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 September 30, 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 reporting company)		Emerging growth 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:	32,015,317 shares
(Title of Class)	(Outstanding as of November 3, 2017)

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Table of Contents

		Page
PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Statements of Condition at September 30, 2017 (unaudited) and December 31, 2016	3
	Consolidated Statements of Income for the three and nine months ended September 30, 2017 and 2016 (unaudited)	4
	Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2017 and 2016 (unaudited)	5
	Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2017 and 2016 (unaudited)	6
	Consolidated Statements of Cash Flows for the nine months ended September 30, 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	44
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

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Item 1. Financial Statements

CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION

		September 30,				December 31,
(in thousands, except for share data)		2017				2016
		(unaudited)
ASSETS
Cash and due from banks		$	41,114			$	37,150
Interest-bearing deposits with banks			100,148				163,249
Cash and cash equivalents			141,262				200,399
Securities available-for-sale			400,516				353,290
Loans held-for-sale (net of valuation allowance of $15,287 and $-0-, respectively)			89,386				78,005
Loans receivable			3,889,289				3,475,832
Less: Allowance for loan losses			29,870				25,744
Net loans receivable			3,859,419				3,450,088
Investment in restricted stock, at cost			29,672				24,310
Bank premises and equipment, net			21,917				22,075
Accrued interest receivable			14,841				12,965
Bank owned life insurance			110,762				98,359
Other real estate owned			-				626
Goodwill			145,909				145,909
Core deposit intangibles			2,533				3,088
Other assets			28,538				37,234
Total assets		$	4,844,755			$	4,426,348
LIABILITIES
Deposits:
Noninterest-bearing		$	719,582			$	694,977
Interest-bearing			2,904,187				2,649,294
Total deposits			3,623,769				3,344,271
Borrowings			585,124				476,280
Subordinated debentures (net of debt issuance costs of $498 and $621, respectively)			54,657				54,534
Other liabilities			23,514				20,231
Total liabilities			4,287,064				3,895,316
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY
Common stock, no par value, authorized 50,000,000 shares; issued 34,079,239 shares at September 30, 2017 and 34,018,731 at December 31, 2016; outstanding 32,015,317 shares at September 30, 2017 and 31,948,307 at December 31, 2016			412,546				412,726
Additional paid-in capital			12,840				11,407
Retained earnings			151,851				126,462
Treasury stock, at cost (2,063,922 common shares at September 30, 2017 and December 31, 2016)			(16,717	)			(16,717	)
Accumulated other comprehensive loss			(2,829	)			(2,846	)
Total stockholders’ equity			557,691				531,032
Total liabilities and stockholders’ equity		$	4,844,755			$	4,426,348

See accompanying notes to unaudited consolidated financial statements.

3

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

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(in thousands, except for per share data)		2017			2016			2017			2016
Interest income
Interest and fees on loans		$	43,241		$	37,803		$	121,879		$	109,381
Interest and dividends on securities:
Taxable			1,695			1,774			5,042			5,879
Tax-exempt			870			988			2,655			2,867
Dividends			362			352			982			1,074
Interest on federal funds sold and other short-term investments			170			261			555			541
Total interest income			46,338			41,178			131,113			119,742
Interest expense
Deposits			6,113			5,159			16,717			13,532
Borrowings			3,206			2,995			9,135			9,472
Total interest expense			9,319			8,154			25,852			23,004
Net interest income			37,019			33,024			105,261			96,738
Provision for loan losses			1,450			6,750			4,000			13,500
Net interest income after provision for loan losses			35,569			26,274			101,261			83,238
Noninterest income
Annuities and insurance commissions			-			68			39			140
Income on bank owned life insurance			985			615			2,402			1,843
Net gains on sale of loans held-for-sale			50			56			120			147
Deposit, loan and other income			721			706			2,023			1,984
Net gains on sales of securities available-for-sale			-			4,131			1,596			4,234
Total noninterest income			1,756			5,576			6,180			8,348
Noninterest expenses
Salaries and employee benefits			8,872			7,791			25,710			23,143
Occupancy and equipment			1,969			2,049			6,215			6,450
FDIC insurance			840			745			2,550			1,955
Professional and consulting			740			667			2,192			2,078
Marketing and advertising			225			293			770			817
Data processing			1,176			1,002			3,474			3,036
Amortization of core deposit intangible			169			193			555			627
Increase in valuation allowance, loans held-for-sale			3,000			-			15,325			-
Other expenses			1,650			1,811			5,402			5,150
Total noninterest expenses			18,641			14,551			62,193			43,256
Income before income tax expense			18,684			17,299			45,248			48,330
Income tax expense			5,607			5,443			12,608			15,224
Net income			13,077			11,856			32,640			33,106
Less: Preferred stock dividends			-			-			-			22
Net income available to common stockholders		$	13,077		$	11,856		$	32,640		$	33,084
Earnings per common share:
Basic		$	0.41		$	0.39		$	1.02		$	1.10
Diluted			0.41			0.39			1.01			1.09
Dividends per common share		$	0.075		$	0.075		$	0.225		$	0.225

See accompanying notes to unaudited consolidated financial statements.

