U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 2012 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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FOR THE TRANSITION PERIOD FROM TO |
ConnectOne Bancorp, Inc.
(Exact name of registrant as specified in its charter)
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New Jersey |
26-1998619 |
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301 Sylvan Avenue, Englewood Cliffs, NJ |
07632 |
(201) 816-8900
(Registrants telephone number including area code)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
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Title of each class |
Name of each exchange on |
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Common Stock, no par value |
Nasdaq |
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes £ No S
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes £ No S
Check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes S No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes S No £
Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-K contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by referenced in Part III of this Form 10-K or any amendment to this Form 10-K. S
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and small reporting company in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer £ Accelerated filer
£ Non-accelerated filer S Smaller reporting company £
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No S
As of March 26, 2013 there were 5,019,940 shares of common stock, no par value per share outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
10-K Item
Document Incorporated
Item 10.
Directors and Executive Officers of the Registrant
Proxy Statement for 2013 Annual Meeting of Shareholders to be filed no later than April 30, 2013.
Item 11.
Executive Compensation
Proxy Statement for 2013 Annual Meeting of Shareholders to be filed no later than April 30, 2013.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Proxy Statement for 2013 Annual Meeting of Shareholders to be filed no later than April 30, 2013.
Item 13.
Certain Relationships and Related Transactions
Proxy Statement for 2013 Annual Meeting of Shareholders to be filed no later than April 30, 2013.
Item 14.
Principal Accountant Fees and Services
Proxy Statement for 2013 Annual Meeting of Shareholders to be filed no later than April 30, 2013.
PART I Item 1. Business. General ConnectOne Bancorp, Inc. (we, us our, the Company) is a New Jersey corporation formed in 2008 to become the holding company for ConnectOne Bank (the Bank). Our sole activity currently is ownership and control of the Bank. The Bank operates as a locally headquartered, community-
oriented bank serving customers throughout New Jersey from offices in Bergen, Hudson, and Monmouth Counties, New Jersey. We offer a broad range of deposit and loan products and services to the general public and, in particular, to small and mid-sized businesses, local professionals and individuals residing, working and shopping in our trade area. Historically, we have concentrated on organic growth, through opening new branches and offering new technology and product delivery channels to acquire new customers. While we expect to take an opportunistic approach to acquisitions, considering opportunities to purchase whole institutions,
branches or lines of business that complement our existing strategy, we expect the bulk of our growth to continue to be organic. Our goal is to open new offices in the counties contained in our broader trade area discussed above. However, we do not believe that we need to establish a physical location
in each market that we serve. We believe that advances in technology have created new delivery channels which allow us to service customers and maintain business relationships without a physical presence, and that these customers can also be serviced through a regional office. We believe the key to
customer acquisition and retention is establishing quality teams of lenders and business relationship officers who will frequently go to the customer, rather than having the customer come into the branch. The Banks organizers originally incorporated the Bank, in part, because they did not believe that the targeted segments of our primary trade area were being adequately served by the then existing financial institutions operating in our market area. Through increased bank consolidation in recent
years in New Jersey, many banks have been acquired by larger institutions. In our trade area, a number of the acquiring institutions are headquartered outside of the region and the state. We believe that one effect of bank consolidation is to make it difficult for small to mid-sized businesses to obtain
direct access to credit decision-makers because the decision-makers are not located in the customers market area. Further, we believe that many larger, multi-state institutions have curtailed lending to small and mid-sized businesses during the current economic turbulence. In response, we emphasize
superior customer service and relationship banking. The Bank offers high-quality service by minimizing personnel turnover and by providing more direct, personal attention than the Bank believes is offered by competing financial institutions, the majority of which are branch offices of banks headquartered
outside the Banks primary trade area. By emphasizing the need for a professional, responsive and knowledgeable staff, the Bank offers a superior level of service to our customers. As of result of senior managements availability for consultation on a daily basis, the Bank believes it offers customers a
quicker response on loan applications and other banking transactions, as well as greater certainty that these transactions will actually close, than competitors, whose decisions may be made in distant headquarters. We believe that this response time and certainty to close result in a pricing advantage to us,
in that we frequently may exceed competitors loan pricing and still win customers. We also provide state-of-the-art banking technology, including remote deposit capture, internet banking and mobile banking, to provide our customers with the most choices and maximum flexibility. We believe that this
combination of quick, responsive and personal service and advanced technology provides the Banks customers with a superior banking experience. Our Market Area Our banking offices are located in Bergen, Hudson and Monmouth Counties in New Jersey, which include some of the most affluent markets in the United States. We also attract business and customers from a broader region, primarily defined as the northeastern quarter of the state of 1
New Jersey, from Route 195 to the south and Route 287 to the west to the New York state border on the north. Products and Services We derive substantially all of our income from our net interest income (i.e. the difference between the interest we receive on our loans and securities and the interest we pay on deposits and other borrowings.) The Bank offers a broad range of deposit and loan products. In addition, to attract the
business of consumer and business customers, we also provide a broad array of other banking services. Products and services provided include personal and business checking accounts, retirement accounts, money market accounts, time and savings accounts, credit cards, wire transfers, access to automated
teller services, internet banking, Treasury Direct, ACH origination, lockbox services and mobile banking by phone. In addition, the Bank offers safe deposit boxes. The Bank also offers remote deposit capture banking for both retail and business customers, providing the ability to electronically scan and
transmit checks for deposit, reducing time and cost. Checking consists of both retail and business demand deposit products. Retail products include Totally Free checking and, for businesses, both interest-bearing accounts, which require a minimum balance, and non-interest bearing accounts. NOW accounts consist of both retail and business interest-
bearing transaction accounts that have minimum balance requirements. Money market accounts consist of products that provide a market rate of interest to depositors but have limited check writing capabilities. Our savings accounts consist of both passbook and statement type accounts. Time deposits
consist of certificates of deposit, including those held in IRA accounts, generally with initial maturities ranging from 7 days to 60 months and brokered certificates of deposit, which the Company uses for asset liability management purposes and to supplement other sources of funding. Deposits serve as the primary source of funding for the Banks interest-earning assets, but also generate non-interest revenue through insufficient funds fees, stop payment fees, safe deposit rental fees, card income, including foreign ATM fees and credit and debit card interchange, gift card fees, and
other miscellaneous fees. In addition, the Bank generates additional non-interest revenue associated with residential loan origination and sale, loan servicing, late fees and merchant services. The Bank offers personal and commercial business loans on a secured and unsecured basis, revolving lines of credit, commercial mortgage loans, and residential mortgages on both primary and secondary residences, home equity loans, bridge loans and other personal purpose loans. However, the Bank
is not and has not been a participant in the sub-prime lending market. Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, taxi medallions, inventory and equipment, and liens on
commercial and residential real estate. Commercial construction loans are loans to finance the construction of commercial or residential properties secured by first liens on such properties. Commercial real estate loans include loans secured by first liens on completed commercial properties, including multi-
family properties, to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Home equity loans and lines of credit
include loans secured by first or second liens on residential real estate for primary or secondary residences. Consumer loans are made to individuals who qualify for auto loans, cash reserve, credit cards and installment loans. The Board of Directors has approved a loan policy granting designated lending authorities to members of the Senior Lending Group, which is comprised of the Chief Executive Officer, Chief Lending Officer and Chief Credit Officer. Combined authorities allow the group to approve loans up to the
Banks legal lending limit (currently $12.8 million as of December 31, 2012 for most loans), provided that (i) the credit does not involve an exception to policy, and (ii) the credit does not exceed a certain dollar amount threshold set forth in our policy, which varies by loan type. The Board Loan
Committee (which includes the Chief Executive Officer and four other Board members) approves credits that are both exceptions to policy and are above prescribed amounts related to loan type and collateral. 2
The Banks lending policies generally provide for lending inside of our primary trade area. However, the Bank will make loans to persons outside of our primary trade area when the Bank deems it prudent to do so. In an effort to promote a high degree of asset quality, the Bank focuses primarily
upon offering secured loans. However, the Bank is willing to make short-term unsecured loans to borrowers with high net worth and income profiles. The Bank generally requires loan customers to maintain deposit accounts with the Bank. In addition, the bank generally provides for a minimum required
rate of interest in its variable rate loans. We believe that having senior management on-site allows for an enhanced local presence and rapid decision-making that attracts borrowers. The Banks legal lending limit to any one borrower is 15% of the Bankss capital base (defined as tangible equity plus the
allowance for loan losses) for most loans ($12.8 million) and 25% of the capital base for loans secured by readily marketable collateral ($21.3 million). At December 31, 2012, the Banks largest borrower had an aggregate borrowing outstanding of $10.8 million. The largest single loan outstanding at the
Bank at December 31, 2012 was $9.1 million. Our business model includes using industry best practices for community banks, including personalized service, state-of-the-art technology and extended hours. We believe that this will generate deposit accounts with somewhat larger average balances than are found at many other financial institutions.
We also use pricing techniques in our efforts to attract banking relationships having larger than average balances. Competition The banking business is highly competitive. We face substantial immediate competition and potential future competition both in attracting deposits and in originating loans. We compete with numerous commercial banks, savings banks and savings and loan associations, many of which have assets,
capital and lending limits larger than those that we have. Other competitors include money market mutual funds, mortgage bankers, insurance companies, stock brokerage firms, regulated small loan companies, credit unions and issuers of commercial paper and other securities. Our larger competitors have greater financial resources to finance wide-ranging advertising campaigns. Additionally, we endeavor to compete for business by providing high quality, personal service to customers, customer access to our decision-makers and competitive interest rates and fees. We seek to hire and retain quality employees who desire greater responsibility than may be available working
for a larger employer. Additionally, the local real estate and other business activities of our Directors help us develop business relationships by increasing our profile in our communities. In the financial services industry in recent years, intense market demands, technological and regulatory changes and economic pressures have eroded industry classifications that were once clearly defined. As a result of increased competition, existing banks have been forced to diversify their services,
increase rates paid on deposits and become more cost effective. Corresponding changes in the regulatory framework have resulted in increasing homogeneity in the financial services offered by financial institutions. Some of the results of those market dynamics in the financial services industry include an
increase in the number of new bank and non-bank competitors and increased customer awareness of product and service differences among competitors. Those results may be expected to affect our business prospects. Employees As of December 31, 2012, we had 94 full-time and 3 part-time employees. None of our employees are subject to a collective bargaining agreement. SUPERVISION AND REGULATION We are a bank holding company within the meaning of the BHCA. As a bank holding company, we are subject to regulation and examination by the Board of Governors of the Federal Reserve System (the Federal Reserve). In addition, the Bank is subject to examination and 3
supervision by the FDIC, as the insurer of our deposits, and the New Jersey Department of Banking and Insurance, as the chartering entity of the Bank. Recently Enacted Regulatory Reform On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) which imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. Although the
Dodd-Frank Act is primarily aimed at the activities of investment banks and large, national commercial banks, many of the provisions of the Dodd-Frank Act will impact the operations of community banks like the Bank. The following discussion summarizes significant aspects of the new law that may
affect the Bank and the Company. Many regulations implementing these changes have not been promulgated, so we cannot determine the full impact on our business and operations at this time. The following aspects of the financial reform and consumer protection act are related to the operations of the Bank:
A new independent consumer financial protection bureau was established within the Federal Reserve, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. However, smaller financial institutions, like
the Bank, are subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws. The act also imposes new obligations on originators of residential mortgage loans, such as the Bank. Among other things, originators must make a reasonable and good faith determination based on documented information that a borrower has a reasonable ability to repay a particular mortgage loan
over the long term. If the originator cannot meet this standard, the loan may be unenforceable in foreclosure proceedings. The act contains an exception from this ability to repay rule for qualified mortgages, which are deemed to satisfy the rule, but does not define the term, and left authority to
the Consumer Financial Protection Bureau (CFPB) to adopt a definition. A rule issued by the CFPB in January 2013, and effective January 10, 2014, sets forth specific underwriting criteria for a loan to qualify as a Qualified Mortgage Loan. The criteria generally exclude loans that are interest-
only, have excessive upfront points or fees, have negative amortization features or balloon payments, or have terms in excess of 30 years. The underwriting criteria also impose a maximum debt to income ratio of 43%. If a loan meets these criteria and is not a higher priced loan as defined in
Federal Reserve 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 consumers 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 Sullivan 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 institutions total assets minus the sum of its average tangible equity during the assessment period. 4
The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent 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. The following aspects of the financial reform and consumer protection act are related to the operations of the Company:
The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries. The Securities and Exchange Commission is authorized to adopt rules requiring public companies to make their proxy materials available to shareholders for nomination of their own candidates for election to the board of directors. Public companies (other than emerging growth companies like the Company) are now required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have
a say on pay vote every one, two or three years. A separate, non-binding shareholder vote is now required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments. Securities exchanges are now required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain significant matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be
significant. Stock exchanges are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation payable on the basis of financial information reportable under the securities laws, and (ii) the recovery from current or former
executive officers, following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount
that would have been paid on the basis of the restated financial information. Disclosure in annual proxy materials will be required concerning the relationship between the executive compensation paid and the financial performance of the issuer. Item 402 of Regulation S-K will be amended to require companies to disclose the ratio of the Chief Executive Officers annual total compensation to the median annual total compensation of all other employees. Holding Company Supervision and Regulation General As a bank holding company registered under the Bank Holding Company Act (the BHCA), the Company is subject to the regulation and supervision applicable to bank holding companies by the Federal Reserve. The Company is required to file with the Federal Reserve annual reports and other
information regarding its business operations and those of its subsidiaries. The BHCA requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire all or substantially all of the assets of any other bank, (ii) acquire direct or indirect ownership or control of more than 5% of the outstanding voting
stock of any bank (unless it owns a majority of such companys voting shares), or (iii) merge or consolidate with any other bank holding company. The Federal Reserve will not approve any acquisition, merger, or consolidation that would have a substantially anti-competitive effect, unless the anti-
competitive impact of the proposed transaction is clearly outweighed by a greater public 5
interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial resources and future prospects of the companies and the banks concerned, together with the convenience and needs of the community to
be served, when reviewing acquisitions or mergers. Among other things, the BHCA requires regulatory filings by a stockholder or other party that seeks to acquire direct or indirect control of an FDIC-insured depository institution. The determination whether an investor controls a depository institution is based on all of the facts and
circumstances surrounding the investment. As a general matter, a party is deemed to control a depository institution or other company if the party owns or controls 25% or more of any class of voting stock. A party may be presumed to control a depository institution or other company if the investor
owns or controls 10% or more of any class of voting stock. Ownership by affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a partys ownership of the Company were to exceed certain thresholds, the investor could be deemed to control the Company for
regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences. The Bank Holding Company Act generally prohibits a bank holding company, with certain limited exceptions, from (i) acquiring or retaining direct or indirect ownership or control of more than 5% of the outstanding voting stock of any company which is not a bank or bank holding company, or (ii)
engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or performing services for its subsidiaries, unless such non-banking business is determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be properly
incident thereto. The Bank Holding Company Act was substantially amended through the Gramm-Leach Bliley Financial Modernization Act of 1999 (Financial Modernization Act). The Financial Modernization Act permits bank holding companies and banks, which meet certain capital, management and Community
Reinvestment Act standards to engage in a broader range of non-banking activities. In addition, bank holding companies that elect to become financial holding companies may engage in certain banking and non-banking activities without prior Federal Reserve approval. Finally, the Financial Modernization
Act imposes certain privacy requirements on all financial institutions and their treatment of consumer information. At this time, the Company has elected not to become a financial holding company, as it does not engage in any activities that are not permissible for banks. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event the
depository institution becomes in danger of default. Under provisions of the Federal Deposit Insurance Act, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it
might not do so absent such requirement. The Federal Reserve also has the authority under the Bank Holding Company Act to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary upon the Federal Reserves determination that such activity or
control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company. Capital Adequacy Guidelines for Bank Holding Companies The Federal Reserve has adopted risk-based capital guidelines for bank holding companies. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies to account for off-balance sheet
exposure, and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet
items. These requirements apply on a consolidated basis to bank holding companies with consolidated assets of $500 million or more and to certain bank holding companies with less than 6
$500 million in consolidated assets if they are engaged in substantial non-banking activities or meet certain other criteria. In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a bank holding company must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank holding company
that has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum. Payment of Dividends The Federal Reserve has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserves policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding
company appears consistent with the organizations capital needs asset quality and overall financial condition. Federal Reserve regulations also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide
adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Under the prompt corrective action laws, the ability of a bank holding
company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions. Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act of 2002 generally established a comprehensive framework to modernize and reform the oversight of public company auditing, improve the quality and transparency of financial reporting by those companies and strengthen the independence of auditors. Among other things, the
legislation (i) created a public company accounting oversight board which is empowered to set auditing, quality control and ethics standards, to inspect registered public accounting firms, to conduct investigations and to take disciplinary actions, subject to SEC oversight and review; (ii) strengthened auditor
independence from corporate management by, among other things, limiting the scope of consulting services that auditors can offer their public company audit clients; (iii) heightened the responsibility of public company directors and senior managers for the quality of the financial reporting and disclosure
made by their companies; (iv) adopted a number of provisions to deter wrongdoing by corporate management; (v) imposed a number of new corporate disclosure requirements; (vi) adopted provisions which generally seek to limit and expose to public view possible conflicts of interest affecting securities
analysts; and (vii) imposed a range of new criminal penalties for fraud and other wrongful acts, as well as extended the period during which certain types of lawsuits can be brought against a company or its insiders. Supervision and Regulation of the Bank As a New Jersey-chartered commercial bank, the Bank is subject to the regulation, supervision, and control of the New Jersey Department of Banking and Insurance (the Banking Department). As an FDIC-insured institution, the Bank is subject to regulation, supervision and control of the FDIC,
