FIRST BUSINESS FINANCIAL SERVICES, INC. General
Unless otherwise indicated or unless the context requires otherwise, all
references in this Report to the "Corporation," "we," "us," "our," or similar
references mean
Forward-Looking Statements
This report may include forward-looking statements as defined in the Private
Securities Litigation Reform Act of 1995, which reflect our current views with
respect to future events and financial performance. Forward-looking statements
are not based on historical information, but rather are related to future
operations, strategies, financial results, or other developments.
Forward-looking statements are based on management's expectations as well as
certain assumptions and estimates made by, and information available to,
management at the time the statements are made. Such statements are subject to
risks and uncertainties, including among other things:
•Adverse changes in the economy or business conditions, either nationally or in
our markets, including, without limitation, the adverse effects of the COVID-19
pandemic on the global, national, and local economy, which may affect the
Corporation's credit quality, revenue, and business operations.
•Competitive pressures among depository and other financial institutions
nationally and in our markets.
•Increases in defaults by borrowers and other delinquencies.
•Our ability to manage growth effectively, including the successful expansion of
our client support, administrative infrastructure, and internal management
systems.
•Fluctuations in interest rates and market prices.
•The consequences of continued bank acquisitions and mergers in our markets,
resulting in fewer but much larger and financially stronger competitors.
•Changes in legislative or regulatory requirements applicable to us and our
subsidiaries.
•Changes in tax requirements, including tax rate changes, new tax laws, and
revised tax law interpretations.
•Fraud, including client and system failure or breaches of our network security,
including our internet banking activities.
•Failure to comply with the applicable SBA regulations in order to maintain the
eligibility of the guaranteed portions of SBA loans.
These risks could cause actual results to differ materially from what we have
anticipated or projected. These risk factors and uncertainties should be
carefully considered by our stockholders and potential investors. See Part I,
Item 1A - Risk Factors in our Annual Report on Form 10-K for the year ended
December 31, 2020 for discussion relating to risk factors impacting us.
Investors should not place undue reliance on any such forward-looking
statements, which speak only as of the date made. The factors described within
this Form 10-Q could affect our financial performance and could cause actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods.
Where any such forward-looking statement includes a statement of the
assumptions or bases underlying such forward-looking statement, we caution that,
while our management believes such assumptions or bases are reasonable and are
made in good faith, assumed facts or bases can vary from actual results, and the
differences between assumed facts or bases and actual results can be material,
depending on the circumstances. Where, in any forward-looking statement, an
expectation or belief is expressed as to future results, such expectation or
belief is expressed in good faith and believed to have a reasonable basis, but
there can be no assurance that the statement of expectation or belief will be
achieved or accomplished.
We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements.
The following discussion and analysis is intended as a review of significant
events and factors affecting our financial condition and results of operations
for the periods indicated. The discussion should be read in conjunction with the
unaudited Consolidated Financial Statements and the Notes thereto presented in
this Form 10-Q.
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Overview
We are a registered bank holding company incorporated under the laws of the
State of Wisconsin and are engaged in the commercial banking business through
our wholly-owned banking subsidiary, FBB. All of our operations are conducted
through FBB and First Business Specialty Finance, LLC ("FBSF"), a wholly-owned
subsidiary of FBB. We operate as a business bank focusing on delivering a full
line of commercial banking products and services tailored to meet the specific
needs of small and medium-sized businesses, business owners, executives,
professionals, and high net worth individuals. Our products and services include
those for business banking, private wealth, and bank consulting. Within business
banking, we offer commercial lending, consumer and other lending, asset-based
lending, accounts receivable financing, equipment financing, floorplan
financing, vendor financing, SBA lending and servicing, treasury management
services, and company retirement plans. Our private wealth services for
executives and individuals include trust and estate administration, financial
planning, investment management, and private banking. For other financial
institutions, our bank consulting experts provide investment portfolio
administrative services, asset liability management services, and asset
liability management process validation. We do not utilize a branch network to
attract retail clients. Our operating philosophy is predicated on deep client
relationships within our commercial bank markets and skilled expertise within
our nationwide specialty finance business lines, combined with the efficiency of
centralized administrative functions, such as information technology, loan and
deposit operations, finance and accounting, credit administration, compliance,
marketing, and human resources. Our focused model allows experienced staff to
provide the level of financial expertise needed to develop and maintain
long-term relationships with our clients.
Financial Performance Summary
Results as of and for the three and nine months ended
•Net income totaled$9.2 million , or diluted earnings per share of$1.07 , for the three months endedSeptember 30, 2021 , compared to$4.3 million , or diluted earnings per share of$0.50 , for the same period in 2020. Net income totaled$27.2 million , or diluted earnings per share of$3.15 , for the nine months endedSeptember 30, 2021 , compared to$10.9 million , or diluted earnings per share of$1.27 , for the same period in 2020. •Annualized return on average assets and annualized return on average equity for the three months endedSeptember 30, 2021 measured 1.41% and 16.39%, respectively, compared to 0.68% and 8.58% for the same period in 2020. Annualized return on average assets and annualized return on average equity for the nine months endedSeptember 30, 2021 measured 1.39% and 16.63%, respectively, compared to 0.62% and 7.49% for the same period in 2020. •Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled$9.7 million for the three months endedSeptember 30, 2021 , up 3.9% from the same period in 2020. Pre-tax, pre-provision adjusted return on average assets was 1.49% for the three months endedSeptember 30, 2021 , compared to 1.47% for the same period in 2020. Pre-tax, pre-provision adjusted earnings totaled$30.3 million for the nine months endedSeptember 30, 2021 , up 13.6% from the same period in 2020. Pre-tax, pre-provision adjusted return on average assets was 1.55% for the nine months endedSeptember 30, 2021 , compared to 1.51% for the same period in 2020. •Net interest margin was 3.45% for the three months endedSeptember 30, 2021 , up from 3.14% for the same period in 2020. Adjusted net interest margin, which excludes certain one-time and volatile items, was 3.22% for the three months endedSeptember 30, 2021 compared to 3.24% for the same period in 2020. Net interest margin was 3.46% for the nine months endedSeptember 30, 2021 , up from 3.30% for the same period in 2020. Adjusted net interest margin was 3.21% for the nine months endedSeptember 30, 2021 compared to 3.29% for the same period in 2020. •Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled$2.8 million for the three months endedSeptember 30, 2021 compared to$1.5 million for the three months endedSeptember 30, 2020 . Fees in lieu of interest totaled$9.5 million for the nine months endedSeptember 30, 2021 compared to$4.6 million for the nine months endedSeptember 30, 2020 . PPP fee income, included in loan fee amortization, was$1.7 million and$6.4 million for the three and nine months endedSeptember 30, 2021 compared to$1.1 million and$2.0 million for the same periods in 2020. •Top line revenue, defined as net interest income plus non-interest income, totaled$28.2 million for the three months endedSeptember 30, 2021 , up 8.5% from the same period in 2020. Top line revenue totaled$84.3 million for the nine months endedSeptember 30, 2021 , up 12.8% from the same period in 2020. •Provision for loan and lease losses was a benefit of$2.3 million for the three months endedSeptember 30, 2021 compared to an expense of$3.8 million for the same period in 2020. Provision for loan and lease losses was a benefit of$5.3 million for the nine months endedSeptember 30, 2021 compared to an expense of$12.5 million for the same period in 2020. •The efficiency ratio was 65.68% for the three months endedSeptember 30, 2021 , up from 64.16% for the three months endedSeptember 30, 2020 . The efficiency ratio improved to 64.02% for the nine months endedSeptember 30, 2021 , down from 64.29% for the nine months endedSeptember 30, 2020 . 43 -------------------------------------------------------------------------------- Table of Contents •Total assets atSeptember 30, 2021 increased$16.6 million to$2.584 billion from$2.568 billion atDecember 31, 2020 . •Period-end gross loans and leases receivable were$2.123 billion and$2.146 billion as ofSeptember 30, 2021 andDecember 31, 2020 , respectively. Average gross loans and leases of$2.179 billion increased$226.2 million , or 11.6%, for the nine months endedSeptember 30, 2021 , compared to$1.953 billion for the same period in 2020. •Period-end gross loans and leases receivable, excluding net PPP loans, atSeptember 30, 2021 increased$138.2 million , or 9.6% annualized, to$2.059 billion from$1.921 billion as ofDecember 31, 2020 . Average gross loans and leases, excluding net PPP loans, of$1.993 billion increased$232.9 , or 13.2%, for the nine months endedSeptember 30, 2021 , compared to$1.760 billion for the same period in 2020. •Period-end gross PPP loans and PPP deferred processing fees were$65.9 million and$1.4 million , respectively, atSeptember 30, 2021 . Average PPP loans, net of deferred processing fees, were$185.7 million for the nine months endedSeptember 30, 2021 compared to$192.5 million for the same period in 2020. •Non-performing assets were$7.6 million and 0.29% of total assets as ofSeptember 30, 2021 , compared to$26.7 million and 1.04% of total assets as ofDecember 31, 2020 . Non-performing assets to total assets, excluding net PPP loans, was 0.30% as ofSeptember 30, 2021 , compared to 1.14% as ofDecember 31, 2020 . •The allowance for loan and lease losses decreased$3.8 million , or 13.5%, compared toDecember 31, 2020 . The allowance for loan and lease losses decreased to 1.16% of total loans, compared to 1.33% atDecember 31, 2020 . Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.20% of total loans as ofSeptember 30, 2021 , compared to 1.48% as ofDecember 31, 2020 . •Period-end in-market deposits atSeptember 30, 2021 increased$146.6 million to$1.830 billion from$1.683 billion as ofDecember 31, 2020 . Average in-market deposits of$1.756 billion increased$228.9 million , or 15.0%, for the nine months endedSeptember 30, 2021 , compared to$1.528 billion for the same period in 2020. •Private wealth and trust assets under management and administration increased by$445.2 million , or 26.4% annualized, to$2.694 billion atSeptember 30, 2021 , compared to$2.249 billion atDecember 31, 2020 . COVID-19 Update Paycheck Protection Program OnDecember 27, 2020 , the Consolidated Appropriations Act, 2021 ("CAA") was signed into law. The CAA is a$2.3 trillion spending bill that combines$900 billion in stimulus relief for the COVID-19 pandemic inthe United States with a$1.4 trillion omnibus spending bill for the 2021 federal fiscal year and prevented a government shutdown. The CAA allowed for a second draw for certain businesses under the PPP. Like the original program, loan proceeds are available to help fund payroll and group health benefit costs, as well as certain mortgage interest, rent and utilities. In addition, authorized costs now also include COVID-19 related worker protection costs, uninsured property damage costs due to looting or vandalism during 2020 and certain supplier costs and expenses for operations. The CAA also expands benefit costs to include group dental, vision, life and disability benefits. All of these changes are generally retroactive to the original CARES Act, meaning that the changes may be taken into account in processing loan forgiveness with respect to an original PPP loan. The Corporation accepted and processed applications for second draw PPP loans fromJanuary 13, 2021 through the application deadline ofMay 31, 2021 .. As ofSeptember 30, 2021 , the Corporation had$65.9 million in gross PPP loans outstanding and deferred processing fees outstanding of$1.4 million . The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. During the three and nine months endedSeptember 30, 2021 ,$1.7 million and$6.4 million , respectively, was recognized in loans and leases interest income in the unaudited Consolidated Statements of Income. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at theFederal Reserve and from an increase in in-market deposits. Deferral Requests The Corporation provided loan modifications deferring payments for certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation's loan modification program. Excluding gross PPP loans, as ofSeptember 30, 2021 , the Corporation had five deferred loans outstanding in an aggregate amount of$24.1 million , or 1.2% of gross loans and leases, compared to$27.0 million , or 1.4% of gross loans and leases as ofDecember 31, 2020 . Of the$24.1 million of deferred loans outstanding,$23.5 million relates to three hospitality credits which received principal payment deferrals and are accruing and current on interest payments. Management believes there will be no losses associated with these three credits. 44
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Table of Contents The following tables represent a breakdown of the deferred loan balances by industry segment and collateral type:
As of
September 30, 2021
Collateral Type
Industries Description Balance Real Estate Non Real Estate
(In Thousands)
Accommodation and Food Services $ 23,521 $ 23,521 $ -
Manufacturing 428 - 428
Retail Trade 115 - 115
Total deferred loan balances $ 24,064 $ 23,521 $ 543
The following table is a further breakdown of the deferred loan balances by certain credit quality indicators. Please refer to Note 6 - Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses for the risk category definitions.
