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EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.connect3318581-ex321.htm
EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.connect3318581-ex322.htm
EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.connect3318581-ex312.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER OF THE PARENT CORPORATION - ConnectOne Bancorp, Inc.connect3318581-ex311.htm

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

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended 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)


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


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


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.

4


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.

5


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.

6


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.

7


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

Note 1. Nature of Operations and Principles of Consolidation

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

The Bank is a community-based, full-service New Jersey-chartered commercial bank that was founded in 2005. The Bank operates from its headquarters located at 301 Sylvan Avenue in the Borough of Englewood Cliffs, Bergen County, New Jersey and through its twenty other banking offices. 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.

8


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


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


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:

Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands, except for per share data)
    2017     2016     2017     2016
Net income available to common stockholders $        13,035 $                 11,812 $        32,534 $        33,084
Earnings allocated to participating securities 42 44 106 22
Net income $ 13,077 $ 11,856 $ 32,640 $ 33,106
Weighted average common shares outstanding, including participating securities 32,015 30,143 31,999 30,094
Weighted average participating securities (103 ) (113 ) (104 ) (98 )
Weighted average common shares outstanding 31,912 30,030 31,895 29,996
Incremental shares from assumed conversions of options, performance units and restricted shares 270 329 272 351
Weighted average common and equivalent shares outstanding 32,182 30,359 32,167 30,347
 
Earnings per common share:
Basic $ 0.41 $ 0.39 $ 1.02 $ 1.10
Diluted 0.41 0.39 1.01 1.09

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


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:

Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2017       Cost       Gains       Losses       Value
(dollars in thousands)
Federal agency obligations   $        55,819   $        290   $        (171 )   $        55,938
Residential mortgage pass-through securities 133,517 668 (1,021 ) 133,164
Commercial mortgage pass-through securities     4,088     42     -       4,130
Obligations of U.S. states and political subdivisions 143,787 2,233 (1,044 ) 144,976
Trust preferred securities     4,576     122     (71 )     4,627
Corporate bonds and notes 30,052 255 (219 ) 30,088
Asset-backed securities     12,605     66     (38 )     12,633
Certificates of deposit 622 5 - 627
Equity securities     376     254     -       630
Other securities 13,976 - (273 ) 13,703
Total securities available-for-sale   $ 399,418   $ 3,935   $ (2,837 )   $ 400,516
 
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2016 Cost Gains Losses Value
  (dollars in thousands)
Federal agency obligations   $ 52,826   $ 282   $ (271 )   $ 52,837
Residential mortgage pass-through securities 72,922 519 (944 ) 72,497
Commercial mortgage pass-through securities     4,186     23     -       4,209
Obligations of U.S. states and political subdivisions 148,747 2,789 (931 ) 150,605
Trust preferred securities     5,575     242     (151 )     5,666
Corporate bonds and notes 36,717 586 (375 ) 36,928
Asset-backed securities     14,867     2     (286 )     14,583
Certificates of deposit 973 10 - 983
Equity securities     376     192     -       568
Other securities 14,739 - (325 ) 14,414
Total securities available-for-sale   $ 351,928   $ 4,645   $ (3,283 )   $ 353,290

12


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.

September 30, 2017
Amortized Fair
      Cost       Value
(dollars in thousands)
Securities available-for-sale:
Due in one year or less $        6,775 $        6,801
Due after one year through five years 30,824 31,197
Due after five years through ten years 39,489 40,174
Due after ten years 170,373 170,717
Residential mortgage pass-through securities 133,517 133,164
Commercial mortgage pass-through securities 4,088 4,130
Equity securities 376 630
Other securities 13,976 13,703
Total $ 399,418 $ 400,516

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


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


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


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


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


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.