an agency of the federal government. The regulations of the FDIC and the Banking Department affect virtually all of the Banks activities, including the minimum level of capital, the ability to pay dividends, the ability to expand through new branches or acquisitions and various other matters. 7
Insurance of Deposits The deposits of the Bank are insured by the Deposit Insurance Fund, which is administered by the FDIC. The Dodd-Frank Act permanently increased deposit insurance on most accounts to $250,000. The FDICs risk-based premium system provides for quarterly assessments. Each insured institution is placed in one of four risk categories depending on supervisory and capital considerations. Within its risk category, an institution is assigned to an initial base assessment rate which is then adjusted to
determine its final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. The FDIC recently amended its deposit insurance regulations (1) to change the assessment base for insurance from domestic deposits to average assets minus average tangible equity and (2) to lower
overall assessment rates. The revised assessments rates are 2.5 to 9 basis points for banks in the lowest risk category and between 30 to 45 basis points for banks in the highest risk category. The amendments became effective during the second quarter of 2011 and reduced the Banks insurance premium
expense. In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund. The assessment
rate for the fourth quarter of fiscal 2012 was .00165% of insured deposits and is adjusted quarterly. These assessments will continue until the Financing Corporation bonds mature in 2019. The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the
accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the Banks deposit insurance. Interstate Acquisitions The Interstate Banking Act allows federal regulators to approve mergers between adequately capitalized banks from different states regardless of whether the transaction is prohibited under any state law, unless one of the banks home states has enacted a law expressly prohibiting out-of-state mergers
before June 1997. This act also allows a state to permit out-of-state banks to establish and operate new branches in that state. The State of New Jersey has not opted out of this interstate merger provision. Therefore, the federal provision permitting interstate acquisitions applies to banks chartered in
New Jersey. New Jersey law, however, retained the requirement that an acquisition of a New Jersey institution by a New Jersey or a non-New Jersey based holding company must be approved by the Banking Department. The Interstate Banking Act also allows a state to permit out-of-state banks to
establish and operate new branches in this state. New Jersey law permits an out of state banking institution to establish additional branch offices in New Jersey if the out of state banking institution has at least one existing branch office location in New Jersey and complies with certain other requirements. Dividend Rights Under the New Jersey Corporation Act, we are permitted to pay cash dividends provided that the payment does not leave us insolvent. As a bank holding company under the BHCA, we would be prohibited from paying cash dividends if we are not in compliance with any capital requirements
applicable to it. However, as a practical matter, for so long as our major operations consist of ownership of the Bank, the Bank will remain our source of dividend payments, and our ability to pay dividends will be subject to any restrictions applicable to the Bank. 8
Under the New Jersey Banking Act of 1948, as amended, dividends may be paid by the Bank only if, after the payment of the dividend, the capital stock of the Bank will be unimpaired and either the Bank will have a surplus of not less than 50% of its capital stock or the payment of the dividend
will not reduce the Banks surplus. The payment of dividends is also dependent upon the Banks ability to maintain adequate capital ratios pursuant to applicable regulatory requirements. Capital Adequacy Guidelines The FDIC has promulgated risk-based capital guidelines that are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Under those guidelines, assets
and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. Bank assets are given risk-weights of 0%, 20%, 50% and 100%. In addition, certain off-balance sheet items are given similar credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. Those computations result in the total risk-weighted
assets. Most loans are assigned to the 100% risk category, except for performing first mortgage loans fully secured by residential property, which carry a 50% risk weighting. Most investment securities (including, primarily, general obligation claims of states or other political subdivisions of the United
States) are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of the U.S. Treasury or obligations backed by the full faith and credit of the U.S. Government, which have a 0% risk-weight. In converting off-balance sheet items,
direct credit substitutes, including general guarantees and standby letters of credit backing financial obligations, are given a 100% risk weighting. Transaction-related contingencies such as bid bonds, standby letters of credit backing nonfinancial obligations, and undrawn commitments (including commercial
credit lines with an initial maturity of more than one year), have a 50% risk weighting. Short-term commercial letters of credit have a 20% risk weighting, and certain short-term unconditionally cancelable commitments have a 0% risk weighting. The minimum ratio of total capital to risk-weighted assets required by FDIC regulations (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least 4% of the total capital is required to be Tier 1 Capital, consisting of common stockholders equity and qualifying
preferred stock or hybrid instruments, less certain goodwill items and other intangible assets. The remainder (Tier 2 Capital) may consist of (a) the allowance for loan losses of up to 1.25% of risk weighted assets, (b) excess of qualifying preferred stock, (c) hybrid capital instruments, (d) perpetual debt,
(e) mandatory convertible securities, and (f) qualifying subordinated debt and intermediate-term preferred stock up to 50% of Tier 1 Capital. Total capital is the sum of Tier 1 and Tier 2 Capital less reciprocal holdings of other banking organizations capital instruments, investments in unconsolidated
subsidiaries and any other deductions as determined by the FDIC (determined on a case-by-case basis or as a matter of policy after formal rules-making). In addition to the risk-based capital guidelines, the FDIC has adopted a minimum Tier 1 Capital (leverage) ratio, under which a bank must maintain a minimum level of Tier 1 Capital to average total consolidated assets of at least 3% in the case of a bank that has the highest regulatory examination
rating and is not contemplating significant growth or expansion. All other banks are expected to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum. The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, which constitutes a strengthened set of capital requirements for banking organizations in the United States and around the world. Basel III is
currently the subject of notices of proposed rulemakings released in June of 2012 by the respective U.S. federal banking agencies. The comment period for these notices of proposed rulemakings ended on October 22, 2012. Basel III is intended to be implemented beginning January 1, 2013 and to be fully-
phased in on a global basis on January 1, 2019. Basel III would require a minimum amount of capital to be held in the form of tangible common equity, generally increase the required capital ratios, phase out certain kinds of intangibles treated as capital and 9
certain types of instruments and change the risk weightings of assets used to determine required capital ratios. In addition, institutions that seek the freedom to make capital distributions and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% in common equity
attributable to a capital conservation buffer to be phased in from January 1, 2016 until January 1, 2019. However, on November 9, 2012, the U.S. federal banking agencies announced that they do not expect that any of the proposed rules would become effective on January 1, 2013. They did not indicate the
likely new effective date. 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. Community Reinvestment Act All insured depository institutions have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. An institutions failure to comply with the provisions of the Community
Reinvestment Act could result in restrictions on its activities. The Bank received a satisfactory Community Reinvestment Act rating in its most recently completed examination. Privacy Requirements of the Gramm-Leach-Bliley Act Federal law places limitations on financial institutions like the Bank regarding the sharing of consumer financial information with unaffiliated third parties. Specifically, these provisions require all financial institutions offering financial products or services to retail customers to provide such customers
with the financial institutions privacy policy and provide such customers the opportunity to opt out of the sharing of personal financial information with unaffiliated third parties. The Bank currently has a privacy protection policy in place and believes such policy is in compliance with the regulations. Anti-Money Laundering Federal anti-money laundering rules impose various requirements on financial institutions intended to prevent the use of the U.S. financial system to fund terrorist activities. These provisions include a requirement that financial institutions operating in the United States have anti-money laundering
compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such compliance programs supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control
Regulations. The Bank has established policies and procedures to ensure compliance with the federal anti-laundering provisions. Item 1A. Risk Factors. Risks Applicable to Our Business: Nationwide economic weakness may adversely affect our business by reducing real estate values in our trade area and stressing the ability of our customers to repay their loans. Our trade area, like the rest of the United States, is currently experiencing weak economic conditions. In addition, the financial services industry is a major employer in our trade area. The financial services industry has been adversely affected by current economic and regulatory factors. As a result,
many companies have experienced reduced revenues and have laid off employees. These factors have stressed the ability of both commercial and consumer customers to repay their loans, 10
and may result in higher levels of non-accrual loans. In addition, real estate values have declined in our trade area. Since the number of our loans secured by real estate represents a material segment of our overall loan portfolio, declines in the market value of real estate impact the value of the collateral
securing our loans, and could lead to greater losses in the event of defaults on loans secured by real estate. Our recent growth has substantially increased our expenses and impacted our results of operations. As a strategy, we have focused on growth by aggressively pursuing business development opportunities, and we have grown rapidly since our incorporation. Our assets have grown from $179.8 million at December 31, 2006, to $930.0 million at December 31, 2012, representing a compound annual
growth rate in excess of 30%. During that time, we have opened four new offices. Although we believe that our growth strategy will support our long term profitability and franchise value, the expense associated with our growth, including compensation expense for the employees needed to support this
growth and leasehold and other expenses associated with our locations, has and may continue to negatively affect our results. In addition, in order for our most recently opened branches to contribute to our long term profitability, we will need to be successful in attracting and maintaining cost efficient
deposits at these locations. In order to successfully manage our growth, we need to adopt and effectively implement policies, procedures and controls to maintain our credit quality and oversee our operations. We can give you no assurance that we will be successful in this strategy. Our growth-oriented business strategy could be adversely affected if we are not able to attract and retain skilled employees. 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. 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 historic rate of growth, we will be required to maintain our regulatory capital ratios at levels higher than the minimum ratios set by our regulators. In light of current economic conditions, our regulators have been seeking higher capital bases for insured depository institutions
experiencing strong growth. In addition, the implementation of certain new regulatory requirements, such as the Basel III accord and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), may establish higher tangible capital requirements for financial institutions.
These developments may require us to raise additional capital in the future. 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 and commercial business loans. Our loan portfolio is made up largely of commercial real estate loans and commercial business 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, the collateral securing these loans may not be sold as easily as residential real estate, and loan terms with a balloon payment rather than full amortization over the loan term. In addition, commercial real estate and commercial 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 11
significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us. At December 31, 2012, we had $549.2 million of commercial real estate loans, which represented 64.7% of our total loan portfolio. Our commercial real estate loans include loans secured by multi-family, owner occupied and non-owner occupied properties for commercial uses. In addition, we make
both secured and unsecured commercial and industrial loans. At December 31, 2012, we had $147.5 million of commercial business loans, which represented 17.4% of our total loan portfolio. 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. 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. Loans secured by owner-occupied real estate and commercial and industrial loans are both reliant on the operating businesses to provide cash flow to meet debt service obligations, and as a result they are more susceptible to the general impact on the economic environment affecting those operating
companies as well as the real estate. Although the economy in our market area generally, and the real estate market in particular, is improving slowly, we can give you no assurance that it will continue to grow or that the rate of growth will accelerate to historical levels. Many factors, including continuing European economic difficulties
could reduce or halt growth in our local economy and real estate market. Accordingly, it may be more difficult for commercial real estate borrowers to repay their loans in a timely manner in the current economic climate, as commercial real estate borrowers ability to repay their loans frequently
depends on the successful development of their properties. The deterioration of one or a few of our commercial real estate loans could cause a material increase in our level of nonperforming loans, which would result in a loss of revenue from these loans and could result in an increase in the provision
for loan 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. Given the continued weaknesses in the commercial real estate market in general, there may be loans where the value of our collateral has been negatively impacted. The weakening of the commercial real estate market may increase the likelihood of
default of these loans, which could negatively impact our loan portfolios 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. 12
The nature 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, 2012, we had $549.2 million in commercial real estate loans outstanding. Approximately seventy-five percent (75%)
of the loans, or $411.9 million, had been originated in the past three years. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of our loan
portfolio. These loans may have delinquency or charge-off levels above our expectations, which could negatively affect our performance. 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 borrowers 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 borrowers 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. Regulatory changes allowing the payment of interest on commercial accounts may negatively impact our core deposit strategy and our net interest income. Our current core deposit strategy includes continuing to increase our noninterest-bearing commercial accounts in order to lower our cost of funds. Recent changes effected by the Dodd-Frank Act, however, permit the payment of interest on such accounts, which was previously prohibited. If our
competitors begin paying interest on commercial accounts, this may increase competition from other financial institutions for these deposits and negatively affect our ability to continue to increase commercial deposit accounts, may require us to consider paying interest on such accounts, or may otherwise
require us to revise our core deposit strategy, any of which could increase our interest expense and therefore our cost of funds and, as a result, decrease our net interest income which would adversely impact our results of operations. The loss of our Chairman and Chief Executive Officer could hurt our operations. We rely heavily on our Chairman and Chief Executive Officer, Frank Sorrentino III. Mr. Sorrentino has served as Chief Executive Officer of the Bank for five years. It was Mr. Sorrentino who originally conceived of the business idea of organizing ConnectOne Bank, and he spearheaded the efforts
to organize the Bank in 2005. The loss of Mr. Sorrentino could have a material adverse effect on us, as he is central to virtually all aspects of our business operations and management. In addition, as a small community bank, we have fewer management-level personnel who are in position to succeed and
assume the responsibilities of Mr. Sorrentino. Our lending limit may restrict our growth. We are limited in the amount we can loan to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. Based upon our current capital levels, the amount we may lend is significantly less than
that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our lending limit from doing business with us. We accommodate larger loans by selling 13
participations in those loans to other financial institutions, but his strategy may not always be available. We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance. We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an
integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results may be materially adversely
affected. Historically low interest rates may adversely affect our net interest income and profitability. During the last four years it has been the policy of the Board of Governors of the Federal Reserve System (the Federal Reserve) to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, yields on
securities we have purchased, and to a lesser extent, market rates on the loans we have originated, have been at levels lower than were available prior to 2008. Consequently, the average yield on our interest-earning assets has decreased during the recent low interest rate environment. As a general
matter, our interest-bearing liabilities re-price or mature more quickly than our interest-earning assets, which have contributed to increases in net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) in the short term. However, our ability to
lower our interest expense is limited at these interest rate levels, while the average yield on our interest-earning assets may continue to decrease. The Federal Reserve has indicated its intention to maintain low interest rates in the near future. Accordingly, our net interest income may decrease, which may
have an adverse effect on our profitability. For information with respect to changes in interest rates, see Risk Factors-Changes in interest rates may adversely affect or our earnings and financial condition. Anti-takeover provisions in our corporate documents and in New Jersey corporate law may make it difficult and expensive to remove current management. Anti-takeover provisions in our corporate documents and in New Jersey law may render the removal of our existing board of directors and management more difficult. Consequently, it may be difficult and expensive for our stockholders to remove current management, even if current management is
not performing adequately. Competition from other financial institutions in originating loans and attracting deposits may adversely affect our profitability. We face substantial competition in originating loans. This competition comes principally from other banks, savings institutions, mortgage banking companies, credit unions and other lenders. Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a
wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that we
originate and the interest rates we may charge on these loans. In attracting deposits, we face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages, including
greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing 14
deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations which may increase our cost of funds. We also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, insurance companies and governmental organizations which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that
govern our operations. As a result, such non-bank competitors may have advantages over us in providing certain products and services. This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our earnings and financial condition. Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations. Hurricanes and other weather events can disrupt our operations, result in damage to our properties and negatively affect the local economies in which we operate. In addition, these weather events may result in a decline in value or destruction of properties securing our loans and an increase in
delinquencies, foreclosures and loan losses. We do not expect to pay cash dividends on shares of our common stock. We have not paid cash dividends on our common stock since the formation of the Bank in 2005, and expect that we will continue to retain earnings to augment our capital base and finance future growth. Therefore, investors should not purchase shares of common stock with a view for a current
return on their investment in the form of cash dividends. Risks Applicable to the Banking Industry Generally: The financial services industry is undergoing a period of great volatility and disruption. Beginning in mid-2007, there has been significant turmoil and volatility in global financial markets. Nationally, economic factors including inflation, recession, a rise in unemployment, a weakened US dollar, dislocation and volatility in the credit markets, and rising consumer costs persist. Recent
market uncertainty regarding the financial sector has increased. In addition to the impact on the economy generally, changes in interest rates, in the shape of the yield curve, or in valuations in the debt or equity markets or disruptions in the liquidity or other functioning of financial markets, all of which
have been seen recently, could directly impact us in one or more of the following ways:
Net interest income, the difference between interest earned on our interest earning assets and interest paid on interest bearing liabilities, represents a significant portion of our earnings. Both increases and decreases in the interest rate environment may reduce our profits. We expect that we will
continue to realize income from the spread between the interest we earn on loans, securities and other interest-earning assets, and the interest we pay on deposits, borrowings and other interest-bearing liabilities. The net interest spread is affected by the differences between the maturity and
repricing characteristics of our interest-earning assets and interest-bearing liabilities. Our interest-earning assets may not reprice as slowly or rapidly as our interest-bearing liabilities. The market value of our securities portfolio may decline and result in other than temporary impairment charges. The value of securities in our portfolio is affected by factors that impact the U.S. securities market in general as well as specific financial sector factors and entities. Recent uncertainty in
the market regarding the financial sector has negatively impacted the value of securities within our portfolio. Further declines in these sectors may result in future other than temporary impairment charges. Asset quality may deteriorate as borrowers become unable to repay their loans. 15
Our allowance for loan losses may not be adequate to cover actual losses. Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and nonperformance. The process for determining the amount of the allowance is critical to our financial results and conditions. It requires difficult, subjective and complex judgments about the future,
including the impact of national and regional economic conditions on the ability of our borrowers to repay their loans. If our judgment proves to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio. Further, state and federal regulatory agencies, as
an integral part of their examination process, review our loans and allowance for loan losses and may require an increase in our allowance for loan losses. At December 31, 2012, our allowance for loan losses as a percentage of total loans was 1.56% and as a percentage of total non-accrual loans was 166.8%. Although we believe that our allowance for loan losses is adequate to cover known and probable incurred losses included in the portfolio, we
cannot assure you that we will not further increase the allowance for loan losses or that our regulators will not require us to increase this allowance. Either of these occurrences could adversely affect our earnings. Changes in interest rates may adversely affect our earnings and financial condition. Our net income depends primarily upon our net interest income. Net interest income is the difference between interest income earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and borrowed funds. The level of net interest income is primarily
