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 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.
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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,
(dollars in thousands)
Classified Loans:
Loss - -
Total classified and special mention loans $ 199,793 $ 119,324
During the year ended December 31, 2020, “substandard” loans and “doubtful” loans, which include lower credit quality loans which possess higher risk characteristics than “special mention” loans, increased from $82.3 million, or 1.6% of loans receivable, as of December 31, 2019 to $119.7 million, or 1.9% of loans receivable, as of December 31, 2020. During the year ended December 31, 2020, “special mention” loans increased to $79.9 million, or 1.3% of loans receivable from $37.0 million, or 0.7% of loans receivable, as of December 31, 2019. The increase in both substandard and special mention loans is primarily attributable to an increased level in deferrals resulting from the continued economic uncertainty regarding the ongoing pandemic. Deferred loans as of December 31, 2020 were $207.1 million, of which $166.8 million were not included in the table above.
Nonperforming Loans, Performing Troubled Debt Restructurings, Past Due Loans and OREO
Nonperforming loans include nonaccrual loans. 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. Performing 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. For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.
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:
As of December 31,
(dollars in thousands)
Nonaccrual loans (held-for-sale) - - - - 63,044
(2) Includes loans held-for-sale.
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Allowance for Loan Losses and Related Provision
The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. We maintain an allowance for loan 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 losses.
As of December 31, 2020, the allowance for loan losses was $79.2 million, an increase of $40.9 million, or 106.9%, from $38.3 million as of December 31, 2019. The increase in the allowance for loan losses was primarily attributable to an increase in general provisioning related to economic uncertainties associated with the COVID-19 pandemic. With our adoption of CECL beginning on January 1, 2021, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance.
During the year ended December 31, 2020, the Bank recorded net charge-offs of $0.1 million, compared with net charge-offs of $4.8 million during the year ended December 31, 2019. The allowance for loan losses as a percentage of loans receivable was 1.27% as of December 31, 2020 and 0.75% as of December 31, 2019. Excluding PPP loans receivable, which are 100% federally guaranteed, the allowance for loan losses as a percentage of loans receivable was 1.36% as of December 31, 2020. During 2019, the bank had a $2.1 million charge-off related to one commercial real estate secured credit. In 2020, a $0.8 million recovery was received for this credit.
The Company is adopting ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”) effective January 1, 2021. The main objective of this amendment is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendment requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to enhance their credit loss estimates. The Company’s CECL implementation efforts are continuing to focus on completion of model validation, developing new disclosures, establishing formal policies and procedures and other governance and control documentation. Based on the Company’s portfolio balances, and forecasted economic conditions as of December 31, 2020, management believes the adoption of the CECL standard will result in an increase to its total current reserves. An increase to the Company's reserve levels will include nonaccretable credit marks on PCI loans, which will be transferred into current reserves at adoption.
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Five-Year Statistical Allowance for Loan Losses
The following table reflects the relationship of loan volume, the provision and allowance for loan losses and net charge-offs for the past five years.
Years Ended December 31,
(dollars in thousands)
Charge-offs:
Recoveries:
(1) For the years ended December 31, 2019, December 31, 2018 and December 31, 2016, the loan charge-offs within the commercial loan segment included $1.0 million, $17.0 million and $36.7 million in charge-offs related to the taxi medallion portfolio, respectively.
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 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 as of 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 gross loans, along with the amount of the unallocated allowance. Commercial loan type shown below includes commercial, commercial real estate and construction loans.
Commercial Residential Real Estate Consumer Unallocated
(dollars in thousands)
Investments
For the year ended December 31, 2020, the average volume of investment securities, including equity securities, decreased by $34.4 million to approximately $444.1 million or 6.4% of average earning assets, from $478.5 million, or 8.5% of average earning assets, for the year ended December 31, 2019. As of December 31, 2020, 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 Subdivisions, Corporate Bonds and other debt and equity securities.
During the year ended December 31, 2020, rate related factors decreased investment revenue by $3.1 million, while volume related factors decreased investment revenue by $0.8 million. The tax-equivalent yield on investments decreased by 65 basis points to 2.25% from a yield of 2.90% during the year ended December 31, 2019. This was primarily due to overall declines in prevailing investment rates over the course of 2020.
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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 Consolidated Statement of Condition.
