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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Table of Contents
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 months ended
•Net income totaled$9.7 million , or diluted earnings per share of$1.12 , for the three months endedMarch 31, 2021 , compared to$3.3 million , or diluted earnings per share of$0.38 , for the same period in 2020. •Annualized return on average assets and annualized return on average equity for the three months endedMarch 31, 2021 measured 1.51% and 18.48%, respectively, compared to 0.62% and 7.14% for the same period in 2020. •Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled$10.6 million for the three months endedMarch 31, 2021 , up 40.1% from the same period in 2020. Pre-tax, pre-provision adjusted return on average assets was 1.65% for the three months endedMarch 31, 2021 , compared to 1.44% for the same period in 2020. •Net interest margin was 3.44% for both the three months endedMarch 31, 2021 andMarch 31, 2020 . Adjusted net interest margin, which excludes certain one-time and discrete items, was 3.20% for the three months endedMarch 31, 2021 compared to 3.32% for the three months endedMarch 31, 2020 . •Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled$3.1 million for the three months endedMarch 31, 2021 compared to$798,000 for the three months endedMarch 31, 2020 . •Top line revenue, defined as net interest income plus non-interest income, totaled$28.1 million for the three months endedMarch 31, 2021 , up 19.6% from the same period in 2020. •Provision for loan and lease losses was a benefit of$2.1 million for the three months endedMarch 31, 2021 compared to an expense of$3.2 million for the same period in 2020. •Non-interest income totaled$7.2 million for the three months endedMarch 31, 2021 , once again exceeding the Corporation's goal of 25%, compared to$6.4 million for the three months endedMarch 31, 2020 . •Non-interest expense was$17.3 million for the three months endedMarch 31, 2021 compared to$16.1 million for the three months endedMarch 31, 2020 . Operating expense, which excludes certain one-time and discrete items, totaled$17.4 million for the three months endedMarch 31, 2021 compared to$15.9 million for the three months endedMarch 31, 2020 . •The efficiency ratio improved to 62.19% for the three months endedMarch 31, 2021 , down from 67.74% for the three months endedMarch 31, 2020 . •Total assets atMarch 31, 2021 increased$52.9 million , or 8.2% annualized, to$2.621 billion from$2.568 billion atDecember 31, 2020 . •Period-end gross loans and leases receivable atMarch 31, 2021 increased$89.1 million , or 16.6% annualized, to$2.235 billion from$2.146 billion as ofDecember 31, 2020 . Average gross loans and leases of$2.183 billion increased$449.2 million , or 25.9%, for the three months endedMarch 31, 2021 , compared to$1.734 billion for the same period in 2020. •Period-end gross loans and leases receivable, excluding net PPP loans, atMarch 31, 2021 increased$46.9 million , or 9.8% annualized, to$1.968 billion from$1.921 billion as ofDecember 31, 2020 . Average gross loans and leases, excluding net PPP loans, of$1.941 billion increased$207.0 million , or 11.9%, for the three months endedMarch 31, 2021 , compared to$1.734 billion for the same period in 2020. 40 -------------------------------------------------------------------------------- Table of Contents •PPP loans and PPP deferred processing fees were$272.7 million and$5.1 million , respectively, atMarch 31, 2021 . Average PPP loans, net of deferred processing fees, were$242.2 million for the three months endedMarch 31, 2021 . •Non-performing assets were$19.0 million and 0.73% of total assets as ofMarch 31, 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 0.81% as ofMarch 31, 2021 . •The allowance for loan and lease losses increased$461,000 , or 1.6%, compared toDecember 31, 2020 . The allowance for loan and lease losses decreased to 1.29% of total loans, compared to 1.33% atDecember 31, 2020 . Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.47% of total loans as ofMarch 31, 2021 , compared to 1.48% as ofDecember 31, 2020 . •Period-end in-market deposits atMarch 31, 2021 increased$54.2 million , or 12.9% annualized, to$1.737 billion from$1.683 billion as ofDecember 31, 2020 . Average in-market deposits of$1.722 billion increased$356.0 million , or 26.1%, for the three months endedMarch 31, 2021 , compared to$1.366 billion for the same period in 2020. •Private wealth and trust assets under management and administration increased by$137.5 million , or 24.5% annualized, to$2.387 billion atMarch 31, 2021 , compared to$2.249 billion atDecember 31, 2020 . •OnJanuary 28, 2021 , the Board of Directors of the Corporation adopted a new share repurchase program that authorizes the Corporation to repurchase up to$5 million of the Corporation's common stock over a period of approximately twelve months, ending onJanuary 31, 2022 . As ofMarch 31, 2021 , the Corporation had repurchased 5,736 shares of its common stock at a weighted average price of$22.49 per share, for a total value of$129,000 . •OnJanuary 29, 2021 , the Corporation's Board of Directors declared a regular quarterly dividend of$0.18 per share. The quarterly dividend represents a 9% increase over the quarterly dividend declared inOctober 2020 and, based on fourth quarter 2020 earnings per share, a dividend payout ratio of 25.5%. This regular cash dividend was payable onFebruary 18, 2021 to shareholders of record at the close of business onFebruary 8, 2021 . The Board of Directors routinely considers dividend declarations as part of its normal course of business. 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 prevents a government shutdown. The CAA allows 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 began accepting and processing applications for second draw PPP loans onJanuary 13, 2021 . As ofMarch 31, 2021 , the Corporation had$272.7 million in gross PPP loans outstanding and deferred processing fees outstanding of$5.1 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 months endedMarch 31, 2021 , the Corporation recognized$2.2 million of processing fees 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 at all, 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. As ofMarch 31, 2021 , the Corporation had deferred loans outstanding of$13.0 million , or 0.7% of gross loans and leases, excluding gross PPP loans, compared to$323.2 million , or 18.6% of gross loans and leases, excluding gross PPP loans, as ofJune 30, 2020 . 41