As of
September 30, 2021
Category
I II III IV Total
(Dollars in Thousands)
Total deferred loan balances $ - $ - $ 24,064 $ - $ 24,064
% of Total - % - % 100.0 % - % 100.0 %
As of
December 31, 2020
Category
I II III IV Total
(Dollars in Thousands)
Total deferred loan balances $ 13,466 $ 13,448 $ 58 $ 38 $ 27,010
% of Total 49.9 % 49.8 % 0.2 % 0.1 % 100.0 %
Exposure to
Certain industries have been and are expected to be particularly impacted by social distancing, quarantines, and the economic impact of the COVID-19 pandemic, such as the following:
As of
September 30, 2021 December 31, 2020
% Gross Loans % Gross Loans
Industries: Balance and Leases (1) Balance and Leases (1)
(Dollars in Thousands)
Retail (2) (3) $ 76,635 3.7 % $ 62,719 3.3 %
Hospitality 77,286 3.7 % 80,832 4.2 %
Entertainment 13,533 0.7 % 14,208 0.7 %
Restaurants & food service 22,393 1.1 % 24,854 1.3 %
Total outstanding exposure $ 189,847 9.2 % $ 182,613 9.5 %
(1)Excluding net PPP loans.
(2)Includes $39.6 million and $48.9 million in loans secured by commercial real
estate as of September 30, 2021 and December 31, 2020 , respectively.
(3)Includes $23.2 million and $7.7 million in fully collateralized asset-based
loans as of September 30, 2021 and December 31, 2020 , respectively.
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As ofSeptember 30, 2021 , the Corporation had no meaningful direct exposure to the energy sector, airline industry or retail consumer, and does not participate in Shared National Credits. Because of the uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our clients and prospects, and on the national and local economy as a whole, there can be no assurances as to the future effect of the ongoing pandemic on the Corporation's loan portfolio. Results of Operations
Top Line Revenue
Top line revenue, comprised of net interest income and non-interest income, increased 8.5% for the three months endedSeptember 30, 2021 compared to the same period in 2020 primarily due to a$2.6 million , or 14.0%, increase in net interest income. The increase in net interest income was driven by an increase in average loans and leases receivable, excluding PPP loans, and loan fees in lieu of interest. Top line revenue increased 12.8% for the nine months endedSeptember 30, 2021 compared to the same period in 2020 primarily due to higher net interest income driven by an increase in average loans and leases receivable and loan fees in lieu of interest. Non-interest income for the nine months ended increased due to stronger gains on the sale of SBA loans and private wealth fee income, which was partially offset by a decrease in swap fees from our commercial loan interest rate swap program.
The components of top line revenue were as follows:
For the Three Months Ended September 30, For the Nine Months Ended September 30,
2021 2020 $ Change % Change 2021 2020
$ Change % Change
(Dollars in Thousands)
Net interest income $ 21,223 $ 18,621 $ 2,602 14.0 % $ 63,738 $ 54,558 $ 9,180 16.8 %
Non-interest income 7,015 7,408 (393) (5.3) 20,531 20,141 390 1.9
Top line revenue $ 28,238 $ 26,029 $ 2,209 8.5 $ 84,269 $ 74,699 $ 9,570 12.8
Annualized Return on Average Assets and Annualized Return on Average Equity
ROAA for the three and nine months endedSeptember 30, 2021 increased to 1.41% and 1.39%, compared to 0.68% and 0.62% for the three and nine months endedSeptember 30, 2020 . The increase in ROAA was primarily due to a decrease in provision for loan and lease losses related to two large loan recoveries received in January andSeptember 2021 combined with continued credit quality improvement following significant reserve build during the COVID-19 pandemic. ROAA also benefited from an increase in fees in lieu of interest, strong gains on sale of SBA loans, and consistently strong and growing private wealth fee income. The increase in profitability was partially offset by a decrease in commercial loan interest rate swap fee income and increase in non-interest expense. We consider ROAA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures. ROAE for the three and nine months endedSeptember 30, 2021 was 16.39% and 16.63%, compared to 8.58% and 7.49% for the three and nine months endedSeptember 30, 2020 . The reasons for the increase in ROAE are consistent with the explanations discussed above with respect to ROAA. We view ROAE as an important measurement for monitoring profitability and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses, and minimizing our costs of credit. Efficiency Ratio and Pre-Tax, Pre-Provision Adjusted Earnings Efficiency ratio is a non-GAAP measure representing operating expense, which is non-interest expense excluding the effects of the SBA recourse benefit or provision, impairment of tax credit investments, net gains or losses on foreclosed properties, amortization of other intangible assets, losses on early extinguishment of debt, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized net gains or losses on securities, if any. Pre-tax, pre-provision adjusted earnings is defined as operating revenue less operating expense. In the judgment of the Corporation's management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation's operating expenses in relation to its core operating revenue by removing the volatility associated with certain one-time items and other discrete items. 46
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The efficiency ratio was 65.68% and 64.02% for the three and nine months endedSeptember 30, 2021 , compared to 64.16% and 64.29% for the three and nine months endedSeptember 30, 2020 . Operating expense growth exceeded operating revenue growth for the three months endedSeptember 30, 2021 compared to the same period in 2020 primarily due to a$1.5 million , or 12.6%, increase in compensation principally driven by increased headcount and incentive compensation. Operating revenue growth outpaced the growth in operating expense for the nine months endedSeptember 30, 2021 compared to the same period in 2020, resulting in positive operating leverage. This improvement was attributed to an increase in net interest income driven by a 11.6% increase in average loans and leases receivable and a$4.9 million increase in fees in lieu of interest. The increase in operating revenue was partially offset by a$5.6 million , or 16.5%, increase in compensation expense. Excluding the non-recurring impact of PPP loan fee income and interest income, we believe we will generate positive operating leverage annually and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth and operating efficiency through the use of technology. These initiatives include efforts to expand our specialized lending commercial banking business lines, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets. We believe the efficiency ratio and pre-tax, pre-provision adjusted earnings allow investors and analysts to better assess the Corporation's operating expenses in relation to its top line revenue by removing the volatility that is associated with certain non-recurring and other discrete items. The efficiency ratio and pre-tax, pre-provision adjusted earnings also allow management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio and pre-tax, pre-provision adjusted earnings to its most comparable GAAP measure. 47
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Please refer to the Non-Interest Income and Non-Interest Expense sections below for discussion on additional drivers of the year-over-year change in the efficiency ratio.
For the Three Months Ended September 30 , For
the Nine Months Ended
2021 2020 $ Change % Change 2021
2020 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 18,490 $ 16,758 $ 1,732 10.3 % $ 54,003 $ 51,245 $ 2,758 5.4 %
Less:
Net loss (gain) on foreclosed
properties 6 (121) 127 NM 7 329 (322) (97.9)
Amortization of other
intangible assets 7 9 (2) (22.2) 23 27 (4) (14.8)
SBA recourse (benefit)
provision (69) 57 (126) NM 45 53 (8) (15.1)
Tax credit investment
impairment - 113 (113) NM - 2,066 (2,066) NM
Loss on early extinguishment
of debt - - - NM - 744 (744) NM
Total operating expense $ 18,546 $ 16,700 $ 1,846 11.1 $ 53,928 $ 48,026 $ 5,902 12.3
Net interest income 21,223 18,621 2,602 14.0 $ 63,738 $ 54,558 $ 9,180 16.8
Total non-interest income 7,015 7,408 (393) (5.3) 20,531 20,141 390 1.9
Less:
Net gain (loss) on sale of
securities - - - NM 29 (4) 33 NM
Adjusted non-interest income 7,015 7,408 (393) (5.3) $ 20,502 $ 20,145 $ 357 1.8
Total operating revenue $ 28,238 $ 26,029 $ 2,209 8.5 $ 84,240 $ 74,703 $ 9,537 12.8
Efficiency ratio 65.68 % 64.16 % 64.02 % 64.29 %
Pre-tax, pre-provision
adjusted earnings $ 9,692 $ 9,329 $ 363 3.9 $ 30,312 $ 26,677 $ 3,635 13.6
Average total assets 2,608,198 2,540,735 67,463 2.7 2,602,347 2,357,792 244,555 10.4
Pre-tax, pre-provision
adjusted return on average
assets 1.49 % 1.47 % 1.55 % 1.51 %
NM = Not Meaningful
Net Interest Income
Net interest income levels depend on the amount of and yield on
interest-earning assets as compared to the amount of and rate paid on
interest-bearing liabilities. Net interest income is sensitive to changes in
market rates of interest and the asset/liability management processes to prepare
for and respond to such changes.