As of December 31, 2020, net unrealized gains on securities available-for-sale, which are carried as a component of accumulated other comprehensive income and included in stockholders’ equity, net of tax, amounted to $7.9 million as compared with net unrealized gains of $2.7 million as of December 31, 2019. The increase in unrealized gains is predominately attributable to changes in market conditions and interest rates. For additional information regarding the Company’s investment portfolio, see Note 4, Note 16 and Note 21 of the Notes to the Consolidated Financial Statements.
During 2020, there were sales totaling $19.6 million from the Company’s available-for-sale portfolio, as compared with $183.7 million in sales in 2019 and no sales in 2018. The gross realized gains or (losses) on securities sold, called or matured mounted to approximately $29 thousand in 2020, $(280) thousand in 2019 and $-0- in 2018, while there were no impairment charges in 2020, 2019 and 2018.
The table below illustrates the maturity distribution and weighted average yield on a tax-equivalent basis for amortized cost of our investment securities, excluding equity securities, as of December 31, 2020, on a contractual maturity basis.
(dollars in thousands)
Investment Securities Available-for-Sale
For information regarding the carrying value of the investment portfolio, see Note 4, Note 16 and Note 21 of the Notes to the Consolidated Financial Statements.
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 as of December 31, 2020. Other securities do not have a contractual maturity and are included in the “Due in 1 year or less” 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.
(dollars in thousands)
Investment Securities Available-for-Sale:
Commercial mortgage pass-through securities 6,922 4,997 3,874
Trust preferred securities - - -
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For other information regarding the Company’s investment securities portfolio, see Note 4, Note 16 and Note 21 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, 2020, and December 31, 2019, 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, 2020, 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 0.70%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 5.18%. As of December 31, 2019, 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 1.55%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 1.71%.
Based on our model, which was run as of December 31, 2020, 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 3.89%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 8.56%. As of December 31, 2019, 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 2.86%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 4.86%.
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, 2020, would decline by 7.76% with an instantaneous rate shock of up 200 basis points, and increase by 5.70% with an instantaneous rate shock of down 100 basis points. Our EVE as of December 31, 2019, would decline by 7.2% with an instantaneous rate shock of up 200 basis points, and increase by 3.69% with an instantaneous rate shock of down 100 basis points.
The following table illustrates the most recent results for EVE and NII as of December 31, 2020.
Amount % Amount %
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 21 of the Notes to Consolidated Financial Statements for additional discussion.
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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.
As of December 31, 2020, 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, 2020, liquid assets (cash and due from banks, interest-bearing deposits with banks and unencumbered investment securities) were $697.4 million, which represented 9.2% of total assets and 10.9% of total deposits and borrowings, compared to $506.0 million as of December 31, 2019, which represented 8.2% of total assets and 9.6% of total deposits and borrowings on such date.
The Bank is a member of the Federal Home Loan Bank of New York and, based on available qualified collateral as of December 31, 2020, had the ability to borrow $2.0 billion. In addition, as of December 31, 2020, 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 $5.2 million. As of December 31, 2020, the Bank had aggregate available and unused credit of approximately $1.1 billion, which represents the aforementioned facilities totaling $2.0 billion net of $935 million in outstanding borrowings and letters of credit. As of December 31, 2020, outstanding commitments for the Bank to extend credit were $0.9 billion.
Cash and cash equivalents totaled $303.8 million on December 31, 2020, increasing by $102.3 million from $201.5 million as of December 31, 2019. Operating activities provided $81.1 million in net cash. Investing activities used $323.4 million in net cash, primarily reflecting an increase in loans. Financing activities provided $344.5 million in net cash, primarily reflecting a net increase of $410.6 million in deposits, offset by net FHLB repayments of $123.9 million.
Deposits
Deposits are our primary source of funds. Average total deposits increased by $1.2 billion, or 25.3%, to $5.8 billion in 2020 from $4.6 billion in 2019 and increased $775 million, or 20.1%, to $4.6 billion in 2019 from 2018. The increase in total average deposits in 2020 was primarily attributable to both the acquisition of BNJ and organic growth, while the increase in 2019 was attributable to the acquisition of GHB and organic growth. The following table sets forth the year-to-date average balances and weighted average rates for various types of deposits for 2020, 2019 and 2018.
Balance Rate Balance Rate Balance Rate
(dollars in thousands)
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The following table sets forth the distribution of total deposit accounts, by account types for each of the dates indicated.
