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EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.exhibit31-2.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.exhibit32-1.htm
EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.exhibit32-2.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.exhibit31-1.htm

UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
 
            QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
      

For the Quarterly Period Ended March 31, 2016

OR

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

For the transition period from _____ to _____

Commission File Number: 000-11486

ConnectOne Bancorp, Inc.
(Exact Name of Registrant as Specified in Its Charter)

New Jersey       52-1273725
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)

301 Sylvan Avenue
Englewood Cliffs, New Jersey 07632
(Address of Principal Executive Offices) (Zip Code)

201-816-8900
(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   No

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

       Large accelerated filer         Accelerated filer         Non-accelerated filer         Smaller reporting company 
      (Do not check if 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

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

Common Stock, no par value: 30,179,900 shares
(Title of Class) (Outstanding as of May 6, 2016)



Table of Contents

       Page
PART I – FINANCIAL INFORMATION
 
Item 1. Financial Statements
Consolidated Statements of Condition at March 31, 2016 (unaudited) and December 31, 2015   3
Consolidated Statements of Income for the three months ended March 31, 2016 and 2015 (unaudited) 4
Consolidated Statements of Comprehensive Income for the three months ended March 31, 2016 and 2015
  (unaudited) 5
Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2016 (unaudited)
and for the year ended December 31, 2015 6
Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and 2015 (unaudited) 7
  Notes to Consolidated Financial Statements 8
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 42
 
Item 3. Qualitative and Quantitative Disclosures about Market Risks 54
 
Item 4. Controls and Procedures 55
 
PART II – OTHER INFORMATION
 
Item 1. Legal Proceedings 56
 
Item 1a. Risk Factors 56
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 57
 
Item 3. Defaults Upon Senior Securities 57
 
Item 4. Mine Safety Disclosures 57
 
Item 5. Other Information 57
 
Item 6. Exhibits 58
 
SIGNATURES

2



Item 1. Financial Statements

CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION

March 31, December 31,
(in thousands, except for share data)    2016    2015
(unaudited)
ASSETS
Cash and due from banks $ 34,603 $ 31,291
Interest-bearing deposits with banks 83,656 169,604
       Cash and cash equivalents 118,259 200,895
  
Investment securities:
       Available-for-sale 191,331 195,770
       Held-to-maturity (fair value of $229,470 and $230,558) 219,373 224,056
  
Loans receivable 3,263,813 3,099,007
Less: Allowance for loan and lease losses 29,074 26,572
       Net loans receivable 3,234,739 3,072,435
 
Investment in restricted stock, at cost 31,487 32,612
Bank premises and equipment, net 22,652 22,333
Accrued interest receivable 12,604 12,545
Bank-owned life insurance 79,412 78,801
Other real estate owned 1,696 2,549
Goodwill 145,909 145,909
Core deposit intangibles 3,691 3,908
Other assets 29,847 24,096
       Total assets $ 4,091,000 $ 4,015,909
LIABILITIES
Deposits:
       Noninterest-bearing $ 614,507 $ 650,775
       Interest-bearing 2,278,564 2,140,191
              Total deposits 2,893,071 2,790,966
Borrowings 646,501 671,587
Subordinated debentures (net of $763 and $812 in debt issuance costs) 54,392 54,343
Other liabilities 22,309 21,669
       Total liabilities 3,616,273 3,538,565
  
COMMITMENTS AND CONTINGENCIES
 
STOCKHOLDERS’ EQUITY
Preferred stock, $1,000 liquidation value per share, authorized 5,000,000 shares; issued and outstanding    
       11,250 shares of Series B preferred stock at December 31, 2015; total liquidation value of $11,250 at
       December 31, 2015   -   11,250
 
Common stock, no par value, authorized 50,000,000 shares; issued 32,227,000 shares at March 31, 2016  
       and 32,149,585 at December 31, 2015; outstanding 30,163,078 shares at March 31, 2016 and 30,085,663
       at December 31, 2015 374,287 374,287
Additional paid-in capital   9,324 8,527
Retained earnings 112,663 104,606
Treasury stock, at cost (2,063,922 common shares at March 31, 2016 and December 31, 2015) (16,717) (16,717)
Accumulated other comprehensive loss (4,830) (4,609)
       Total stockholders’ equity 474,727 477,344
       Total liabilities and stockholders’ equity $    4,091,000 $    4,015,909

See accompanying notes to unaudited consolidated financial statements.

3



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)

Three Months Ended
March 31,    
(dollars in thousands, except for per share data)       2016       2015
Interest income
Interest and fees on loans $ 35,017 $ 29,314
Interest and dividends on investment securities:    
       Taxable 2,140 2,910
       Tax-exempt 883   883
       Dividends   352 220
Interest on federal funds sold and other short-term investments 134 43
              Total interest income 38,526 33,370
Interest expense
Deposits 3,939 3,025
Borrowings 3,267 2,053
              Total interest expense 7,206 5,078
Net interest income 31,320 28,292
Provision for loan and lease losses 3,000 1,825
Net interest income after provision for loan and lease losses 28,320 26,467
Noninterest income
Annuities and insurance commissions 40 86
Bank-owned life insurance 612 386
Net gains on sale of loans held for sale 35 114
Deposit, loan and other income 515 463
Net gains on sale of investment securities - 506
              Total other income 1,202 1,555
Noninterest expense
Salaries and employee benefits 7,599 6,628
Occupancy and equipment 2,247 2,082
FDIC insurance 595 560
Professional and consulting 711 494
Marketing and advertising 184 194
Data processing 1,024 900
Amortization of core deposit intangible 217 241
Other expenses 1,776 1,532
              Total other expense 14,353 12,631
Income before income tax expense 15,169 15,391
Income tax expense 4,778 5,012
Net Income 10,391 10,379
Less: Preferred stock dividends 22 28
Net income available to common stockholders $ 10,369 $ 10,351
Earnings per common share
              Basic $ 0.35 $ 0.35
              Diluted $ 0.34 $ 0.34
Weighted average common shares outstanding
              Basic 29,995,870 29,757,316
              Diluted        30,257,676        30,149,469
Dividends per common share $ 0.075 $ 0.075

See accompanying notes to unaudited consolidated financial statements.

4



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)

Three Months Ended
March 31,
(in thousands)       2016       2015
Net income $ 10,391 $ 10,379
Other comprehensive income (loss):
Unrealized gains and losses on securities:
       Unrealized holding gains on available-for-sale securities arising
              during the period 895 1,509
       Tax effect (357) (595)
              Net of tax 538 914
       Reclassification adjustment for realized gains included in net
              income -   (506)
       Tax effect - 207
              Net of tax - (299)
       Amortization of unrealized net losses on held-to-maturity  
              securities transferred from available-for-sale securities 51 65
       Tax effect (20) (25)
              Net of tax 31 40
Unrealized losses on cash flow hedge (1,437) (534)
Tax effect 587   218
       Net of tax (850) (316)
Unrealized pension plan gains and losses:            
       Unrealized pension plan (losses) gains before reclassifications     (1)     634
       Tax effect     -     (259)
              Net of tax     (1)     375
       Reclassification adjustment for realized losses included in net            
              income     102     108
       Tax effect     (41)     (44)
              Net of tax     61     64
Total other comprehensive (loss) income     (221)     778
Total comprehensive income   $ 10,170   $ 11,157

See accompanying notes to unaudited consolidated financial statements.

5



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)

Accumulated
Additional Other Total
Preferred Common Paid In Retained Treasury Comprehensive Stockholders’
(dollars in thousands, except for per share data)      Stock      Stock      Capital      Earnings      Stock      Loss      Equity
Balance as of December 31, 2014 $ 11,250 $ 374,287 $ 6,015 $ 72,398 $ (16,717) $ (1,014) $ 446,219
Net income - - - 10,379 - - 10,379
Other comprehensive income, net of tax - - - - - 778 778
Dividend on series B preferred stock - - - (28) - - (28)
Cash dividends declared on common stock
       ($0.075 per share) - - - (2,223) - - (2,223)
Exercise of stock options (110,500 shares) - - 590 - - - 590
Restricted stock grants (59,466 shares) - - - - - - -
Stock-based compensation - - 479 - - - 479
Balance as of March 31, 2015 $ 11,250 $ 374,287 $ 7,084 $ 80,526 $ (16,717) $ (236) $ 456,194
Balance as of December 31, 2015 $ 11,250 $ 374,287 $ 8,527 $ 104,606 $ (16,717) $ (4,609) $ 477,344
Net income - - - 10,391 - - 10,391
Other comprehensive loss, net of tax - - - - - (221) (221)
Dividend on series B preferred stock - - - (22) - - (22)
Cash dividends declared on common stock
       ($0.075 per share) - - - (2,312) - - (2,312)
Redemption of preferred stock (11,250) - - - - - (11,250)
Exercise of stock options (5,495 shares) - - 42 - - - 42
Restricted stock grants (71,920 shares) - - - - - - -
Stock-based compensation - - 755 - - - 755
Balance as of March 31, 2016 $     - $     374,287 $     9,324 $     112,663 $     (16,717) $     (4,830) $     474,727

See accompanying notes to unaudited consolidated financial statements.