The following table provides information with respect to (1) the change in net
interest income attributable to changes in rate (changes in rate multiplied by
prior volume) and (2) the change in net interest income attributable to changes
in volume (changes in volume multiplied by prior rate) for the three and nine
months ended September 30, 2021 compared to the same period in 2020. The change
in net interest income attributable to changes in rate and volume (changes in
rate multiplied by changes in volume) has been allocated to the rate and volume
changes in proportion to the relationship of the absolute dollar amounts of the
change in each.
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Increase (Decrease) for the Three Months Increase (Decrease) for the Nine Months Ended
Ended September 30, September 30,
2021 Compared to 2020 2021 Compared to 2020
Rate Volume Net Rate Volume Net
(In Thousands)
Interest-earning assets
Commercial real estate and other mortgage
loans(1) $ (254) $ 1,004 $ 750 $ (4,583) $ 4,975 $ 392
Commercial and industrial loans(1) 2,382 (1,256) 1,126 2,252 2,169 4,421
Direct financing leases(1) 30 (81) (51) 124 (212) (88)
Consumer and other loans(1) (24) 41 17 (101) 207 106
Total loans and leases receivable 2,134 (292) 1,842 (2,308) 7,139 4,831
Mortgage-related securities (113) (61) (174) (576) (275) (851) Other investment securities (26) 51 25 (78) 191 113 FHLB and FRB Stock - 6 6 (108) 113 5 Short-term investments 3 36 39 (153) 67 (86) Total net change in income on interest-earning assets 1,998 (260) 1,738 (3,223) 7,235
4,012
Interest-bearing liabilities Transaction accounts (42) 34 (8) (821) 373 (448) Money market accounts (40) 28 (12) (1,787) 94 (1,693) Certificates of deposit (224) (218) (442) (706) (824) (1,530) Wholesale deposits (134) (193) (327) (1,289) 93 (1,196) Total deposits (440) (349) (789) (4,603) (264) (4,867) FHLB advances (155) 27 (128) (578) 141 (437) Federal reserve PPP lending facility - (26) (26) - (44) (44) Other borrowings (37) 116 79 (87) 270 183 Junior subordinated notes - - - (4) 1
(3)
Total net change in expense on interest-bearing liabilities (632) (232) (864) (5,272) 104
(5,168)
Net change in net interest income$ 2,630 $ (28) $ 2,602 $ 2,049 $ 7,131
(1)The average balances of loans and leases include non-accrual loans and leases and loans held for sale.
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The tables below shows our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three and nine months endedSeptember 30, 2021 and 2020. The average balances are derived from average daily balances. For the Three Months Ended September 30, 2021 2020 Average Average Average Average Balance Interest Yield/Rate(4) Balance Interest Yield/Rate(4) (Dollars in Thousands) Interest-earning assets Commercial real estate and other mortgage loans(1)$ 1,388,236 $ 13,090 3.77 %$ 1,282,132 $ 12,340 3.85 % Commercial and industrial loans(1) 680,563 9,259 5.44 791,909 8,133 4.11 Direct financing leases(1) 18,611 207 4.45 26,129 258 3.95 Consumer and other loans(1) 43,689 391 3.58 39,269 374 3.81 Total loans and leases receivable(1) 2,131,099 22,947 4.31 2,139,439 21,105 3.95 Mortgage-related securities(2) 154,372 659 1.71 167,326 833 1.99 Other investment securities(3) 45,196 196 1.73 34,004 171 2.01 FHLB and FRB stock 13,279 167 5.03 12,835 161 5.02 Short-term investments 116,621 45 0.15 21,287 6 0.11 Total interest-earning assets 2,460,567 24,014 3.90 2,374,891 22,276 3.75 Non-interest-earning assets 147,631 165,844 Total assets$ 2,608,198 $ 2,540,735 Interest-bearing liabilities Transaction accounts$ 509,089 251 0.20$ 445,687 259 0.23 Money market accounts 703,460 306 0.17 642,881 318 0.20 Certificates of deposit 42,370 71 0.67 110,891 513 1.85 Wholesale deposits 89,135 206 0.92 160,067 533 1.33 Total interest-bearing deposits 1,344,054 834 0.25 1,359,526 1,623 0.48 FHLB advances 381,061 1,228 1.29 379,915 1,356 1.43 Federal reserve PPPLF - - - 29,605 26 0.35 Other borrowings 32,630 449 5.50 24,403 370 6.06 Junior subordinated notes 10,070 280 11.12 10,056 280 11.14 Total interest-bearing liabilities 1,767,815 2,791 0.63 1,803,505 3,655 0.81 Non-interest-bearing demand deposit accounts 556,029 445,245 Other non-interest-bearing liabilities 59,865 91,810 Total liabilities 2,383,709 2,340,560 Stockholders' equity 224,489 200,175 Total liabilities and stockholders' equity$ 2,608,198 $ 2,540,735 Net interest income$ 21,223 $ 18,621 Interest rate spread 3.27 % 2.94 % Net interest-earning assets$ 692,752 $ 571,386 Net interest margin 3.45 % 3.14 % Average interest-earning assets to average interest-bearing liabilities 139.19 % 131.68 % Return on average assets(4) 1.41 0.68 Return on average equity(4) 16.39 8.58 Average equity to average assets 8.61 7.88 Non-interest expense to average assets(4) 2.84 2.64 (1)The average balances of loans and leases include non-accrual loans and leases and loans held for sale. Interest income related to non-accrual loans and leases is recognized when collected. Interest income includes net loan fees in lieu of interest. (2)Includes amortized cost basis of assets available-for-sale and held-to-maturity. (3)Yields on tax-exempt municipal securities are not presented on a tax-equivalent basis in this table. (4)Represents annualized yields/rates. 50
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For the Nine Months Ended September 30,
2021 2020
Average Average Average Average
Balance Interest Yield/Rate(4) Balance Interest Yield/Rate(4)
(Dollars in Thousands)
Interest-earning assets
Commercial real estate and other mortgage
loans(1) $ 1,377,302 $ 38,704 3.75 % $ 1,209,810 $ 38,312 4.22 %
Commercial and industrial loans(1) 736,623 28,759 5.21 678,650 24,338 4.78
Direct financing leases(1) 20,242 673 4.43 27,065 761 3.75
Consumer and other loans(1) 44,780 1,197 3.56 37,260 1,091 3.90
Total loans and leases receivable(1) 2,178,947 69,333 4.24 1,952,785 64,502 4.40
Mortgage-related securities(2) 155,617 1,955 1.67 173,985 2,806 2.15
Other investment securities(3) 42,992 569 1.76 29,177 456 2.08
FHLB and FRB stock 13,308 496 4.97 10,558 491 6.20
Short-term investments 65,769 67 0.14 39,293 153 0.52
Total interest-earning assets 2,456,633 72,420 3.93 2,205,798 68,408 4.13
Non-interest-earning assets 145,714 151,994
Total assets $ 2,602,347 $ 2,357,792
Interest-bearing liabilities
Transaction accounts $ 509,709 749 0.20 $ 362,326 1,197 0.44
Money market accounts 674,858 862 0.17 649,999 2,555 0.52
Certificates of deposit 48,540 360 0.99 122,781 1,890 2.05
Wholesale deposits 139,205 825 0.79 132,811 2,021 2.03
Total interest-bearing deposits 1,372,312 2,796 0.27 1,267,917 7,663 0.81
FHLB advances 384,581 3,761 1.30 371,738 4,198 1.51
Federal reserve PPPLF - - - 16,855 44 0.35
Other borrowings 30,811 1,293 5.60 24,490 1,110 6.04
Junior subordinated notes 10,066 832 11.02 10,052 835 11.07
Total interest-bearing liabilities 1,797,770 8,682 0.64 1,691,052 13,850 1.09
Non-interest-bearing demand deposit accounts 523,368 392,455
Other non-interest-bearing liabilities 63,366 80,270
Total liabilities 2,384,504 2,163,777
Stockholders' equity 217,843 194,015
Total liabilities and stockholders' equity $ 2,602,347 $ 2,357,792
Net interest income $ 63,738 $ 54,558
Interest rate spread 3.29 % 3.04 %
Net interest-earning assets $ 658,863 $ 514,746
Net interest margin 3.46 % 3.30 %
Average interest-earning assets to average
interest-bearing liabilities 136.65 % 130.44 %
Return on average assets(4) 1.39 0.62
Return on average equity(4) 16.63 7.49
Average equity to average assets 8.37 8.23
Non-interest expense to average assets(4) 2.77 2.90
(1)The average balances of loans and leases include non-accrual loans and leases
and loans held for sale. Interest income related to non-accrual loans and leases
is recognized when collected. Interest income includes net loan fees in lieu of
interest.
(2)Includes amortized cost basis of assets available-for-sale and
held-to-maturity.
(3)Yields on tax-exempt municipal securities are not presented on a
tax-equivalent basis in this table.
(4)Represents annualized yields/rates.
51--------------------------------------------------------------------------------
Table of Contents Comparison of Net Interest Income for the Three and Nine Months Ended September
30, 2021 and 2020
Net interest income increased $2.6 million , or 14.0%, during the three months
ended September 30, 2021 compared to the three months ended September 30, 2020 .