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(in thousands)		2017				2016				2017				2016
Net income		$	13,077			$	11,856			$	32,640			$	33,106
Other comprehensive income:
Unrealized gains and losses:
Unrealized holding gains (losses) on available-for-sale securities arising during the period			415				(523	)			1,332				1,551
Tax effect			(165	)			187				(525	)			(634	)
Net of tax			250				(336	)			807				917
Unrealized gains on securities transferred from held-to-maturity to available-for-sale the period			-				10,069				-				10,069
Tax effect			-				(3,815	)			-				(3,815	)
Net of tax			-				6,254								6,254
Reclassification adjustment for realized gains included in net income			-				(4,131	)			(1,596	)			(4,234	)
Tax effect			-				1,640				579				1,682
Net of tax			-				(2,491	)			(1,017	)			(2,552	)
Amortization of unrealized net losses on held-to-maturity securities transferred from available-for-sale securities			-				1,890				-				1,986
Tax effect			-				(774	)			-				(813	)
Net of tax							1,116				-				1,173
Unrealized gains (losses) on cash flow hedges			119				644				76				(1,081	)
Tax effect			(48	)			(263	)			(31	)			441
Net of tax			71				381				45				(640	)
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 amortization included in net income			103				204				309				306
Tax effect			(42	)			(83	)			(126	)			(124	)
Net of tax			61				121				183				182
Total other comprehensive income			382				5,045				17				5,333
Total comprehensive income		$	13,459			$	16,901			$	32,657			$	38,439

See accompanying notes to unaudited consolidated financial statements.

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

																					Accumulated
										Additional											Other				Total
(dollars in thousands, except for per		Preferred				Common				Paid-In			Retained				Treasury				Comprehensive				Stockholders’
share data)		Stock				Stock				Capital			Earnings				Stock				(Loss) Income				Equity
Balance as of December 31, 2015		$	11,250			$	374,287			$	8,527		$	104,606			$	(16,717	)		$	(4,609	)		$	477,344
Net income			-				-				-			33,106				-				-				33,106
Other comprehensive income, net of tax			-				-				-			-				-				5,333				5,333
Dividend on series B preferred stock			-				-				-			(22	)			-				-				(22	)
Cash dividends declared on common stock ($0.225 per share)			-				-				-			(6,805	)			-				-				(6,805	)
Redemption of preferred stock			(11,250	)			-				-			-				-				-				(11,250	)
Exercise of stock options (36,135 shares)			-				-				232			-				-				-				232
Restricted stock and performance units grants (75,520 shares)			-				-				-			-				-				-				-
Stock-based compensation expense			-				-				1,650			-				-				-				1,650
Balance as of September 30, 2016		$	-			$	374,287			$	10,409		$	130,885			$	(16,717	)		$	724			$	499,588
Balance as of December 31, 2016		$	-			$	412,726			$	11,407		$	126,462			$	(16,717	)		$	(2,846	)		$	531,032
Net income			-				-				-			32,640				-				-				32,640
Other comprehensive income, net of tax			-				-				-			-				-				17				17
Cash dividends declared on common stock ($0.225 per share)			-				-				-			(7,251	)			-				-				(7,251	)
Stock issuance costs			-				(180	)			-			-				-				-				(180	)
Exercise of stock options (10,846 shares)			-				-				118			-				-				-				118
Restricted stock grants (57,164 shares)			-				-				-			-				-				-				-
Stock-based compensation expense			-				-				1,315			-				-				-				1,315
Balance as of September 30, 2017		$	-			$	412,546			$	12,840		$	151,851			$	(16,717	)		$	(2,829	)		$	557,691

See accompanying notes to unaudited consolidated financial statements.