6



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

Three Months Ended
March 31,
(in thousands)     2016     2015
Cash flows from operating activities
Net income $ 10,391 $ 10,379
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment 653 799
Provision for loan and lease losses 3,000 1,825
Amortization of intangibles 217 241
Net accretion of loans (1,174) (1,442)
Accretion on bank premises (31) (26)
Accretion on deposits (75)     (191)
Accretion on borrowings (86) (143)
Stock-based compensation 755 479
Gains on sales of investment securities, net - (506)
Gains on sale of loans held for sale, net   (35) (114)
Loans originated for resale   (1,916) (8,468)
Proceeds from sale of loans held for sale 1,951 7,190
Net loss on sale of other real estate owned 115 112
Increase in cash surrender value of bank-owned life insurance (612) (386)
Amortization of premiums and accretion of discounts on investments securities, net 417 518
(Increase) decrease in accrued interest receivable (58) 187
Increase in other assets (7,137) (49)
Increase (decrease) in other liabilities 960 (2,388)
       Net cash provided by operating activities 7,335 8,017
  
Cash flows from investing activities
Investment securities available-for-sale:
              Purchases (19,135) (1,543)
              Sales - 9,537
              Maturities, calls and principal repayments 24,295 6,673
Investment securities held-to-maturity:
              Purchases (1,000) (9,986)
              Maturities and principal repayments 5,439 2,749
Net redemptions (purchases) of restricted investment in bank stocks 1,125 (1,339)
Net increase in loans (164,130) (100,708)
Purchases of premises and equipment (941) (478)
Proceeds from sale of other real estate owned 738 126
       Net cash used in investing activities (153,609) (94,969)
  
Cash flows from financing activities
Net increase in deposits 102,180 20,595
Advances of FHLB borrowings 50,000 90,101
Repayments of FHLB borrowings (75,000) (60,363)
Cash dividends paid on common stock (2,312) (2,247)
Cash dividends paid on preferred stock (22) (28)
Redemption of preferred stock (11,250) -
Proceeds from exercise of stock options 42 590
       Net cash provided by financing activities 63,638 48,648
Net change in cash and cash equivalents (82,636) (38,304)
Cash and cash equivalents at beginning of period 200,895 126,847
Cash and cash equivalents at end of period $ 118,259 $ 88,543
 
Supplemental disclosures of cash flow information
Cash payments for:
       Interest paid on deposits and borrowings $ 6,492 $ 4,724
       Income taxes $ 10,235 $ 5,500

See accompanying notes to unaudited consolidated financial statements.

7



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1. Nature of Operations and Principles of Consolidation

The consolidated financial statements of ConnectOne Bancorp, Inc. (the “Parent Corporation”) are prepared on an accrual basis and include the accounts of the Parent Corporation and its wholly-owned subsidiary, ConnectOne Bank (the “Bank” and, collectively with the Parent Corporation and the Parent Corporation’s other direct and indirect subsidiaries, the “Company”). All significant intercompany accounts and transactions have been eliminated from the accompanying consolidated financial statements.

The Bank is a community-based, full-service New Jersey-chartered commercial bank that was founded in 2005. The Bank operates from its headquarters located at 301 Sylvan Avenue in the Borough of Englewood Cliffs, Bergen County, New Jersey and through its twenty other banking offices. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from business operations. There are no significant concentrations of loans to any one industry or client. However, the clients’ ability to repay their loans is dependent on the cash flows, real estate and general economic conditions in the area.

The preceding unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and, accordingly, do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2016, or for any other interim period. The Company’s 2015 Annual Report on Form 10-K should be read in conjunction with these financial statements.

In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and that affect the results of operations for the periods presented. Actual results could differ significantly from those estimates.

The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”). Some items in the prior year financial statements were reclassified to conform to current presentation. Reclassifications had no effect on prior year net income or stockholders’ equity.

Note 2. New Authoritative Accounting Guidance

ASU No. 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period ("ASU 2014-12"). ASU 2014-12 requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The Company adopted ASU 2014-12 effective on January 1, 2016 and is not expected to have a significant impact on the Company's consolidated financial statements.

ASU No. 2015-03, "Interest-Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs" requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in the ASU No. 2015-03. The Company adopted ASU 2015-03 effective on January 1, 2016 and is not expected to have a significant impact on the Company's consolidated financial statements.

ASU No. 2015-12, "Plan Accounting: Defined Benefit Pension Plans (Topic 960): Defined Contribution Pension Plans, (Topic 962): Health and Welfare Benefit Plans, (Topic 965): (Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient." ASU No. 2015-12 simplifies accounting for employee benefit plans as follows: (i) fully benefit-responsive investment contracts are now to be measured, presented and disclosed at contract value, (ii) the requirement to disclose investments that represent 5 percent or more of net assets available for benefits has been eliminated, (iii) the net appreciation or depreciation in investments for the period should be presented in the aggregate, but is no longer required to be disaggregated and disclosed by general type, (iv) if an investment is measured using the net asset value per share (or its equivalent) practical expedient in Topic 820, and that investment is in a fund that files a U.S. Department of Labor Form 5500, Annual Return/Report of Employee Benefit Plan, as a direct filing entity, disclosure of that investment’s strategy is no longer required, and (v) allows employers to measure (as a practical expedient) benefit plan assets on a month-end date nearest to the employer’s fiscal year end when the fiscal period does not coincide with a month end. ASU No. 2015-12 is effective for the Company on January 1, 2016 and is not expected to have a significant impact on the Company’s consolidated financial statements.

ASU No. 2016-02, “Leases (Topic 842)” requires the recognition of a right of use asset and related lease liability by lessees for leases classified as operating leases under current GAAP. Topic 842, which replaces the current guidance under Topic 840, retains a distinction between finance leases and operating leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee also will not significantly change from current GAAP. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize right of use assets and lease liabilities. Topic 842 will be effective for the Company for reporting periods beginning January 1, 2019, with an early adoption permitted. The Company must apply a modified retrospective transition approach for the applicable leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Management is currently evaluating the impact of Topic 842 on the Company’s consolidated financial statements.

8



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 3. Earnings per Common Share

Basic earnings per common share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted EPS includes any additional common shares as if all potentially dilutive common shares were issued (e.g., stock options). The Company’s weighted average common shares outstanding for diluted EPS include the effect of stock options and restricted stock awards outstanding using the Treasury Stock Method, which are not included in the calculation of basic EPS.

Earnings per common share have been computed as follows:

Three Months Ended
March 31,
(in thousands, except for per share data)       2016       2015
Net income $ 10,391 $ 10,379
Preferred stock dividends (22)     (28)
       Net income available to common stockholders   $ 10,369 $ 10,351
Basic weighted average common shares outstanding 29,996 29,757
Effect of dilutive options 262 392
       Diluted weighted average common shares outstanding        30,258        30,149
Earnings per common share:
       Basic $ 0.35 $ 0.35
       Diluted $ 0.34 $ 0.34

Note 4. Investment Securities

The Company’s investment securities are classified as available-for-sale and held-to-maturity at March 31, 2016 and December 31, 2015. Investment securities available-for-sale are reported at fair value with unrealized gains or losses included in equity, net of tax. Accordingly, the carrying value of such securities reflects their fair value as of March 31, 2016. Fair value is based upon either quoted market prices, or in certain cases where there is limited activity in the market for a particular instrument, assumptions are made to determine their fair value. See Note 7 of the Notes to Consolidated Financial Statements for a further discussion.

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

9



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 4. Investment Securities

The following tables present information related to the Company’s investment securities at March 31, 2016 and December 31, 2015 (dollars in thousands):

Gross Gross
  Amortized Unrealized Unrealized Fair
March 31, 2016       Cost       Gains       Losses       Value
Investment securities available-for-sale
       Federal agency obligations $     31,370 $     486 $     (29) $     31,827
       Residential mortgage pass-through securities 47,404 1,162 (21) 48,545
       Commercial mortgage pass-through securities 2,965 88 - 3,053
       Obligations of U.S. states and political subdivisions 9,642 164 - 9,806
       Trust preferred securities 16,089 440 (350) 16,179
       Corporate bonds and notes 40,771 873 (256) 41,388
       Asset-backed securities 18,682 - (528) 18,154
       Certificates of deposit 1,496 20 - 1,516
       Equity securities 376 29 (28) 377
       Other securities 20,490 84 (88) 20,486
              Total securities available-for-sale $ 189,285   $ 3,346 $ (1,300) $ 191,331
 
Gross Gross
Amortized Unrecognized Unrecognized Fair
      Cost       Gains       Losses       Value
Investment securities held-to-maturity
       U.S. Treasury and agency securities $     28,523 $     1,890 $     - $     30,413
       Federal agency obligations 31,567 700 (8) 33,259
       Residential mortgage-backed securities 3,489 28 (15) 3,502
       Commercial mortgage-backed securities 1,317 30 - 1,347
       Obligations of U.S. states and political divisions 117,416 6,208 - 123,624
       Corporate bonds and notes 37,061 1,396 (132) 38,325
              Total securities held-to-maturity $ 219,373 $ 10,252 $ (155) $ 229,470
   
       Total investment securities $ 408,658 $ 13,598 $ (1,455) $ 420,801

10



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 4. Investment Securities – (continued)

Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2015 Cost Gains Losses Value
Investment securities available-for-sale                        
       Federal agency obligations $     29,062 $     142 $     (58) $     29,146
       Residential mortgage pass-through securities 44,155 803 (48) 44,910
       Commercial mortgage pass-through securities 2,981 - (9) 2,972
       Obligations of U.S. states and political subdivisions 8,188 169 - 8,357
       Trust preferred securities 16,088 398 (231) 16,255
       Corporate bonds and notes 53,566 702 (292) 53,976
       Asset-backed securities 20,005 18 (298) 19,725
       Certificates of deposit 1,895 18 (8) 1,905
       Equity securities 376 21 (23) 374
       Other securities 18,303 - (153) 18,150
              Total securities available-for-sale $ 194,619 $ 2,271 $ (1,120) $ 195,770
  
Gross Gross
Amortized Unrecognized Unrecognized Fair
Cost Gains Losses Value
Investment securities held-to-maturity
       U.S. Treasury and agency securities $     28,471 $     755 $     - $     29,226
       Federal agency obligations 33,616 280 (119) 33,777
       Residential mortgage-backed securities 3,805 11 (6) 3,810
       Commercial mortgage-backed securities 4,110 27 (2) 4,135
       Obligations of U.S. states and political divisions 118,015 5,001 (3) 123,013
       Corporate bonds and notes 36,039 719 (161) 36,597
              Total securities held-to-maturity $ 224,056 $ 6,793 $ (291) $ 230,558
    
       Total investment securities $ 418,675 $ 9,064 $ (1,411) $ 426,328

The following table presents information for investment securities at March 31, 2016, based on scheduled maturities. Actual maturities can be expected to differ from scheduled maturities due to prepayment or early call options of the issuer.