The increase in net interest income reflected an increase in average gross loans
and leases excluding PPP loans, an increase in fees in lieu of interest, and a
decrease in interest expense, partially offset by a reduction in the yield on
average interest-earning assets excluding PPP loan fees. Fees in lieu of
interest, which can vary from quarter to quarter, totaled $2.8 million for the
three months ended September 30, 2021 , compared to $1.5 million for the same
period in 2020. Excluding fees in lieu of interest and interest income from PPP
loans, net interest income increased $1.9 million , or 11.4%. Average gross loans
and leases for the three months ended September 30, 2021 decreased $8.3 million ,
or 0.4%, compared to the three months ended September 30, 2020 . Excluding net
PPP loans, average gross loans and leases for the three months ended
September 30, 2021 increased $227.2 million , or 12.5%, compared to the three
months ended September 30, 2020 . Net interest income increased $9.2 million , or
16.8%, during the nine months ended September 30, 2021 compared to the nine
months ended September 30, 2020 . The reasons for the increase in net income for
the nine months ended September 30, 2021 are consistent with the explanations
discussed above with respect to the three months ended September 30, 2021 . Fees
in lieu of interest totaled $9.5 million for the nine months ended September 30,
2021 , compared to $4.6 million for the same period in 2020. Excluding fees in
lieu of interest and interest income from PPP loans, net interest income
increased $4.3 million , or 8.9%. Average gross loans and leases for the nine
months ended September 30, 2021 increased $226.2 million , or 11.6%, compared to
the nine months ended September 30, 2020 . Excluding net PPP loans, average gross
loans and leases for the nine months ended September 30, 2021 increased $232.9
million , or 13.2%, compared to the nine months ended September 30, 2020 .
The yield on average loans and leases for the three and nine months ended
September 30, 2021 was 4.31% and 4.24%, respectively, compared to 3.95% and
4.40% for the three and nine months ended September 30, 2020 , respectively.
Excluding the impact of fees in lieu of interest and PPP loan interest income,
the yield on average loans and leases excluding net PPP loans for the three and
nine months ended September 30, 2021 was 3.89% and 3.91%, respectively, compared
to 4.13% and 4.43% for the three and nine months ended September 30, 2020 ,
respectively. Similarly, the yield on average interest-earning assets for the
three and nine months ended September 30, 2021 measured 3.90% and 3.93%,
respectively, compared to 3.75% and 4.13% three and nine months ended
September 30, 2020 , respectively. Excluding fees in lieu of interest and PPP
loan interest income, the yield on average interest-earning assets excluding net
PPP loans for the three and nine months ended September 30, 2021 was 3.53% and
3.61%, respectively, compared to 3.89% and 4.13% for the three and nine months
ended September 30, 2020 , respectively. The decline in yields for both periods
of comparison was primarily due to the decrease in LIBOR and Prime rates and
related impact on variable-rate loans, in addition to the renewal of fixed-rate
loans and reinvestment of cash flows from the securities portfolio at
historically low interest rates.
The average rate paid on total interest-bearing liabilities for the three and
nine months ended September 30, 2021 decreased to 0.63% and 0.64% compared to
0.81% and 1.09% for the three and nine months ended September 30, 2020 ,
respectively. Total interest-bearing liabilities include interest-bearing
deposits, federal funds purchased, FHLB advances, subordinated and junior
subordinated notes payable, and other borrowings. The average rate paid declined
as the Corporation decreased deposit rates in response to the Federal Open
Market Committee's ("FOMC") decision to lower the target federal funds rate 150
basis points from January 2020 to March 2020 . For the nine months ended
September 30, 2021 compared to the nine months ended September 30, 2020 , the
average target federal funds rate decreased 39 basis points.
Consistent with the Corporation's longstanding funding strategy to manage
interest rate risk and use the most efficient and cost effective source of
wholesale funds, a combination of fixed rate wholesale deposits and fixed rate
FHLB advances are used at various maturity terms to meet the Corporation's
funding needs. Average FHLB advances for the three months ended September 30,
2021 increased $1.1 million to $381.1 million at an average rate paid of 1.29%,
compared to $379.9 million at an average rate paid of 1.43% for the three months
ended September 30, 2020 . Average FHLB advances for the nine months ended
September 30, 2021 increased $12.8 million to $384.6 million at an average rate
paid of 1.30%, compared to $371.7 million at an average rate paid of 1.51% for
the nine months ended September 30, 2020 . As of September 30, 2021 , the weighted
average original maturity of our FHLB term advances was 6.2 years, compared to
5.1 years as of September 30, 2020 . Average wholesale deposits, consisting
of brokered certificates of deposit, deposits gathered from internet listing
services, and non-reciprocal interest bearing transaction accounts, for
the three months ended September 30, 2021 decreased $70.9 million to $89.1
million at an average rate paid of 0.92%, compared to $160.1 million at an
average rate paid of 1.33% for the same period in 2020. The decrease in
wholesale deposits was primarily due to voluntary reduction of non-maturity
brokered deposits given current levels of excess liquidity. Average wholesale
deposits for the nine months ended September 30, 2021 increased $6.4
million to $139.2 million at an average rate paid of 0.79%, compared to $132.8
million at an average rate paid of 2.03% for the same period in 2020. As
of September 30, 2021 , the weighted average original maturity of our termed
wholesale deposits was 3.7 years, compared to 4.3 years as of September 30,
2020 . The rate paid on average wholesale funding
52
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is greater than the cost of in-market deposits and changes more gradually
because the portfolio includes longer original maturities as the Corporation
match-funds its longer-term fixed rate loans to mitigate interest rates risk.
Net interest margin was 3.45% and 3.46% for the three and nine months
ended September 30, 2021 , respectively, compared to 3.14% and 3.30% for the
three and nine months ended September 30, 2020 , respectively. Excluding fees in
lieu of interest, PPP loan interest income, Federal Reserve interest income, and
FHLB dividends, adjusted net interest margin measured 3.22% and 3.21% for the
three and nine months ended September 30, 2021 , respectively, compared to 3.24%
and 3.29% for the three and nine months ended September 30, 2020 , respectively.
The decrease in adjusted net interest margin for both periods of comparison was
primarily due to the decrease in average yield on loans and leases receivable
and investment securities, partially offset by a decrease in the average rate
paid on in-market deposits and wholesale funding.
Management believes its success in growing in-market deposits, disciplined
loan pricing, and increased production in existing higher-yielding specialized
lending commercial banking products will allow the Corporation to achieve a net
interest margin of at least 3.50%, on average, over the long-term. However, the
collection of loan fees in lieu of interest is an expected source of volatility
to quarterly net interest income and net interest margin, particularly given the
nature of the Corporation's asset-based lending business and the Corporation's
participation in the PPP. Net interest margin may also experience volatility due
to events such as the collection of interest on loans previously in non-accrual
status or the accumulation of significant short-term deposit inflows. Given the
Corporation's excess liquidity and the current interest rate environment, in the
near-team management believes net interest margin will be slightly less than the
long-term target of 3.50%.
Despite an uncertain rate environment, management expects to effectively manage
the Corporation's liability structure in both term and rate. Further, we expect
to attract new in-market deposit relationships which we believe will contribute
to our ability to maintain an appropriate cost of funds. In-market deposits,
comprised of all transaction accounts, money market accounts, and non-wholesale
deposits, increased $146.6 million , or 11.6% annualized, to $1.830 billion at
September 30, 2021 , compared to $1.683 billion at December 31, 2020 . Average
in-market deposits increased $228.9 million , or 15.0%, to $1.756 billion for the
nine months ended September 30, 2021 , compared to $1.528 billion for the nine
months ended September 30, 2020 . This significant increase in deposits was due
to successful business development efforts combined with excess liquidity
resulting from our clients' participation in the PPP.
Provision for Loan and Lease Losses
We determine our provision for loan and lease losses pursuant to our allowance
for loan and lease loss methodology, which is based on the magnitude of current
and historical net charge-offs recorded throughout the established look-back
period, the evaluation of several qualitative factors for each portfolio
category, and the amount of specific reserves established for impaired loans
that present collateral shortfall positions. Refer to Allowance for Loan and
Lease Losses, below, for further information regarding our allowance for loan
and lease loss methodology.
The long-term impact of COVID-19 on the economy is unknown, however, economic
conditions have improved steadily in 2021 following the vaccine rollout and the
termination of various pandemic safety protocols by states and businesses. While
the outbreak did have a temporary adverse impact on certain industries the
Corporation serves, including retail, hospitality, entertainment, and
restaurants and food services, management believes the long-term impact it may
have on the Corporation's loan portfolio will be limited. Additional detail
about certain exposure to stressed industries is included in the section titled
COVID-19 Update, above.
The Corporation recognized a $2.3 million and $5.3 million provision benefit
for the three and nine months ended September 30, 2021 , respectively, compared
to provision expense of $3.8 million and $12.5 million for the three and nine
months ended September 30, 2020 , respectively. The provision benefit for the
three months ended September 30, 2021 was primarily due to a net recovery of
$1.3 million , a $923,000 reduction in the general reserve from improving
historical loss rates, and a $451,000 decrease in specific reserves. These
decreases were partially offset by a $426,000 increase in the general reserve
due to loan growth. The provision benefit for the nine months ended
September 30, 2021 was primarily due to a net recovery of $1.5 million , a $3.6
million reduction in the general reserve from improving historical loss rates
and a $2.1 million decrease in specific reserves. These decreases were partially
offset by a $1.5 million increase in the general reserve due to loan growth.
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The following table shows the components of the provision for loan and lease
losses for the three and nine months ended September 30, 2021 compared to the
three and six months ended September 30, 2020 .
For the Three Months Ended For the Nine Months Ended September
September 30, 30,
2021 2020 2021 2020
(InThousands)
Change in general reserve due to subjective factor changes$ (51) $ (766) $ 379 $ 4,697 Change in general reserve due to historical loss factor changes (923) (16) (3,594) (380) Charge-offs 364 505 3,402 1,454 Recoveries (1,634) (23) (4,852) (264) Change in specific reserves on impaired loans, net (451) 2,974 (2,111) 5,533 Change due to loan growth, net 426 1,161 1,481 1,447 Total provision for loan and lease losses$ (2,269) $ 3,835
The legacy on-balance sheet SBA portfolio, defined as SBA 7(a) and Express
loans originated in 2016 and prior, was a source of elevated non-performing
assets and charge-offs. Additional information on our legacy SBA portfolio is as
follows:
As of
September 30, June 30, September 30,
2021 2021 2020
(In Thousands)
Performing loans:
Off-balance sheet loans $ 13,340 $ 14,161 $ 26,017
On-balance sheet loans 3,905 6,836 15,175
Gross loans 17,245 20,997 41,192
Non-performing loans:
Off-balance sheet loans 3,689 3,943 2,574
On-balance sheet loans 624 1,800 9,561
Gross loans 4,313 5,743 12,135
Total loans:
Off-balance sheet loans 17,029 18,104 28,591
On-balance sheet loans 4,529 8,636 24,736
Gross loans $ 21,558 $ 26,740 $ 53,327
The addition of specific reserves on impaired loans represents new specific
reserves established when collateral shortfalls or government guaranty
deficiencies are present, while conversely the release of specific reserves
represents the reduction of previously established reserves that are no longer
required. Changes in the allowance for loan and lease losses due to subjective
factor changes reflect management's evaluation of the level of risk within the
portfolio based upon several factors for each portfolio segment. Charge-offs in
excess of previously established specific reserves require an additional
provision for loan and lease losses to maintain the allowance for loan and lease
losses at a level deemed appropriate by management. This amount is net of the
release of any specific reserve that may have already been provided. Change in
the inherent risk of the portfolio is primarily influenced by the overall growth
in gross loans and leases and an analysis of loans previously charged off, as
well as movement of existing loans and leases in and out of an impaired loan
classification where a specific evaluation of a particular credit may be
required rather than the application of a general reserve loss rate. Refer
to Asset Quality, below, for further information regarding the overall credit
quality of our loan and lease portfolio.
