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Item 7. Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Company’s results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document.

Cautionary Statement Concerning Forward-Looking Statements

See Item 1 of this Annual Report on Form 10-K for information regarding forward-looking statements.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Accounting policies considered critical to our financial results include the allowance for loan losses and related provision, income taxes, goodwill and business combinations. For information on our significant accounting policies, see Note 1a in the Notes to Consolidated Financial Statements.

Allowance for Loan Losses and Related Provision

The allowance for loan losses represents management’s estimate of probable incurred loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated probable incurred losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Company’s Consolidated Statements of Condition.

The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.

The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb probable incurred loan losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the originated loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect our borrowers’ ability to pay. The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. Various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to make additional provisions for loan losses based upon information available to them at the time of their examination. All of the factors considered in the analysis of the adequacy of the allowance for loan losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods. Additional information can be found in Note 1a of the Notes to Consolidated Financial Statements.

Income Taxes

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s consolidated financial statements or tax returns.

Fluctuations in the actual outcome of these future tax consequences could impact the Company’s consolidated financial condition or results of operations. Note 1 (under the caption “Use of Estimates”) and Note 11 of the Notes to Consolidated Financial Statements include additional discussion on the accounting for income taxes.

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Goodwill

The Company has adopted the provisions of FASB ASC 350-10-05, which requires that goodwill be reported separate from other intangible assets in the Consolidated Statements of Condition and not be amortized but tested for impairment annually or more frequently if indicators arise for impairment. The goodwill impairment evaluation involves significant estimates and subjective assumptions, which requires Management’s judgment on factors such as 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. No impairment charge was deemed necessary for the years ended December 31, 2020, 2019 and 2018.

Business Combinations

The Company accounts for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that we believe to be reasonable, and whenever necessary, include assistance from independent third-party appraisal and valuation firms.

Overview and Strategy

We serve as a holding company for the Bank, which is our primary asset and only operating subsidiary. We follow a business plan that emphasizes the delivery of customized banking services in our market area to customers who desire a high level of personalized service and responsiveness. The Bank conducts a traditional banking business, making commercial loans, consumer loans and residential and commercial real estate loans. In addition, the Bank offers various non-deposit products through non-proprietary relationships with third party vendors. The Bank relies upon deposits as the primary funding source for its assets. The Bank offers traditional deposit products.

Many of our customer relationships start with referrals from existing customers. We then seek to cross sell our products to customers to grow the customer relationship. For example, we will frequently offer an interest rate concession on credit products for customers that maintain a noninterest-bearing deposit account at the Bank. This strategy has helped maintain our funding costs and the growth of our interest expense even as we have substantially increased our total deposits. It has also helped fuel our significant loan growth. We believe that the Bank’s significant growth and increasing profitability demonstrate the need for and success of our brand of banking.

Our results of operations depend primarily on our net interest income, which is the difference between the interest earned on our interest-earning assets and the interest paid on funds borrowed to support those assets, primarily deposits. Net interest margin is the difference between the weighted average rate received on interest-earning assets and the weighted average rate paid to fund those interest-earning assets, which is also affected by the average level of interest-earning assets as compared with that of interest-bearing liabilities. Net income is also affected by the amount of noninterest income and noninterest expenses.

General

The following discussion and analysis present the more significant factors affecting the Company’s financial condition as of December 31, 2020 and 2019 and results of operations for each of the years in the three-year period ended December 31, 2020. The MD&A should be read in conjunction with the consolidated financial statements, notes to consolidated financial statements and other information contained in this report.

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Operating Results Overview

Net income for the year ended December 31, 2020 was $71.3 million, a decrease of $2.1 million, or 2.9%, compared to net income of $73.4 million for 2019. Diluted earnings per share were $1.79 for 2020, a 13.5% decrease from $2.07 for 2019.

The change in net income from 2019 to 2020 was attributable to the following:

•

Increased provision for loan losses of $32.9 million was primarily due to the continued economic uncertainties associated with the COVID-19 pandemic.

•

Increase in noninterest expenses of $28.8 million, primarily due to an increase in salaries and employee benefits of $9.9 million, merger expenses of $5.7 million, occupancy and equipment expense of $4.2 million and professional and consulting expenses of $1.9 million. These increases are mainly attributable to the acquisition of BNJ. Additionally, the Company saw an increase in value of acquisition price of $2.3 million related to its BoeFly acquisition.

•

Increased net interest income of $51.7 million primarily due to the acquisition of BNJ and an 11-basis point widening of the net interest margin.

•

Increase in noninterest income of $6.4 million primarily resulting from an increase in deposit, loan, and other income, increase in bank owned life insurance and net gains on sale of loans held-for-sale.

•

Decrease in income tax expense of $1.5 million resulting primarily from a decrease in income from taxable sources.

Net income for the year ended December 31, 2019 was $73.4 million, an increase of $13.0 million, or 21.6%, compared to net income of $60.4 million for 2018. Diluted earnings per share were $2.07 for 2019, an 11.3% increase from $1.86 for 2018.