a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-
bearing liabilities which, in turn, are impacted by such external factors as the local economy, 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, 2012, a 200 basis point increase in interest rates would have resulted in our economic value of portfolio equity declining by approximately $22.2 million or 19.4%. See Managements Discussion and Analysis of Financial Condition and Results of
OperationsInterest Rate Sensitivity Analysis. Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience gaps in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more
sensitive to changes in market interest rates than our interest-earning assets, or vice versa. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets
mature or re-price more quickly than interest-bearing liabilities, falling interest rates could reduce our net interest income. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, deflation, recession, unemployment, money
supply, domestic and international events and changes in the United States and other financial markets. We also attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate sensitive assets and interest rate sensitive liabilities. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely
affect our results of operations and financial performance. The banking business is subject to significant government regulations. We are subject to extensive governmental supervision, regulation and control. These laws and regulations are subject to change, and may require substantial modifications to our operations or 16
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, smaller financial institutions, like
the Bank, are subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws. The act also imposes new obligations on originators of residential mortgage loans, such as the Bank. Among other things, originators must make a reasonable and good faith determination based on documented information that a borrower has a reasonable ability to repay a particular mortgage loan
over the long term. If the originator cannot meet this standard, the loan may be unenforceable in foreclosure proceedings. The act contains an exception from this ability to repay rule for qualified mortgages, which are deemed to satisfy the rule, but does not define the term, and left authority to
the Consumer Financial Protection Bureau (CFPB) to adopt a definition. A rule issued by the CFPB in January 2013, and effective January 10, 2014, sets forth specific underwriting criteria for a loan to qualify as a Qualified Mortgage Loan. The criteria generally exclude loans that are interest-
only, have excessive upfront points or fees, have negative amortization features or balloon payments, or have terms in excess of 30 years. The underwriting criteria also impose a maximum debt to income ratio of 43%. If a loan meets these criteria and is not a higher priced loan as defined in
Federal Reserve 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 consumers 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 Sullivan 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 institutions total assets minus the sum of its average tangible equity during the assessment period. 17
The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent 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. The following aspects of the financial reform and consumer protection act are related to the operations of the Company:
The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries. The Securities and Exchange Commission is authorized to adopt rules requiring public companies to make their proxy materials available to shareholders for nomination of their own candidates for election to the board of directors. Public companies (other than emerging growth companies like the Company) are now required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have
a say on pay vote every one, two or three years. A separate, non-binding shareholder vote is now required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments. Securities exchanges are now required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain significant matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be
significant. Stock exchanges are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation payable on the basis of financial information reportable under the securities laws, and (ii) the recovery from current or former
executive officers, following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount
that would have been paid on the basis of the restated financial information. Disclosure in annual proxy materials will be required concerning the relationship between the executive compensation paid and the financial performance of the issuer. Item 402 of Regulation S-K will be amended to require companies to disclose the ratio of the Chief Executive Officers annual total compensation to the median annual total compensation of all other employees. The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, which constitutes a strengthened set of capital requirements for banking organizations in the United States and around the world. Basel III is
currently the subject of notices of proposed rulemakings released in June of 2012 by the respective U.S. federal banking agencies. The comment period for these notices of proposed rulemakings ended on October 22, 2012. Basel III is intended to be implemented beginning January 1, 2013 and to be fully-
phased in on a global basis on January 1, 2019. Basel III would require capital to be held in the form of tangible common equity, generally increase the required capital ratios, phase out certain kinds of intangibles treated as capital and certain types of instruments and change the risk weightings of assets
used to determine required capital ratios. However, on November 9, 2012, the U.S. federal banking agencies announced that they do not expect that any of the proposed rules would become effective on January 1, 2013. They did not indicate the likely new effective date. 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 18
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 and Basel III, 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. See Supervision and Regulation. Our securities are not FDIC insured. Our securities are not savings or deposit accounts or other obligations of any bank and are not insured by the FDIC, the Deposit Insurance Fund or any other governmental agency and are subject to investment risk, including the possible loss of principal. 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; Telephone banking; 19
Debit cards and so-called smart cards; and Remote deposit capture. Our ability to compete successfully in the future will depend, to a certain extent, on whether we can anticipate and respond to technological changes. We offer electronic banking services for our consumer and business customers via our website, www.cnob.com, including internet banking and
electronic bill payment, as well as mobile banking by phone. We also offer check cards, ATM cards, credit cards, and automatic and ACH transfers. The successful operation and further development of these and other new technologies will likely require additional capital investments in the future. In
addition, increased use of electronic banking creates opportunities for interruptions in service or security breaches which could expose us to claims by customers or other third parties. We cannot assure you that we will have sufficient resources or access to the necessary proprietary technology to remain
competitive in the future, or that we will be able to maintain a secure electronic environment. If and when the Bank becomes subject to increased internal control reporting under FDIC regulations, if it cannot favorably assess the effectiveness of its internal controls over financial reporting or if its independent registered public accounting firm is unable to provide an unqualified attestation report
on the Banks internal controls, we may be subject to additional regulatory scrutiny. If and when the Banks total assets exceed $1.0 billion, it will be subject to further reporting requirements under the rules of the FDIC as of for the fiscal year in which it exceeds such threshold. Pursuant to these rules, management will be required to prepare a report that contains an assessment by
management of the Banks effectiveness of internal control structure and procedures for financial reporting as of the end of such fiscal year. The Bank will also be required to obtain an independent public accountants attestation report concerning its internal control structure over financial reporting that
includes the call report and/or the FR Y-9C report. The rules that must be met for management to assess the Banks internal controls over financial reporting are complex, and require significant documentation, testing and possible remediation. The effort to comply with regulatory requirements relating to
internal controls will likely cause us to incur increased expenses and will cause a diversion of managements time and other internal resources. We also may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of the Banks internal
controls over financial reporting. In addition, in connection with the attestation process, the Bank may encounter problems or delays in completing the implementation of any requested improvements or receiving a favorable attestation from its independent registered public accounting firm. If the Bank
cannot favorably assess the effectiveness of its internal controls over financial reporting, or if its independent registered public accounting firm is unable to provide an unqualified attestation report on the Banks internal controls, investor confidence and the price of our common stock could be adversely
affected and we may be subject to additional regulatory scrutiny. Item 1B. Unresolved Staff Comments. There are no unresolved staff comments Item 2. Properties. Bank Premises The Bank leases its main office and seven branch locations. The Banks headquarters and main branch is a three story brick and glass building located on Sylvan Avenue in Englewood Cliffs, in the heart of Englewood Cliffs commercial business district, easily accessible from major highways
including Route 80, the New Jersey Turnpike and the Palisades Parkway. In addition, Sylvan Avenue is a major north-south corridor and approach to the George Washington Bridge. 20
The Lemoine Avenue, Fort Lee office is located at 1620 Lemoine Avenue in a strip mall on a major north south through way in the center of town. The strip mall has seven parking spaces, two of which are dedicated to the Bank. The Palisades Avenue, Fort Lee office is located at 899 Palisades Avenue on the corner of Palisades Avenue and Columbia Avenue which is right on the border with Cliffside Park. This location features a drive-through and on-site parking. This branch was a former Bridgeview Bank branch
location and is familiar to many of our customers who had banked there in the past. The Cresskill office is located at One Union Avenue in Cresskill, a prominent corner location on Piermont and Union Avenues in the heart of Cresskill. The facility has a drive-through and on-site parking. The Hackensack office is located at the intersection of Essex Street and Railroad Avenue, a high visibility location between the County Courthouse and Hackensack University Medical Center. This facility has a two lane drive-through and plenty of parking. It is convenient to all the major
highways, and especially to the legal and medical professions in the area. The West New York office is located at the intersection of Park Avenue and 60th Street. The facility has a drive-through and onsite parking, a rarity in the Hudson County Market. The Ridgewood office is located on Ridgewood Avenue. The facility is located in a highly visible position between the Post Office and Starbucks in downtown Ridgewood. This branch was formerly a branch of Citizens Community Bank; we acquired it from FDIC receivership in May 2009 when we
entered into a purchase and assumption agreement with the FDIC to acquire certain assets and assume certain liabilities of the failed bank. The Holmdel office is located at 963 Holmdel Road. The facility is located one block from Main St., has a two lane drive-through and shares a location with a prominent local realtor. Item 3. Legal Proceedings. From time to time we are a party to various litigation matters incidental to the conduct of our business. We are not presently party to any such legal proceeding the resolution of which we believe would have a material adverse effect on our business, operating results, financial condition or cash flow. Item 4. Mine Safety Disclosures. Not applicable. 21
PART II Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information for Common Stock Our common stock has been listed on the NASDAQ Global Market under the symbol CNOB since February 12, 2013. Prior to that time, there was no public market for our stock. Holders of Record As of March 26, 2013, there were 586 stockholders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. Dividend Policy We have not paid cash dividends on our common stock since the formation of the Bank in 2005, and expect that we will continue to retain earnings to augment our capital base and finance future growth. Therefore, investors should not purchase shares of common stock with a view for a current
return on their investment in the form of cash dividends. Use of Proceeds On February 11, 2013 our registration statement on Form S-1 (File No. 333-185979) was declared effective by the Securities and Exchange Commission (SEC) for our initial public offering pursuant to which we sold an aggregate of 1,840,000 shares of our common stock at a price to the public of
$28.00 per share. As a result of the offering, we received net proceeds of approximately $47.8 million, after deducting approximately $3.3 million in underwriting discounts and commissions and approximately $350,000 in IPO-related expenses. There has been no material change in the planned use of proceeds from our initial public offering as described in our final prospectus filed with the SEC on February 12, 2013 pursuant to Rule 424(b). Equity Compensation Plan Information The following table presents certain information regarding our equity compensation plans as of December 31, 2012.
Plan category
Number of Securities
Weighted Average
Number of Securities Equity compensation plans approved by security holders
300,438
12.32
269,074 Equity compensation plans not approved by security holders
Total
300,438
12.32
269,074 22
To Be Issued Upon
Exercise of
Outstanding
Options,
Warrants and Rights
Exercise Price of
Outstanding Options,
Warrants and Rights
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
Item 6. Selected Financial Data. Set forth below is selected historical financial data of the Company. This information is derived in part from and should be read in conjunction with the consolidated financial statements and notes thereto presented elsewhere in this Annual Report on Form 10-K.
Year Ended December 31,
2012
2011
2010
(dollars in thousands) SELECTED BALANCE SHEET DATA Total assets
$
929,926
$
729,741
$
602,377 Gross loans
849,269
629,459
494,186 Allowance for loan losses
13,246
9,617
7,414 Securities available for sale
19,252
27,435
24,025 Goodwill and other intangible assets
260
260
260 Deposits
769,318
609,421
482,685 Tangible common stockholders equity(1)
72,102
40,093
33,715 Total stockholders equity
72,362
56,857
49,299 Average total assets
831,451
665,292
560,851 Average common stockholders equity
55,894
37,468
31,092 SELECTED INCOME STATEMENT DATA Interest income
$
40,787
$
33,676
$
28,963 Interest expense
6,319
6,207
6,051 Net interest income
34,468
27,469
22,912 Provision for loan losses
3,990
2,355
2,930 Net interest income after provision for loan losses
30,478
25,114
19,982 Non-interest income
1,142
1,113
900 Non-interest expense
17,488
15,057
12,941 Income tax expense
5,711
4,504
3,212 Net income
8,421
6,666
4,729 Dividends on preferred shares
354
600
479 Net income available to common stockholders
$
8,067
$
6,066
$
4,250
(1)
These measures are not measures recognized under generally accepted accounting principles (United States) (GAAP), and are therefore considered to be non-GAAP financial measures. SeeNon-GAAP Financial Measures for a reconciliation of these measurers to their most comparable GAAP
measures.
23
At or for the Year Ended
2012
2011
2010
(dollars in thousands) PER COMMON SHARE DATA: Basic earnings per share
$
2.99
$
2.71
$
1.91 Diluted earnings per share
2.63
2.18
1.61 Book value per common share
22.86
17.99
15.16 Tangible book value per common share
22.77
17.87
15.04 Basic weighted average common shares
2,700,772
2,242,085
2,227,296 Diluted weighted average common shares
3,196,558
3,063,076
2,938,655 SELECTED PERFORMANCE RATIOS Return on average assets
1.01
%
1.00
%
0.84
% Return on average common stockholders equity
14.43
%
16.19
%
13.67
% Net interest margin
4.20
%
4.21
%
4.22
% Efficiency ratio(1)(2)
49.1
%
52.9
%
54.3
% SELECTED ASSET QUALITY RATIOS Nonaccrual loans to total loans
0.93
%
1.02
%
0.82
% Nonaccrual loans and loans past due 90 days and still accruing to total loans
0.93
%
1.02
%
0.97
% Non-performing assets(3) to total assets
0.90
%
0.88
%
0.67
% Allowance for loan losses to total loans
1.56
%
1.53
%
1.50
% Allowance for loan losses to non-accrual loans
166.8
%
149.4
%
183.1
% Net loan charge-offs to average loans
0.05
%
0.03
%
0.06
% CAPITAL RATIOS (Consolidated) Leverage ratio
7.84
%
7.76
%
8.19
% Risk-based Tier 1 capital ratio
9.26
%
9.90
%
10.16
% Risk-based total capital ratio
10.52
%
11.15
%
11.41
% Tangible common equity to tangible assets(1)
7.76
%
5.50
%
5.60
%
(1)
These measures are not measures recognized under generally accepted accounting principles (United States) (GAAP), and are therefore considered to be non-GAAP financial measures. SeeNon-GAAP Financial Measures for a reconciliation of these measurers to their most comparable GAAP
measures. (2) Efficiency ratio is total non-interest expenses divided by the sum of net interest income and total other income (excluding securities gains/(losses)). (3) Non-performing assets are defined as nonaccrual loans plus other real estate owned. 24
December 31,
Non-GAAP Financial Measures.
For the Year Ended
2012
2011
2010
(Dollars in thousands, Efficiency Ratio Non-interest expense (numerator)
$
17,488
$
15,057
$
12,941 Net interest income
34,468
27,469
22,912 Non-interest income
1,142
1,113
900 Less: gains on sales of securities
(96
)
Adjusted operating revenue (denominator)
$
35,610
$
28,486
$
23,812 Efficiency Ratio
49.1
%
52.9
%
54.3
% Tangible Common Equity and Tangible Common Common equity
$
72,362
$
40,353
$
33,975 Less: intangible assets
(260
)
(260
)
(260
) Tangible common equity
$
72,102
$
40,093
$
33,715 Total assets
$
929,926
$
729,741
$
602,377 Less: Intangible assets
(260
)
(260
)
(260
) Tangible assets
$
929,666
$
729,481
$
602,117 Tangible Common Equity/Tangible Assets
7.76
%
5.50
%
5.60
% Tangible Book Value per Common Share Book Value Per Common Share
$
22.86
$
17.99
$
15.16 Less: Effects of intangible assets
(0.09
)
(0.12
)
(0.12
) Tangible Book Value per Common Share
$
22.77
$
17.87
$
15.04 25
December 31,
except per share data)
Equity/Tangible Assets
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Some of the statements in this document discuss future expectations, contain projections or results of operations or financial conditions or state other forward-looking information. Those statements are subject to known and unknown risk; uncertainties and other factors that could cause the actual
results to differ materially from those contemplated by the statements. We based the forward-looking statements on various factors and using numerous assumptions. Important factors that may cause actual results to differ from those contemplated by forward-looking statements include those disclosed
under Item 1ARisk Factors as well as the following factors:
the success or failure of our efforts to implement our business strategy; the effect of changing economic conditions and, in particular, changes in interest rates; changes in government regulations, tax rates and similar matters; our ability to attract and retain quality employees; and other risks which may be described in our future filings with the SEC We do not promise to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those statements. Critical Accounting Policies and Estimates Managements Discussion and Analysis of Financial Condition and Results of Operations, is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to our audited consolidated financial statements contains a summary of our significant accounting policies. Management believes our policy with respect to the methodology for the
determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially
impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and our Board of Directors. The allowance for loan losses is based upon managements evaluation of the adequacy of the allowance, including an assessment of known and probable incurred losses included in the portfolio, including giving consideration to the size and composition of the loan portfolio, actual loan loss experience,
level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best
information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change. 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. Furthermore, the majority of our loans are secured by real estate in the State of New Jersey. Accordingly, the collectability of a substantial portion of the carrying value of our loan
portfolio is susceptible to changes in local market conditions and may be adversely affected by declines in real estate values, or if the Central or Northern areas of New Jersey experience an adverse economic shock. Future adjustments to the allowance for loan losses may be necessary due to economic,
operating, regulatory and other conditions beyond our control. 26
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 non-interest
bearing deposit account at the Bank. This strategy has lowered our funding costs and helped slow 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 Banks 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 non-interest
income and non-interest expenses. Operating Results Overview Net income for the year ended December 31, 2012 was $8.4 million, an increase of $1.7 million, or 26.3%, compared to net income of $6.7 million for 2011. Net income available to common shareholders for the year ended December 31, 2012 was $8.1 million, an increase of $2.0 million, or 33.0%,
compared to net income available to common shareholders of $6.1 million for 2011. Diluted earnings per share were $2.63 for 2012, a 20.6% increase from $2.18 for 2011. Net income available to common shareholders and diluted earnings per share were impacted by three series of convertible preferred
stock issued at various times between 2009 and 2012. During 2012, all three series of preferred stock were converted into common shares and, as of December 31, 2012, stockholders equity was comprised solely of common equity. The increases in net income, net income available to common shareholders, and diluted earnings per share were primarily attributable to significant increases in net interest income due to the Companys rapid growth in loans and deposits, and in its customer base. Partially offsetting the revenue
increases were higher noninterest expenses, largely staff-related, commensurate with the Companys growing infrastructure. Credit costs have kept pace with both loan growth and a changing mix in the loan portfolio, while benefitting from overall sound credit quality. Net Interest Income For the year ended December 31, 2012, net interest income was $34.5 million, an increase of $7.0 million, or 25.5%, compared to net interest income of $27.5 million in 2011. The increase in net interest income was largely attributable to growth in average interest-earning assets, principally loans,
which increased by 29.6% to $743.2 million in 2012 from $573.6 million in 2011. The net interest margin remained relatively stable at 4.20% in 2012 as compared to 4.21% for the prior year period, as reduced yields on our loan portfolio resulting from the persistently low interest rate environment were
offset by a lower cost of funds and a higher level of loan prepayment fees. Average Balance Sheets The following table sets forth certain information relating to our average assets and liabilities for the years ended December 31, 2012, 2011 and 2010 and reflect the average yield on assets and 27
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.
For the Years Ended
December 31, 2012
December 31, 2011
December 31, 2010
Average
Interest
Average
Average
Interest
Average
Average
Interest
Average
(dollars in thousands) Interest earning assets: Investment securities(1)
$
31,009
$
1,079
3.48
%
$
43,980
$
1,505
3.42
%
$
48,154
$
1,805
3.75
% Loans receivable(2)(3)
743,178
39,677
5.34
%
573,648
32,113
5.60
%
446,048
27,054
6.07
% Federal funds sold and interest-
46,902
31
0.07
%
35,339
58
0.16
%
49,110
104
0.21
% Total interest-earning assets
821,089
40,787
4.97
%
652,967
33,676
5.16
%
543,312
28,963
5.33
% Allowance for loan losses
(11,196
)
(8,651
)
(5,855
) Non-interest earning assets
21,558
20,976
23,394 Total assets
$
831,451
$
665,292
$
560,851 Interest-bearing liabilities: Savings, NOW, Money Market, Interest Checking
$
313,475
1,397
0.45
%
$
270,374
2,356
0.87
%
$
242,918
2,621
1.08
% Time deposits
229,150
3,380
1.48
%
160,580
2,532
1.58
%
134,355
2,273
1.69
% Total interest-bearing deposits
542,625
4,777
0.88
%
430,954
4,888
1.13
%
377,273
4,894
1.30
% Borrowings
77,473
1,349
1.74
%
68,217
1,121
1.64
%
57,720
956
1.66
% Capital lease obligation
3,224
193
5.99
%
3,293
198
6.01
%
3,346
201
6.01
% Total interest-bearing liabilities
623,322
6,319
1.01
%
502,464
6,207
1.24
%
438,339
6,051
1.38
% Noninterest-bearing deposits
138,155
106,174
77,722 Other liabilities
4,345
2,970
2,214 Stockholders equity
65,629
53,684
42,576 Total liabilities and stockholders equity
$
831,451
$
665,292
$
560,851 Net interest income/interest rate spread
$
34,468
3.95
%
$
27,469
3.92
%
$
22,912
3.95
% Net interest margin(4)
4.20
%
4.21
%
4.22
%
(1)
Average balances are calculated on amortized cost and include investments in restricted stock. (2) Includes loan fee income. (3) Loans receivable include non-accrual loans. (4) Represents net interest income divided by average total interest-earning assets. 28
Balance
Rate
Balance
Rate
Balance
Rate
earning deposits with banks
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.