Because of the significant uncertainties related to the ultimate duration of the
COVID-19 pandemic and its potential effects on clients and prospects, and on the
national and local economy as a whole, there can be no assurances as to the
future effect of the ongoing pandemic on the Corporation's loan portfolio.
54--------------------------------------------------------------------------------
Table of Contents Comparison of Non-Interest Income for the Three and Nine Months Ended September
30, 2021 and 2020Non-Interest Income
Non-interest income decreased$393,000 , or 5.3%, to$7.0 million for the three months endedSeptember 30, 2021 compared to$7.4 million for the same period in 2020. Non-interest income increased$390,000 , or 1.9%, to$20.5 million for the nine months endedSeptember 30, 2021 compared to$20.1 million for the same period in 2020. Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream. Total non-interest income accounted for 24.8% and 24.4% of total revenues for the three and nine months endedSeptember 30, 2021 , compared to 28.5% and 27.0% for the three and nine months endedSeptember 30, 2020 . The decline in fee revenue compared to total revenue is primarily due to an increase in net interest income and a reduction in commercial loan interest rate swap fee income. Management believes the continued gradual expansion of its SBA lending program and the geographic expansion of its private wealth management business in bank markets outside of South Central Wisconsin will allow the Corporation to achieve a strategic target of 25% over the long-term.
The components of non-interest income were as follows:
For the Three Months Ended September 30, For the Nine Months Ended September 30,
2021 2020 $ Change % Change 2021 2020 $ Change % Change
(Dollars in Thousands)
Private wealth
management services fee
income $ 2,759 $ 2,167 $ 592 27.3 % $ 7,910 $ 6,402 $ 1,508 23.6 %
Gain on sale of SBA
loans 721 760 (39) (5.1) 3,002 1,598 1,404 87.9
Service charges on
deposits 956 881 75 8.5 2,814 2,527 287 11.4
Loan fees 713 478 235 49.2 1,828 1,414 414 29.3
Increase in cash
surrender value of
bank-owned life
insurance 357 365 (8) (2.2) 1,056 1,037 19 1.8
Net gain (loss) on sale
of securities - - - NM 29 (4) 33 NM
Swap fees - 2,446 (2,446) (100.0) 684 5,782 (5,098) (88.2)
Other non-interest
income 1,509 311 1,198 385.2 3,208 1,385 1,823 131.6
Total non-interest
income $ 7,015 $ 7,408 $ (393) (5.3) $ 20,531 $ 20,141 $ 390 1.9
Fee income ratio(1) 24.8 % 28.5 % 24.4 % 27.0 %
(1) Fee income ratio is fee income, per the above table, divided by top line revenue (defined as net interest income plus non-interest income).
Private wealth management service fees increased$592,000 , or 27.3%, and$1.5 million , or 23.6%, for the three and nine months endedSeptember 30, 2021 , respectively, compared to the three and nine months endedSeptember 30, 2020 . Private wealth management fee income is primarily driven by the amount of assets under management and administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets. This increase was driven by growth in assets under management and administration attributable to both new client relationships and increased equity market values. As ofSeptember 30, 2021 , private wealth and trust assets under management and administration totaled a record$2.694 billion , increasing$445.2 million , or 26.4% annualized, compared to$2.249 billion as ofDecember 31, 2020 and$676.6 million , or 33.5%, compared to$2.018 billion as ofSeptember 30, 2020 . No commercial loan interest rate swap fee income was recognized for the three months endedSeptember 30, 2021 , compared to$2.4 million for the same period in 2020. Commercial loan interest rate swap fee income was$684,000 for the nine months endedSeptember 30, 2021 , compared to$5.8 million for the nine months endedSeptember 30, 2020 . We originate commercial real estate loans in which we offer clients a floating rate and an interest rate swap. The client's swap is then offset with a counter-party dealer. The execution of these transactions generates swap fee income. The aggregate amortizing notional value of interest rate swaps with various borrowers was$634.0 million as ofSeptember 30, 2021 , compared to$577.9 million as ofSeptember 30, 2020 . Interest rate swaps can be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter. Subsequent toSeptember 30 , 2021,we completed two commercial loan interest rate swap transactions which generated swap fees totaling$684,000 . 55
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Gains on sale of SBA loans for the three months endedSeptember 30, 2021 decreased$39,000 , or 5.1%, compared to the same period in 2020. We expect this revenue stream to return to levels consistent with the first half of the year in the coming quarters and continue to believe gains on sale of traditional SBA loans (i.e., SBA loans unrelated to PPP loans), while variable based on timing of closings, will continue to increase annually at a measured pace. Gain on sale of SBA loans increased$1.4 million , or 87.9%, for the nine months endedSeptember 30, 2021 compared to the same period in 2020. Loans fees increased$235,000 , or 49.2%, and$414,000 , or 29.3%, for the three and nine months endedSeptember 30, 2021 , respectively, compared to the three and nine months endedSeptember 30, 2020 . The increase in both periods of comparison is primarily due to a full year of floorplan financing curtailment fees. Other non-interest income increased$1.2 million , or 385.2%, and$1.8 million , or 131.6%, for the three and nine months endedSeptember 30, 2021 , respectively, compared to the three and nine months endedSeptember 30, 2020 . The increase in both periods of comparison was primarily due to an increase in returns from the Corporation's investments in mezzanine funds and an increase in bank consulting services fee income. Comparison of Non-Interest Expense for the Three and Nine Months Ended September 30, 2021 and 2020 Non-Interest Expense Non-interest expense for the three months endedSeptember 30, 2021 increased by$1.7 million , or 10.3%, to$18.5 million compared to$16.8 million for the same period in 2020. Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased$1.8 million , or 11.1%, to$18.5 million for the three months endedSeptember 30, 2021 compared to$16.7 million for the same period in 2020. Non-interest expense for the nine months endedSeptember 30, 2021 increased by$2.8 million , or 5.4%, to$54.0 million compared to$51.2 million for the same period in 2020. Operating expense increased$5.9 million , or 12.3%, to$53.9 million for the nine months endedSeptember 30, 2021 compared to$48.0 million for the same period in 2020. The increase in operating expense in both periods of comparison was primarily due to an increase in compensation. The components of non-interest expense were as follows: For the Three Months Ended September 30, For the Nine Months Ended September 30, 2021 2020 $ Change % Change 2021 2020 $ Change % Change (Dollars in Thousands) Compensation$ 13,351 $ 11,857 $ 1,494 12.6 %$ 39,263 $ 33,705 $ 5,558 16.5 % Occupancy 544 570 (26) (4.6) 1,628 1,696 (68) (4.0) Professional fees 1,024 943 81 8.6 2,803 2,621 182 6.9 Data processing 746 679 67 9.9 2,315 2,066 249 12.1 Marketing 572 356 216 60.7 1,474 1,169 305 26.1 Equipment 260 310 (50) (16.1) 767 905 (138) (15.2) Computer software 999 1,017 (18) (1.8) 3,244 2,873 371 12.9 FDIC insurance 291 312 (21) (6.7) 933 760 173 22.8 Collateral liquidation costs 47 45 2 4.4 224 281
(57) (20.3)
Net loss (gain) on
foreclosed properties 6 (121) 127 NM 7 329 (322) (97.9)
Impairment on tax credit
investments - 113 (113) NM - 2,066 (2,066) (100.0)
SBA recourse (benefit)
provision (69) 57 (126) NM 45 53 (8) NM
Loss on early
extinguishment of debt - - - NM - 744 (744) NM
Other non-interest
expense 719 620 99 16.0 1,300 1,977 (677) (34.2)
Total non-interest
expense $ 18,490 $ 16,758 $ 1,732 10.3 $ 54,003 $ 51,245 $ 2,758 5.4
Total operating
expense(1) $ 18,546 $ 16,700 $ 1,846 11.1 $ 53,928 $ 48,026 $ 5,902 12.3
Full-time equivalent
employees 307 300 307 300
56-------------------------------------------------------------------------------- Table of Contents (1)Total operating expense represents total non-interest expense, adjusted to exclude the impact of discrete items as previously defined in the non-GAAP efficiency ratio calculation, above. Compensation expense for the three and nine months endedSeptember 30, 2021 was$13.4 million , an increase of$1.5 million , or 12.6%, and$39.3 million , an increase of$5.6 million , or 16.5%, respectively, compared to the three and nine months endedSeptember 30, 2020 . The increase in both periods of comparison reflects new hires, annual merit increases, growth in employee benefit costs, and an increase in the expected payout on annual corporate and individual incentive compensation plans. The annual corporate bonus and individual incentive compensation plans for the three and nine months endedSeptember 30, 2021 totaled$2.6 million and$6.7 million , respectively, due to strong Bank performance driven by effective business development efforts and continued improvement in credit, compared to$1.7 million and$3.9 million for three and nine months endedSeptember 30, 2020 , respectively. Average full-time equivalent employees for the nine months endedSeptember 30, 2021 increased to 309, up 7.7%, compared to 287 for the nine months endedSeptember 30, 2020 . We expect to continue investing in talent, both in the form of additional business development and operational staff, to support our long-term strategic plan. Data processing expense increased$67,000 , or 9.9%, and$249,000 , or 12.1%, for the three and nine months endedSeptember 30, 2021 , respectively, compared to the three and nine months endedSeptember 30, 2020 . The increase in data processing expense was due to the increase in deposit accounts and implementation costs for various client-facing products and functionality. Management expects data processing expense to continue to increase modestly commensurate with the increase in deposit accounts. Marketing expense increased$216,000 , or 60.7%, and$305,000 , or 26.1%, for the three and nine months endedSeptember 30, 2021 , respectively, compared to the three and nine months endedSeptember 30, 2020 . Management expects marketing expense to continue to increase modestly and return to pre-pandemic levels over the next several quarters primarily driven by sponsorships and business development activities. Computer software expense decreased$18,000 , or 1.8%, and increased$371,000 , or 12.9%, for the three and nine months endedSeptember 30, 2021 , respectively, compared to the three and nine months endedSeptember 30, 2020 . The increase for the nine months endedSeptember 30, 2021 was principally due to investments in and maintenance of technology platforms to improve the client experience and continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy. Management