18


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:

September 30,       December 31,
2017 2016
(dollars in thousands)
Commercial $        47,430 $        70,105
Commercial real estate 41,811   7,712
Residential real estate   145   188
Total carrying amount $ 89,386 $ 78,005

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:

      Three Months       Three Months
Ended Ended
September 30, September 30,
2017 2016
(dollars in thousands)
Balance at beginning of period $        12,325   $        -
Reduction from loans paid off (38 )     -
Increase in valuation allowance 3,000 -
Balance at end of period $ 15,287 $ -
 
 
Nine Months Nine Months
Ended Ended
September 30, September 30,
2017 2016
(dollars in thousands)
Balance at beginning of period $ - $ -
Reduction from loans paid off (38 ) -
Increase in valuation allowance   15,325 -
Balance at end of period $ 15,287 $ -

19


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:

      September 30,       December 31,
2017 2016
(dollars in thousands)
Commercial $        641,613 $        553,576
Commercial real estate 2,585,205 2,204,710
Commercial construction 399,453   486,228  
Residential real estate 264,244 232,547
Consumer 1,912   2,380
Gross loans   3,892,427   3,479,441
Net deferred loan fees (3,138 ) (3,609 )
Total loans receivable $ 3,889,289 $ 3,475,832

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.

      September 30,       December 31,
2017 2016
(dollars in thousands)
Commercial $        5,243   $        7,098
Commercial real estate   232   982
Total carrying amount $ 5,475 $ 8,080

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:

      Three Months       Three Months
Ended Ended
September 30, September 30,
2017 2016
(dollars in thousands)
Balance at beginning of period $        2,496 $        3,233
Accretion of income (180 ) (185 )
Balance at end of period $ 2,316 $ 3,048
 
Nine Months Nine Months
Ended Ended
September 30, September 30,
2017 2016
(dollars in thousands)
Balance at beginning of period $ 2,860   $ 3,599
Accretion of income   (544 )   (551 )
Balance at end of period $ 2,316   $ 3,048

20


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:

      September 30,       December 31,
2017 2016
(dollars in thousands)
Commercial   $        951 $        1,460
Commercial real estate   8,369   1,081
Residential real estate 4,435   3,193
Total loans receivable on nonaccrual status $ 13,755 $ 5,734

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

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:

September 30, 2017
            Special                  
Pass Mention Substandard Doubtful Total
(dollars in thousands)
Commercial $        630,818 $        3,882 $        6,913 $        - $        641,613
Commercial real estate 2,535,005 30,875 19,325 - 2,585,205
Commercial construction 393,625 3,239 2,589 - 399,453
Residential real estate 264,244 - - - 264,244
Consumer 1,912 - - - 1,912
Gross loans $ 3,825,604 $ 37,996 $ 28,827 $ - $ 3,892,427
 
December 31, 2016
Special
Pass Mention Substandard Doubtful Total
(dollars in thousands)
Commercial $ 539,961 $ 3,255 $ 10,360 $ - $ 553,576
Commercial real estate 2,154,343 31,173 19,194 - 2,204,710
Commercial construction 480,319 3,388 2,521 - 486,228
Residential real estate 228,990 - 3,557 - 232,547
Consumer 2,318 - 62 - 2,380
Gross loans $ 3,405,931 $ 37,816 $ 35,694 $ - $ 3,479,441

21


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:

      September 30, 2017
      Unpaid      
Recorded Principal Related
Investment Balance Allowance
No related allowance recorded (dollars in thousands)
Commercial $ 3,068 $ 3,073
Commercial real estate 19,221 19,283
Commercial construction 4,340 4,340  
Residential real estate 2,520 2,749
Consumer 46 46
Total $ 29,195 $ 29,491
 
With an allowance recorded
Commercial real estate $ 1,640 $ 2,052 $        110
 
Total
Commercial $ 3,068 $ 3,073 $ -
Commercial real estate 20,861 21,335   110
Commercial construction 4,340 4,340   -
Residential real estate 2,520 2,749 -
Consumer 46 46 -
Total (including allowance) $ 30,835 $ 31,543 $ 110
  