For the Year Ended
For the Year Ended
Increase (Decrease)
Increase (Decrease)
Volume
Rate
Net
Volume
Rate
Net Interest Income: Investment securities
$
(452
)
$
26
$
(426
)
$
(150
)
$
(150
)
$
(300
) Loan receivable
8,969
(1,405
)
7,564
6,923
(1,864
)
5,059 Federal funds sold and interest-
earning deposits with banks
33
(60
)
(27
)
(26
)
(20
)
(46
) Total interest income
$
8,550
$
(1,439
)
$
7,111
$
6,747
$
(2,034
)
$
4,713 Interest Expense: Savings, NOW, Money Market, Interest Checking
$
464
$
(1,423
)
$
(959
)
$
377
$
(642
)
$
(265
) Time deposits
999
(151
)
848
397
(138
)
259 Borrowings
158
70
228
172
(7
)
165 Capital lease obligation
(4
)
(1
)
(5
)
(3
)
0
(3
) Total interest expense
$
1,617
$
(1,505
)
$
112
$
943
$
(787
)
$
156 Net interest income
$
6,933
$
66
$
6,999
$
5,804
$
(1,247
)
$
4,557 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 and lease review. For the year ended December 31, 2012, the provision for loan losses was $4.0 million, an increase of $1.6 million, compared to the provision for loan losses of $2.4 million for the same period in 2011. The increase is substantially attributable to the increased loan growth in 2012 versus 2011. Non-Interest Income The Companys non-interest income consists primarily of service charges on deposit accounts, gains on sale of residential mortgages, card (ATM, credit and debit cards) income and fees from a title insurance agency in which the Bank is a 49% owner. Non-interest income amounted to $1.1 million for
both 2012 and 2011. Card income grew by approximately $80,000 in 2012 versus 2011, while 2011 included $96,000 in securities gains. To date, the Bank has de-emphasized fee income, focusing instead on customer growth and retention. Non-Interest Expense Noninterest expenses have increased significantly since inception of the Bank as we have expanded our geographic reach and invested in our infrastructure to support our strong asset growth. For the year ended December 31, 2012, noninterest expenses totaled $17.5 million, a $2.4 million, or 16.1%,
increase from $15.1 million for the year ended December 31, 2011. The largest factor contributing to the year-over-year increase was salaries and employee benefits expense, which increased by $1.4 million to $8.4 million in 2012 from $6.9 million in 2011; this increase was 29
December 31, 2012 versus 2011
December 31, 2011 versus 2010
Due to Change in Average
Due to Change in Average
primarily a result of increased staffing levels, particularly at the executive and senior management level. Also contributing to the increase were data processing expenses ($260,000), advertising and promotion expenses ($133,000) and other expenses ($574,000). The increases in these categories were all
primarily related to the Companys increased volume of business. Management continues to focus efforts on supporting growth primarily by adding to staff, investing in technology, and by enhancing risk controls. At the same time, management seeks to contain costs whenever prudent. Our success in this regard is evident in the recent improvements in our efficiency
ratio, a widely-followed metric in the banking industry which measures operating expenses as a percentage of net revenue. The ratio is computed by dividing total noninterest expense by the sum of net interest income and noninterest income less securities gains/(losses). The Companys efficiency ratio
improved from 52.9% in 2011 to 49.1% in 2012. Income Taxes Income tax expense was $5.7 million for the year ended December 31, 2012 versus $4.5 million for the year ended December 31, 2011. The effective tax rate was approximately 40% for all periods presented representing the combined federal and state statutory tax rates for a New Jersey corporation,
and reflecting no tax-advantaged investments such as municipal securities or bank owned life insurance. Management has thus far taken a conservative approach to the Companys tax position and is currently exploring various strategies to potentially lower our effective tax rates in the future. Financial Condition Overview At December 31, 2012, total assets were $930.0 million, an increase of $200.2 million, or 27.4%, from $729.7 million at December 31, 2011. At December 31, 2012, net loans receivable were $835.6 million, an increase of $215.8 million, or 34.8%, from $619.8 million at December 31, 2011. At
December 31, 2012, total deposits were $769.3 million, an increase of $159.9 million, or 26.2%, compared to $609.4 million at December 31, 2011. Loan Portfolio The Banks lending activities are generally oriented to small-to-medium sized businesses, high net worth individuals, professional practices and consumer and retail customers living and working in the Banks market area of Hudson, Bergen and Monmouth Counties, New Jersey. The Bank has not
made loans to borrowers outside of the United States. The Bank believes that its strategy of high-quality customer service, competitive rate structures and selective marketing have enabled it to gain market entry. Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, taxi medallions, inventory and equipment and liens on
commercial and residential real estate. Commercial construction loans are loans to finance the construction of commercial or residential properties secured by first liens on such properties. Commercial real estate loans include loans secured by first liens on completed commercial properties, including multi-
family properties, to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Home equity loans and lines of credit
include loans secured by first or second liens on residential real estate for primary or secondary residences. Consumer loans are made to individuals who qualify for auto loans, cash reserve, credit cards and installment loans. During 2012 and 2011, loan portfolio growth was positively impacted in several ways including (i) an increase in demand for small business lines of credit, and business term loans as economic conditions have stabilized and begun to improve, (ii) industry consolidation and lending restrictions involving
larger competitors allowing the Bank to gain market share, (iii) an increase in refinancing strategies employed by borrowers during the current low rate environment, and (iv) the Banks 30
success in attracting highly experienced commercial loan officers with substantial local market knowledge. Gross loans at December 31, 2012 totaled $849.3 million, an increase of $219.8 million, or 34.9%, over gross loans at December 31, 2011 of $629.5 million. The biggest component of our loan portfolio at December 31, 2012 and December 31, 2011 was commercial real estate loans. Our commercial
real estate loans at December 31, 2012 were $549.2 million, an increase of $173.5 million, or 46.2%, over commercial real estate loans at December 31, 2011 of $375.7 million. Our commercial loans were $147.5 million at December 31, 2012, an increase of $39.4 million, or 36.4%, over commercial loans at
December 31, 2011 of $108.1 million. Our commercial construction loans at December 31, 2012 were $36.9 million, an increase of $8.4 million, or 29.2%, over commercial construction loans at December 31, 2011 of $28.5 million. Our residential real estate loans were $83.0 million at December 31, 2012, a
decrease of $5.7 million, or 6.4%, over residential real estate loans at December 31, 2011 of $88.7 million. Our home equity loans were $31.0 million at December 31, 2012, an increase of $3.4 million, or 12.3%, over home equity loans of $27.6 million at December 31, 2011. Our consumer loans at
December 31, 2012 were $1.8 million, an increase of $0.9 million, 102.2%, over consumer loans of $0.9 million at December 31, 2011. The growth in our loan portfolio reflects the success of our business strategy, in particular emphasizing high-quality customer service strategy, which has led to continued
customer referrals. The following table sets forth the classification of our gross loans held for investment by loan portfolio class as of December 31, 2012, 2011, 2010, 2009, and 2008:
As of December 31,
2012
2011
2010
2009
2008
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
(dollars in thousands) Commercial
$
147,455
17.4
%
$
108,066
17.2
%
$
106,544
21.6
%
$
78,217
19.6
%
$
58,686
19.3
% Commercial real estate
549,218
64.7
%
375,719
59.7
%
259,694
52.5
%
230,324
57.8
%
155,272
51.2
% Commercial construction
36,872
4.3
%
28,543
4.5
%
37,065
7.5
%
24,111
6.1
%
36,473
12.0
% Residential real estate
82,962
9.8
%
88,666
14.1
%
64,648
13.1
%
39,764
10.0
%
31,033
10.2
% Home equity
30,961
3.6
%
27,575
4.4
%
25,056
5.1
%
25,000
6.3
%
21,617
7.1
% Consumer
1,801
0.2
%
890
0.1
%
1,179
0.2
%
870
0.2
%
617
0.2
% Total gross loans
$
849,269
100.0
%
$
629,459
100.0
%
$
494,186
100.0
%
$
398,286
100.0
%
$
303,698
100.0
% 31
of Total
of Total
of Total
of Total
of Total
The following table sets forth the classification of our gross loans held for investment by loan portfolio class and by fixed and adjustable rate loans as of December 31, 2012 and 2011 in term of contractual maturity.
As of December 31, 2012
As of December 31, 2011
Due Under
Due 1-5
Due More than
Due Under
Due 1-5
Due More than
(dollars in thousands) Commercial
$
54,601
$
81,619
$
11,235
$
49,561
$
46,068
$
12,437 Commercial real estate
20,139
43,101
485,978
13,718
35,632
326,369 Commercial construction
32,513
4,359
21,006
7,537
Residential real estate
1,437
12,955
68,570
3,318
6,713
78,635 Home equity
3,141
27,820
3,558
24,017 Consumer
623
1,128
50
38
644
208 Total gross loans
$
109,313
$
146,303
$
593,653
$
87,641
$
100,152
$
441,666 Fixed
$
60,678
$
123,008
$
573,509
$
36,297
$
87,021
$
406,350 Adjustable
48,635
23,295
20,144
51,344
13,131
35,316 Total gross loans
$
109,313
$
146,303
$
593,653
$
87,641
$
100,152
$
441,666 Asset Quality General. One of our key objectives is to maintain a high level of asset quality. When a borrower fails to make a scheduled payment, we attempt to cure the deficiency by making personal contact with the borrower. Initial contacts typically are made 15 days after the date the payment is due, and late
notices are sent approximately 15 days after the date the payment is due. In most cases, deficiencies are promptly resolved. If the delinquency continues, late charges are assessed and additional efforts are made to collect the deficiency. All loans which are delinquent 30 days or more are reported to the
board of directors of the Bank on a monthly basis. On loans where the collection of principal or interest payments is doubtful, the accrual of interest income ceases (non-accrual 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 which is 90 days or more 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 borrowers financial condition and payment record demonstrate an ability to service the debt. Real estate which is acquired as a result of foreclosure is classified as 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 is 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. We account for our impaired loans in accordance with GAAP. An impaired loan generally is one for which it is probable, based on current information, that the lender will not collect all the amounts due under the contractual terms of the loan. Large groups of smaller balance, homogeneous loans
are collectively evaluated for impairment. Loans collectively evaluated for impairment include smaller balance residential real estate loans and consumer loans. These loans are evaluated as a group because they have similar characteristics and performance experience. Larger commercial and construction
loans are individually evaluated for impairment. The recorded investments of impaired loans amounted to $12.0 million at December 31, 2012, compared to $13.0 million at December 31, 2011. In limited situations we will modify or restructure a borrowers existing loan terms and conditions. A restructured loan is considered a troubled debt restructuring (TDR) when, for economic or legal reasons related to a borrowers financial difficulties, we grant a concession to the 32
One Year
Years
Five Years
One Year
Years
Five Years
borrower in modifying or renewing a loan that the institution would not otherwise consider. We had five TDRs totaling $3.0 million, which, as of December 31, 2012, were currently performing under their restructured terms. Subsequent to December 31, 2012, one of these credits, with a balance of $0.6
million was taken into OREO, with a related charge-off of $0.1 million. 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 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 banks determination as to the classification of its assets and the amount of its valuation allowances is subject to review by Federal bank regulators which can order the establishment of additional general or specific loss allowances. The Federal banking agencies, have adopted an interagency policy
statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of allowances and guidance for banking agency examiners to use in determining the adequacy of general
valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management analyze all significant factors that affect the collectability of the portfolio in a reasonable manner; and that
management establish acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Our management believes that, based on information currently available, our allowance for loan 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. 33
The table below sets forth information on our classified assets and assets designated special mention at the dates indicated.
As of
2012
2011
(dollars in thousands) Classified Assets: Substandard
$
18,462
$
20,323 Doubtful
Loss
Total classified assets
18,462
20,323 Special mention assets
18,336
11,810 Total classified and special mention assets
$
36,798
$
32,133 Delinquent Loans. The following tables show the delinquencies in our loan portfolio as of the dates indicated.
At December 31, 2012 Loans Delinquent For:
At December 31, 2012
30-89 Days
90 Days and Greater
Total Delinquent Loans
Number
Amount
% of Total
Number
Amount
% of Total
Number
Amount
% of Total
(dollars in thousands) Commercial
$
0.0
%
1
$
273
5.4
%
1
$
273
3.9
% Commercial real estate
1
142
7.3
%
2
2,446
48.1
%
3
2,588
36.8
% Commercial construction
0.0
%
0.0
%
0.0
% Residential real estate
1
1,769
90.9
%
1
2,369
46.5
%
2
4,138
58.8
% Home equity
1
35
1.8
%
0.0
%
1
35
0.5
% Consumer
0.0
%
0.0
%
0.0
% Total
3
$
1,946
100.0
%
4
$
5,088
100.0
%
7
$
7,034
100.0
%
At December 31, 2011 Loans Delinquent For:
At December 31, 2011
30-89 Days
90 Days and Greater
Total Delinquent Loans
Number
Amount
% of Total
Number
Amount
% of Total
Number
Amount
% of Total
(dollars in thousands) Commercial
$
0.0
%
3
$
388
6.0
%
3
$
388
5.7
% Commercial real estate
0.0
%
4
6,049
94.0
%
4
6,049
88.8
% Commercial construction
1
289
75.7
%
0.0
%
1
289
4.2
% Residential real estate
1
83
21.7
%
0.0
%
1
83
1.2
% Home equity
1
10
2.6
%
0.0
%
1
10
0.1
% Consumer
0.0
%
0.0
%
0.0
% Total
3
$
382
100.0
%
7
$
6,437
100.0
%
10
$
6,819
100.0
% 34
December 31,
Delinquent
Loans 30-
89 Days
Delinquent
Loans
90 Days
or Greater
Delinquent
Loans
Delinquent
Loans 30-
89 Days
Delinquent
Loans
90 Days
or Greater
Delinquent
Loans
Non-Performing Assets, TDRs, and Loans 90 Days Past Due and Accruing. The following table sets forth information concerning our non-performing assets, TDRs, and past-due accruing loans as of the dates indicated:
As of December 31,
2012
2011
2010
2009
2008
(dollars in thousands) Nonaccrual loans: Commercial
$
3,124
$
388
$
$
$
Commercial real estate
2,446
6,049
2,538
Commercial construction
Residential real estate
2,369
1,511
2,197
Home equity
Consumer
Total nonaccrual loans
7,939
6,437
4,049
2,197
Other real estate owned
433
Total non-performing assets(1)
$
8,372
$
6,437
$
4,049
$
2,197
$
Loans past due 90 days and still accruing
$
$
$
723
$
$
Performing troubled debt restructured loans
$
2,996
$
4,831
$
$
$
Nonaccrual loans to total loans
0.93
%
1.02
%
0.82
%
0.55
%
Nonaccrual loans and loans past due 90 days and still accruing to total loans
0.93
%
1.02
%
0.97
%
0.55
%
Non-performing assets to total assets(1)
0.90
%
0.88
%
0.67
%
0.43
%
(1)
Non-performing assets are defined as nonaccrual loans plus other real estated owned.
Allowance for Loan Losses 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 managements 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 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. At December 31, 2012, the allowance for loan losses was $13.2 million, an increase of $3.6 million or 37.7%, from $9.6 million for the year ended December 31, 2011. Net charge-offs totaled $0.4 million during 2012 and $0.2 million for 2011. The allowance for loan losses as a percentage of loans
receivable was 1.56% at December 31, 2012 and 1.53% at December 31, 2011. 35
The following is a summary of the reconciliation of the allowance for loan losses for the periods indicated:
For the Year Ended December 31,
2012
2011
2010
2009
2008
(dollars in thousands) Balance at beginning of period
$
9,617
$
7,414
$
4,759
$
3,316
$
2,003 Provision charged to operating expenses
3,991
2,355
2,930
1,455
1,288 Recoveries of loans previously charged-off: Commercial
18
1
30 Consumer
31
Residential real estate
Total recoveries
31
18
1
30 Loans charged-off: Commercial
(240
)
(293
)
(13
)
(5
) Consumer
(62
)
Residential real estate
(153
)
(90
)
Total charge-offs
(393
)
(152
)
(293
)
(13
)
(5
) Net charge-offs
(362
)
(152
)
(275
)
(12
)
25 Balance at end of period
$
13,246
$
9,617
$
7,414
$
4,759
$
3,316 Net charge-offs to average loans outstanding
0.05
%
0.03
%
0.06
%
0.00
%
(0.01
)% Allowance for loan losses to total loans
1.56
%
1.53
%
1.50
%
1.19
%
1.09
% The following table sets forth, by loan portfolio class, the amount and percentage of our allowance for loan losses attributable to such class, and the percentage of total loans represented by such class, as of the dates indicated:
As of December 31, 2012
As of December 31, 2011
As of December 31, 2010
Amount
% of
% of
Amount
% of
% of
Amount
% of
% of
(dollars in thousands) Commercial
$
2,402
18.1
%
17.4
%
$
653
6.8
%
17.2
%
$
634
8.6
%
21.6
% Commercial real estate
7,718
58.3
%
64.7
%
5,658
58.8
%
59.7
%
2,902
39.1
%
52.5
% Commercial construction
660
5.0
%
4.3
%
430
4.5
%
4.5
%
808
10.9
%
7.5
% Residential real estate
1,542
11.6
%
9.8
%
2,534
26.4
%
14.1
%
2,773
37.4
%
13.1
% Home equity
617
4.7
%
3.6
%
339
3.5
%
4.4
%
292
3.9
%
5.1
% Consumer
41
0.3
%
0.2
%
3
0.0
%
0.1
%
5
0.1
%
0.2
% Unallocated
266
2.0
%
0.0
%
0.0
%
0.0
%
0.0
%
0.0
% Total
$
13,246
100.0
%
100.0
%
$
9,617
100.0
%
100.0
%
$
7,414
100.0
%
100.0
% As of December 31, 2009 As of December 31, 2008 Amount % of % of Amount % of % of (dollars in thousands) Commercial
$
407
8.6
%
19.6
%
$
284
8.6
%
19.3
% Commercial real estate
1,863
39.1
%
57.8
%
1,298
39.1
%
51.2
% Commercial construction
519
10.9
%
6.1
%
361
10.9
%
12.0
% Residential real estate
1,780
37.4
%
10.0
%
1,240
37.4
%
10.2
% Home equity
187
3.9
%
6.3
%
131
3.9
%
7.1
% Consumer
3
0.1
%
0.2
%
2
0.1
%
0.2
% Unallocated
0.0
%
0.0
%
0.0
%
0.0
% Total
$
4,759
100.0
%
100.0
%
$
3,316
100.0
%
100.0
% 36
ALL
Total Loans
ALL
Total Loans
ALL
Total Loans
ALL
Total Loans
ALL
Total Loans
Investment Securities Our investment portfolio remains modest in size relative to our total assets and loan portfolio. Nevertheless, the investment portfolio provides and additional source of interest income and liquidity. The portfolio is composed of obligations of U.S. Government Agencies, mortgage-backed securities and
Community Reinvestment Act (CRA) related investments. Securities are classified as held-to-maturity (HTM), available for sale (AFS), or trading at time of purchase. Securities are classified as HTM based upon managements intent and our ability to hold them to maturity. Such securities are stated at cost, adjusted for unamortized purchase premiums
and discounts. Securities which are bought and held principally for resale in the near term are classified as trading securities, which are carried at market value. Realized gains and losses as well as gains and losses from marking the portfolio to market value are included in trading revenue. We have no
trading securities. Securities not classified as HTM or trading securities are classified as AFS and are stated at fair value. Unrealized gains and losses on AFS securities are excluded from results of operations, and are reported as a component of accumulated other comprehensive (loss) income, net of
taxes, which is included in stockholders equity. Securities classified as AFS include securities that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase regulatory capital, or other similar requirements. Management determines the appropriate classification of securities, whether AFS or HTM, at the time of purchase. The carrying value of our AFS investment securities portfolio at December 31, 2012 was $19.3 million, a decrease of $8.1 million, or 29.8%, from December 31, 2011 of $27.4 million.