expects computer software expense growth to moderate in 2022 and beyond and generally increase commensurate with headcount and the related increase in software licensing costs. No historic tax credits or related impairment were recognized for the three and nine months endedSeptember 30, 2021 . The impairment on tax credit investments for the three and nine months endedSeptember 30, 2020 are related to a new market and historic tax credits. The impairment on tax credits are more than offset by a reduction to income tax expense resulting in a net benefit to earnings in the year the credits are earned. Management intends to continue actively pursuing in-market tax credit opportunities throughout 2022 and beyond. The Corporation incurred a$744,000 loss, recognized through non-interest expense, on the early extinguishment of$59.5 million in FHLB term advances late in the second quarter of 2020, as the Corporation lowered wholesale funding costs and improved the Corporation's funding position. Other non-interest expense increased$99,000 , or 16.0%, and decreased$677,000 , or 34.2%, for the three and nine months endedSeptember 30, 2021 , respectively, compared to the three and nine months endedSeptember 30, 2020 . The increase for the three months endedSeptember 30, 2021 was due to an increase in travel and other general business-related expenses. The decrease for the nine months endedSeptember 30, 2021 was principally due to a reduction in the credit valuation adjustment ("CVA") related to the commercial loan interest rate swap program and a reduction in the loan servicing valuation adjustment related to the Bank's SBA portfolio. The CVA represents a change in the market value of the Company's commercial loan interest rate swaps to estimate potential borrower credit risk within the portfolio. The CVA can vary from period to period based on the size of the portfolio, credit metrics, and the interest rate environment in any given quarter. There was no CVA as ofSeptember 30, 2020 . 57 -------------------------------------------------------------------------------- Table of Contents Income Taxes Income tax expense totaled$8.4 million for the nine months endedSeptember 30, 2021 compared to an income tax expense of$73,000 for the nine months endedSeptember 30, 2020 . The income tax expense for the nine months endedSeptember 30, 2020 reflects a benefit from the recognition of$2.5 million in tax credits which correspond with the$1.7 million impairment of relationship-based historic tax credit investments during the same period. The effective tax rate, excluding tax credits and other discrete items, for the nine months endedSeptember 30, 2021 was 23.5% compared to 19.3% for the nine months endedSeptember 30, 2020 . Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. The rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change. Financial Condition
General
Total assets increased by$16.6 million , or 0.6%, to$2.584 billion as ofSeptember 30, 2021 compared to$2.568 billion atDecember 31, 2020 . The increase in total assets was primarily driven by short-term investments and securities, partially offset by a decrease in loans and leases receivable and derivatives. Short-Term Investments Short-term investments increased by$63.1 million to$90.4 million atSeptember 30, 2021 from$27.4 million atDecember 31, 2020 . The increase in short-term investments was primarily due to solid in-market deposit growth and PPP loan forgiveness proceeds. Our short-term investments primarily consist of interest-bearing deposits held at the FRB. We value the safety and soundness provided by the FRB and therefore incorporate short-term investments in our on-balance sheet liquidity program. In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio. Please refer to the section entitled Liquidity and Capital Resources for further discussion. Securities Total securities, including available-for-sale and held-to-maturity, increased by$5.0 million , or 2.4%, to$215.3 million atSeptember 30, 2021 compared to$210.3 million atDecember 31, 2020 . During the nine months endedSeptember 30, 2021 we recognized unrealized losses of$3.0 million before income taxes through other comprehensive income, compared to gains of$3.9 million for the same period in 2020. As ofSeptember 30, 2021 andDecember 31, 2020 , our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 5.7 years and 5.0 years, respectively. Our investment philosophy remains as stated in our most recent Annual Report on Form 10-K. We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, data integrity validation primarily through comparison of current price to an expectation-based analysis of movement in prices based upon the changes in the related yield curves, and other market factors. No securities within our portfolio were deemed to be other-than-temporarily impaired as ofSeptember 30, 2021 . Loans and Leases Receivable Loans and leases receivable, net of allowance for loan and lease losses, decreased by$18.8 million to$2.099 billion atSeptember 30, 2021 from$2.117 billion atDecember 31, 2020 which was driven by PPP loan forgiveness, partially offset by commercial loan growth. Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by$142.1 million , or 10.0% annualized, to$2.034 billion atSeptember 30, 2021 fromDecember 31, 2020 . Excluding net PPP loans, C&I loans increased$109.6 million , or 28.8% annualized, to$616.6 million from$507.0 million atDecember 31, 2020 primarily due to an increase in asset-based lending, small-ticket equipment financing, and dealer floorplan financing. The majority of our specialized lending commercial banking business lines are early stage and faster 58 -------------------------------------------------------------------------------- Table of Contents growing while the more mature business lines, like asset-based lending, have historically experienced counter cyclical growth, growing during and following times of economic stress. Management expects specialized lending volume to continue to increase in 2021 and 2022 following the proactive investments made prior to and during the COVID-19 pandemic. Including net PPP loans, our C&I portfolio decreased$51.3 million to$681.1 million from$732.3 million atDecember 31, 2020 . Total commercial real estate ("CRE") loans increased$28.6 million to$1.388 billion , up from$1.359 billion atDecember 31, 2020 . Non-owner occupied CRE and multi-family loans drove CRE loan growth as ofSeptember 30, 2021 , increasing$74.9 million , and$2.2 million , respectively, fromDecember 31, 2020 . There continues to be a concentration in CRE loans which represented 67.3% and 70.6% of our total loans, excluding net PPP loans, as ofSeptember 30, 2021 andDecember 31, 2020 , respectively. As ofSeptember 30, 2021 , 17.4% of the CRE loans were owner-occupied CRE, compared to 18.7% as ofDecember 31, 2020 . We consider owner-occupied CRE more characteristic of the Corporation's C&I portfolio as, in general, the client's primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property. Management has elevated its underwriting standards during the COVID-19 pandemic to ensure borrowers have characteristics such as robust liquidity, strong operating performance, and collateral positions. Even with these higher standards, the Corporation has been able to grow loans and deepen banking relationships. Underwriting of new credit is primarily through approval from a serial sign-off or committee process and is a key component of our operating philosophy. Business development officers have no individual lending authority limits, and thus, a significant portion of our new credit extensions require approval from a loan approval committee regardless of the type of loan or lease, amount of the credit, or the related complexities of each proposal. In addition, we make every reasonable effort to ensure that there is appropriate collateral or a government guarantee at the time of origination to protect our interest in the related loan or lease. To monitor the ongoing credit quality of our loans and leases, each credit is evaluated for risk at the time of origination, subsequent renewal, evaluation of updated financial information from our borrowers, or as other circumstances dictate. While we continue to experience significant competition from banks operating in our primary geographic areas, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to expect our new loan and lease activity to be more than adequate to replace normal amortization, allowing us to continue growing in future years. The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K. Deposits As ofSeptember 30, 2021 , deposits increased by$48.8 million , or 3.5% annualized, to$1.904 billion from$1.856 billion atDecember 31, 2020 primarily due to a$66.5 million and$87.2 million increase in transaction accounts and money market accounts, respectively, partially offset by a decrease in wholesale deposits and certificates of deposit of$97.9 million and$7.1 million , respectively. The large increase in deposits was primarily due to successful business development efforts and PPP forgiveness proceeds. Period-end deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to maintain existing and new client relationships. Our strategic efforts remain focused on adding in-market deposit relationships. We measure the success of in-market deposit gathering efforts based on the number and average balances of our deposit accounts as compared to ending balances due to the volatility of some of our larger relationships. The Bank's average in-market deposits, consisting of all transaction accounts, money market accounts, and certificates of deposit, were approximately$1.756 billion for the nine months endedSeptember 30, 2021 , up 16.0% annualized, compared to$1.569 billion for the year endedDecember 31, 2020 . FHLB Advances and Other Borrowings As ofSeptember 30, 2021 , FHLB advances and other borrowings decreased by$25.1 million , or 6.0%, to$394.1 million from$419.2 million atDecember 31, 2020 . While total wholesale funding as a percentage of total bank funding has decreased meaningfully overall due to significant in-market deposit growth, we continue to replace the majority of our maturing brokered certificates of deposit with FHLB advances at lower rates, as needed, to match-fund fixed rate loans and mitigate interest rate risk. Total bank funding is defined as total deposits plus FHLB advances, and Federal Reserve Discount Window advances. 59 -------------------------------------------------------------------------------- Table of Contents As ofSeptember 30, 2021 andDecember 31, 2020 , the Corporation had other borrowings of$12.5 million and$920,000 respectively, which consisted of sold loans which were accounted for as a secured borrowing, because they did not qualify for true sale accounting, in addition to borrowings associated with our investment in a community development entity.