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

		Nine Months Ended
		September 30,
(dollars in thousands)		2017				2016
Cash flows from operating activities
Net income		$	32,640			$	33,106
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment			2,364				2,084
Provision for loan losses			4,000				13,500
Increase in valuation allowance			15,325				-
Amortization of intangibles			555				627
Net accretion of loans			(1,106	)			(3,381	)
Accretion on bank premises			(58	)			(94	)
Accretion on deposits			(19	)			(167	)
Accretion on borrowings			(156	)			(250	)
Stock-based compensation			1,315				1,650
Gains on sales of investment securities, net			(1,596	)			(4,234	)
Gains on sales of loans held-for-sale, net			(120	)			(147	)
Gains on sales of fixed assets, net			(8	)			-
Loans originated for resale			(6,790	)			(6,399	)
Proceeds from sale of loans held-for sale			12,015				4,948
Net loss (gain) on sale of other real estate owned			82				(182	)
Increase in cash surrender value of bank owned life insurance			(2,402	)			(1,843	)
Amortization of premiums and accretion of discounts on investments securities, net			1,808				1,148
(Increase) decrease in accrued interest receivable			(1,876	)			48
Decrease (increase) in other assets			8,894				(2,813	)
Increase (decrease) in other liabilities			3,444				(981	)
Net cash provided by operating activities			68,311				36,620
Cash flows from investing activities
Investment securities available-for-sale:
Purchases			(138,945	)			(114,844	)
Sales			29,543				85,253
Maturities, calls and principal repayments			61,700				109,452
Investment securities held-to-maturity:
Purchases			-				(1,000	)
Maturities and principal repayments			-				14,758
Net (purchases) redemptions of restricted investment in bank stocks			(5,362	)			8,077
Payments on loans held-for-sale			2,841				-
Net increase in loans			(447,457	)			(359,945	)
Proceeds from sales of fixed assets			8				-
Purchases of premises and equipment			(2,148	)			(1,769	)
Purchases of bank owned life insurance			(10,000	)			(17,000	)
Proceeds from sale of other real estate owned			1,124				2,992
Net cash used in investing activities			(508,696	)			(274,026	)
Cash flows from financing activities
Net increase in deposits			279,517				478,150
Advances of Federal Home Loan Bank (“FHLB”) borrowings			780,000				375,000
Repayments of FHLB borrowings			(656,000	)			(565,000	)
Repayment of repurchase agreement			(15,000	)			-
Cash dividends paid on common stock			(7,207	)			(6,805	)
Cash dividends paid on preferred stock			-				(22	)
Common stock issuance costs			(180	)			-
Redemption of preferred stock			-				(11,250	)
Proceeds from exercise of stock options			118				232
Net cash provided by financing activities			381,248				270,305
Net change in cash and cash equivalents			(59,137	)			32,899
Cash and cash equivalents at beginning of period			200,399				200,895
Cash and cash equivalents at end of period		$	141,262			$	233,794
Supplemental disclosures of cash flow information
Cash payments for:
Interest paid on deposits and borrowings		$	25,807			$	22,791
Income taxes			4,670				18,195
Supplemental disclosures of noncash investing activities
Transfer of loans to other real estate owned		$	580			$	887
Transfer of loans from held-for-investment to held-for-sale			34,652				13,514
Transfer of investment securities from held-to-maturity to available-for-sale			-				209,855

See accompanying notes to unaudited consolidated financial statements.

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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. Substantially all loans are secured with various types of collateral, including business assets, consumer assets and commercial/residential real estate. Each borrower’s ability to repay its loans is dependent on the conversion of assets, cash flows generated from the borrowers’ 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 and nine months ended September 30, 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. 2017-12 “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” ASU No. 2017-12 refines and expands hedge accounting for both financial (e.g., interest rate) and commodity risks. Its provisions create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes. It also makes certain targeted improvements to simplify the application of hedge accounting guidance. ASU 2017-12 will be effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Although management continues to evaluate the potential impact of ASU 2017-12 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. 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. 2017-04, “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. Although management continues to evaluate the potential impact of ASU 2017-04 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.

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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. Although management continues to evaluate the potential impact of ASU 2016-05 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. 2016-13, “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, the amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company has formed a CECL committee that will be assessing our data and system needs. The Company has also met with multiple third-party vendors who may provide assistance in implementation and model creation. 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. 2016-02, “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 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 2016-01, 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 2016-01 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.

9

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

Note 2. New Authoritative Accounting Guidance – (continued)

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. 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.

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments relate to when another party, along with the entity, is involved in providing a good or service to a customer. The amendments in this update affect the guidance in ASU No. 2014-09 above, which is not yet effective. The effective date will be the same as the effective date of ASU No. 2014-09.

In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The amendments clarify the following two aspects of Topic 606: identifying performance obligations, and the licensing implementation guidance. The amendments in this update are intended to improve the operability and understandability of the licensing implementation guidance. The amendments in this update affect the guidance in ASU No. 2014-09 above, which is not yet effective. The effective date will be the same as the effective date of ASU No. 2014-09.

