ConnectOne Bancorp, Inc. 10-K

Item 8. Financial Statements and Supplementary Data All Financial Statements: The following financial statements are filed as part of this report under Item 8 - “Financial Statements and Supplementary Data.” Page Report of Independent Registered Public Accounting Firm 49 Consolidated Statements of Financial Condition 54 Consolidated Statements of Income 55 Consolidated Statements of Comprehensive Income 56 Consolidated Statements of Changes in Stockholders’ Equity 57 Consolidated Statements of Cash Flows 58 Notes to Consolidated Financial Statements 59 - 48 - Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of ConnectOne Bancorp, Inc. and Subsidiaries Englewood Cliffs, New Jersey Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated statements of financial condition of ConnectOne Bancorp, Inc. and Subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO. Basis for Opinions The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. - 49 - Table of Contents Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Allowance for Loan Losses – Exogenous Factors Related to Commercial, Commercial Real Estate, and Commercial Construction Loan Segments The allowance for loan losses represents management’s estimate of probable incurred credit losses inherent in the loan portfolio. As described in Notes 1a and 5 to the consolidated financial statements, the Company’s consolidated allowance for loan losses was $79,226,000 at December 31, 2020, which consisted of the allowance for loans losses allocated to 1) loans individually evaluated for impairment, representing $14,314,000, 2) loans collectively evaluated for impairment (“general component”), representing $58,504,000, and 3) loans acquired, representing $5,840,000, as well as an unallocated allowance for loan losses of $568,000. The general component can be further broken down as the general component related to the commercial, commercial real estate, and commercial construction loan segments of $56,572,000 and the general component related to the residential real estate and consumer segments of $1,932,000. The general component is based on historical loss experience adjusted for current factors. This actual loss experience is supplemented with exogenous factor adjustments based on the risks present for each loan category. Changes in these exogenous factor adjustments related to the commercial, commercial real estate, and commercial construction loan segments could have a material impact on the Company’s financial results. - 50 - Table of Contents The general component of the Company’s allowance for loan losses involves consideration of the following exogenous factors: concentrations of credit; delinquency and nonaccrual trends; economic and 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. The consideration of these factors contributes significantly to the general component of the allowance for loan losses for the commercial, commercial real estate, and commercial construction loan segments. Management’s analysis of these exogenous factors requires significant judgment, and management’s allocation of exogenous factors relies on a qualitative analysis to determine the quantitative impact the exogenous factors have on the general component for the commercial, commercial real estate, and commercial construction loan segments. We identified auditing management’s analysis and allocation of the exogenous factors to the general component of the allowance for loan losses for the commercial, commercial real estate, and commercial construction loan segments as a critical audit matter as it involved especially subjective auditor judgment. The primary audit procedures we performed to address this critical audit matter included: • Testing the effectiveness of controls over the evaluation of the exogenous factors used to estimate the general component for the commercial, commercial real estate, and commercial construction loan segments, including controls addressing: ○ Management’s review of the completeness and accuracy of data used as the basis for the adjustments relating to exogenous factors;   ○ Management’s judgments related to the qualitative and quantitative assessment of the data used in the determination of qualitative reserve factors and the resulting allocation to the allowance allocated to loans collectively evaluated for impairment; and,   ○ Management’s review of the exogenous factor reserve for mathematical accuracy.   • Substantively testing management’s process, including evaluating their judgments and significant assumptions, for developing the exogenous factors used to estimate the general component for the commercial, commercial real estate, and commercial construction loan segments which included: ○ Evaluation of the completeness and accuracy of data used as a basis for the adjustments relating to exogenous factors;   ○ Evaluation of the reasonableness of management’s judgments related to the qualitative and quantitative assessment of the data used in the determination of exogenous factors and the resulting allocation to the allowance allocated to loans collectively evaluated for impairment. Among other procedures, our evaluation considered actual charge offs, loan portfolio performance and third-party data, and whether such assumptions were applied consistently period over period;   ○ Analytically evaluating the exogenous factor allocation year over year for reasonableness; and,   ○ Recalculation of the exogenous factor reserve.   - 51 - Table of Contents Business Combinations – Fair Value of Acquired Non-Credit-Impaired Loans As described in Note 2 to the consolidated financial statements, on January 2, 2020 the Company completed its acquisition of Bancorp of New Jersey, Inc. The business combination was accounted under the acquisition method of accounting, with assets acquired and liabilities assumed recorded at fair value as of the acquisition date. The fair value of loans acquired in the acquisition totaled $774,720,000, which included $763,020,000 of non-credit-impaired loans and $11,700,000 of credit-impaired loans. The fair values of non-credit-impaired loans acquired were estimated based on the value of the expected cash flows, which were projected based on the contractual terms of loans, including both maturity and contractual amortization. Projected cash flows were adjusted for expected losses and prepayments, where appropriate. Expected losses assumptions were developed using peer group loss data. Projected cash flows were then discounted to present value using a discount rate developed based on the relative risk of the cash flows, considering the loan type, liquidity risk, the maturity of the loans, servicing costs and a required return on capital. Changes in these estimates and assumptions could have a significant impact on the fair values of the acquired non-credit-impaired loans. We identified auditing the fair value of acquired non-credit-impaired loans as a critical audit matter as it involved especially subjective auditor judgment. The primary audit procedures we performed to address this critical audit matter included: • Testing the effectiveness of controls over the judgments, significant assumptions and data used to estimate the fair value of acquired non-credit-impaired loans, including controls addressing: ○ Management’s evaluation of the reasonableness of the judgments and assumptions used to estimate fair value; and,   ○ Management’s review of the completeness and accuracy of the data used.   • Substantively testing management’s process, including evaluating their judgments and assumptions, for estimating the fair value of acquired non-credit-impaired loans which included: ○ Evaluation of the reasonableness of judgments and assumptions used by management;   ○ Evaluation of the completeness and accuracy of the data used; and,   ○ Utilization of an internal valuation specialist to assist with the evaluation of the appropriateness of assumptions, judgments and data used and overall reasonableness of the fair values.   - 52 - Table of Contents Goodwill Impairment Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. As described in Notes 1a and 7 to the consolidated financial statements, the Company’s consolidated goodwill balance was $208,372,000 at December 31, 2020. Goodwill is tested annually for impairment in the fourth quarter, or more frequently if events and circumstances exist that indicate it is more likely than not impairment has occurred. During the quarter ended June 30, 2020, the Company determined a triggering event had occurred and performed a quantitative goodwill impairment evaluation using both income and market approaches to estimate the fair value of the Company and based on results of evaluation, no goodwill impairment was recorded. The goodwill impairment evaluation involved significant estimates and subjective assumptions, which required a high degree of management judgment. Significant estimates and subjective assumptions included discount rate, prospective financial information, earnings retention rate and peer group market data. Changes in these estimates and assumptions could have a significant impact on the conclusions reached regarding whether impairment occurred and the amount of impairment. We identified auditing the goodwill impairment evaluation as a critical audit matter as it involved especially subjective auditor judgment. The primary audit procedures we performed to address this critical audit matter included: • Testing the effectiveness of controls over the judgments, assumptions and data used to estimate the fair value of the Company, including controls addressing: ○ Management’s review of the reasonableness and accuracy of the Company’s prospective financial information used in the income approach.   ○ Management’s evaluation of significant assumptions used, including valuation methodologies, discount rate, earnings retention rate and peer group market data.   • Substantively testing management’s process, including evaluating their judgments and significant assumptions, for estimating the fair value of the Company which included: ○ Evaluation of key financial data for accuracy.   ○ Evaluation of management’s ability to reasonably forecast cash flows.   ○ Utilization of an internal valuation specialist to assist with the evaluation of the appropriateness of valuation methodologies, discount rate, earnings retention rate, peer group market data and overall reasonableness of the fair value.     /s/ Crowe LLP   We have served as the Company’s auditor since 2014.   New York, New York March 1, 2021 - 53 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 2020 2019 (in thousands, except share data) ASSETS Cash and due from banks $ 63,637 $ 65,717 Interest-bearing deposits with banks   240,119   135,766 Cash and cash equivalents 303,756 201,483   Securities available-for-sale 487,955 404,701 Equity securities 13,387 11,185   Loans held-for-sale 4,710 33,250   Loans receivable 6,236,307 5,113,527 Less: Allowance for loan losses   79,226   38,293 Net loans receivable 6,157,081 5,075,234   Investment in restricted stock, at cost 25,099 27,397 Bank premises and equipment, net 30,108 19,236 Accrued interest receivable 35,317 20,949 Bank owned life insurance 165,960 137,961 Right of use operating lease assets 16,159 15,137 Goodwill 208,372 162,574 Core deposit intangibles 10,977 5,460 Other assets   88,458   59,465 Total assets $ 7,547,339 $ 6,174,032 LIABILITIES Deposits: Noninterest-bearing $ 1,339,108 $ 861,728 Interest-bearing   4,620,116   3,905,814 Total deposits 5,959,224 4,767,542 Borrowings 425,954 500,293 Operating lease liabilities 18,026 16,449 Subordinated debentures, net of debt issuance costs 202,648 128,885 Other liabilities   26,177   29,673 Total liabilities   6,632,029   5,442,842   COMMITMENTS AND CONTINGENCIES   STOCKHOLDERS’ EQUITY Preferred Stock: Authorized 5,000,000 shares - - Common stock, no par value: Authorized 50,000,000 shares; issued 42,444,031 shares as of December 31, 2020 and 37,676,006 shares as of December 31, 2019; outstanding 39,785,398 shares as of December 31, 2020 and 35,072,066 as of December 31, 2019 586,946 468,571 Additional paid-in capital 23,887 21,344 Retained earnings 331,951 271,782 Treasury stock, at cost ( 2,658,633 shares as of December 31, 2020 and 2,603,940 shares as of December 31, 2019) ( 30,271 ) ( 29,360 ) Accumulated other comprehensive income (loss)   2,797   ( 1,147 ) Total stockholders’ equity   915,310   731,190 Total liabilities and stockholders’ equity $ 7,547,339 $ 6,174,032 See the accompanying notes to the consolidated financial statements. - 54 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2020 2019 2018 (dollars in thousands, except for per share data) Interest income: Interest and fees on loans $ 296,611 $ 255,479 $ 201,524 Interest and dividends on investment securities: Taxable 6,456 9,131 8,482 Tax-exempt 2,797 3,929 3,276 Dividends 1,642 1,778 2,012 Interest on federal funds sold and other short-term investments   694   1,167   839 Total interest income   308,200   271,484   216,133 Interest expense: Deposits 52,386 65,570 39,936 Borrowings   17,823   19,595   18,982 Total interest expense   70,209   85,165   58,918 Net interest income 237,991 186,319 157,215 Provision for loan losses   41,000   8,100   21,100 Net interest income after provision for loan losses   196,991   178,219   136,115 Noninterest income: Income on bank owned life insurance 5,007 3,484 3,094 Net gains on sale of loans held-for-sale 2,085 512 61 Deposit, loan and other income 7,077 4,025 2,584 Net gains (losses) on equity securities 202 294 ( 266 ) Net gains (losses) on sale of investment securities   29   ( 280 )   - Total noninterest income   14,400   8,035   5,473 Noninterest expense: Salaries and employee benefits 58,877 49,021 39,556 Occupancy and equipment 13,882 9,712 8,312 FDIC insurance 4,002 2,011 3,115 Professional and consulting 7,383 5,506 3,568 Marketing and advertising 1,200 1,353 980 Data processing 6,008 4,503 4,421 Merger expenses 14,640 8,955 1,335 Loss on extinguishment of debt - 1,047 - Amortization of core deposit intangible 2,559 1,408 627 Other components of net periodic pension (income) expense ( 119 ) 114 28 Increase in value of acquisition price 2,333 - - Other expenses   10,236   8,598   8,512 Total noninterest expenses   121,001   92,228   70,454 Income before income tax expense 90,390 94,026 71,134 Income tax expense   19,101   20,631   10,782 Net income $ 71,289 $ 73,395 $ 60,352 Earnings per common share: Basic $ 1.80 $ 2.08 $ 1.87 Diluted 1.79 2.07 1.86 See the accompanying notes to the consolidated financial statements. - 55 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31, 2020 2019 2018 (dollars in thousands)   Net income $ 71,289 $ 73,395 $ 60,352 Other comprehensive income: Unrealized gains and losses: Unrealized holding gains (losses) on available-for-sale securities arising during the period 7,005 11,286 ( 6,444 ) Tax effect   ( 1,847 )   ( 2,923 )   1,638 Net of tax   5,158   8,363   ( 4,806 ) Reclassification adjustment for realized (gains) losses included in net income ( 29 ) 280 - Tax effect   6   ( 79 )   - Net of tax   ( 23 )   201   - Unrealized (losses) gains on cash flow hedges ( 3,423 ) ( 755 ) 825 Tax effect   962   213   ( 228 ) Net of tax   ( 2,461 )   ( 542 )   597 Reclassification adjustment for losses (gains) arising during this period 1,577 ( 677 ) ( 464 ) Tax effect   ( 443 )   190   130 Net of tax   1,134   ( 487 )   ( 334 ) Unrealized pension plan (losses) gains: Unrealized pension plan (losses) gains before reclassifications ( 112 ) ( 209 ) 236 Tax effect   31   59   ( 67 ) Net of tax   ( 81 )   ( 150 )   169 Reclassification adjustment for realized losses included in net income 301 358 359 Tax effect   ( 84 )   ( 101 )   ( 101 ) Net of tax   217   257   258 Total other comprehensive income (loss)   3,944   7,642   ( 4,116 ) Total comprehensive income $ 75,233 $ 81,037 $ 56,236 See the accompanying notes to the consolidated financial statements. - 56 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY     Preferred Stock     Common Stock     Additional Paid In Capital     Retained Earnings     Treasury Stock     Accumulated Other Comprehensive Income (Loss)     Total Stockholders’ Equity   (in thousands, except share and per share data)                                                         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 16)     -       -       -       709       -       ( 709 )       -   Cumulative effect of adopting ASU 2016-01 (see Note 16)     -       -       -       ( 55 )       -       55       -   Net income     -       -       -       60,352       -       -       60,352   Other comprehensive loss, net of tax     -       -       -       -       -       ( 4,116 )       ( 4,116 )   Cash dividends declared on common stock ($ 0.30 per share)     -       -       -       ( 9,686 )       -       -       ( 9,686 )   Exercise of stock options ( 189,992 shares)     -       -       875       -       -       -       875   Restricted stock, net of forfeitures ( 24,018 shares)     -       -       -       -       -       -       -   Net shares issued in satisfaction of performance units earned ( 42,672 shares)     -       -       ( 819 )       -       -       -       ( 819 )   Stock-based compensation expense     -       -       1,884       -       -       -       1,884   Balance as of December 31, 2018   $ -     $ 412,546     $ 15,542     $ 211,345     $ ( 16,717 )     $ ( 8,789 )     $ 613,927   Net income     -       -       -       73,395       -       -       73,395   Other comprehensive income, net of tax     -       -       -       -       -       7,642       7,642   Cash dividends declared on common stock ($ 0.36 per share)     -       -       -       ( 12,958 )       -       -       ( 12,958 )   Repurchase of stock ( 540,018 shares)     -       -       -       -       ( 12,643 )       -       ( 12,643 )   Net shares issued in satisfaction of restricted stock units earned ( 4,904 shares)     -       -       -       -       -       -       -   Exercise of stock options ( 38,937 shares)     -       -       360       -       -       -       360   Restricted stock, net of forfeitures ( 56,772 shares)     -       -       -       -       -       -       -   Net shares issued in satisfaction of performance units earned ( 31,425 shares)     -       -       196       -       -       -       196   Stock issued ( 3,032,496 shares) in acquisition of GHB     -       56,025       -       -       -       -       56,025   Stock issued ( 119,008 shares) in acquisition of BoeFly, LLC - - 2,500 - - - 2,500 Stock-based compensation expense   -   -   2,746   -   -   -   2,746 Balance as of December 31, 2019   $ -     $ 468,571     $ 21,344     $ 271,782     $ ( 29,360 )     $ ( 1,147 )     $ 731,190   Net income     -       -       -       71,289       -       -       71,289   Other comprehensive income, net of tax     -       -       -       -       -       3,944       3,944   Cash dividends declared on common stock ($ 0.27 per share)     -       -       -       ( 11,120 )       -       -       ( 11,120 )   Repurchase of treasury stock ( 54,693 shares)     -       -       -       -       ( 911 )       -       ( 911 )   Net shares issued in satisfaction of restricted stock units earned ( 16,541 shares)     -       -       -       -       -       -       -   Exercise of stock options ( 35,413 shares)     -       -       233       -       -       -       233   Restricted stock grants, net of forfeitures ( 89,879 shares)     -       -       -       -       -       -       -   Stock grants issued ( 1,340 shares)     -       -       -       -       -       -       -   Net shares issued in satisfaction of performance units earned ( 22,402 shares)     -       -       -       -       -       -       -   Share redemption for tax withholdings on performance units and restricted stock units earned     -       -       ( 639 )       -       -       -       ( 639 )   Stock issued ( 4,602,450 shares) in acquisition of Bancorp of New Jersey - 118,375 - - - - 118,375 Stock-based compensation expense   -   -   2,949   -   -   -   2,949 Balance as of December 31, 2020   $ -     $ 586,946     $ 23,887     $ 331,951     $ ( 30,271 )     $ 2,797     $ 915,310   See the accompanying notes to the consolidated financial statements. - 57 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS     Years Ended December 31,   (dollars in thousands)   2020     2019     2018   Cash flows from operating activities                         Net income   $ 71,289     $ 73,395     $ 60,352   Adjustments to reconcile net income to net cash provided by operating activities:                         Depreciation and amortization of premises and equipment     4,244       3,053       3,062   Provision for loan losses     41,000       8,100       21,100   Amortization of intangibles     2,559       1,408       627   Net accretion of loans     ( 6,687 )       ( 5,056 )       ( 1,127 )   Accretion on bank premises     ( 90 )       ( 86 )       ( 67 )   Accretion on deposits     ( 4,301 )       ( 1,149 )       ( 57 )   (Accretion) amortization on borrowings     ( 183 )       209       ( 76 )   Net deferred income tax expense     ( 7,495 )     104       926   Stock-based compensation     2,949       2,942       1,884   Losses (gains) on sales of investment securities, net     ( 29 )       280       -   Change in fair value of equity securities, net     ( 202 )       ( 294 )       267   Gains (losses) on sale of loans held-for-sale, net     ( 2,085 )       ( 512 )       ( 61 )   Loans originated for resale     ( 63,114 )       ( 20,499 )       ( 4,121 )   Loss on extinguishment of debt     -       1,047       -   Proceeds from sale of loans held-for-sale     80,323       21,011       4,552   Net (gains) losses on disposition of premises and equipment     -       ( 8 )       26   Net (gains) losses on sale of other real estate owned     -       ( 8 )       192   Increase in cash surrender value of bank owned life insurance     ( 4,793 )       ( 3,484 )       ( 3,094 )   Amortization of premiums and accretion of discounts on investments securities, net     5,506       4,299       3,233   Amortization of subordinated debt issuance costs     323       329       332   Increase in accrued interest receivable     ( 11,458 )       ( 301 )       ( 2,744 )   Net change in operating leases     41       1,312       -   Increase in other assets     ( 22,498 )       ( 22,619 )       ( 1,134 )   (Decrease) increase in other liabilities     ( 4,174 )       ( 2,785 )       4,988   Net cash provided by operating activities     81,125       60,688       89,060   Cash flows from investing activities                         Investment securities available-for-sale:                         Purchases     ( 338,087 )       ( 225,853 )       ( 140,013 )   Sales     19,624       183,728       -   Maturities, calls and principal repayments     256,782       178,116       141,859   Net redemptions (purchases) of restricted investment in bank stocks     5,362       3,739       2,361   Purchases of equity securities     ( 2,000 )       -       -   Sales of equity securities     -       569       -   Loans held-for-sale payments     1,186       47       159   Net increase in loans     ( 329,210 )       ( 243,430 )       ( 362,625 )   Purchases of premises and equipment     ( 2,199 )       ( 1,527 )       ( 2,051 )   Purchases of bank owned life insurance     ( 25,000 )       ( 10,000 )       -   Proceeds from life insurance death benefits     1,794       -       585   Proceeds from sale of premises and equipment     -       18       1,627   Cash and cash equivalents acquired in acquisitions, net     87,391       11,211       -   Proceeds from sale of other real estate owned     992       915       884   Net cash used in investing activities     ( 323,365 )       ( 102,467 )       ( 357,214 )   Cash flows from financing activities                         Net increase in deposits     410,605       260,489       297,021   Increase in subordinated debt     73,440       -       73,525   Advances of borrowings     1,526,489       2,597,000       1,733,000   Repayments of borrowings     ( 1,650,387 )       ( 2,762,150 )       ( 1,803,000 )   Cash dividends paid on common stock     ( 14,317 )       ( 12,160 )       ( 9,664 )   Purchase of treasury stock     ( 911 )       ( 12,643 )       -   Proceeds from exercise of stock options     233       360       875   Share redemption for tax withholdings on performance units and restricted stock units earned     ( 639 )       -       ( 819 )   Net cash provided by financing activities     344,513       70,896       290,938                             Net change in cash and cash equivalents     102,273       29,117       22,784   Cash and cash equivalents at beginning of period     201,483       172,366       149,582   Cash and cash equivalents at end of period   $ 303,756     $ 201,483     $ 172,366   Supplemental disclosures of cash flow information:                                                   Cash payments for:                         Interest paid   $ 74,701     $ 88,522     $ 55,662   Income taxes paid     18,497       18,497       9,092                             Supplemental disclosures of noncash investing activities:                         Transfer of loans to other real estate owned   $ -     $ 907     $ 538   Transfer of loan held-for-sale to loans held-for-investment     10,995       -       45,552   Transfer of loans held-for-investment to loans held-for-sale     26,548       33,297       21,236   Business combinations :                         Fair value of net assets acquired, net of cash and cash equivalents   $ 949,282     $ 534,146     $ -   See the accompanying notes to the consolidated financial statements. - 58 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies Business 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 New Jersey 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), NJCB Spec-1, LLC (a New Jersey limited liability company) and BoeFly, Inc. (a New Jersey online business lending marketplace). 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-seven 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. Principals of Consolidation The consolidated financial statements of the Parent Corporation are prepared on an accrual basis and include the accounts of the Parent Corporation and the Company. All significant intercompany accounts and transactions have been eliminated from the accompanying consolidated financial statements. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles. Segments FASB ASC 28, “Segment Reporting,” requires companies to report certain information about operating segments. The Company is managed as one segment: a community bank. All decisions including but not limited to loan growth, deposit funding, interest rate risk, credit risk and pricing are determined after assessing the effect on the totality of the organization. For example, loan growth is dependent on the ability of the organization to fund this growth through deposits or other borrowings. As a result, the Company is managed as one operating segment. Use of Estimates 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. Risks and Uncertainties As previously disclosed, on March 11, 2020, the World Health Organization declared the outbreak of COVID-19 as a global pandemic, which continues to spread throughout the United States and around the world. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted to, among other things, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic. The COVID-19 pandemic has adversely affected, and continues to adversely affect economic activity globally, nationally and locally. Actions taken around the world to help mitigate the spread of COVID-19 include restrictions on travel, quarantines in certain areas, and forced closures for certain types of public places and businesses. COVID-19 and actions taken to mitigate the spread of it have had and are expected to continue to have an adverse impact on the economies and financial markets of many countries, including the New Jersey/New York metropolitan area in which the Company primarily operates. Although the Company has been able to continue operations while taking steps to ensure the safety of employees and customers, COVID-19 could also potentially create widespread business continuity issues for the Company. - 59 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies – (continued) Federal Reserve reductions in interest rates and other effects of the COVID-19 pandemic may adversely affect the Company's financial condition and results of operations in future periods. It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Company. It is reasonably possible that estimates made in the financial statements could be materially and adversely impacted in the near term as a result of these conditions, including the determination of the allowance for loan losses, fair value of financial instruments, impairment of goodwill and other intangible assets and income taxes. Cash and Cash Equivalents Cash and cash equivalents include cash, deposits with other financial institutions with maturities of less than 90 days , and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest-bearing deposits in other financial institutions, and federal funds purchased and repurchase agreements. Investment Securities The Company accounts for its investment securities in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320-10-05. Investments are classified into the following categories: (1) held-to-maturity securities, for which the Company has both the positive intent and ability to hold until maturity, which are reported at amortized cost; (2) trading securities, which are purchased and held principally for the purpose of selling in the near term and are reported at fair value with unrealized gains and losses included in earnings; and (3) available-for-sale securities, which do not meet the criteria of the other two categories and which management believes may be sold prior to maturity due to changes in interest rates, prepayment risk, liquidity or other factors, and are reported at fair value, with unrealized gains and losses, net of applicable income taxes, reported as a component of accumulated other comprehensive income, which is included in stockholders’ equity and excluded from earnings. Investment securities are adjusted for amortization of premiums and accretion of discounts as adjustments to interest income, which are recognized on a level yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Investment securities gains or losses are determined using the specific identification method. Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. FASB ASC 320-10-65 clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, management must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment. In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, FASB ASC 320-10-65 changed the presentation and amount of the other-than-temporary impairment recognized in the Consolidated Statement of Income. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized through earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized through other comprehensive income. Equity Securities The Company’s equity securities are recorded at fair value, with unrealized gains and losses included in earnings beginning January 1, 2018 after adoption of Accounting Standards Update No. 2016-01, “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. 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. - 60 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies – (continued) Other loans held-for-sale are carried at the lower of aggregate cost or estimated fair value. Fair value on 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. Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, purchase premium and discounts 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. Loans that are 90 days past due are placed on nonaccrual and previously accrued interest is reversed and charged against interest income unless the loans are both well-secured and in the 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 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. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The policy of the Company is to generally grant commercial, residential and consumer loans to residents and businesses within its New Jersey and New York 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. Allowance for Loan Losses The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan 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. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Loans for which the terms have been modified as a concession to the borrower due to the borrower experiencing financial difficulties (other than with regard to loans meeting the requirements of the CARES Act or regulatory guidance regarding mitigating the impact of the COVID-19 pandemic) are considered troubled debt restructurings (“TDR”) and are classified as impaired. The impairment of a loan can be measured at (1) the fair value of the collateral less costs to sell, if the loan is collateral dependent, (2) at the value of expected future cash flows using the loan’s effective interest rate, or (3) at the loan’s observable market price. Generally, the Bank measures impairment of such loans by reference to the fair value of the collateral less costs to sell. Loans of $ 250,000 and over are individually evaluated for impairment. If a loan is identified as impaired and the individual test results in an impairment, a portion of the allowance is allocated so that the loan is reported, net, at the fair value of collateral less costs to sell if repayment is expected solely from the collateral or at the present value of estimated future cash flows using the loan’s existing rate if the loan is dependent on cash flow. Loans with balances less than $250,000 are collectively evaluated for impairment, and accordingly, are not separately identified for impairment disclosures. - 61 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies – (continued) 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. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan 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 segment and is based on the actual loss history experienced by the Bank over an actual three-year rolling calculation. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. This actual loss experience is supplemented with the exogenous factor adjustments based on the risks present for each loan category. These exogenous factors (nine total) include consideration of the following: concentrations of credit; delinquency & nonaccrual trends; economic & business conditions including evaluation of the national and regional economies and industries with significant loan concentrations; external factors including legal, regulatory or competitive pressures that may impact the loan portfolio; changes in the experience, ability, or size of the lending staff, management, or board of directors that may impact the loan portfolio; changes in underwriting standards, collection procedures, charge-off practices, or other changes in lending policies and procedures that may impact the loan portfolio; loss and recovery trends; changes in portfolio size and mix; and trends in problem loans. - 62 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies – (continued) Purchased Credit-Impaired Loans The Company acquires groups of loans in conjunction with mergers, some of which have shown evidence of credit deterioration since origination. These purchased credit-impaired loans are recorded at their estimated fair value, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses. Such purchased credit-impaired loans (“PCI”) are identified on an individual basis. The Company estimates the amount and timing of expected cash flows for each loan and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference). A PCI loan may be resolved either through a sale of the loan, by working with the customer and obtaining partial or full repayment, by short sale of the collateral, or by foreclosure. A gain or loss on resolution would be recognized based on the difference between the proceeds received and the carrying amount of the loan. PCI loans that met the criteria for nonaccrual may be considered performing, regardless of whether the customer is contractually delinquent, if management can reasonably estimate the timing and amount of the expected cash flows on such loans and if management expects to fully collect the new carrying value of the loans. As such, management may no longer consider the loans to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable discount. Derivatives The Company records cash flow hedges at the inception of the derivative contract based on the Company’s intentions and belief as to likely effectiveness as a hedge. Cash flow hedges represent a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. The changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as noninterest income. Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged. The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended. When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings. - 63 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies – (continued) Restricted Stock The Bank is a member of the Federal Home Loan Bank (“FHLB”) of New York. Members are required to own a certain amount of stock based on the level of borrowings and other factors and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Cash dividends on the stock are reported as income. Transfers of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Premises and Equipment Land is carried at cost and premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 4 to 30 years. Leasehold improvements are depreciated using the straight-line method over the terms of the respective leases, or the estimated useful lives of the improvements, whichever is shorter. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 10 years. Leases Leases are classified as operating or finance leases at the lease commencement date. Lease expense for operating leases and short-term leases is recognized on a straight-line basis over the lease team. The Company includes lease extension and termination options in the lease term if, after considering relevant economic factors, it is reasonably certain the Company will exercise the option. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the lease commencement date based on the estimated present value of the lease payments over the lease term. The Company uses its incremental borrowing rate at lease commencement to calculate the present value of lease payments when the rate implicit in a lease is not known. The Company has elected not to recognize leases with original terms of 12 months or less on the consolidated balance sheet. Other Real Estate Owned Other real estate owned (“OREO”), representing property acquired through foreclosure and held-for-sale, is initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequently, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Costs relating to holding the assets are charged to expenses. Employee Benefit Plans The Company has a noncontributory pension plan that covered all eligible employees up until September 30, 2007, at which time the Company froze its defined benefit pension plan. As such, all future benefit accruals in this pension plan were discontinued and all retirement benefits that employees would have earned as of September 30, 2007 were preserved. The Company’s policy is to fund at least the minimum contribution required by the Employee Retirement Income Security Act of 1974. The costs associated with the plan are accrued based on actuarial assumptions and included in salaries and employee benefits expense. The Company accounts for its defined benefit pension plan in accordance with FASB ASC 715-30. FASB ASC 715-30 requires that the funded status of defined benefit postretirement plans be recognized on the Company’s statement of financial condition and changes in the funded status be reflected in other comprehensive income. FASB ASC 715-30 also requires companies to measure the funded status of the plan as of the date of its fiscal year-end. The Company maintains a 401(k)-employee savings plan to provide for defined contributions which covers substantially all employees of the Company. Employee 401(k) and profit-sharing plan expense is the amount of matching contributions. - 64 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies – (continued) Stock-Based Compensation Stock compensation accounting guidance (FASB ASC 718, “Compensation-Stock Compensation”) requires that the compensation cost related to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. Stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. See Note 18 of the Notes to Consolidated Financial Statements for a further discussion. Treasury Stock Subject to limitations applicable to the Parent Corporation, treasury stock purchases may be made from time to time as, in the opinion of management, market conditions warrant, in the open market or in privately negotiated transactions. Shares repurchased are added to the corporate treasury and will be used for future stock dividends and other issuances. The repurchased shares are recorded as treasury stock, which results in a decrease in stockholders’ equity. Treasury stock is recorded using the cost method and accordingly is presented as a reduction of stockholders’ equity. During the year ended December 31, 2020 and December 31, 2019, the Parent Corporation repurchased 54,693 and 540,018 shares under a board-approved share repurchase program. During the year ended December 31, 2018, the Parent Corporation did not repurchase any of its shares. Goodwill Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized but tested for impairment annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. The Company has selected December 31 as the date to perform the annual impairment test. No impairment charge was deemed necessary as of the years ended December 31, 2020, 2019 and 2018. Other Intangible Assets Other intangible assets consist of core deposit intangibles arising from business combinations that are amortized over their estimated useful lives to their estimated residual value. 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, unrecognized actuarial gains and losses of the Company’s defined benefit pension plan and unrealized gains and losses on cash flow hedges, net of taxes. Restrictions on Cash Cash on hand or on deposit with the Federal Reserve Bank is required to meet regulatory reserve and clearing requirements. Dividend Restriction Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Parent Corporation or by the Parent Corporation to the stockholders. - 65 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1a – Nature of Business, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies – (continued) Fair Value of Financial Instruments Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Bank Owned Life Insurance The Company invests in Bank Owned Life Insurance (“BOLI”) to help offset the cost of employee benefits. The change in the cash surrender value of the BOLI is recorded as a component of noninterest income. Income Taxes Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50 % likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. Advertising Costs The Company recognizes its marketing and advertising cost as incurred. Reclassifications Certain reclassifications have been made in the consolidated financial statements and footnotes for 2019 and 2018 to conform to the classifications presented in 2020. Such reclassifications had no impact on net income or stockholders’ equity. Note 1b – Authoritative Accounting Guidance Adoption of New Accounting Standards in 2021 ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Assets Measured at Amortized Cost.” (modified by ASU 2018-19, ASU 2019-04 and ASU 2019-05). 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, 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 SEC filers that are not smaller reporting companies, the amendments in this update are effective for the fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. In December 2018, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”). Under the CARES Act, the effective date for the implementation of ASU No. 2016-13 was delayed until the earlier of the end of the health crises caused by the COVID-19 Pandemic or December 31, 2020. The Economic Aid Act then further delayed implementation until the earlier of the end of the health crises caused by the COVID-19 Pandemic or December 31, 2022. The Company is adopting Topic 326, as of January 1, 2021. While the Company has not finalized the impact of implementing CECL, the Company expects to recognize a one-time cumulative effect adjustment to the allowance and beginning retained earnings, net of tax, upon adoption. The future impact of CECL on the Company’s allowance for credit losses and provision expense subsequent to the initial adoption will depend on changes in the loan portfolio, economic conditions and refinements to key assumptions including forecasting and qualitative factors. The Company measured its allowance under its current incurred loan loss model as of December 31, 2020. ASU 2018-14, “ Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans. ” These amendments modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. ASU 2018-14 went effective for the Company as of January 1, 2021 and did not have a significant impact on our consolidated financial statements. Adoption of New Accounting Standards in 2020 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. ASU 2017-04 was effective for the Company on January 1, 2020 and did not have a material impact on the Company’s financial statement disclosures. - 66 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1b – Authoritative Accounting Guidance – (continued) 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 was effective for the Company on January 1, 2020 and did not have a material impact on the Company’s financial statement disclosures. ASU 2018-13, “ Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement .” The amendments in this update modify disclosure requirements on fair value measurements by removing, modifying and adding certain disclosure requirements. The amendments primarily pertain to Level 3 fair value measurements and depending on the amendment are applied either prospectively or retrospectively. ASU 2018-03 was effective for the Company on January 1, 2020 and did not have a material impact on the Company’s financial statement disclosures. ASU 2018-15, “ Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ” These amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. ASU 2018-15 was effective for the Company on January 1, 2020 and did not have a material impact on the Company’s financial statement disclosures. Note 2 – Business Combination On January 2, 2020, Bancorp of New Jersey, Inc. (“BNJ”) merged with and into the Company, with the Company as the surviving entity. As a result of the merger, the Company acquired nine branch offices all located in Bergen County, New Jersey. Subject to the allocation and proration procedures set forth in the merger agreement, holders of BNJ common stock had the right to elect, with respect to each share of BNJ common stock, to receive either (i) $ 16.25 in cash or (ii) 0.780 of a share of Company common stock (plus cash in lieu of any fractional shares of Company common stock to which such holder would otherwise be entitled). The allocation and proration procedures set forth in the merger agreement required that approximately 20 % of the shares of BNJ common stock be converted into cash and the remaining approximately 80 % of BNJ common shares be converted into shares of the Company’s common stock. - 67 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 – Business Combination – (continued) The acquisition of BNJ was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at their estimated fair values as of the acquisition date. The application of the acquisition method of accounting resulted in the recognition of goodwill of $ 45.8 million and a core deposit intangible of $ 8.1 million. The assets acquired and liabilities assumed, and consideration paid in the acquisition of BNJ were recorded at their estimated fair values based on management’s best estimates using information available at the date of the acquisition. In connection with the acquisition, the consideration paid, and the fair value of identifiable assets acquired, and liabilities assumed as of the date of acquisition are summarized in the following table: Estimated FairValue at January 2, 2020 (in thousands) Consideration paid: Common stock issued in acquisition $ 118,375 Cash paid in acquisition 23,977 Total consideration paid: 142,352 Assets acquired : Cash and cash equivalents 111,368 Securities available-for-sale 20,073 Loans, net 774,720 Premises and equipment, net 12,826 Accrued interest receivable 2,910 Core deposit intangibles 8,076 Other assets 19,309 Total assets acquired 949,282 Liabilities assumed : Deposits 785,378 Borrowings 49,742 Other liabilities 17,608 Total liabilities assumed 852,728   Net assets acquired 96,554   Goodwill recorded in acquisition $ 45,798 The amount of goodwill recorded represents the excess purchase price over the estimated fair value of the net assets acquired by the Company and reflects the economies of scale, increased market share and lending capabilities, greater access to best-in-class banking technology, and related synergies that are expected to result from the acquisition. Loans acquired in the BNJ acquisition were recorded at fair value, and there was no carryover related allowance for loan losses. The fair values of loans acquired from BNJ were estimated based on the value of the expected cash flows, which were projected based on the contractual terms of the loans, including both maturity and contractual amortization. The monthly principal and interest cash flows were adjusted for expected losses and prepayments, where appropriate. Expected losses assumptions were developed using peer group loss data. Projected cash flows were then discounted to present value using a discount rate developed based on the relative risk of the cash flows, considering the loan type, liquidity risk, the maturity of the loans, servicing costs and a required return on capital. - 68 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 – Business Combination – (continued) The following is a summary of the loans accounted for in accordance with ASC 310-30 that were acquired in the BNJ acquisition as of the Merger date: Estimated FairValue at January 2, 2020 (in thousands) Contractually required principal and interest acquisition $ 14,416 Contractual cash flows not expected to be collected (non-accretable discount) ( 2,111 ) Expected cash flows at acquisition 12,305 Interest component of expected cash flows (accretable discount) ( 605 ) Fair value of acquired loans $ 11,700 Goodwill related to BNJ is not amortized for book purposes; however, it is reviewed at least annually for impairment and is not deductible for tax purposes. The fair value of retail demand and interest-bearing deposit accounts was assumed to approximate the carrying value as those accounts have no stated maturity and are payable on demand. The fair value of time deposits was estimated by discounting the contractual future cash flows using market rates offered for time deposits of similar remaining maturities. The fair value of borrowed funds was estimated by discounting the future cash flows using market rates for similar borrowings. Direct acquisition and integration costs of the BNJ acquisition were expensed as incurred. These items were recorded as merger expenses on the consolidated statement of income. During the year ended December 31, 2020, merger expenses related to the BNJ acquisition were $ 11.6 million. 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 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: Years Ended December 31, 2020 2019 2018 (in thousands, except per share amounts) Net income available to common stockholders $ 71,289 $ 73,395 $ 60,352 Earnings allocated to participating securities   ( 356 )   ( 295 )   ( 139 ) Income attributable to common stock $ 70,933 $ 73,100 $ 60,213 Weighted average common shares outstanding, including participating securities 39,643 35,289 32,198 Weighted average participating securities   ( 131 )   ( 84 )   ( 74 ) Weighted average common shares outstanding 39,512 35,205 32,124 Incremental shares from assumed conversions of options, restricted stock units, performance units and restricted stock   132   88   233 Weighted average common and equivalent shares outstanding   39,644   35,293   32,357 Earnings per common share: Basic $ 1.80 $ 2.08 $ 1.87 Diluted 1.79 2.07 1.86 There were no antidilutive common share equivalents as of December 31, 2020, 2019 and 2018. - 69 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4 – Investment Securities The Company’s investment securities are classified as available-for-sale as of December 31, 2020 and December 31, 2019. Investment 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 December 31, 2020 and December 31, 2019. 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 21 of the Notes to Consolidated Financial Statements for a further discussion. The following tables present information related to the Company’s portfolio of securities available-for-sale as of December 31, 2020 and 2019. Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (dollars in thousands) December 31, 2020 Investment securities available-for-sale Federal agency obligations $ 37,015 $ 1,508 $ ( 65 ) $ 38,458 Residential mortgage pass-through securities 266,114 4,811 ( 41 ) 270,884 Commercial mortgage pass-through securities 6,906 203 ( 187 ) 6,922 Obligations of U.S. states and political subdivisions​​ 138,539 4,269 - 142,808 Corporate bonds and notes 24,925 222 ( 52 ) 25,095 Asset-backed securities 3,521 - ( 41 ) 3,480 Certificates of deposit 149 2 - 151 Other securities   157   -   -   157 Total securities available-for-sale $ 477,326 $ 11,015 $ ( 386 ) $ 487,955 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (dollars in thousands) December 31, 2019 Investment securities available-for-sale Federal agency obligations $ 27,667 $ 612 $ ( 42 ) $ 28,237 Residential mortgage pass-through securities 199,611 1,528 ( 643 ) 200,496 Commercial mortgage pass-through securities 4,995 37 ( 35 ) 4,997 Obligations of U.S. states and political subdivisions​​ 134,500 2,411 ( 392 ) 136,519 Corporate bonds and notes 28,142 285 ( 45 ) 28,382 Asset-backed securities 5,845 - ( 65 ) 5,780 Certificates of deposit 148 2 - 150 Other securities   140   -   -   140 Total securities available-for-sale $ 401,048 $ 4,875 $ ( 1,222 ) $ 404,701 - 70 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4 – Investment Securities – (continued) Investment securities having a carrying value of approximately $ 107.6 million and $ 111.5 million as of December 31, 2020 and December 31, 2019, respectively, were pledged to secure public deposits, borrowings, Federal Reserve Discount Window borrowings and Federal Home Loan Bank advances and for other purposes required or permitted by law.As of December 31, 2020, and December 31, 2019, 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. The following table presents information for investments in securities available-for-sale as of December 31, 2020, 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. December 31, 2020 Amortized Cost Fair Value (dollars in thousands) Investment Securities Available-for-Sale: Due in one year or less $ 10,486 $ 10,541 Due after one year through five years 19,968 20,180 Due after five years through ten years 18,316 18,797 Due after ten years 155,379 160,474 Residential mortgage pass-through securities 266,114 270,884 Commercial mortgage pass-through securities 6,906 6,922 Other securities   157   157 Total securities available-for-sale $ 477,326 $ 487,955 Gross gains and losses from the sales, calls, and maturities of investment securities for the years ended December 31, 2020, 2019 and 2018 were as follows: Years Ended December 31, 2020 2019 2018 (dollars in thousands) Proceeds $ 19,624 $ 183,728 $ - Gross gains on sales of investment securities $ 29 $ 401 $ - Gross losses on sales of investment securities   -   ( 681 )   - Net gains (losses) on sales of investment securities   29   ( 280 )   - Tax provision on net gains   ( 6 )   79   - Net gains (losses) on sales of investment securities, after tax​​ $ 23 $ ( 201 ) $ - - 71 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4 – Investment Securities – (continued) 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 a restructuring and/or filed for bankruptcy, has disclosed severe liquidity problems that cannot be resolved, disclosed deteriorating financial condition or sustained significant losses. Temporarily Impaired Investments The Company does not believe that any of the unrealized losses, which were comprised of 21 and 53 securities as of December 31, 2020 and December 31, 2019, 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, and asset-backed securities are not considered to be other-than-temporary because these unrealized losses are related to changes in interest rates and do not affect the expected cash flows of the underlying collateral or issuer. Factors which may contribute to unrealized losses include credit risk, market risk, changes in interest rates, economic cycles, and liquidity risk. The magnitude of any unrealized loss may be affected by the relative concentration of the Company’s investment in any one issuer or industry. The Company has established policies to reduce exposure through diversification of the securities portfolio including limits on concentrations to any one issuer. The Company believes the securities portfolio is prudently diversified. The unrealized losses included in the tables below are primarily related to changes in interest rates and credit spreads. All of the Company’s securities are performing and are expected to continue to perform in accordance with their respective contractual terms and conditions. These are largely intermediate duration holdings, and, in certain cases, monthly principal payments can further reduce loss exposure resulting from an increase in rates. 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. - 72 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4 – Investment Securities – (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 as of December 31, 2020 and 2019. There were no investments held-to-maturity as of December 31, 2020 and 2019. December 31, 2020 Total Less than 12 Months 12 Months or Longer Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (dollars in thousands) Investment Securities Available-for-Sale: Federal agency obligation $ 8,978 $ ( 65 ) $ 8,975 $ ( 65 ) $ 3 $ - Residential mortgage pass-through securities 20,895 ( 41 ) 20,886 ( 41 ) 9 - Commercial mortgage pass-through securities 3,954 ( 187 ) 3,954 ( 187 ) - - Corporate bonds and notes 3,928 ( 52 ) 3,928 ( 52 ) - - Asset-backed securities   3,083   ( 41 )   622   -   2,461   ( 41 ) Total Temporarily Impaired Securities $ 40,838 $ ( 386 ) $ 38,365 $ ( 345 ) $ 2,473 $ ( 41 ) December 31, 2019 Total Less than 12 Months 12 Months or Longer Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (dollars in thousands) Investment Securities Available-for-Sale: Federal agency obligation $ 6,512 $ ( 42 ) $ 6,498 $ ( 42 ) $ 14 $ - Residential mortgage pass-through securities 94,980 ( 643 ) 49,154 ( 179 ) 45,826 ( 464 ) Commercial mortgage pass-through securities 2,006 ( 35 ) 2,006 ( 35 ) - - Obligations of U.S. states and political subdivisions 34,775 ( 392 ) 10,306 ( 8 ) 24,469 ( 384 ) Corporate bonds and notes 5,437 ( 45 ) 2,478 ( 23 ) 2,959 ( 22 ) Asset-backed securities 5,718 ( 65 ) 2,268 ( 22 ) 3,450 ( 43 ) Total Temporarily Impaired Securities $ 149,428 $ ( 1,222 ) $ 72,710 $ ( 309 ) $ 76,718 $ ( 913 ) - 73 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses Loans Receivable : The following table sets forth the composition of the Company’s loan portfolio segments, including net deferred fees, as of December 31, 2020 and December 31, 2019: 2020 2019 (dollars in thousands) Commercial (1) $ 1,521,967 $ 1,129,661 Commercial real estate 3,783,550 3,041,959 Commercial construction 617,747 623,326 Residential real estate 322,564 320,020 Consumer   1,853   3,328 Gross loans 6,247,681 5,118,294 Net deferred fees   ( 11,374 )   ( 4,767 ) Loans receivable $ 6,236,307 $ 5,113,527   (1) Included in commercial loans as of December 31, 2020 were PPP loans of $ 397.5 million. As of December 31, 2020, and 2019, loan balances of approximately $ 2.7 billion and $ 2.5 billion, respectively, were pledged to secure borrowings from the Federal Home Loan Bank. The loan segments in the above table have unique risk characteristics with respect to credit quality: • The repayment of commercial loans is generally dependent on the creditworthiness and cash flow of borrowers, and if applicable, guarantors, which may be negatively impacted by adverse economic conditions. While the majority of these loans are secured, collateral type, marketing, coverage, valuation and monitoring is not as uniform as in other portfolio classes and recovery from liquidation of such collateral may be subject to greater variability. • Payment on commercial mortgages is driven principally by operating results of the managed properties or underlying business and secondarily by the sale or refinance of such properties. Both primary and secondary sources of repayment, and value of the properties in liquidation, may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. • Properties underlying construction, land and land development loans often do not generate sufficient cash flows to service debt and thus repayment is subject to ability of the borrower and, if applicable, guarantors, to complete development or construction of the property and carry the project, often for extended periods of time. As a result, the performance of these loans is contingent upon future events whose probability at the time of origination is uncertain. • The ability of borrowers to service debt in the residential and consumer loan portfolios is generally subject to personal income which may be impacted by general economic conditions, such as increased unemployment levels. These loans are predominately collateralized by first and/or second liens on single family properties. If a borrower cannot maintain the loan, the Company’s ability to recover against the collateral in sufficient amount and in a timely manner may be significantly influenced by market, legal and regulatory conditions. • The Company considers loan classes and loan segments to be one and the same. Loans Held-For-Sale : The following table presents loans held-for-sale by loan segment as of December 31, 2020 and December 31, 2019: 2020 2019 (dollars in thousands) Commercial $ - $ 2,285 Commercial real estate   1,990   30,965 Residential mortgage   2,720   - Total carrying amount $ 4,710 $ 33,250 - 74 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – 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 carrying amount of those loans is as follows as of December 31, 2020 and December 31, 2019. 2020 2019 (dollars in thousands) Commercial $ 3,878 $ 5,452 Commercial real estate   5,555   1,101 Residential real estate   4,084   - Total carrying amount $ 13,517 $ 6,553 For those purchased loans disclosed above, the Company did not increase the allowance for loan losses for the years ended December 31, 2020 and 2019. No allowances for loan losses were reversed during 2020 and 2019. The accretable yield, or income expected to be collected, on the purchased credit-impaired loans above is as follows for the years presented:     2020     2019   2018     (dollars in thousands) Balance as of January 1,   $ 1,301     $ 1,134     $ 1,387   New loans purchased     605       1,286       -   Accretion of income     ( 796 )       ( 1,119 )       ( 253 )   Balance as of December 31,   $ 1,110     $ 1,301     $ 1,134   Loans Receivable on Nonaccrual Status : The following tables present nonaccrual loans included in loans receivable by loan class as of December 31, 2020 and December 31, 2019: 2020 2019 (dollars in thousands) Commercial $ 33,019 $ 31,455 Commercial real estate 10,111 8,338 Commercial construction 14,015 6,773 Residential real estate   4,551   2,915 Consumer   -   - Total loans receivable on nonaccrual status $ 61,696 $ 49,481 Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and loans individually evaluated for impairment. - 75 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses – (continued) Credit Quality Indicators - 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. The following table presents information about the loan credit quality by loan class of gross loans (which exclude net deferred fees) as of December 31, 2020 and December 31, 2019: December 31, 2020 Pass Special Mention Substandard Doubtful Total (dollars in thousands) Commercial $ 1,447,097     $ 30,725     $ 43,930 $ 215 $ 1,521,967 Commercial real estate 3,700,498 49,143 33,909 - 3,783,550 Commercial construction 587,266 - 30,481 - 617,747 Residential real estate 311,174 - 11,390 - 322,564 Consumer   1,853   -   -   -   1,853 Gross loans $ 6,047,888 $ 79,868 $ 119,710 $ 215 $ 6,247,681 December 31, 2019 Pass Special Mention Substandard Doubtful Total (dollars in thousands) Commercial $ 1,059,852 $ 22,159 $ 47,650 $ - $ 1,129,661 Commercial real estate 3,014,956 10,301 16,702 - 3,041,959 Commercial construction 604,298 4,609 14,419 - 623,326 Residential real estate 316,476 - 3,544 - 320,020 Consumer   3,328   -   -   -   3,328 Gross loans $ 4,998,910 $ 37,069 $ 82,315 $ - $ 5,118,294 - 76 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses – (continued) The following table provides an analysis of the impaired loans by class as of and for the years ended December 31, 2020, 2019 and 2018. December 31, 2020 No Related Allowance Recorded Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized (dollars in thousands) Commercial $ 11,325 $ 11,835 $ 11,627 $ 203 Commercial real estate 13,105 13,449 13,215 287 Commercial construction 24,284 24,907 21,279 377 Residential real estate 5,378 5,723 4,733 104 Consumer   -   -       -   - Total $ 54,092 $ 55,914     $ 50,854 $ 971   With An Allowance Recorded Commercial $ 23,736 $ 69,122 $ 12,985 $ 23,625 $ - Commercial real estate 2,722 2,722 1,329 2,722 - Total $ 26,458 $ 71,844 $ 14,314 $ 26,347 $ -   Total Commercial $ 35,061 $ 80,957 $ 12,985 $ 35,252 $ 203 Commercial real estate 15,827 16,171 1,329 15,937 287 Commercial construction 24,284 24,907 - 21,279 377 Residential real estate 5,378 5,723 - 4,733 104 Consumer   -   -   -   -   - Total (including related allowance) $ 80,550 $ 127,758 $ 14,314 $ 77,201 $ 971 December 31, 2019 No Related Allowance Recorded Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized (dollars in thousands) Commercial $ 37,984 $ 83,225 $ 39,801 $ 815 Commercial real estate 15,249 15,467 15,421 428 Commercial construction 8,649 8,649 8,394 332 Residential real estate 1,311 1,463 1,311 - Consumer   -   -       -   - Total $ 63,193 $ 108,804     $ 64,927 $ 1,575   With An Allowance Recorded Commercial construction $ 3,530 $ 3,530 $ 1,244 $ 3,530 $ 91 Residential real estate 263 263 23 257 11 Total $ 3,793 $ 3,793 $ 1,267 $ 3,787 $ 102   Total Commercial $ 37,984 $ 83,225 $ - $ 39,801 $ 815 Commercial real estate 15,249 15,467 - 15,421 428 Commercial construction 12,179 12,179 1,244 11,924 423 Residential real estate 1,574 1,726 23 1,568 11 Consumer   -   -   -   -   - Total (including related allowance) $ 66,986 $ 112,597 $ 1,267 $ 68,714 $ 1,677 - 77 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses – (continued) December 31, 2018 No Related Allowance Recorded Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized (dollars in thousands) Commercial $ 29,896 $ 83,596 $ 31,721 $ 66 Commercial real estate 16,839 17,935 17,676 149 Commercial construction 9,240 9,240 11,215 493 Residential real estate 2,209 2,521 2,284 - Consumer   -   -       -   - Total $ 58,184 $ 113,292     $ 62,896 $ 708   With An Allowance Recorded Commercial real estate $ 1,488 $ 1,488 $ 7 $ 1,511 $ 46 Residential real estate   260   266   29   265   - Total $ 1,748 $ 1,754 $ 36 $ 1,776 $ 46   Total Commercial $ 29,896 $ 83,596 $ - $ 31,721 $ 66 Commercial real estate 18,327 19,423 7 19,187 195 Commercial construction 9,240 9,240 - 11,215 493 Residential real estate 2,469 2,787 29 2,549 - Consumer   -   -   -   -   - Total (including related allowance) $ 59,932 $ 115,046 $ 36 $ 64,672 $ 754 Included in impaired loans as of December 31, 2020 and December 31, 2019 are loans that are deemed troubled debt restructurings. Cash basis interest and interest income recognized on accrual basis approximate each other. - 78 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses – (continued) Aging Analysis : The following table provides an analysis of the aging of the loans by class, excluding net deferred fees, that are past due as of December 31, 2020 and December 31, 2019 (dollars in thousands): December 31, 2020 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due and Still Accruing Nonaccrual Total Past Due and Nonaccrual Current Total Loans Receivable Commercial $ 1,445 $ 558 $ 3,182 $ 33,019 $ 38,204 $ 1,483,763 $ 1,521,967 Commercial real estate 13,258 4,140 5,555 10,111 33,064 3,750,486 3,783,550 Commercial construction 2,472 - - 14,015 16,487 601,260 617,747 Residential real estate 1,367 241 4,084 4,551 10,243 312,321 322,564 Consumer   2   -   -   -   2   1,851   1,853 Total $ 18,544 $ 4,939 $ 12,821 $ 61,696 $ 98,000 $ 6,149,681 $ 6,247,681 Included in the 90 days or greater past due and still accruing category as of December 31, 2020 are purchased credit-impaired loans, net of fair value marks, which accretes income per the valuation at date of acquisition. December 31, 2019 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due and Still Accruing Nonaccrual Total Past Due and Nonaccrual Current Total Loans Receivable Commercial $ 239 $ - $ 3,107 $ 31,455 $ 34,801 $ 1,094,860 $ 1,129,661 Commercial real estate 1,980 490 - 8,338 10,808 3,031,151 3,041,959 Commercial construction - - - 6,773 6,773 616,553 623,326 Residential real estate 3,357 143 - 2,915 6,415 313,605 320,020 Consumer   -   -   -   -   -   3,328   3,328 Total $ 5,576 $ 633 $ 3,107 $ 49,481 $ 58,797 $ 5,059,497 $ 5,118,294 Included in the 90 days or greater past due and still accruing category as of December 31, 2019 are purchased credit-impaired loans, net of fair value marks, which accretes income per the valuation at date of acquisition. - 79 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses – (continued) The following tables detail, at the period-end presented, the amount of gross loans (excluding loans held-for-sale) that are evaluated individually, and collectively, for impairment, those acquired with deteriorated quality, and the related portion of the allowance for loan losses that are allocated to each loan portfolio segment:     December 31, 2020       Commercial     Commercial real estate     Commercial construction     Residential real estate     Consumer     Unallocated     Total       (dollars in thousands)   Allowance for loan losses                                                         Individually evaluated for impairment   $ 12,985     $ 1,329     $ -     $ -     $ -     $ -     $ 14,314   Collectively evaluated for impairment     15,412       33,373       7,787       1,928       4       568       59,072   Acquired portfolio     46       4,628       407       759       -       -       5,840   Acquired with deteriorated credit quality     -       -       -       -       -       -       -   Total   $ 28,443     $ 39,330     $ 8,194     $ 2,687     $ 4     $ 568     $ 79,226                                                             Gross loans                                                         Individually evaluated for impairment   $ 35,061     $ 15,827     $ 24,284     $ 5,378     $ -             $ 80,550   Collectively evaluated for impairment     1,414,626       2,959,978       574,118       241,925       1,627               5,192,274   Acquired portfolio     68,402       802,190       19,345       71,177       226               961,340   Acquired with deteriorated credit quality     3,878       5,555       -       4,084       -               13,517   Total   $ 1,521,967     $ 3,783,550     $ 617,747     $ 322,564     $ 1,853             $ 6,247,681   Included in the commercial loans collectively evaluated for impaired are PPP loans of $ 397.5 million as of December 31, 2020. PPP loans receivable are guaranteed by the Federal government and have no allocation of the allowance for loan losses.     December 31, 2019       Commercial     Commercial real estate     Commercial construction     Residential real estate     Consumer     Unallocated     Total       (dollars in thousands)   Allowance for loan losses                                                         Individually evaluated for impairment   $ -     $ -     $ 1,244     $ 23     $ -     $ -     $ 1,267   Collectively evaluated for impairment     8,309       19,967       5,744       1,662       3       99       35,784   Acquired portfolio     40       886       316       -       -       -       1,242   Acquired with deteriorated credit quality     -       -       -       -       -       -       -   Total   $ 8,349     $ 20,853     $ 7,304     $ 1,685     $ 3     $ 99     $ 38,293                                                             Gross loans                                                         Individually evaluated for impairment   $ 37,984     $ 15,249     $ 12,179     $ 1,574     $ -             $ 66,986   Collectively evaluated for impairment     1,011,708       2,669,999       578,620       276,177       3,064               4,539,568   Acquired portfolio     74,517       355,610       32,527       42,269       264               505,187   Acquired with deteriorated credit quality     5,452       1,101       -       -       -               6,553   Total   $ 1,129,661     $ 3,041,959     $ 623,326     $ 320,020     $ 3,328             $ 5,118,294   - 80 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – 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. A summary of the activity in the allowance for loan losses by loan segment is as follows: Commercial Commercial real estate Commercial construction Residential real estate Consumer Unallocated Total (dollars in thousands) Balance as of January 1, 2020 $ 8,349 $ 20,853 $ 7,304 $ 1,685 $ 3 $ 99 $ 38,293 Loan charge-offs ( 552 ) - - ( 341 ) ( 7 ) - ( 900 ) Recoveries 4 802 - 23 4 - 833   Provision for loan losses   20,642   17,675   890   1,320   4   469   41,000 Balance as of December 31, 2020 $ 28,443 $ 39,330 $ 8,194 $ 2,687 $ 4 $ 568 $ 79,226     Commercial     Commercial real estate     Commercial construction     Residential real estate     Consumer     Unallocated     Total       (dollars in thousands)   Balance as of January 1, 2019   $ 9,875     $ 18,847     $ 4,519     $ 1,266     $ 2     $ 445     $ 34,954   Loan charge-offs     ( 1,029 )       ( 3,470 )       -       ( 557 )       ( 20 )       -       ( 5,076 )   Recoveries     265       30       -       3       17       -       315     Provision for loan losses     ( 762 )       5,446       2,785       973       4       ( 346 )       8,100   Balance as of December 31, 2019   $ 8,349     $ 20,853     $ 7,304     $ 1,685     $ 3     $ 99     $ 38,293   Commercial Commercial real estate Commercial construction Residential real estate Consumer Unallocated Total (dollars in thousands) Balance as of January 1, 2018 $ 8,233 $ 17,112 $ 4,747 $ 1,050 $ 1 $ 605 $ 31,748 Loan charge-offs ( 17,066 ) ( 915 ) - ( 23 ) ( 7 ) - ( 18,011 ) Recoveries 109 - - 2 6 - 117   Provision for loan losses   18,599   2,650   ( 228 )   237   2   ( 160 )   21,100 Balance as of December 31, 2018 $ 9,875 $ 18,847 $ 4,519 $ 1,266 $ 2 $ 445 $ 34,954 For the year ended December 31, 2018, the loan charge-offs within the commercial loan segment were primarily made up of $ 17.0 million in charge-offs related to the taxi medallion portfolio. Troubled Debt Restructurings Loans are considered to have been modified in a troubled debt restructuring (“TDRs”) when, except as discussed below, due to a borrower’s financial difficulties, the Company makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a nonaccrual loan that has been modified in a troubled debt restructuring remains on nonaccrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is uncertain, the loan remains on nonaccrual status. As of December 31, 2020, there were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status or were contractually past due 90 days or greater and still accruing interest, or whose terms have been modified in troubled debt restructurings. - 81 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses – (continued) As of December 31, 2020, TDRs totaled $ 49.4 million, of which $ 25.7 million were on nonaccrual status and $ 23.7 million were performing under their restructured terms. As of December 31, 2019, TDRs totaled $ 52.0 million, of which $ 30.6 million were on nonaccrual status and $ 21.4 million were performing under their restructured terms. The Company has allocated $- 0 - and $ 1.3 million of specific allowance as of December 31, 2020 and December 31, 2019, respectively. There were no charge-offs in connection with a loan modification at the time of modification during the year ended December 31, 2020, 2019 and 2018. There were no TDRs for which there was a payment default within twelve months following the modification during the year ended December 31, 2020, 2019 and 2018. The following table presents loans by class modified as TDRs that occurred during year ended December 31, 2020: Number of Loans Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment (dollars in thousands) Troubled debt restructurings: Commercial 1 $ 188 $ 188 Commercial real estate 1 93 93 Commercial construction 1 4,021 4,021 Residential real estate 2 2,184 2,184   Total   5 $ 6,486 $ 6,486 The five loan modifications during the year ended December 31, 2020 were maturity extensions. The following table presents loans by class modified as TDRs that occurred during the year ended December 31, 2019 Number of Loans Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment (dollars in thousands) Troubled debt restructurings: Commercial 11 $ 14,558 $ 14,558 Commercial real estate 3 5,863 5,863 Commercial construction 3 5,630 5,630   Total   17 $ 26,051 $ 26,051 Included in the commercial loan segment of the troubled debt restructurings is one taxi medallion loan totaling $ 0.3 million. This taxi medallion loan was on nonaccrual status prior to modification and will remain on nonaccrual status post-modification. All loan modifications during the year ended December 31, 2019 included interest rate reductions and/or maturity extensions. - 82 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Loans and the Allowance for Loan Losses – (continued) The following table presents loans by class modified as TDRs that occurred during the year ended December 31, 2018: Number of Loans Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment (dollars in thousands) TDRs Commercial 32 $ 16,017 $ 16,017 Commercial real estate 3 1,422 1,422 Commercial construction 3 4,773 4,773 Residential real estate   2   454   454   Total   40 $ 22,666 $ 22,666 Included in the commercial loan segment of the troubled debt restructurings are 27 taxi medallion loans totaling $ 11.2 million. All 27 taxi medallion loans included above were on nonaccrual status prior to modification and remain on nonaccrual status post-modification. All loan modifications during the year ended December 31, 2018 included interest rate reductions and/or maturity extensions. In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., three to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Provisions of the CARES Act largely mirrored the provisions of the interagency statement, providing that modified loans would not be considered TDR’s if they were performing at year-end 2019, and the other conditions set forth in the interagency statement were met. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented or at year-end 2019. As of December 31, 2020, the Bank had 113 deferred loans totaling approximately $207.1 million. The majority of these loans were deferred between 90 and 120 days. The following table sets forth the composition of these loans by loan segments as of December 31, 2020: Number of Loans Unpaid Principal Balance (dollars in thousands) Commercial 49 $ 17,637 Commercial real estate 63 188,778 Residential real estate   1 666   Total   113 $ 207,081 As of December 31, 2020, there were no deferred loans that were delinquent or on nonaccrual status. As of December 31, 2020, $ 40.3 million of deferred loans were risk rated “special mention” or worse. The Company evaluates its deferred loans after the initial deferral period and will either return the deferred loans to its original loan terms or the loan will be reassessed at that time to determine if a further deferment should be granted and if a downgrade in risk rating is appropriate. - 83 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 – Premises and Equipment Premises and equipment are summarized as follows: Estimated Useful Life (Years) 2020 2019 (dollars in thousands) Land - $ 7,232 $ 2,403 Buildings 10 - 25 15,159 15,159 Furniture, fixtures and equipment 3 - 7 40,930 35,637 Leasehold improvements 10 - 20   28,860   16,842 Subtotal 92,181 70,041 Less: accumulated depreciation, amortization and fair value adjustments   62,073   50,805 Total premises and equipment, net $ 30,108 $ 19,236 Depreciation and amortization expense of premises and equipment was $ 4.2 million, $ 3.1 million and $ 3.1 million for 2020, 2019 and 2018, respectively. Finance Leases : The Company acquired a lease agreement for a building under a finance lease. The lease arrangement requires monthly payments through 2028. The Company has included this lease in premises and equipment as follows:     2020     2019       (dollars in thousands)   Capital Lease   $ 3,408     $ 3,408   Less: accumulated amortization     2,038       1,867       $ 1,370     $ 1,541   The following is a schedule by year of future minimum lease payments under the finance lease, together with the present value of net minimum lease payments as of December 31, 2020 (dollars in thousands): 2021 $ 321 2022 321 2023 323 2024 353 2025 353 Thereafter   1,029 Total minimum lease payments 2,700   Less amount representing interest   567 Present value of net minimum lease payments $ 2,133 - 84 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 – Premises and Equipment – (continued) The Company leases certain premises and equipment under operating leases. As of December 31, 2020, the Company had lease liabilities totaling $ 18.0 million and right-of-use assets totaling $16.2 million. As of December 31, 2020, the weighted average remaining lease term for operating leases was 6.0 years and the weighted average discount rate used in the measurement of operating lease liabilities was 2.9 %. Total lease costs for the year ended December 31, 2020 was $ 4.3 million. As of December 31, 2019, the Company had lease liabilities totaling $ 16.4 million and right-of-use assets totaling $15.1 million. As of December 31, 2019, the weighted average remaining lease term for operating leases was 7.2 years and the weighted average discount rate used in the measurement of operating lease liabilities was 3.0 %. Total lease costs for the year ended December 31, 2019 was $ 3.1 million. A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liability is as follows: December 31, 2020 (dollars in thousands) Lease payments due: Less than 1 year $ 4,229 1 year through less than 2 years 3,378 2 years through less than 3 years 3,060 3 years through less than 4 years 2,523 4 years through 5 years 2,231 After 5 years 4,435 Total undiscounted cash flows 19,856 Impact of discounting ( 1,830 ) Total lease liability $ 18,026 Note 7 – Goodwill and Other Intangible Assets A goodwill impairment test is required under ASC 350, Intangibles – Goodwill and Other, and the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment,” allowing an initial qualitative assessment of goodwill commonly known as step zero impairment testing. In general, the step zero test allows an entity to first assess qualitative factors to determine whether it is more likely than not (i.e., more than 50%) that the fair value of a reporting unit is less than its carrying value. If a step zero impairment test results in the conclusion that it is more likely than not that the fair value of the reporting unit exceeds its carrying value, then no further testing is required. In accordance with ASC 350, the Company performs goodwill impairment test at least annually, or more frequently if triggering event occurs. In the second quarter of 2020, the impact of COVID-19, prompted the Company to quantitively evaluate goodwill for impairment. The Company engaged an independent third-party to evaluate the fair value of the Company compared to its carrying value. To estimate the fair value of the Company, the third-party relied on a weighted discounted cash flow method, guideline public company method, and transaction method. The results concluded that the fair value of the Company exceeded its current carrying value and goodwill impairment did not exist as of June 30, 2020. Based upon management’s review through December 31, 2020, the Company’s goodwill was not impaired. Management concludes that the ASC 350 goodwill step zero test has been passed, and no further testing is required. Goodwill The change in goodwill during the year is as follows: 2020 2019 (dollars in thousands) Balance, January 1 $ 162,574 $ 145,909 Acquired goodwill 45,798   16,665 Impairment   -   - Balance, December 31 $ 208,372 $ 162,574 - 85 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 7 – Goodwill and Other Intangible Assets – (continued) Acquired Intangible Assets The table below provides information regarding the carrying amounts and accumulated amortization of total amortized intangible assets as of the dates set forth below. Gross Carrying Amount Accumulated Amortization Net Carrying Amount (dollars in thousands) As of December 31, 2020   Core deposit intangibles $ 18,515 $ ( 7,538 ) $ 10,977   As of December 31, 2019   Core deposit intangibles $ 10,439 $ ( 4,979 ) $ 5,460   Aggregate amortization expense was approximately $2.6 million, $1.4 million and $0.6 million for 2020, 2019 and 2018, respectively. Estimated amortization expense for each of the next five years (dollars in thousands): 2021 $ 1,981 2022 1,485 2023 1,438 2024 1,235 2025 1,116 Note 8 – Deposits Time Deposits As of December 31, 2020, and 2019, the Company’s total time deposits were $ 1.5 billion and $ 1.6 billion, respectively. Included in time deposits were nonreciprocal brokered time deposits of $ 217.5 million and $ 399.2 million as of December 31, 2020 and 2019, respectively. As of December 31, 2020, the contractual maturities of these time deposits were as follows (dollars in thousands): 2021 $ 1,028,184 2022 353,345 2023 62,153 2024   11,612 2025 5,471 Sub-Total $ 1,460,765 Fair value premium 3,367 Total $ 1,464,132 The amount of time deposits with balances of $250,000 or more was $ 409.3 million and $ 331.6 million as of December 31, 2020 and 2019, respectively. - 86 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9 – FHLB Borrowings The Company’s FHLB borrowings and weighted average interest rates are summarized below: December 31, 2020 December 31, 2019 Amount Rate Amount Rate (dollars in thousands) Total FHLB borrowings $ 425,954 1.07 % $ 500,293 1.96 %   By remaining period to maturity: Less than 1 year $ 297,570 0.84 % $ 400,000 1.84 % 1 year through less than 2 years 75,644 1.42 % 62,000 2.26 % 2 years through less than 3 years 50,000 1.84 % 10,737 2.45 % 3 years through less than 4 years - n/a 25,000 2.92 % 4 years through 5 years   - n/a   - After 5 Years   2,824 2.42 %   2,882 2.43 % Total FHLB borrowings 426,038 1.07 % 500,619 1.96 % Fair value (discount) premium ( 84 ) ( 326 ) FHLB borrowings, net $ 425,954 $ 500,293 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. Advances are payable at stated maturity, with a prepayment penalty for fixed rate advances. All FHLB advances are fixed rates. The advances as of December 31, 2020 were primarily collateralized by approximately $ 2.0 billion of commercial mortgage and residential loans, net of required over collateralization amounts, under a blanket lien arrangement. As of December 31, 2020, the Company had remaining borrowing capacity of approximately $ 1.0 billion at the FHLB. - 87 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10 – 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 as of December 31, 2020 was 3.06 %. 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 as of December 31, 2020 and December 31, 2019. Issuance Date Securities Issued Liquidation Value Coupon Rate Maturity Redeemable by Issuer Beginning 12/19/2003 $ 5,000,000 $1,000 per Capital Security Floating 3-month LIBOR + 285 Basis Points 01/23/2034 01/23/2009 On June 10, 2020, the Parent Corporation issued $ 75 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “2020 Notes”). The 2020 Notes bear interest at 5.75 % annually from, and including, the date of initial issuance to, but excluding, June 15, 2025 or the date of earlier redemption, payable semi-annually in arrears on June 15 and December 15 of each year, commencing December 15, 2020. From and including June 15, 2025 through maturity or earlier redemption, the interest rate shall reset quarterly to an interest rate per annum equal to a benchmark rate, which is expected to be Three-Month Term SOFR (as defined in the Second Supplemental Indenture), plus 560.5 basis points , payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing on September 15, 2025. Notwithstanding the foregoing, if the benchmark rate is less than zero, then the benchmark rate shall be deemed to be zero. On January 11, 2018, the Parent Corporation issued $ 75 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “2018 Notes”). The 2018 Notes 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 2018 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. During June 2015, the Parent Corporation issued $ 50 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “2015 Notes”). As of December 31, 2020, the 2015 Notes have a stated maturity of July 1, 2025 , and bear interest until the maturity date or early redemption date at a variable rate equal to the then current three-month LIBOR rate plus 393 basis points . As of December 31, 2020, the variable interest rate was 4.16 % and all costs related to 2015 issuance have been amortized. The 2015 Notes were redeemed in full on January 1, 2021. - 88 - Table of Contents Note 11 – Income Taxes The current and deferred amounts of income tax expense for 2020, 2019 and 2018 are as follows (dollars in thousands):     2020     2019     2018   Current:                         Federal   $ 19,590     $ 15,509     $ 8,902   State     7,006       5,018       954   Subtotal     26,596       20,527       9,856   Deferred:                         Federal     ( 3,881 )       916       2,455   State     ( 3,614 )       ( 812 )       ( 1,529 )   Subtotal     ( 7,495 )       104       926   Income tax expense   $ 19,101     $ 20,631     $ 10,782   On July 1, 2018 New Jersey Governor Phil Murphy signed Assembly Bill 4202 (“the Bill”) into law. The legislation imposes a temporary surtax on corporations earning New Jersey allocated income in excess of $ 1 million of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and of 1.5 % for tax years beginning on or after January 1, 2020 through December 31, 2021. However, in 2020, this surtax was extended through December 31, 2023, at the 2.5 % level. The legislation also requires combined filing for members of an affiliated group for tax years beginning on or after January 1, 2019, changing New Jersey’s current status as a separate return state, and limits the deductibility of dividends received. Actual income tax expense differs from the tax computed based on pre-tax income and the applicable statutory federal tax rate for the following reasons (dollars in thousands):     2020     2019     2018   Income before income tax expense   $ 90,390     $ 94,026     $ 71,134   Federal statutory rate     21 %     21 %     21 % Computed “expected” Federal income tax expense     18,982       19,745       14,938   State tax, net of federal tax benefit     1,913       3,436       1,104   Impact of the Tax Cuts and Jobs Act 2017     -       -       ( 790 )   Impact of the “the Bill”     -       -       ( 618 )   Bank owned life insurance     ( 1,052 )       ( 732 )       ( 650 )   Tax-exempt interest and dividends     ( 1,491 )       ( 2,519 )       ( 1,521 )   Tax benefits from stock-based compensation     157       ( 27 )       ( 1,100 )   Other, net     592       728       ( 581 )   Income tax expense   $ 19,101     $ 20,631     $ 10,782   - 89 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11 – Income Taxes – (continued) The tax effects of temporary differences that give rise to significant portions of the deferred tax asset and deferred tax liability as of December 31, 2020 and 2019 are presented in the following table:     2020     2019       (dollars in thousands)   Deferred tax assets                 Allowance for loan losses   $ 23,399     $ 11,333   Purchase accounting     -       4,543   Pension actuarial losses     1,385       -   New Jersey net operating loss     4,370       3,424   Deferred compensation     1,835       1,440   Unrealized losses on securities and swaps     -       1,509   Deferred loan costs, net of fees     357       20   Capital lease     225       230   Nonaccrual interest     51       69   Other     4,519       2,240   Total deferred tax assets   $ 36,141     $ 24,808   Deferred tax liabilities                 Employee benefit plans   $ ( 2,161 )     $ ( 2,131 )   Purchase accounting     ( 1,821 )       -   Pension actuarial gains     -       ( 1,062 )   Depreciation     ( 187 )       ( 1,146 )   Prepaid expenses     ( 201 )       ( 173 )   Market discount accretion     ( 428 )       ( 32 )   Unrealized gains on securities and swaps     ( 2,171 )       -   Total deferred tax liabilities     ( 6,969 )       ( 4,544 )   Net deferred tax assets   $ 29,172     $ 20,264   In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all the deferred tax assets will not be realized. The ultimate realization of deferred tax assets for state purposes is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible, while for Federal purposes the deferred tax assets can also be realized through tax carrybacks. Management considers the scheduled reversal of deferred tax liabilities, the projected future taxable income, and tax planning strategies in making this assessment. During 2020 and 2019, based on the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, the Company believes the net deferred tax assets are more likely than not to be realized. There are no unrecorded tax benefits and the Company does not expect the total amount of unrecognized income tax benefits to significantly increase in the next twelve months. The Company’s federal income tax returns are open and subject to examination from the 2017 tax return year and forward. The Company’s state income tax returns are generally open from the 2015 and later tax return years based on individual state statutes of limitations. - 90 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12 – 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 20 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 December 31, 2020 and December 31, 2019: Gross Amounts Not Offset Gross Amounts Recognized Gross Amounts Offset in the Statement of Financial Condition Net Amounts of Assets Presented in the Statement of Financial Condition Financial Instruments Recognized Cash or Financial Instrument Collateral Net Amount (dollars in thousands) December 31, 2020 Assets: Interest rate swaps $ - $ - $ - $ - $ - $ - Liabilities: Interest rate swaps $ ( 2,119 ) $ - $ ( 2,119 ) $ - $ ( 2,119 ) $ - December 31, 2019 Assets: Interest rate swaps $ - $ - $ - $ - $ - $ - Liabilities: Interest rate swaps $ ( 273 ) $ - $ ( 273 ) $ - $ ( 273 ) $ - - 91 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13 – Commitments, Contingencies and Concentrations of Credit Risk In the normal course of business, the Company has outstanding commitments and contingent liabilities, such as standby and commercial letters of credit, unused portions of lines of credit and commitments to extend various types of credit. Commitments to extend credit and standby letters of credit generally do not exceed one year. These financial instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated financial statements. The commitment or contract amount of these financial instruments is an indicator of the Company’s level of involvement in each type of instrument as well as the exposure to credit loss in the event of nonperformance by the other party to the financial instrument. The Company controls the credit risk of these financial instruments through credit approvals, limits and monitoring procedures. To minimize potential credit risk, the Company generally requires collateral and other credit-related terms and conditions from the customer. In the opinion of management, the financial condition of the Company will not be materially affected by the final outcome of these commitments and contingent liabilities. A substantial portion of the Bank’s loans are secured by real estate located in New Jersey and New York. Accordingly, the collectability of a substantial portion of the loan portfolio of the Bank is susceptible to changes in the metropolitan New York real estate market. The following table provides a summary of financial instruments with off-balance sheet risk as of December 31, 2020 and 2019: 2020 2019 (dollars in thousands) Commitments under commercial loans and lines of credit $ 525,606 $ 564,444 Home equity and other revolving lines of credit 65,690 47,278 Outstanding commercial mortgage loan commitments 327,745 392,225 Standby letters of credit 28,738 32,155 Overdraft protection lines   1,020   752 Total $ 948,799 $ 1,036,854 The Company is subject to claims and lawsuits that arise in the ordinary course of business. Based upon the information currently available in connection with such claims, it is the opinion of management that the disposition or ultimate determination of such claims will not have a material adverse impact on the consolidated financial position, results of operations, or liquidity of the Company. Note 14 – Transactions with Executive Officers, Directors and Principal Stockholders Loans to principal officers, directors, and their affiliates during the years ended December 31, 2020 and 2019 were as follows:     2020     2019       (dollars in thousands)   Balance, January 1   $ 57,409     $ 56,903   New loans     1,500       8,684   Repayments     ( 37,375 )       ( 8,178 )   Balance, December 31   $ 21,534     $ 57,409   Deposits from principal officers, directors, and their affiliates as of December 31, 2020 and 2019 were $ 55.4 million and $ 24.5 million respectively. The Company has had, and may be expected to have in the future, banking transactions in the ordinary course of business with its executive officers, directors, principal stockholders, their immediate families and affiliated companies (commonly referred to as related parties). The Company leases banking offices from related party entities. In addition, the Company also utilizes an advertising and public relations agency at which one of the Company’s directors is President and CEO and a principal owner. For these transactions, the expenses are not significant to the operations of the Company. - 92 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15 – Stockholders’ Equity and Regulatory Requirements Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The net unrealized gain or loss on available for sale securities is not included in computing regulatory capital. Management believes as of December 31, 2020, the Bank and the Parent Corporation meet all capital adequacy requirements to which they are subject. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is classified as adequately capitalized or lower, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is growth and expansion, and capital restoration plans are required. As of December 31, 2020, and 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category. The following is a summary of the Bank’s and the Parent Corporation’s actual capital amounts and ratios as of December 31, 2020 and 2019, compared to the FRB and FDIC minimum capital adequacy requirements and the FDIC requirements for classification as a well-capitalized institution. Minimum Capital Adequacy For Classification Under Corrective Action Plan as Well Capitalized Amount Ratio Amount     Ratio Amount Ratio The Bank           (dollars in thousands)           December 31, 2020 Leverage (Tier 1) capital $ 776,430 10.64 % $ 291,958 4.00 % $ 364,947 5.00 % Risk-Based Capital: CET 1 $ 776,430 12.24 % $ 285,473 4.50 % $ 412,349 6.50 % Tier 1 776,430 12.24 % 380,630 6.00 % 507,507 8.00 % Total 887,906 14.00 % 507,507 8.00 % 634,384 10.00 %   December 31, 2019 Leverage (Tier 1) capital $ 637,824 10.81 % $ 236,188 4.00 % $ 295,235 5.00 % Risk-Based Capital: CET 1 $ 637,824 11.37 % $ 252,432 4.50 % $ 364,625 6.50 % Tier 1 637,824 11.37 % 336,577 6.00 % 448,769 8.00 % Total 708,367 12.63 % 448,769 8.00 % 560,961 10.00 % - 93 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15 – Stockholders’ Equity and Regulatory Requirements – (continued) Minimum Capital Adequacy For Classification as Well Capitalized   Amount Ratio Amount Ratio Amount Ratio The Company (dollars in thousands) December 31, 2020 Leverage (Tier 1) capital $ 694,895 9.51 % $ 292,349 4.00 % N/A N/A Risk-Based Capital: CET 1 $ 689,740 10.79 % $ 287,746 4.50 % N/A N/A Tier 1 694,895 10.87 % 383,661 6.00 % N/A N/A Total 964,121 15.08 % 511,548 8.00 % N/A N/A   December 31, 2019 Leverage (Tier 1) capital $ 563,464 9.54 % $ 236,259 4.00 % N/A N/A Risk-Based Capital: CET 1 $ 558,309 9.95 % $ 252,439 4.50 % N/A N/A Tier 1 563,464 10.04 % 336,586 6.00 % N/A N/A Total 726,757 12.96 % 448,781 8.00 % N/A N/A As of December 31, 2020, both the Company and Bank satisfy the capital conservation buffer requirements applicable to them. The lowest ratio at the Company is the Tier 1 Ratio which was 2.37 % above the minimum buffer ratio and, at the Bank, the lowest ratio was the Total Risk Based Capital Ratio which was 3.50 % above the minimum buffer ratio. - 94 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16 – Comprehensive Income Total comprehensive income includes all changes in equity during a period from transactions and other events and circumstances from non-owner sources. The Company’s other comprehensive income is comprised of unrealized holding gains and losses on securities available-for-sale, unrealized gains and losses on cash flow hedges, obligations for defined benefit pension plan and an adjustment to reflect the curtailment of the Company’s defined benefit pension plan, each net of taxes. The following table represents the reclassification out of accumulated other comprehensive (loss) income for the periods presented: Details about Accumulated Other Comprehensive Income (Loss) Components Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) Affected Line Item in the Consolidated Statements of Income For the Year Ended December 31, (dollars in thousands) 2020 2019 2018 Sale of investment securities available-for-sale $ 29 $ ( 280 ) $ - Net gains (losses) on sale of investment securities   ( 6 )   79   - Income tax expense 23 ( 201 ) - Net interest (expense) income on swaps ( 1,577 ) 677 464 Interest expense   443   ( 190 )   ( 130 ) Income tax expense ( 1,134 ) 487 334 Amortization of pension plan net actuarial losses ( 301 ) ( 358 ) ( 359 ) Salaries and employee benefits   84   101   101 Income tax benefit   ( 217 )   ( 257 )   ( 258 ) Total reclassification $ ( 1,328 ) $ 29 $ 76 Accumulated other comprehensive income (loss) as of December 31, 2020 and 2019 consisted of the following:     2020     2019       (dollars in thousands)   Investment securities available-for-sale, net of tax   $ 7,859     $ 2,724   Cash flow hedge, net of tax     ( 1,520 )       ( 193 )   Defined benefit pension and post-retirement plans, net of tax     ( 3,542 )       ( 3,678 )   Total   $ 2,797     $ ( 1,147 )   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 of 2017. In order to comply with this new ASU, the Company recorded an adjustment to the Consolidated Statement of Condition on January 1, 2018 of approximately $ 709 thousand that increased retained earnings and increased 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 Consolidated Statement of Condition of approximately $ 55 thousand. - 95 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 – Pension and Other Benefits Defined Benefit Plans The Company maintains a frozen noncontributory pension plan covering employees of the Company prior to the merger with Legacy ConnectOne. The benefits are based on years of service and the employee’s compensation over the prior five-year period. The plan’s benefits are payable in the form of a ten-year certain and life annuity. The plan is intended to be a tax-qualified defined benefit plan under Section 401(a) of the Internal Revenue Code. Payments may be made under the Pension Plan once attaining the normal retirement age of 65 and are generally equal to 44% of a participant’s highest average compensation over a 5-year period. The following table sets forth changes in projected benefit obligation, changes in fair value of plan assets, funded status, and amounts recognized in the consolidated statements of condition for the Company’s pension plans as of December 31, 2020 and 2019.     2020     2019       (dollars in thousands)   Change in Benefit Obligation:                 Projected benefit obligation as of January 1,   $ 12,533     $ 10,969   Interest cost     364       453   Actuarial loss     1,300       1,909   Benefits paid     ( 721 )       ( 798 )   Projected benefit obligation as of December 31,   $ 13,476     $ 12,533   Change in Plan Assets:                 Fair value of plan assets as of January 1,   $ 14,616     $ 13,023   Actual return on plan assets     1,973       2,391   Employer contributions     -       -   Benefits paid     ( 721 )       ( 798 )   Fair value of plan assets as of December 31,   $ 15,868     $ 14,616   Funded status   $ 2,392     $ 2,083   The accumulated benefit obligation was $ 13.5 million and $ 12.5 million as of the year ended December 31, 2020 and 2019, respectively. Amounts recognized as a component of accumulated other comprehensive loss as of year-end that have not been recognized as a component of the net periodic pension expense for the plan are presented in the following table. The Company expects to recognize approximately $ 0.3 million of the net actuarial loss reported in the following table as of December 31, 2020 as a component of net periodic pension expense during 2021. 2020 2019 (dollars in thousands) Net actuarial loss recognized in accumulated other comprehensive income   $ 4,926     $ 5,116   The net periodic pension expense and other comprehensive income (before tax) for 2020, 2019 and 2018 includes the following: 2020 2019 2018 (dollars in thousands) Interest cost   $ 364     $ 453     $ 427   Expected return on plan assets ( 784 ) ( 697 ) ( 765 ) Net amortization   301   358   366 Total net periodic pension expense $ ( 119 ) $ 114 $ 28   Total gain recognized in other comprehensive income   ( 190 )   ( 150 )   ( 595 ) Total recognized in net periodic expense and other comprehensive income (before tax) $ ( 309 ) $ ( 36 ) $ ( 567 ) - 96 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 – Pension and Other Benefits – (continued) The following table presents the weighted average assumptions used to determine the pension benefit obligations as of December 31, for the following periods: 2020 2019 Discount rate 2.17 % 2.99 % Rate of compensation increase N/A N/A The following table presents the weighted average assumptions used to determine net periodic pension cost for the following three years: 2021 2020 2019 Discount rate 2.17 % 2.99 % 4.05 % Expected long-term return on plan assets 5.50 % 5.50 % 5.50 % Rate of compensation increase N/A N/A N/A The process of determining the overall expected long-term rate of return on plan assets begins with a review of appropriate investment data, including current yields on fixed income securities, historical investment data, historical plan performance and forecasts of inflation and future total returns for the various asset classes. This data forms the basis for the construction of a best-estimate range of real investment returns for each asset class. An average weighted real-return range is computed reflecting the plan’s expected asset mix, and that range, when combined with an expected inflation range, produces an overall best-estimate expected return range. Specific factors such as the plan’s investment policy, reinvestment risk and investment volatility are taken into consideration during the construction of the best estimate real return range, as well as in the selection of the final return assumption from within the range. - 97 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 – Pension and Other Benefits – (continued) Plan Assets The general investment policy of the Pension Trust is for the fund to experience growth in assets that will allow the market value to exceed the value of benefit obligations over time. The Company’s pension plan asset allocation as of December 31, 2020 and 2019, target allocation, and expected long-term rate of return by asset are as follows: Target Allocation % of Plan Assets – Year Ended 2020 % of Plan Assets – Year Ended 2019 Weighted Average Expected Long-Term Rate of Return Equity Securities                                 Domestic 50 % 55 % 47 % 3.4 % International 10 % 6 % 7 % 0.7 % Debt and/or fixed income securities 36 % 35 % 37 % 1.2 % Cash and other alternative investments, including real estate funds, commodity funds, hedge funds and equity structured notes   4 %   4 %   9 %   0.2 % Total   100 % $ 100 % $ 100 % $ 5.5 % - 98 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 – Pension and Other Benefits – (continued) The fair values of the Company’s pension plan assets as of December 31, 2020 and 2019, by asset class, are as follows: December 31, 2020 Fair Value Measurements at Reporting Date Using Asset Class Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) Cash   $ 406     $ 406     $ -     $ -   Equity securities: U.S. companies 8,737 8,737 - - International companies 1,031 1,031 - - Debt and/or fixed income securities 5,522 5,522 Commodity funds 115 115 Real estate funds   57   57   -   - Total $ 15,868 $ 15,868 $ - $ - December 31, 2019 Fair Value Measurements at Reporting Date Using Asset Class Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) Cash   $ 1,171     $ 1,171     $ -     $ -   Equity securities: U.S. companies 6,896 6,896 - - International companies 1,023 1,023 - - Debt and/or fixed income securities 5,355 5,355 Commodity funds 115 115 Real estate funds   56   56   -   - Total $ 14,616 $ 14,616 $ - $ - - 99 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 – Pension and Other Benefits – (continued) Fair Value of Plan Assets The Company used the following valuation methods and assumptions to estimate the fair value of assets held by the plan (for further information on fair value methods, see Note 21): Equity securities and real estate funds : The fair values for equity securities and real estate funds are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). Debt and fixed income securities : Certain debt securities are valued at the closing price reported in the active market in which the bond is traded (Level 1 inputs). Other debt securities are valued based upon recent bid prices or the average of recent bid and asked prices when available (Level 2 inputs) and, if not available, they are valued through matrix pricing models developed by sources considered by management to be reliable. Matrix pricing, which is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations. The investment manager is not authorized to purchase, acquire or otherwise hold certain types of market securities (subordinated bonds, real estate investment trusts, limited partnerships, naked puts, naked calls, stock index futures, oil, gas or mineral exploration ventures or unregistered securities) or to employ certain types of market techniques (margin purchases or short sales) or to mortgage, pledge, hypothecate, or in any manner transfer as security for indebtedness, any security owned or held by the Plan. Cash Flows Contributions The Bank does not expect to make a contribution in 2021. Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, for the following years are as follows (dollars in thousands): 2021 $ 754 2022 733 2023 712 2024 699 2025 697 2026-2030 3,664 401(k) Plan The Company maintains a 401(k) plan to provide for defined contributions which covers substantially all employees of the Company. Beginning with the 2014 plan year, the 401(k) plan was amended to provide for a match of 50% of elective contributions, up to 6% of an employee’s contribution. In 2018, the 401 (k) plan was amended to provide for 100% matching of employee contributions up to 5% of employee contributions. For 2020, 2019 and 2018, employer contributions amounted to $ 1.6 million, $ 1.3 million and $ 0.9 million, respectively. Supplemental Executive Retirement Plan (“SERP”) During 2019 the Company adopted supplemental executive retirement plans (“SERP’s”) for the benefit of several of its executive officers. Each SERP is a non-qualified plan which provides supplemental retirement benefits to the participating officers of the Company. SERP compensation expense was $ 0.4 million and $ 0.3 million for the years ended December 31, 2020 and December 31, 2019 respectively. - 100 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 18 – 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 December 31, 2020. 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 December 31, 2020 are approximately 435,674 . The Company intends to issue all shares under the Plan in the form of newly issued shares. Restricted stock, options and restricted stock units 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 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, performance units and restricted stock units do not. All awards are issued at the 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 recorded as incurred. Stock-based compensation expense was $2.9 million, $2.7 million and $1.9 million for the years ended December 31, 2020, 2019 and 2018 respectively. Activity under the Company’s options for the year ended December 31, 2020 was as follows:     Number of Stock Options     Weighted- Average Exercise Price     Weighted- Average Remaining Contractual Term (in years)     Aggregate Intrinsic Value   Outstanding as of December 31, 2019     73,426     $ 8.19       0     $ 0   Granted     -       -                   Exercised     ( 35,413 )       7.28                   Forfeited/cancelled/expired     -       -                   Outstanding as of December 31, 2020     38,013       9.04       1.2     $ 409,000                                     Exercisable as of December 31, 2020     38,013     $ 9.04       1.2     $ 409,000   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 December 31, 2020 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 December 31, 2020. This amount changes based on the fair market value of the Company’s stock. Activity under the Company’s restricted shares for year ended December 31, 2020 was as follows:     Nonvested Shares     Weighted- Average Grant Date Fair Value   Nonvested as of December 31, 2019     75,351     $ 21.61   Granted     90,200       17.11   Vested     ( 52,014 )       21.32   Forfeited/cancelled/expired     ( 423 )       23.65   Nonvested December 31, 2020     113,114     $ 18.15   - 101 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 18 – Stock-Based Compensation – (continued) As of December 31, 2020, there was approximately $ 1.3 million of total unrecognized compensation cost related to nonvested restricted shares granted. The cost is expected to be recognized over a weighted average period of 1.3 years. A summary of the status of unearned performance unit awards and the change during the period is presented in the table below: Units (expected) Units (maximum) Weighted Average Grant Date Fair Value Unearned as of December 31, 2019   90,097   0 $ 23.85   Awarded 82,579 10.77 Change in estimate 12,297 29.61 Vested shares   ( 37,337 ) 22.75 Unearned as of December 31, 2020   147,636   206,744 $ 17.29 As of December 31, 2020, the specific number of shares related to performance units that were expected to vest was 147,636 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. As of December 31, 2020, the maximum number of shares related to performance units that ultimately could vest if performance targets were exceeded is 206,744. During the year ended December 31, 2020, 37,337 shares vested. A total of 14,935 shares were netted from the vested shares to satisfy employee tax obligations. The net shares issued from vesting of performance units during the year ended December 31, 2020 were 22,402 shares. As of December 31, 2020, compensation cost of approximately $ 1.0 million related to non-vested performance units not yet recognized is expected to be recognized over a weighted-average period of 1.7 years. A summary of the status of unearned restricted stock units and the changes in restricted stock units during the period is presented in the table below:     Units (expected)     Weighted Average Grant Date Fair Value   Unearned as of December 31, 2019 73,069 $ 23.62 Awarded 123,870 10.77 Vested shares   ( 27,626 ) 24.53 Unearned as of December 31, 2020   169,313 $ 14.07 Any forfeitures would result in previously recognized expense being reversed. A portion of the shares that vest will be netted out to satisfy the tax obligations of the recipient. During the year ended December 31, 2020, 27,626 shares vested. A total of 11,085 shares were netted from the vested shares to satisfy employee tax obligations. The net shares issued from vesting of restricted stock units during the year ended December 31, 2020 were 16,541 shares. As of December 31, 2020, compensation cost of approximately $ 1.5 million related to non-vested restricted stock units, not yet recognized, is expected to be recognized over a weighted-average period of 1.8 years. Note 19 – Dividends and Other Restrictions Certain restrictions, including capital requirements, exist on the availability of undistributed net profits of the Bank for the future payment of dividends to the Parent Corporation. A dividend may not be paid if it would impair the capital of the Bank. As of December 31, 2020, approximately $ 253.5 million was available for payment of dividends based on regulatory guidelines. - 102 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20 – 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, January 27, 2020 and March 3, 2020 each with a respective notional amount of $ 25.0 million and were designated as a cash flow hedge of a Federal Home Loan Bank (“FHLB”) advance. In addition, interest rate swaps were entered into on June 4, 2019 and August 6, 2019, each with a respective notional amount of $ 50.0 million and were designated as a cash flow hedge of a FHLB advance. The swaps were determined to be fully effective during the period presented and therefore no amount of ineffectiveness has been included in net income. 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: December 31, 2020 December 31, 2019 (dollars in thousands) Notional amount   $ 175,000     $ 150,000   Weighted average pay rates 1.85 % 1.82 % Weighted average receive rates 0.92 % 2.37 % Weighted average maturity 0.8 years 1.5 years Fair value $ ( 2,119 ) $ ( 273 ) Interest expense recorded on these swap transactions totaled approximately $( 1.6 ) million, $( 0.7 ) million, and $( 0.5 ) million during 2020, 2019, and 2018 is reported as a component of interest expense on FHLB Advances. Cash Flow Hedge The following table presents the net gains (losses), recorded in accumulated other comprehensive income and the Consolidated Statements of Income relating to the cash flow derivative instruments for the years ended December 31: 2020 (dollars in thousands) Amount of gain (loss) recognized in OCI (Effective Portion) Amount of (gain) loss reclassified from OCI to interest expense Amount of gain (loss) recognized in other Noninterest income (Ineffective Portion) Interest rate contracts $ ( 3,423 ) $ ( 1,577 ) $ - 2019 (dollars in thousands) Amount of gain (loss) recognized in OCI (Effective Portion) Amount of (gain) loss reclassified from OCI to interest expense Amount of gain (loss) recognized in other Noninterest income (Ineffective Portion) Interest rate contracts $ ( 755 ) $ ( 677 ) $ - The following table reflects the cash flow hedges included in the Consolidated Statements of Condition as of December 31, 2020 and December 31, 2019: 2020 2019 (dollars in thousands) Notional Amount Fair Value Notional Amount Fair Value Included in other assets/(liabilities):                                 Interest rate swaps related to FHLB Advances $ 175,000 $ ( 2,119 ) $ 150,000 $ ( 273 ) - 103 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20 – Derivatives – (continued) There were no net gains (losses) recorded in accumulated other comprehensive income or in the Consolidated Statement of Income relating to cash flow derivative instruments for the years ended December 31, 2020, December 31, 2019 and December 31, 2018. Note 21 – Fair Value Measurements and Fair Value of Financial Instruments Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820-10-05 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurements and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. FASB ASC 820-10-65 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10-05 when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly. FASB ASC 820-10-05 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820-10-05 are as follows: Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Level 2: Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (for example, supported with little or no market activity). An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. Assets and Liabilities Measured at Fair Value on a Recurring Basis The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis as of December 31, 2020 and December 31, 2019: Securities Available-for-Sale: Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 inputs include securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy include municipal bonds and certain agency collateralized mortgage obligations. In certain cases where there is limited activity in the market for a particular instrument, assumptions must be made to determine the fair value of the instruments and these are classified as Level 3. When measuring fair value, the valuation techniques available under the market approach, income approach and/or cost approach are used. The Company’s evaluations are based on market data and the Company employs combinations of these approaches for its valuation methods depending on the asset class. - 104 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – Fair Value Measurements and Fair Value of Financial Instruments – (continued) Derivatives: The fair value of derivatives are based on valuation models using observable market data as of the measurement date (level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rate, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. 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 as of December 31, 2020 and December 31, 2019 are as follows: December 31, 2020 Fair Value Measurements at Reporting Date Using Total Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) Recurring fair value measurements:                                 Assets Investment securities : Available-for-sale : Federal agency obligations $ 38,458 $ - $ 38,458 $ - Residential mortgage pass-through securities 270,884 - 270,884 - Commercial mortgage pass-through securities 6,922 - 6,922 - Obligations of U.S. states and political subdivision 142,808 - 133,964 8,844 Corporate bonds and notes 25,095 - 25,095 - Asset-backed securities 3,480 - 3,480 - Certificates of deposit 151 - 151 - Other securities   157   157   157   - Total available-for-sale $ 487,955 $ 155 $ 478,954 $ 8,844   Equity securities 13,387 13,387 - - Total assets $ 501,341 $ 13,543 $ 478,954 $ 8,844   Liabilities Derivatives $ ( 2,119 ) $ - $ ( 2,119 ) $ - Total liabilities $ ( 2,119 )   -   ( 2,119 )   - There were no transfers between Level 1 and Level 2 during the years ended December 31, 2020 and 2019. - 105 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – Fair Value Measurements and Fair Value of Financial Instruments – (continued) December 31, 2019 Fair Value Measurements at Reporting Date Using Total Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) Recurring fair value measurements:                                 Assets Investment securities : Available-for-sale : Federal agency obligations $ 28,237 $ - $ 28,237 $ - Residential mortgage pass-through securities 200,496 - 200,496 - Commercial mortgage pass-through securities 4,997 - 4,997 - Obligations of U.S. states and political subdivision 136,519 - 127,405 9,114 Corporate bonds and notes 28,382 - 28,382 - Asset-backed securities 5,780 - 5,780 - Certificates of deposit 150 - 150 - Other securities   140   140   -   - Total available-for-sale $ 404,701 $ 140 $ 395,447 $ 9,114   Equity securities 11,185 11,185 - - Total assets $ 415,886 $ 11,325 $ 395,447 $ 9,114 Assets Measured at Fair Value on a Non-Recurring Basis The Company may be required periodically to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or impairment write-downs of individual assets. The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis as of December 31, 2020 and December 31, 2019: - 106 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – 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 as of December 31, 2020 and December 31, 2019 are as follows:           Fair Value Measurements at Reporting Date Using   Assets measured at fair value on a nonrecurring basis:   December 31, 2020     Quoted Prices in Active Markets for Identical Assets (Level 1)     Significant Other Observable Inputs (Level 2)     Significant Unobservable Inputs (Level 3)   Impaired loans:   (dollars in thousands)   Commercial $ 10,751 $ - $ - $ 10,751 Commercial real estate 1,393 - - 1,393           Fair Value Measurements at Reporting Date Using   Assets measured at fair value on a nonrecurring basis:   December 31, 2019     Quoted Prices in Active Markets for Identical Assets (Level 1)     Significant Other Observable Inputs (Level 2)     Significant Unobservable Inputs (Level 3)   Impaired loans:   (dollars in thousands)   Commercial construction $ 2,286 $ - $ - $ 2,286 Residential 240 - - 240 Impaired loans - Collateral dependent impaired loans as of December 31, 2020 that required a valuation allowance were $ 26.5 million with a related valuation allowance of $ 14.3 million compared to $ 3.8 million with a related valuation allowance of $ 1.3 million as of December 31, 2019. - 107 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – 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 year ended December 31, 2020 and year ended December 31, 2019:   Municipal Securities     (dollars in thousands)   Beginning balance, January 1, 2020 $ 9,114   Principal paydowns   ( 270 )   Ending balance, December 31, 2020 $ 8,844   Municipal Securities (dollars in thousands) Beginning balance, January 1, 2019 $ 9,377   Principal paydowns   ( 263 ) Ending balance, December 31, 2019 $ 9,114 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 as of December 31, 2020 and December 31, 2019. The table below provides quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy. December 31, 2020 Fair Value Valuation Techniques Unobservable Input Range Securities available-for-sale:         (dollars in thousands)           Municipal securities $ 8,844 Discounted cash flows Discount rate 2.9 % December 31, 2019 Fair Value Valuation Techniques Unobservable Input Range   Securities available-for-sale:         (dollars in thousands)         Municipal securities $ 9,114 Discounted cash flows Discount rate 2.9 % - 108 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – Fair Value Measurements and Fair Value of Financial Instruments – (continued) Non-recurring basis The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis for the periods presented. The tables below provide quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy. December 31, 2020 (dollars in thousands)   Fair Value     Valuation Techniques   Unobservable Input   Range (weighed average) Impaired loans:                     Commercial   $ 10,524     Market approach (100%)   Average transfer price as a price to unpaid principal balance   48 - 53  ( 49 ) Commercial   $ 227     Appraisals of collateral value   Adjustment for comparable sales   1 % to 5 % (+ 2 %)                       Commercial real estate   $ 1,393     Appraisals of collateral value   Adjustment for comparable sales   - 25 % to + 20 % (- 8 %) December 31, 2019 (dollars in thousands)   Fair Value     Valuation Techniques   Unobservable Input   Range (weighed average) Impaired loans:                     Commercial construction   $ 2,286     Appraisals of collateral value   Comparable sales   0 % - 5 % ( 3 %)                       Residential   $ 240     Appraisals of collateral value   Comparable sales   2 % - 14 % ( 9 %) Fair Value of Financial Instruments FASB ASC 825-10 requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in FASB ASC 825-10. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Company’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities except for loans held-for-sale and investment securities available-for-sale. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Company for the purposes of this disclosure. - 109 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – Fair Value Measurements and Fair Value of Financial Instruments – (continued) Fair values for financial instruments must be estimated by management using techniques such as discounted cash flow analysis and comparison to similar instruments. These estimates are highly subjective and require judgments regarding significant matters, such as the amount and timing of future cash flows and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near-term changes. Fair values disclosed in accordance with ASC Topic 825 do not reflect any premium or discount that could result from the sale of a large volume of a particular financial instrument, nor do they reflect possible tax ramifications or estimated transaction costs. Cash and cash equivalents. The carrying amounts of cash and short-term instruments approximate fair values. FHLB stock. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability. Loans. The fair value of portfolio loans, net is determined using an exit price methodology. The exit price methodology continues to be based on a discounted cash flow analysis, in which projected cash flows are based on contractual cash flows adjusted for prepayments for certain loan types ( e.g. residential mortgage loans and multi-family loans) and the use of a discount rate based on expected relative risk of the cash flows. The discount rate selected considers loan type, maturity date, a liquidity premium, cost to service, and cost of capital, which is a Level 3 fair value estimate. Deposits. The carrying amounts of deposits with no stated maturities (i.e., non­interest-bearing, savings, NOW, and money market deposits) are assigned fair values equal to the carrying amounts payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity. Term Borrowings and Subordinated Debentures . The fair value of the Company’s long-term borrowings and subordinated debentures were calculated using a discounted cash flow approach and applying discount rates currently offered based on weighted remaining maturities. Accrued Interest Receivable/Payable. The carrying amounts of accrued interest approximate fair value resulting in a level 2 or level 3 classification based on the level of the asset or liability with which the accrual is associated. - 110 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – Fair Value Measurements and Fair Value of Financial Instruments – (continued) The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of December 31, 2020 and December 31, 2019: Fair Value Measurements Carrying Amount Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) December 31, 2020 Financial assets: Cash and due from banks $ 303,756 $ 303,756 $ 303,756 $ - $ - Investment securities available-for-sale 487,955 487,955 157 478,954 8,844 Restricted investment in bank stocks 25,099 n/a n/a n/a n/a Equity securities 13,387 13,387 13,387 - - Net loans 6,157,081 6,244,037 - - 6,244,037 Accrued interest receivable 35,317 35,317 - 1,764 33,553   Financial liabilities: Noninterest-bearing deposits 1,339,108 1,339,108 1,339,108 - - Interest-bearing deposits 4,620,116 4,633,961 3,155,983 1,477,978 - Borrowings 425,954 429,671 - 429,671 - Subordinated debentures 202,648 214,113 - 214,113 - Derivatives 2,119 2,119 - 2,119 - Accrued interest payable 3,687 3,687 - 3,687 -   December 31, 2019                                         Financial assets: Cash and due from banks $ 201,483 $ 201,483 $ 201,483 $ - $ - Investment securities available-for-sale 404,701 404,701 140 395,447 9,114 Restricted investment in bank stocks 27,397 n/a n/a n/a n/a Equity securities 11,185 11,185 11,185 - - Net loans 5,075,234 5,096,669 - - 5,096,669 Accrued interest receivable 20,949 20,949 - 2,187 18,762   Financial liabilities: Noninterest-bearing deposits 861,728 861,728 861,278 - - Interest-bearing deposits 3,905,814 3,917,405 2,352,093 1,565,312 - Borrowings 500,293 502,026 - 502,026 - Subordinated debentures 128,885 134,973 - 134,973 - Derivatives 273 273 - 273 - Accrued interest payable 4,018 4,018 - 4,018 - - 111 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 – 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, considering the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date. The fair value of commitments to originate loans is immaterial and not included in the tables above. Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values. The Company’s remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than has been customary with historical cost accounting. No disclosure of the relationship value of the Company’s core deposit base is required by FASB ASC 825-10. Fair value estimates are based on existing balance sheet financial instruments, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, there are certain significant assets and liabilities that are not considered financial assets or liabilities, such as the brokerage network, 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 22 – Parent Corporation Only Financial Statements The Parent Corporation operates its wholly-owned subsidiary, the Bank. The earnings of this subsidiary are recognized by the Parent Corporation using the equity method of accounting. Accordingly, earnings are recorded as increases in the Parent Corporation’s investment in the subsidiaries and dividends paid reduce the investment in the subsidiaries. The ability of the Parent Corporation to pay dividends will largely depend upon the dividends paid to it by the Bank. Dividends payable by the Bank to the Parent Corporation are restricted under supervisory regulations (see Note 19 of the Notes to Consolidated Financial Statements). - 112 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 22 – Parent Corporation Only Financial Statements – (continued) Condensed financial statements of the Parent Corporation only are as follows: Condensed Statements of Condition As of December 31, 2020 2019 (dollars in thousands) ASSETS Cash and cash equivalents $ 34,388 $ 21,392 Investment in subsidiaries 1,001,998 810,705 Receivable due from subsidiaries 32,250 32,250 Securities available-for-sale 155 155 Other assets   51,288   1,282 Total assets $ 1,120,079 $ 865,784 LIABILITIES AND STOCKHOLDERS’ EQUITY Other liabilities $ 2,121 $ 5,709 Subordinated debentures 202,648 128,855 Stockholders’ equity   915,310   731,190 Total liabilities and stockholders’ equity $ 1,120,079 $ 865,784 Condensed Statements of Income For Years Ended December 31, 2020 2019 2018 (dollars in thousands) Income:                         Dividend income from subsidiaries $ 15,200 $ 30,050 $ 16,700 Other income   1,683   1,652   1,618 Total Income 16,883 31,702 18,318 Expenses   ( 9,263 )   ( 7,386 )   ( 7,201 ) Income before equity in undistributed earnings of subsidiaries 7,620 24,316 11,117 Equity in undistributed earnings of subsidiaries   63,669   49,079   49,235 Net Income $ 71,289 $ 73,395 $ 60,352 - 113 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 22 – Parent Corporation Only Financial Statements – (continued) Condensed Statements of Cash Flows     For Years Ended December 31       2020     2019     2018       (dollars in thousands)   Cash flows from operating activities:                         Net income   $ 71,289     $ 73,395     $ 60,352   Adjustments to reconcile net income to net cash provided by operating activities:                         Equity in undistributed earnings of subsidiary     ( 63,669 )       ( 49,079 )       ( 49,235 )   Loss on equity securities, net     -       38       4   Amortization of subordinated debt issuance costs     323       329       332   (Increase) decrease in other assets     ( 50,001 )     -       ( 959 )   (Decrease) increase in other liabilities     ( 391 )       ( 1,509 )       3,843   Net cash provided by operating activities     ( 42,449 )     23,174       14,337                             Cash flows from investing activities:                         Purchase of available-for-sale securities     -       ( 2 )       ( 8 )   Sales of available-for-sale securities     -       23       -   Sales of equity securities     -       569       -   Payment of short-term borrowing     ( 3,000 )       -       -   Capital infusion to subsidiary     -       -       ( 64,500 )   Net cash provided by (used) in investing activities     ( 3,000 )       590       ( 64,508 )                             Cash flows from financing activities:                         Proceeds from subordinated debt     73,440       -       73,525   Cash dividends on common stock     ( 14,317 )       ( 12,160 )       ( 9,664 )   Repurchase of stock     ( 911 )       ( 12,643 )       -   Proceeds from exercise of stock options     233       360       875   Net cash (used in) provided by financing activities     58,445       ( 24,443 )       64,736                             (Decrease) increase in cash and cash equivalents     12,996       ( 679 )       14,565   Cash and cash equivalents as of January 1,     21,392       22,071       7,506   Cash and cash equivalents as of December 31,   $ 34,388     $ 21,392     $ 22,071   - 114 - Table of Contents CONNECTONE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 23 – Quarterly Financial Information of ConnectOne Bancorp, Inc. (unaudited) 2020 4th Quarter 3rd Quarter 2nd Quarter 1st Quarter (dollars in thousands, except per share data) Total interest income $ 75,588 $ 77,221 $ 78,677 $ 76,714 Total interest expense   14,217   16,672   17,887   21,433 Net interest income 61,371 60,549 60,790 55,281 Provision for loan losses 5,000 5,000 15,000 16,000 Total other income, net of securities gains 3,442 3,483 4,621 2,854 Other expenses   26,402   26,478   33.063   35,058 Income before income taxes 33,411 32,554 17,348 7,077 Income tax expense   7,770   7,768   2,516   1,047 Net income $ 25,641 $ 24,786 $ 14,832 $ 6,030 Earnings per share: Basic $ 0.64 $ 0.62 $ 0.37 $ 0.15 Diluted 0.64 0.62 0.37 0.15 2019 4th Quarter 3rd Quarter 2nd Quarter 1st Quarter (dollars in thousands, except per share data) Total interest income $ 68,008 $ 70,389 $ 67,878 $ 65,209 Total interest expense   20,577   21,983   22,348   20,257 Net interest income 47,431 48,406 45,530 44,952 Provision for loan losses 500 2,000 1,100 4,500 Total other income, net of securities gains 2,246 2,109 1,942 1,738 Other expenses   22,197   20,379   21,590   28,062 Income before income taxes 26,980 28,136 24,782 14,128 Income tax expense   6,197   6,440   5,501   2,493 Net income $ 20,783 $ 21,696 $ 19,281 $ 11,635 Earnings per share: Basic $ 0.59 $ 0.60 $ 0.55 $ 0.33 Diluted 0.59 0.60 0.54 0.33 Note: Due to rounding, quarterly earnings per share may not sum to reported annual earnings per share. - 115 - Table of Contents Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures None.