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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
March 31, 2021
Collateral Type
Non Real
Industries Description Balance Real Estate Estate
(In Thousands)
Real Estate and Rental and Leasing $ 9,425 $ 9,425 $ -
Manufacturing 3,000 - 3,000
Professional, Scientific, and Technical Services 39 - 39
Other Services (except Public Administration) 328 212 116
Educational Services 195 195 -
Administrative and Support and Waste Management and
Remediation Services 11 - 11
Total deferred loan balances $ 12,998 $ 9,832 $ 3,166 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
March 31, 2021
Category
I II III IV Total
(Dollars in Thousands)
Total deferred loan balances $ 407 $ 11 $ 12,425 $ 155 $ 12,998
% of Total 3.1 % 0.1 % 95.6 % 1.2 % 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
March 31, 2021 December 31, 2020
% Gross Loans % Gross Loans
Industries: Balance and Leases (1) Balance and Leases (1)
(Dollars in Thousands)
Retail (2) (3) $ 74,534 3.8 % $ 62,719 3.3 %
Hospitality 82,604 4.2 % 80,832 4.2 %
Entertainment 13,943 0.7 % 14,208 0.7 %
Restaurants & food service 23,385 1.2 % 24,854 1.3 %
Total outstanding exposure $ 194,466 9.9 % $ 182,613 9.5 %
(1)Excluding net PPP loans.
(2)Includes $40.2 million and $48.9 million in loans secured by commercial real
estate as of March 31, 2021 and December 31, 2020 , respectively.
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(3)Includes $21.3 million and $7.7 million in fully collateralized asset-based
loans as of March 31, 2021 and December 31, 2020 , respectively.
As of March 31, 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 significant 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 how the
crisis may ultimately affect the Corporation's loan portfolio.
Results of OperationsTop Line Revenue
Top line revenue, comprised of net interest income and non-interest income, increased 19.6% for the three months endedMarch 31, 2021 compared to the same period in the prior year primarily due to a$3.8 million , or 22.4%, increase in net interest income and a$781,000 , or 12.2%, increase in non-interest income. The increase in net interest income was driven by an increase in average loans and leases outstanding, and loan fees in lieu of interest, while the increase in non-interest income was primarily a result of an increase in gains on the sale of SBA loans and increase in private wealth fee income.
The components of top line revenue were as follows:
For the Three Months Ended March 31,
2021 2020 $ Change % Change
(Dollars in Thousands)
Net interest income $ 20,863 $ 17,050 $ 3,813 22.4 %
Non-interest income 7,195 6,414 781 12.2
Top line revenue $ 28,058 $ 23,464 $ 4,594 19.6
Annualized Return on Average Assets and Annualized Return on Average Equity
ROAA for the three months endedMarch 31, 2021 increased significantly to 1.51% compared to 0.62% for the three months endedMarch 31, 2020 . The increase in ROAA was primarily due to a decrease in the provision for loan and lease losses related to a large loan recovery received inJanuary 2021 , increase in fees in lieu of interest, and increase in gains on the sale of SBA loans. This 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 months endedMarch 31, 2021 was 18.48% compared to 7.14% for the three months endedMarch 31, 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 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 that is associated with certain one-time items and other discrete items. The efficiency ratio was 62.19% for the three months endedMarch 31, 2021 compared to 67.74% for the three months endedMarch 31, 2020 . Operating revenue growth outpaced the change in operating expense for the three months endedMarch 31, 2021 , resulting in positive operating leverage. This improvement was attributable to an increase in net interest income driven by a 25.9% increase in average loans and leases receivable, an$813,000 increase in gains on the sale of SBA 43 -------------------------------------------------------------------------------- Table of Contents loans, and$2.3 million increase in fees in lieu of interest. The increase in fees in lieu of interest included$2.2 million in PPP processing fees. The increase in operating revenue was partially offset by a$1.6 million , or 14.5%, increase in compensation expense reflecting in part the Corporation's continued execution of its growth strategy. Full-time equivalent employees ("FTE") were 306 as ofMarch 31, 2021 , increasing by 25, or 8.9%, from 281 as ofMarch 31, 2020 . We believe we will continue to generate modest positive operating leverage and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth. These initiatives include efforts to expand our specialty finance lines of business, 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 to its most comparable GAAP measure.