March 31, 2016
  Amortized Fair
Cost Value
(in thousands)
Investment securities available-for-sale:            
       Due in one year or less $      10,948 $      10,967
       Due after one year through five years 15,800 16,287
       Due after five years through ten years 37,582 37,795
       Due after ten years 53,720 58,821
       Residential mortgage pass-through securities 47,404 48,545
       Commercial mortgage pass-through securities 2,965 3,053
       Equity securities 376 377
       Other securities 20,490 20,486
              Total $ 189,285 $ 191,331
Investment securities held-to-maturity:
       Due in one year or less $ 1,000 $ 1,000
       Due after one year through five years 14,561 14,907
       Due after five years through ten years 85,428 90,182
       Due after ten years 113,578 118,532
       Residential mortgage pass-through securities 3,489 3,502
       Commercial mortgage pass-through securities 1,317 1,347
              Total $ 219,373 $ 229,470
 
Total investment securities $ 408,658 $ 420,801

11



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 4. Investment Securities – (continued)

Gross gains and losses from the sales, calls and maturities of investment securities for the three months ended March 31, 2016 and 2015 were as follows:

Three Months Ended
March 31,
(in thousands)   2016       2015
Proceeds $     - $       9,537
Gross gains on sales of investment securities   - 506
Gross losses on sales of investment securities   - -
       Net gains on sales of investment securities   - 506
       Less: tax provision on net gains - 207
              Total $ - $ 299

The Company performs regular analysis on the securities portfolio to determine whether a decline in fair value indicates that an investment is other-than-temporarily impaired in accordance with FASB ASC 320-10. FASB ASC 320-10 requires companies to record other-than-temporary impairment (“OTTI”) charges, through earnings, if they have the intent to sell, or more likely than not will be required to sell, an impaired debt security before recovery of its amortized cost basis. If the Company intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current period credit loss, the OTTI is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its estimated fair value at the balance sheet date. If the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis less any current period loss, and the Company determines that a decline in fair value is other than temporary, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

The Company maintains a watch list for the identification and monitoring of securities experiencing problems that require a heightened level of review. This could include credit rating downgrades.

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

Temporarily Impaired Investments

The Company does not believe that the unrealized losses, for all securities, which were comprised of 46 and 74 investment securities as of March 31, 2016 and December 31, 2015, respectively, represent an other-than-temporary impairment. The gross unrealized losses associated with U.S. Treasury and agency securities, federal agency obligations, mortgage-backed securities, corporate bonds, tax-exempt securities, asset-backed securities, trust preferred securities, mutual funds and equity securities are not considered to be other than temporary because these unrealized losses are related to changes in interest rates and do not affect the expected cash flows of the underlying collateral or issuer.

Factors affecting the market price include credit risk, market risk, interest rates, economic cycles, and liquidity risk. The magnitude of any unrealized loss may be affected by the relative concentration of the Company’s investment in any one issuer or industry. The Company has established policies to reduce exposure through diversification of concentration of the investment portfolio including limits on concentrations to any one issuer. The Company believes the investment portfolio is prudently diversified.

The decline in value is related to a change in interest rates and subsequent change in credit spreads required for these issues affecting market price. All issues are performing and are expected to continue to perform in accordance with their respective contractual terms and conditions. Short to intermediate average durations and in certain cases monthly principal payments should reduce further market value exposure to increases in rates.

12



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 4. Investment Securities – (continued)

The Company evaluates all securities with unrealized losses quarterly to determine whether the loss is other than temporary. Unrealized losses in the corporate debt securities category consist primarily of senior unsecured corporate debt securities issued by large financial institutions, insurance companies and other corporate issuers. Single issuer corporate trust preferred securities are also included, and in the case of one holding the market valuation loss is largely based upon the floating rate coupon and corresponding market valuation. Neither that trust preferred issuer, nor any other corporate issuers, have defaulted on interest payments. The unrealized loss in equity securities consists of losses on other bank equities. The decline in fair value is due in large part to the lack of an active trading market for these securities, changes in market credit spreads and rating agency downgrades. Management concluded that these securities were not other-than-temporarily impaired at March 31, 2016.

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

The following tables indicate gross unrealized losses not recognized in income and fair value, aggregated by investment category and the length of time individual securities have been in a continuous unrealized loss position at March 31, 2016 and December 31, 2015:

March 31, 2016
Total Less than 12 Months 12 Months or Longer
        Fair       Unrealized       Fair       Unrealized       Fair       Unrealized
Value Losses Value Losses Value Losses
(in thousands)
Investment securities
       available-for-sale:
 
Federal agency obligation $    7,070 $    (29) $    6,836 $    (28) $    234 $    (1)
Residential mortgage
       pass-through securities 7,173 (21) 6,679 (14) 494 (7)
Trust preferred securities 1,227 (350) - - 1,227 (350)
Corporate bonds and notes 15,553 (256) 11,727 (118) 3,826 (138)
Asset-backed securities 18,154 (528) 14,825 (417) 3,329 (111)
Equity securities 117 (28) - - 117 (28)
Other securities 5,412 (88) - - 5,412 (88)
       Total $ 54,706 $ (1,300) $ 40,067 $ (577) $ 14,639 $ (723)
 
Investment securities
       held-to-maturity:
 
Federal agency obligation $ 4,161 $ (8) $ 2,300 $ (6) $ 1,861 $ (2)
Residential mortgage
       pass-through securities 1,920 (15) 1,920 (15) - -
Corporate bonds and notes 2,632 (131) 2,632 (131) - -
       Total $ 8,713 $ (154) $ 6,852 $ (152) $ 1,861 $ (2)
 
Total temporarily impaired
       securities $ 63,419 $ (1,454) $ 46,919 $ (729) $ 16,500 $ (725)

13



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 4. Investment Securities – (continued)

December 31, 2015
Total Less than 12 Months 12 Months or Longer
  Fair Unrealized Fair Unrealized Fair Unrealized
      Value       Losses       Value       Losses       Value       Losses
(dollars in thousands)
Investment Securities
       Available-for-Sale:
Federal agency obligation $     12,260 $     (58) $     12,013 $     (54) $     247 $     (4)
Residential mortgage
       pass-through securities 9,027 (48) 9,027 (48)
Commercial mortgage-backed
       securities 2,971 (9) 2,971 (9)
Trust preferred securities 1,345 (231) 1,345 (231)
Corporate bonds and notes 16,533 (292) 12,702 (161) 3,831 (131)
Asset-backed securities 14,745 (298) 11,250 (188) 3,495 (110)
Certificates of deposit 215 (8) 215 (8)
Equity securities 123 (23) 123 (23)
Other securities 5,347 (153) 5,347 (153)
Total $ 62,566 $ (1,120) $ 48,178 $ (468) $ 14,388 $ (652)
Investment Securities
       Held-to-Maturity:
Federal agency obligation 12,554 (119) 11,783 (109) 771 (10)
Residential mortgage
       pass-through securities 2,480 (6) 2,480 (6)
Commercial mortgage-backed
       securities 1,331 (2) 1,331 (2)
Obligations of U.S. states
       and political subdivisions 981 (3) 981 (3)
Corporate bonds and notes 5,536 (161) 5,536 (161)
Total $ 22,882 $ (291) $ 22,111 $ (281) $ 771 $ (10)
Total Temporarily Impaired
       Securities $ 85,448 $ (1,411) $ 70,289 $ (749) $ 15,159 $ (662)

Investment securities having a carrying value of approximately $155.3 million and $142.5 million at March 31, 2016 and December 31, 2015, respectively, were pledged to secure public deposits, borrowings, Federal Reserve Discount Window and Federal Home Loan Bank advances and for other purposes required or permitted by law.

As of March 31, 2016 and December 31, 2015, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

Note 5 – Derivatives

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

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

14



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 5 – Derivatives – (continued)

Summary information about the interest rate swaps designated as cash flow hedges as of March 31, 2016, December 31, 2015 and March 31, 2015 are presented in the following table.

      March 31,       December 31,       March 31,
(dollars in thousands) 2016 2015 2015
Notional amount $       75,000 $      75,000 $      50,000
Weighted average pay rates 1.57% 1.56% 1.58%
Weighted average receive rates 0.56% 0.44% 0.24%
Weighted average maturity 3.6 years 3.8 years 4.2 years
Fair value $ (1,568) $ (131) $ (486)

Interest expense recorded on these swap transactions totaled approximately $191 thousand for the three months ended March 31, 2016 and $166 thousands for the three months ended March 31, 2015.

Cash Flow Hedge

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

Three Months Ended March 31, 2016
Amount of
loss
recognized
in other
  Amount of loss Non-
recognized Amount of loss interest
in OCI reclassified income
      (Effective       from OCI to interest       (Ineffective
(in thousands) Portion) income Portion)
Interest rate contracts $ (1,437) $ - $     -
 
Three Months Ended March 31, 2015
Amount of
loss
recognized
in other
Amount of loss non-
recognized Amount of loss interest
in OCI reclassified income
(effective from OCI to interest (ineffective
(in thousands) Portion) income portion)
Interest rate contracts $     (534) $     - $     -

The following table reflects the cash flow hedges included in the consolidated statements of condition as of March 31, 2016 and December 31, 2015:

2016 2015
  Notional Notional
(in thousands)       Amount       Fair Value       Amount       Fair Value
Included in other assets/(liabilities):
       Interest rate swaps related to FHLB Advances $     75,000 $     (1,568) $     75,000 $     (131)

15



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses

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

Loan segments are defined as a group of loans and leases, which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. Management has determined that the Company has five segments of loans and leases: commercial (including lease financing), commercial real estate, commercial construction, residential real estate (including home equity) and consumer.