The change in net income from 2018 to 2019 was attributable to the following:

•

Increased net interest income of $29.1 million primarily due to the acquisition of GHB.

•

Decreased provision for loan losses of $13.0 million primarily due to $17.0 million increase in specific reserves (then concurrently charged-off) within the taxi medallion loan portfolio in 2018.

•

Increase in noninterest income of $2.6 million primarily resulting from an increase in deposit, loan, and other income, which included higher overdrafts fees, and income related to the operations of BoeFly.

•

Increase in noninterest expenses of $21.8 million, primarily due to an increase in salaries and employee benefits of $9.6 million, merger expenses of $7.6 million and professional and consulting expenses of $1.9 million. The increases are mainly attributable to the acquisition of GHB.

•

Increase in income tax expense of $9.8 million resulting primarily from an increase in income from taxable sources.

Net Interest Income

Fully taxable equivalent net interest income for 2020 totaled $239.9 million, an increase of $51.9 million, or 27.6%, from 2019. The increase in net interest income was due to an increase in average interest-earning assets, which grew by 23.6% to $6.9 billion and a widening of 11 basis-points in the net interest margin. The widening of the net interest margin was mainly attributable to lower cost of funds, offset by higher average cash balances and lower yields on loans and securities. Average total loans, which includes loans held-for-sale, increased by 22.8% to $6.2 billion in 2020 from $5.0 billion in 2019. The increase in average total loans is primarily attributable to the acquisition of BNJ.

Fully taxable equivalent net interest income for 2019 totaled $188.0 million, an increase of $28.8 million, or 18.1%, from 2018. The increase in net interest income was due to an increase in average interest-earning assets, which grew by 15.7% to $5.6 billion and a widening of 7 basis-points in the net interest margin. The widening of the net interest margin was mainly attributable to increases in both rates and the volume of loans, offset by higher cost of funds. Average total loans, which includes loans held-for-sale, increased by 16.6% to $5.0 billion in 2019 from $4.3 billion in 2018. The increase in average total loans is primarily attributable to the acquisition of GHB.

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Average Balance Sheets

The following table sets forth certain information relating to our average assets and liabilities for the years ended December 31, 2020, 2019 and 2018 and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown.

Years Ended December 31,

(dollars in thousands)

ASSETS

Interest-earning assets:

Noninterest-earning assets:

LIABILITIES & STOCKHOLDERS’ EQUITY

(1) Average balances are based on amortized cost.

(3) Includes loan fee income and accretion of purchase accounting adjustments.

(4) Loans include nonaccrual loans.

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Rate/Volume Analysis

The following table presents, by category, the major factors that contributed to the changes in net interest income. Changes due to both volume and rate have been allocated in proportion to the relationship of the dollar amount change in each.

Average Volume Average Rate Net Change Average Volume Average Rate Net Change

(dollars in thousands)

Interest income:

Interest expense:

Capital lease obligation (11 ) - (11 ) (9 ) - (9 )

Provision for Loan Losses

In determining the provision for loan losses, management considers national and local economic trends and conditions; trends in the portfolio including orientation to specific loan types or industries; experience, ability and depth of lending management in relation to the complexity of the portfolio; effects of changes in lending policies, trends in volume and terms of loans; levels and trends in delinquencies, impaired loans and net charge-offs and the results of independent third party loan review.

For the year ended December 31, 2020, the provision for loan losses was $41.0 million, an increase of $32.9 million, compared to the provision for loan losses of $8.1 million for 2019. The increase was due to the continued economic uncertainties associated with the COVID-19 pandemic and increases to specific reserves within our commercial portfolio.

For the year ended December 31, 2019, the provision for loan losses was $8.1 million, a decrease of $13.0 million, compared to the provision for loan losses of $21.1 million for 2018. The decline was due primarily to specific reserves (and concurrent charge-offs) of $17.0 million related to the taxi medallion loans in 2018.

With the adoption of CECL beginning on January 1, 2021, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance. See Note 1b to our audited financial statements included herein.

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Noninterest Income

Noninterest income for the full-year 2020 increased by $6.4 million, or 79.2%, to $14.4 million from $8.0 million in 2019. The increase was primarily the result of a $3.0 million increase in deposit, loan and other income. This increase was largely attributable to loan referral fee income of $2.3 million generated by BoeFly as a result of its participation in the PPP program. Additionally, increases in net gains on sale of loans held-for-sale of $1.6 million and increases in bank owned life insurance of $1.5 million contributed to the overall increase in noninterest income.

Noninterest income for the full-year 2019 increased by $2.6 million, or 46.8%, to $8.0 million from $5.5 million in 2018. The increase was primarily the result of a $1.4 million increase in deposit, loan and other income. This increase was mainly attributable to higher overdraft fees and income related to the operations of BoeFly. Increase in net gains on sale of loans held-for-sale of $0.5 million was mainly attributable to increases in gains on mortgage loan sales of $0.3 million and net gains on the sale of a pool of commercial real estate loans during the third quarter 2019 of $0.2 million. Other increases in noninterest income include an increase of $0.4 million in BOLI and increase of $0.6 million in net gains on equity securities, offset by net losses in sales of securities available-for-sale of $0.3 million.

Noninterest Expense

Noninterest expenses for the full-year 2020 increased by $28.8 million, or 31.2%, to $121.0 million from $92.2 million in 2019. The increase was primarily attributable to increases in salaries and employee benefits of $9.9 million, merger expenses of $5.7 million, occupancy and equipment of $4.2 million, increase in value of acquisition price of $2.3 million, FDIC insurance expense of $2.0 million, professional and consulting of $1.9 million and amortization of core deposit intangibles of $1.1 million. These increases were mainly the result of the acquisition of BNJ.

Noninterest expenses for the full-year 2019 increased by $21.8 million, or 30.9%, to $92.2 million from $70.5 million in 2018. The increase was primarily attributable to increases in salaries and employee benefits of $9.6 million, merger expenses of $7.6 million, professional and consulting of $1.9 million, and occupancy and equipment of $1.4 million. These increases were mainly the result of the acquisitions of GHB and BNJ. In addition, the Bank had a loss on extinguishment of debt of $1.0 million during the second quarter of 2019. Lastly, there was a decrease in FDIC expense of $1.1 million that was attributable to the Bank receiving a small bank credit of approximately $1.3 million during the second quarter of 2019.

Income Taxes

Income tax expense was $19.1 million for 2020 compared to $20.6 million for 2019 and $10.8 million for 2018. The slight decrease in income tax expense in 2020 when compared to 2019 was primarily the result of lower taxable income. The higher level of income tax expense in 2019 when compared to 2018 was primarily attributable to higher income before taxes and the negative impact of recent tax legislation in New Jersey. The effective tax rates were 21.1% in 2020, 21.9% in 2019 and 15.2% for 2018.

For a more detailed description of income taxes see Note 11 of the Notes to Consolidated Financial Statements.

Financial Condition Overview

As of December 31, 2020, the Company’s total assets were $7.5 billion, an increase of $1.4 billion from December 31, 2019. Total loans (including loans held-for-sale) were $6.2 billion, an increase of $1.1 billion from December 31, 2019. Deposits were $6.0 billion, an increase of $1.2 billion from December 31, 2019. These increases were primarily the result of the acquisition of BNJ.

As of December 31, 2019, the Company’s total assets were $6.2 billion, an increase of $712 million from December 31, 2018. Total loans (including loans held-for-sale) were $5.1 billion, an increase of $606 million from December 31, 2018. Deposits were $4.8 billion, an increase of $675 million from December 31, 2018. These increases were primarily the result of the acquisition of GHB.

Loan Portfolio

The Bank’s lending activities are generally oriented to small-to-medium sized businesses, high net worth individuals, professional practices and consumer and retail clients living and working in the Bank’s metropolitan, New York market area, consisting of Bergen, Union, Morris, Essex, Hudson, Mercer and Monmouth counties, New Jersey, as well as NYC’s five boroughs, Nassau Rockland, Orange and Westchester counties, in New York. The Bank has not made loans to borrowers outside of the United States. The Bank believes that its strategy of high-quality client service, competitive rate structures and selective marketing have enabled it to gain market share.

Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, inventory and equipment and liens on commercial and residential real estate. Commercial construction loans are loans to finance the construction of commercial or residential properties secured by first liens on such properties. Commercial real estate loans include loans secured by first liens on completed commercial properties, including multi-family properties, to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate and are generally made to existing clients of the Bank to purchase or refinance primary and secondary residences. Home equity loans and lines of credit include loans secured by first or second liens on residential real estate for primary or secondary residences. Consumer loans are made to individuals who qualify for auto loans, cash reserve, credit cards and installment loans.

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Gross loans as of December 31, 2020 totaled $6.3 billion, an increase of $1.2 billion, or 23.8%, over gross loans as of December 31, 2019 of $5.1 billion. The increase in gross loans was primarily attributable to the acquisition of BNJ.

The largest component of the gross loan portfolio as of December 31, 2020 and December 31, 2019 was commercial real estate loans. Commercial real estate loans as of December 31, 2020 totaled $3.8 billion, an increase of $742 million, or 24.4%, compared to commercial real estate loans as of December 31, 2019 of $3.0 billion. Commercial loans totaled $1.5 billion as of December 31, 2020, an increase of $392 million, or 34.7%, compared to commercial loans as of December 31, 2019 of $1.1 billion. Included in commercial loans were PPP loans of $397.5 million, contributing to the increase. Commercial construction loans as of December 31, 2020 totaled $618 million, a decrease of $5.6 million, or 0.9%, compared to construction loans as of December 31, 2019 of $623 million.

Residential real estate loans totaled $323 million as of December 31, 2020, an increase of $3 million, or 0.8%, compared to residential real estate loans as of December 31, 2019 of $320 million. Consumer loans as of December 31, 2020 totaled $2 million, a decrease of $1 million, or 44.3%, compared to consumer loans of $3 million as of December 31, 2019. The growth in our gross loans for 2020 was primarily attributable to the acquisition of BNJ.

The following table sets forth the classification of our loans by loan portfolio segment for the periods presented.

December 31,

(dollars in thousands)

The following table sets forth the classification of our gross loans by loan portfolio segment and by fixed and adjustable rate loans as of December 31, 2020 by remaining contractual maturity.

As of December 31, 2020, Maturing

In One Year or Less After One Year through Five Years After Five Years Total

(dollars in thousands)

Loans with:

For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.

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Asset Quality

General. One of our key objectives is to maintain a high level of asset quality. When a borrower fails to make a scheduled payment, we attempt to cure the deficiency by sending late notices, as well as making personal contact with the borrower. Typically, late notices are sent approximately 10 days after the date the payment is due, followed up by direct contact with the borrower approximately 15 days after payment is due. In most cases, deficiencies are promptly resolved. If the delinquency continues, late charges are assessed, and additional efforts are made to collect the deficiency. Total loans delinquent 30 days or more are reported to the board of directors of the Bank on a monthly basis.

On loans where the collection of principal or interest payments is doubtful, the accrual of interest income ceases (“nonaccrual” loans). Except for loans that are well secured and in the process of collection, it is our policy to discontinue accruing additional interest and reverse any interest accrued on any loan that is 90 days or greater past due. On occasion, this action may be taken earlier if the financial condition of the borrower raises significant concern with regard to his/her ability to service the debt in accordance with the terms of the loan agreement. Interest income is not accrued on these loans until the borrower’s financial condition and payment record demonstrate an ability to service the debt.

Real estate acquired as a result of foreclosure is classified as other real estate owned (“OREO”) until sold. OREO is recorded at the lower of cost or fair value less estimated selling costs. Costs associated with acquiring and improving a foreclosed property are usually capitalized to the extent that the carrying value does not exceed fair value less estimated selling costs. Holding costs are charged to expense. Gains and losses on the sale of OREO are charged to operations, as incurred.

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. Factors considered by management in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans for which the terms have been modified as a concession to the borrower due to the borrower experiencing financial difficulties are considered troubled debt restructurings (“TDR”) and are classified as impaired, unless the restructuring complies with the provisions of the CARES Act and regulatory guidance related to the COVID-19 pandamic. Loans considered to be TDRs can be categorized as nonaccrual or performing. 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 that experience minor payment delays and payment shortfalls generally are not classified as impaired.

Generally, impaired loans consist of nonaccrual loans and performing troubled debt restructurings. Of this group of impaired loans, loans of $250,000 and over are individually evaluated for impairment, while loans with balances less than $250,000 are collectively evaluated for impairment, and, accordingly, are not separately identified for impairment disclosures.

Asset Classification. Federal regulations and our policies require that we utilize an internal asset classification system as a means of reporting problem and potential problem assets. We have incorporated an internal asset classification system, substantially consistent with Federal banking regulations, as a part of our credit monitoring system. Federal banking regulations set forth a classification scheme for problem and potential problem assets as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention.”

When an insured institution classifies one or more assets, or portions thereof, as “substandard” or “doubtful,” it is required that a general valuation allowance for loan losses must be established for loan losses in an amount deemed prudent by management. General valuation allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies one or more assets, or portions thereof, as “loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.

A bank’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by Federal bank regulators which can order the establishment of additional general or specific loss allowances. The Federal banking agencies have adopted an interagency policy statement on the allowance for loan losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management analyze all significant factors that affect the collectability of the portfolio in a reasonable manner; and that management establish acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Our management believes that, based on information currently available, our allowance for loan losses is maintained at a level which covers all known and probable incurred losses in the portfolio at each reporting date. However, actual losses are dependent upon future events and, as such, further additions to the level of allowances for loan losses may become necessary.

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The table below sets forth information on our classified loans and loans designated as special mention (excluding loans held-for-sale) as of the dates presented:

December 31,

(dollars in thousands)

Classified Loans:

Loss - -

Total classified and special mention loans $ 199,793 $ 119,324

During the year ended December 31, 2020, “substandard” loans and “doubtful” loans, which include lower credit quality loans which possess higher risk characteristics than “special mention” loans, increased from $82.3 million, or 1.6% of loans receivable, as of December 31, 2019 to $119.7 million, or 1.9% of loans receivable, as of December 31, 2020. During the year ended December 31, 2020, “special mention” loans increased to $79.9 million, or 1.3% of loans receivable from $37.0 million, or 0.7% of loans receivable, as of December 31, 2019. The increase in both substandard and special mention loans is primarily attributable to an increased level in deferrals resulting from the continued economic uncertainty regarding the ongoing pandemic. Deferred loans as of December 31, 2020 were $207.1 million, of which $166.8 million were not included in the table above.

Nonperforming Loans, Performing Troubled Debt Restructurings, Past Due Loans and OREO

Nonperforming loans include nonaccrual loans. Nonaccrual loans represent loans on which interest accruals have been suspended. The Company considers charging off loans, or a portion thereof, when they become contractually past due ninety days or more as to interest or principal payments or when other internal or external factors indicate that collection of principal or interest is doubtful. Performing troubled debt restructurings represent loans on which a concession was granted to a borrower, such as a reduction in interest rate to a rate lower than the current market rate for new debt with similar risks, and which are currently performing in accordance with the modified terms. For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.

The following table sets forth, as of the dates indicated, the amount of the Company’s nonaccrual loans, other real estate owned (“OREO”), performing troubled debt restructurings (“TDRs”) and loans past due 90 days or greater and still accruing:

As of December 31,

(dollars in thousands)

Nonaccrual loans (held-for-sale) - - - - 63,044

(2) Includes loans held-for-sale.

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Allowance for Loan Losses and Related Provision

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. We maintain an allowance for loan losses at a level considered adequate to provide for all known and probable incurred losses in the portfolio. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited. Our officers analyze risks within the loan portfolio on a continuous basis and through an external independent loan review function, and the results of the loan review function are also reviewed by our Audit Committee. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly and, as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to our allowance for loan losses.

As of December 31, 2020, the allowance for loan losses was $79.2 million, an increase of $40.9 million, or 106.9%, from $38.3 million as of December 31, 2019. The increase in the allowance for loan losses was primarily attributable to an increase in general provisioning related to economic uncertainties associated with the COVID-19 pandemic. With our adoption of CECL beginning on January 1, 2021, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance.

During the year ended December 31, 2020, the Bank recorded net charge-offs of $0.1 million, compared with net charge-offs of $4.8 million during the year ended December 31, 2019. The allowance for loan losses as a percentage of loans receivable was 1.27% as of December 31, 2020 and 0.75% as of December 31, 2019. Excluding PPP loans receivable, which are 100% federally guaranteed, the allowance for loan losses as a percentage of loans receivable was 1.36% as of December 31, 2020. During 2019, the bank had a $2.1 million charge-off related to one commercial real estate secured credit. In 2020, a $0.8 million recovery was received for this credit.

The Company is adopting ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”) effective January 1, 2021. The main objective of this amendment is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendment requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to enhance their credit loss estimates. The Company’s CECL implementation efforts are continuing to focus on completion of model validation, developing new disclosures, establishing formal policies and procedures and other governance and control documentation. Based on the Company’s portfolio balances, and forecasted economic conditions as of December 31, 2020, management believes the adoption of the CECL standard will result in an increase to its total current reserves. An increase to the Company's reserve levels will include nonaccretable credit marks on PCI loans, which will be transferred into current reserves at adoption.

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Five-Year Statistical Allowance for Loan Losses

The following table reflects the relationship of loan volume, the provision and allowance for loan losses and net charge-offs for the past five years.

Years Ended December 31,

(dollars in thousands)

Charge-offs:

Recoveries:

(1) For the years ended December 31, 2019, December 31, 2018 and December 31, 2016, the loan charge-offs within the commercial loan segment included $1.0 million, $17.0 million and $36.7 million in charge-offs related to the taxi medallion portfolio, respectively.

For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.

Implicit in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made, the creditworthiness of the borrower and prevailing economic conditions. The allowance for loan losses has been allocated in the table below according to the estimated amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans as of December 31, for each of the past five years.

The table below shows, for three types of loans, the amounts of the allowance allocable to such loans and the percentage of such loans to gross loans, along with the amount of the unallocated allowance. Commercial loan type shown below includes commercial, commercial real estate and construction loans.

Commercial Residential Real Estate Consumer Unallocated

(dollars in thousands)

Investments

For the year ended December 31, 2020, the average volume of investment securities, including equity securities, decreased by $34.4 million to approximately $444.1 million or 6.4% of average earning assets, from $478.5 million, or 8.5% of average earning assets, for the year ended December 31, 2019. As of December 31, 2020, the principal components of the investment portfolio are U.S. Treasury and Government Agency Obligations, Federal Agency Obligations including mortgage-backed securities, Obligations of U.S. States and Political Subdivisions, Corporate Bonds and other debt and equity securities.

During the year ended December 31, 2020, rate related factors decreased investment revenue by $3.1 million, while volume related factors decreased investment revenue by $0.8 million. The tax-equivalent yield on investments decreased by 65 basis points to 2.25% from a yield of 2.90% during the year ended December 31, 2019. This was primarily due to overall declines in prevailing investment rates over the course of 2020.

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Securities available-for-sale are a part of the Company’s interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk, liquidity management and other factors. The Company continues to reposition the investment portfolio as part of an overall corporate-wide strategy to produce reasonable and consistent margins where feasible, while attempting to limit risks inherent in the Company’s Consolidated Statement of Condition.

As of December 31, 2020, net unrealized gains on securities available-for-sale, which are carried as a component of accumulated other comprehensive income and included in stockholders’ equity, net of tax, amounted to $7.9 million as compared with net unrealized gains of $2.7 million as of December 31, 2019. The increase in unrealized gains is predominately attributable to changes in market conditions and interest rates. For additional information regarding the Company’s investment portfolio, see Note 4, Note 16 and Note 21 of the Notes to the Consolidated Financial Statements.

During 2020, there were sales totaling $19.6 million from the Company’s available-for-sale portfolio, as compared with $183.7 million in sales in 2019 and no sales in 2018. The gross realized gains or (losses) on securities sold, called or matured mounted to approximately $29 thousand in 2020, $(280) thousand in 2019 and $-0- in 2018, while there were no impairment charges in 2020, 2019 and 2018.

The table below illustrates the maturity distribution and weighted average yield on a tax-equivalent basis for amortized cost of our investment securities, excluding equity securities, as of December 31, 2020, on a contractual maturity basis.

(dollars in thousands)

Investment Securities Available-for-Sale

For information regarding the carrying value of the investment portfolio, see Note 4, Note 16 and Note 21 of the Notes to the Consolidated Financial Statements.

The securities listed in the table above are either rated investment grade by Moody’s and/or Standard and Poor’s or have shadow credit ratings from a credit agency supporting an investment grade and conform to the Company’s investment policy guidelines. There were no municipal securities, or corporate securities, of any single issuer exceeding 10% of stockholders’ equity as of December 31, 2020. Other securities do not have a contractual maturity and are included in the “Due in 1 year or less” maturity in the table above.

The following table sets forth the carrying value of the Company’s investment securities, as of December 31 for each of the last three years.

(dollars in thousands)

Investment Securities Available-for-Sale:

Commercial mortgage pass-through securities 6,922 4,997 3,874

Trust preferred securities - - -

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For other information regarding the Company’s investment securities portfolio, see Note 4, Note 16 and Note 21 of the Notes to the Consolidated Financial Statements.

Interest Rate Sensitivity Analysis

The principal objective of our asset and liability management function is to evaluate the interest-rate risk included in certain balance sheet accounts; determine the level of risk appropriate given our business focus, operating environment, and capital and liquidity requirements; establish prudent asset concentration guidelines; and manage the risk consistent with Board approved guidelines. We seek to reduce the vulnerability of our operations to changes in interest rates, and actions in this regard are taken under the guidance of the Bank’s Asset Liability Committee (the “ALCO”). The ALCO generally reviews our liquidity, cash flow needs, maturities of investments, deposits and borrowings, and current market conditions and interest rates.

We currently utilize net interest income simulation and economic value of equity (“EVE”) models to measure the potential impact to the Bank of future changes in interest rates. As of December 31, 2020, and December 31, 2019, the results of the models were within guidelines prescribed by our Board of Directors. If model results were to fall outside prescribed ranges, action, including additional monitoring and reporting to the Board, would be required by the ALCO and Bank’s management.

The net interest income simulation model attempts to measure the change in net interest income over the next one-year period, and over the next three-year period on a cumulative basis, assuming certain changes in the general level of interest rates.

Based on our model, which was run as of December 31, 2020, we estimated that over the next one-year period a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 0.70%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 5.18%. As of December 31, 2019, we estimated that over the next one-year period a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 1.55%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 1.71%.

Based on our model, which was run as of December 31, 2020, we estimated that over the next three years, on a cumulative basis, a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 3.89%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 8.56%. As of December 31, 2019, we estimated that over the next three years, on a cumulative basis, a 200 basis-point instantaneous increase in the general level of interest rates would increase our net interest income by 2.86%, while a 100 basis-point instantaneous decrease in interest rates would decrease net interest income by 4.86%.

An EVE analysis is also used to dynamically model the present value of asset and liability cash flows with instantaneous rate shocks of up 200 basis points and down 100 basis points. The economic value of equity is likely to be different as interest rates change. Our EVE as of December 31, 2020, would decline by 7.76% with an instantaneous rate shock of up 200 basis points, and increase by 5.70% with an instantaneous rate shock of down 100 basis points. Our EVE as of December 31, 2019, would decline by 7.2% with an instantaneous rate shock of up 200 basis points, and increase by 3.69% with an instantaneous rate shock of down 100 basis points.

The following table illustrates the most recent results for EVE and NII as of December 31, 2020.

Amount % Amount %

Estimates of Fair Value

The estimation of fair value is significant to certain assets of the Company, including available-for-sale investment securities. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, expected cash flows, credit quality, discount rates, or market interest rates. Fair values for most available-for-sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. See Note 21 of the Notes to Consolidated Financial Statements for additional discussion.

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These estimates are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Impact of Inflation and Changing Prices

The financial statements and notes thereto presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the operations; unlike most industrial companies, nearly all of the Company’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Liquidity

Liquidity is a measure of a bank’s ability to fund loans, withdrawals or maturities of deposits, and other cash outflows in a cost-effective manner. Our principal sources of funds are deposits, scheduled amortization and prepayments of loan principal, maturities of investment securities, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flow and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.

As of December 31, 2020, the amount of liquid assets remained at a level management deemed adequate to ensure that, on a short and long-term basis, contractual liabilities, depositors’ withdrawal requirements, and other operational and client credit needs could be satisfied. As of December 31, 2020, liquid assets (cash and due from banks, interest-bearing deposits with banks and unencumbered investment securities) were $697.4 million, which represented 9.2% of total assets and 10.9% of total deposits and borrowings, compared to $506.0 million as of December 31, 2019, which represented 8.2% of total assets and 9.6% of total deposits and borrowings on such date.

The Bank is a member of the Federal Home Loan Bank of New York and, based on available qualified collateral as of December 31, 2020, had the ability to borrow $2.0 billion. In addition, as of December 31, 2020, the Bank had in place borrowing capacity of $25 million through correspondent banks. The Bank also has a credit facility established with the Federal Reserve Bank of New York for direct discount window borrowings with capacity based on pledged collateral of $5.2 million. As of December 31, 2020, the Bank had aggregate available and unused credit of approximately $1.1 billion, which represents the aforementioned facilities totaling $2.0 billion net of $935 million in outstanding borrowings and letters of credit. As of December 31, 2020, outstanding commitments for the Bank to extend credit were $0.9 billion.

Cash and cash equivalents totaled $303.8 million on December 31, 2020, increasing by $102.3 million from $201.5 million as of December 31, 2019. Operating activities provided $81.1 million in net cash. Investing activities used $323.4 million in net cash, primarily reflecting an increase in loans. Financing activities provided $344.5 million in net cash, primarily reflecting a net increase of $410.6 million in deposits, offset by net FHLB repayments of $123.9 million.

Deposits

Deposits are our primary source of funds. Average total deposits increased by $1.2 billion, or 25.3%, to $5.8 billion in 2020 from $4.6 billion in 2019 and increased $775 million, or 20.1%, to $4.6 billion in 2019 from 2018. The increase in total average deposits in 2020 was primarily attributable to both the acquisition of BNJ and organic growth, while the increase in 2019 was attributable to the acquisition of GHB and organic growth. The following table sets forth the year-to-date average balances and weighted average rates for various types of deposits for 2020, 2019 and 2018.

Balance Rate Balance Rate Balance Rate

(dollars in thousands)

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The following table sets forth the distribution of total deposit accounts, by account types for each of the dates indicated.

Amount % of total Amount % of total

(dollars in thousands)

The following table summarizes the maturity distribution of time deposits in denomination of $100,000 or more:

(dollars in thousands)

Federal Home Loan Bank Advances

Federal Home Loan Bank advances are secured, under the terms of a blanket collateral agreement, primarily by commercial mortgage loans. As of December 31, 2020, the Company had a net carrying value of $426.0 million in notes outstanding at a weighted average interest rate of 1.07%. As of December 31, 2019, the Company had a net carrying value of $500.3 million in notes outstanding at a weighted average interest rate of 1.96%.

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Contractual Obligations and Other Commitments

The following table summarizes contractual obligations as of December 31, 2020 and the effect such obligations are expected to have on liquidity and cash flows in future periods.

Total Less than 1 year 1 – 3 years 4 – 5 years Over 5 years

December 31, 2020 (dollars in thousands)

Contractual obligations:

Other long-term liabilities/long-term debt:

Other commercial commitments – off balance sheet:

Capital

The maintenance of a solid capital foundation continues to be a primary goal for the Company. Accordingly, capital plans, stock repurchases, and dividend policies are monitored on an ongoing basis. The most important objective of the capital planning process is to balance effectively the retention of capital to support future growth and the goal of providing stockholders with an attractive long-term return on their investment.

The Company’s Tier 1 leverage capital (defined as tangible stockholders’ equity for common stock and Trust Preferred Capital Securities) as of December 31, 2020 amounted to $694.9 million or 9.5% of average total assets. As of December 31, 2019, the Company’s Tier 1 leverage capital amounted to $563.5 million or 9.5% of average total assets. The increase in Tier 1 capital reflects the Company’s retained earnings during 2019 and the acquisition of BNJ.

United States bank regulators have issued guidelines establishing minimum capital standards related to the level of assets and off balance-sheet exposures adjusted for credit risk. Specifically, these guidelines categorize assets and off balance-sheet items into risk-weightings and require banking institutions to maintain a minimum ratio of capital to risk-weighted assets. As of December 31, 2020, the Company’s CET 1, Tier 1 and total risk-based capital ratios were 10.79%, 10.87% and 15.08%, respectively. For information on risk-based capital and regulatory guidelines for the Parent Corporation and its bank subsidiary, see Note 15 to the Consolidated Financial Statements.

The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the bank regulators regarding capital components, risk weightings, and other factors.

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Subordinated Debentures

During December 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 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 part. The floating interest rate on the subordinated debentures is three-month LIBOR plus 2.85% and re-prices quarterly. The rate as of December 31, 2020 was 3.06%.

During June 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.

During January 2018, the Parent Corporation issued $75 million in aggregate principal amount of fixed-to-floating rate subordinated notes (the “Notes”) to certain accredited investors. The net proceeds from the sale of the Notes were used in the first quarter of 2018 for general corporate purposes, which included the Parent Corporation contributing $65 million of the net proceeds to the Bank in the form of debt and common equity. The Notes are non-callable for five years, have a stated maturity of February 1, 2028 and bear interest at a fixed rate of 5.20% per year, from and including January 17, 2018 to, but excluding February 1, 2023. From and including February 1, 2023 to, but excluding the maturity date, or early redemption date, the interest rate will reset quarterly to a level equal to the then current three-month LIBOR rate plus 284 basis points.

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.

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Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest Sensitivity

Market Risk

Interest rate risk management is our primary market risk. See “Item 7- Management’s Discussion and Analysis of Financial Condition and Results of Operation- Interest Rate Sensitivity Analysis” herein for a discussion of our management of our interest rate risk.

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

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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.

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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.

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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.

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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.

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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

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CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31,

(in thousands, except share data)

ASSETS

Investment in restricted stock, at cost 25,099 27,397

LIABILITIES

Deposits:

Subordinated debentures, net of debt issuance costs 202,648 128,885

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS’ EQUITY

Preferred Stock:

Common stock, no par value:

Accumulated other comprehensive income (loss) 2,797 (1,147)

See the accompanying notes to the consolidated financial statements.

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CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31,

(dollars in thousands, except for per share data)

Interest income:

Interest and dividends on investment securities:

Interest on federal funds sold and other short-term investments 694 1,167 839

Interest expense:

Noninterest income:

Net gains on sale of loans held-for-sale 2,085 512 61

Net gains (losses) on equity securities 202 294 (266)

Net gains (losses) on sale of investment securities 29 (280) -

Noninterest expense:

Loss on extinguishment of debt - 1,047 -

Other components of net periodic pension (income) expense (119 ) 114 28

Increase in value of acquisition price 2,333 - -

Earnings per common share:

See the accompanying notes to the consolidated financial statements.

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CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years Ended December 31,

(dollars in thousands)

Other comprehensive income:

Unrealized gains and losses:

Tax effect 6 (79) -

Unrealized (losses) gains on cash flow hedges (3,423) (755) 825

Unrealized pension plan (losses) gains:

Unrealized pension plan (losses) gains before reclassifications (112) (209) 236

See the accompanying notes to the consolidated financial statements.

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CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(in thousands, except share and per share data)

Cumulative effect of adopting ASU 2016-01 (see Note 16) - - - (55) - 55 -

Other comprehensive loss, net of tax - - - - - (4,116) (4,116)

Restricted stock, net of forfeitures (24,018 shares) - - - - - - -

Stock-based compensation expense - - 1,884 - - - 1,884

Other comprehensive income, net of tax - - - - - 7,642 7,642

Exercise of stock options (38,937 shares) - - 360 - - - 360

Restricted stock, net of forfeitures (56,772 shares) - - - - - - -

Stock-based compensation expense - - 2,746 - - - 2,746

Other comprehensive income, net of tax - - - - - 3,944 3,944

Repurchase of treasury stock (54,693 shares) - - - - (911) - (911)

Exercise of stock options (35,413 shares) - - 233 - - - 233

Restricted stock grants, net of forfeitures (89,879 shares) - - - - - - -

Stock grants issued (1,340 shares) - - - - - - -

Stock-based compensation expense - - 2,949 - - - 2,949

See the accompanying notes to the consolidated financial statements.

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CONNECTONE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31,

Cash flows from operating activities

Depreciation and amortization of premises and equipment 4,244 3,053 3,062

Accretion on bank premises (90) (86) (67)

(Accretion) amortization on borrowings (183) 209 (76)

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)

Loss on extinguishment of debt - 1,047 -

Net (gains) losses on disposition of premises and equipment - (8) 26

Net (gains) losses on sale of other real estate owned - (8) 192

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 -

(Decrease) increase in other liabilities (4,174) (2,785) 4,988

Cash flows from investing activities

Investment securities available-for-sale:

Purchases of equity securities (2,000) - -

Sales of equity securities - 569 -

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

Cash flows from financing activities

Purchase of treasury stock (911) (12,643) -

Proceeds from exercise of stock options 233 360 875

Supplemental disclosures of cash flow information:

Cash payments for:

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

Business combinations:

See the accompanying notes to the consolidated financial statements.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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Note 2 – Business Combination – (continued)