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
2021 2020 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 17,330 $ 16,146 $ 1,184 7.3 %
Less:
Net loss on foreclosed properties 3 102 (99) (97.1) Amortization of other intangible assets 8 9 (1) (11.1) SBA recourse (benefit) provision (130) 25 (155) N/A Tax credit investment impairment - 113 (113) N/A Total operating expense$ 17,449 $ 15,897 $ 1,552 9.8 Net interest income 20,863 17,050 3,813 22.4 Total non-interest income 7,195 6,414 781 12.2
Less:
Net loss on sale of securities - (4) 4 N/A Adjusted non-interest income 7,195 6,418 777 12.1 Total operating revenue$ 28,058 $ 23,468 $ 4,590 19.6 Efficiency ratio 62.19 % 67.74 % Pre-tax, pre-provision adjusted earnings$ 10,609 $ 7,571 $ 3,038 40.1 Average total assets 2,577,164 2,104,862 472,302 22.4 Pre-tax, pre-provision adjusted return on average assets 1.65 % 1.44 % 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 months endedMarch 31, 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. 44
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Increase (Decrease) for the Three Months
Ended March 31,
2021 Compared to 2020
Rate Volume Net
(In Thousands)
Interest-earning assets
Commercial real estate and other mortgage loans(1) $ (3,147) $ 2,152 $ (995)
Commercial and industrial loans(1) (1,465) 3,233 1,768
Direct financing leases(1) 162 (26) 136
Consumer and other loans(1) (52) 89 37
Total loans and leases receivable (4,502) 5,448 946
Mortgage-related securities (301) (94) (395)
Other investment securities (28) 88 60
FHLB and FRB Stock (419) 366 (53)
Short-term investments (93) (31) (124)
Total net change in income on interest-earning assets (5,343) 5,777 434
Interest-bearing liabilities
Transaction accounts (738) 341 (397)
Money market accounts (1,563) (32) (1,595)
Certificates of deposit (252) (321) (573)
Wholesale deposits (710) 178 (532)
Total deposits (3,263) 166 (3,097)
FHLB advances (1,301) 991 (310)
Other borrowings (12) 43 31
Junior subordinated notes (3) - (3)
Total net change in expense on interest-bearing liabilities (4,579) 1,200 (3,379)
Net change in net interest income $ (764) $ 4,577 $ 3,813 (1)The average balances of loans and leases include non-accrual loans and leases and loans held for sale.
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The table 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 months endedMarch 31, 2021 and 2020. The average balances are derived from average daily balances. For the Three Months Ended March 31, 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)$ 1,357,141 $ 12,528 3.69 %$ 1,153,972 $ 13,523 4.69 % Commercial and industrial loans(1) 757,898 9,625 5.08 515,935 7,857 6.09 Direct financing leases(1) 22,271 244 4.38 27,961 108 1.55 Consumer and other loans(1) 45,648 398 3.49 35,874 361 4.03 Total loans and leases receivable(1) 2,182,958 22,795 4.18 1,733,742 21,849 5.04 Mortgage-related securities(2) 163,324 666 1.63 180,590 1,061 2.35 Other investment securities(3) 42,177 187 1.77 23,280 127 2.18 FHLB and FRB stock 12,465 152 4.88 8,512 205 9.63 Short-term investments 24,575 6 0.10 35,763 130 1.45 Total interest-earning assets 2,425,499 23,806 3.93 1,981,887 23,372 4.72 Non-interest-earning assets 151,665 122,975 Total assets$ 2,577,164 $ 2,104,862 Interest-bearing liabilities Transaction accounts$ 521,130 250 0.19$ 271,531 647 0.95 Money market accounts 657,690 274 0.17 669,482 1,869 1.12 Certificates of deposit 57,424 177 1.23 134,000 750 2.24 Wholesale deposits 166,752 318 0.76 132,468 850 2.57 Total interest-bearing deposits 1,402,996 1,019 0.29 1,207,481 4,116 1.36 FHLB advances 366,670 1,249 1.36 325,929 1,559 1.91 Other borrowings 27,296 401 5.88 24,385 370 6.07 Junior subordinated notes 10,063 274 10.89 10,048 277 11.03 Total interest-bearing liabilities 1,807,025 2,943 0.65 1,567,843 6,322 1.61 Non-interest-bearing demand deposit accounts 485,863 291,129 Other non-interest-bearing liabilities 73,695 62,367 Total liabilities 2,366,583 1,921,339 Stockholders' equity 210,581 183,523 Total liabilities and stockholders' equity$ 2,577,164 $ 2,104,862 Net interest income$ 20,863 $ 17,050 Interest rate spread 3.27 % 3.10 % Net interest-earning assets$ 618,474 $ 414,044 Net interest margin 3.44 % 3.44 % Average interest-earning assets to average interest-bearing liabilities 134.23 % 126.41 % Return on average assets(4) 1.51 0.62 Return on average equity(4) 18.48 7.14 Average equity to average assets 8.17 8.72 Non-interest expense to average assets(4) 2.69 3.07 (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. 46
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Comparison of Net Interest Income for the Three Months Ended
2020
Net interest income increased $3.8 million , or 22.4%, during the three months
ended March 31, 2021 compared to the three months ended March 31, 2020 . The
increase in net interest income reflected an increase in average gross loans and
leases, an increase in fees in lieu of interest, and a decrease in interest
expense, partially offset by adjusted net interest margin compression. Fees in
lieu of interest, which can vary from quarter to quarter, totaled $3.1 million
for the three months ended March 31, 2021 , compared to $798,000 for the same
period in 2020. Excluding fees in lieu of interest and interest income from PPP
loans, net interest income increased $923,000 , or 5.7%. Average gross loans and
leases for the three months ended March 31, 2021 increased $449.2 million , or
25.9%, compared to the three months ended March 31, 2020 . Excluding net PPP
loans, average gross loans and leases for the three months ended March 31, 2021
increased $207.0 million , or 11.9%, compared to the three months ended March 31,
2020 .
