UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

CONNECTONE BANCORP, INC.
(Exact Name of Registrant as Specified in Its Charter)

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, smaller reporting company or emerging growth company. See definition of “large accelerated filer”, “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐	Smaller reporting company ☐
		(Do not check if smaller	Emerging growth company ☐
		reporting company)

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

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

Common Stock, no par value:	32,184,713 shares
(Title of Class)	(Outstanding as of May 4, 2018)

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Table of Contents

				Page
PART I – FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Statements of Condition at March 31, 2018 (unaudited) and December 31, 2017		3
		Consolidated Statements of Income for the three months ended March 31, 2018 and 2017 (unaudited)		4
		Consolidated Statements of Comprehensive Income for the three months ended March 31, 2018 and 2017 (unaudited)		5
		Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2018 and 2017 (unaudited)		6
		Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017 (unaudited)		7
		Notes to Consolidated Financial Statements (unaudited)		8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		43
Item 3.		Qualitative and Quantitative Disclosures about Market Risks		55
Item 4.		Controls and Procedures		55
PART II – OTHER INFORMATION
Item 1.		Legal Proceedings		56
Item 1a.		Risk Factors		56
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		57
Item 3.		Defaults Upon Senior Securities		57
Item 4.		Mine Safety Disclosures		57
Item 5.		Other Information		57
Item 6.		Exhibits		58
SIGNATURES

2

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Item 1. Financial Statements

CONNECTONE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION

		March 31,				December 31,
(in thousands, except for share data)		2018				2017
		(unaudited)
ASSETS
Cash and due from banks		$	36,396			$	52,565
Interest-bearing deposits with banks			106,391				97,017
Cash and cash equivalents			142,787				149,582
Securities available-for-sale			424,322				435,284
Equity securities			11,607				-
Loans held-for-sale			45,886				24,845
Loans receivable			4,202,679				4,171,456
Less: Allowance for loan losses			32,529				31,748
Net loans receivable			4,170,150				4,139,708
Investment in restricted stock, at cost			34,622				33,497
Bank premises and equipment, net			21,039				21,659
Accrued interest receivable			16,020				15,470
Bank owned life insurance			111,500				111,311
Other real estate owned			1,076				538
Goodwill			145,909				145,909
Core deposit intangibles			2,195				2,364
Other assets			31,255				28,275
Total assets		$	5,158,368			$	5,108,442
LIABILITIES
Deposits:
Noninterest-bearing		$	739,174			$	776,843
Interest-bearing			3,010,413				3,018,285
Total deposits			3,749,587				3,795,128
Borrowings			695,032				670,077
Subordinated debentures (net of debt issuance costs of $1,845 and $456, respectively)			128,310				54,699
Other liabilities			21,173				23,101
Total liabilities			4,594,102				4,543,005
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY
Preferred stock, authorized 5,000,000 shares; issued -0- share of Series B preferred stock at March 31, 2018 and December 31, 2017; outstanding -0- shares at March 31, 2018 and December 31, 2017; liquidation value of $-0- at March 31, 2018 and December 31, 2017			-				-
Common stock, no par value, authorized 50,000,000 shares; issued 34,239,155 shares at March 31, 2018 and 34,135,782 at December 31, 2017; outstanding 32,175,233 shares at March 31, 2018 and 32,071,860 at December 31, 2017			412,546				412,546
Additional paid-in capital			13,434				13,602
Retained earnings			162,510				160,025
Treasury stock, at cost (2,063,922 common shares at March 31, 2018 and December 31, 2017)			(16,717	)			(16,717	)
Accumulated other comprehensive loss			(7,507	)			(4,019	)
Total stockholders’ equity			564,266				565,437
Total liabilities and stockholders’ equity		$	5,158,368			$	5,108,442

See accompanying notes to unaudited consolidated financial statements.

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

		Three Months Ended
		March 31,
(dollars in thousands, except for per share data)		2018			2017
Interest income
Interest and fees on loans		$	47,025		$	38,006
Interest and dividends on investment securities:
Taxable			1,887			1,548
Tax-exempt			814			954
Dividends			485			330
Interest on federal funds sold and other short-term investments			264			246
Total interest income			50,475			41,084
Interest expense
Deposits			7,688			5,109
Borrowings			4,640			2,834
Total interest expense			12,328			7,943
Net interest income			38,147			33,141
Provision for loan losses			17,800			1,100
Net interest income after provision for loan losses			20,347			32,041
Noninterest income
Income on bank owned life insurance			774			703
Deposit, loan and other income			616			643
Net gains on sale of loans held-for-sale			17			21
Net gains on sales of securities available-for-sale			-			1,596
Annuities and insurance commissions			-			39
Total noninterest income			1,407			3,002
Noninterest expenses
Salaries and employee benefits			9,672			8,144
Occupancy and equipment			2,143			2,255
Data processing			1,148			1,149
FDIC insurance			850			895
Professional and consulting			723			718
Marketing and advertising			207			256
Amortization of core deposit intangible			169			193
Other components of net periodic pension expense			7			62
Increase in valuation allowance, loans held-for-sale			-			2,600
Other expenses			2,140			1,977
Total noninterest expenses			17,059			18,249
Income before income tax expense			4,695			16,794
Income tax expense			444			4,914
Net income		$	4,251		$	11,880
Earnings per common share
Basic		$	0.13		$	0.37
Diluted			0.13			0.37
Dividends per common share		$	0.075		$	0.075

See accompanying notes to unaudited consolidated financial statements.

4

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

		Three Months Ended
		March 31,
(in thousands)		2018				2017
Net income		$	4,251			$	11,880
Other comprehensive income (loss):
Unrealized gains and losses on securities:
Unrealized holding (losses) gains on available-for-sale securities arising during the period			(5,019	)			689
Tax effect			1,292				(268	)
Net of tax			(3,727	)			421
Reclassification adjustment for realized gains included in net income			-				(1,596	)
Tax effect			-				579
Net of tax			-				(1,017	)
Unrealized gains on cash flow hedge			916				160
Tax effect			(258	)			(65	)
Net of tax			658				95
Unrealized pension plan gains and losses:
Unrealized pension plan gains (losses) before reclassifications			236				(2	)
Tax effect			(67	)			1
Net of tax			169				(1	)
Reclassification adjustment for realized losses included in net income			91				103
Tax effect			(25	)			(42	)
Net of tax			66				61
Total other comprehensive loss			(2,834	)			(441	)
Total comprehensive income		$	1,417			$	11,439

See accompanying notes to unaudited consolidated financial statements.