The carrying value of our HTM investment securities portfolio at December 31, 2012 was $2.0 million, a decrease of $1.7 million, or 46.3%, from $3.7 million at December 31, 2011. The decreases in both AFS and HTM portfolios were primarily due to paydowns of mortgage-backed securities and the
calls of two securities in our AFS portfolio, and application of the proceeds to fund new loan demand. The following table summarizes the fair value of our non-equity AFS investment securities portfolio for the dates presented:
December 31,
2012
2011
2010
(dollars in thousands) Available for sale U.S. Government agency
$
1,005
$
4,036
$
6,762 Mortgage backed-securities
12,029
17,226
11,274 CRA investment fund
6,218
6,173
5,989 Total available for sale
$
19,252
$
27,435
$
24,025 The following table sets the maturity distribution of our non-equity AFS investment securities portfolio for the periods presented:
December 31, 2012
Due Under 1 Year
Due 1-5 Years
> 5 Years
Amount
Yield
Amount
Yield
Amount
Yield
(dollars in thousands) U.S. Government agency
$
1,005
1.78
%
$
$
Mortgage backed-securities
12,029
3.84
% Total
$
1,005
1.78
%
$
$
12,029
3.84
%
December 31, 2011
Due Under 1 Year
Due 1-5 Years
> 5 Years
Amount
Yield
Amount
Yield
Amount
Yield
(dollars in thousands) U.S. Government agency
$
$
3,025
1.59
%
$
1,011
2.00
% Mortgage backed-securities
17,226
3.94
% Total
$
$
3,025
1.59
%
$
18,237
3.83
% 37
Refer to Note 2-Securities in the consolidated financial statements for more information regarding our AFS and HTM securities. Deposits Deposits are our primary source of funds. Average total deposits increased $143.7 million, or 26.7%, to $680.8 million in 2012 from $537.1 million in 2011. Transaction and non-transaction (time) deposits have grown as the Banks customer base has expanded. The following table sets forth the average amount of various types of deposits for each of the periods indicated:
December 31,
2012 Average
2011 Average
2010 Average
Balance
Rate
Balance
Rate
Balance
Rate
(dollars in thousands) Demand, non-interest bearing
$
138,155
$
106,174
$
77,722
Demand, interest bearing & NOW
57,818
0.25
%
25,813
0.79
%
16,089
0.96
% Money market accounts
177,180
0.51
%
163,561
0.83
%
174,055
1.06
% Savings
78,477
0.44
%
81,000
0.99
%
52,774
1.18
% Time
229,150
1.48
%
160,580
1.58
%
134,355
1.69
% Total Deposits
$
680,780
0.70
%
$
537,128
0.91
%
$
454,995
1.07
% The following table summarizes the maturity distribution of time deposits in denominations of $100,000 or more:
December 31,
December 31,
(dollars in thousands) 3 months or less
$
33,033
$
19,462 3 to 6 months
47,758
34,887 6 to 12 months
58,517
13,485 Over 12 months
55,780
55,582 Total
$
195,088
$
123,416 Borrowings Long-term borrowings consist of long term advances from the Federal Home Loan Bank. These advances are secured, under the terms of a blanket collateral agreement, by commercial mortgage loans. As of December 31, 2012 and December 31, 2011, the Company had $79.6 million in notes
outstanding at a weighted average interest rate of 1.7% and $55.6 million in notes outstanding at a weighted average interest rate of 2.1%, respectively. The following table summarizes short-term borrowings, (borrowings with maturities of one year or less) which consist of federal funds purchased, repurchase agreements and weighted average interest rates paid:
Year Ended
December 31, 2012
December 31, 2011
December 31, 2010
(dollars in thousands) Average daily amount of short-term borrowings outstanding during the period
$
$
19,263
$
22,400 Weighted average interest rate on average daily short-term borrowings
0.35
%
0.39
% Maximum outstanding short-term borrowings outstanding at any month-end
$
$
28,860
$
26,631 Short-term borrowings outstanding at period end
$
$
$
22,189 Weighted average interest rate on short-term borrowings at period end
0.69
% 38
2012
2011
Liquidity Liquidity is a measure of a banks ability to fund loans, withdrawals or maturities of deposits, and other cash outflows in a cost-effective manner. Our principal sources of funds are deposits, scheduled amortization and prepayments of loan principal, maturities of investment securities, and funds
provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flow and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. At December 31, 2012, 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 customer credit needs could be satisfied. As of December 31,
2012, liquid assets (cash and due from banks, interest-bearing deposits with banks and unencumbered investment securities) were $71.5 million, which represented 7.7% of total assets and 9.3% of total deposits and borrowings, compared to $90.0 million at December 31, 2011, which represented 12.3% of
total assets and 14.7% 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, 2012, had the ability to borrow $341.4 million. In addition, at December 31, 2012, the Bank had in place additional borrowing capacity of $5.0 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, although no collateral was pledged at year-end 2012. At December 31, 2012, the Bank had aggregate available and unused credit of $266.8 million,
which represents the aforementioned facilities totaling $346.4 million net of $79.6 million in outstanding borrowings. At December 31, 2012, outstanding commitments for the Bank to extend credit were $130.9 million. Cash and cash equivalents decreased by $8.6 million or 14.4%, from $59.2 million at December 31, 2011 to $50.6 million at December 31, 2012. The decrease was primarily due to a $212.6 million increase in investing activities, largely an increase in loans receivable, partially offset by $191.0 million in
financing activities, including an increase in deposits and a net increase in FHLB borrowings, and by $13.0 million from operating activities. Off-Balance Sheet Arrangements We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Our exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by
the contractual amount of those instruments. We use the same credit analyses in making commitments and conditional obligations as we do for on-balance-sheet instruments. Commitments under standby letters of credit, both financial and performance do not necessarily represent future cash requirements,
in that these commitments often expire without being drawn upon. Further discussion of these commitments is included in Note 12 to the consolidated financial statements. 39
Contractual Obligations The following table shows our contractual obligations by expected payment period, as of December 31, 2012 and December 31, 2011. Further discussion of these commitments is included in Notes 4, 5 and 7 to the Consolidated Financial Statements.
Contractual Obligation
December 31, 2012
December 31, 2011
Total
2013-2015
2016-2017
2018
Total
2012-2014
2015-2016
2017
(dollars in thousands) Operating Lease Obligations
$
4,256
$
2,579
$
993
$
684
$
4,733
$
2,215
$
1,492
$
1,026 Capital Lease Obligations
5,069
851
584
3,634
5,332
824
584
3,924 Federal Home Loan Bank Borrowings
79,568
54,568
10,000
15,000
55,556
22,850
17,706
15,000 Time Deposits
275,472
229,472
16,702
29,298
186,741
161,894
20,891
3,956 Operating leases represent obligations entered into by us for the use of land, premises and equipment. The leases generally have escalation terms based upon certain defined indexes. 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 Banks 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 portfolio equity (EVPE) models to measure the potential impact to the Bank of future changes in interest rates. As of December 31, 2012 and December 31, 2011 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 Banks management. The net interest income simulation model attempts to measure the change in net interest income over the next one-year period, and the next three-year period on a cumulative basis, assuming certain changes in the general level of interest rates. In our model, which was run as of December 31, 2012, we estimated that, over the next one-year period, a 200 basis-point increase in the general level of interest rates will decrease our net interest income by 1.6%, while a 100 basis-point decrease in interest rates will decrease net interest income by
0.5%. As of December 31, 2011, we estimated that, over the next one-year period, a 200 basis-point increase in the general level of interest rates will decrease our net interest income by 0.9%, while a 100 basis-point decrease in the general level of interest rates will decrease our interest rates by 1.8%. In our model, which was run as of December 31, 2012, we estimated that, over the next three years on a cumulative basis, a 200 basis-point increase in the general level of interest rates will decrease our net interest income by 0.9%, while a 100 basis-point decrease in interest rates will decrease net
interest income by 2.8%. As of December 31, 2011, we estimated that, over the next three years on a cumulative basis, a 200 basis-point increase in the general level of interest rates will increase our net interest income by 3.9%, while a 100 basis-point decrease in the general level of interest rates will
decrease our interest rates by 4.9%. An EVPE analysis is also used to dynamically model the present value of asset and liability cash flows with 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 EVPE as of December 31, 2012, would 40
and later
and later
decline by 19.37% with a rate shock of up 200 basis points, and increase by 9.73% with a rate shock of down 100 basis points. Our EVPE as of December 31, 2011, would decline by 13.05% with a rate shock of up 200 basis points, and increase by 5.85% with a rate shock of down 100 basis points. Capital A significant measure of the strength of a financial institution is its capital base. The Federal regulators of the Company and the Bank have classified and defined capital into the following components: (1) Tier 1 Capital, which includes tangible stockholders equity for common stock, qualifying
preferred stock and certain qualifying hybrid instruments, and (2) Tier 2 Capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt, and preferred stock which does not qualify for Tier 1 Capital. Minimum capital levels are regulated by risk-based capital adequacy
guidelines which require certain capital as a percent of the Banks assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets). The Company and the Bank are required to maintain, at a minimum, Tier 1 Capital as a percentage of risk-adjusted assets of 4.0% and combined Tier 1 and Tier 2 Capital as a percentage of risk-adjusted assets of 8.0%. In addition to the risk-based guidelines, the regulators require that an institution which meets the regulators highest performance and operation standards maintain a minimum leverage ratio (Tier 1 Capital as a percentage of average tangible assets) of 4.0%. For those institutions with higher levels of
risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be evaluated through the ongoing regulatory examination process. The following table summarizes the risk-based and leverage capital ratios for the Company and the Bank as well as the required minimum regulatory capital ratios:
At December 31, 2012
At December 31, 2011
Actual
Minimum
Well
Actual
Minimum
Well The Company: Leverage ratio
7.84
%
4.00
%
n/a
7.76
%
4.00
%
n/a Tier 1 Risk-based capitalization
9.26
%
4.00
%
n/a
9.90
%
4.00
%
n/a Total Risk-based capitalization
10.52
%
8.00
%
n/a
11.15
%
8.00
%
n/a The Bank: Leverage ratio
7.84
%
4.00
%
5.00
%
7.76
%
4.00
%
5.00
% Tier 1 Risk-based capitalization
9.26
%
4.00
%
6.00
%
9.89
%
4.00
%
6.00
% Total Risk-based capitalization
10.51
%
8.00
%
10.00
%
11.15
%
8.00
%
10.00
% The Companys tangible common equity ratio was 7.76% as of December 31, 2012, and 5.50% as of December 31, 2011. Over the past several years, we issued shares of preferred stock in order to augment our capital base. In 2009, we issued 125,000 shares of our Series A Preferred Stock and 400,000 shares of our Series B Stock; in 2010, we issued 241,175 shares of our Series B Preferred Stock; in 2011, we issued
59,025 shares of our Series B Preferred Stock; and in 2012 we issued 7,500 shares of our Series C Preferred Stock. All of these shares were issued pursuant to exemptions from registration under Section 5 of the Securities Act. We received an aggregate of $24.0 million in proceeds from the sale of these
preferred shares. In accordance with the terms of each class of preferred stock, all of our outstanding preferred stock converted, during 2012, into shares of our common stock. We issued an aggregate of 909,921 shares of our common stock upon conversion of our outstanding preferred stock, and as of
December 31, 2012, no shares of our preferred stock were outstanding. We converted our outstanding preferred stock to common stock because (i) our Board believed the Company would be better served by maintaining a more simplified capital structure and (ii) the Board believed regulatory agencies
look more favorably on common stock as a capital component. 41
Ratio
Requirement
Capitalized
Requirement
Ratio
Requirement
Capitalized
Requirement
Impact of Inflation and Changing Prices Our consolidated 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 and due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike most industrial companies, nearly all of our assets and liabilities are monetary. Therefore, interest rates have a greater impact on our 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. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Interest Rate Risk Management Interest rate risk management is our primary market risk. See Item 7Managements Discussion and AnalysisInterest Rate Sensitivity Analysis herein for a discussion of our management of our interest rate risk. Inflation Risk Management Inflation has an important impact on the growth of total assets in the banking industry and causes a need to increase equity capital higher than normal levels in order to maintain an appropriate equity-to-assets ratio. We cope with the effects of inflation by managing our interest rate sensitivity
position through our asset/liability management program, and by periodically adjusting our pricing of services and banking products to take into consideration current costs. Item 8. Financial Statements and Supplementary Data. The information required by this item is included elsewhere in this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable Item 9A. Controls and Procedures. (a) Evaluation of disclosure controls and procedures The Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Companys disclosure controls and procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to be included in the Companys periodic SEC filings. (b) Managements report on internal control over financial reporting The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Companys system of internal control over financial reporting was designed by or under the supervision of the Companys chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of the preparation of the Companys financial statements for external
and regulatory reporting purposes, in accordance with U.S. generally accepted accounting principles. The Companys management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal ControlIntegrated
Framework issued by the COSO. Based on the 42
assessment, management determined that, as of December 31, 2012, the Companys internal control over financial reporting is effective. The forgoing shall not deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that Section. In addition, this information shall not be deemed to be incorporated by reference into any of the Registrants filings with
the Securities and Exchange Commission, except as shall be expressly set forth by specific reference in any such filing.
/s/ FRANK
SORRENTINO III
/s/ WILLIAM S. BURNS
Frank Sorrentino III.
William S. Burns (c) Changes in internal controls: In our subsequent review of financial information for the nine months ended September 30, 2012 included in our initial confidential draft registration statement on Form S-1 filed with the Securities and Exchange Commission, we identified an error in the diluted earnings per share calculation for that
period. The error resulted from an incorrect mathematical calculation used in the if converted method of calculating diluted earnings per share, specifically with respect to the number of days outstanding for the convertible preferred stock issuances which were converted entirely in 2012. The error had
no impact on equity, net income, or net income available to common stockholders. As a result, we restated our diluted earnings per share disclosure in the prospectus contained in the registration statement on Form S-1. When such errors occur, we evaluate the impact on our internal controls over financial reporting. Because our controls did not timely identify the error in the financial statements included in our initial confidential draft registration statement with respect to the nine months ended September 30, 2012,
we have concluded that a material weakness existed with respect to this matter at September 30, 2012, which ultimately necessitated the aforementioned restatement. In reviewing calculations of diluted earnings per share for periods subsequent to September 30, 2012, our controls discovered the error and
our calculation was modified to properly reflect the correct number of days outstanding, including the restatement of September 30, 2012 and the other affected period, the eleven months ended November 30, 2012 included in the prospectus included in the registration statement on Form S-1. There was
no effect on other periods presented as the error occurred only in the periods during which preferred stock was converted to common stock. Furthermore, since all of the shares of convertible preferred stock have been converted, there will be no effect on future period presentations. Management has
concluded that the material weakness has been fully remediated as of November 30, 2012. Other than as described above, there were not any significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Item 9B. Other Information. None. 43
Chairman & Chief Executive
Officer
Executive Vice President & Chief Financial Officer
PART III Item 10. Directors, Executive Officers and Corporate Governance. Information required by this part is included in the definitive Proxy Statement for the Companys 2013 Annual Meeting under the captions ELECTION OF DIRECTORS and SECTION 16(A) BENEFICIAL OWNERSHIP REPORTS COMPLIANCE, each of which is incorporated herein by
reference. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2013. Item 11. Executive Compensation. Information concerning executive compensation is included in the definitive Proxy Statement for the Companys 2013 Annual Meeting under the captions EXECUTIVE COMPENSATION and DIRECTOR COMPENSATION, which is incorporated by reference herein. It is expected that such
Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2013. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. Information concerning security ownership of certain beneficial owners and management is included in the definitive Proxy statement for the Companys 2013 Annual Meeting under the caption SECURITY OWNERSHIP OF MANAGEMENT, which is incorporated herein by reference. It is
expected that such Proxy statement will be filed with the Securities and Exchange Commission no later than April 30, 2013. Item 13. Certain Relationships and Related Transactions, and Director Independence. Information concerning certain relationships and related transactions is included in the definitive Proxy Statement for the Companys 2013 Annual Meeting under the caption INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS, which is incorporated herein by
reference. It is expected that such Proxy statement will be filed with the Securities and Exchange Commission no later than April 30, 2013. Item 14. Principal Accounting Fees and Services. The information concerning principal accountant fees and services as well as related pre-approval policies under the caption RATIFICATION OF INDEPENDENT AUDITORS in the Proxy Statement for the Companys 2013 Annual Meeting of Shareholders is incorporated by reference herein. It
is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2013. 44
PART IV Item 15. Exhibits, Financial Statement Schedules. (a) Exhibits
Exhibit 3(i).1
Restated Certificate of Incorporation(1)
Exhibit 3(i).2
Certificate of Amendment to the Restated Certificate of Incorporation(1)
Exhibit 3(ii)
Bylaws(1)
Exhibit 10.1
Employment Agreement of Frank Sorrentino III effective as of January 1, 2013(1)
Exhibit 10.2
Change in Control Agreement of Laura Criscione dated May 7, 2008(1)
Exhibit 10.3
Change in Control Agreement of Elizabeth Magennis dated October 22, 2007(1)
Exhibit 10.4
Employment Agreement with William S. Burns dated September 18, 2012(1)
Exhibit 10.5
North Jersey Community Bank 2005 Stock Option PlanA(1)
Exhibit 10.6
North Jersey Community Bank 2005 Stock Option PlanB(1)
Exhibit 10.7
North Jersey Community Bank 2006 Equity Compensation Plan(1)
Exhibit 10.8
North Jersey Community Bank 2008 Equity Compensation Plan(1)
Exhibit 10.9
North Jersey Community Bank 2009 Equity Compensation Plan(1)
Exhibit 10.10
2012 Equity Compensation Plan(1)
Exhibit 21
Subsidiaries of the Registrant
Exhibit 31
Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 32
Section 1350 Certifications
(1) 45
Incorporated by reference from the Registrants Registration Statement on Form S-1, as amended, File No. 333-185979, declared effective on February 11, 2012
CONSOLIDATED FINANCIAL STATEMENTS CONTENTS
47
48
50
51
52
53
54 46
December 31, 2012 and 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of We have audited the accompanying consolidated balance sheets of ConnectOne Bancorp, Inc. (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in stockholders equity and cash flows for the years then ended. These
financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ConnectOne Bancorp, Inc. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted
accounting principles. /s/Crowe Horwath LLP Livingston, New Jersey 47
ConnectOne Bancorp, Inc.