The yield on average loans and leases for the three months ended March 31,
2021 declined to 4.18%, compared to 5.04% for the three months ended March 31,
2020 . 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 months ended March 31, 2021 was 3.94%, compared to 4.86% for the three
months ended, March 31, 2020 . Similarly, the yield on average interest-earning
assets for the three months ended March 31, 2021 measured 3.93% compared to
4.72% three months ended March 31, 2020 . 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 months ended March 31, 2021 was 3.69%, compared to
4.56% for the three months ended March 31, 2020 . The decline in yields for the
three months ended March 31, 2021 compared to the three months ended March 31,
2020 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 security cash flows at historically low interest rates.
The average rate paid on total interest-bearing liabilities for the three
months ended March 31, 2021 decreased to 0.65% compared to 1.61% for the three
months ended March 31, 2020 . 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 three
months ended March 31, 2021 compared to the three months ended March 31, 2020 ,
the average target federal funds rate decreased 115 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 March 31,
2021 increased $40.7 million to $366.7 million at an average rate paid of 1.36%,
compared to $325.9 million at an average rate paid of 1.91% for the three months
ended March 31, 2020 . As of March 31, 2021 , the weighted average original
maturity of our FHLB term advances was 5.7 years, compared to 5.9 years as of
March 31, 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 March 31,
2021 increased $34.3 million to $166.8 million at an average rate paid of 0.76%,
compared to $132.5 million at an average rate paid of 2.57%. The increase in
wholesale deposits was primarily due to receiving non-reciprocal interest
bearing transaction accounts, which was partially offset by a decrease in
brokered certificates of deposits. As of March 31, 2021 , the weighted average
original maturity of our termed wholesale deposits was 3.9 years, compared to
4.8 years as of March 31, 2020 . The rate paid on average wholesale funding 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 3.44% for both the three months ended March 31,
2021 and March 31, 2020 . Excluding fees in lieu of interest, PPP loan interest
income, Federal Reserve interest income, and FHLB dividends, net interest margin
measured 3.20% for the three months ended March 31, 2021 , compared to 3.32% for
the three months ended March 31, 2020 . The decrease 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 specialty
finance lines of business 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.
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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 $54.2 million , or 12.9% annualized, to $1.737 billion at
March 31, 2021 , compared to $1.683 billion at December 31, 2020 . Average
in-market deposits increased $356.0 million , or 26.1%, to $1.722 billion for the
three months ended March 31, 2021 , compared to $1.366 billion for the three
months ended March 31, 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 full impact of COVID-19 is still unknown. It has caused substantial
disruption in international and U.S. economies, markets, and employment. The
outbreak has had a significant adverse impact on certain industries the
Corporation serves, including retail, hospitality, entertainment, and
restaurants and food services. Due to COVID-19 and the economic impact it could
have on the Corporation's loan portfolio, additional detail about certain
exposure to stressed industries is included in the section titled COVID-19
Update, above.
The Corporation recognized a $2.1 million provision benefit for the three
months ended March 31, 2021 , compared to provision expense of $3.2 million for
the three months ended March 31, 2020 . The quarterly provision benefit was
primarily due to a $2.5 million net recovery and $984,000 reduction in the
general reserve related to a decrease in historical loss factors. This reserve
release was partially offset by a $1.4 million increase in the commercial real
estate general reserve associated with an increase in qualitative factors due to
the recent rate of growth in the segment.
The following table shows the components of the provision for loan and lease
losses for the three months ended March 31, 2021 compared to the three months
ended March 31, 2020 .
For the Three Months Ended
March 31,
2021 2020
(In Thousands)
Change in general reserve due to
subjective factor changes $ 1,082 $ 2,831
Change in general reserve due to
historical loss factor changes (984) (255)
Charge-offs 144 131
Recoveries (2,673) (177)
Change in specific reserves on
impaired loans, net (194) 436
Change due to loan growth, net 557 216
Total provision for loan and lease
losses $ (2,068) $ 3,182
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The legacy on-balance sheet SBA portfolio, defined as SBA 7(a) and Express
loans originated in 2016 and prior, has been a source of elevated non-performing
assets. Additional information on our legacy SBA portfolio is as follows:
As of
March 31, December 31, March 31,
2021 2020 2020
(In Thousands)
Performing loans:
Off-balance sheet loans $ 17,523 $ 23,354 $ 31,212
On-balance sheet loans 7,340 11,117 17,935
Gross loans 24,863 34,471 49,147
Non-performing loans:
Off-balance sheet loans 1,835 1,931 4,887
On-balance sheet loans 6,832 7,435 13,833
Gross loans 8,667 9,366 18,720
Total loans:
Off-balance sheet loans 19,358 25,285 36,099
On-balance sheet loans 14,172 18,552 31,768
Gross loans $ 33,530 $ 43,837 $ 67,867
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 how the
crisis may ultimately affect the Corporation's loan portfolio.
Comparison of Non-Interest Income for the Three Months Ended March 31,
2021 and 2020Non-Interest Income
For the three months endedMarch 31, 2021 non-interest income increased by$781,000 , or 12.2%, to$7.2 million from$6.4 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 through greater contribution from fee-based revenues. Total non-interest income accounted for 25.6% of total revenues for the three months endedMarch 31, 2021 , compared to 27.3% for the three months endedMarch 31, 2020 , exceeding our long-term goal of 25% in both periods of comparison. Management believes the expected gradual expansion of its SBA lending program, fees from commercial loan interest rate swap activity with commercial borrowers, and the geographic expansion of its private wealth management division in our bank markets outside ofGreater Dane County will allow the Corporation to sustain a strategic target of 25% over the long-term. The increase in total non-interest income for the three months endedMarch 31, 2021 primarily reflected a significant increase in gains on the sale of SBA loans, increase in returns on mezzanine fund investments, and strong private wealth management services fee income, partially offset by a decrease in swap fees. 49
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The components of non-interest income were as follows:
For
the Three Months Ended
2021 2020 $ Change % Change
(Dollars in Thousands)
Private wealth management services fee
income $ 2,407 $ 2,112 $ 295 14.0 %
Gain on sale of SBA loans 1,078 265 813 NM
Service charges on deposits 917 818 99 12.1
Loan fees 545 485 60 12.4
Increase in cash surrender value of
bank-owned life insurance 350 295 55 18.6
Net loss on sale of securities - (4) 4 NM
Swap fees 684 1,681 (997) (59.3)
Other non-interest income 1,214 762 452 59.3
Total non-interest income $ 7,195 $ 6,414 $ 781 12.2
Fee income ratio(1) 25.6 % 27.3 %
(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$295,000 , or 14.0%, for the three months endedMarch 31, 2021 , compared to the three months endedMarch 31, 2020 . Private wealth management services 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 ofMarch 31, 2021 , private wealth and trust assets under management and administration totaled a record$2.387 billion , increasing$137.5 million , or 6.1%, compared to$2.249 billion as ofDecember 31, 2020 and$722.1 million , or 43.4%, compared to$1.664 billion as ofMarch 31, 2020 . Commercial loan interest rate swap fee income was$684,000 for the three months endedMarch 31, 2021 , compared to$1.7 million for the three months endedMarch 31, 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$645.1 million as ofMarch 31, 2021 , compared to$397.7 million as ofMarch 31, 2020 . Interest rate swaps continue to 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. Gains on sale of SBA loans increased$813,000 for the three months endedMarch 31, 2021 , compared to the three months endedMarch 31, 2020 . Gross SBA loan commitments closed for the three months endedMarch 31, 2021 totaled$9.7 million , compared to$6.2 million for the same period in 2020. Based on this recent activity, an enhanced business development team, and a consistent pipeline of new business, management believes the annual gain on sale of SBA loans will continue to increase at a measured pace moving forward. Other non-interest income for the three months endedMarch 31, 2021 totaled$1.2 million , compared to$762,000 for three months endedMarch 31, 2020 . The increase was primarily due to above average returns from the Corporation's investments in mezzanine funds. 50
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Comparison of Non-Interest Expense for the Three Months Ended March,
2021 and 2020
Non-Interest Expense
Non-interest expense for the three months ended March 31, 2021 increased by $1.2
million , or 7.3%, to $17.3 million compared to $16.1 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 $1.6 million , or 9.8%,
to $17.4 million for the three months ended March 31, 2021 compared to $15.9
million for the same period in 2020. The increase in operating expense was
primarily due to an increase in compensation, computer software, and FDIC
insurance expense, partially offset by a decrease in other non-interest
expense.
The components of non-interest expense were as follows:
For
the Three Months Ended
2021 2020 $ Change % Change
(Dollars in Thousands)
Compensation $ 12,657 $ 11,052 $ 1,605 14.5 %
Occupancy 552 572 (20) (3.5)
Professional fees 866 819 47 5.7
Data processing 770 677 93 13.7
Marketing 391 461 (70) (15.2)
Equipment 246 291 (45) (15.5)
Computer software 1,115 889 226 25.4
FDIC insurance 362 208 154 74.0
Collateral liquidation costs 94 121 (27) (22.3)
Net loss on foreclosed properties 3 102 (99) (97.1)
Impairment on tax credit investments - 113 (113) NM
SBA recourse (benefit) provision (130) 25 (155) NM
Other non-interest expense 404 816 (412) (50.5)
Total non-interest expense $ 17,330 $ 16,146 $ 1,184 7.3
Total operating expense(1) $ 17,449 $ 15,897 $ 1,552 9.8
Full-time equivalent employees 306 281
(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 months endedMarch 31, 2021 was$12.7 million , an increase of$1.6 million , or 14.5%, compared to the three months endedMarch 31, 2020 . The increase reflects new hires, annual merit increases, growth in employee benefit costs, and an increase in individual incentive compensation. Average full-time equivalent employees increased to 305, up 6.6% for the quarter endedMarch 31, 2021 , compared to 286 for the quarter endedMarch 31, 2020 . The increase reflects new hires, annual merit increases, and an increase in the annual corporate incentive plan accrual compared to a reduction to the same accrual during the first quarter of 2020 due to uncertainty amid the COVID-19 pandemic. We believe we will continue to generate modest positive operating leverage and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth. These initiatives include efforts to expand our specialty finance lines of business, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets. 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. Computer software expense increased$226,000 to$1.1 million for the three months endedMarch 31, 2021 compared to$889,000 for the three months endedMarch 31, 2020 . The increase was principally due to investments in technology platforms to improve the client experience and continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy.FDIC insurance expense for the three months endedMarch 31, 2021 was$362,000 , an increase of$154,000 compared to the three months endedMarch 31, 2020 . Management expectsFDIC insurance expense to increase commensurate with asset growth going forward. 51
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No historic tax credits or related impairment were recognized for the three months endedMarch 31, 2021 . The impairment on tax credit investments for the three months endedMarch 31, 2020 is related to a new market tax credit which is more than offset by a reduction to income tax expense, which results in a net benefit to earnings. Management intends to continue actively pursuing in-market tax credit opportunities throughout 2021 and beyond. SBA recourse provision was a benefit of$130,000 for the three months endedMarch 31, 2021 , compared to recourse expense of$25,000 for the three months endedMarch 31, 2020 . The total recourse reserve balance was$593,000 , or 0.7% of total sold SBA loans outstanding, atMarch 31, 2021 , compared to$723,000 , or 0.9%, atDecember 31, 2020 , and$1.1 million , or 1.6%, atMarch 31, 2020 . Changes to SBA recourse reserves may be a source of non-interest expense volatility in future quarters, though the magnitude of this volatility should continue to diminish over time as the outstanding balance of sold legacy SBA loans continues to decline. Other non-interest expense for the three months endedMarch 31, 2021 was$404,000 , a decrease of$412,000 compared to the three months endedMarch 31, 2020 . The decrease was principally due to a decrease in business-related travel expenses due to the Corporation's adherence to COVID-19 restrictions and a reduction in the credit valuation adjustment ("CVA") related to the commercial loan interest rate swap program. 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 ofMarch 31, 2020 . Income Taxes Income tax expense totaled$3.1 million for the three months endedMarch 31, 2021 compared to an income tax expense of$858,000 for the three months endedMarch 31, 2020 . The effective tax rate, excluding tax credits and other discrete items, for the three months endedMarch 31, 2021 was 23.4% compared to 20.7% for the three months endedMarch 31, 2020 . Financial Condition
General
Total assets increased by$52.9 million , or 2.1%, to$2.621 billion as ofMarch 31, 2021 compared to$2.568 billion atDecember 31, 2020 . The increase in total assets was primarily driven by loan growth, partially offset by a decrease in securities. Short-Term Investments Short-term investments increased by$11.4 million , or 41.6%, to$38.7 million atMarch 31, 2021 from$27.4 million atDecember 31, 2020 . Our short-term investments primarily consist of interest-bearing deposits held at the FRB and commercial paper. We value the safety and soundness provided by the FRB and therefore incorporate short-term investments in our on-balance sheet liquidity program. As ofMarch 31, 2021 andDecember 31, 2020 , we did not hold any commercial paper. Due to current economic conditions, we decided to temporarily exit this short-term investment. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio. The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to be in a position to benefit from an anticipated change in the yield curve level and shape. 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, decreased by$12.3 million , or 5.8%, to$198.0 million atMarch 31, 2021 compared to$210.3 million atDecember 31, 2020 . During the three months endedMarch 31, 2021 , due to a steepening yield curve, we recognized unrealized losses of$2.2 million before income taxes through other comprehensive income, compared to gains of$4.5 million for the same period in 2020. As ofMarch 31, 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 5.1 years and 5.0 years, respectively. Our investment philosophy remains as stated in our most recent Annual Report on Form 10-K. 52
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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 ofMarch 31, 2021 . Loans and Leases Receivable Loans and leases receivable, net of allowance for loan and lease losses, increased by$88.7 million to$2.206 billion atMarch 31, 2021 from$2.117 billion atDecember 31, 2020 which was driven by second draw PPP loans and commercial loan growth, partially offset by PPP loan forgiveness. Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by$46.4 million , or 9.8% annualized, to$1.939 billion atMarch 31, 2021 fromDecember 31, 2020 . Total commercial real estate ("CRE") increased$33.4 million to$1.392 billion , up from$1.359 billion atDecember 31, 2020 . Non-owner occupied CRE, multi-family, and construction loans were the largest contributors to CRE loan growth as ofMarch 31, 2021 , increasing$27.6 million ,$10.8 million , and$10.3 million , respectively, fromDecember 31, 2020 . There continues to be a concentration in CRE loans which represented 70.5% and 63.2% of our total loans, excluding net PPP loans, as ofMarch 31, 2021 andDecember 31, 2020 , respectively. As ofMarch 31, 2021 , 18.4% 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 business owners and guarantors have robust liquidity, operating performance, and collateral positions. Even with these higher standards, the Corporation has been able to grow loans and deepen banking relationships. Our C&I portfolio increased$52.0 million , or 28.4% annualized, to$784.3 million from$732.3 million atDecember 31, 2020 . Excluding net PPP loans, C&I loans increased$9.7 million , or 7.7% annualized, to$516.7 million from$507.0 million atDecember 31, 2020 primarily due to a$15.6 million increase in asset-based loans. Some of our specialty finance products have historically experienced counter cyclical growth, growing during times of economic stress and uncertainty. As such, management expects asset-based loans and accounts receivable financing volume to increase in 2021. We will continue to actively pursue C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management, and private wealth management relationships which generate additional fee revenue. 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 proper risk rating using a nine grade risk rating system 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 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 ofMarch 31, 2021 , deposits increased by$47.2 million , or 10.2% annualized, to$1.903 billion from$1.856 billion atDecember 31, 2020 primarily due to a$81.5 million increase in transaction accounts, partially offset by a decrease in certificate of deposits and money market accounts of$17.9 million and$9.4 million , respectively. 53 -------------------------------------------------------------------------------- Table of Contents Transaction account balances increased primarily due to the influx of PPP loan proceeds. Management attributes the transition from money market accounts to reciprocal transaction accounts with fullFDIC insurance to our clients' preferences for safety and soundness amid the economic uncertainty created by the COVID-19 pandemic. 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$1.722 billion for the three months endedMarch 31, 2021 , compared to$1.569 billion for the year endedDecember 31, 2020 . FHLB Advances and Other Borrowings As ofMarch 31, 2021 , FHLB advances and other borrowings increased by$29.3 million , or 7.0%, to$448.4 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, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances. As ofMarch 31, 2021 andDecember 31, 2020 , the Corporation had other borrowings of$8.9 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 and 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 Paycheck Protection Program Liquidity Facility ("PPPLF") in the event funding was required to support the Banks PPP lending efforts. OnApril 28, 2020 , the Corporation borrowed$29.6 million from the PPPLF at a rate of 0.35%. The borrowing was fully collateralized by a tranche of PPP loans originated by the Bank onApril 15, 2020 and matures onApril 15, 2022 , or when the tranche of PPP loans utilized to collateralize the PPPLF borrowing are forgiven, whichever comes first. As ofNovember 2, 2020 , the borrowing was paid in full. 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$247.4 million , or 62.2%, to$645.1 million as ofMarch 31, 2021 , compared to$397.7 million as ofMarch 31, 2020 . The fair value of these interest rate swaps decreased$23.3 million , or 47.1%, to$26.1 million as ofMarch 31, 2021 , compared to$49.4 million as ofMarch 31, 2020 . The significant decline in fair value of the derivative contracts is directly related to the level of interest rates as ofMarch 31, 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. 54
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Asset QualityImpaired Assets
Total impaired assets consisted of the following at
March 31, December 31,
2021 2020
(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied $ 2,169 $ 5,429
Commercial real estate - non-owner occupied 3,016 3,783
Land development - 890
Construction - -
Multi-family - -
1-4 family 493 250
Total non-accrual commercial real estate 5,678 10,352
Commercial and industrial 12,716 16,155
Direct financing leases, net 49 49
Consumer and other:
Home equity and second mortgages 534 40
Other 15 21
Total non-accrual consumer and other loans 549 61
Total non-accrual loans and leases 18,992 26,617
Foreclosed properties, net 31 34
Total non-performing assets 19,023 26,651
Performing troubled debt restructurings 59 46
Total impaired assets Total non-accrual loans and leases to gross loans and leases 0.85 % 1.24 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
0.85 1.24
Total non-performing assets to total assets 0.73 1.04
Allowance for loan and lease losses to gross loans and leases 1.29 1.33
Allowance for loan and lease losses to non-accrual loans and leases
152.60 107.15
Net PPP loans outstanding as of March 31, 2021 and December 31, 2020 , were
$267.6 million and $225.3 million , respectively. The following asset quality
ratios exclude net PPP loans as they are fully guaranteed by the SBA:
March 31, December 31,
2021 2020
Total non-accrual loans and leases to gross loans and leases 0.96 % 1.38 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
0.96 1.38
Total non-performing assets to total assets 0.81 1.14
Allowance for loan and lease losses to gross loans and leases 1.47 1.48
Non-accrual loans decreased $7.6 million , or 28.6%, to $19.0 million at
March 31, 2021 , compared to $26.6 million at December 31, 2020 . The decrease in
non-accrual loans was principally due to loan payoffs and loans returning to
accrual status. The Corporation's non-accrual loans as a percentage of total
gross loans and leases measured 0.85% and 1.24% at March 31, 2021 and
December 31, 2020 , respectively. Non-accrual loans as a percentage of total
gross loans and leases, excluding net PPP loans, was 0.96% and 1.38% at
March 31, 2021 and December 31, 2020 , respectively. As of March 31, 2021 and
December 31 ,
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2020,
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 0.73% atMarch 31, 2021 from 1.04% atDecember 31, 2020 . As ofMarch 31, 2021 , the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.4% of the total portfolio was in a current payment status, compared to 99.0% as ofDecember 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 ofMarch 31, 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. 56
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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 Three Months Ended Year Ended
March 31, December 31,
2021 2020 2020
(In Thousands)
Impaired loans and leases with no impairment
reserves required $ 10,391
8,660 15,025 7,697
Total impaired loans and leases 19,051 28,031 26,663
Less: Impairment reserve (included in allowance
for loan and lease losses) 3,487 3,802 3,681
Net impaired loans and leases $ 15,564 $ 24,229 $ 22,982
Average impaired loans and leases $ 22,091 $ 22,144 $ 27,703
Foregone interest income attributable to impaired
loans and leases $ 603
68 9 636
Net foregone interest income on impaired loans and leases
$ 535 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 Three Months Ended March Year Ended
31, 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 - - 80
Proceeds from sale of foreclosed properties - (1,148) (2,582)
Net gain (loss) on sale of foreclosed
properties - 16 (20)
Impairment adjustments (3) (118) (363)
Balance at the end of the period $ 31 $ 1,669 $ 34
Allowance for Loan and Lease Losses
The allowance for loan and lease losses increased$461,000 , or 1.6%, from$28.5 million as ofDecember 31, 2020 to$29.0 million as ofMarch 31, 2021 . The allowance for loan and lease losses as a percentage of gross loans and leases decreased from 1.33% as ofDecember 31, 2020 to 1.29% as ofMarch 31, 2021 . The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.47% as ofMarch 31, 2021 compared to 1.48% as ofDecember 31, 2020 . The decreased in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by a significant loan recovery and the related impact it had on our historical loss factors. This general reserve release was offset by an increase in the commercial real estate general reserve associated with an increase in qualitative factors due to the recent rate of growth in the segment and 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. Please refer to the section titled COVID-19 Update for additional information. During the three months endedMarch 31, 2021 , we recorded net recoveries on impaired loans and leases of$2.5 million , comprised of$144,000 of charge-offs and$2.7 million of recoveries. We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed, in particular as it relates to our commercial clients impacted by the COVID-19 pandemic. Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios. 57
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As ofMarch 31, 2021 andDecember 31, 2020 , our allowance for loan and lease losses to total non-accrual loans and leases was 152.60% and 107.15%, respectively. This ratio increased 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 ofMarch 31, 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. 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 ofMarch 31, 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$29.0 million , or 1.29% of gross loans and leases, atMarch 31, 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. 58
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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
March 31,
2021 2020
(Dollars in Thousands)
Allowance at beginning of period $ 28,521 $ 19,520 Charge-offs:
Commercial real estate: Commercial real estate - owner occupied - - Commercial real estate - non-owner occupied - - Construction and land development - - Multi-family - - 1-4 family - - Commercial and industrial (144) (125) Direct financing leases - - Consumer and other: Home equity and second mortgages - - Other - (6) Total charge-offs (144) (131) Recoveries: Commercial real estate: Commercial real estate - owner occupied 140 1 Commercial real estate - non-owner occupied - - Construction and land development 2,078 - Multi-family - - 1-4 family 1 - Commercial and industrial 453 176 Direct financing leases - - Consumer and other: Home equity and second mortgages 1 - Other - - Total recoveries 2,673 177 Net recoveries 2,529 46 Provision for loan and lease losses (2,068) 3,182 Allowance at end of period$ 28,982 $ 22,748
Annualized net recoveries as a percent of average gross loans and leases
(0.46) % (0.01) %
Annualized net recoveries as a percent of average gross loans and leases, excluding average net PPP loans
(0.52) % (0.01) %
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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 March 31, 2021 were the interest payments due on subordinated
and junior subordinated notes. On January 29, 2021 , the Bank's Board of
Directors declared a dividend in the aggregate amount of $2.0 million bringing
year-to-date dividend declarations to $2.0 million . The capital ratios of the
Bank met all applicable regulatory capital adequacy requirements in effect on
March 31, 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, Federal Reserve Discount Window advances, and
Federal Reserve PPPLF 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
March 31, 2021 and December 31, 2020 , our immediate on-balance sheet liquidity
was $724.2 million and $640.2 million , respectively. The increase as of
March 31, 2021 compared to December 31, 2020 is principally due to the Banks
ability to pledge PPP loans and borrow from the Federal Reserve PPPLF. Excluding
Federal Reserve PPPLF availability, immediate on-balance sheet liquidity was
$456.6 million and $414.9 million as of March 31, 2021 and December 31, 2020 ,
respectively. This increase in on-balance sheet liquidity compared to
December 31, 2020 is primarily due to a decrease in securities pledged. At
March 31, 2021 and December 31, 2020 , the Bank had $37.7 million and $44.4
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 $581.3 million of outstanding wholesale funds at March 31, 2021 ,
compared to $567.0 million of wholesale funds as of December 31, 2020 , which
represented 25.1% and 25.2%, respectively, of ending balance total bank funding.
Wholesale funds include FHLB advances, Federal Reserve PPPLF advances, brokered
certificates of deposit, and deposits gathered from internet listing services.
Total bank funding is defined as total deposits plus FHLB advances and Federal
Reserve PPPLF 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 $54.2 million , or 12.9% annualized,
to $1.737 billion at March 31, 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 remain
stable; 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 funds are
certificates of deposit which 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
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maturity terms and no call provisions. 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
March 31, 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 March 31, 2021 .
In the event that there is a disruption in the availability of wholesale funds
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
March 31, 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.
During the three months endedMarch 31, 2021 , operating activities resulted in a net cash inflow of$6.8 million , which included net income of$9.7 million , partially offset by a$2.1 million provision for loan and lease loss benefit. Net cash used in investing activities for the three months endedMarch 31, 2021 was approximately$79.5 million which consisted of cash outflows to fund net loan growth, partially offset by a net reduction in securities. Net cash provided by financing activities resulted in a net cash inflow of$74.6 million for the three months endedMarch 31, 2021 primarily due to a net increase in FHLB advances and a net increase in deposits. 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 ofMarch 31, 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 endedDecember 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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