Amount % of total Amount % of total
(dollars in thousands)
The following table summarizes the maturity distribution of time deposits in denomination of $100,000 or more:
(dollars in thousands)
Federal Home Loan Bank Advances
Federal Home Loan Bank advances are secured, under the terms of a blanket collateral agreement, primarily by commercial mortgage loans. As of December 31, 2020, the Company had a net carrying value of $426.0 million in notes outstanding at a weighted average interest rate of 1.07%. As of December 31, 2019, the Company had a net carrying value of $500.3 million in notes outstanding at a weighted average interest rate of 1.96%.
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Contractual Obligations and Other Commitments
The following table summarizes contractual obligations as of December 31, 2020 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, 2020 (dollars in thousands)
Contractual obligations:
Other long-term liabilities/long-term debt:
Other commercial commitments – off balance sheet:
Capital
The maintenance of a solid capital foundation continues to be a primary goal for the Company. Accordingly, capital plans, stock repurchases, and dividend policies are monitored on an ongoing basis. The most important objective of the capital planning process is to balance effectively the retention of capital to support future growth and the goal of providing stockholders with an attractive long-term return on their investment.
The Company’s Tier 1 leverage capital (defined as tangible stockholders’ equity for common stock and Trust Preferred Capital Securities) as of December 31, 2020 amounted to $694.9 million or 9.5% of average total assets. As of December 31, 2019, the Company’s Tier 1 leverage capital amounted to $563.5 million or 9.5% of average total assets. The increase in Tier 1 capital reflects the Company’s retained earnings during 2019 and the acquisition of BNJ.
United States bank regulators have issued guidelines establishing minimum capital standards related to the level of assets and off balance-sheet exposures adjusted for credit risk. Specifically, these guidelines categorize assets and off balance-sheet items into risk-weightings and require banking institutions to maintain a minimum ratio of capital to risk-weighted assets. As of December 31, 2020, the Company’s CET 1, Tier 1 and total risk-based capital ratios were 10.79%, 10.87% and 15.08%, respectively. For information on risk-based capital and regulatory guidelines for the Parent Corporation and its bank subsidiary, see Note 15 to the Consolidated Financial Statements.
The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the bank regulators regarding capital components, risk weightings, and other factors.
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Subordinated Debentures
During December 2003, Center Bancorp Statutory Trust II, a statutory business trust and wholly owned subsidiary of the Parent Corporation issued $5.0 million of MMCapS capital securities to investors due on January 23, 2034. The trust loaned the proceeds of this offering to the Company and received in exchange $5.2 million of the Parent Corporation’s subordinated debentures. The subordinated debentures are redeemable in whole or part. The floating interest rate on the subordinated debentures is three-month LIBOR plus 2.85% and re-prices quarterly. The rate as of December 31, 2020 was 3.06%.
During June 2020, the Parent Corporation issued $75 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “2020 Notes”). The 2020 Notes bear interest at 5.75% annually from, and including, the date of initial issuance to, but excluding, June 15, 2025 or the date of earlier redemption, payable semi-annually in arrears on June 15 and December 15 of each year, commencing December 15, 2020. From and including June 15, 2025 through maturity or earlier redemption, the interest rate shall reset quarterly to an interest rate per annum equal to a benchmark rate, which is expected to be Three-Month Term SOFR (as defined in the Second Supplemental Indenture), plus 560.5 basis points, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing on September 15, 2025. Notwithstanding the foregoing, if the benchmark rate is less than zero, then the benchmark rate shall be deemed to be zero.
During January 2018, the Parent Corporation issued $75 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “Notes”) to certain accredited investors. The net proceeds from the sale of the Notes were used in the first quarter of 2018 for general corporate purposes, which included the Parent Corporation contributing $65 million of the net proceeds to the Bank in the form of debt and common equity. The Notes are non-callable for five years, have a stated maturity of February 1, 2028 and bear interest at a fixed rate of 5.20% per year, from and including January 17, 2018 to, but excluding February 1, 2023. From and including February 1, 2023 to, but excluding the maturity date, or early redemption date, the interest rate will reset quarterly to a level equal to the then current three-month LIBOR rate plus 284 basis points.
During June 2015, the Parent Corporation issued $50 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “2015 Notes”). As of December 31, 2020, the 2015 Notes have a stated maturity of July 1, 2025, and bear interest until the maturity date or early redemption date at a variable rate equal to the then current three-month LIBOR rate plus 393 basis points. As of December 31, 2020, the variable interest rate was 4.16% and all costs related to 2015 issuance have been amortized. The 2015 Notes were redeemed in full on January 1, 2021.