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

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

The policy of the Company is to generally grant commercial, residential and consumer loans to residents and businesses within its market area. The borrowers’ abilities to repay their obligations are dependent upon various factors including the borrowers’ income and net worth, cash flows generated by the borrowers’ underlying collateral, value of the underlying collateral, and priority of the lender’s lien on the property. Such factors are dependent upon various economic conditions and individual circumstances beyond the control of the Company. The Company is therefore subject to risk of loss. The Company believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan and lease losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for a large majority of the Company’s loans.

Allowance for Loan and Lease Losses

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

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

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

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

16



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

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

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

Purchased Credit-Impaired Loans

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

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

A PCI loan may be resolved either through a sale of the loan, by working with the customer and obtaining partial or full repayment, by short sale of the collateral, or by foreclosure. A gain or loss on resolution would be recognized based on the difference between the proceeds received and the carrying amount of the loan.

Payments received earlier than expected or in excess of expected cash flows from sales or other resolutions may result in the carrying value of a pool being reduced to zero even though outstanding contractual balances and expected cash flows remain related to loans in the pool. Once the carrying value of a pool is reduced to zero, any future proceeds, which may include cash or real estate acquired in foreclosure, from the remaining loans, representing further realization of accretable yield, are recognized as interest income upon receipt.

PCI loans that met the criteria for nonaccrual may be considered performing, regardless of whether the customer is contractually delinquent, if management can reasonably estimate the timing and amount of the expected cash flows on such loans and if management expects to fully collect the new carrying value of the loans. As such, management may no longer consider the loans to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable discount.

17



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

Composition of Loan Portfolio

The following table sets forth the composition of the Company’s loan portfolio, including net deferred loan fees, at March 31, 2016 and December 31, 2015:

March 31, December 31,
2016 2015
(in thousands)
Commercial       $     601,708       $     570,116
Commercial real estate 2,028,301 1,966,696
Commercial construction 402,594 328,838
Residential real estate 231,319 233,690
Consumer 1,851 2,454
       Gross loans 3,265,773 3,101,794
Net deferred loan fees (1,960) (2,787)
       Total loans receivable $ 3,263,813 $ 3,099,007

At March 31, 2016 and December 31, 2015 loan balances of approximately $1.6 billion were pledged to secure borrowings from the Federal Home Loan Bank of New York.

Purchased Credit-Impaired Loans

The Company holds purchased loans for which there was, at their acquisition date, evidence of deterioration of credit quality since their origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans is as follows at March 31, 2016 and December 31, 2015.

March 31, December 31,
2016       2015
        (in thousands)
Commercial $ 7,059 $ 7,078
Commercial real estate 1,745 1,775
Residential real estate 334 328
       Total carrying amount $ 9,138 $ 9,181

For those purchased loans disclosed above, the Company did not increase the allowance for loan and lease losses for the three months ended March 31, 2016.

The accretable yield, or income expected to be collected, on the purchased loans disclosed above for the three months ended March 31, 2016 is as follows (in thousands):

Three Months Three Months
  Ended March Ended March
31, 2016 31, 2015
Beginning balance       $     3,599       $     4,805
New loans purchased - -
Accretion of income (183) (54)
Reclassification from nonaccretable differences - -
Disposals - -
Ending balance $ 3,416 $ 4,751

18



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

The following table presents information about the recorded investment in loan receivables on nonaccrual status by segment at March 31, 2016 and December 31, 2015:

Loans Receivable on Nonaccrual Status

March 31, December 31,
2016 2015
(in thousands)
Commercial $ 7,239       $ 6,586
Commercial real estate 8,841 9,112
Commercial construction 1,636 1,479
Residential real estate 3,734 3,559
       Total loans receivable on nonaccrual status $             21,450 $             20,736

The Company continuously monitors the credit quality of its loans receivable. In addition to its internal staff, the Company utilizes the services of a third party loan review firm to rate the credit quality of its loans receivable. Credit quality is monitored by reviewing certain credit quality indicators. Assets classified “Pass” are deemed to possess average to superior credit quality, requiring no more than normal attention. Assets classified as “Special Mention” have generally acceptable credit quality yet possess higher risk characteristics/circumstances than satisfactory assets. Such conditions include strained liquidity, slow pay, stale financial statements, or other conditions that require more stringent attention from the lending staff. These conditions, if not corrected, may weaken the loan quality or inadequately protect the Company’s credit position at some future date. Assets are classified “Substandard” if the asset has a well-defined weakness that requires management’s attention to a greater degree than for loans classified special mention. Such weakness, if left uncorrected, could possibly result in the compromised ability of the loan to perform to contractual requirements. An asset is classified as “Doubtful” if it is inadequately protected by the net worth and/or paying capacity of the obligor or of the collateral, if any, that secures the obligation. Assets classified as doubtful include assets for which there is a “distinct possibility” that a degree of loss will occur if the inadequacies are not corrected. The following table presents information, excluding net deferred loan fees, about the Company’s loan credit quality at March 31, 2016 and December 31, 2015:

March 31, 2016
            Special                  
Pass Mention Substandard Doubtful Total
(in thousands)
Commercial $ 494,413 $ 6,976 $       100,319 $ - $ 601,708
Commercial real estate 1,979,211       17,820 31,270 -       2,028,301
Commercial construction 400,131 827 1,636 - 402,594
Residential real estate 226,879 - 4,440 - 231,319
Consumer 1,770 - 81 - 1,851
 
       Total loans $       3,102,404 $ 25,623 $ 137,746 $ - $ 3,265,773
 
December 31, 2015
Special
Pass Mention Substandard Doubtful Total
(in thousands)
Commercial $ 462,358 $ 11,760 $ 95,998 $ - $ 570,116
Commercial real estate 1,919,041 18,990 28,426 239 1,966,696
Commercial construction 326,697 662 1,479 - 328,838
Residential real estate 229,426 - 4,264 - 233,690
Consumer 2,368 - 86 - 2,454
                               
       Total loans $ 2,939,890 $ 31,412 $ 130,253 $ 239 $ 3,101,794

19



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

The following table provides an analysis of the impaired loans, by loan segment, at March 31, 2016 and December 31, 2015:

      March 31, 2016
      Unpaid      
Recorded Principal Related
Investment Balance Allowance
No related allowance recorded (in thousands)
Commercial $ 3,320 $ 3,625
Commercial real estate 15,271 15,202
Commercial construction 2,466 2,538
Residential real estate 4,123 4,532
Consumer 81 81
       Total $ 25,261 $ 25,978
 
With an allowance recorded
Commercial $ 91,928 $ 91,851 $ 7,677
 
Total
Commercial $ 95,248 $ 95,476 $ 7,677
Commercial real estate 15,271 15,202 -
Commercial construction 2,466 2,538 -
Residential real estate 4,123 4,532 -
Consumer 81 81 -
       Total $ 117,189 $      117,829 $           7,677
 
December 31, 2015
Unpaid
Recorded Principal Related
Investment Balance Allowance
No related allowance recorded (in thousands)
Commercial $ 610 $ 645
Commercial real estate 15,517 16,512
Commercial construction 2,149 2,141
Residential real estate 3,954 4,329
Consumer 87 86
       Total $ 22,317 $ 23,713
 
With an allowance recorded
Commercial $ 84,787 $ 84,449 $ 6,725
 
Total
Commercial $ 85,397 $ 85,094 $ 6,725
Commercial real estate 15,517 16,512 -
Commercial construction 2,149 2,141 -
Residential real estate 3,954 4,329 -
Consumer 87 86 -
       Total $      107,104 $ 108,162 $ 6,725

20



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

The following table provides an analysis related to the average recorded investment and interest income recognized on impaired loans by segment as of and for the three and nine months ended March 31, 2016 and 2015 (in thousands):

Three Months Ended March 31,
      2016       2015
Average       Interest Average       Interest
Recorded Income Recorded Income
Investment Recognized Investment Recognized
Impaired loans with
no related allowance
recorded
 
Commercial $ 2,591 $ 24 $ 290 $ -
Commercial real
estate 15,274 25 6,052 19
Commercial
construction 2,307 16 - -
Residential real
estate 4,107 5 3,613 2
Consumer 84 1 106 1
 
      Total $ 24,363 $ 71 $ 10,061 $ 22
 
Impaired loans with
an allowance
recorded
 
Commercial $ 83,759 $ 737 $ 387 $ -
Commercial real  
estate - - 6,335 -
 
      Total $ 83,759 $ 737 $ 6,722 $ -
 
Total impaired loans
 
Commercial $ 86,350 $ 761 $ 677 $ -
Commercial real
estate 15,274 25 12,387 19
Commercial    
construction 2,307 16
Residential real
estate 4,107 5 3,613 2
Consumer 84 1 106 1
 
Total $ 108,122 $ 808 $ 16,783 $ 22

Included in impaired loans at March 31, 2016 and December 31, 2015 are loans that are deemed troubled debt restructurings. The recorded investment in loans include accrued interest receivable and other capitalized costs such as real estate taxes paid on behalf of the borrower and loan origination fees, net, when applicable. Cash basis interest and interest income recognized on accrual basis approximate each other.