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

																					Accumulated
									Additional												Other				Total
(dollars in thousands, except for per share		Preferred			Common				Paid-In				Retained				Treasury				Comprehensive				Stockholders’
data)		Stock			Stock				Capital				Earnings				Stock				(Loss) Income				Equity
Balance as of December 31, 2016		$	-		$	412,726			$	11,407			$	126,462			$	(16,717	)		$	(2,846	)		$	531,032
Net income			-			-				-				11,880				-				-				11,880
Other comprehensive loss, net of tax			-			-				-				-				-				(441	)			(441	)
Cash dividends declared on common stock ($0.075 per share)			-			-				-				(2,403	)			-				-				(2,403	)
Stock issuance costs			-			(180	)			-				-				-				-				(180	)
Restricted stock grants (56,164)			-			-				-				-				-				-				-
Stock-based compensation			-			-				389				-				-				-				389
Balance as of March 31, 2017		$	-		$	412,546			$	11,796			$	135,939			$	(16,717	)		$	(3,287	)		$	540,277
Balance as of December 31, 2017		$	-		$	412,546			$	13,602			$	160,025			$	(16,717	)		$	(4,019	)		$	565,437
Reclassification of stranded tax effects (ASU 2018-02) (see Note 8)			-			-				-				709				-				(709	)			-
Cumulative effect of adopting ASU 2016-01 (see Note 8)			-			-				-				(55	)			-				55				-
Net income			-			-				-				4,251				-				-				4,251
Other comprehensive loss, net of tax			-			-				-				-				-				(2,834	)			(2,834	)
Cash dividends declared on common stock ($0.075 per share)			-			-				-				(2,420	)			-				-				(2,420	)
Exercise of stock options (38,697 shares)			-			-				202				-				-				-				202
Restricted stock grants (22,004 shares)			-			-				-				-				-				-				-
Net performance units issued (42,672 shares)			-			-				(819	)			-				-				-				(819	)
Stock-based compensation			-			-				449				-				-				-				449
Balance as of March 31, 2018		$	-		$	412,546			$	13,434			$	162,510			$	(16,717	)		$	(7,507	)		$	564,266

See accompanying notes to unaudited consolidated financial statements.

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

		Three Months Ended
		March 31,
(in thousands)		2018				2017
Cash flows from operating activities
Net income		$	4,251			$	11,880
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment			775				775
Increase in valuation allowance, loans held-for-sale			-				2,600
Provision for loan losses			17,800				1,100
Amortization of intangibles			169				193
Net accretion of loans			(179	)			(590	)
Accretion on bank premises			(16	)			(23	)
Accretion on deposits			(15	)			(4	)
Accretion on borrowings			(45	)			(54	)
Stock-based compensation			(370	)			389
Gains on sales of securities available-for-sale, net			-				(1,596	)
Loss on equity securities, net			121				-
Gains on sale of loans held-for-sale, net			(17	)			(21	)
Gains on sale of fixed assets, net			-				(8	)
Loans originated for resale			(1,045	)			(2,105	)
Proceeds from sale of loans held-for-sale			1,145				6,440
Net loss on sale of other real estate owned			-				82
Increase in cash surrender value of bank owned life insurance			(189	)			(704	)
Amortization of premiums and accretion of discounts on securities available-for-sale			1,045				489
Amortization of subordinated debt issuance costs			86				41
(Increase) decrease in accrued interest receivable			(550	)			264
(Increase) decrease in other assets			(2,269	)			6,332
Decrease in other liabilities			(464	)			(664	)
Net cash provided by operating activities			20,233				24,816
Cash flows from investing activities
Securities available-for-sale:
Purchases			(46,333	)			(49,912	)
Sales			-				29,543
Maturities, calls and principal repayments			39,503				21,383
Net purchases of restricted investment in bank stocks			(1,125	)			(675	)
Payments on loans held-for-sale			112				1,677
Net increase in loans			(69,837	)			(88,605	)
Proceeds from sales of fixed assets			-				8
Purchases of premises and equipment			(139	)			(936	)
Proceeds from sale of other real estate owned			-				544
Net cash used in investing activities			(77,819	)			(86,973	)
Cash flows from financing activities
Net (decrease) increase in deposits			(45,526	)			11,210
Increase in subordinated debentures			73,525				-
Advances of Federal Home Loan Bank (“FHLB”) borrowings			435,000				100,000
Repayments of FHLB borrowings			(410,000	)			(85,000	)
Cash dividends paid on common stock			(2,410	)			(2,403	)
Common stock issuance costs			-				(180	)
Proceeds from exercise of stock options			202				-
Net cash provided by financing activities			50,791				23,627
Net change in cash and cash equivalents			(6,795	)			(38,530	)
Cash and cash equivalents at beginning of period			149,582				200,399
Cash and cash equivalents at end of period		$	142,787			$	161,869
Supplemental disclosures of cash flow information
Cash payments for:
Interest paid on deposits and borrowings		$	10,927			$	7,603
Income taxes			1,223				55
Supplemental disclosures of noncash investing activities
Transfer of loans to other real estate owned		$	538			$	580
Transfer of loans from held-for-investment to held-for-sale			21,236				-
Transfer of loans from held-for-sale to held-for-investment			-				7,159

See accompanying notes to unaudited consolidated financial statements.

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

Note 1. Nature of Operations and Principles of Consolidation

ConnectOne Bancorp, Inc. (the “Parent Corporation”) is incorporated under the laws of the 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-one 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 ended March 31, 2018 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2018, or for any other interim period. The Company’s 2017 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 2018-01, “Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842.” ASU 2018-01 provides an optional transition practical expedient for the adoption of ASU 2016-02 that, if elected, would not require an organization to reconsider their accounting for existing land easements that are not currently accounted for under the old leases standard; and clarify that new or modified land easements should be evaluated under ASU 2016-02, once an entity has adopted the new standard. ASU 2018-01 is effective for fiscal years beginning after December 15, 2018. We believe the adoption of this standard will not have a significant impact on our consolidated financial statements.