Englewood Cliffs, New Jersey
March 27, 2013
CONNECTONE BANCORP, INC.
2012
2011
(dollars in thousands) ASSETS Cash and due from banks
$
3,242
$
5,147 Interest-bearing deposits with banks
47,387
54,029 Cash and cash equivalents
50,629
59,176 Securities available for sale
19,252
27,435 Securities held to maturity, fair value of $2,084 at 2012 and $3,844 at 2011
1,985
3,694 Loans held for sale
405
140 Loans receivable
848,842
629,371 Less: Allowance for loan losses
(13,246
)
(9,617
) Net loans receivable
835,596
619,754 Investment in restricted stock, at cost
4,744
3,378 Bank premises and equipment, net
7,904
8,612 Accrued interest receivable
3,361
2,747 Deferred income taxes
4,314
2,168 Other real estate owned
433
Goodwill
260
260 Other assets
1,043
2,377 Total assets
$
929,926
$
729,741 See accompanying notes to consolidated financial statements. 48
CONSOLIDATED BALANCE SHEETS
December 31, 2012 and 2011
CONNECTONE BANCORP, INC.
2012
2011
(dollars in thousands, LIABILITIES AND STOCKHOLDERS EQUITY Liabilities Deposits Non-interest-bearing
$
170,355
$
118,583 Interest-bearing
598,963
490,838 Total deposits
769,318
609,421 Long-term borrowings
79,568
55,556 Accrued interest payable
2,803
1,950 Capital lease obligation
3,185
3,257 Other liabilities
2,690
2,700 Total liabilities
857,564
672,884 Commitments and Contingencies Stockholders Equity Preferred stock (Series A), no par value; $20 liquidation value; no shares issued and outstanding at December 31, 2012; authorized 125,000 shares; issued and outstanding 125,000 at December 31, 2011
2,500 Preferred stock (Series B), no par value; $20 liquidation value; no shares issued and outstanding at December 31, 2012; authorized 867,500 shares; issued and outstanding 700,200 at December 31, 2011
14,004 Preferred stock (Series C), no par value; $1,000 liquidation value; authorized 7,500 shares; and no shares issued and outstanding
Common stock, no par value; authorized 10,000,000 shares at December 31, 2012, and 5,000,000 shares at December 31, 2011; issued and outstanding 3,166,217 at December 31, 2012, and 2,243,067 at December 31, 2011
51,205
27,149 Retained earnings
20,661
12,594 Accumulated other comprehensive income
496
610 Total stockholders equity
72,362
56,857 Total liabilities and stockholders equity
$
929,926
$
729,741 See accompanying notes to consolidated financial statements. 49
CONSOLIDATED BALANCE SHEETS
December 31, 2012 and 2011
except per share data)
CONNECTONE BANCORP, INC.
2012
2011
(dollars in thousands, Interest Income Loans receivable, including fees
$
39,677
$
32,113 Securities
1,079
1,505 Other interest income
31
58 Total interest income
40,787
33,676 Interest expense Deposits
4,777
4,888 Short-term borrowings
66 Long-term borrowings
1,349
1,055 Capital lease
193
198 Total interest expense
6,319
6,207 Net interest income
34,468
27,469 Provision for loan losses
3,990
2,355 Net interest income after provision for loan losses
30,478
25,114 Non-interest income Service fees
393
396 Gains on sales of loans
470
458 Gains on sales of securities
96 Other income
279
163 Total non-interest income
1,142
1,113 Non-interest expenses Salaries and employee benefits
8,352
6,911 Occupancy and equipment
2,847
2,796 Professional fees
1,143
1,171 Advertising and promotion
489
356 Data processing
1,697
1,437 Other expenses
2,960
2,386 Total non-interest expenses
17,488
15,057 Income before income tax expense
14,132
11,170 Income tax expense
5,711
4,504 Net income
8,421
6,666 Dividends on preferred shares
354
600 Net income available to common stockholders
$
8,067
$
6,066 Earnings per common sharebasic
$
2.99
$
2.71 Earnings per common sharediluted
$
2.63
$
2.18 See accompanying notes to consolidated financial statements. 50
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2012 and 2011
except per share data)
CONNECTONE BANCORP, INC.
2012
2011
(dollars in Net income
$
8,421
$
6,666 Unrealized holdings (losses)/gains on available for sale securities arising during the period
(190
)
413 Reclassification adjustment for gains realized in income
(96
) Net unrealized (losses)/gains
(190
)
317 Tax effect
(76
)
126 Other comprehensive (loss) income
(114
)
191 Comprehensive income
$
8,307
$
6,857 See accompanying notes to consolidated financial statements. 51
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31, 2012 and 2011
thousands)
CONNECTONE BANCORP, INC.
Common
Preferred
Preferred
Preferred
Retained
Accumulated
Total
(dollars in thousands) Balance at January 1, 2011
$
27,028
$
2,500
$
12,824
$
$
6,528
$
419
$
49,299 Net income
6,666
6,666 Other comprehensive income, net of taxes
191
191 Issuance of preferred stock, Series B, 59,025 shares
1,180
1,180 Cash dividends paid on preferred stock
(600
)
(600
) Stock compensation expense
121
121 Balance at December 31, 2011
27,149
2,500
14,004
12,594
610
56,857 Net income
8,421
8,421 Other comprehensive loss, net of taxes
(114
)
(114
) Issuance of convertible preferred stock; Series C, 7,500 shares
7,500
7,500 Conversion of preferred stock; Series A, Series B, and Series C
24,004
(2,500
)
(14,004
)
(7,500
)
Cash dividends paid on preferred stock
(354
)
(354
) Stock compensation expense
52
52 Balance at December 31, 2012
$
51,205
$
$
$
$
20,661
$
496
$
72,362 See accompanying notes to consolidated financial statements. 52
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Years ended December 31, 2012 and 2011
Stock
Stock,
Series A
Stock,
Series B
Stock,
Series C
Earnings
Other
Comprehensive
Income
CONNECTONE BANCORP, INC.
2012
2011
(dollars in thousands) Cash flows from operating activities Net income
$
8,421
$
6,666 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses
3,990
2,355 Depreciation and amortization
1,288
1,219 Net amortization of securities discounts and premiums
66
50 Amortization of intangible assets
14
14 Stock compensation earned
52
121 Gain on sales of securities
(96
) Proceeds from sale of loans
20,612
23,925 Origination of loans held for sale
(20,407
)
(22,875
) Gain on sales of loans
(470
)
(458
) Increase in accrued interest receivable
(614
)
(148
) (Increase) decrease in deferred income taxes
(2,070
)
312 Increase in accrued interest payable
853
731 Increase (decrease) in other liabilities
(10
)
563 Decrease (increase) in other assets
1,320
(877
) Net cash provided by operating activities
13,045
11,502 Cash flows from investing activities Net increase in loans
(220,265
)
(135,730
) Purchases of securities available for sale
(20,984
) Purchases of securities held to maturity
(2,000
) Maturities, calls and principal repayments of securities held to maturity and available for sale
9,636
31,542 Proceed from sales of securities available for sale
4,779 Net increase in investments in restricted stock, at cost
(1,366
)
(740
) Purchases of premises and equipment
(580
)
(1,351
) Net cash used in investing activities
(212,575
)
(124,484
) Cash flows from financing activities Net increase in deposits
159,897
126,736 Decrease in securities sold under agreements to repurchase
(17,189
) Net change in federal funds purchased
(5,000
) Proceeds from long-term borrowing
60,000
20,000 Repayments of long-term borrowings
(35,988
)
(5,968
) Proceeds from sale of preferred stock
7,500
1,180 Decrease in capital lease obligation
(72
)
(67
) Preferred stock dividends
(354
)
(600
) Net cash provided by financing activities
190,983
119,092 Net increase (decrease) in cash and cash equivalents
(8,547
)
6,110 Cash and cash equivalentsbeginning
59,176
53,066 Cash and cash equivalentsending
$
50,629
$
59,176 Supplementary cash flows information: Interest paid
$
5,466
$
5,476 Income taxes paid
$
6,700
$
5,102 Noncash disclosures: Transfer to other real estate owned
$
433
$
See accompanying notes to consolidated financial statements. 53
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2012 and 2011
CONNECTONE BANCORP, INC. NOTE 1SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Principles of Consolidation: The consolidated financial statements include ConnectOne Bancorp, Inc. and its wholly owned subsidiary, ConnectOne Bank (the Bank), together referred to as the Company. Intercompany transactions and balances are eliminated
in consolidation. The Company provides financial services through its offices in Bergen, Hudson, and Monmouth counties, New Jersey. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans.
Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from business operations. There are no significant concentrations of loans to any one industry
or customer. However, the customers ability to repay their loans is dependent on the cash flows, real estate and general economic conditions in the area. Use of Estimates: To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and
the disclosures provided, and actual results could differ. The allowance for loan losses and fair values of financial instruments are particularly subject to change. Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions with maturities of less than 90 days, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, and
federal funds purchased and repurchase agreements. Securities: Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily
determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on
the trade date and determined using the specific identification method. Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the
unrealized loss, and the financial condition and near-term prospect of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria
regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to
credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For
equity securities, the entire amount of the impairment is recognized through earnings. Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments 54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Loans are sold servicing released. Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal
balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged off no later than when the loan is 120 days past due. Past due status is based
on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively
evaluated for impairment and individually classified impaired loans. A loan is moved to non-accrual status in accordance with the Companys policy, typically after 90 days of non-payment. All interest accrued but not received for loans placed on nonaccrual are reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made
for specific loans, but the entire allowance is available for any loan that, in managements judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial
difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as
impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment record,
and the amount of the shortfall in relation to the principal and interest owed. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loans existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loans effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at
the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses. The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years. This actual
loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume
and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and
effects of changes in credit concentrations. The following portfolio segments have been identified: commercial, commercial real estate, commercial construction, residential real estate, home equity and consumer loans. Restricted Stock: The Bank is a member of the Federal Home Loan Bank (FHLB) of New York. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as
a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Cash dividends on the stock are reported as income. Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free
of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Foreclosed Assets: Assets acquired through deed in lieu or loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost of fair value less estimated costs to sell. If fair value
declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 4 to 39 years. Furniture, fixtures and equipment are depreciated using the
straight-line (or accelerated) method with useful lives ranging from 1 to 10 years. Goodwill and Other Intangible Assets: Goodwill resulting from business combinations 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. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected December 31 as the date to perform the
annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet. 56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. Stock-Based Compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the fair value of
the Companys common stock at the award date is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases
of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. A tax position is recognized as a benefit only if it is more likely than not that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the more likely than not test, no tax benefit is recorded. The company recognizes interest and/or penalties related to income tax matters in other expense. Retirement Plans: Employee 401(k) and profit sharing plan expense is the amount of matching contributions. Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under
stock option plans and convertible preferred stock. Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity. Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure
to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any
such matters that will have a material effect on the financial statements. Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank is required to meet regulatory reserve and clearing requirements. Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to shareholders. Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates,
credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Segment Reporting: FASB ASC 28, Segment Reporting, requires companies to report certain information about operating segments. The Company is managed as one segment; a community bank. All decisions including but not limited to loan growth, deposit funding, interest rate risk,
credit risk and pricing are determined after assessing the effect on the totality of the organization. 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. For example, loan growth is dependent on the ability of the organization to fund this growth through deposits or other borrowings. As a result, the Company is managed as one operating segment. Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or stockholders equity. Adoption of New Accounting Guidance: In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820)Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs which represents convergence of the FASBs
and the International Accounting Standards Boards (IASB) guidance on fair value measurement. ASU 2011-04 reflects the common requirements under U.S. GAAP and International Financial Reporting Standards (IFRS) for measuring fair value and for disclosing information about fair value
measurements, including a consistent meaning of the term fair value. The new guidance does not extend the use of fair value but, rather, provides guidance about how fair value should be applied where it is already required or permitted under IFRS or U.S. GAAP. For U.S. GAAP, most of the
changes are clarifications of existing guidance or wording changes to align with IFRS 13. A public company is required to apply the ASU prospectively for interim and annual periods beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Companys financial
condition or results of operations. Required disclosures have been added to these financial statements. In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220)Presentation of Comprehensive Income the provisions of which allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive
income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for
other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. ASU 2011-05 does not change the items that must be reported in other
comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 is effective for public companies for fiscals years, and interim periods within those years, beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Companys financial condition or results of operations. Required disclosures of separate
statements of comprehensive income have been presented in these financial statements. 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. NOTE 2SECURITIES The amortized cost, gross unrealized gains and losses and fair value of securities available for sale at December 31, 2012 and 2011, are as follows (dollars in thousands):
Amortized
Gross
Gross
Fair December 31, 2012 Securities available for sale: U.S. Government agencies
$
1,000
$
5
$
$
1,005 Mortgage-backed securitiesresidential
11,421
608
12,029 CRA investment fund
6,000
218
6,218
$
18,421
$
831
$
$
19,252 December 31, 2011 Securities available for sale: U.S. Government agencies
$
4,000
$
36
$
$
4,036 Mortgage-backed securitiesresidential
16,414
812
17,226 CRA investment fund
6,000
173
6,173
$
26,414
$
1,021
$
$
27,435 The amortized cost, gross unrecognized gains and losses and fair value of securities held to maturity at December 31, 2012 and 2011, are as follows (dollars in thousands):
Amortized
Gross
Gross
Fair December 31, 2012 Securities held-to-maturity: Mortgage-backed securitiesresidential
$
1,985
$
99
$
$
2,084 December 31, 2011 Securities held-to-maturity: Mortgage-backed securitiesresidential
$
3,694
$
150
$
$
3,844 The amortized cost and fair value of debt securities held to maturity and available for sale at December 31, 2012, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties. Securities not due at a single maturity date are shown separately. 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Cost
Unrealized
Gains
Unrealized
Losses
Value
Cost
Unrecognized
Gains
Unrecognized
Losses
Value
CONNECTONE BANCORP, INC.
Available for Sale
Held to Maturity
Amortized
Fair
Amortized
Fair
(dollars in thousands) December 31, 2012 U.S. Government agencies: Due in under one year or less
$
1,000
$
1,005
$
$
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed securitiesresidential
11,421
12,029
1,985
2,084
$
12,421
$
13,034
$
1,985
$
2,084 For the year ended December 31, 2012, there were no sales of available for sale securities. For the year ended December 31, 2011, there was one sale of an available for sale security which resulted in a pre-tax gain of $96,000. Securities with a carrying value of $322,272 and $426,000 at December 31, 2012 and 2011, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes as required or permitted by law. There were no securities in an unrealized loss position at December 31, 2012 and 2011. NOTE 3LOANS RECEIVABLE The composition of loans receivable (which excludes loans held for sale) at December 31, 2012 and 2011, is as follows (dollars in thousands):
2012
2011 Commercial
$
147,455
$
108,066 Commercial real estate
549,218
375,719 Commercial construction
36,872
28,543 Residential real estate
82,962
88,666 Home equity
30,961
27,575 Consumer
1,801
890 Gross loans
849,269
629,459 Unearned net origination fees and costs
(427
)
(88
) Loans receivable
848,842
629,371 Less: Allowance for loan losses
(13,246
)
(9,617
) Net loans receivable
$
835,596
$
619,754 The portfolio classes in the above table have unique risk characteristics with respect to credit quality:
The repayment of commercial loans is generally dependent on the creditworthiness and cash flow of borrowers, and if applicable, guarantors, which may be negatively impacted by adverse economic conditions. While the majority of these loans are secured, collateral type, marketing, coverage,
valuation and monitoring is not as uniform as in other portfolio classes and recovery from liquidation of such collateral may be subject to greater variability. Payment on commercial mortgages is driven principally by operating results of the managed properties or underlying business and secondarily by the sale or refinance of such properties. Both primary and secondary sources of repayment, and value of the properties in liquidation, 60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Cost
Value
Cost
Value
CONNECTONE BANCORP, INC.