In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. The amendments do not change the core revenue recognition principle in Topic 606. The amendments provide clarifying guidance in certain narrow areas and add some practical expedients.

In December 2016, the FASB issued ASU No. 2016-20, Revenue from Contracts with Customers (Topic 606): Technical Corrections and Improvements. The FASB board decided to issue a separate update for technical corrections and improvements to Topic 606 and other Topics amended by ASU No. 2014-09 to increase awareness of the proposals and to expedite improvements to ASU No. 2014-09. The amendment affects narrow aspects of the guidance issued in ASU No. 2014-09.

10

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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 previously 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:

There were no antidilutive share equivalents as of September 30, 2017 and September 30, 2016.

Note 4. Securities Available-For-Sale

The Company’s securities are all classified as available-for-sale at September 30, 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 September 30, 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.

During the quarter ended September 30, 2016, the Company transferred all securities previously categorized as held-to-maturity to available-for-sale classification. The transfer resulted in an increase of approximately $210 million in amortized cost basis of available-for-sale securities and resulted in a net increase to accumulated other comprehensive income of $7.4 million, net of tax. The transfer enhanced liquidity and increased 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.

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.

11

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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 September 30, 2017 and December 31, 2016:

12

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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 September 30, 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.

Gross gains and losses from the sales, calls and maturities of securities for periods presented were as follows (dollars in thousands):

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2017			2016			2017			2016
Net gains on sales of securities, after tax		$	-		$	78,680		$	29,543		$	85,253
Gross gains on sales of securities			-			4,131			1,596			4,234
Gross losses on sales of securities			-			-			-			-
Net gains on sales of securities			-			4,131			1,596			4,234
Less: tax provision on net gains			-			1,640			579			1,682
Net gains on sales of securities, after tax		$	-		$	2,491		$	1,017		$	2,552

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.

13

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

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

Temporarily Impaired Securities

The Company does not believe that any of the unrealized losses, which were comprised of 75 and 84 securities as of September 30, 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 OTTI at September 30, 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.

14

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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 September 30, 2017 and December 31, 2016:

		September 30, 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)
Federal agency obligation		$	21,451		$	(171	)		$	17,679		$	(116	)		$	3,772		$	(55	)
Residential mortgage pass-through securities			77,391			(1,021	)			49,079			(457	)			28,312			(564	)
Obligations of U.S. states and political subdivisions			54,073			(1,044	)			47,016			(829	)			7,057			(215	)
Trust preferred securities			1,507			(71	)			-			-				1,507			(71	)
Corporate bonds and notes			13,123			(219	)			3,946			(38	)			9,177			(181	)
Asset-backed securities			7,929			(38	)			-			-				7,929			(38	)
Other securities			11,193			(273	)			5,911			(56	)			5,282			(217	)
Total temporarily impaired securities		$	186,667		$	(2,837	)		$	123,631		$	(1,496	)		$	63,036		$	(1,341	)

		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)
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 $139.5 million and $121.9 million at September 30, 2017 and December 31, 2016, respectively, were pledged to secure public deposits, Federal Reserve Bank discount window borrowings, Federal Home Loan Bank (“FHLB”) advances and for other purposes required or permitted by law.

As of September 30, 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.

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.

15

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

Note 5. Derivatives – (continued)

Interest rate swaps were entered into on April 13, 2017, 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 an FHLB 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 September 30, 2017, December 31, 2016 and September 30, 2016 are presented in the following table.

		September 30,				December 31,				September 30,
		2017				2016				2016
		(dollars in thousands)
Notional amount		$	100,000			$	75,000			$	75,000
Weighted average pay rates			1.52	%			1.59	%			1.58	%
Weighted average receive rates			1.07	%			0.69	%			0.70	%
Weighted average maturity			2.7 years				2.8 years				3.1 years
Fair value		$	164			$	88			$	(1,212	)

Interest expense recorded on these swap transactions totaled approximately $95,000 and $326,000 for the three and nine months ended September 30, 2017, respectively, and $167,000 and $534,000 for the three and nine months ended September 30, 2016, respectively.

Cash Flow Hedge

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

		Nine Months Ended September 30, 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
		Portion)			interest income			(Ineffective Portion)
		(dollars in thousands)
Interest rate contracts		$	45		$	-		$	-

		Nine Months Ended September 30, 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
		Portion)				interest income			(Ineffective Portion)
		(dollars in thousands)
Interest rate contracts		$	(640	)		$	-		$	-

The following table reflects the cash flow hedges included in the consolidated statements of condition as of September 30, 2017 and December 31, 2016:

		September 30, 2017						December 31, 2016
		Notional						Notional
		Amount			Fair Value			Amount			Fair Value
		(dollars in thousands)
Interest rate swaps related to FHLB advances included in assets		$	100,000		$	164		$	75,000		$	88

16

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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 consideration of 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.