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

Note 2. New Authoritative Accounting Guidance – (continued)

ASU No. 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 on 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 public business entities for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. 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 on our consolidated financial statements.

ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Assets Measured at Amortized Cost.” ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates and affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. For public business entities, 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 is assessing our data and system needs. The Company has engaged a third-party vendor to assist is analyzing our data and developing a CECL model. The Company has recently met with the third-party vendor and discussed our data, in terms of what is available and potential gaps. The Company also discussed modeling standards, loan segmentation, as well as potential external inputs to supplement our historical loss history. 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.

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

Note 2. New Authoritative Accounting Guidance – (continued)

ASU No. 2016-02, “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.

Note 3. Earnings per Common Share

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

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

There were no antidilutive share equivalents as of March 31, 2018 and March 31, 2017.

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

Note 4. Securities Available-for-Sale

Securities available-for-sale are reported at fair value with unrealized gains or losses included in stockholders’ equity, net of tax. Accordingly, the carrying value of such securities reflects their fair value as of March 31, 2018 and December 31, 2017. 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.

The following table summarizes the amortized cost and fair value of securities available-for-sale at March 31, 2018 and December 31, 2017 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss).

Effective January 1, 2018, the Company implemented ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” Under ASU 2016-01, equity securities, with certain exceptions, are to be measured at fair value with changes in fair value recognized in net income. As of March 31, 2018, the Company began separately presenting equity securities with readily determinable fair values on the Statements of Condition within the "Equity securities" caption. Net unrealized losses recognized during the period on equity securities with readily determinable fair values as of March 31, 2018 was $121 thousand.

Investment securities having a carrying value of approximately $174.9 million and $157.8 million at March 31, 2018 and December 31, 2017, respectively, were pledged to secure public deposits, borrowings, repurchase agreements, Federal Reserve Discount Window borrowings and Federal Home Loan Bank advances and for other purposes required or permitted by law. As of March 31, 2018 and December 31, 2017, 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.

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

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

The following table presents information for investments in securities available-for-sale at March 31, 2018, based on scheduled maturities. Actual maturities can be expected to differ from scheduled maturities due to prepayment or early call options of the issuer. Securities not due at a single maturity date are shown separately.

Gross gains and losses from the sales of securities available-for-sale for the three months ended March 31, 2018 and 2017 were as follows:

		Three Months Ended
		March 31,
		2018			2017
		(dollars in thousands)
Proceeds		$	-		$	29,543
Gross gains on sales of securities		$	-		$	1,596
Gross losses on sales of securities			-			-
Net gains on sales of securities			-			1,596
Less: tax provision on net gains			-			(579	)
Net gains on sales of securities, after tax		$	-		$	1,017

Other-than-Temporarily Impaired Investments

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.

12

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

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

Temporarily Impaired Securities

The Company does not believe that any of the unrealized losses, which were comprised of 152 and 112 securities as of March 31, 2018 and December 31, 2017, 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, and trust preferred 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 in 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 decline in fair value is due in large part to the lack of an active trading market for these securities, changes in prevailing interest rates, and changes in market credit spreads. Management concluded that these securities were not OTTI at March 31, 2018.

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.

13

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

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

The following tables indicate gross unrealized losses not recognized in income and fair value, aggregated by investment category and the length of time individual securities have been in a continuous unrealized loss position at March 31, 2018 and December 31, 2017:

		March 31, 2018
		Total							Less than 12 Months							12 Months or Longer
		Fair			Unrealized				Fair			Unrealized				Fair			Unrealized
		Value			Losses				Value			Losses				Value			Losses
		(dollars in thousands)
Investment Securities
Available-for-Sale:
Federal agency obligation		$	47,303		$	(876	)		$	35,987		$	(538	)		$	11,316		$	(338	)
Residential mortgage pass-through securities			179,661			(3,960	)			142,446			(2,428	)			37,215			(1,532	)
Commercial mortgage pass-through securities			3,959			(61	)			3,959			(61	)			-			-
Obligations of U.S. states and political subdivisions			68,741			(2,738	)			31,497			(630	)			37,244			(2,108	)
Trust preferred securities			1,496			(83	)			-			-				1,496			(83	)
Corporate bonds and notes			19,693			(392	)			10,637			(87	)			9,056			(305	)
Asset-backed securities			2,907			(22	)			923			(11	)			1,984			(11	)
Total Temporarily Impaired Securities		$	323,760		$	(8,132	)		$	225,449		$	(3,755	)		$	98,311		$	(4,377	)
		December 31, 2017
		Total							Less than 12 Months							12 Months or Longer
		Fair			Unrealized				Fair			Unrealized				Fair			Unrealized
		Value			Losses				Value			Losses				Value			Losses
		(dollars in thousands)
Investment Securities
Available-for-Sale:
Federal agency obligation		$	39,813		$	(416	)		$	28,407		$	(213	)		$	11,406		$	(203	)
Residential mortgage pass-through securities			148,574			(1,948	)			117,556			(1,146	)			31,018			(802	)
Commercial mortgage pass-through securities			1,198			(3	)			1,198			(3	)			-			-
Obligations of U.S. states and political subdivisions			57,685			(1,334	)			17,909			(246	)			39,776			(1,088	)
Trust preferred securities			1,469			(111	)			-			-				1,469			(111	)
Corporate bonds and notes			11,074			(271	)			1,965			(21	)			9,109			(250	)
Asset-backed securities			7,428			(37	)			993			(2	)			6,435			(35	)
Equity securities			11,116			(350	)			-			-				11,116			(350	)
Total Temporarily Impaired Securities		$	278,357		$	(4,470	)		$	168,028		$	(1,631	)		$	110,329		$	(2,839	)

14

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

Note 5. Derivatives

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

Interest rate swaps were entered into on April 13, 2017, August 24, 2015, October 15, 2014 and December 30, 2014, each with a respective notional amount of $25.0 million and were designated as a cash flow hedge of a Federal Home Loan Bank advance. The swaps were determined to be fully effective during the period presented and therefore no amount of ineffectiveness has been included in net income. Therefore, 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 swap designated as a cash flow hedges as of year-end is as follows (dollars in thousands):

		March 31,				December 31,
		2018				2017
Notional amount		$	100,000			$	100,000
Weighted average pay rates			1.79	%			1.66	%
Weighted average receive rates			1.82	%			1.23	%
Weighted average maturity			2.2 years				2.4 years
Fair value		$	1,714			$	798

Interest income recorded on these swap transactions totaled approximately $5 thousand during the three months ended March 31, 2018, compared to $108 thousand of interest expense recorded during the three months ended March 31, 2017.