During the second quarter of 2020, the Corporation tested its ability to
borrow from the Federal Reserve PPPLF in the event funding was required to
support the Banks PPP lending efforts. On
Consistent with our funding philosophy to manage interest rate risk, we will use the most efficient and cost effective source of wholesale funds. We will utilize FHLB advances to the extent we maintain an adequate level of excess borrowing capacity for liquidity and contingency funding purposes and pricing remains favorable in comparison to the wholesale deposit alternative. We will use FHLB advances and/or brokered certificates of deposit in specific maturity periods needed, typically three to five years, to match-fund fixed rate loans and effectively mitigate the interest rate risk measured through our asset/liability management process and to support asset growth initiatives while taking into consideration our operating goals and desired level of usage of wholesale funds. Please refer to the section titled Liquidity and Capital Resources, below, for further information regarding our use and monitoring of wholesale funds. Derivatives The Corporation's derivative financial instruments, under which the Corporation is required to either receive cash from or pay cash to counterparties depending on changes in interest rates applied to notional amounts, are carried at fair value on the consolidated balance sheets. We offer interest rate swap products directly to qualified commercial borrowers, originating a floating rate loan and an interest rate swap providing a fixed rate to the borrower. The client's swap is then offset with a counter-party dealer. The execution of these transactions generates swap fee income. The aggregate amortizing notional value of interest rate swaps with various borrowers increased$4.9 million , or 0.8%, to$634.0 million as ofSeptember 30, 2021 , compared to$629.1 million as ofDecember 31, 2020 . The fair value of these interest rate swaps decreased$20.7 million , or 41.9%, to$28.7 million as ofSeptember 30, 2021 , compared to$49.4 million as ofDecember 31, 2020 . The decline in fair value of the derivative contracts is directly related to the level of interest rates as ofSeptember 30, 2021 , compared to the maturity term and amortization rates when the derivative contracts were originally executed. For further information and discussion of our derivatives, see Note 13 - Derivative Financial Instruments of the Consolidated Financial Statements. 60
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Asset QualityImpaired Assets
Total impaired assets consisted of the following at
September 30, December 31,
2021 2020
(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied $ 1,109 $ 5,429
Commercial real estate - non-owner occupied - 3,783
Land development - 890
Construction - -
Multi-family - -
1-4 family 391 250
Total non-accrual commercial real estate 1,500 10,352
Commercial and industrial 5,884 16,155
Direct financing leases, net 49 49
Consumer and other:
Home equity and second mortgages - 40
Other - 21
Total non-accrual consumer and other loans - 61
Total non-accrual loans and leases 7,433 26,617
Foreclosed properties, net 172 34
Total non-performing assets 7,605 26,651
Performing troubled debt restructurings 53 46
Total impaired assets Total non-accrual loans and leases to gross loans and leases 0.35 % 1.24 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
0.36 1.24
Total non-performing assets to total assets 0.29 1.04
Allowance for loan and lease losses to gross loans and leases 1.16 1.33
Allowance for loan and lease losses to non-accrual loans and leases
331.98 107.15
Net PPP loans outstanding as of
September 30, December 31,
2021 2020
Total non-accrual loans and leases to gross loans and leases 0.36 % 1.38 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
0.37 1.38
Total non-performing assets to total assets 0.30 1.14
Allowance for loan and lease losses to gross loans and leases 1.20 1.48
Non-accrual loans decreased $19.2 million , or 72.1%, to $7.4 million at
September 30, 2021 , compared to $26.6 million at December 31, 2020 . The decrease
in non-accrual loans was principally due to loan payoffs, loans returning to
accrual status, and $3.4 million of charge-offs, of which $2.2 million was from
the legacy SBA portfolio. All charge-offs for the nine months ended
September 30, 2021 were previously identified impaired loans and unrelated to
the economic slowdown from the COVID-19 pandemic. Management does not view these
charge-offs as being indicative of any systemic issues across the Corporation's
loan and lease portfolio. The Corporation's non-accrual loans as a percentage of
total gross loans and leases
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measured 0.35% and 1.24% at September 30, 2021 and December 31, 2020 ,
respectively. Non-accrual loans as a percentage of total gross loans and leases,
excluding net PPP loans, was 0.36% and 0.96% at September 30, 2021 and
December 31, 2020 , respectively. As of September 30, 2021 and December 31, 2020 ,
$857,000 and $6.5 million of non-accrual loans and leases were considered
troubled debt restructurings, respectively. Please refer to the section titled
COVID-19 Update for additional information on credit quality.
We use a wide variety of available metrics to assess the overall asset quality
of the portfolio and no one metric is used independently to make a final
conclusion as to the asset quality of the portfolio. Non-performing assets as a
percentage of total assets decreased to 0.29% at September 30, 2021 from 1.04%
at December 31, 2020 . As of September 30, 2021 , the payment performance of our
loans and leases did not point to any new areas of concern, as approximately
99.8% of the total portfolio was in a current payment status, compared to 99.0%
as of December 31, 2020 . We also monitor asset quality through our established
categories as defined in Note 6 - Loan and Lease Receivables, Impaired Loans and
Leases and Allowance for Loan and Lease Losses of the Consolidated Financial
Statements. As we continue to actively monitor the credit quality of our loan
and lease portfolios, we may identify additional loans and leases for which the
borrowers or lessees are having difficulties making the required principal and
interest payments based upon factors including, but not limited to, the
inability to sell the underlying collateral, inadequate cash flow from the
operations of the underlying businesses, liquidation events, or bankruptcy
filings. We are proactively working with our impaired loan borrowers to find
meaningful solutions to difficult situations that are in the best interests of
the Bank.
As of September 30, 2021 , as well as in all previous reporting periods, there
were no loans over 90 days past due and still accruing interest. Loans and
leases greater than 90 days past due are considered impaired and are placed on
non-accrual status. Cash received while a loan or a lease is on non-accrual
status is generally applied solely against the outstanding principal. If
collectability of the contractual principal and interest is not in doubt,
payments received may be applied to both interest due on a cash basis and
principal.
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The following represents additional information regarding our impaired loans
and leases:
As of and for
the
As of and for the Nine Months Ended Year Ended
September 30, December 31,
2021 2020 2020
(In Thousands)
Impaired loans and leases with no impairment
reserves required $ 4,985
2,501 20,540 7,697
Total impaired loans and leases 7,486 36,097 26,663
Less: Impairment reserve (included in allowance
for loan and lease losses) 1,570 8,898 3,681
Net impaired loans and leases $ 5,916 $ 27,199 $ 22,982
Average impaired loans and leases $ 16,700 $ 24,899 $ 27,703
Foregone interest income attributable to impaired
loans and leases $ 1,002
164 467 636
Net foregone interest income on impaired loans and leases
$ 838 Non-performing assets also include foreclosed properties. A summary of foreclosed properties activity is as follows:
As of and for the
As of and for the Nine Months Ended Year Ended
September 30, December 31,
2021 2020 2020
(In Thousands)
Balance at the beginning of the period $ 34 $ 2,919 $ 2,919
Transfer of loans and leases to foreclosed
properties 145 80 80
Proceeds from sale of foreclosed properties - (2,057) (2,582)
Net gain (loss) on sale of foreclosed
properties - 34 (20)
Impairment adjustments (7) (363) (363)
Balance at the end of the period $ 172 $ 613 $ 34
Allowance for Loan and Lease Losses
The allowance for loan and lease losses decreased$3.8 million , or 13.5%, to$24.7 million as ofSeptember 30, 2021 from$28.5 million as ofDecember 31, 2020 . The allowance for loan and lease losses as a percentage of gross loans and leases decreased to 1.16% as ofSeptember 30, 2021 from 1.33% as ofDecember 31, 2020 . The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.20% as ofSeptember 30, 2021 compared to 1.48% as ofDecember 31, 2020 . The decrease in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by significant commercial real estate loan recoveries, and the related impact it had on our commercial real estate historical loss factors, and the release of specific reserves following loan payoffs and charge-offs. These general and specific reserve releases were partially offset primarily by an increase in general reserve commensurate with loan growth. There have been no substantive changes to our methodology for estimating the appropriate level of allowance for loan and lease loss reserves from what was previously outlined in our most recent Annual Report on Form 10-K. During the nine months endedSeptember 30, 2021 , we recorded net recoveries on impaired loans and leases of$1.5 million , comprised of$3.4 million of charge-offs and$4.9 million of recoveries. While we likely will continue to experience some level of periodic charge-offs in the future, as exit strategies are considered and executed, management believes charge-offs in the foreseeable future will remain at low levels based on total non-accrual loans and leases as a percentage of gross loans and leases of 0.35% atSeptember 30, 2021 ; which is the Corporation's lowest level of non-accrual loans since the fourth quarter of 2006. Loans and leases with previously established specific reserves, however, may ultimately result in a charge-off under a variety of scenarios. 63
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As ofSeptember 30, 2021 andDecember 31, 2020 , our ratio of allowance for loan and lease losses to total non-accrual loans and leases was 331.98% and 107.15%, respectively. This ratio continues to increase due to the significant decline in non-accrual loans and as our remaining non-accrual loan and lease portfolio has a larger proportion of SBA loans when compared toDecember 31, 2020 , which historically carry larger collateral shortfalls when compared to our conventional commercial loans. Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we try to ensure that we have sufficient collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases either does not require additional specific reserves or requires only a minimal amount of required specific reserve, as we believe the loans and leases are adequately collateralized as of the measurement period. In addition, management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined with certainty that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease loss to non-accrual loans and leases ratio as compared to our peers or industry expectations. As asset quality strengthens, our allowance for loan and lease losses is measured more through general characteristics, including historical loss experience, of our portfolio rather than through specific identification and we would therefore expect this ratio to rise. Conversely, if we identify further impaired loans, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as ofSeptember 30, 2021 . To determine the level and composition of the allowance for loan and lease losses, we break out the portfolio by segments with similar risk characteristics. First, we evaluate loans and leases for potential impairment classification. We analyze each loan and lease identified as impaired on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of expected cash flows. For each segment of loans and leases that has not been individually evaluated, management segregates the Bank's loss factors into a quantitative general reserve component based on historical loss rates throughout the defined look back period. The quantitative general reserve component also considers an estimate of the historical loss emergence period, which is the period of time between the event that triggers the loss to the charge-off of that loss. The methodology also focuses on evaluation of several qualitative factors for each portfolio category, including but not limited to: management's ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, existing economic conditions, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations of loans to specific industries, and other qualitative factors that could affect credit losses such as the economic uncertainty related to the COVID-19 pandemic. As ofSeptember 30, 2021 , the allowance for loan and lease losses included$733,000 in general reserve related to economic uncertainty, compared to$947,000 as ofDecember 31, 2020 . Management removed qualitative factors due to COVID-19 uncertainty from the majority of our specialized lending and commercial and industrial portfolios reflecting continued strong performance while maintaining a general reserve on industries previously identified as stressed, specifically hospitality and retail. When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for loan and lease loss reserve to bring the loan or lease to its net realizable value. Many of the impaired loans as ofSeptember 30, 2021 are collateral dependent. It is typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment at least annually, or more frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, we have found that in general real estate values have been stable or improved; however, in specific situations current fair values collateralizing certain impaired loans were inadequate to support the entire amount of the outstanding debt. Foreclosure actions may have been initiated on certain of these commercial real estate and other mortgage loans. As a result of our review process, we have concluded an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was$24.7 million , or 1.16% of gross loans and leases, atSeptember 30, 2021 . However, given ongoing complexities with current workout situations and the uncertainty surrounding future economic conditions, further charge-offs, and increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion. In addition, various federal and state regulatory agencies review the allowance for loan and lease losses. These agencies could require certain loan and lease balances to be classified differently or charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. 64