17

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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 (“ALLL”). After acquisition, probable incurred credit losses are recognized by an increase in the ALLL.

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.

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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:

As of September 30, 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 $47.4 million and $65.6 million, net of $15.3 million and $-0- million valuation allowance, respectively. The commercial real estate segment reflects multifamily loans, with a carrying value of $41.8 million as of September 30, 2017. These loans were designated as loans held-for-sale during the quarter ended September 30, 2017. No portion of the valuation allowance has been designated toward the loans held-for-sale within the commercial real estate segment.

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

19

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

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

Loans receivable: The following table sets forth the composition of the Company’s loan portfolio, including net deferred loan fees, at September 30, 2017 and December 31, 2016:

At September 30, 2017 and December 31, 2016, loan balances of approximately $1.9 billion and $1.8 billion, respectively, were pledged to secure borrowings from the FHLB of New York.

Purchased Credit-Impaired Loans: The Company holds purchased loans for which there was, at their acquisition date, evidence of deterioration of credit quality since their origination and it was probable, at acquisition, that all contractually required payments would not be collected. The recorded investment of those loans is as follows at September 30, 2017 and December 31, 2016.

For those purchased loans disclosed above, the Company did not increase the allowance for loan losses during both the three and nine months ended September 30, 2017 and September 30, 2016. There were no reversals from the allowance for loan losses during the three and nine months ended September 30, 2017 and 2016.

The following tables presents the accretable yield, or income expected to be collected, on the purchased credit-impaired loans for the following periods:

20

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

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

Loans Receivable on Nonaccrual Status: The following tables presents nonaccrual loans included in loans receivable by loan segment as of the periods presented:

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.

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 September 30, 2017 and December 31, 2016:

21

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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 September 30, 2017 and December 31, 2016:

22

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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 and nine months ended September 30, 2017 and 2016:

		Three Months Ended September 30,												Nine Months Ended September 30,
		2017						2016						2017						2016
		Average			Interest			Average			Interest			Average			Interest			Average			Interest
		Recorded			Income			Recorded			Income			Recorded			Income			Recorded			Income
		Investment			Recognized			Investment			Recognized			Investment			Recognized			Investment			Recognized
		(dollars in thousands)
Impaired loans (no allowance)
Commercial		$	3,100		$	34		$	6,704		$	66		$	3,149		$	115		$	4,317		$	86
Commercial real estate			19,302			221			9,129			65			18,813			424			8,167			118
Commercial construction			4,285			63			1,224			21			4,273			215			979			54
Residential real estate			2,529			2			3,271			5			2,551			6			3,247			15
Consumer			48			1			70			1			54			2			74			3
Total		$	29,264		$	321		$	20,398		$	158		$	28,840		$	762		$	16,784		$	276
Impaired loans (allowance):
Commercial		$	-		$	-		$	91,393		$	925		$	-		$	-		$	85,620		$	2,447
Commercial real estate			1,645			2			153			-			1,654			39			153			-
Total		$	1,645		$	2		$	91,546		$	925		$	1,654		$	39		$	85,773		$	2,447
Total impaired loans:
Commercial		$	3,100		$	34		$	98,097		$	991		$	3,149		$	115		$	89,937		$	2,533
Commercial real estate			20,947			223			9,282			65			20,467			463			8,320			118
Commercial construction			4,285			63			1,224			21			4,273			215			979			54
Residential mortgage			2,259			2			3,271			5			2,551			6			3,247			15
Consumer			48			1			70			1			54			2			74			3
Total		$	30,909		$	323		$	111,944		$	1,083		$	30,494		$	801		$	102,557		$	2,723

Included in impaired loans at September 30, 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.

23

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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 September 30, 2017 and December 31, 2016 by segment:

Aging Analysis

		September 30, 2017
								90 Days or
								Greater Past						Total Past
		30-59 Days			60-89 Days			Due and Still						Due and
		Past Due			Past Due			Accruing			Nonaccrual			Nonaccrual			Current			Gross Loans
		(dollars in thousands)
Commercial		$	199		$	288		$	4,209		$	951		$	5,647		$	635,966		$	641,613
Commercial real estate			586			8,057			-			8,369			17,012			2,568,193			2,585,205
Commercial construction			-			-			-			-			-			399,453			399,453
Residential real estate			918			541			-			4,435			5,894			258,350			264,244
Consumer			-			2			-			-			2			1,910			1,912
Total		$	1,703		$	8,888		$	4,209		$	13,755		$	28,555		$	3,863,872		$	3,892,427
		December 31, 2016
								90 Days or
								Greater Past						Total Past
		30-59 Days			60-89 Days			Due and Still						Due and
		Past Due			Past Due			Accruing			Nonaccrual			Nonaccrual			Current			Gross Loans
		(dollars in thousands)
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			223,835			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 or greater past due and still accruing/accreting category as of both September 30, 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.