Cash Flow Hedge

The following table presents the net gains recorded in accumulated other comprehensive income and the Consolidated Statements of Income relating to the cash flow derivative instruments for the three months ended March 31, 2018 and March 31, 2017:

		2018
		Amount of gain			Amount of gain			Amount of gain (loss)
		(loss) recognized			(loss) reclassified			recognized in other
		in OCI (Effective			from OCI to			Noninterest income
(dollars in thousands)		Portion)			interest income			(Ineffective Portion)
Interest rate contracts		$	916		$	-		$		-
		2017
		Amount of gain			Amount of gain			Amount of gain (loss)
		(loss) recognized			(loss) reclassified			recognized in other
		in OCI (Effective			from OCI to			Noninterest income
(dollars in thousands)		Portion)			interest income			(Ineffective Portion)
Interest rate contracts		$	160		$	-		$		-

The following table reflects the cash flow hedges included in the Consolidated Statements of Condition as of March 31, 2018 and December 31, 2017:

		2018						2017
(dollars in thousands)		Notional Amount			Fair Value			Notional Amount			Fair Value
Included in other assets/(liabilities):
Interest rate swaps related to FHLB Advances		$	100,000		$	1,714		$	100,000		$	798

15

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

Note 6. Loans and the Allowance for Loan Losses

Loans Receivable: 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. Fair value of these loans is determined based on the terms of the loan, such as interest rate, maturity date, reset term, as well as sales of similar assets.

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.

16

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

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

17

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

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

Loans receivable - The following table sets forth the composition of the Company’s loan portfolio, including net deferred loan fees, at March 31, 2018 and December 31, 2017:

At March 31, 2018 and December 31, 2017, loan balances of approximately $2.0 billion and $1.9 billion, respectively, were pledged to secure borrowings from the FHLB of New York.

Loans held-for-sale - The following table sets forth the composition of the Company’s loans held-for-sale portfolio at March 31, 2018 and December 31, 2017:

Valuation allowance - The following table sets forth the composition of the Company’s valuation allowance within the loans held-for-sale portfolio during the three months ended March 31, 2018 and March 31, 2017:

18

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

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

Purchased Credit-Impaired Loans: The Company holds purchased loans for which there was, at their acquisition date, evidence of deterioration of credit quality since their origination and it was probable, at acquisition, that all contractually required payments would not be collected. The recorded investment of those loans is as follows at March 31, 2018 and December 31, 2017.

For those purchased loans disclosed above, the Company did not increase the allowance for loan losses during both the three months ended March 31, 2018 and March 31 2017. There were no reversals from the allowance for loan losses during the three months ended March 31, 2018 and March 31, 2017.

The following table presents the accretable yield, or income expected to be collected, on the purchased credit-impaired loans for three months ended March 31, 2018 and March 31, 2017:

Loans Receivable on Nonaccrual Status - The following table sets forth the composition of the Company’s nonaccrual loans as of March 31, 2018 and December 31, 2017:

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 decrease in nonaccruals from the year-end 2017 was mainly attributable to a $17.0 million charge-off, related to the taxi medallion loan portfolio (which is included in the Commercial loan segment). The taxi medallion loan portfolio was classified as substandard and impaired as of March 31, 2018 and December 31, 2017.

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.

19

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

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

Credit Quality Indicators - The following table presents information, excluding loans held-for-sale and net deferred loan fees, about the Company’s loan credit quality at March 31, 2018 and December 31, 2017:

		March 31, 2018
					Special
		Pass			Mention			Substandard			Doubtful			Total
		(dollars in thousands)
Commercial		$	764,418		$	13,278		$	34,163		$	-		$	811,859
Commercial real estate			2,586,173			12,350			34,442			-			2,632,965
Commercial construction			470,386			4,646			4,158			-			479,190
Residential real estate			274,123			-			4,862			-			278,985
Consumer			2,426			-			35			-			2,461
Gross loans		$	4,097,526		$	30,274		$	77,660		$	-		$	4,205,460
		December 31, 2017
					Special
		Pass			Mention			Substandard			Doubtful			Total
		(dollars in thousands)
Commercial		$	767,020		$	3,764		$	53,298		$	-		$	824,082
Commercial real estate			2,534,973			34,335			23,601			-			2,592,909
Commercial construction			475,066			5,521			2,629			-			483,216
Residential real estate			266,163			-			5,632			-			271,795
Consumer			2,767			-			41			-			2,808
Gross loans		$	4,045,989		$	43,620		$	85,201		$	-		$	4,174,810

20

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

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

The following table provides an analysis of the impaired loans by segment as of March 31, 2018 and December 31, 2017:

21

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

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

The following table provides an analysis related to the average recorded investment and interest income recognized on impaired loans by segment as of and for the three months ended March 31, 2018 and 2017:

Included in impaired loans at March 31, 2018 and December 31, 2017 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.

22

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

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

The following table provides an analysis of the aging of gross loans (excluding loans held-for-sale) that are past due at March 31, 2018 and December 31, 2017 by segment:

Aging Analysis

		March 31, 2018
								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		$	70		$	122		$	428		$	29,883		$	30,503		$	781,356		$	811,859
Commercial real estate			2,237			403			-			15,428			18,068			2,614,897			2,632,965
Commercial construction			-			-			-			-			-			479,190			479,190
Residential real estate			2,257			-			-			4,725			6,982			272,003			278,985
Consumer			19			-			-			-			19			2,442			2,461
Total		$	4,583		$	525		$	428		$	50,036		$	55,572		$	4,149,888		$	4,205,460
		December 31, 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		$	1,708		$	183		$	1,664		$	47,363		$	50,918		$	773,164		$	824,082
Commercial real estate			545			1,475			-			12,757			14,777			2,578,132			2,592,909
Commercial construction			-			-			-			-			-			483,216			483,216
Residential real estate			1,578			-			-			5,493			7,071			264,724			271,795
Consumer			18			-			-			-			18			2,790			2,808
Total		$	3,849		$	1,658		$	1,664		$	65,613		$	72,784		$	4,102,026		$	4,174,810

Included in the 90 days or greater past due and still accruing category as of both March 31, 2018 and December 31, 2017 is one purchased credit-impaired loan, net of its fair value marks, which accretes income per its valuation at date of acquisition.

23

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

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

The following 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:

		March 31, 2018
					Commercial			Commercial			Residential
		Commercial			real estate			construction			real estate			Consumer			Unallocated			Total
		(dollars in thousands)
ALLL
Individually evaluated for impairment		$	-		$	32		$	115		$	-		$	-		$	-		$	147
Collectively evaluated for impairment			8,350			15,903			4,657			1,109			2			661			30,682
Acquired portfolio			200			1,500			-			-			-			-			1,700
Acquired with deteriorated credit quality			-			-			-			-			-			-			-
Total ALLL		$	8,550		$	17,435		$	4,772		$	1,109		$	2		$	661		$	32,529
Gross loans
Individually evaluated for impairment		$	32,100		$	36,035		$	8,803		$	2,603		$	-					$	79,541
Collectively evaluated for impairment			765,024			2,258,103			470,387			222,920			2,038						3,718,472
Acquired portfolio			12,091			338,827			-			53,462			423						404,803
Acquired with deteriorated credit quality			2,644			-			-			-			-						2,644
Total gross loans		$	811,859		$	2,632,965		$	479,190		$	278,985		$	2,461					$	4,205,460
		December 31, 2017
					Commercial			Commercial			Residential
		Commercial			real estate			construction			real estate			Consumer			Unallocated			Total
		(dollars in thousands)
Allowance for loan losses
Individually evaluated for impairment		$	-		$	39		$	-		$	-		$	-		$	-		$	39
Collectively evaluated for impairment			8,032			15,472			4,747			1,051			2			605			29,909
Acquired portfolio			200			1,600			-			-			-			-			1,800
Acquired with deteriorated credit quality			-			-			-			-			-			-			-
Total		$	8,232		$	17,111		$	4,747		$	1,051		$	2		$	605		$	31,748
Gross loans
Individually evaluated for impairment		$	49,761		$	25,038		$	6,662		$	3,203		$	-					$	84,664
Collectively evaluated for impairment			757,923			2,190,686			476,554			212,350			2,338						3,639,851
Acquired portfolio			13,715			377,185			-			56,242			470						447,612
Acquired with deteriorated credit quality			2,683			-			-			-			-						2,683
Total		$	824,082		$	2,592,909		$	483,216		$	271,795		$	2,808					$	4,174,810

24

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

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

The 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, 2017.

A summary of the activity in the ALLL is as follows:

		Three Months Ended March 31, 2018
						Commercial			Commercial			Residential
		Commercial				real estate			construction			real estate				Consumer			Unallocated			Total
		(dollars in thousands)
Balance at December 31, 2017		$	8,233			$	17,112		$	4,747		$	1,050			$	1		$	605		$	31,748
Charge-offs			(17,020	)			-			-			(18	)			-			-			(17,038	)
Recoveries			19				-			-			-				-			-			19
Provision for loan losses			17,318				323			25			77				1			56			17,800
Balance at March 31, 2018		$	8,550			$	17,435		$	4,772		$	1,109			$	2		$	661		$	32,529

		Three Months Ended March 31, 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	)			-				-			(1	)			-				(72	)
Recoveries			126				3				-				-			-				-				129
Provision			(91	)			1,603				(215	)			50			1				(248	)			1,100
Balance at March 31, 2017		$	6,667			$	14,118			$	4,574			$	1,008		$	3			$	531			$	26,901

25

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

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

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 TDR 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.

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

TDRs totaled $24.7 million at March 31, 2018, of which $10.4 million were on nonaccrual status and $14.3 million were performing under restructured terms. At December 31, 2017, TDRs totaled $20.5 million, of which $5.6 million were on nonaccrual status and $14.9 million were performing under restructured terms. TDRs as of March 31, 2018 increased the ALLL during the three months ended March 31, 2018 by $147 thousand. There were no charge-offs in connection with a loan modification at the time of modification during the three months ended March 31, 2018. There were no TDRs for which there was a payment default within twelve months following the modification during the three months ended March 31, 2018.

The following table presents loans by class modified as TDRs that occurred during the three months ended March 31, 2018 (dollars in thousands):

These six loan modifications included interest rate reductions and maturity extensions.

26

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

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

TDRs totaled $14.9 million at March 31, 2017, of which $4.9 million were on nonaccrual status and $10.0 million were performing under restructured terms. TDRs as of March 31, 2017 did not increase the ALLL during the three months ended March 31, 2017. There were no charge-offs in connection with a loan modification at the time of modification during the three months ended March 31, 2017. There were no TDRs for which there was a payment default within twelve months following the modification during the three months ended March 31, 2017.

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

These two loan modifications included interest rate reductions and maturity extensions.

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.

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).

27

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

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

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at March 31, 2018 and December 31, 2017:

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

Derivatives: The fair value of derivatives 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.

28

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

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

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2018 and December 31, 2017 are as follows:

					March 31, 2018
					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
Investment securities:
Available-for-sale:
Federal agency obligations		$	52,471		$	-		$	52,471		$	-
Residential mortgage pass-through securities			188,757			-			188,757			-
Commercial mortgage pass-through securities			3,959			-			3,959			-
Obligations of U.S. states and political subdivision			127,370			-			117,802			9,568
Trust preferred securities			4,614			-			4,614			-
Corporate bonds and notes			29,003			-			29,003			-
Asset-backed securities			11,494			-			11,494			-
Certificates of deposit			623			-			623			-
Other securities			6,031			6,031			-			-
Total available-for-sale		$	424,322		$	6,031		$	408,723		$	9,568
Equity securities			11,607			11,607			-			-
Derivatives			1,714			-			1,714			-
Total assets		$	437,643		$	17,638		$	410,437		$	9,568

29

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

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

					December 31, 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
Investment securities:
Available-for-sale:
Federal agency obligations		$	56,022		$	-		$	56,022		$	-
Residential mortgage pass-through securities			181,891			-			181,891			-
Commercial mortgage pass-through securities			4,054			-			4,054			-
Obligations of U.S. states and political subdivision			131,128			-			121,496			9,632
Trust preferred securities			4,671			-			4,671			-
Corporate bonds and notes			29,693			-			29,693			-
Asset-backed securities			12,050			-			12,050			-
Certificates of deposit			625			-			625			-
Equity securities			11,728			11,728			-			-
Other securities			3,422			3,422			-			-
Total available-for-sale		$	435,284		$	15,150		$	410,502		$	9,632
Derivatives			798			-			798			-
Total assets		$	436,082		$	15,150		$	411,300		$	9,632

There were no transfers between Level 1 and Level 2 during the quarter ended March 31, 2018 and during the year ended December 31, 2017.

Assets Measured at Fair Value on a Nonrecurring Basis

The Company may be required periodically to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or impairment write-downs of individual assets. The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a nonrecurring basis at March 31, 2018 and December 31, 2017:

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).

30

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

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

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 nonrecurring basis, the fair value measurements at March 31, 2018 and December 31, 2017 are as follows:

Fair Value Measurements at Reporting Date Using

Quoted

Prices

in Active

Significant

Markets for

Other

Significant

Identical

Observable

Unobservable

March 31,

Assets

Inputs

Inputs

Assets measured at fair value on a nonrecurring basis:

2018

(Level 1)

(Level 2)

(Level 3)

Impaired loans:

(dollars in thousands)

Commercial real estate

$

1,092

$

-

$

-

$

1,092

Commercial construction

2,554

-

-

2,554

Commercial loans (taxi medallion loans)

29,405

-

-

29,405

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:

2017

(Level 1)

(Level 2)

(Level 3)

Impaired loans:

(dollars in thousands)

Commercial real estate

$

1,094

$

-

$

-

$

1,094

Impaired loans – Collateral dependent impaired loans at March 31, 2018 that required a valuation allowance were $3.8 million with a related valuation allowance of $0.1 million compared to $1.1 million with a related valuation allowance of $39 thousand at December 31, 2017. In addition, the Company had impaired taxi medallion loans of $29.4 million that required no additional valuation allowance as of March 31, 2018. During the three months ended March 31, 2018, the Company charged-off $17.0 million related to the taxi medallion loans.

31

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

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 three months ended March 31, 2018 and for the year ended December 31, 2017:

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at March 31, 2018 and December 31, 2017. The table below provides quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy.

March 31, 2018
					Valuation		Unobservable
		Fair Value			Techniques		Input		Range
Securities available-for-sale:					(dollars in thousands)
Municipal securities		$	9,568		Discounted cash flows		Discount rate		2.9%
December 31, 2017
					Valuation		Unobservable
		Fair Value			Techniques		Input		Range
Securities available-for-sale:					(dollars in thousands)
Municipal securities		$	9,632		Discounted cash flows		Discount rate		2.9%

32

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

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

Nonrecurring basis: The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a nonrecurring basis for the periods presented. The tables below provide quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy.

March 31, 2018
					Valuation		Unobservable
		Fair Value			Techniques		Input		Range
Impaired loans:					(dollars in thousands)
Commercial real estate		$	1,092		Sales comparison approach		Adjustment for differences between the comparable sales		0% - 10%[5%]
Commercial construction		$	2,554		Sales comparison approach		Adjustment for differences between the comparable sales		12% - 17%[15%]
Commercial taxi medallion loans		$	29,405		Market approach (75%)		New York City Taxi and Limousine Commission transfers as a price to unpaid principal balance		26 - 99 (38)
					Discounted cash flows (25%)		Discount Rate		7%
December 31, 2017
					Valuation		Unobservable
		Fair Value			Techniques		Input		Range
Impaired loans:					(dollars in thousands)
Commercial real estate		$	1,094		Sales comparison approach		Adjustment for differences between the comparable sales		0% - 10%[5%]

33

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

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

As of March 31, 2018 the fair value measurements presented are consistent with Topic 820, Fair Value Measurement, in which fair value represents exit price. The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of March 31, 2018 and December 31, 2017:

								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)
March 31, 2018
Financial assets:
Cash and cash equivalents		$	142,787		$	142,787		$	142,787		$	-		$	-
Securities available-for-sale			424,322			424,322			6,031			408,724			9,568
Equity securities			11,607			11,607			11,607			-			-
Loans held-for-sale			45,886			45,886			-			288			45,598
Net loans			4,170,150			4,039,339			-			-			4,039,339
Derivatives			1,714			1,714			-			1,714			-
Financial liabilities:
Noninterest-bearing deposits			739,174			739,174			739,174			-			-
Interest-bearing deposits			3,010,413			3,002,902			1,754,759			1,248,143			-
Borrowings			695,032			692,766			-			692,766			-
Subordinated debentures			128,310			132,015			-			132,015			-
December 31, 2017
Financial assets:
Cash and cash equivalents		$	149,582		$	149,582		$	149,582		$	-		$	-
Securities available-for-sale			435,284			435,284			15,150			410,502			9,632
Loans held-for-sale			24,845			24,845			-			370			24,475
Net loans			4,139,708			4,118,542			-			-			4,118,542
Derivatives			798			798			-			798			-
Financial liabilities:
Noninterest-bearing deposits			776,843			776,843			776,843			-			-
Interest-bearing deposits			3,018,285			3,018,285			1,842,151			1,176,134			-
Borrowings			670,077			669,680			-			669,680			-
Subordinated debentures			54,699			57,340			-			57,340			-

34

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

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

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

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. Comprehensive Income

Total comprehensive income includes all changes in equity during a period from transactions and other events and circumstances from nonowner sources. The Company’s other comprehensive income (loss) is comprised of unrealized holding gains and losses on securities available-for-sale, obligations for defined benefit pension plan and an adjustment to reflect the curtailment of the Company’s defined benefit pension plan, net of taxes.

35

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

Note 8. Comprehensive Income – (continued)

Accumulated other comprehensive loss at March 31, 2018 and December 31, 2017 consisted of the following:

		March 31,				December 31,
		2018				2017
		(dollars in thousands)
Investment securities available-for-sale, net of tax			(4,762	)			(902	)
Cash flow hedge, net of tax			1,232				472
Defined benefit pension and post-retirement plans, net of tax			(3,977	)			(3,589	)
Total		$	(7,507	)		$	(4,019	)

Effective January 1, 2018, the Company implemented ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” Under ASU 2018-02, the FASB amended existing guidance to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (“Tax Act”). In order to comply with this new ASU, the Company recorded an adjustment to the balance sheet of approximately $709 thousand that increased retained earnings and decreased accumulated other comprehensive loss.

Effective January 1, 2018, the Company implemented ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” Under ASU 2016-01, equity securities, with certain exceptions, are to be measured at fair value with changes in fair value recognized in net income. In order to comply with this new ASU, the Company recorded a cumulative-effect adjustment to the balance sheet of approximately $55 thousand. As of March 31, 2018, the Company's equity securities had readily determinable fair values, and, prospectively, changes in fair value will be recognized in net income.

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 March 31, 2018. 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 March 31, 2018 are approximately 668,000. 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.

36

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

Note 9. Stock-Based Compensation – (continued)

Activity under the Company’s option plans as of and for the three months ended March 31, 2018 was as follows:

							Weighted-
							Average
				Weighted-			Remaining
				Average			Contractual
				Exercise			Term		Aggregate
		Shares		Price			(In Years)		Intrinsic Value
Outstanding at December 31, 2017		291,978		$	6.18
Granted		-			-
Exercised		38,697			5.23
Forfeited/cancelled/expired		1,323			14.24
Outstanding at March 31, 2018		251,958		$	6.28		1.91		$	5,673,608
Exercisable at March 31, 2018		249,751		$	6.21		1.88		$	5,641,474

The aggregate intrinsic value of outstanding and exercisable options above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on March 31, 2018 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2018. This amount changes based on the fair market value of the Parent Corporation’s stock.

The below table represents information regarding restricted shares currently outstanding at March 31, 2018:

As of March 31, 2018, there was approximately $1,430,000 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 1.25 years. A total of 23,282 and 56,164 restricted shares were granted during the three months ended March 31, 2018 and March 31, 2017, respectively.

At March 31, 2018, the specific number of shares related to performance unit awards that were expected to vest was approximately 151,000, determined by actual performance in consideration of the established range of the performance targets, which is consistent with the level of expense currently being recognized over the vesting period. Should this expectation change, additional compensation expense could be recorded in future periods or previously recognized expense could be reversed. At March 31, 2018 the maximum amount of performance units that ultimately could vest if performance targets were exceeded is approximately 227,000.

37

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

Note 9. Stock-Based Compensation – (continued)

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

At March 31, 2018, compensation cost of approximately $977,000 related to non-vested performance unit awards not yet recognized is expected to be recognized over a weighted-average period of 1.25 years. A total of 19,614 and 24,891 performance units were awarded during the three months ended March 31, 2018 and March 31, 2017, respectively. During the three months ended March 31, 2018, a total of 42,672 net shares were issued in satisfaction of earned performance units. The shares issued were calculated based on a net down of 26,955 shares to satisfy tax obligations created by vesting.

At March 31, 2018, the specific number of shares related to restricted stock unit awards that were expected to vest was approximately 29,423. Any forfeitures would result in previously recognized expense being reversed. A portion of the shares that vest will be repurchased to satisfy the tax obligations of the recipient.

A summary of the status of unearned restricted share units and the change during the period is presented in the table below:

At March 31, 2018, compensation cost of approximately $910,000 related to non-vested restricted stock unit awards, not yet recognized, is expected to be recognized over a weighted-average period of 2.96 years. A total of 29,423 and -0- restricted stock units were awarded during the three months ended March 31, 2018 and 2017, respectively.

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 expenses for the three months ended March 31, 2018 and March 31, 2017 is a benefit of approximately $541 thousand and $133 thousand, respectively, which resulted from the effect of implementing ASU 2016-09.

38

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

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								Affected Line Item in the Consolidated
		March 31,								Statements of Income
		2018				2017
Service cost		$	-			$	-
Interest cost			107				119			Other components of net periodic pension expense
Expected return on plan assets			(191	)			(160	)		Other components of net periodic pension expense
Net amortization			91				103			Other components of net periodic pension expense
Total periodic pension cost		$	7			$	62

Effective January 1, 2018, the Company implemented ASU 2017-07, “Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” Under ASU 2017-07, the FASB requires employers to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The table above details the affected line items within the Consolidated Statements of Income related to the net periodic pension costs for the following periods.

This ASU is also required to be applied retrospectively to all periods presented. The following table summarizes the impact of retrospective application to the consolidated statement of condition for the three months ended March 31, 2017:

Contributions

The Company made a $2.0 million contribution during the three months ended March 31, 2018. The Company does not plan on contributing amounts to the Pension Trust for the remainder of 2018. The trust is established to provide retirement and other benefits for eligible employees and their beneficiaries. No part of the trust assets may be applied to any purpose other than providing benefits under the plan and for defraying expenses of administering the plan and the trust.

Note 11. FHLB Borrowings

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

		March 31, 2018						December 31, 2017
		Amount			Rate			Amount			Rate
		(dollars in thousands)
Total FHLB borrowings		$	695,032		2.07	%		$	670,077		1.76	%
By remaining period to maturity:
Less than 1 year		$	525,032		1.98	%		$	505,077		1.59	%
1 year through less than 2 years			50,000		1.66	%			35,000		1.60	%
2 years through less than 3 years			75,000		2.92	%			85,000		2.65	%
3 years through less than 4 years			45,000		2.15	%			45,000		2.15	%
4 years through 5 years			-		-				-		-
Total FHLB borrowings		$	695,032		2.07	%		$	670,077		1.76	%

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

One of the FHLB notes, $5.0 million due July 16, 2018, contains a convertible option which allows the FHLB, at quarterly intervals, to convert the fixed convertible advance into replacement funding for the same or lesser principal based on any advance then offered by the FHLB at its current market rate. The Company has the option to repay this advance, if converted, without penalty. The remaining advances are payable at stated maturity, with a prepayment penalty for fixed rate advances. All FHLB advances are fixed rates. The advances at March 31, 2018 were primarily collateralized by approximately $1.5 billion of commercial mortgage loans, net of required over collateralization amounts, under a blanket lien arrangement. At March 31, 2018 the Company had remaining borrowing capacity of approximately $762 million at FHLB.

39

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

Note 12. Revenue Recognition

Effective January 1, 2018, the Company adopted ASU 2014-09 Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively, "ASC 606”), which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets, such as OREO. The majority of the Company’s revenues come from interest income and other sources, including loans, leases, securities, and derivatives that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented within noninterest income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include deposit service charges on deposits, interchange income, and the sale of OREO.

The Company using a modified retrospective transition approach determined that there will be no cumulative effect adjustment to retained earnings as a result of adopting the new standard, nor will the standard have a material impact on our consolidated financial statements including the timing or amounts of revenue recognized.

All of the Company’s revenue from contracts with customers within the scope of ASC 606 is recognized within noninterest income. The following table presents the Company’s sources of noninterest income for the three months ended March 31, 2018 and 2017. Items outside of ASC 606 are noted as such.

		Three Months			Three Months
		Ended			Ended
		March 31,			March 31,
		2018			2017 (b)
		(dollars in thousands)
Noninterest income
Service charges on deposits
Overdraft fees		$	202		$	179
Other			155			169
Interchange income			143			173
Net gains on sales of loans (a)			17			21
Wire transfer fees (a)			72			58
Loan servicing fees (a)			23			30
Bank-owned life insurance (a)			774			703
Net gains on sales of securities (a)			-			1,596
Annuity and insurance income (a)			-			39
Other			21			34
Total noninterest income		$	1,407		$	3,002

(a)	Not within scope of ASC 606.
(b)	The Company elected the modified respective approach of adoption; therefore, prior period balances are presented under legacy GAAP and may not be comparable to current year presentation.

A description of the Company’s revenue streams accounted for under ASC 606 is as follows:

Service Charges on Deposit Accounts: The Company earns fees from deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed at the point in the time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.

Interchange Income: The Company earns interchange fees from debit and credit card holder transaction conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided by the cardholder.

Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether the collectability of the transaction prices is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present.

40

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

Note 13. Subordinated Debentures

During 2003, the Company formed a statutory business trust, which exists for the exclusive purpose of (i) issuing Trust Securities representing undivided beneficial interests in the assets of the Trust; (ii) investing the gross proceeds of the Trust securities in junior subordinated deferrable interest debentures (subordinated debentures) of the Company; and (iii) engaging in only those activities necessary or incidental thereto. On December 19, 2003, Center Bancorp Statutory Trust II, a statutory business trust and wholly-owned subsidiary of the Parent Corporation issued $5.0 million of MMCapS capital securities to investors due on January 23, 2034. The capital securities presently qualify as Tier I capital. The trust loaned the proceeds of this offering to the Company and received in exchange $5.2 million of the Parent Corporation’s subordinated debentures. The subordinated debentures are redeemable in whole or in part prior to maturity. The floating interest rate on the subordinate debentures is three month LIBOR plus 2.85% and reprices quarterly. The rate at March 31, 2018 was 4.62%. These subordinated debentures and the related income effects are not eliminated in the consolidated financial statements as the statutory business trust is not consolidated in accordance with FASB ASC 810-10. Distributions on the subordinated debentures owned by the subsidiary trust have been classified as interest expense in the Consolidated Statements of Income.

The following table summarizes the mandatory redeemable trust preferred securities of the Company’s Statutory Trust II at March 31, 2018 and December 31, 2017.

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

During June 2015, the Parent Corporation issued $50 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “Notes”). The Notes are non-callable for five years, have a stated maturity of July 1, 2025, and bear interest at a fixed rate of 5.75% per year, from and including June 30, 2015 to, but excluding July 1, 2020. From and including July 1, 2020 to the maturity date or early redemption date, the interest rate will reset quarterly to a level equal to the then current three month LIBOR rate plus 393 basis points. As of March 31, 2018, unamortized costs related to this debt issuance were approximately $407,000.

On January 11, 2018, the Parent Corporation issued $75.0 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “Notes”). The Notes will bear interest at 5.20% annually from, and including, the date of initial issuance to, but excluding, February 1, 2023, payable semi-annually in arrears. From and including February 1, 2023 through maturity or earlier redemption, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month LIBOR rate plus 284 basis points (2.84%) payable quarterly in arrears. If three-month LIBOR is not available for any reason, then the rate for that interest period will be determined by such alternate method as provided in the Supplemental Indenture. Interest on the Notes will be paid on February 1, and August 1, commencing August 1, 2018 to but not including February 1, 2023, and from and including February 1, 2023, on February 1, May 1, August 1, and November 1, of each year to but excluding the stated maturity date, unless in any case previously redeemed. As of March 31, 2018, unamortized costs related to this debt issuance were approximately $1,438,000.

41

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

Note 14. Offsetting Assets and Liabilities

Certain financial instrument-related assets and liabilities may be eligible for offset on the consolidated statements of condition because they are subject to master netting agreements or similar agreements. However, the Company does not elect to offset such arrangements on the consolidated financial statements. The Company enters into interest rate swap agreements with financial institution counterparties. For additional detail regarding interest rate swap agreements refer to Note 5 within this section. In the event of default on, or termination of, any one contract, both parties have the right to net settle multiple contracts. Also, certain interest rate swap agreements may require the Company to receive or pledge cash or financial instrument collateral based on the contract provisions. The following table presents information about financial instruments that are eligible for offset as of March 31, 2018 and December 31, 2017:

Gross Amounts Not Offset

Net Amounts

Gross Amounts

of Assets

Offset in the

Presented in the

Cash or

Statement of

Statement of

Financial

Financial

Gross Amounts

Financial

Financial

Instruments

Instrument

Net

Recognized

Condition

Condition

Recognized

Collateral

Amount

(dollars in thousands)

March 31, 2018

Assets:

Interest rate swaps

$

1,714

$

-

$

1,714

$

-

$

-