may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Properties underlying construction, land and land development loans often do not generate sufficient cash flows to service debt and thus repayment is subject to ability of the borrower and, if applicable, guarantors, to complete development or construction of the property and carry the project, often
for extended periods of time. As a result, the performance of these loans is contingent upon future events whose probability at the time of origination is uncertain. The ability of borrowers to service debt in the residential, home equity and consumer loan portfolios is generally subject to personal income which may be impacted by general economic conditions, such as increased unemployment levels. These loans are predominately collateralized by first and/or
second liens on single family properties. If a borrower cannot maintain the loan, the Companys ability to recover against the collateral in sufficient amount and in a timely manner may be significantly influenced by market, legal and regulatory conditions. The following table represents the allocation of allowance for loan losses and the related loans by loan portfolio segment disaggregated based on the impairment methodology at December 31, 2012 and 2011 (dollars in thousands):
Commercial
Commercial
Commercial
Residential
Home
Consumer
Unallocated
Total December 31, 2012 Allowance for loan losses: Individually evaluated for impairment
$
165
$
1,006
$
27
$
$
$
$
$
1,198 Collectively evaluated for impairment
2,237
6,712
633
1,542
617
41
266
12,048 Total
$
2,402
$
7,718
$
660
$
1,542
$
617
$
41
$
266
$
13,246 Loans receivable: Individually evaluated for impairment
$
3,124
$
4,697
$
395
$
2,995
$
119
$
$
$
11,330 Collectively evaluated for impairment
144,331
544,521
36,477
79,967
30,842
1,801
837,939 Total
$
147,455
$
549,218
$
36,872
$
82,962
$
30,961
$
1,801
$
$
849,269 December 31, 2011 Allowance for loan losses: Individually evaluated for impairment
$
2
$
990
$
17
$
$
$
$
$
1,009 Collectively evaluated for impairment
651
4,668
430
2,517
339
3
8,608 Total
$
653
$
5,658
$
447
$
2,517
$
339
$
3
$
$
9,617 Loans receivable: Individually evaluated for impairment
$
402
$
10,713
$
84
$
1,796
$
$
$
$
12,995 Collectively evaluated for impairment
107,664
365,006
28,459
86,870
27,575
890
616,464 Total
$
108,066
$
375,719
$
28,543
$
88,666
$
27,575
$
890
$
$
629,459 61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Real Estate
Construction
Real Estate
Equity
Lines of
Credit
CONNECTONE BANCORP, INC. The following table presents information related to impaired loans by class of loans as of and for the years ended December 31, 2012 and 2011 (dollars in thousands):
Unpaid
Recorded
Allowance for
Average
Interest
Cash Basis December 31, 2012 With no related allowance recorded: Commercial
$
273
$
291
$
$
285
$
$
Commercial real estate
1,705
1,738
1,354
46
Commercial construction
Residential real estate
2,995
3,196
3,047
119
Home equity lines of credit
119
125
121
7
Consumer
5,092
5,350
4,806
172 With an allowance recorded: Commercial
2,851
2,984
165
2,895
135
33 Commercial real estate
2,992
3,206
1,006
3,200
26
Commercial construction
395
424
27
414
29
Residential real estate
Home equity lines of credit
Consumer
6,238
6,615
1,198
6,509
191
33 Total
$
11,330
$
11,965
$
1,198
$
11,315
$
363
$
33 December 31, 2011 With no related allowance recorded: Commercial
$
388
$
388
$
$
388
$
2
$
Commercial real estate
6,480
6,493
6,199
41
Commercial construction
Residential real estate
1,796
1,803
1,811
127
Home equity lines of credit
Consumer
8,664
8,684
8,398
170
With an allowance recorded: Commercial
14
14
2
19
2
Commercial real estate
4,233
4,246
990
4,318
123
Commercial construction
84
84
17
425
59
Residential real estate
Home equity lines of credit
Consumer
4,331
4,344
1,009
4,762
184
Total
$
12,995
$
13,028
$
1,009
$
13,160
$
354
$
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Principal
Balance
Investment
Loan Losses
Allocated
Recorded
Investment
Income
Recognized
Interest
Recognized
CONNECTONE BANCORP, INC. The recorded investment in loans include accrued interest receivable and other capitalized costs such as real estate taxes paid on behalf of the borrower and loan origination fees, net. The following tables presents nonaccrual and loans past due over 90 days still on accrual by class of loans (dollars in thousands):
Nonaccrual
Loans Past Due
2012
2011
2012
2011 Commercial
$
3,124
$
388
$
$
Commercial real estate
2,446
6,049
Commercial construction
Residential real estate
2,369
Home equity lines of credit
Consumer
Total
$
7,939
$
6,437
$
$
The following table presents past due and current loans by the loan portfolio class as of December 31, 2012 and 2011 (dollars in thousands):
30-59
60-89
90 Days
Total
Current
Total December 31, 2012 Commercial
$
$
$
273
$
273
$
147,182
$
147,455 Commercial real estate
142
2,446
2,588
546,630
549,218 Commercial construction
36,872
36,872 Residential real estate
1,769
2,369
4,138
78,824
82,962 Home equity lines of credit
35
35
30,926
30,961 Consumer
1,801
1,801 Total
$
1,804
$
142
$
5,088
$
7,034
$
842,235
$
849,269 December 31, 2011 Commercial
$
$
$
388
$
388
$
107,678
$
108,066 Commercial real estate
6,049
6,049
369,670
375,719 Commercial construction
289
289
28,254
28,543 Residential real estate
83
83
88,583
88,666 Home equity lines of credit
10
10
27,565
27,575 Consumer
890
890 Total
$
93
$
289
$
6,437
$
6,819
$
622,640
$
629,459 Troubled Debt Restructurings During the years ending December 31, 2012 and 2011, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity
date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. The balance of troubled debt restructurings at December 31, 2012, consists of five loans that were performing at such date under their restructured terms and for which the Bank had no commitment to lend additional funds and three credits that were classified as non-accrual. The balance of troubled
debt restructurings at December 31, 2011, consists of seven loans that were 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
90 Days or
Greater and
Still Accruing
Days
Past Due
Days
Past Due
or Greater
Past Due
Past Due
Gross
Loans
CONNECTONE BANCORP, INC. performing at such date under their restructured terms and for which the Bank has no commitment to lend additional funds and three credits that were currently classified as non-accrual loans. The Company has allocated $211,000 of specific allocations with respect to loans whose loan terms had been
modified in troubled debt restructurings as of December 31, 2012. The Company allocated $17,000 of specific allocations with respect to loans whose terms have been modified in troubled debt restructurings as of December 31, 2011. The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2012 (dollars in thousands):
Number of
Pre-Modification
Post-Modification Troubled debt restructurings: Commercial
2
$
3,901
$
3,901 Commercial real estate
Commercial construction
Residential real estate
Home equity lines of credit
Consumer
Total
2
$
3,901
$
3,901 There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the year ended December 31, 2012. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2011 (dollars in thousands):
Number of
Pre-Modification
Post-Modification Troubled debt restructurings: Commercial
$
$
Commercial real estate
3
5,317
5,317 Commercial construction
Residential real estate
5
1,880
1,880 Home equity lines of credit
Consumer
Total
8
$
7,197
$
7,197 64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Loans
Outstanding
Recorded
Investment
Outstanding
Recorded
Investment
Loans
Outstanding
Recorded
Investment
Outstanding
Recorded
Investment
CONNECTONE BANCORP, INC. The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the year ending December 31, 2011 (dollars in thousands):
Number of
Recorded Troubled debt restructurings that subsequently defaulted: Commercial
2
$
273 Commercial real estate
Commercial construction
1
2,366 Residential real estate
Home equity lines of credit
Consumer
Total
3
$
2,639 A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. The troubled debt restructurings that subsequently defaulted described above increased the allowance for loan losses by $75,000 and resulted in charge offs of $0 during the year ending December 31, 2011. Credit Quality Indicators The Bank categorizes loans into risk categories based on relevant information about the quality and realizable value of collateral, if any, and the ability of borrowers to service their debts such as: current financial information, historical payment experience, credit documentation, public information,
and current economic trends, among other factors. The Bank analyzes loans individually by classifying the loans as to credit risk. This analysis is performed whenever a credit is extended, renewed or modified, or when an observable event occurs indicating a potential decline in credit quality, and no less
than annually for large balance loss. The Bank used the following definitions for risk ratings: Special Mention: Loans classified as special mention have a potential weakness that deserves managements close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the Banks credit position at some future date. Substandard: Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment and liquidation of the debt. They
are characterized by distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Normal payment from the borrower is in jeopardy, although loss of principal, while still possible, is not imminent. Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable. 65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Loans
Investment
CONNECTONE BANCORP, INC. The following table presents the risk category of loans by class of loans based on the most recent analysis performed as of December 31, 2012 and 2011 (dollars in thousands):
Credit Risk Profile by
Pass
Special Mention
Substandard
Doubtful
Total December 31, 2012 Commercial
$
131,887
$
11,733
$
3,835
$
$
147,455 Commercial real estate
529,453
6,602
13,163
549,218 Commercial construction
35,985
887
36,872 Total
$
697,325
$
18,335
$
17,885
$
$
733,545 December 31, 2011 Commercial
$
100,044
$
3,822
$
4,200
$
$
108,066 Commercial real estate
355,133
6,020
14,566
375,719 Commercial construction
25,018
1,968
1,557
28,543 Total
$
480,195
$
11,810
$
20,323
$
$
512,328 Residential real estate, home equity lines of credit, and consumer loans are not rated. The Company evaluates credit quality of those loans by aging status of the loan and by payment activity, which was previously presented. The following table presents the activity in the Companys allowance for loan losses by class of loans (dollars in thousands):
Commercial
Commercial
Commercial
Residential
Home Equity
Consumer
Unallocated
Total Allowance for loan losses: Beginning balance at January 1, 2012
$
653
$
5,658
$
447
$
2,517
$
339
$
3
$
$
9,617 Charge-offs
(115
)
(109
)
(16
)
(153
)
(393
) Recoveries
32
32 Provision for loan losses
1,864
2,169
229
(822
)
278
6
266
3,990 Total ending balance at December 31, 2012
$
2,402
$
7,718
$
660
$
1,542
$
617
$
41
$
266
$
13,246 Allowance for loan losses: Beginning balance at January 1, 2011
$
634
$
2,902
$
808
$
2,773
$
292
$
5
$
$
7,414 Charge-offs
(90
)
(62
)
(152
) Recoveries
Provision for loan losses
19
2,756
(361
)
(166
)
47
60
2,355 Total ending balance at December 31, 2011
$
653
$
5,658
$
447
$
2,517
$
339
$
3
$
$
9,617 66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Internally Assigned Grades
Real Estate
Construction
Real Estate
Lines of Credit
CONNECTONE BANCORP, INC. NOTE 4BANK PREMISES AND EQUIPMENT The components of premises and equipment at December 31, 2012 and 2011, are as follows (dollars in thousands):
2012
2011 Building
$
3,422
$
3,422 Leasehold improvements
5,933
5,817 Furniture, fixtures and equipment
2,897
2,751 Computer equipment and data processing software
1,970
1,652 Vehicles
152
152
14,374
13,794 Accumulated depreciation and amortization
(6,470
)
(5,182
)
$
7,904
$
8,612 Depreciation expense amounted to $1,288,000 and $1,219,000 for the years ended December 31, 2012 and 2011, respectively. Capital Leases: The Company has entered into a lease agreement for a building under a capital lease. The lease arrangement requires monthly payments through 2028. The Company has included these leases in premises and equipment as follows (dollars in thousands):
2012
2011 Building
$
3,422
$
3,422 Accumulated depreciation
(684
)
(513
)
$
2,738
$
2,909 The following is a schedule by year of future minimum lease payments under the capitalized lease, together with the present value of net minimum lease payments at December 31, 2012 (dollars in thousands): 2013
$
267 2014
292 2015
292 2016
292 2017
292 Thereafter
3,632 Total minimum lease payments
5,067 Less amount representing interest
1,882 Present value of net minimum lease payments
$
3,185 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. Operating Leases: The Company leases certain branch properties under operating leases. Rent expense was $1,031,000 and $899,000 for the years ended December 31, 2012 and 2011, respectively. Rent commitments, before considering renewal options that generally are present were as
follows at December 31, 2012 (dollars in thousands): 2013
$
938 2014
845 2015
796 2016
673 2017
320 Thereafter
684
$
4,256 NOTE 5DEPOSITS The components of deposits at December 31, 2012 and 2011 are as follows (dollars in thousands):
2012
2011 Demand, non-interest bearing
$
170,355
$
118,583 Demand, interest-bearing & NOW
57,198
50,122 Money market accounts
193,600
170,096 Savings
72,693
83,879 Time, $100 and over
195,088
123,416 Time, other
80,384
63,325
$
769,318
$
609,421 At December 31, 2012, the scheduled maturities of time deposits are as follows (dollars in thousands): 2013
$
206,797 2014
16,317 2015
6,358 2016
16,072 2017
630 Thereafter
29,298
$
275,472 At December 31, 2012 and 2011, the Company had $29,298,000 and $3,956,000 of brokered certificates of deposit, respectively. NOTE 6SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE Securities sold under agreements to repurchase represent overnight or less than 30-day borrowings for the Company. There were no securities sold under agreements to repurchase during 2012. Short-term borrowings consisted of the following at December 31, 2011 (dollars in thousands):
2011
Ending
Average
Maximum
Average Securities sold under agreements to repurchase
$
$
19,263
$
28,860
0.33
% 68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Balance
Balance
Month-End
Balance
Rate
CONNECTONE BANCORP, INC. Securities sold under repurchase agreements were retained under the Companys control at its safekeeping agent. During December 2011, the Company terminated its sweep product thereby terminating its need to pledge its securities. The Company had, as of December 31, 2012, a $5.0 million line of credit for the sale of federal funds with Atlantic Central Bankers Bank (ACBB). There was no amount outstanding in overnight borrowings with ACBB at December 31, 2012 and 2011, under this line. The line of credit with ACBB
expires on June 30, 2013. NOTE 7LONG-TERM BORROWINGS The components of FHLB borrowings are as follows (dollars in thousands): December 31, 2012
December 31, 2011 Maturity
Interest
Outstanding
Maturity
Interest
Outstanding 3/11/13
1.16
%
$
5,000
3/11/13
1.16
%
$
5,000 7/22/13
1.47
2,000
7/22/13
1.47
2,000 5/12/14
2.44
10,000
5/12/14
2.44
10,000 8/05/14
1.08
3,000
8/05/14
1.08
3,000 2/23/15
0.88
10,000
5/11/15
2.17
3,556 5/07/15
0.81
15,000
5/11/15
2.91
5,000 5/11/15
2.91
5,000
8/05/15
1.49
2,000 5/11/15
2.17
2,568
8/03/16
1.93
10,000 8/05/15
1.49
2,000
4/02/18
2.51
2,500 8/03/16
1.93
10,000
4/02/18
1.98
7,500 4/02/18
2.51
2,500
7/16/18
2.99
5,000 4/02/18
1.98
7,500 7/16/18
2.99
5,000
$
79,568
$
55,556 Three of the FHLB notes ($2,500,000 and $7,500,000 each due April 2, 2018, and $5,000,000 due July 16, 2018) contain a convertible option which allows the FHLB, at quarterly intervals, to convert the fixed convertible advance into replacement funding for the same or lesser principal based on any
advance then offered by the FHLB at their current market rate. The Company has the option to repay these advances, if converted, without penalty. The advances were collateralized by $341,412,000 and $208,905,000 of commercial mortgage loans, net of required over-collateralization amounts, under a
blanket lien arrangement at December 31, 2012 and 2011, respectively. Payments over the next five years are as follows (dollars in thousands): 2013
$
7,977 2014
13,977 2015
32,614 2016
10,000 2017
Thereafter
15,000
$
79,568 NOTE 8STOCKHOLDERS EQUITY In September 2009, the Company completed its offering of Series A preferred stock and issued 125,000 shares of Series A preferred at $20 per share for net proceeds of $2,500,000. The Series A 69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Date
Rate
Date
Rate
CONNECTONE BANCORP, INC. shares had no right to require the Company to redeem the shares. The Series A shares were entitled to receive their liquidation preference before any distribution is made on common stock. The shares were convertible after the third anniversary of issuance by the holder or the Company to that number
of common shares equal to the liquidation preference divided by the then current tangible book value per common share of stock. The Series A shares voted together with the common stock and are entitled to noncumulative dividends at the Prime Rate, as reported in the Wall Street Journal, plus 1.5%
reset quarterly, with a floor of 4.75%. Dividends were payable only when declared by the Board of Directors. In December of 2009, the Company completed its first offering of Series B preferred stock and issued 400,000 shares at $20 per share for net proceeds of $8,000,000. The Series B shares had substantially the same rights as the Series A shares with a few differences. The Series B shares were
convertible after the third anniversary of issuance by the holder or the Company to the number of common shares equal to the stated value of the shares divided by one-and-a-half times the then book value per share of the Companys common stock upon 60 days notice. The Series B shares were non-
voting and entitled to a 4% non-cumulative dividend for the first year and non-cumulative dividends after the first year at the Prime Rate with a maximum dividend rate of 7%. The Series B shares ranked pari passu with the Series A shares. In January of 2010, the Company completed another offering of Series B preferred stock and issued 50,200 shares at $20 per share for net proceeds of $1,004,000. In December of 2010, the Company completed a third offering of Series B preferred stock and issued 190,975 shares at $20 per share for net proceeds of $3,820,000. In January of 2011, the Company completed another offering of Series B preferred stock and issued 59,025 shares at $20 per share for net proceeds of $1,180,000. In March of 2012 the Company completed its first offering of Series C preferred stock and issued 7,500 shares at $1,000 per share for net proceeds of $7,500,000. The Shares did not bear voting rights, except in certain circumstances required by law, and were entitled to non-cumulative dividends at a
variable rate equal to the prime rate as reported in the Wall Street Journal from time to time, with a maximum dividend rate of 7% per annum. In addition, the Shares were convertible into shares of our common stock at the election of the holder, and the Company could require conversion of the
Shares into shares of our common stock, any time, at a ratio equal to the purchase price ($1,000) divided by the product of 1.25 multiplied by the then current book value per share of our common stock. The series C shares ranked pari passu with Series A and B shares. During 2012, the Series A preferred shares were converted into 127,676 common shares at an average conversion price of $19.58, the Series B preferred shares were converted into 475,857 common shares at an average conversion price of $29.44, and the Series C preferred shares were converted into
306,388 common shares at an average price of $24.48. NOTE 9STOCK OPTION PLANS AND EQUITY COMPENSATION PLAN In 2005, the Company adopted two stock option plans that were approved by stockholders on April 29, 2005. The 2005 A Stock Option Plan provides for granting of stock options to directors and employees to purchase up to 120,000 shares. The determination of the recipients of these options and
the vesting of these options is at the discretion of the Board of Directors. The shares granted under this plan may be either non-qualified options or incentive stock options, which are subject to the limitations under Section 422 of the Internal Revenue Code. Under this plan, incentive stock options
must have an exercise price of no less than 100% of the fair market value of the common stock on the date of grant, and non-qualified options may have an exercise price to be determined by the Board of Directors at grant, but no less than 85% of the fair market value of the common stock on the
date of grant. 70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. The 2005 B Stock Option plan permits grants of options to directors and employees to purchase up to 60,000 shares of common stock. The terms of this plan are substantially the same as the A Plan, with the exception that under the B Stock Option Plan, only non-qualified options may be granted. In 2006, the Company adopted the 2006 Equity Compensation Plan. This plan provides for granting of 45,300 stock options or restricted stock awards to directors and employees. The determination of the recipients of the equity compensation and the related vesting is at the discretion of the Board of
Directors. Stock options granted under this plan may be either non-qualified options or incentive stock options, which are subject to the limitations under Section 422 of the Internal Revenue Code. Under this plan, the non-qualified options and incentive stock options must have an exercise price of
no less than 100% of the fair market value of the common stock on the date of grant. In 2008, the Company adopted the 2008 Equity Compensation Plan. The plan provides for granting of 108,099 stock options or restricted awards to directors and employees. The determination of the recipients of the equity compensation and the related vesting is at the discretion of the Board of
Directors. Stock options granted under this plan may be either non-qualified options or incentive stock options, which are subject to the limitations under Section 422 of the Internal Revenue Code. Under this plan, the non-qualified options and incentive stock options must have an exercise price of
no less than 100% of the fair market value of the common stock on the date of grant. In 2009, the Company adopted the 2009 Equity Compensation Plan. The plan provides for granting of 111,113 stock options or restricted awards to directors and employees. The determination of the recipients of the equity compensation and the related vesting is at the discretion of the Board of
Directors. Stock options granted under this plan may be either non-qualified or incentive stock options, which are subject to the limitations under Section 422 of the Internal Revenue Code. Under this plan, the non-qualified options must have an exercise price of no less than 100% of the fair market
value of the common stock on the date of grant. In 2012, the Company adopted the 2012 Equity Compensation Plan. The plan provides for granting of 125,000 stock options, restricted awards or performance units, or any combination thereof, to directors, employees, members of any advisory committee or any other service provider to the Company.