December 31, 2016
Unpaid
Recorded Principal Related
Investment Balance Allowance
No related allowance recorded (dollars in thousands)
Commercial $        3,637 $        4,063
Commercial real estate 18,288 18,288
Commercial construction 5,909 5,909
Residential real estate 1,851 2,055
Consumer 62 62
Total $ 29,747 $ 30,377
 
With an allowance recorded
Commercial real estate $ 1,244 $ 1,244 $ 145
 
Total
Commercial $ 3,637 $ 4,063 $ -
Commercial real estate   19,532   19,532 145
Commercial construction   5,909 5,909 -
Residential real estate 1,851 2,055 -
Consumer 62   62 -
Total (including allowance) $ 30,991 $ 31,621 $ 145

22


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

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

The following table provides an analysis 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


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


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


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


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


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:

Nine Months Ended Year Ended
September 30, 2017 December 31, 2016
(dollars in thousands)
Recorded Recorded
      Investment       ALLL       Investment       ALLL
Troubled Debt Restructurings
  
Beginning balance $      13,818 $      - $      86,629 $      4,500
Additions 5,668 - 26,325 8,250
Payoffs/paydowns (1,309 ) - (2,616 ) -
Transfers (580 ) - (96,520 ) -
Other - - - (12,750 )
Ending balance $ 17,597 $ - $ 13,818 $ -

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):

Pre-Modification Post-Modification
Outstanding Outstanding
Number of Recorded Recorded
      Loans       Investment       Investment
Troubled debt restructurings:
Commercial 16 $ 19,311 $ 19,311
Commercial real estate 2 581 581
Commercial construction - - -
Residential real estate - - -
Consumer - - -
 
Total 18 $ 19,892 $ 19,892

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


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


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


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


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 loansCollateral 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-saleLoans 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


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:

Municipal
      Securities
(dollars in thousands)
Beginning balance, January 1, 2017 $                           18,218
Principal paydowns (353 )
Ending balance, September 30, 2017 $ 17,865
 
Municipal
Securities
(dollars in thousands)
Beginning balance, January 1, 2016 $ -
Other(1) 18,335
Principal paydowns (117 )
Ending balance, December 31, 2016 $ 18,218

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

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at 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


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


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


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


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


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:

September 30, December 31,
      2017       2016
(dollars in thousands)
Securities available-for-sale $             723 $           933
Cash flow hedge 97 52
Defined benefit pension and post-retirement plans (3,649 ) (3,831 )
Total accumulated other comprehensive loss $ (2,829 ) $ (2,846 )

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


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:

Weighted-
Average
Weighted- Remaining
Average Contractual
Exercise Term Aggregate
      Shares       Price       (In Years)       Intrinsic Value
Outstanding at December 31, 2016 358,367 $      6.26
Granted - -
Exercised 10,846 10.89
Forfeited/cancelled/expired - -
Outstanding at September 30, 2017 347,521 $ 6.11 1.90 $      6,425,663
Exercisable at September 30, 2017 343,991 $ 6.03 1.86 $ 6,387,912

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:

Weighted-
Average
Nonvested Grant Date
      Shares       Fair Value
Nonvested at December 31, 2016        111,273 $      16.81
Granted 57,164 23.82
Vested (65,359 ) 16.49
Forfeited/cancelled/expired - -
Nonvested at September 30, 2017 103,078 $ 20.41

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:

Weighted
Average Grant
Units Units Date Fair
      (expected)       (maximum)       Value
Unearned at December 31, 2016       151,572 189,455 $ 18.47
Awarded 24,891 37,336 22.75
Forfeited - - -
Adjustments (25,269 ) - 18.47
Unearned at September 30, 2017 151,194 226,791 $ 19.19

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


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 Nine Months Ended
September 30, September 30,
      2017       2016       2017       2016
(dollars in thousands)
Interest cost $      119 $      129 $      358 $      386
Expected return on plan assets (160 ) (166 ) (480 ) (457 )
Net amortization 103