21



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

The following table provides an analysis of the aging of the recorded investment of loans, excluding net deferred loan fees that are past due at March 31, 2016 and December 31, 2015 by segment:

Aging Analysis

March 31, 2016
                  Loans
   Receivable 90
90 Days or Days or Greater
30-59 Days 60-89 Days Greater Past Total Past Total Loans Past Due and
Past Due Past Due Due Due Current Receivable Accruing
(in thousands)
Commercial $ 5,539 $ - $ 12,409 $ 17,948 $ 583,760 $ 601,708 $ 5,250
Commercial real
estate 5,408 - 10,027 15,435 2,012,866 2,028,301 1,382
Commercial
construction 1,750 - - 1,750 400,844 402,594 -
Residential real
estate 1,741 380 2,746 4,867 226,452 231,319 -
Consumer 2 - - 2 1,849 1,851
       Total $ 14,440 $ 380 $ 25,181 $ 40,002 $ 3,225,771 $ 3,265,773 $ 6,632
 
December 31, 2015
Loans
Receivable 90
90 Days or Days or Greater
30-59 Days 60-89 Days Greater Past Total Past Total Loans Past Due and
Past Due Past Due Due Due Current Receivable Accruing
(in thousands)
Commercial $ 6,887 $ 3,505 $ 6,865 $ 17,257 $ 552,859 $ 570,116 $ -
Commercial real
estate 1,998 988 9,561 12,547 1,954,149 1,966,696 -
Commercial  
construction - - 1,479 1,479 327,359 328,838 -
Residential real
estate - - 2,122 2,122 231,568 233,690 -
Consumer 4 9 - 13 2,441 2,454 -
       Total $ 8,889 $ 4,502 $ 20,027 $ 33,418 $   3,068,376 $ 3,101,794 $ -

22



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

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

March 31, 2016
Commercial Commercial Residential
Commercial     real estate     construction     real estate     Consumer     Unallocated     Total
    (in thousands)
Allowance for loan and lease losses
        Individually evaluated for impairment $ 7,677 $ - $ - $ - $ - $ - $ 7.677
Collectively evaluated for impairment 5,420 10,941 3,617 1,074 4 341 21,397
Acquired with deteriorated credit quality - - - - - - -
Total $ 13,097 $ 10,941 $ 3,617 $ 1,074 $ 4 $ 341 $ 29,074
 
Gross loans
Individually evaluated for impairment $ 95,248 $ 15,271 $ 2,466 $ 4,123 $ 81 $ - $ 117,189
Collectively evaluated for impairment 499,401 2,011,285 400,128 226,862 1,770 - 3,139,446
Acquired with deteriorated credit quality 7,059 1,745 - 334 - - 9,138
Total $ 601,708 $ 2,028,301 $ 402,594 $ 231,319 $ 1,851 $ - $   3,265,773

The table above includes approximately $824 million of acquired loans for the period ended March 31, 2016 reported as collectively evaluated for impairment, of which approximately $661 million were included in the commercial real estate loan segment.

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

December 31, 2015
Commercial Commercial Residential
   Commercial    real estate    construction    real estate    Consumer    Unallocated    Total
  (in thousands)
Allowance for loan and lease losses
         Individually evaluated for impairment $ 6,725 $ - $ - $ - $ - $ - $ 6,725
Collectively evaluated for impairment 4,224 10,926 3,253 976 4 464 19,847
Acquired with deteriorated credit quality - - - - - - -
Total $ 10,949 $ 10,926 $ 3,253 $ 976 $ 4 $ 464 $ 26,572
 
Gross loans
Individually evaluated for impairment $ 85,397 $ 15,517 $ 2,149 $ 3,954 $ 87 $ - $ 107,104
Collectively evaluated for impairment 477,641 1,949,404 326,689 229,408 2,367 - 2,985,509
Acquired with deteriorated credit quality 7,078 1,775 - 328 - - 9,181
Total $ 570,116 $ 1,966,696 $ 328,838 $ 233,690 $ 2,454 $ - $   3,101,794

The tables above include approximately $867 million of acquired loans as of December 31, 2015 reported as collectively evaluated for impairment, of which $672 million were included in the commercial real estate loan segment.

23



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

       The Company’s allowance for loan and lease losses is analyzed quarterly. Many factors are considered, including growth in the portfolio, delinquencies, nonaccrual loan levels, and other factors inherent in the extension of credit. There have been no material changes to the allowance for loan and lease losses methodology as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

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

Three Months Ended March 31, 2016
      Commercial    Commercial    Residential         
Commercial real estate construction real estate Consumer Unallocated Total
(in thousands)
Balance at December 31,
2015 $ 10,949 $ 10,926 $ 3,253 $ 976 $ 4 $ 464 $ 26,572
 
Charge-offs (445) - - (67) - - (512)
 
Recoveries 1 13 - - - - 14
 
Provision 2,592 2 364 165 - (123) 3,000
                                                       
Balance at March 31, 2016 $ 13,097 $ 10,941 $ 3,617 $ 1,074 $ 4 $ 341 $ 29,074  
 
Three Months Ended March 31, 2015
Commercial Commercial Residential
Commercial real estate construction real estate   Consumer Unallocated Total
(in thousands)
Balance at December 31,
2014 $              3,083 $              7,799 $ 1,239 $ 1,113 $ 7 $              919 $ 14,160
 
Charge-offs (45) (4) - -              (11) - (60)
 
Recoveries 6 - - 1 1 - 8
 
Provision 883 1,051 279          (133) 7 (262) 1,825
                                                       
Balance at March 31, 2015 $ 3,927 $ 8,846 $ 1,518 $ 981 $ 4 $ 657 $   15,933

24



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

Trouble Debt Restructurings

At March 31, 2016, there were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status or were contractually past due in excess of 90 days and still accruing interest, or whose terms have been modified in troubled debt restructurings.

The policy of the Company generally is to grant commercial, mortgage and consumer loans to residents and businesses within its market area. The ability of borrowers abilities to repay their obligations are dependent upon various factors, including the borrowers’ income and net worth, cash flows generated by the borrowers’ underlying collateral, value of the underlying collateral, and priority of the lender’s lien on the property. Such factors are dependent upon various economic conditions and individual circumstances beyond the control of the Company. The Company is therefore subject to risk of loss. The Company believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan and lease losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for virtually all loans. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

Loans modified in troubled debt restructurings totaled $96.5 million at March 31, 2016, of which $1.4 million were on nonaccrual status and $95.1 million were performing troubled debt restructurings. At December 31, 2015, loans modified in troubled debt restructurings totaled $86.6 million, of which $0.7 million were on nonaccrual status and $85.9 million were performing troubled debt restructurings. The Company has allocated $6.0 million in specific allocations with respect to loans whose loan terms had been modified in troubled debt restructurings as of March 31, 2016. At December 31, 2015, there were $4.5 million in specific allocations with respect to performing troubled debt restructurings, and there were no specific allocations with respect to troubled debt restructurings as of March 31, 2015. Performing TDRs as of March 31, 2016 increased the allowance for loan and lease losses by $1.5 million for the three months ended March 31, 2016. Performing TDRs as of March 31, 2015 did not increase the allowance for loan and lease losses for the three months ended March 31, 2015.

The $6.0 million in specific allocations referenced above were associated with taxi medallion lending and were calculated based on the present value of estimated cash flows, including contractual debt interest service through maturity, and principal repayments based on the fair value of the collateral excluding any consideration for personal guarantees of borrowers, which provide an additional source of repayment but cannot be relied upon. The valuation per corporate medallion used for the calculation at March 31, 2016 was approximately $775,000. An additional $1.5 million specific allocation was required at March 31, 2016 due to a decline in the Company’s estimated valuation of taxi medallions at December 31, 2015, when the specific allocation was $4.5 million.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three months ended March 31, 2016 (dollars in thousands):

Pre-Modification Post-Modification
Outstanding Outstanding
  Number of Recorded Recorded
      Loans       Investment       Investment
Troubled debt restructurings:
       Commercial 9 $ 9,555 $ 9,555
       Commercial real estate - - -
       Commercial construction - - -
       Residential real estate - - -
       Consumer - - -
 
              Total 9 $ 9,555 $ 9,555

The increase in TDRs was primarily due to six loans secured by New York City taxi medallions totaling $8.0 million that were modified during the first quarter of 2016. Four of these modifications consisted of short-term extensions of the loans’ contractual maturity dates at the pre-existing contractual rate and two of these modifications interest rates decreased from approximately 3% to 1.3-1.6%. These six loans were accruing prior to modification, while five remained in accrual status post-modification.

The troubled debt restructurings described above increased the allowance for loan and lease losses by $45 thousand during the three months ended March 31, 2016. There were no charge-offs in connection with a loan modification at the time of modification during the three months ended March 31, 2016. There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the three months ended March 31, 2016.

25



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 6. Loans and the Allowance for Loan and Lease Losses – (continued)

There were no troubled debt restructurings occurring during the three months ended March 31, 2015. There were no charge-offs in connection with a loan modification at the time of modification during the three months ended March 31, 2015. There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the three months ended March 31, 2015.

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments

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 value:

FASB ASC 820-10-05 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurements and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

FASB ASC 820-10-65 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10-05 when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

FASB ASC 820-10-05 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820-10-05 are as follows:

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

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

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

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at March 31, 2016 and December 31, 2015:

Securities Available-for-Sale

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 inputs include securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy include municipal bonds and certain agency collateralized mortgage obligations. In certain cases where there is limited activity in the market for a particular instrument, assumptions must be made to determine the fair value of the instruments and these are classified as Level 3. When measuring fair value, the valuation techniques available under the market approach, income approach and/or cost approach are used. The Company’s evaluations are based on market data and the Company employs combinations of these approaches for its valuation methods depending on the asset class.

26



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments

Derivatives

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

Loans Held for Sale

Loans held for sale are required to be measured at the lower of cost or fair value. Under FASB ASC 820-10-05, market value is to represent fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions.