The determination of the recipients of awards, the types of awards granted and the specific terms of each award is at the discretion of the Compensation Committee of the Board of Directors, subject to the terms of the Plan. Stock options granted under this plan may be either non-qualified or incentive
stock options, which are subject to the limitations under Section 422 of the Internal Revenue Code. Under this plan, the non-qualified options must have an exercise price of no less than 100% of the fair market value of the common stock on the date of grant. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model. Expected volatilities are based on estimated historical volatilities of the Companys common stock. The expected term of options granted is based on historical data and
represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The fair value of
stock options granted during 2012 was $4.94 on the date of grant using the Black-Scholes option pricing model with the following assumptions for 2012: stock price volatility of 27.63%, risk free interest rate of .84%, 0% dividend rate and expected life of 5.5 years. No options were granted in 2011. At December 31, 2012, there were 269,074 options available for grants under the plans. 71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. A summary of the activity in the stock option plan for 2012 follows:
Shares
Weighted
Weighted
Aggregate Outstanding at beginning of year
280,766
$
11.88 Granted
25,484
18.18 Exercised
Forfeited
(5,812
)
16.78 Expired
Outstanding at end of year
300,438
$
12.32
4.40
$
3,166,979 Fully vested and expected to vest
300,438
$
12.32
4.40
$
3,166,979 Exercisable at end of year
276,166
$
11.80
3.99
$
3,053,387 As of December 31, 2012 and 2011, there was $85,000 and $3,000, respectively, of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of 2.1 years. Aggregate intrinsic value is based on
a fair value share price of $22.86 which is derived from the book value per share at December 31, 2012. In conjunction with the plans above, the Company granted restricted shares to certain executive officers. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date. The fair value of the stock was based on the book value of stock on
the date of the award. One third of the shares immediately vested on the date of grant, with another third vesting six months after grant date, and the final third vesting one and a half years after the grant date. A summary of changes in the Companys nonvested restricted shares for the year ended December 31, 2012 follows:
Nonvested Shares
Shares
Weighted- Nonvested at December 31, 2011
5,469
$
15.17 Granted
8,592 Vested
(2,734
) Forfeited
(1,252
) Nonvested at December 31, 2012
10,075
$
18.26 As of December 31, 2012, there was $128,131 of total unrecognized compensation cost related to nonvested shares granted under the plans. The cost is expected to be recognized over a weighted average period of 2 years. The total fair value of shares vested during year ended December 31, 2012,
was $41,475. 72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Average
Exercise
Price
Average
Remaining
Contractual
Term (Years)
Intrinsic
Value
Average
Grant-Date
Fair Value
CONNECTONE BANCORP, INC. NOTE 10FEDERAL INCOME TAXES The components of income tax expense for the years ended December 31, 2012 and 2011 are as follows (dollars in thousands):
2012
2011 Current expense Federal
$
5,931
$
3,224 State
1,850
968 Deferred expense (benefit) Federal
(1,558
)
231 State
(512
)
81
$
5,711
$
4,504 A reconciliation of the statutory federal income tax to the income tax expense included in the statements of income for the years ended December 31, 2012 and 2011 is as follows (dollars in thousands):
2012
2011 Income before income tax expense
$
14,132
$
11,170 Federal statutory rate
34
%
34
% Federal income tax at statutory rate
$
4,805
$
3,798 State income taxes, net of federal benefit
883
693 Other
23
13
$
5,711
$
4,504 The components of the net deferred tax asset at the years ended December 31, 2012 and 2011 are as follows (dollars in thousands): Deferred tax assets: Allowance for loan losses
$
5,253
$
3,776 Equity based compensation
185
162 Deferred loan fees
171
Other
88
87 Total deferred tax assets
5,697
4,025 Deferred tax liabilities Premises and equipment
802
1,111 Section 481 adjustment
134
Unrealized gain on securities available for sale
335
411 Other
112
335
1,383
1,857 Net deferred tax asset
$
4,314
$
2,168 Based upon the level of historical taxable income and projections for future taxable income over periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. At December 31, 2012 and 2011, the Company had no unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months. The Companys policy is to account for interest as a component of interest expense
and penalties as a component of other expense. There was no amount of interest and penalties recorded in the income statement for the years ended December 31, 2012 and 2011. 73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. The Company and its subsidiary are subject to U.S. federal income tax as well as income tax of the State of New Jersey. The Company is no longer subject to examination by taxing authorities for years before 2009. NOTE 11TRANSACTIONS WITH EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS Loans to principal officers, directors, and their affiliates during the years ended December 31, 2012 and 2011, were as follows (dollars in thousands):
2012
2011 Beginning balance
$
22,984
$
17,267 New loans
8,162
9,418 Repayments
(8,961
)
(3,701
) Ending balance
$
22,185
$
22,984 Deposits from principal officers, directors, and their affiliates at December 31, 2012 and 2011, were $26,475,000 and $26,111,000, respectively. The Company has had, and may be expected to have in the future, banking transactions in the ordinary course of business with its executive officers, directors, principal stockholders, their immediate families and affiliated companies (commonly referred to as related parties). The company also leases
branch facilities from related party entities. Total expenses to these entities were $538,000 and $436,000 for the years ended December 31, 2012 and 2011, respectively. The Company also utilizes an advertising and public relations agency at which one of the Companys directors is President and CEO and
a principal owner. Advertising expenses with this agency were $526,000 and $254,000 for the years ended December 31, 2012 and 2011, respectively. NOTE 12FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the balance sheet. The Companys exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. The contract or notional amount of financial instruments where contract amounts represent credit risk at December 31, 2012 and 2011, are as follows (dollars in thousands):
2012
2011 Commitments to grant loans
$
38,365
$
31,632 Unused lines of credit
90,858
107,289 Standby letters of credit
1,696
1,000 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customers credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on managements credit evaluation. Collateral held 74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. varies but may include personal or commercial real estate, accounts receivable, inventory and equipment. Outstanding letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The majority of these standby letters of credit expire within the next twelve months. The credit risk involved in issuing letters of credit is essentially
the same as that involved in extending other loan commitments. The Company requires collateral supporting these letters of credit as deemed necessary. The current amount of the liability as of December 31, 2012 and 2011, for guarantees under standby letters of credit issued was not material. NOTE 13REGULATORY MATTERS The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary-actions by regulators that, if undertaken, could have a
direct material effect on the Companys and Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Companys and Banks assets,
liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Companys and Banks capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank and the Company to maintain minimum amounts and ratios (set forth below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted asset and of Tier 1 capital to average assets.
Management believes, as of December 31, 2012 and 2011, that the Company and the Bank meet all capital adequacy requirements to which they are subject. At year-end 2012 and 2011, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. There are no conditions or events since that notification that management believes have changed the institutions category. 75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
CONNECTONE BANCORP, INC. Actual and required capital and ratios are presented below for December 31, 2012 and 2011 (dollars in thousands):
Actual
For Capital
To Be Well
Amount
Ratio
Amount
Ratio
Amount
Ratio December 31, 2012 Total capital to risk-weighted assets: Company
$
81,282
10.52
%
$
61,835
8.0
%
N/A
N/A Bank
81,262
10.51
61,835
8.0
$
77,294
10.0
% Tier 1 capital to risk-weighted assets: Company
71,576
9.26
30,918
4.0
N/A
N/A Bank
71,556
9.26
30,918
4.0
46,376
6.0 Tier 1 capital to total assets: Company
71,576
7.84
36,498
4.0
N/A
N/A Bank
71,556
7.84
36,498
4.0
45,623
5.0 December 31, 2011 Total capital to risk-weighted assets: Company
$
63,088
11.15
%
$
45,248
8.0
%
N/A
N/A Bank
63,041
11.15
45,248
8.0
$
56,599
10.0
% Tier 1 capital to risk-weighted assets: Company
55,987
9.90
22,624
4.0
N/A
N/A Bank
55,939
9.89
22,624
4.0
33,936
6.0 Tier 1 capital to total assets: Company
55,987
7.76
28,843
4.0
N/A
N/A Bank
55,939
7.76
28,843
4.0
36,054
5.0 The Bank is subject to certain regulatory restrictions on the amount of dividends that it may declare without regulatory approval. NOTE 14FAIR VALUE MEASUREMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS Management uses its best judgment in estimating the fair value of the Companys financial instruments; however, there are inherent weaknesses in any estimation technique. The estimated fair value amounts have been measured as of December 31, 2012 and 2011, and have not been re-evaluated or
updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that
may be used to measure fair values: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. 76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Adequacy
Requirements
Capitalized
Under
Prompt
Corrective
Action
Provisions
CONNECTONE BANCORP, INC. Level 3: Significant unobservable inputs that reflect a reporting entitys own assumptions about the assumptions that market participants would use in pricing an asset or liability. The Company used the following methods and significant assumptions to estimate fair value: An assets or liabilitys level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted
prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and
optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations. Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income
approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2012 and 2011 are as follows (dollars in thousands): Assets and Liabilities Measured on a Recurring Basis
Fair Value Measurements Using
Quoted Prices
Significant
Significant December 31, 2012 Securities: U.S. Government Agencies
$
$
1,005
$
Mortgage-backedresidential
12,029
CRA mutual fund
6,218
Fair Value Measurements Using
Quoted Prices
Significant
Significant December 31, 2011 Securities: U.S. Government Agencies
$
$
4,036
$
Mortgage-backedresidential
17,226
CRA mutual fund
6,173
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
In Active
Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Unobservable
Inputs
(Level 3)
In Active
Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Unobservable
Inputs
(Level 3)
CONNECTONE BANCORP, INC. Assets and Liabilities Measured on a Non-recurring Basis Assets measured at fair value on a non-recurring basis are summarized below (dollars in thousands):
Fair Value Measurements Using
Quoted Prices
Significant
Significant December 31, 2012 Impaired loans: Commercial
$
$
$
Commercial real estate
1,986 Commercial construction
368 December 31, 2011 Impaired loans: Commercial
$
$
$
12 Commercial real estate
3,243 Commercial construction
67 As of December 31, 2012, impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had an unpaid principal balance of $3,387,000, with a valuation allowance of $1,033,000, resulting in an additional provision for loan losses of $558,000 for
the year ended December 31, 2012. As of December 31, 2011, impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had an unpaid principal balance of $4,331,000, with a valuation allowance of $1,009,000, resulting in an additional provision for loan losses of $849,000 for
the year ended December 31, 2011. The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2012 (dollars in thousands):
Fair Value
Valuation
Unobservable Input(s)
Discount
Impaired loans: Commercial real estate Commercial construction 78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
In Active
Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Unobservable
Inputs
(Level 3)
Technique(s)
Range
$1,986
Sales comparison
and income
approach.
Adjustments for
maintenance, property
type, selling and legal
costs and date of
appraisal.
10%-65%
$368
Sales comparison
and income
approach.
Adjustments for
maintenance,
selling and legal costs.
15%
CONNECTONE BANCORP, INC. The carrying value and estimated fair value of financial instruments as of December 31, 2012 are summarized below (dollars in thousands):
Carrying Value
Fair Value Measurements Using
Quoted Prices
Significant
Significant Financial assets: Cash and due from banks
$
3,242
$
3,242
$
$
Interest bearing deposits
47,387
47,387
Securities available for sale
19,252
19,252
Securities held to maturity
1,985
2,084
Loans held for sale
405
414
Loans receivable, gross
849,269
874,438 Accrued interest receivable
3,361
68
3,293 Financial liabilities: Deposits: Demand, NOW, money market and savings
$
505,264
$
505,264
$
$
Certificates of deposit
264,054
277,614
Long-term borrowings
79,568
81,703
Accrued interest payable
2,803
2,803
The methods and assumptions, not previously presented, used to estimate fair values for the year ended December 31, 2012, are described as follows: Cash and due from banks: The carrying amounts of cash and short-term instruments approximate fair values and care classified as Level 1. Loans: Fair value of loans, excluding loans held for sale, is estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated
using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification. Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1
classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification. Long-term borrowings: Long-term borrowings consists of Federal Home Loan Bank of New York borrowings which are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly Federal Home Loan
borrowings maturities. 79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
In Active
Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Unobservable
Inputs
(Level 3)
CONNECTONE BANCORP, INC. Accrued interest receivable/payable: The carrying amounts of accrued interest approximate the fair value resulting in a Level 2 or Level 3 classification. The carrying amounts and estimated fair values of financial instruments at December 31 2011 are as follows (dollars in thousands):
2011
Carrying
Fair Financial assets: Cash and due from banks
$
5,147
$
5,147 Interest bearing deposits
54,029
54,029 Securities available for sale
27,435
27,435 Securities held to maturity
3,694
3,844 Loans held for sale
140
140 Loans receivable, gross
629,459
641,247 Accrued interest receivable
2,747
2,747 Financial liabilities: Deposits
$
609,421
$
605,507 Long-term borrowings
55,556
58,064 Accrued interest payable
1,950
1,950 The methods and assumptions, not previously presented, used to estimate fair values for the year ended December 31, 2011 are described as follows: Carrying amount is the estimated fair value for cash and cash equivalents, interest-bearing deposits, accrued interest receivable and payable, demand deposits, short-term debt, and variable-rate loans or deposits that reprice frequently and fully. The methods for determining the fair values for securities
were described previously. For fixed-rate loans or deposits and for variable-rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk, including consideration of widening credit
spreads. Fair value of debt is based on current rates for similar financing. NOTE 15PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION CONDENSED STATEMENTS OF FINANCIAL CONDITION
2012
2011
(in thousands) ASSETS Cash and cash equivalents
$
27
$
172 Investment in banking subsidiary
72,342
56,839 Total assets
$
72,369
$
57,011 LIABILITIES AND EQUITY Accrued expenses and other liabilities
$
7
$
154 Stockholders equity
72,362
56,857 Total liabilities and stockholders equity
$
72,369
$
57,011 80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Amount
Value
December 31,
CONNECTONE BANCORP, INC. CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
2012
2011 Equity in undistributed subsidiary income
$
8,421
$
6,666 Net income
$
8,421
$
6,666 Comprehensive income
$
8,307
$
6,857 CONDENSED STATEMENTS OF CASH FLOWS
2012
2011
(in thousands) Cash flows from operating activities Net income
$
8,421
$
6,666 Adjustments: Equity in undistributed subsidiary income
(8,421
)
(6,666
) Change in other liabilities
(197
)
33 Net cash provided by (used in) operating activities
(197
)
33 Cash flows from investing activities Investments in subsidiaries
(7,094
)
(588
) Net cash used in investing activities
(7,094
)
(588
) Cash flows from financing activities Proceeds from stock issue
7,500
1,180 Dividends paid
(354
)
(600
) Net cash provided by financing activities
7,146
580 Net change in cash and cash equivalents
(145
)
25 Beginning cash and cash equivalents
172
147 Ending cash and cash equivalents
$
27
$
172 81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
Years ended December 31,
Years ended December 31,
CONNECTONE BANCORP, INC. NOTE 16EARNINGS PER SHARE The factors used in the earnings per share computation follow (in thousands, except per share data):
2012
2011 Basic Net income available to common stockholders
$
8,067
$
6,066 Weighted average common shares outstanding
2,701
2,242 Basic earnings per common share
$
2.99
$
2.71 Diluted Net income available to common stockholders
$
8,067
$
6,066 Add: Preferred dividends
354
600 Net income
8,421
6,666 Weighted average common shares outstanding for basic earnings per common share
2,701
2,242 Add: Dilutive effects of assumed exercises of stock options
83
55 Add: Dilutive effects of assumed conversion of preferred stock
413
766 Average shares and dilutive potential common shares
3,197
3,063 Diluted earnings per common share
$
2.63
$
2.18 There were no stock options that resulted in anti-dilution for the periods presented. NOTE 17QUARTERLY FINANCIAL DATA (unaudited)
Selected Consolidated Quarterly Financial Data
March 31,
June 30,
September 30,
December 31,
(in thousands, except per share data) Total interest income
$
9,304
$
10,369
$
10,289
$
10,825 Total interest expense
1,561
1,553
1,611
1,594 Net interest income
7,743
8,816
8,678
9,231 Provision for loan losses
750
1,140
950
1,150 Net interest income after provision for loan losses
6,993
7,676
7,728
8,081 Other income
245
277
294
326 Other expenses
4,148
4,457
4,335
4,548 Income before income taxes
3,090
3,496
3,687
3,859 Income tax expense
1,248
1,418
1,488
1,557 Net income
1,842
2,078
2,199
2,302 Dividends on preferred stock
146
206
2
Net income available to common stockholders
$
1,696
$
1,872
$
2,197
$
2,302 Earnings per share(1) Basic
$
0.76
$
0.83
$
0.70
$
0.73 Diluted
$
0.62
$
0.62
$
0.68
$
0.71 82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
2012 Quarter Ended,
CONNECTONE BANCORP, INC.
Selected Consolidated Quarterly Financial Data
March 31,
June 30,
September 30,
December 31,
(in thousands, except per share data) Total interest income
$
7,802
$
8,114
$
8,741
$
9,019 Total interest expense
1,484
1,460
1,592
1,671 Net interest income
6,318
6,654
7,149
7,348 Provision for loan losses
610
692
900
153 Net interest income after provision for loan losses
5,708
5,962
6,249
7,195 Other income
193
292
248
380 Other expenses
3,313
3,548
3,781
4,415 Income before income taxes
2,588
2,706
2,716
3,160 Income tax expense
1,044
1,091
1,094
1,275 Net income
1,544
1,615
1,622
1,885 Dividends on preferred stock
139
152
154
155 Net income available to common stockholders
$
1,405
$
1,463
$
1,468
$
1,730 Earnings per share(1): Basic
$
0.63
$
0.65
$
0.65
$
0.77 Diluted
$
0.51
$
0.53
$
0.53
$
0.61
(1) NOTE 18SUBSEQUENT EVENTS On February 11, 2013, the Securities and Exchange Commission declared effective the Companys registration statement on Form S-1 registering shares of the Companys common stock. The offering of shares was priced at $28 per share, and at the closing on February 15, 2013, the Company issued
1,600,000 shares of its common stock for net proceeds to the Company of $41.9 million. On February 15, the underwriters for the offering notified the Company they were exercising their overallotment option to purchase an additional 240,000 shares of the Companys common stock for net proceeds to
the Company of $6.3 million. 83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
December 31, 2012 and 2011
2011 Quarter Ended,
Earnings per share (EPS) in each quarter is computed using the weighted-average number of shares outstanding during that quarter while EPS for the full year is computed using the weighted-average number of shares outstanding during the year. Thus, the sum of the four quarters EPS does not
equal the full-year EPS.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the Borough of Bernardsville, State of New Jersey, on March 27, 2013. CONNECTONE
BANCORP, INC.,
By: /s/ FRANK
SORRENTINO III Frank Sorrentino III Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated below on March 27, 2013
Signature
Title
Date
/S/ FRANK
SORRENTINO III (Frank Sorrentino III) Chairman & Chief Executive Officer March 27, 2013 /S/ WILLIAM S. BURNS (William S. Burns) Executive Vice President & Chief Financial March 27, 2013 /S/ FRANK
BAIER (Frank Baier) Director March 27, 2013 /S/ STEPHEN
BOSWELL (Stephen Boswell) Director March 27, 2013 /S/ FRANK
CAVUOTO (Frank Cavuoto) Director March 27, 2013 /S/ DALE
CREAMER (Dale Creamer) Director March 27, 2013 /S/ STEVEN M. GOLDMAN (Steven M. Goldman) Director March 27, 2013 /S/ FRANK
HUTTLE III (Frank Huttle III) Director March 27, 2013 /S/ MICHAEL
KEMPNER (Michael Kempner) Director March 27, 2013 /S/ JOSEPH
PARISI
JR. (Joseph Parisi Jr.) Director March 27, 2013 84
Chairman & Chief Executive Officer
(principal executive officer)
Officer (principal financial and accounting officer)