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A summary of the activity in the allowance for loan and lease losses follows:
As of and for the Three Months Ended As of and for the Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
(Dollars in Thousands)
Allowance at beginning of period $ 25,675 $ 27,464 $ 28,521 $ 19,520 Charge-offs:
Commercial real estate: Commercial real estate - owner occupied (7) - (11) (27) Commercial real estate - non-owner occupied - - - - Construction and land development - - - - Multi-family - - - - 1-4 family - - (245) - Commercial and industrial (356) (505) (3,121) (1,358) Direct financing leases - - - (56) Consumer and other: Home equity and second mortgages - - - - Other (1) - (25) (13) Total charge-offs (364) (505) (3,402) (1,454) Recoveries: Commercial real estate: Commercial real estate - owner occupied 70 - 295 1 Commercial real estate - non-owner occupied 1,431 - 1,431 2 Construction and land development - - 2,078 - Multi-family - - - - 1-4 family - - - - Commercial and industrial 128 21 1,041 259 Direct financing leases - - - - Consumer and other: Home equity and second mortgages - - 1 - Other 5 2 6 2 Total recoveries 1,634 23 4,852 264 Net recoveries 1,270 (482) 1,450 (1,190) Provision for loan and lease losses (2,269) 3,835 (5,295) 12,487 Allowance at end of period$ 24,676 $ 30,817 $ 24,676 $ 30,817 Annualized net (recoveries) charge-offs as a percent of average gross loans and leases (0.24) % 0.09 % (0.09) % 0.08 % Annualized net (recoveries) charge-offs as a percent of average gross loans and leases, excluding average net PPP loans (0.25) % 0.11 % (0.10) % 0.09 % 65
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Liquidity and Capital Resources
The Corporation expects to meet its liquidity needs through existing cash on
hand, established cash flow sources, its third party senior line of credit, and
dividends received from the Bank. While the Bank is subject to certain generally
applicable regulatory limitations regarding its ability to pay dividends to the
Corporation, we do not believe that the Corporation will be adversely affected
by these dividend limitations. The Corporation's principal liquidity
requirements at September 30, 2021 were the interest payments due on
subordinated and junior subordinated notes. On July 30, 2021 , the Bank's Board
of Directors declared a dividend in the aggregate amount of $3.0
million bringing year-to-date dividend declarations to $7.5 million . The capital
ratios of the Bank met all applicable regulatory capital adequacy requirements
in effect on September 30, 2021 , and continue to meet the heightened
requirements imposed by Basel III, including the capital conservation buffer
that was fully phased-in as of January 1, 2019 . The Corporation's Board and
management teams adhere to the appropriate regulatory guidelines on decisions
which affect their capital positions, including but not limited to, decisions
relating to the payment of dividends and increasing indebtedness.
The Bank maintains liquidity by obtaining funds from several sources. The
Bank's primary source of funds are principal and interest payments on loans
receivable and mortgage-related securities, deposits, and other borrowings, such
as federal funds, FHLB advances, and Federal Reserve Discount Window advances.
The scheduled payments of loans and mortgage-related securities are generally a
predictable source of funds. Deposit flows and loan prepayments, however, are
greatly influenced by general interest rates, economic conditions, and
competition.
We view on-balance sheet liquidity as a critical element to maintaining adequate
liquidity to meet our cash and collateral obligations. We define our on-balance
sheet liquidity as the total of our short-term investments, our unencumbered
securities available-for-sale, and our unencumbered pledged loans. As of
September 30, 2021 and December 31, 2020 , our immediate on-balance sheet
liquidity was $535.3 million and $640.2 million , respectively. At September 30,
2021 and December 31, 2020 , the Bank had $89.9 million and $26.7 million on
deposit with the FRB recorded in short-term investments, respectively. Any
excess funds not used for loan funding or satisfying other cash obligations were
maintained as part of our on-balance sheet liquidity in our interest-bearing
accounts with the FRB, as we value the safety and soundness provided by the FRB.
We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay
down maturing debt, allow run off of maturing wholesale certificates of deposit
or invest in securities to maintain adequate liquidity at an improved margin.
We had $432.4 million of outstanding wholesale funds at September 30, 2021 ,
compared to $567.0 million of wholesale funds as of December 31, 2020 , which
represented 19.1% and 25.2%, respectively, of ending balance total bank funding.
Wholesale funds include FHLB advances, brokered certificates of deposit,
deposits gathered from reciprocal deposit programs above the general cap, if
applicable, and unreciprocated deposits from reciprocal deposit programs. Total
bank funding is defined as total deposits plus FHLB advances. We are committed
to raising in-market deposits while utilizing wholesale funds to mitigate
interest rate risk. Wholesale funds continue to be an efficient and cost
effective source of funding for the Bank and allows it to gather funds across a
larger geographic base at price levels and maturities that are more attractive
than local time deposits when required to raise a similar level of in-market
deposits within a short time period. Access to such deposits and borrowings
allows us the flexibility to refrain from pursuing single service deposit
relationships in markets that have experienced unfavorable pricing levels. In
addition, the administrative costs associated with wholesale funds are
considerably lower than those that would be incurred to administer a similar
level of local deposits with a similar maturity structure. During the time
frames necessary to accumulate wholesale funds in an orderly manner, we will use
short-term FHLB advances to meet our temporary funding needs. The short-term
FHLB advances will typically have terms of one week to one month to cover the
overall expected funding demands.
Period-end in-market deposits increased $146.6 million , or 11.6% annualized,
to $1.830 billion at September 30, 2021 from $1.683 billion at December 31, 2020
as in-market deposit balances increased due to our client's PPP loan proceeds
and successful business development efforts. Our in-market relationships
continue to grow; however, deposit balances associated with those relationships
will fluctuate. We expect to establish new client relationships and continue
marketing efforts aimed at increasing the balances in existing clients' deposit
accounts. Nonetheless, we will continue to use wholesale funds in specific
maturity periods, typically three to five years, needed to effectively mitigate
the interest rate risk measured through our asset/liability management process
or in shorter time periods if in-market deposit balances decline. In order to
provide for ongoing liquidity and funding, all of our wholesale certificates of
deposit do not allow for withdrawal at the option of the depositor before the
stated maturity (with the exception of deposits accumulated through the internet
listing service which have the same early withdrawal privileges and fees as do
our other in-market deposits) and FHLB advances with contractual maturity terms.
The Bank limits the percentage of wholesale funds to total bank funds in
accordance with liquidity policies approved by its Board. The Bank was in
compliance with its policy limits as of September 30, 2021 .
The Bank was able to access the wholesale funding market as needed at rates
and terms comparable to market standards during the year ended September 30,
2021 . In the event that there is a disruption in the availability of wholesale
funds
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at maturity, the Bank has managed the maturity structure, in compliance with our
approved liquidity policy, so at least one year of maturities could be funded
through on-balance sheet liquidity. These potential funding sources include
deposits maintained at the FRB or Federal Reserve Discount Window utilizing
currently unencumbered securities and acceptable loans as collateral. As of
September 30, 2021 , the available liquidity was in excess of the stated policy
minimum. We believe the Bank will also have access to the unused federal funds
lines, cash flows from borrower repayments, and cash flows from security
maturities. The Bank also has the ability to raise local market deposits by
offering attractive rates to generate the level required to fulfill its
liquidity needs.
The Bank is required by federal regulation to maintain sufficient liquidity to
ensure safe and sound operations. We believe that the Bank has sufficient
liquidity to match the balance of net withdrawable deposits and short-term
borrowings in light of present economic conditions and deposit flows.
The Corporation's capital ratios continued to exceed the highest required
regulatory benchmark levels. As of September 30, 2021 , total capital to
risk-weighted assets was 11.14%, tier 1 capital to risk-weighted assets was
9.14%, tier 1 leverage capital to adjusted average assets was 8.69% and common
equity tier 1 capital to risk-weighted assets was 8.73%. In addition, as of
September 30, 2021 , tangible common equity to tangible assets was 8.28%.
As of September 30, 2021 , the Corporation had purchased 157,520 shares of its
common stock, since the adoption of its previously disclosed stock repurchase
program, at a weighted average price of $26.90 per share, for a total value of
$4.3 million . The Corporation had $717,000 of buyback authority remaining under
the program as of September 30, 2021 .
As previously announced, during the third quarter of 2021, the Corporation's
Board of Directors declared a regular quarterly dividend of $0.18 per share. The
dividend was paid on August 19, 2021 to stockholders of record at the close of
business on August 6, 2021 . Measured against third quarter 2021 diluted earnings
per share of $1.07 , the dividend represents a 16.8% payout ratio. The Board of
Directors routinely considers dividend declarations as part of its normal course
of business.
During the nine months ended September 30, 2021 , operating activities resulted
in a net cash inflow of $24.8 million , which included net income of $27.2
million , partially offset by a $5.3 million provision for loan and lease loss
benefit. Net cash provided by investing activities for the nine months ended
September 30, 2021 was $14.5 million primarily due to proceeds received from the
sale of securities available for sale. Net cash provided by financing activities
was $14.5 million for the nine months ended September 30, 2021 primarily due to
a net increase in deposits, partially offset by a net reduction in FHLB advances
and cash dividends paid. Please refer to the Consolidated Statements of Cash
Flows included in PART I., Item 1 for further details regarding significant
sources of cash flow for the Corporation.
Contractual Obligations and Off-Balance Sheet Arrangements
As of September 30, 2021 , there were no material changes to our contractual
obligations and off-balance sheet arrangements disclosed in our Annual Report on
Form 10-K for the year ended December 31, 2020 . We continue to believe that we
have adequate capital and liquidity available from various sources to fund
projected contractual obligations and commitments.
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