24

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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 credit quality, and the related portion of the allowance for loan losses (“ALLL”) that are allocated to each loan portfolio segment:

		September 30, 2017
					Commercial			Commercial			Residential
		Commercial			real estate			construction			real estate			Consumer			Unallocated			Total
		(dollars in thousands)
ALLL
Individually evaluated for impairment		$	-		$	110		$	-		$	-		$	-		$	-		$	110
Collectively evaluated for impairment			7,716			15,224			3,940			1,052			2			326			28,260
Acquired portfolio			-			1,500			-			-			-			-			1,500
Acquired with deteriorated credit quality			-			-			-			-			-			-			-
Total ALLL		$	7,716		$	16,834		$	3,940		$	1,052		$	2		$	326		$	29,870
Gross loans
Individually evaluated for impairment		$	3,068		$	20,861		$	4,340		$	2,520		$	46					$	30,835
Collectively evaluated for impairment			618,012			2,142,385			395,113			199,902			1,410						3,356,822
Acquired portfolio			15,290			421,727			-			61,822			456						499,295
Acquired with deteriorated credit quality			5,243			232			-			-			-						5,475
Total gross loans		$	641,613		$	2,585,205		$	399,453		$	264,244		$	1,912					$	3,892,427
		December 31, 2016
					Commercial			Commercial			Residential
		Commercial			real estate			construction			real estate			Consumer			Unallocated			Total
		(dollars in thousands)
ALLL
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 ALLL		$	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

25

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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 (“ALLL”) 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 ALLL is as follows:

		Three Months Ended September 30, 2017
						Commercial				Commercial				Residential
		Commercial				real estate				construction				real estate				Consumer				Unallocated				Total
		(dollars in thousands)
Balance at June 30, 2017		$	7,238			$	15,389			$	4,241			$	985			$	2			$	546			$	28,401
Charge-offs			-				-				-				-				(1	)			-				(1	)
Recoveries			17				2				-				-				1				-				20
Provision for loan losses			461				1,443				(301	)			67				-				(220	)			1,450
Balance at September 30, 2017		$	7,716			$	16,834			$	3,940			$	1,052			$	2			$	326			$	29,870
		Three Months Ended September 30, 2016
						Commercial				Commercial				Residential
		Commercial				real estate				construction				real estate				Consumer				Unallocated				Total
		(dollars in thousands)
Balance at June 30, 2016		$	15,548			$	11,371			$	4,040			$	1,091			$	4			$	709			$	32,763
Charge-offs			(1,878	)			-				-				(27	)			(5	)			-				(1,910	)
Recoveries			1				10				-				-				1				-				12
Provision for loan losses			6,725				(6	)			32				110				4				(115	)			6,750
Balance at September 30, 2016		$	20,396			$	11,375			$	4,072			$	1,174			$	4			$	594			$	37,615

26

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

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

		Nine Months Ended September 30, 2017
						Commercial				Commercial				Residential
		Commercial				real estate				construction				real estate				Consumer				Unallocated				Total
		(dollars in thousands)
Balance at December 31, 2016		$	6,632			$	12,583			$	4,789			$	958			$	3			$	779			$	25,744
Charge-offs			-				(71	)			-				-				(12	)			-				(83	)
Recoveries			158				50				-				-				1				-				209
Provision for loan losses			926				4,272				(849	)			94				10				(453	)			4,000
Balance at September 30, 2017		$	7,716			$	16,834			$	3,940			$	1,052			$	2			$	326			$	29,870
		Nine Months Ended September 30, 2016
						Commercial				Commercial				Residential
		Commercial				real estate				construction				real estate				Consumer				Unallocated				Total
		(dollars in thousands)
Balance at December 31, 2015		$	10,949			$	10,926			$	3,253			$	976			$	4			$	464			$	26,572
Charge-offs			(2,396	)			-				-				(94	)			(10	)			-				(2,500	)
Recoveries			2				35				-				3				3				-				43
Provision for loan losses			11,841				414				819				289				7				130				13,500
Balance at September 30, 2016		$	20,396			$	11,375			$	4,072			$	1,174			$	4			$	594			$	37,615

Troubled 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 nine 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 September 30, 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.