Loans Receivable

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

Off-Balance Sheet Financial Instruments

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

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

27



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments

Assets and Liabilities Measured at Fair Value on a Recurring Basis

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2016 and December 31, 2015 are as follows:

March 31, 2016
Fair Value Measurements at Reporting Date Using
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Assets Inputs Inputs
            (Level 1)       (Level 2)       (Level 3)
(in thousands)
Recurring fair value measurements:
Assets
Investment securities:
       Available-for-sale:
              Federal agency obligations $      31,827 $      - $      31,827 $      -
              Residential mortgage pass-
                     through securities   48,545 - 48,545 -
              Commercial mortgage pass-
                     through securities 3,053 - 3,053 -
              Obligations of U.S. states and
                     political subdivision 9,806 - 9,806 -
              Trust preferred securities   16,179   -   16,179   -
              Corporate bonds and notes 41,388   - 41,388   -
              Asset-backed securities 18,154 -   18,154 -
              Certificates of deposit 1,516 - 1,516 -
              Equity securities 377 377 - -
              Other securities 20,486 20,486 - -
       Total available-for-sale $ 191,331 $ 20,863 $ 170,468 $ -
Liabilities
Derivatives $ 1,568 $ - $ 1,568 $ -
 
Total liabilities $ 1,568 $ - $ 1,568 $ -

There were no transfers between Level 1, Level 2 and Level 3 during the three months ended March 31, 2016.

28



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments – (continued)

December 31, 2015
Fair Value Measurements at Reporting Date Using
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Assets Inputs Inputs
            (Level 1)       (Level 2)       (Level 3)
(in thousands)
Recurring fair value measurements:                        
Assets
Investment securities:                        
       Available-for-sale:
              Federal agency obligations   $      29,146   $      -   $      29,146   $      -
              Residential mortgage pass-
                     through securities 44,910 - 44,910 -
              Commercial mortgage pass-                        
                     through securities     2,972     -     2,972     -
              Obligations of U.S. states and  
                     political subdivision 8,357 - 8,357 -
              Trust preferred securities     16,255     -     16,255     -
              Corporate bonds and notes 53,976 - 53,976 -
              Asset-backed securities     19,725     -     19,725     -
              Certificates of deposit 1,905 - 1,905 -
              Equity securities     374     374     -     -
              Other securities 18,150 18,150 - -
       Total available-for-sale   $ 195,770   $ 18,524   $ 177,246   $ -
       Liabilities
       Derivatives   $ 131   $ -   $ 131   $ -
       Total liabilities $ 131 $ - $ 131 $ -

There were no transfers between Level 1, Level 2 and Level 3 during the year ended December 31, 2015.

Assets Measured at Fair Value on a Non-Recurring Basis

The Company may be required periodically to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or impairment write-downs of individual assets. The Company primarily utilized appraisal value less cost to sell and other unobservable market inputs to determine fair value of assets, and therefore, these valuations are classified as a Level 3 measurement. For assets measured at fair value on a non-recurring basis, the fair value measurements at March 31, 2016 and December 31, 2015 are as follows:

Impaired loans       Valuation Techniques       Range of Unobservable Inputs
Commercial Appraisals of collateral value Adjustment for age of comparable sales, generally a decline of 0% to 15%. Adjustment for age of lease payments. Market capitalization rates between 4% and 8%

29



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments – (continued)

Fair Value Measurements at Reporting Date Using
Quoted
Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
March 31, Assets Inputs Inputs
Assets measured at fair value on a nonrecurring basis:     2016     (Level 1)     (Level 2)     (Level 3)
Impaired loans   (in thousands)
Commercial $         3,410 $         - $     - $         3,410
 
Fair Value Measurements at Reporting Date Using
Quoted
  Prices
in Active Significant
  Markets for Other Significant
  Identical Observable Unobservable
December 31, Assets Inputs Inputs
Assets measured at fair value on a nonrecurring basis: 2015 (Level 1) (Level 2) (Level 3)
Impaired loans   (in thousands)
Commercial $ 3,751 $ - $ - $ 3,751

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis at March 31, 2016 and December 31, 2015.

Impaired loans - The value of the impaired loans above were measured based upon the fair value of the collateral of the loans. Smaller balance homogeneous loans that are collectively evaluated for impairment, such as residential mortgage loans and consumer loans, are specifically excluded from the impaired loan portfolio. The Company’s impaired loans are primarily collateral dependent. Impaired loans are individually assessed to determine that each loan’s carrying value is not in excess of the fair value of the related collateral. Impaired loans at March 31, 2016 that required a valuation allowance were $5.1 million with a related valuation allowance of $1.7 million compared to $6.0 million with a related valuation allowance of $2.2 million at December 31, 2015.

Fair Value of Financial Instruments

FASB ASC 825-10 requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in FASB ASC 825-10. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Company’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities except for loans held-for-sale and investment securities available-for-sale. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Company for the purposes of this disclosure.

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

FHLB stock. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

30



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments – (continued)

Investment Securities Held-to-Maturity. The fair value of the Company’s investment securities held-to-maturity was primarily measured using information from a third-party pricing service. If quoted prices were not available, fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. In cases where there may be limited or less transparent information provided by the Company’s third-party pricing service, fair value may be estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

Loans. The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were segregated by types such as commercial, residential and consumer loans. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

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

Term Borrowings and Subordinated Debentures. The fair value of the Company’s long-term borrowings and subordinated debentures were calculated using a discounted cash flow approach and applying discount rates currently offered based on weighted remaining maturities.

Accrued Interest Receivable/Payable. The carrying amounts of accrued interest approximate fair value resulting in a level 2 or level 3 classification based on the level of the asset or liability with which the accrual is associated.

31



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments – (continued)

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of March 31, 2016 and December 31, 2015.

Fair Value Measurements
Quoted
Prices in
Active Significant
Markets for Other Significant
Identical Observable Unobservable
Carrying Fair Assets Inputs Inputs
      Amount       Value       (Level 1)       (Level 2)       (Level 3)
(in thousands)
March 31, 2016
Financial assets
       Cash and due from banks $      118,259 $      118,259 $      118,259 $      - $      -
       Investment securities available-for-sale 191,331 191,331 20,863 170,468 -
       Investment securities held-to-maturity 219,373 229,470 30,413 180,553 18,504
       Restricted investment in bank stocks 31,487 n/a n/a n/a n/a
       Net loans 3,234,739 3,242,398 - - 3,242,398
       Accrued interest receivable 12,604 12,604 199 2,486 9,919
 
Financial liabilities
       Noninterest-bearing deposits 614,507 614,507 614,507 - -
       Interest-bearing deposits 2,278,564 2,285,918 - 2,285,918 -
       Borrowings 646,501 651,739 - 651,739 -
       Subordinated debentures, net 54,392 57,879 - 57,879 -
       Derivatives 1,568 1,568 - 1,568 -
       Accrued interest payable $ 5,101 $ 5,101 $ - $ 5,101 $ -
 
December 31, 2015
Financial assets
       Cash and due from banks $ 200,895 $ 200,895 $ 200,895 $ - $ -
       Investment securities available-for-sale 195,770 195,770 18,524 177,246 -
       Investment securities held-to-maturity 224,056 230,558 29,226 182,774 18,558
       Restricted investment in bank stocks 32,612 n/a n/a n/a n/a
       Net loans 3,072,435 3,059,343 - - 3,059,343
       Accrued interest receivable 12,545 12,545 68 2,699 9,778
 
Financial liabilities
       Noninterest-bearing deposits 650,775 650,775 650,775 - -
       Interest-bearing deposits 2,140,191 2,137,149 - 2,137,149 -
       Borrowings 671,587 674,131 - 674,131 -
       Subordinated debentures, net 54,343 55,209 - 55,209 -
       Derivatives 131 131 - 131 -
       Accrued interest payable $ 4,387 $ 4,387 $ - $ 4,387 $ -

32



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Fair Value Measurements and Fair Value of Financial Instruments – (continued)

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.

Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values.

The Company’s remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than has been customary with historical cost accounting. No disclosure of the relationship value of the Company’s core deposit base is required by FASB ASC 825-10.

Fair value estimates are based on existing balance sheet financial instruments, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, there are certain significant assets and liabilities that are not considered financial assets or liabilities, deferred taxes, premises and equipment, and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Management believes that reasonable comparability between financial institutions may not be likely, due to the wide range of permitted valuation techniques and numerous estimates which must be made, given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Note 8. Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss (net of tax) at March 31, 2016 and December 31, 2015 consisted of the following:

March 31, December 31,
      2016       2015
(in thousands)
Net unrealized gain on investment securities available-for-sale $      1,251 $      713
Cash flow hedge (927) (77)
Unamortized component of securities transferred from available-for-sale to held-to-  
       maturity   (1,142) (1,173)
Defined benefit pension and post-retirement plans   (4,012)     (4,072)
       Total accumulated other comprehensive loss $ (4,830) $ (4,609)

33



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 9. Stock-Based Compensation

The Company maintains three stock-based compensation plans from which new grants could be issued. The Company’s stock-based compensation plans permit Parent Corporation common stock to be issued to key employees and directors of the Company and its subsidiaries. Grants under the existing plans can be in the form of stock options (qualified or non-qualified), restricted shares, or performance units. Shares available for grant and issuance under the existing plans as of March 31, 2016 are as follows 68,516 under the 2009 Equity Incentive Plan and 235,090 shares under the North Jersey Community Bancorp 2009 Equity Compensation Plan. The Company intends to issue all shares under these plans in the form of newly issued shares.

Restricted stock and option awards typically have a three-year vesting period starting one year after the date of grant with one-third vesting each year. The options generally expire ten years from the date of grant. Restricted stock awards granted to new employees and board members may be granted with shorter vesting periods. Grants of performance units typically have a cliff vesting after 3 years. All issuances are subject to forfeiture if the recipient leaves or is terminated prior to the awards vesting. Restricted shares have the same dividend and voting rights as common stock while options and performance units do not.

All awards are issued at fair value of the underlying shares at the grant date. The Company expenses the cost of the awards, which is determined to be the fair market value of the awards at the date of grant, ratably over the vesting period.

No options were granted during the three months ended March 31, 2016 or 2015.

During the three months ended March 31, 2016 and 2015 a total of 71,920 and 48,507 restricted shares were awarded, respectively. The compensation expense related to restricted stock awards during the quarter ended March 31, 2016 was $182,000.