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest Sensitivity
Market Risk
Interest rate risk management is our primary market risk. See “Item 7- Management’s Discussion and Analysis of Financial Condition and Results of Operation- Interest Rate Sensitivity Analysis” herein for a discussion of our management of our interest rate risk.
Item 8. Financial Statements and Supplementary Data
All Financial Statements:
The following financial statements are filed as part of this report under Item 8 - “Financial Statements and Supplementary Data.”
Page
Report of Independent Registered Public Accounting Firm 49
Consolidated Statements of Financial Condition 54
Consolidated Statements of Income 55
Consolidated Statements of Comprehensive Income 56
Consolidated Statements of Changes in Stockholders’ Equity 57
Consolidated Statements of Cash Flows 58
Notes to Consolidated Financial Statements 59
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
ConnectOne Bancorp, Inc. and Subsidiaries
Englewood Cliffs, New Jersey
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated statements of financial condition of ConnectOne Bancorp, Inc. and Subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Allowance for Loan Losses – Exogenous Factors Related to Commercial, Commercial Real Estate, and Commercial Construction Loan Segments
The allowance for loan losses represents management’s estimate of probable incurred credit losses inherent in the loan portfolio. As described in Notes 1a and 5 to the consolidated financial statements, the Company’s consolidated allowance for loan losses was $79,226,000 at December 31, 2020, which consisted of the allowance for loans losses allocated to 1) loans individually evaluated for impairment, representing $14,314,000, 2) loans collectively evaluated for impairment (“general component”), representing $58,504,000, and 3) loans acquired, representing $5,840,000, as well as an unallocated allowance for loan losses of $568,000. The general component can be further broken down as the general component related to the commercial, commercial real estate, and commercial construction loan segments of $56,572,000 and the general component related to the residential real estate and consumer segments of $1,932,000. The general component is based on historical loss experience adjusted for current factors. This actual loss experience is supplemented with exogenous factor adjustments based on the risks present for each loan category. Changes in these exogenous factor adjustments related to the commercial, commercial real estate, and commercial construction loan segments could have a material impact on the Company’s financial results.
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The general component of the Company’s allowance for loan losses involves consideration of the following exogenous factors: concentrations of credit; delinquency and nonaccrual trends; economic and business conditions including evaluation of the national and regional economies and industries with significant loan concentrations; external factors including legal, regulatory or competitive pressures that may impact the loan portfolio; changes in the experience, ability, or size of the lending staff, management, or board of directors that may impact the loan portfolio; changes in underwriting standards, collection procedures, charge-off practices, or other changes in lending policies and procedures that may impact the loan portfolio; loss and recovery trends; changes in portfolio size and mix; and trends in problem loans. The consideration of these factors contributes significantly to the general component of the allowance for loan losses for the commercial, commercial real estate, and commercial construction loan segments. Management’s analysis of these exogenous factors requires significant judgment, and management’s allocation of exogenous factors relies on a qualitative analysis to determine the quantitative impact the exogenous factors have on the general component for the commercial, commercial real estate, and commercial construction loan segments. We identified auditing management’s analysis and allocation of the exogenous factors to the general component of the allowance for loan losses for the commercial, commercial real estate, and commercial construction loan segments as a critical audit matter as it involved especially subjective auditor judgment.
The primary audit procedures we performed to address this critical audit matter included:
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Testing the effectiveness of controls over the evaluation of the exogenous factors used to estimate the general component for the commercial, commercial real estate, and commercial construction loan segments, including controls addressing:
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Management’s review of the completeness and accuracy of data used as the basis for the adjustments relating to exogenous factors;
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Management’s judgments related to the qualitative and quantitative assessment of the data used in the determination of qualitative reserve factors and the resulting allocation to the allowance allocated to loans collectively evaluated for impairment; and,
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Management’s review of the exogenous factor reserve for mathematical accuracy.
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Substantively testing management’s process, including evaluating their judgments and significant assumptions, for developing the exogenous factors used to estimate the general component for the commercial, commercial real estate, and commercial construction loan segments which included:
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Evaluation of the completeness and accuracy of data used as a basis for the adjustments relating to exogenous factors;
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Evaluation of the reasonableness of management’s judgments related to the qualitative and quantitative assessment of the data used in the determination of exogenous factors and the resulting allocation to the allowance allocated to loans collectively evaluated for impairment. Among other procedures, our evaluation considered actual charge offs, loan portfolio performance and third-party data, and whether such assumptions were applied consistently period over period;
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Analytically evaluating the exogenous factor allocation year over year for reasonableness; and,
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Recalculation of the exogenous factor reserve.