27

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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 a rollforward of TDRs and the related changes to the allowance for loan losses (“ALLL”) that occurred for the periods presented:

TDRs totaled $17.6 million at September 30, 2017, of which $4.8 million were on nonaccrual status and $12.8 million were performing under restructured terms. At December 31, 2016, TDRs totaled $13.8 million, of which $0.5 million were on nonaccrual status and $13.3 million were performing under restructured terms. TDRs as of September 30, 2017 did not increase the ALLL during the three and nine months ended September 30, 2017. There were no charge-offs in connection with a loan modification at the time of modification during the three or nine months ended September 30, 2017. There were no TDRs for which there was a payment default within twelve months following the modification during the three and nine months ended September 30, 2017.

TDRs totaled $106.7 million at September 30, 2016, of which $1.4 million were on nonaccrual status and $105.3 million were performing under restructured terms. The Company had allocated $12.5 in specific allocations with respect to loans whose loan terms had been modified in troubled debt restructurings as of September 30, 2016. TDRs as of September 30, 2016 increased the ALLL by $5.0 and $8.3 million during the three and nine months ended September 30, 2016, respectively.

The $12.5 million in specific allocations referenced above were associated with New York City taxi medallion lending and were calculated based on the present value of estimated cash flows, including contractual debt interest service through maturity, and principal repayments based on the estimated fair value of the collateral excluding any consideration for personal guarantees of borrowers, which provide an additional source of repayment but cannot be relied upon.

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2016 (dollars in thousands):

Included in the above TDRs were 14 loans secured by 25 New York City taxi medallions totaling $17.3 million. These loan modifications included interest rate reductions and maturity extensions. All 14 loans were accruing prior to modification, while 13 remained in accrual status post-modification.

28

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

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

The TDRs described above increased the allowance for loan losses by $8.3 million during the nine months ended September 30, 2016. There were no charge-offs in connection with a loan modification at the time of modification during the three and nine months ended September 30, 2016. There were no TDRs for which there was a payment default within twelve months following the modification during the three or nine months ended September 30, 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).

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 September 30, 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.

29

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

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

Derivatives

The fair value of derivatives is 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.

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 September 30, 2017 and December 31, 2016 are as follows:

					September 30, 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:
Federal agency obligations		$	55,938		$	-		$	55,938		$	-
Residential mortgage pass-through securities			133,164			-			133,164			-
Commercial mortgage pass-through securities			4,130			-			4,130			-
Obligations of U.S. states and political subdivisions			144,976			-			127,111			17,865
Trust preferred securities			4,627			-			4,627			-
Corporate bonds and notes			30,088			-			30,088			-
Asset-backed securities			12,633			-			12,633			-
Certificates of deposit			627			-			627			-
Equity securities			630			630			-			-
Other securities			13,703			13,703			-			-
Total available-for-sale			400,516			14,333			368,318			17,865
Derivatives			164			-			164			-
Total Assets		$	400,680		$	14,333		$	368,482		$	17,865

30

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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:
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 subdivisions			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 September 30, 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 September 30, 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).

31

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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 September 30, 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 September 30, 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

September

Assets

Inputs

Inputs

Assets measured at fair value on a nonrecurring basis:

30, 2017

(Level 1)

(Level 2)

(Level 3)

(dollars in thousands)

Impaired loans:

Commercial real estate

$

1,198

$

-

$

-

$

1,198

Loans held-for-sale:

Commercial

47,430

-

-

47,430

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)

(dollars in thousands)

Impaired loans:

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 loans – Collateral dependent impaired loans at September 30, 2017 that required a valuation allowance were $1.3 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.

Loans held-for-sale – Loans held-for-sale at September 30, 2017 that required a valuation allowance were $62.7 million with a related valuation allowance of $15.3 million compared to $65.6 million with no valuation allowance at December 31, 2016.

32

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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 on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2017 and year ended December 31, 2016:

(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 September 30, 2017 and December 31, 2016. The table below provides quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy.

September 30, 2017
					Valuation		Unobservable
		Fair Value			Techniques		Input		Range
					(dollars in thousands)
Securities available-for-sale:
Municipal securities		$	17,865		Discounted cash flows		Discount rate		2.8%
December 31, 2016
					Valuation		Unobservable
		Fair Value			Techniques		Input		Range
					(dollars in thousands)
Securities available-for-sale:
Municipal securities		$	18,218		Discounted cash flows		Discount rate		2.8%

33

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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.