During 2016 and 2015, the Company granted to various key employees performance unit awards, with each unit entitling the holder to one share of the Company’s common stock contingent upon the Company meeting or exceeding certain return on asset targets over the course of a three-year period commencing on the date of issuance. Under the agreement, and assuming the Company has met or exceeded the applicable targets, grants of performance unit awards will vest on the third anniversary of the grant date or on an earlier date in the event of a change in control, as defined in the agreement. At March 31, 2016, the specific number of shares related to performance unit awards that were expected to vest was 151,577, determined by actual performance in consideration of the established range of the performance targets, which is consistent with the level of expense currently being recognized over the vesting period. Should this expectation change, additional compensation expense could be recorded in future periods or previously recognized expense could be reversed. The maximum amount of performance unit awards is 181,892 shares. The total amount of compensation cost related to performance unit awards included in salary expense during the quarter ended March 31, 2016 and 2015 was $193,000 and $0, respectively.

Option activity under the principal option plans as of March 31, 2016 and changes during the three months ended March 31, 2016 were as follows:

Weighted-
Average
Weighted- Remaining
Average Contractual
Exercise Term Aggregate
      Shares       Price       (In Years)       Intrinsic Value
Outstanding at December 31, 2015 535,906 $      6.48
Granted - -
Exercised (5,495) 7.67
Forfeited/cancelled/expired      (20,839) 9.77      
Outstanding at March 31, 2016 509,572 $ 6.34 2.92 $      5,102,923
Exercisable at March 31, 2016 503,941 $ 6.22 2.90 $ 5,071,354

34



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 9. Stock-Based Compensation

Information related to stock option exercises during 2016:

2016
Intrinsic value of options exercised $       54,326
Cash received from options exercised 42,171
Tax benefit realized from options exercised 17,114
Weighted average fair value of options granted   -

The aggregate intrinsic value of options above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on March 31, 2016 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2016. This amount changes based on the fair market value of the Parent Corporation’s stock.

The below table represents information regarding restricted shares currently outstanding at March 31, 2016:

Weighted-
Average
Nonvested Grant Date
      Shares       Fair Value
Nonvested at December 31, 2015 96,902 $ 16.81
Granted 71,920   15.88
Vested (54,648)   16.01
Forfeited/cancelled/expired   (1,000) 19.58
Nonvested at March 31, 2016 113,174 $      16.81

As of March 31, 2016, there was $1,806,000 of total unrecognized compensation cost related to nonvested restricted shares granted under the plans. The cost is expected to be recognized over a weighted average period of 24.0 months. The total fair value of shares vested during the quarter ended March 31, 2016, was $686,000.

35



CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 9 - Stock Based Compensation – (continued)

A summary of the status of unearned performance unit awards and the change during the period is presented in the table below:

Weighted-
Average
Grant Date
Shares Fair Value
Unearned at December 31, 2015       94,485       $ 19.46
Awarded 64,540 17.15
 
Forfeited       (7,447) 19.46
Expired - -
Unearned at March 31, 2016 151,578 $      19.46

At March 31, 2016, compensation cost of $2,198,000 related to nonvested awards not yet recognized is expected to be recognized over a weighted-average period of 2.3 years.

Note 10. Components of Net Periodic Pension Cost

The Company maintained a non-contributory defined benefit pension plan for substantially all of its employees until March 31, 2007, at which time the Company froze the plan. The following table sets forth the net periodic pension cost of the Company’s pension plan for the periods indicated.

Three Months Ended
March 31,
2016 2015
Interest cost $      128 $      138
Expected return on plan assets       (136)       (137)
Net amortization 102 108
Recognized settlement loss - 450
       Total periodic pension expense $ 94 $ 559
 
Net actuarial gain $ (101) $ (742)
 
Total recognized in other comprehensive income $ (101) $ (742)
 
Total recognized in net periodic expense and other
comprehensive income (before tax) $ (7) $ (183)

Contributions

As of March 31, 2016, The Company intended to contribute $2.0 million to its Pension Trust during the second quarter of 2016. (As intended, the company contributed $2.0 million to its Pension Trust in April 2016). The trust is established to provide retirement and other benefits for eligible employees and their beneficiaries. No part of the trust assets may be applied to any purpose other than providing benefits under the plan and for defraying expenses of administering the plan and the trust.

36




CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 11. FHLB and other borrowings

The Company’s FHLB and other borrowings and weighted average interest rates are summarized below:

March 31, 2016 December 31, 2015
Amount Rate Amount Rate
(in thousands)
By type of borrowing:
       FHLB borrowings $ 631,501 1.30 % $ 656,587 1.26 %
       Repurchase agreements ("REPO") 15,000 5.95 15,000 5.95
Total borrowings $ 646,501 1.41 $ 671,587 1.37
 
By remaining period to maturity:                        
       One year or less $ 330,501 0.64 270,587 0.64
       One to two years 121,000 1.90 171,000 1.56
       Two to three years 105,000 1.96 130,000 1.84
       Three to four years 50,000 1.66 35,000 1.60
       Four to five years 40,000 3.42 65,000 2.82
Total borrowings $     646,501      1.41 % $     671,587      1.37 %

The FHLB borrowings are secured by pledges of certain collateral including, but not limited to, U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgages and commercial real estate loans.

The Company has entered into agreements under which it has sold securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. The obligation to repurchase the securities is reflected as a liability in the Company’s consolidated statement of condition, while the securities underlying the securities sold under agreements to repurchase remain in the respective asset accounts and are delivered to and held as collateral by third party trustees.

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 its current market rate. The Company has the option to repay these advances, if converted, without penalty. The remaining advances are payable at stated maturity, with a prepayment penalty for fixed rate advances. All FHLB advances are fixed rate while the REPOs are variable rate advances. The advances at March 31, 2016 were collateralized by approximately $1.2 billion of commercial mortgage loans, net of required over-collateralization amounts, under a blanket lien arrangement. At March 31, 2016 the Company had remaining borrowing capacity of approximately at FHLB of approximately $594 million.

37




CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 12 – Securities Sold under Agreements to Repurchase

Repurchase agreements are secured borrowings. The Company pledges investment securities to secure those borrowings. Information concerning repurchase agreements is summarized as follows for the periods presented:

March 31, December 31, March 31,
(dollars in thousands) 2016 2015 2015
Average daily balance during the year-to-date $ 15,000 $ 22,890 $ 31,000
Average interest rate during the year-to-date 5.95% 5.92% 5.90%
Maximum month-end balance during the year-to-date $     15,000 $     31,000 $     31,000%
Weighted average interest rate during the year-to-date       5.95%       5.92%       5.90%

The table below shows the remaining contractual maturity of agreement by fair value of collateral pledged:

March 31, 2016
Remaining Contractual Maturity of the Agreements
Overnight and Up to 30 Greater Than
(dollars in thousands) Continuous Days 30-90 Days 90 Days Total
Repurchase agreements and
Repurchase-to-maturity transactions
       U.S. Treasury and agency securities       $ -       $ -       $ -       $ 5,069       $ 5,069
       Residential mortgage pass-through securities - - - 14,849 14,849
Total Borrowings $     - $     - $     - $     19,918 $     19,918
 
Amounts related to agreements not included in offsetting disclosure in Note 14 $ 4,918

December 31, 2015
Remaining Contractual Maturity of the Agreements
Overnight and Up to 30 Greater Than
(dollars in thousands) Continuous Days 30-90 Days 90 Days Total
Repurchase agreements and
Repurchase-to-maturity transactions
       U.S. Treasury and agency securities       $ -       $ -       $ -       $ 6,313       $ 6,313
       Residential mortgage pass-through securities - - - 12,589 12,589
Total Borrowings $     - $     - $     - $     18,902 $     18,902
 
Amounts related to agreements not included in offsetting disclosure in Note 14 $ 3,902

The fair value of securities pledged to secure repurchase agreement may decline. The Company manages this risk by having a policy to pledge securities valued at 8% above the gross outstanding balance of repurchase agreement. Securities sold under agreements to repurchase are secured by securities with a carrying amount of $19.1 million and $18.8 million at March 31, 2016 and December 31, 2015.

Note 13 - Subordinated Debentures

During 2003, the Company formed a statutory business trust, which exists for the exclusive purpose of (i) issuing Trust Securities representing undivided beneficial interests in the assets of the Trust; (ii) investing the gross proceeds of the Trust securities in junior subordinated deferrable interest debentures (subordinated debentures) of the Company; and (iii) engaging in only those activities necessary or incidental thereto. On December 19, 2003, Center Bancorp Statutory Trust II, a statutory business trust and wholly-owned subsidiary of the Parent Corporation issued $5.0 million of MMCapS capital securities to investors due on January 23, 2034. The capital securities presently qualify as Tier I capital. The trust loaned the proceeds of this offering to the Company and received in exchange $5.2 million of the Parent Corporation’s subordinated debentures. The subordinated debentures are redeemable in whole or in part prior to maturity. The floating interest rate on the subordinate debentures is three-month LIBOR plus 2.85% and reprices quarterly. The rate at March 31, 2016 was 3.47%. These subordinated debentures and the related income effects are not eliminated in the consolidated financial statements as the statutory business trust is not consolidated in accordance with FASB ASC 810-10. Distributions on the subordinated debentures owned by the subsidiary trust have been classified as interest expense in the Consolidated Statements of Income.

38




CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 13 - Subordinated Debentures – (continued)

The following table summarizes the mandatory redeemable trust preferred securities of the Company’s Statutory Trust II at March 31, 2016 and December 31, 2015.

Securities Redeemable by
Issuance Date       Issued       Liquidation Value       Coupon Rate       Maturity       Issuer Beginning
      12/19/2003 $      5,000,000 $1,000 per Capital Floating 3-month 01/23/2034 01/23/2009
Security LIBOR + 285 Basis  
Points

During June 2015, the Parent Corporation issued $50 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “Notes”) to certain institutional investors. The Notes are non-callable for five years, have a stated maturity of July 1, 2025, and bear interest at a fixed rate of 5.75% per year, from and including June 30, 2015 to, but excluding July 1, 2020. From and including July 1, 2020 to the maturity date or early redemption date, the interest rate will reset quarterly to a level equal to the then current three-month LIBOR rate plus 393 basis points. As of March 31, 2016, unamortized costs related to the debt issuance were $763,000.

The net proceeds from the sale of the Notes were used by the Parent Corporation to contribute $35.0 million of common equity to the Bank on June 30, 2015, and to repay, on March 11, 2016, $11.25 million of SBLF preferred issued to the U.S. Treasury. Remaining funds will be used for general corporate purposes.

In connection with the issuance of the Notes, the Parent Corporation obtained ratings from Kroll Bond Rating Agency (“KBRA”). KBRA assigned investment grade ratings of BBB- for the Company’s subordinated debt and a senior deposit rating of BBB+ for the Bank.

Note 14 – Offsetting Assets and Liabilities

Certain financial instrument-related assets and liabilities may be eligible for offset on the consolidated statements of condition because they are subject to master netting agreements or similar agreements. However, the Company does not elect to offset such arrangements on the consolidated financial statements. The Company enters into interest rate swap agreements with financial institution counterparties. For additional detail regarding interest rate swap agreements refer to Footnote 5 within this section. In the event of default on, or termination of, any one contract, both parties have the right to net settle multiple contracts. Also, certain interest rate swap agreements may require the Company to receive or pledge cash or financial instrument collateral based on the contract provisions.

39




CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 14 – Offsetting Assets and Liabilities – (continued)

The Company also entered into an agreement to sell securities subject to an obligation to repurchase the same or similar securities, referred to as a repurchase agreement. Under this agreement, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. The obligation to repurchase the securities is reflected as a liability in the Company’s consolidated statement of condition, while the securities underlying the repurchase agreements remain in the respective investment securities account, therefore there is no offsetting or netting of the investment securities assets with the repurchase agreement liability. The following table presents information about financial instruments that are eligible for offset as of March 31, 2016 and December 31, 2015:

Gross Amounts Not Offset
Gross Amounts Net Amounts Cash or
Offset in the of Assets Presented in the Financial Financial
Gross Amounts Statement of Statement of Financial Instruments Instrument Net
Recognized Financial Position Position Recognized Collateral Amount
(in thousands)
March 31, 2016
Assets:
       Interest rate swaps     $ -     $ -     $ -     $ -     $ -     $ -
Liabilities:
       Interest rate swaps $ 1,568 $ - $ 1,568 $ - $ 1,568 $ -
       Repurchase
              agreements 15,000 - 15,000 - 15,000 -
                     Total $ 16,568 $ - $ 16,568 $ - $ 16,568 $ -
December 31, 2015
Assets:
       Interest rate swaps $ 48 $ - $ - $ - $ - $ -
Liabilities:
       Interest rate swaps $ 131 $ - $ 131 $ - $ 131 $ -
       Repurchase
              agreements 15,000 - 15,000 - 15,000 -
                     Total $     15,131 $     - $     15,131 $     - $     15,131 $     -

40




CONNECTONE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 15 – Presentation of Debt Issuance Costs

As of January 1, 2016, the Company adopted Accounting Standards Update (“ASU”) No. 2015-03 “Simplifying the Presentation of Debt Issuance Costs,” which requires that debt issuance costs be presented in the consolidated statement of condition as a direct deduction from the carrying amount of debt liability. This ASU is required to be applied retrospectively to all periods presented. The following table summarizes the impact of retrospective application to the consolidated statement of condition for the year ended December 31, 2015:

December 31,
(dollars in thousands)       2015
Other assets
       As previously reported $ 24,908
       As reported under the new guidance 24,096
 
Total assets
       As previously reported $ 4,016,721
       As reported under the new guidance 4,015,909
 
Subordinated debentures
       As previously reported $ 55,155
       As reported under the new guidance 54,343
 
Total liabilities
       As previously reported $ 3,539,377
       As reported under the new guidance 3,538,565

41




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Company’s results of operations for the periods presented herein and financial condition as of March 31, 2016 and December 31, 2015. In order to fully understand this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing elsewhere in this report.

Cautionary Statement Concerning Forward-Looking Statements

This report includes forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, that involve inherent risks and uncertainties. This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of ConnectOne Bancorp Inc. and its subsidiaries, including statements preceded by, followed by or that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) competitive pressures among depository institutions may increase significantly; (2) changes in the interest rate environment may reduce interest margins; (3) prepayment speeds, loan origination and sale volumes, charge-offs and loan and lease loss provisions may vary substantially from period to period; (4) general economic conditions may be less favorable than expected; (5) political developments, sovereign debt problems, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions may adversely affect the businesses in which ConnectOne Bancorp is engaged, including, without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and regulations issued thereunder; (7) changes and trends in the securities markets may adversely impact ConnectOne Bancorp; (8) a delayed or incomplete resolution of regulatory issues could adversely impact planning by ConnectOne Bancorp; (9) the impact on reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; and (10) the outcome of regulatory and legal investigations and proceedings may not be anticipated. Further information on other factors that could affect the financial results of ConnectOne Bancorp is included in Item 1a. of ConnectOne Bancorp’s Annual Report on Form 10-K and in ConnectOne Bancorp’s other filings with the Securities and Exchange Commission. These documents are available free of charge at the Commission’s website at http://www.sec.gov and/or from ConnectOne Bancorp, Inc.

Critical Accounting Policies and Estimates

The accounting and reporting policies followed by ConnectOne Bancorp, Inc. and its subsidiaries (collectively, the “Company”) conform, in all material respects, to U.S. generally accepted accounting principles. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and for the periods indicated in the consolidated statements of operations. Actual results could differ significantly from those estimates.

The Company’s accounting policies are fundamental to understanding Management’s Discussion and Analysis (“MD&A”) of financial condition and results of operations. The Company has identified the determination of the allowance for loan and lease losses, the other-than-temporary impairment evaluation of securities, the evaluation of the impairment of goodwill and the evaluation of deferred tax assets to be critical because management must make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available. Additional information on these policies is provided below.

Allowance for loan and lease losses and Related Provision

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

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

42




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

Other-Than-Temporary Impairment of Investment Securities

Investment securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. FASB ASC 320-10-65 clarifies the interaction of the factors that should be considered when determining whether a debt security is other–than-temporarily impaired. For debt securities, management assesses whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery.

In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

Fair Value of Investment Securities

FASB ASC 820-10-35 clarifies the application of the provisions of FASB ASC 820-10-05 in an inactive market and how an entity would determine fair value in an inactive market. The Company applies the guidance in FASB ASC 820-10-35 when determining fair value for the Company’s private label collateralized mortgage obligations, pooled trust preferred securities and single name corporate trust preferred securities. See Note 8 of the Notes to Consolidated Financial Statements for further discussion.

FASB ASC 820-10-65 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10-05 when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

Goodwill

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

Income Taxes

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

Fluctuations in the actual outcome of these future tax consequences could impact the Company’s consolidated financial condition or results of operations. Note 12 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2015 includes additional discussion on the accounting for income taxes.

43




Operating Results Overview

Net income available to common stockholders for both the three months ended March 31, 2016 and March 31, 2015 amounted to $10.4 million, or $0.34 per diluted share.

Net Interest Income and Margin

Net interest income is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets. Net interest income is presented on a tax-equivalent basis by adjusting tax-exempt income (primarily interest earned on obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues. Net interest margin is defined as net interest income on a tax-equivalent basis as a percentage of total average interest-earning assets.

Fully taxable equivalent net interest income for the first quarter of 2016 was $32.0 million, an increase of $3.1 million, or 10.7%, from the same quarter of 2015. This was a result of a 17.2% increase in average interest-earning assets due to significant organic loan growth, partially offset by a 23 basis-point contraction of the net interest margin. Included in net interest income was accretion and amortization of purchase accounting adjustments of $1.3 million during the first quarter of 2016 and $1.8 million in the same quarter of 2015. Excluding these purchase accounting adjustments, the adjusted net interest margin was 3.31% in the first quarter of 2016, 15 basis points lower than the 2015 first quarter adjusted net interest margin of 3.46%. The reduction in the adjusted net interest margin in the first quarter of 2016 versus the same 2015 period was attributable to a decline in yield on loans combined with an increase in overall funding rates. The decline in loan yields largely reflects the impact of a protracted low interest rate environment, while the increase in the cost of funds was due to the June 30, 2015 issuance of approximately $50 million in subordinated debt, the extension of liability duration in connection with interest rate risk management, and the impact of an increasingly competitive environment for deposits.

44




Average Statements of Condition with Interest and Average Rates

The following tables, “Average Statements of Condition with Interest and Average Rates”, present for the three months ended March 31, 2016 and 2015, the Company’s average assets, liabilities and stockholders’ equity. The Company’s net interest income, net interest spread and net interest margin are also reflected.

Three Months Ended March 31,
2016 2015
Interest Interest
Average Income/ Average Average Income/ Average
     Balance      Expense      Rate (7)      Balance      Expense      Rate (7)
(dollars in thousands)
Interest-earning assets:
       Investment securities (1) (2) $ 415,481 $ 3,499      3.39 % $ 509,931 $ 4,268      3.39 %
       Loans (2) (3) (4) 3,189,572 35,206 4.44 2,571,552 29,453 4.65
Federal funds sold and interest bearing with banks 90,712 134 0.59 76,138   43 0.23
Restricted investment in bank stocks 33,193 352 4.26 25,273 220 3.54
       Total interest-earning assets 3,728,958 39,191 4.23 3,182,894 33,984 4.33
Allowance for loan and lease losses (27,221) (14,749)
Noninterest earning assets