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Business Combinations – Fair Value of Acquired Non-Credit-Impaired Loans
As described in Note 2 to the consolidated financial statements, on January 2, 2020 the Company completed its acquisition of Bancorp of New Jersey, Inc. The business combination was accounted under the acquisition method of accounting, with assets acquired and liabilities assumed recorded at fair value as of the acquisition date. The fair value of loans acquired in the acquisition totaled $774,720,000, which included $763,020,000 of non-credit-impaired loans and $11,700,000 of credit-impaired loans.
The fair values of non-credit-impaired loans acquired were estimated based on the value of the expected cash flows, which were projected based on the contractual terms of loans, including both maturity and contractual amortization. Projected cash flows were adjusted for expected losses and prepayments, where appropriate. Expected losses assumptions were developed using peer group loss data. Projected cash flows were then discounted to present value using a discount rate developed based on the relative risk of the cash flows, considering the loan type, liquidity risk, the maturity of the loans, servicing costs and a required return on capital. Changes in these estimates and assumptions could have a significant impact on the fair values of the acquired non-credit-impaired loans. We identified auditing the fair value of acquired non-credit-impaired loans as a critical audit matter as it involved especially subjective auditor judgment.
The primary audit procedures we performed to address this critical audit matter included:
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Testing the effectiveness of controls over the judgments, significant assumptions and data used to estimate the fair value of acquired non-credit-impaired loans, including controls addressing:
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Management’s evaluation of the reasonableness of the judgments and assumptions used to estimate fair value; and,
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Management’s review of the completeness and accuracy of the data used.
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Substantively testing management’s process, including evaluating their judgments and assumptions, for estimating the fair value of acquired non-credit-impaired loans which included:
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Evaluation of the reasonableness of judgments and assumptions used by management;
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Evaluation of the completeness and accuracy of the data used; and,
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Utilization of an internal valuation specialist to assist with the evaluation of the appropriateness of assumptions, judgments and data used and overall reasonableness of the fair values.
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Goodwill Impairment
Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. As described in Notes 1a and 7 to the consolidated financial statements, the Company’s consolidated goodwill balance was $208,372,000 at December 31, 2020. Goodwill is tested annually for impairment in the fourth quarter, or more frequently if events and circumstances exist that indicate it is more likely than not impairment has occurred. During the quarter ended June 30, 2020, the Company determined a triggering event had occurred and performed a quantitative goodwill impairment evaluation using both income and market approaches to estimate the fair value of the Company and based on results of evaluation, no goodwill impairment was recorded.
The goodwill impairment evaluation involved significant estimates and subjective assumptions, which required a high degree of management judgment. Significant estimates and subjective assumptions included discount rate, prospective financial information, earnings retention rate and peer group market data. Changes in these estimates and assumptions could have a significant impact on the conclusions reached regarding whether impairment occurred and the amount of impairment. We identified auditing the goodwill impairment evaluation as a critical audit matter as it involved especially subjective auditor judgment.
The primary audit procedures we performed to address this critical audit matter included:
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Testing the effectiveness of controls over the judgments, assumptions and data used to estimate the fair value of the Company, including controls addressing:
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Management’s review of the reasonableness and accuracy of the Company’s prospective financial information used in the income approach.
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Management’s evaluation of significant assumptions used, including valuation methodologies, discount rate, earnings retention rate and peer group market data.
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Substantively testing management’s process, including evaluating their judgments and significant assumptions, for estimating the fair value of the Company which included:
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Evaluation of key financial data for accuracy.
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Evaluation of management’s ability to reasonably forecast cash flows.
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Utilization of an internal valuation specialist to assist with the evaluation of the appropriateness of valuation methodologies, discount rate, earnings retention rate, peer group market data and overall reasonableness of the fair value.
/s/ Crowe LLP
We have served as the Company’s auditor since 2014.
New York, New York March 1, 2021
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CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31,
(in thousands, except share data)
ASSETS
Investment in restricted stock, at cost 25,099 27,397
LIABILITIES
Deposits:
Subordinated debentures, net of debt issuance costs 202,648 128,885
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY
Preferred Stock: