KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, the preferred stock rating of BB+, and the short-term debt rating of K3 for Englewood Cliffs, New Jersey-based ConnectOne Bancorp, Inc. (NASDAQ: CNOB) ("ConnectOne" or "the company"). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for its main subsidiary, ConnectOne Bank. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The ratings are supported by ConnectOne’s historically strong earnings performance, including ROA averaging 1.55% between 2021-2022, which has been supported by a healthy NIM and very low expense base. With that said, the company’s profitability has trended lower throughout 2023 in common with the rest of the industry due to accelerating deposit costs and NIM compression, though returns remain adequate for the rating category. Moreover, management stated that NIM could stabilize moving forward given that a majority of the deposit repricing has already occurred, with the average cost of deposits of 2.66% for 2Q23. However, if further compression is realized, it will be less material than prior quarters, in the single digits quarter-over-quarter. The maintenance of a stable/stronger margin is crucial given CNOB's reliance on spread revenues and minimal fee income levels to fall back on (<5% of total revenues). In our view, in a more normalized interest rate environment with a steepening yield curve, profitability should return to comfortably above peer levels. Additionally, KBRA positively views ConnectOne's comprehensive credit risk management framework, relationship banking philosophy, and disciplined underwriting, which has helped produce sound credit quality metrics outside of its troubled NYC taxi medallion portfolio that affected many NY-centric banks. When excluding any charge-offs associated with the taxi portfolio, the NCO ratio has tracked below 5 bps on an annual basis since the company's founding, which trends among the lowest of all KBRA rated banks. Moving forward, the potential for weakening economic conditions stemming from the Fed's QT measures could present some challenges in the loan portfolio, especially considering CNOB's concentration in investor CRE at 55% of total loans (449% of total risk-based capital as of 1Q23) given the headwinds on the CRE sector from rising interest rates. However, repricing risk is considered minimal as ConnectOne has a manageable level of CRE loans maturing over the next year, and we recognize that the portfolio has experienced minimal issues historically given conservative underwriting and the healthy market conditions in footprint. We also remain mindful about the company's exposure to the NYC metro region, specifically the office sector, though exposure in both areas is considered minimal. Despite the volatile deposit environment, CNOB has maintained relatively stable core deposit balances year-to-date. However, noncore funding utilization has historically been above peer, notably over the past year due to strong loan growth. As such, the liquidity position measured by the loan-to-core deposit ratio has been managed aggressively, though we view overall liquidity as sufficient, with nearly $4 billion available or 2.5x uninsured/uncollateralized deposits. Management is also moderating loan growth for the remainder of the year, which should help alleviate funding pressures. Risk-based capital measures track slightly below peer, though offsetting that is a strong TCE ratio (9.2% as of 2Q23) that is wholly reflective of mark-to-market impacts (no securities designated as HTM). Moreover, management stated that further capital build is expected prospectively.

Rating Sensitivities

A rating upgrade is not expected in the medium term, though more diversity in revenue composition and in the loan book, stronger capital, and less of a reliance on noncore funding could support positive rating momentum over time. A rating downgrade is not anticipated, though continued NIM compression that exceeds peers, or elevated credit issues throughout a downturn could potentially pressure the ratings.

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Methodologies

Financial Institutions: Bank & Bank Holding Company Global Rating Methodology

ESG Global Rating Methodology

Disclosures

A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider.

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