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EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - ConnectOne Bancorp, Inc.cob3249341-ex322.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - ConnectOne Bancorp, Inc.cob3249341-ex321.htm
EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - ConnectOne Bancorp, Inc.cob3249341-ex312.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - ConnectOne Bancorp, Inc.cob3249341-ex311.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, 2017
 
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   Emerging growth company
reporting company)

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ☐

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:
(Title of Class)
32,005,471 shares
(Outstanding as of April 28, 2017)



Table of Contents

            Page
PART I – FINANCIAL INFORMATION
     
Item 1. Financial Statements
Consolidated Statements of Condition at March 31, 2017 (unaudited) and December 31, 2016 3
Consolidated Statements of Income for the three months ended March 31, 2017 and 2016 (unaudited) 4
Consolidated Statements of Comprehensive Income for the three months ended March 31, 2017 and 2016 (unaudited) 5
Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2017 and for the three months ended March 31, 2016 (unaudited) 6
Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 (unaudited) 7
Notes to Consolidated Financial Statements 8
         
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   45
         
Item 3. Qualitative and Quantitative Disclosures about Market Risks 58
         
Item 4. Controls and Procedures 59
         
PART II – OTHER INFORMATION
     
Item 1. Legal Proceedings 60
         
Item 1a. Risk Factors 60
         
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 61
         
Item 3. Defaults Upon Senior Securities 61
         
Item 4. Mine Safety Disclosures 61
         
Item 5. Other Information 61
         
Item 6. Exhibits 62
         
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)       2017       2016
(unaudited)
ASSETS
Cash and due from banks $ 35,867 $ 37,150
Interest-bearing deposits with banks 126,002 163,249
       Cash and cash equivalents 161,869 200,399
 
Securities available-for-sale 352,476 353,290
 
Loans held-for-sale (net of valuation allowance of $2,600 and $-0-, respectively) 62,255 78,005
 
Loans receivable 3,571,663 3,475,832
Less: Allowance for loan losses 26,901 25,744
       Net loans receivable 3,544,762 3,450,088
 
Investment in restricted stock, at cost 24,985 24,310
Bank premises and equipment, net 22,259 22,075
Accrued interest receivable 12,701 12,965  
Bank owned life insurance 99,063 98,359
Other real estate owned 580 626
Goodwill 145,909 145,909
Core deposit intangibles 2,895 3,088
Other assets 31,062 37,234
       Total assets $       4,460,816 $       4,426,348
LIABILITIES
Deposits:
       Noninterest-bearing $ 671,183 $ 694,977
       Interest-bearing 2,684,294   2,649,294
              Total deposits 3,355,477 3,344,271
Borrowings 491,226     476,280
Subordinated debentures (net of debt issuance costs of $580 and $621, respectively) 54,575   54,534
Other liabilities   19,261   20,231
       Total liabilities 3,920,539   3,895,316
 
COMMITMENTS AND CONTINGENCIES
 
STOCKHOLDERS’ EQUITY
Common stock, no par value, authorized 50,000,000 shares; issued 34,068,393 shares at
March 31, 2017 and 34,018,731 at December 31, 2016; outstanding 32,004,471 shares at March 31, 2017 and 31,948,307 at December 31, 2016
412,546 412,726
Additional paid-in capital 11,796 11,407
Retained earnings 135,939 126,462
Treasury stock, at cost (2,063,922 common shares at March 31, 2017 and December 31, 2016) (16,717 ) (16,717 )
Accumulated other comprehensive loss (3,287 ) (2,846 )
       Total stockholders’ equity 540,277 531,032
       Total liabilities and stockholders’ equity $ 4,460,816 $ 4,426,348

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) 2017       2016
Interest income
Interest and fees on loans $        38,006 $        35,017
Interest and dividends on securities:
       Taxable 1,548 2,140
       Tax-exempt 954 883
       Dividends 330 352
Interest on federal funds sold and other short-term investments 246 134
              Total interest income 41,084 38,526
Interest expense
Deposits 5,109 3,939
Borrowings 2,834 3,267
              Total interest expense 7,943 7,206
Net interest income 33,141 31,320
Provision for loan losses 1,100 3,000
Net interest income after provision for loan losses 32,041 28,320
Noninterest income
Annuities and insurance commissions 39 40
Income on bank owned life insurance 703 612
Net gains on sale of loans held-for-sale 21 35
Deposit, loan and other income 643 515
Net gains on sales of securities available-for-sale 1,596 -
              Total noninterest income 3,002 1,202
Noninterest expenses
Salaries and employee benefits 8,206 7,599
Occupancy and equipment   2,255   2,247
FDIC insurance 895 595
Professional and consulting 718 711
Marketing and advertising 256   184
Data processing 1,149 1,024
Amortization of core deposit intangible 193 217
Increase in valuation allowance, loans held-for-sale 2,600 -
Other expenses 1,977 1,776
              Total noninterest expenses 18,249 14,353
Income before income tax expense 16,794 15,169
Income tax expense 4,914 4,778
Net income 11,880 10,391
Less: Preferred stock dividends - 22
Net income available to common stockholders $ 11,880 $ 10,369
Earnings per common share
              Basic $ 0.37 $ 0.35
              Diluted 0.37 0.34
 
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) 2017       2016
Net income $ 11,880 $ 10,391
Other comprehensive income (loss):
Unrealized gains and losses on securities:
       Unrealized holding (losses) gains on available-for-sale securities
              arising during the period 689 895
       Tax effect (268 ) (357 )
              Net of tax 421 538
       Reclassification adjustment for realized gains included in net
              income (1,596 ) -
       Tax effect 579 -
              Net of tax (1,017 ) -
       Amortization of unrealized net losses on held-to-maturity
              securities transferred from available-for-sale securities - 51
       Tax effect - (20 )
              Net of tax - 31
Unrealized gains (losses) on cash flow hedge 160 (1,437 )
Tax effect (65 ) 587
       Net of tax 95 (850 )
Unrealized pension plan gains and losses:
       Unrealized pension plan losses before reclassifications (2 ) (1 )
       Tax effect 1 -
              Net of tax (1 ) (1 )
       Reclassification adjustment for realized losses included in net  
              income   103 102
       Tax effect (42 )   (41 )
              Net of tax 61   61
Total other comprehensive loss (441 ) (221 )
Total comprehensive income $         11,439 $         10,170

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
(dollars in thousands, except for Preferred Common Paid-In Retained Treasury Comprehensive Stockholders’
per share data) Stock       Stock       Capital       Earnings       Stock       Loss       Equity
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
 
Balance as of December 31, 2016 $ - $ 412,726 $       11,407 $ 126,462 $ (16,717 ) $ (2,846 ) $ 531,032
Net income - - - 11,880 - - 11,880
Other comprehensive loss, net of
     tax - - - - - (441 ) (441 )
Cash dividends declared on
     common stock ($0.075 per
     share) - - - (2,403 ) - - (2,403 )
 
Stock issuance costs - (180 ) - - - - (180 )
Restricted stock
     grants (56,164 shares)   -     -   -   -     - - -
Stock-based compensation              
     expense - -   389 - - - 389
 
Balance as of March 31, 2017 $ - $ 412,546 $ 11,796 $ 135,939 $ (16,717 ) $ (3,287 ) $ 540,277

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) 2017       2016
Cash flows from operating activities              
Net income $ 11,880 $ 10,391
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment 775 653
Increase in valuation allowance, loans held-for-sale 2,600 -
Provision for loan losses 1,100 3,000
Amortization of intangibles 193 217
Net accretion of loans (590 ) (1,174 )
Accretion on bank premises (23 ) (31 )
Accretion on deposits (4 ) (75 )
Accretion on borrowings (54 ) (86 )
Stock-based compensation 389 755
Gains on sales of securities available-for-sale, net (1,596 ) -
Gains on sale of loans held-for-sale, net (21 ) (35 )
Gains on sale of fixed assets, net (8 ) -
Loans originated for resale (2,105 ) (1,916 )
Principal paydowns on loans held-for-sale 1,677 -
Proceeds from sale of loans held-for-sale 6,440 1,951
Net loss on sale of other real estate owned 82 115
Increase in cash surrender value of bank owned life insurance (704 )     (612 )
Amortization of premiums and accretion of discounts on securities available-for-sale 489   417
Decrease (increase) in accrued interest receivable   264 (58 )
Decrease (increase) in other assets 6,373 (7,137 )
(Decrease) increase in other liabilities (664 ) 960
       Net cash provided by operating activities 26,493 7,335
  
Cash flows from investing activities
Securities available-for-sale:
              Purchases (49,912 ) (19,135 )
              Sales 29,543 -
              Maturities, calls and principal repayments 21,383 24,295
Securities held-to-maturity:
              Purchases - (1,000 )
              Maturities and principal repayments - 5,439
Net (purchases) redemptions of restricted investment in bank stocks (675 ) 1,125
Net increase in loans (88,605 ) (164,130 )
Proceeds from sales of fixed assets 8 -
Purchases of premises and equipment (936 ) (941 )
Proceeds from sale of other real estate owned 544 738
       Net cash used in investing activities (88,650 ) (153,609 )
 
Cash flows from financing activities
Net increase in deposits 11,210 102,180
Advances of Federal Home Loan Bank (“FHLB”) borrowings 100,000 50,000
Repayments of FHLB borrowings (85,000 ) (75,000 )
Cash dividends paid on common stock (2,403 ) (2,312 )
Cash dividends paid on preferred stock - (22 )
Common stock issuance costs (180 ) -
Redemption of preferred stock - (11,250 )
Proceeds from exercise of stock options - 42
       Net cash provided by financing activities 23,627 63,638
Net change in cash and cash equivalents (38,530 ) (82,636 )
Cash and cash equivalents at beginning of period 200,399 200,895
Cash and cash equivalents at end of period $        161,869 $        118,259
Supplemental disclosures of cash flow information
Cash payments for:
       Interest paid on deposits and borrowings $ 7,603 $ 6,492
       Income taxes 55 10,235
Noncash activities:
       Loans transferred to other real estate owned $ 580 $ -
       Transfer of loans held-for-sale to loans held-to-maturity 7,159 -

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

ConnectOne Bancorp, Inc. (the “Parent Corporation”) is incorporated under the laws of State of New Jersey and is a registered bank holding company. The Parent Corporation’s business currently consists of the operation of its wholly-owned subsidiary, ConnectOne Bank (the “Bank” and, collectively with the Parent Corporation and the Parent Corporation’s subsidiaries, the “Company”). The Bank’s subsidiaries include Union Investment Co. (a New Jersey investment company), Twin Bridge Investment Co. (a Delaware investment company), ConnectOne Preferred Funding Corp. (a New Jersey real estate investment trust), Center Financial Group, LLC (a New Jersey financial services company), Center Advertising, Inc. (a New Jersey advertising company), Morris Property Company, LLC, (a New Jersey limited liability company), Volosin Holdings, LLC, (a New Jersey limited liability company), and NJCB Spec-1, LLC (a New Jersey limited liability company).

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. Primarily all loans are secured with various types of collateral, including business assets, consumer assets and commercial/residential real estate. The borrowers' ability to repay its loans is dependent on the conversion of assets, cash flows generated from their business, real estate rental and consumer wages.

The preceding unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) 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 GAAP 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, 2017 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2017, or for any other interim period. The Company’s 2016 Annual Report on Form 10-K should be read in conjunction with these consolidated 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 GAAP. Some items in the prior year consolidated 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. 2017-08, “'Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.” ASU No. 2017-08 shortens the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 will be effective for us on January 1, 2019 and we are currently evaluating this ASU to determine the impact on our consolidated financial statements.

ASU No. 2017-07, “'Compensation — Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” ASU No. 2017-07 requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The amendments also allow only the service cost component to be eligible for capitalization when applicable (e.g., as a cost of internally manufactured inventory or a self-constructed asset). ASU 2017-08 will be effective for us on January 1, 2018 and we are currently evaluating this ASU to determine the impact on our consolidated financial statements.

8



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

Note 2. New Authoritative Accounting Guidance – (continued)

ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350).” ASU 2017-04 aims to simplify the subsequent measurement of goodwill. Under these amendments, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The Board also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets and still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019. We are currently evaluating this ASU to determine the impact on our consolidated financial statements.

ASU No. 2017-01, “Business Combinations (Topic 805).” ASU 2017-01 provides a screen to determine when an asset is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the asset is not a business. This screen reduces the number of transactions that need to be further evaluated. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments in this update should be applied prospectively on or after the effective date. We are currently evaluating this ASU to determine the impact on our consolidated financial statements.

ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.” ASU 2016-16 requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The ASU eliminates the exception for an intra-entity transfer of an asset other than inventory. The ASU does not include new disclosure requirements; however, existing disclosure requirements might be applicable when accounting for the current and deferred income taxes for an intra-entity transfer of an asset other than inventory. For public entities that are U.S. Securities and Exchange Commission (SEC) filers, the amendments in this update are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. We are currently evaluating this ASU to determine the impact on our consolidated financial statements.

9



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

Note 2. New Authoritative Accounting Guidance – (continued)

ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” provides guidance on the following eight specific cash flow issues: (1) Debt prepayment or debt extinguishment costs; (2) Settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (3) Contingent consideration payments made after a business combination; (4) Proceeds from the settlement of insurance claims; (5) Proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) Distributions received from equity method investees; (7) Beneficial interests in securitization transactions; and (8) Separately identifiable cash flows and application of the predominance principle. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments in this Update should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. We are currently evaluating this ASU to determine the impact on our consolidated financial statements.

ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Assets Measured at Amortized Cost.” ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates and affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. For public business entities that are U.S. Securities and Exchange Commission (SEC) filers, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently in the process of forming a CECL committee that will be assessing our data and system needs, as well as considering the engagement of a third-party vendor to assist in implementation. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the ASU is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the ASU on our consolidated financial statements.

ASU No. 2016-12,“Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients.”ASU 2016-12 was issued to clarify ASC Topic 606, “Revenue from Contracts with Customers” and to address narrow-scope improvements to the guidance on collectability, noncash consideration, and completed contracts at transition. Additionally, the amendments in this Update provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. The effective date and transition of ASU 2016-12 is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” as discussed above. Although management continues to evaluate the potential impact of ASU 2014-09 on our consolidated financial statements at this time we believe the adoption of this standard will not have a significant impact to our consolidated financial statements.

ASU No. 2016-10,“Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing.”ASU 2016-10 was issued to clarify ASC Topic 606, “Revenue from Contracts with Customers” related to (i) identifying performance obligations; and (ii) the licensing implementation guidance. The effective date and transition of ASU 2016-10 is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” as discussed above. Although management continues to evaluate the potential impact of ASU 2014-09 on our consolidated financial statements at this time we believe the adoption of this standard will not have a significant impact to our consolidated financial statements.

10



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

Note 2. New Authoritative Accounting Guidance – (continued)

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 consolidated financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. The Company is currently leasing seventeen properties as branch locations and is leasing certain office equipment. The adoption of ASU 2016-02 will result in increases to the Company’s assets and liabilities. We are currently in the process of evaluating all of our leases for compliance with the new ASU.

ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-1, among other things; (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. ASU 2016-1 will be effective for us on January 1, 2018 and we are currently evaluating the potential impact of ASU No. 2016-01 on our consolidated financial statements.

ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 was originally going to be effective for us on January 1, 2017; however, the FASB recently issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date” which deferred the effective date of ASU 2014-09 by one year to January 1, 2018. We are currently evaluating the potential impact of ASU 2014-09 on its consolidated financial statements.

11



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

Note 3. Earnings per Common Share

Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) No. 260-10-45 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”). The restricted stock awards and certain restricted stock units granted by the Company contain non-forfeitable rights to dividends and therefore are considered participating securities. The two-class method for calculating basic EPS excludes dividends paid to participating securities and any undistributed earnings attributable to participating securities.

Earnings per common share have been computed based on the following:

Three Months Ended
March 31,
(dollars in thousands, except for per share data) 2017       2016
Net income available to common stockholders $      11,880 $      10,369
Earnings allocated to participating securities 27 22
       Income attributable to common stock $ 11,853 $ 10,347
 
Weighted average common shares outstanding, including
       participating securities 31,938 30,020
Weighted average participating securities (72 ) (63 )
       Weighted average common shares outstanding 31,866 29,957
Incremental shares from assumed conversions of options,
       performance units and restricted shares 327 289
       Weighted average common and equivalent shares outstanding 32,193 30,246
 
Earnings per common share:
       Basic $ 0.37 $ 0.35
       Diluted 0.37 0.34

There were no antidilutive share equivalents as of March 31, 2017 and March 31, 2016.

Note 4. Securities Available-For-Sale

The Company’s securities are classified as available-for-sale at March 31, 2017 and December 31, 2016. 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, 2017 and December 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 held-to-maturity category to the available-for-sale category are made at fair value at the date of transfer. For transfers from the available-for-sale category to the held-to maturity category 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 security. Unrealized holding gains or losses that remain in accumulated other comprehensive income are amortized or accreted out of other comprehensive income with an offsetting entry to interest income as a yield adjustment through earnings over the remaining terms of the securities. For transfers from the held-to-maturity category to the available-for-sale category unrealized holding gain or loss at the date of the transfer shall be recognized in accumulated other comprehensive income, net of applicable taxes.

During the year ended December 31, 2016, the Company transferred all securities previously categorized as held-to-maturity to available-for-sale classification. The transfer resulted in an increase of approximately $210 million in amortized cost basis of available-for-sale securities and resulted in a net increase to accumulated other comprehensive income of $7.4 million, net of tax. The transfer enhances liquidity and increases flexibility with regard to asset-liability management and balance sheet composition. As a result of the transfer, the Company believes it has tainted its held-to-maturity classification and judgment will be required in the future in determining when circumstances have changed such that management can assert that it has the intent and ability to hold debt securities to maturity. Based on this guidance, the Company does not expect to classify any securities as held-to-maturity within the near future.

12



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

Note 4. Securities Available-For-Sale – (continued)

The following tables present information related to the Company’s securities at March 31, 2017 and December 31, 2016 (dollars in thousands):

            Gross       Gross      
Amortized Unrealized Unrealized Fair
March 31, 2017 Cost Gains Losses Value
Securities available-for-sale
       Federal agency obligations $ 56,670 $ 257 $ (277 ) $ 56,650
       Residential mortgage pass-through securities 104,850 602 (981 ) 104,471
       Commercial mortgage pass-through securities 4,153 32 - 4,185
       Obligations of U.S. states and political subdivisions 123,913 2,008 (915 ) 125,006
       Trust preferred securities 4,576 97 (131 ) 4,542
       Corporate bonds and notes 30,602 242 (297 ) 30,547
       Asset-backed securities 14,058 23 (112 ) 13,969
       Certificates of deposit 972 9 - 981
       Equity securities 376 232 - 608
       Other securities 11,851 - (334 ) 11,517
              Total securities available-for-sale $       352,021 $         3,502 $      (3,047 ) $      352,476
 
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2016 Cost Gains Losses Value
Securities available-for-sale
       Federal agency obligations $ 52,826 $ 282 $ (271 ) $ 52,837
       Residential mortgage pass-through securities 72,922 519 (944 ) 72,497
       Commercial mortgage pass-through securities 4,186 23 - 4,209
       Obligations of U.S. states and political subdivisions 148,747 2,789 (931 ) 150,605
       Trust preferred securities 5,575 242 (151 ) 5,666
       Corporate bonds and notes 36,717 586 (375 ) 36,928
       Asset-backed securities 14,867 2 (286 ) 14,583
       Certificates of deposit 973 10 - 983
       Equity securities 376 192 - 568
       Other securities 14,739 - (325 ) 14,414
              Total securities available-for-sale $ 351,928 $ 4,645 $ (3,283 ) $ 353,290

13



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

Note 4. Securities Available-For-Sale – (continued)

The following table presents information for securities at March 31, 2017, 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, 2017
Amortized       Fair
Cost Value
(dollars in thousands)
Securities available-for-sale:
       Due in one year or less $      3,467 $      3,504
       Due after one year through five years 30,171 30,401
       Due after five years through ten years 43,973 44,432
       Due after ten years 153,180 153,358
Residential mortgage pass-through securities 104,850 104,471
Commercial mortgage pass-through securities 4,153 4,185
Equity securities 376 608
Other securities 11,851 11,517
       Total $ 352,021 $ 352,476

Gross gains and losses from the sales for the three months ended March 31, 2017 and 2016 were as follows:

      Three Months Ended
March 31,
(dollars in thousands) 2017       2016
Proceeds $      29,543 $                 -
Gross gains on sales of securities 1,596 -
Gross losses on sales of securities - -
       Net gains on sales of securities 1,596 -
       Less: tax provision on net gains (579 ) -
 
              Net gains on sales of securities, after tax $ 1,017 $ -

14



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

Note 4. Securities Available-For-Sale – (continued)

The Company reviews all securities for potential recognition of other-than-temporary impairment. 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 Securities

The Company does not believe that any of the unrealized losses, which were comprised of 82 and 84 securities as of March 31, 2017 and December 31, 2016, respectively, represent an other-than-temporary impairment (“OTTI”). 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 which may contribute to unrealized losses include credit risk, market risk, changes in 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 the securities portfolio including limits on concentrations to any one issuer. The Company believes the securities portfolio is prudently diversified.

The unrealized losses included in the tables below are primarily related to changes in interest rates and credit spreads. All of the Company’s securities are performing and are expected to continue to perform in accordance with their respective contractual terms and conditions. These are largely intermediate duration holdings and, in certain cases, monthly principal payments can further reduce loss exposure resulting from an increase in rates.

The Company evaluates all securities with unrealized losses quarterly to determine whether the loss is other-than-temporary. Unrealized losses in the corporate debt securities category consist primarily of senior unsecured corporate debt securities issued by large financial institutions, insurance companies and other corporate issuers. Single issuer corporate trust preferred securities are also included, and in the case of one holding the market valuation loss is largely based upon the floating rate coupon and corresponding market valuation. Neither that trust preferred issuer, nor any other corporate issuers, have defaulted on interest payments. The unrealized loss in equity securities consists of losses on other bank equities. The decline in fair value is due in large part to the lack of an active trading market for these securities, changes in market credit spreads and rating agency downgrades. Management concluded that these securities were not other-than-temporarily impaired at March 31, 2017.

In determining whether or not securities are OTTI, 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 OTTI 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, a security is subject to numerous risks as cited above.

15



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

Note 4. Securities Available-For-Sale – (continued)

The following tables indicate gross unrealized losses not recognized in income and fair value, aggregated by investment category and the length of time individual securities have been in a continuous unrealized loss position at March 31, 2017 and December 31, 2016:

      March 31, 2017
Total       Less than 12 Months       12 Months or Longer
Fair       Unrealized Fair       Unrealized Fair       Unrealized
Value Losses Value Losses Value Losses
(dollars in thousands)
Securities available-for-sale:
 
Federal agency obligation $      31,077 $       (277 ) $      29,864 $        (269 ) $      1,213 $         (8 )
Residential mortgage
       pass-through securities 62,928 (981 ) 61,465 (946 ) 1,463 (35 )
Obligations of U.S. states
       and political subdivisions 45,800 (915 ) 45,800 (915 ) - -
Trust preferred securities 1,447 (131 ) - - 1,447 (131 )
Corporate bonds and notes 14,006 (297 ) 2,803 (163 ) 11,203 (134 )
Asset-backed securities 8,628 (112 ) - - 8,628 (112 )
Other securities 11,132 (334 ) - - 11,132 (334 )
       Total temporarily impaired
       securities $ 175,018 $ (3,047 ) $ 139,932 $ (2,293 ) $ 35,086 $ (754 )
 
December 31, 2016
Total Less than 12 Months 12 Months or Longer
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
(dollars in thousands)
Securities available-for-sale:
 
Federal agency obligation $ 22,672 $ (271 ) $ 21,416 $ (262 ) $ 1,256 $ (9 )
Residential mortgage
       pass-through securities 50,136 (944 ) 49,817 (937 ) 319 (7 )
Obligations of U.S. states
       and political subdivisions 52,307 (931 ) 52,307 (931 ) - -
Trust preferred securities 1,427 (151 ) - - 1,427 (151 )
Corporate bonds and notes 15,930 (375 ) 7,671 (265 ) 8,259 (110 )
Asset-backed securities 13,404 (286 ) 3,743 (88 ) 9,661 (198 )
Other securities 11,467 (325 ) - - 11,467 (325 )
Total temporarily impaired
       securities $ 167,343 $ (3,283 ) $ 134,954 $ (2,483 ) $ 32,389 $ (800 )

Securities having a carrying value of approximately $129.2 million and $142.5 million at March 31, 2017 and December 31, 2016, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Reserve Bank discount window borrowings, Federal Home Loan Bank advances and for other purposes required or permitted by law.

As of March 31, 2017 and December 31, 2016, 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.

16



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

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, December 30, 2014 and October 15, 2014, each with a respective notional amount of $25 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.

Summary information about the interest rate swaps designated as cash flow hedges as of March 31, 2017, December 31, 2016 and March 31, 2016 are presented in the following table.

      March 31,       December 31,       March 31,
(dollars in thousands) 2017 2016 2016
Notional amount $      75,000 $      75,000 $      75,000
Weighted average pay rates 1.58 % 1.59 % 1.57 %
Weighted average receive rates 1.00 % 0.69 % 0.56 %
Weighted average maturity 2.5 years 2.8 years 3.6 years
Fair value $ 248 $ 88 $ (1,568 )

Interest expense recorded on these swap transactions totaled approximately $108 thousand for the three months ended March 31, 2017 and $191 thousand for the three months ended March 31, 2016.

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, 2017
      Amount of gain       Amount of gain       Amount of gain (loss)
  (loss) recognized (loss) reclassified recognized in other
in OCI (Effective from OCI to Noninterest income
(dollars in thousands) Portion) interest income (Ineffective Portion)
Interest rate contracts $                      160 $ - $ -
 
Three Months Ended March 31, 2016
Amount of gain Amount of gain Amount of gain (loss)
  (loss) recognized (loss) reclassified recognized in other
in OCI (Effective from OCI to Noninterest income
(dollars in thousands) Portion) interest income (Ineffective Portion)
Interest rate contracts $ (1,437 ) $ - $ -

The following table reflects the cash flow hedges included in the consolidated statements of condition as of March 31, 2017 and December 31, 2016:

      March 31, 2017       December 31, 2016
Notional       Notional      
(dollars in thousands) Amount Fair Value Amount Fair Value
Interest rate swaps related to FHLB advances included in assets $      75,000 $           248 $      75,000 $             88

17



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

Note 6. Loans and the Allowance for Loan Losses

Loans

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

Loan segments are defined as a group of loans, 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: commercial, commercial real estate, commercial construction, residential real estate (including home equity) and consumer.

The recognition of interest income on commercial, commercial real estate, commercial construction and residential loans is 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 our 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 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.

Loans Held-for-Sale

Residential mortgage loans, originated and intended for sale in the secondary market, are carried at the lower of aggregate cost or estimated fair value as determined by outstanding commitments from investors. For these loans originated and intended for sale, gains and losses on loan sales (sale proceeds minus carrying value) are recorded in other income and direct loan origination costs and fees are deferred at origination of the loan and are recognized in other income upon sale of the loan.

Other loans held-for-sale are carried at the lower of aggregate cost or estimated fair value. A portion of these loans, taxi medallion loans, have no material observable trading in any market. Fair value is established with considerations for a range of market participant indications, for all or parts of these loans, and discounted cash flow analyses, which have significant unobservable inputs. See Note 7 for further discussion.

Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

Allowance for Loan losses

The allowance for loan 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 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.

18



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

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

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.

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.

TDRs 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 TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience, 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 and with the exogenous factor adjustments based on the risks present for each loan category. These exogenous factors 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 acquires 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 their estimated fair value, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, probable incurred credit losses are recognized by an increase in the allowance for loan losses.

Such purchased credit-impaired loans (“PCI”) are identified on an individual basis. 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.

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.

19



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

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

Loans held-for-sale

The following table presents loans held-for-sale by loan segment:

      March 31,       December 31,
2017 2016
(in thousands)
Commercial $      61,319 $      70,105
Commercial real estate - 7,712
Residential real estate 936 188
       Total carrying amount $ 62,255 $ 78,005

As of March 31, 2017 and December 31, 2016, the commercial loans held-for-sale segment included the Company’s entire taxi medallion portfolio, with a carrying value of $61.3 million and $65.6 million, net of $2.6 million and $-0- million valuation allowance, respectively.

Activity in the valuation allowance was as follows for the following periods:

      March 31, December 31,
2017       2016
(in thousands)
Beginning balance $ - $ -
Increase to valuation allowance 2,600 -
       Ending balance $      2,600 $      -

Loans receivable

The following table sets forth the composition of the Company’s loan portfolio, including net deferred loan fees, at March 31, 2017 and December 31, 2016:

      March 31, December 31,
2017       2016
(in thousands)
Commercial $ 541,690 $ 553,576
Commercial real estate 2,326,834 2,204,710
Commercial construction 460,611 486,228
Residential real estate 242,883 232,547
Consumer 2,811 2,380
       Gross loans 3,574,829 3,479,441
Net deferred loan fees (3,166 ) (3,609 )
       Total loans receivable $      3,571,663 $        3,475,832

At March 31, 2017 and December 31, 2016 loan balances of approximately $1.8 billion were pledged to secure borrowings from the Federal Home Loan Bank of New York.

20



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

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

Purchased Credit-Impaired Loans

The Company holds purchased loans for which there was, at their acquisition date, evidence of deterioration of credit quality since their origination and it was probable, at acquisition, that all contractually required payments would not be collected. The recorded investment of those loans is as follows at March 31, 2017 and December 31, 2016.

      March 31,       December 31,
2017 2016
(in thousands)
Commercial $ 7,827 $ 7,098
Commercial real estate 290 982
       Total purchased credit-impaired loans $      8,117 $      8,080

For those purchased loans disclosed above, the Company did not increase the allowance for loan losses during both the three months ended March 31, 2017 and March 31, 2016. No allowances for loan losses were reversed during the three months ended March 31, 2017 and March 31, 2016.

The accretable yield, or income expected to be collected, on the purchased credit-impaired loans above is as follows for the following periods:

      Three Months       Three Months
Ended Ended
March 31, March 31,
2017 2016
(in thousands)
Balance at beginning of period $ 2,860 $ 3,599
Accretion of income (186 ) (739 )
       Balance at end of period $                2,674 $                2,860

Loans Receivable on Nonaccrual Status

The following tables presents nonaccrual loans included in loans receivable by loan segment as of the periods presented:

      March 31,       December 31,
2017 2016
(in thousands)
Commercial $ 1,208 $ 1,460
Commercial real estate 7,487 1,081
Residential real estate 4,095 3,193
       Total loans receivable on nonaccrual status $       12,790 $       5,734

Nonaccrual loans and loans 90 days or greater past due and still accruing include both smaller balance homogeneous loans that are collectively evaluated for impairment and loans individually evaluated for impairment.

21



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

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

The Company continuously monitors the credit quality of its loans receivable. In addition to its internal monitoring, the Company utilizes the services of a third-party loan review firm to periodically validate the credit quality of its loans receivable on a sample basis. 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. All loans past due 90 days or greater and all impaired loans are included in the appropriate category below.

Credit Quality Indicators

The following table presents information, excluding loans held-for-sale and net deferred loan fees, about the Company’s loan credit quality at March 31, 2017 and December 31, 2016:

     March 31, 2017
Special
Pass       Mention       Substandard       Doubtful       Total
(in thousands)
Commercial $ 528,596 $ 3,102 $ 9,992 $ - $ 541,690
Commercial real estate 2,276,333 29,930 20,571 - 2,326,834
Commercial construction 455,446 2,670 2,495 - 460,611
Residential real estate 238,643 - 4,240 - 242,883
Consumer 2,754 - 57 - 2,811
Gross loans $ 3,501,772 $ 35,702 $ 37,355 $ - $ 3,574,829
 
December 31, 2016
Special
Pass Mention Substandard Doubtful Total
(in thousands)
Commercial $ 539,961 $ 3,255 $ 10,360 $ - $ 553,576
Commercial real estate 2,154,343 31,173 19,194 - 2,204,710
Commercial construction 480,319 3,388 2,521 - 486,228
Residential real estate 228,990 - 3,557 - 232,547
Consumer 2,318 - 62 - 2,380
Gross loans $      3,405,931 $      37,816 $      35,694 $      - $      3,479,441

22



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

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

The following table provides an analysis of the impaired loans by segment as of March 31, 2017 and December 31, 2016:

      March 31, 2017
      Unpaid      
Recorded Principal Related
Investment Balance Allowance
No related allowance recorded (in thousands)
Commercial $ 3,175 $ 3,175
Commercial real estate 16,394 16,403
Commercial construction 4,245 4,271
Residential real estate 976 1,177
Consumer 57 57
       Total $ 24,847 $ 25,083
 
With an allowance recorded
Commercial real estate $ 780 $ 1,193 $ 96
 
Total
Commercial $ 3,175 $ 3,175 $ -
Commercial real estate 17,174 17,596 96
Commercial construction 4,245 4,271 -
Residential real estate 976 1,177 -
Consumer 57 57 -
       Total (including allowance) $ 25,627 $ 26,276 $ 96
 
December 31, 2016
Unpaid
Recorded Principal Related
Investment Balance Allowance
No related allowance recorded (in thousands)
Commercial $ 3,637 $ 4,063
Commercial real estate 18,288 18,288
Commercial construction 5,909 5,909
Residential real estate 1,851 2,055
Consumer 62 62
       Total $ 29,747 $ 30,377
 
With an allowance recorded
Commercial $ 1,244 $ 1,245 $ 145
 
Total
Commercial $ 3,637 $ 4,063 $ -
Commercial real estate 19,532 19,532 145
Commercial construction 5,909 5,909 -
Residential real estate 1,851 2,055 -
Consumer 62 62 -
       Total (including allowance) $      30,991 $      31,621 $      145

23



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

Note 6. Loans and the Allowance for Loan 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 ended March 31, 2017 and 2016 (in thousands):

      Three Months Ended March 31,
2017       2016
Average       Interest Average       Interest
Recorded Income Recorded Income
Investment Recognized Investment Recognized
Impaired loans with
no related allowance
recorded
 
Commercial $ 2,884 $ 39 $ 2,591 $ 24
Commercial real estate 16,450 106 15,274 25
Commercial construction 4,269 50 2,307 16
Residential real estate 986 2 4,107 5
Consumer 59 1 84 1
 
       Total $ 24,648 $ 198 $ 24,363 $ 71
 
Impaired loans with
an allowance
recorded
 
Commercial $ - $ - $ 83,759 $ 737
Commercial real estate 783 5 - -
 
       Total $ 783 $ 5 $ 83,759 $ 737
 
Total impaired loans
 
Commercial $ 2,884 $ 39 $ 86,350 $ 761
Commercial real estate 17,233 111 15,274 25
Commercial construction 4,269 50 2,307 16
Residential real estate 986 2 4,107 5
Consumer 59 1 84 1
 
Total $      25,431 $      203 $      108,122 $      808

Included in impaired loans at March 31, 2017 and December 31, 2016 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.

24



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

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

The following table provides an analysis of the aging of gross loans (excluding loans held-for-sale) that are past due at March 31, 2017 and December 31, 2016 by segment:

Aging Analysis
 
March 31, 2017
           90 Days or                
Greater Past Total Past
30-59 Days 60-89 Days Due and Still Due and Total Loans
Past Due Past Due Accruing Nonaccrual Nonaccrual Current Receivable
(in thousands)
Commercial $ - $ - $ 5,423 $ 1,208 $ 6,631 $ 535,059 $ 541,690
Commercial real
estate 3,649 444 - 7,487 11,580 2,315,254 2,326,834
Commercial
construction - - - - - 460,611 460,611
Residential real
estate 1,670 6 - 4,095 5,711 237,112 242,883
Consumer 9 1 - - 10 2,801 2,811
       Total $ 5,328 $ 451 $ 5,423 $ 12,790 $ 23,992 $ 3,550,837 $ 3,574,829
 
December 31, 2016
90 Days or
Greater Past Total Past
30-59 Days 60-89 Days Due and Still Due and Total Loans
Past Due Past Due Accruing Nonaccrual Nonaccrual Current Receivable
Commercial $ 475 $ 18 $ 4,630 $ 1,460 $ 6,583 $ 546,993 $ 553,576
Commercial real
estate 4,928 1,584 663 1,081 8,256 2,196,454 2,204,710
Commercial
construction - - - - - 486,228 486,228
Residential real
estate 2,131 388 - 3,193 5,712 226,835 232,547
Consumer - - - - - 2,380 2,380
       Total $      7,534 $      1,990 $      5,293 $      5,734 $      20,551 $      3,458,890 $      3,479,441

Included in the 90 days and still accruing/accreting category as of both March 31, 2017 and December 31, 2016 are three purchased credit-impaired loans, net of their fair value marks, which are accreting income per their valuation at date of acquisition.

25



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

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

The following tables detail, at the period-end presented, the amount of gross loans (excluding loans held-for-sale) that are evaluated individually, and collectively, for impairment, those acquired with deteriorated quality, and the related portion of the allowance for loan losses that are allocated to each loan portfolio segment:

March 31, 2017
Commercial Commercial Residential
      Commercial       real estate       construction       real estate       Consumer       Unallocated       Total
(in thousands)
Allowance for loan losses
Individually evaluated for impairment $ - $ 96 $ - $ - $ - $ - $ 96
Collectively evaluated for impairment 6,667 13,472 4,574 1,008 3 531 26,255
Acquired portfolio - 550 - - - - 550
Acquired with deteriorated credit quality - - - - - - -
Total allowance for loan losses $ 6,667 $ 14,118 $ 4,574 $ 1,008 $ 3 $ 531 $ 26,901
 
Gross loans
Individually evaluated for impairment $ 2,862 $ 17,174 $ 4,245 $ 976 $ 57 $ 25,314
Collectively evaluated for impairment 510,263 1,806,502 455,574 175,973 2,243 2,950,555
Acquired portfolio 20,738 502,868 792 65,934 511 590,843
Acquired with deteriorated credit quality 7,827 290 - - - 8,117
Total gross loans $ 541,690 $ 2,326,834 $ 460,611 $ 242,883 $ 2,811 $ 3,574,829
 
December 31, 2016
Commercial Commercial Residential
Commercial real estate construction real estate Consumer Unallocated Total
(in thousands)
Allowance for loan losses
Individually evaluated for impairment $ - $ 145 $ - $ - $ - $ - $ 145
Collectively evaluated for impairment 6,632 12,438 4,789 958 3 779 25,599
Acquired portfolio - - - - - - -
Acquired with deteriorated credit quality - - - - - - -
Total allowance for loan losses $ 6,632 $ 12,583 $ 4,789 $ 958 $ 3 $      779 $ 25,744
 
Gross loans
Individually evaluated for impairment $ 3,637 $ 19,532 $ 5,909 $ 1,851 $ 62 $ 30,991
Collectively evaluated for impairment 517,869 1,621,745 478,865 163,686 1,757 2,783,922
Acquired portfolio 24,972 562,451 1,454 67,010 561 656,448
Acquired with deteriorated credit quality 7,098 982 - - - 8,080
Total gross loans $      553,576 $      2,204,710 $      486,228 $      232,547 $      2,380 $      3,479,441

26



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

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

The Company’s allowance for loan 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 losses methodology as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

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

   Three Months Ended March 31, 2017
Commercial    Commercial
real estate
   Commercial
construction
   Residential
real estate
   Consumer    Unallocated    Total
(in thousands)
Balance at December 31,
2016 $ 6,632 $ 12,583 $ 4,789 $ 958 $ 3 $ 779 $ 25,744
 
Charge-offs - (71 ) - - (1 ) - (72 )
 
Recoveries 126 3 - - - - 129
 
Provision (91 ) 1,603 (215 ) 50 1 (248 ) 1,100
 
Balance at March 31, 2017 $ 6,667 $ 14,118 $ 4,574 $ 1,008 $ 3 $ 531 $ 26,901
 
Three Months Ended March 31, 2016
Commercial Commercial
real estate
Commercial
construction
Residential
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

27



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

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

Trouble Debt Restructurings

Loans are considered to have been modified in a troubled debt restructuring (“TDRs”) when due to a borrower’s financial difficulties, the Company makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a nonaccrual loan that has been modified in a troubled debt restructuring remains on nonaccrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is uncertain, the loan remains on nonaccrual status.

At March 31, 2017, there were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status or were contractually past due 90 days or greater and still accruing interest, or whose terms have been modified in troubled debt restructurings.

The following table presents a rollforward of loans modified as troubled debt restructurings and the related changes to the allowance for loan losses that occurred during the three months ended March 31, 2017 and for the year ended December 31, 2016 (dollars in thousands):

      March 31, 2017       December 31, 2016
Recorded       Recorded      
Investment ALLL Investment ALLL
Trouble Debt
Restructurings
 
Beginning balance $       13,818 $                - $       86,629 $      4,500
Additions 2,793 - 26,325 8,250
Payoffs/paydowns (1,133 ) - (2,616 ) -
Transfers (580 ) - (96,520 ) -
Other - - - (12,750 )
Ending balance $ 14,898 $ - $ 13,818 $ -

Loans modified in troubled debt restructurings totaled $14.9 million at March 31, 2017, of which $4.9 million were on nonaccrual status and $10.0 million were performing under restructured terms. At December 31, 2016 modified in troubled debt restructurings totaled $13.8 million, of which $0.5 million were on nonaccrual status and $13.3 million were performing under restructured terms.

The following table presents loans by segment modified as troubled debt restructurings that occurred during the three months ended March 31, 2017 (dollars in thousands):

            Pre-Modification       Post-Modification
Outstanding Outstanding
Number of Recorded Recorded
Loans Investment Investment
Troubled debt restructurings:
       Commercial real estate 1 $                     2,775 $                     2,775
       Residential real estate 1 18 18
 
              Total 2 $ 2,793 $ 2,793

There were no charge-offs in connection with a loan modification at the time of modification during three months ended March 31, 2017. 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, 2017.

28



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

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

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

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 consisted of interest rate deductions 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 leases 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.

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.

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).

29



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

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

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.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

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, 2017 and December 31, 2016:

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.

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.

30



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

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

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, 2017 and December 31, 2016 are as follows:

            March 31, 2017
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)
(dollars in thousands)
Recurring fair value measurements:
Assets
Securities:
       Available-for-sale:  
              Federal agency obligations $ 56,650 $ - $ 56,650 $ -
              Residential mortgage pass-  
                     through securities 104,471 - 104,471 -
              Commercial mortgage pass-
                     through securities 4,185 - 4,185 -
              Obligations of U.S. states and
                     political subdivision 125,006 - 106,906 18,100
              Trust preferred securities 4,542 - 4,542 -
              Corporate bonds and notes 30,547 - 30,547 -
              Asset-backed securities 13,969 - 13,969 -
              Certificates of deposit 981 - 981 -
              Equity securities 608 608 - -
              Other securities 11,517 11,517 - -
       Total available-for-sale $      352,476 $ 12,125 $ 322,251 $ 18,100
Derivatives 248 - 248 -
       Total Assets $ 352,724 $ 12,125 $ 322,499 $ 18,100

31



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

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

            December 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)
(dollars in thousands)
Recurring fair value measurements:
Assets
Securities:
       Available-for-sale:
              Federal agency obligations $      52,837 $ - $ 52,837 $ -
              Residential mortgage pass-  
                     through securities 72,497 - 72,497 -
              Commercial mortgage pass-
                     through securities 4,209 - 4,209 -
              Obligations of U.S. states and
                     political subdivision 150,605 - 132,387 18,218
              Trust preferred securities 5,666 - 5,666 -
              Corporate bonds and notes 36,928 - 36,928 -
              Asset-backed securities 14,583 - 14,583 -
              Certificates of deposit 983 - 983 -
              Equity securities 568 568 - -
              Other securities 14,414 14,414 - -
       Total available-for-sale $ 353,290 $ 14,982 $ 320,090 $ 18,218
       Derivatives 88 - 88 -
       Total assets $ 353,378 $ 14,982 $ 320,178 $ 18,218

There were no transfers between Level 1 and Level 2 during the quarter ended March 31, 2017 and during the year ended December 31, 2016.

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 non-recurring 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 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, 2017 and December 31, 2016:

Loans Held-for-Sale

Residential mortgage loans, originated and intended for sale in the secondary market, are carried at the lower of aggregate cost or estimated fair value as determined by outstanding commitments from investors. For these loans originated and intended for sale, gains and losses on loan sales (sale proceeds minus carrying value) are recorded in other income and direct loan origination costs and fees are deferred at origination of the loan and are recognized in other income upon sale of the loan. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions (Level 2).

32



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

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

Other loans held-for-sale are carried at the lower of aggregate cost or estimated fair value. A portion of these loans, taxi medallion loans, have no material observable trading in any market. The approach to determining fair value involved several steps, including a detailed collateral analysis of the underlying medallions, performance projections for individual loans, discounted cash flow modeling and consideration of indicative bids, which at March 31, 2017 did not necessarily contemplate whole loan sales (Level 3).

Impaired Loans

The Company may record adjustments to the carrying value of loans based on fair value measurements, generally as partial charge-offs of the uncollectible portions of these loans. These adjustments also include certain impairment amounts for collateral dependent loans calculated in accordance with GAAP. Impairment amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated impairment amount applicable to that loan does not necessarily represent the fair value of the loan. Real estate collateral is valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable by market participants. However, due to the substantial judgment applied and limited volume of activity as compared to other assets, fair value is based on Level 3 inputs. Estimates of fair value used for collateral supporting commercial loans generally are based on assumptions not observable in the market place and are also based on Level 3 inputs.

For assets measured at fair value on a non-recurring basis, the fair value measurements at March 31, 2017 and December 31, 2016 are as follows:

            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: 2017 (Level 1) (Level 2) (Level 3)
Impaired loans: (in thousands)
       Commercial real estate $ 685 $ - $ - $ 685
 
Loans held-for-sale:
       Commercial 61,319 - - 61,319
 
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: 2016 (Level 1) (Level 2) (Level 3)
Impaired loans: (in thousands)
       Commercial real estate $ 1,099 $ - $ - $ 1,099
 
Loans held-for-sale:
       Commercial 70,105 - 4,509 65,596
       Commercial real estate 7,712 - 7,712 -

Impaired LoansCollateral dependent impaired loans at March 31, 2017 that required a valuation allowance were $0.8 million with a related valuation allowance of $0.1 million compared to $1.2 million with a related valuation allowance of $0.1 million at December 31, 2016.

33



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

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

Assets Measured With Significant Unobservable Level 3 Inputs

Recurring basis

The tables below present a reconciliation of all assets measured at fair value of a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2017 and year ended December 31, 2016 (dollars in thousands):

Municipal
Securities
Beginning balance, January 1, 2017 $        18,218
Other(1) -
Principal paydowns (118 )
Ending balance, March 31, 2017 $ 18,100
 
Municipal
Securities
Beginning balance, January 1, 2016 $ -
Other(1) 18,335
Principal paydowns   (117 )
Ending balance, December 31, 2016 $ 18,218

(1) Includes transfers from held-to-maturity to available-for-sale designation

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, 2017 and December 31, 2016. The table below provides quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy.

March 31, 2017                        
Valuation Unobservable
(dollars in thousands) Fair Value Techniques Input Range
Securities available-for-sale:  
       Municipal securities $        18,100 Discounted Cash Discount Rate 2.8%
Flows
 
December 31, 2016
Valuation Unobservable
(dollars in thousands) Fair Value Techniques Input Range
Securities available-for-sale:
       Municipal securities $ 18,218 Discounted Cash Discount Rate 2.8%
Flows

34



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

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

Non-recurring basis

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 for the periods presented. The tables below provide quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy.

March 31, 2017                                
Valuation
Techniques Unobservable
(dollars in thousands) Fair Value (weightings) Input Range (weighted average)
Impaired loans:
Commercial real $       685 Appraisals of Comparable sales 0% - 15% (6%)
estate collateral value
 
Loans held-for-sale:
Commercial taxi $ 61,319 Market approach Indications under securitized 37 - 100 (56)
medallion loans (70%) transactions expressed as a
  price to unpaid principal
balance
Discounted cash
flows (30%) Discount Rate 14%
 
December 31, 2016
Valuation
Techniques Unobservable
(dollars in thousands) Fair Value (weightings) Input Range (weighted average)
Impaired loans:
Commercial real $ 1,099 Appraisals of Comparable sales 0% - 15% (6%)
estate collateral value
 
Loans held-for-sale:
Commercial taxi $ 65,596 Market approach Indications under securitized 40 - 100 (59)
medallion loans (70%) transactions expressed as a
price to unpaid principal
balance
Discounted cash
flows (30%) Discount Rate 14%

35



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

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

Fair Value of Financial Instruments

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

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. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price and therefore, while permissible for presentation purposes under ASC 825-10, do not conform to ASC 820-10.

Deposits. The carrying amounts of deposits with no stated maturities (i.e., noninterest-bearing, savings, NOW, and money market deposits) are assigned fair values equal to the carrying amounts payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

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.

36



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

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, 2017 and December 31, 2016:

                  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, 2017
Financial assets:
Cash and due from banks $       161,869 $      161,869 $       161,869 $        - $ -
Securities available-for-sale 352,476 352,476 12,125 322,251 18,100
Restricted investment in bank stocks 24,985 n/a n/a n/a n/a
Loans held-for-sale 62,255 62,255 - 936 61,319
Net loans 3,544,762 3,554,778 - - 3,554,778
Derivatives 248 248 - 248 -
Accrued interest receivable 12,701 12,701 - 1,555 11,146
 
Financial liabilities:
Noninterest-bearing deposits 671,183 671,183 671,183 - -
Interest-bearing deposits 2,684,294 2,684,132 1,714,491 969,641 -
Borrowings 491,226 492,818 - 492,818 -
Subordinated debentures 54,575 56,040 - 56,040 -
Accrued interest payable 3,783 3,783 - 3,783 -
 
December 31, 2016
Financial assets:
Cash and due from banks $ 200,399 $ 200,399 $ 200,399 $ - $         -
Securities available-for-sale 353,290 353,290 14,982 320,090 18,218
Restricted investment in bank stocks 24,310 n/a n/a n/a n/a
Loans held-for-sale 78,005 78,005 - 12,409 65,596
Net loans 3,450,088 3,462,138 - - 3,462,138
Derivatives 88 88 - 88 -
Accrued interest receivable 12,965 12,965 - 2,026 10,939
 
Financial liabilities:
Noninterest-bearing deposits 694,977 694,977 694,977 - -
Interest-bearing deposits 2,649,294 2,649,717 1,681,044 968,673 -
Borrowings 476,280 478,286 - 478,286 -
Subordinated debentures 54,534 55,901 - 55,901 -
Accrued interest payable 4,142 4,142 - 4,142 -

37



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

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. The fair value of commitments to originate loans is immaterial and not included in the tables above.

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, such as 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. Other Comprehensive Income (Loss)

The following represents the reclassifications out of accumulated other comprehensive (loss) income for the periods presented:

Affected Line item in the
Details about Accumulated Other Amounts Reclassified from Accumulated Statement Where Net Income is
Comprehensive Income Components Other Comprehensive Income/(Loss) Presented
      Three Months Ended March 31,
2017       2016        
Net gains on sales of securities
Sale of securities available-for-sale $ 1,596   $ - available-for-sale
    (579 ) - Income tax expense
1,017     -  
Amortization of pension plan net          
actuarial losses (103 )     (102 ) Salaries and employee benefits
  42       41 Income tax benefit
(61 ) (61 )
 
Total reclassification $ 956 $ (61 )

Accumulated other comprehensive loss (net of tax) at March 31, 2017 and December 31, 2016 consisted of the following:

      March 31,       December 31,
2017 2016
(dollars in thousands)
Securities available-for-sale, net of tax $ 337 $ 933
Cash flow hedge, net of tax 147 52
Defined benefit pension and post-retirement plans, net of tax              (3,771 )              (3,831 )
       Total accumulated other comprehensive loss $ (3,287 ) $ (2,846 )

38



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

Note 9. Stock-Based Compensation

The Company maintains two 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, 2017 are 68,516 under the 2009 Equity Incentive Plan and 53,431 shares under the North Jersey Community Bancorp 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 three 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, 2017 or 2016.

During quarters ended March 31, 2017 and 2016, 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 January 1 of the year of issuance. Under the grant agreements, 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 agreements. At March 31, 2017, the specific number of shares related to performance unit awards that were expected to vest was 151,194, 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. At March 31, 2017 the maximum amount of performance units that ultimately could vest if performance targets were exceeded is 226,791.

Option activity under the Company’s option plans as of and for the three months ended March 31, 2017 were as follows:

                  Weighted-      
Average
Weighted- Remaining
Average Contractual
Exercise Term Aggregate
Shares Price (In Years) Intrinsic Value
Outstanding at December 31, 2016 354,467 $ 6.26
Granted - -
Exercised - -
Forfeited/cancelled/expired - -
Outstanding at March 31, 2017 354,467 $              6.26 2.37 $              6,377,515
Exercisable at March 31, 2017 350,937 $ 6.18 2.32 $ 6,342,180

39



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

Note 9. Stock-Based Compensation – (continued)

The aggregate intrinsic value of outstanding and exercisable options above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on March 31, 2017 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, 2017. This amount changes based on the fair market value of the Parent Corporation’s stock. There were no options exercised during the three months ended March 31, 2017.

The below table represents information regarding restricted shares currently outstanding at March 31, 2017:

Weighted-
      Average
      Nonvested Grant Date
Shares Fair Value
Nonvested at December 31, 2016          111,273 $          16.81
Granted 56,164 23.82
Vested (65,359 ) 16.46
Forfeited/cancelled/expired - -
Nonvested at March 31, 2017 102,078 $ 20.35

As of March 31, 2017, there was $1,920,809 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 2.0 years.

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
Units Units Date Fair
(expected) (maximum) Value
Unearned at December 31, 2016          151,572 189,455 $ 18.47
Awarded 24,891 37,336 22.75
Forfeited - - -
Adjustments (25,269 ) - 18.47
Unearned at March 31, 2017 151,194 226,791 $ 19.19

At March 31, 2017, compensation cost of $1,216,882 related to non-vested performance unit awards not yet recognized is expected to be recognized over a weighted-average period of 1.6 years.

Effective January 1, 2017, the Company implemented ASU 2016-09,”Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment. Under ASU 2016-09 all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Included in income tax expense for the first quarter of 2017 is a benefit of $133 thousand which resulted from the effect of implementing ASU 2016-09.

40



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

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,
2017       2016
Interest cost $ 119 $ 128
Expected return on plan assets           (160 )           (136 )
Net amortization 103 102
       Total periodic pension expense $ 62 $ 94
 
Amortization of actuarial loss $ (101 ) $ (101 )
 
Total recognized in other comprehensive income $ (101 ) $ (101 )
 
Total recognized in net periodic expense and other
comprehensive income (before tax) $ (39 ) $ (7 )

Contributions

The Company did not make any contributions during the first quarter of 2017. The Company does not plan on contributing amounts to the Pension Trust for the remainder of 2017. 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.

Note 11 – FHLB Borrowings

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

      March 31, 2017        December 31, 2016
  Amount Rate Amount        Rate
(dollars in thousands)
Total FHLB borrowings $         476,226       1.55 % $         461,280 1.55 %
 
By remaining period to maturity:
       Less than 1 year $ 281,226 1.11 % $ 231,280 1.02 %
       1 year through less than 2 years 105,000 1.96 % 130,000 1.84 %
       2 years through less than 3 years 50,000 1.66 % 35,000 1.60 %
       3 years through less than 4 years 40,000 3.43 % 65,000 2.82 %
       Four to five years - - -
Total FHLB borrowings $ 476,226 1.55 % $ 461,280 1.55 %

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.

41



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

Note 11 – FHLB Borrowings – (continued)

Three of the FHLB advances ($2.5 million and $7.5 million each due April 2, 2018, and $5.0 million 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. The advances at March 31, 2017 were primarily collateralized by approximately $1.3 billion of commercial mortgage loans, net of required over collateralization amounts, under a blanket lien arrangement. At March 31, 2017 the Company had remaining borrowing capacity at FHLB of approximately $748 million.

Note 12 – Securities Sold under Agreements to Repurchase

Repurchase agreements are secured borrowings. The Company pledges 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) 2017 2016 2016
Average daily balance during the year-to-date $       15,000 $           15,000 $          15,000
Average interest rate during the year-to-date 5.95 % 5.95 % 5.95 %
Maximum month end balance during the year-to-date $ 15,000 $ 15,000 $ 15,000
Weighted average interest rate during the year-to-date 5.95 % 5.95 % 5.95 %

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

      March 31, 2017
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 $ - $ - $ - $ - $ -
       Residential mortgage pass-through securities     -     -     18,143     -     18,143
Total borrowings $ - $ - $ 18,143 $ - $ 18,143
 
Amounts related to agreements not included in offsetting disclosure in Note 14: $ 3,143
 
December 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 $ - $ - $       - $       - $       -
       Residential mortgage pass-through securities - - - 16,826 16,826
Total borrowings $ - $ - $ - $ 16,826 $ 16,826
 
Amounts related to agreements not included in offsetting disclosure in Note 14: $ 1,826

The fair value of securities pledged to secure repurchase agreements may decline. By contractual agreement, the fair value of securities pledged to secure repurchase agreements must meet or exceed the gross outstanding balance by 8%, or be subject to margin calls. Securities sold under agreements to repurchase are secured by securities with a carrying amount of $18.1 million and $16.8 million at March 31, 2017 and December 31, 2016.

42



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

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, 2017 was 3.89%. 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.

The following table summarizes the mandatory redeemable trust preferred securities of the Company’s Statutory Trust II at March 31, 2017 and December 31, 2016.

      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”). 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, 2017, unamortized costs related to the debt issuance was approximately $580,000.

43



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

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 Note 5. 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.

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 securities account, therefore there is no offsetting or netting of the securities assets with the repurchase agreement liability. The following table presents information about financial instruments that are eligible for offset as of March 31, 2017 and December 31, 2016:

                        Gross Amounts Not Offset
Gross Amounts Net Amounts of       Cash or      
Offset in the Assets Presented in Financial Financial
Gross Amounts Statement of the Statement of Instruments Instrument Net
Recognized Financial Position Financial Position Recognized Collateral Amount
(in thousands)
March 31, 2017
Assets:
       Interest rate swaps $ 248 $ - $ 248 $ - $ - $ 248
Liabilities:      
       Repurchase  
       agreements $ 15,000 $ - $ 15,000 $ - $ 15,000 $ -
December 31, 2016
Assets:    
       Interest rate swaps $ 88 $ - $ 88 $ - $ - $ 88
Liabilities:
       Repurchase
       agreements $ 15,000 $ - $ 15,000 $ - $ 15,000 $ -

44



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, 2017 and December 31, 2016. 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 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 GAAP. 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 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 Losses and Related Provision

The allowance for loan losses represents management’s estimate of probable incurred credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated 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 losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.

45



The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb loan 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 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 losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods. Additional information can be found in Note 1 of the Notes to Consolidated Financial Statements.

Other-Than-Temporary Impairment of Securities Available-for-Sale

Securities available-for-sale 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 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 7 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.

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, 2016 includes additional discussion on the accounting for income taxes.

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Operating Results Overview

Net income for the three months ended March 31, 2017 amounted to $11.9 million compared to $10.4 million for the comparable three-month period ended March 31, 2016. The Company’s diluted earnings per share were $0.37 for the three months ended March 31, 2017 as compared with diluted earnings per share of $0.34 for the same three-month period ended March 31, 2016. The increase in net income was attributable to an increase in net interest income, an increase in noninterest income (primarily due to an increase in net gains on sales of securities available for-sale), and a decrease to provision for loan losses, partially offset by an increase in noninterest expenses (primarily due to a valuation allowance related to the loans held-for-sale portfolio).

Net Interest Income and Margin

Net interest income is the difference between the interest earned on the portfolio of earning assets (principally loans and securities available-for-sale) 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 2017 reflected an increase of $2.0 million, or 6.2%, from the first quarter of 2016, resulting from an 8.7% increase in interest-earning assets, partially offset by a 5 basis-point contraction of the net interest margin to 3.40% from 3.45%. Included in net interest income was accretion and amortization of purchase accounting adjustments of $0.6 million and $1.3 million during the first quarter of 2017 and first quarter of 2016, respectively. Excluding these purchase accounting adjustments, the adjusted net interest margin was 3.33% in the first quarter of 2017, widening by 2 basis-points from the first quarter of 2016 adjusted net interest margin of 3.31%. The slight increase in the adjusted net interest margin was primarily attributable to improved mix and rates on our interest-earning assets.

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The following tables, “Average Statements of Condition with Interest and Average Rates”, present for the three months ended March 31, 2017 and 2016, 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.

Average Statements of Condition with Interest and Average Rates

Three Months Ended March 31,
2017 2016
Interest Interest
Average Income/ Average Average Income/ Average
Balance