September 30, 2017
					Valuation
					Techniques		Unobservable
Type		Fair Value			(weightings)		Input		Range (weighted average)
(dollars in thousands)
Impaired loans:
Commercial real estate		$	1,918		Appraisals of collateral value		Comparable sales		0% - 15% (6%)
Loans held-for-sale:
Commercial taxi medallion loans		$	47,430		Market approach (70%)		Indications expressed as a price to unpaid principal balance		37 - 100 (46)
					Discounted cash flows (30%)		Discount rate		14%
December 31, 2016
					Valuation
					Techniques		Unobservable
Type		Fair Value			(weightings)		Input		Range (weighted average)
(dollars in thousands)
Impaired loans:
Commercial real estate		$	1,099		Appraisals of collateral value		Comparable sales		0% - 15% (6%)
Loans held-for-sale:
Commercial taxi medallion loans		$	65,596		Market approach (70%)		Indications under securitized transactions expressed as a price to unpaid principal balance		40 - 100 (59)
					Discounted cash flows (30%)		Discount Rate		14%

34

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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 was 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.

35

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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 September 30, 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)
		(dollars in thousands)
September 30, 2017
Financial assets:
Cash and due from banks		$	141,262		$	141,262		$	141,262		$	-		$	-
Securities available-for-sale			400,516			400,516			14,333			368,318			17,865
Restricted investment in bank stocks			29,672			n/a			n/a			n/a			n/a
Loans held-for-sale			89,386			89,386			-			41,956			47,430
Net loans			3,859,419			3,862,104			-			-			3,862,104
Derivatives			164			164			-			164			-
Accrued interest receivable			14,841			14,841			-			2,011			12,830
Financial liabilities:
Noninterest-bearing deposits			719,582			719,582			719,582			-			-
Interest-bearing deposits			2,904,187			2,904,285			1,825,846			1,078,439			-
Borrowings			585,124			586,474			-			586,474			-
Subordinated debentures			54,657			56,519			-			56,519			-
Accrued interest payable			4,304			4,304			-			4,304			-
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			-

36

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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								Amounts Reclassified from Accumulated								Statement Where Net Income is
Comprehensive Income Components		Other Comprehensive Income/(Loss)								Other Comprehensive Income/(Loss)								Presented
		(dollars in thousands)
		Three Months Ended September 30,								Nine Months Ended September 30,
		2017				2016				2017				2016
Sale of securities available-for-sale		$	-			$	4,131			$	1,596			$	4,234			Net gains on sales of securities available for sale
			-				(1,640	)			(579	)			(1,682	)		Income tax expense
			-				2,491				1,017				2,552
Amortization of pension plan net actuarial losses			(103	)			(204	)			(309	)			(306	)		Salaries and employee benefits
			42				83				126				124			Income tax benefit
			(61	)			(121	)			(183	)			(182	)
Total reclassification		$	(61	)		$	2,370			$	834			$	2,370

37

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

Note 8. Other Comprehensive (Loss) Income – (continued)

Accumulated other comprehensive (loss) income (net of tax) at September 30, 2017 and December 31, 2016 consisted of the following:

Note 9. Stock-Based Compensation

The Company’s stockholders approved the 2017 Equity Compensation Plan (“the Plan”) on May 23, 2017. The Plan eliminates all remaining issuable shares under previous plans and is the only outstanding plan as of September 30, 2017. The maximum number of shares of common stock or equivalents, which may be issued under the Plan, is 750,000. Grants under the Plan can be in the form of stock options (qualified or non-qualified), restricted shares, restricted share units or performance units. Shares available for grant and issuance under the Plan as of September 30, 2017 are 750,000. The Company intends to issue all shares under the Plan 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 or upon a change of control. 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. Forfeiture rates are not estimated but are handled on a case-by-case basis.

No options or performance units were granted during the three months ended September 30, 2017 or 2016.

38

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

Note 9. Stock-Based Compensation – (continued)

Activity under the Company’s option plans as of and for the nine months ended September 30, 2017 were as follows:

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 September 30, 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 September 30, 2017. This amount changes based on the fair market value of the Parent Corporation’s stock.

The below table represents information regarding restricted shares currently outstanding at September 30, 2017:

As of September 30, 2017, there was approximately $1,366,000 of total unrecognized compensation cost related to nonvested restricted shares granted under the plans. The cost is expected to be recognized over a weighted average period of one year.

At September 30, 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 September 30, 2017 the maximum amount of performance units that ultimately could vest if performance targets were exceeded is 226,791.

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

At September 30, 2017, compensation cost of approximately $1,006,000 related to non-vested performance unit awards not yet recognized is expected to be recognized over a weighted-average period of 1.3 years.

39

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

Note 9. Stock-Based Compensation – (continued)

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 three and nine months ended September 30, 2017 is a benefit of $-0- and $180 thousand, respectively, which resulted from the effect of implementing ASU 2016-09.

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