FIRST BUSINESS FINANCIAL SERVICES, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)
Forward-looking statements
When used in this report the words or phrases "may," "could," "should," "hope," "might," "believe," "expect," "plan," "assume," "intend," "estimate," "anticipate," "project," "likely," or similar expressions are intended to identify "forward-looking statements." 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, inflation, supply chain issues, labor shortages, and the adverse effects of the COVID-19 pandemic on the global, national, and local economy, which may effect 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, together with the risks identified in Item 1A - Risk Factors, 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 shareholders and potential investors. Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. 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 update any forward-looking statements and we specifically disclaim any obligation to update them.
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
Consolidated Financial Statements and the Notes thereto.
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Overview We are a registered bank holding company incorporated under the laws of theState of Wisconsin and are engaged in the commercial banking business through our wholly-owned banking subsidiary, FBB. All of our operations are conducted throughFBB 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, 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, consumer lending, 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 extensive expertise within our nationwide specialized lending 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. Long-Term Strategic Plan In early 2019, management finalized the development of its five year strategic plan and began the implementation of strategies and initiatives that will drive successful execution. Management's objective over this five year period is to excel by building an expert team with diverse experiences who work together to impact client success more than any other financial partner. To meet this objective, we identified four key strategies which are linked to corporate financial goals, all business lines, and centralized administration functions to ensure communication and execution are consistent at all levels of the Corporation. These four strategies are described below: •We will identify, attract, develop, and retain a diverse, high performing team to positively impact the overall performance and efficiency of the Corporation. •We will increase internal efficiencies, deliver a differentiated client experience, and drive client experience utilizing technology where possible. •We will diversify and grow our deposit base. •We will optimize our business lines for diversification and performance.
The table below presents the Company’s performance for the years ended
As of and for the Year Ended December 31,
Key Performance Indicators 2019 2020 2021 2023 Goal
Return on average equity ("ROAE") 12.55% 8.64% 16.21% 13.50%
Return on average assets ("ROAA") 1.14% 0.70% 1.37% 1.15%
Top line revenue growth 9.1% 11.5% 8.4% ? 10% per year
In-market deposits to total bank funding 75.5% 74.8% 82.9% ? 75%
Employee engagement (1) 82% 91% 87% ? 80%
Client satisfaction (1) 93% 96% 93% ? 90%
(1) Anonymous surveys carried out annually
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Financial Performance Summary
Results as of and for the year ended
•Net income for the year endedDecember 31, 2021 was$35.8 million , increasing 110.6% compared to$17.0 million for the year endedDecember 31, 2020 . •Diluted earnings per common share were$4.17 for the year endedDecember 31, 2021 , increasing 111.4% compared to$1.97 in the prior year. •Return on average assets and return on average equity for the year endedDecember 31, 2021 were 1.37% and 16.21% respectively, compared to 0.70% and 8.64%, respectively, for 2020. •Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, for the year endedDecember 31, 2021 was$41.2 million , increasing 7.2% compared to$38.4 million for the year endedDecember 31, 2020 . Pre-tax, pre-provision adjusted return on average assets for the year endedDecember 31, 2021 was 1.58%, compared to 1.59% for the year endedDecember 31, 2020 . •Net interest margin was 3.44% for the year endedDecember 31, 2021 , increasing 4 basis points from 3.40% for the year endedDecember 31, 2020 . Adjusted net interest margin, which excludes certain one-time and discrete items, was 3.21% for the year endedDecember 31, 2021 , decreasing seven basis points from 3.28% for the year endedDecember 31, 2020 . •Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled$11.2 million for the year endedDecember 31, 2021 , increasing 19.8% compared to$9.3 million for the year endedDecember 31, 2020 . Loan fee amortization for the year endedDecember 31, 2021 andDecember 31, 2020 includes PPP processing fee income of$7.3 million and$5.3 million , respectively. •Top line revenue, which consists of net interest income and non-interest income, grew 8.4% to$112.8 million for the year endedDecember 31, 2021 , compared to$104.0 million for the year endedDecember 31, 2020 . •Provision for loan and lease losses was a net benefit of$5.8 million for the year endedDecember 31, 2021 , compared to provision expense of$16.8 million for the year endedDecember 31, 2020 . Net recoveries as a percentage of average loans and leases were 0.07% for the year endedDecember 31, 2021 , compared to net charge-offs of 0.39% for the year endedDecember 31, 2020 . •Total assets atDecember 31, 2021 increased$85.1 million , or 3.3%, to$2.653 billion from$2.568 billion atDecember 31, 2020 . •Period-end gross loans and leases receivable atDecember 31, 2021 increased$93.4 million , or 4.4%, to$2.239 billion from$2.146 billion as ofDecember 31, 2020 . Average gross loans and leases of$2.179 billion increased$167.8 million , or 8.3% for the year endedDecember 31, 2021 , compared to$2.011 billion for the same period in 2020. •Period-end gross loans and leases receivable, excluding net PPP loans, atDecember 31, 2021 increased$291.5 million , or 15.18%, to$2.212 billion from$1.921 billion as ofDecember 31, 2020 . Average gross loans and leases, excluding net PPP loans, of$2.027 billion increased$230.6 million , or 12.8% for the year endedDecember 31, 2021 , compared to$1.796 billion for the same period in 2020. •PPP loans and PPP deferred processing fees were$27.9 million and$557,000 , respectively, atDecember 31, 2021 . Average PPP loans, net of deferred processing fees, were$152.3 million for the year endedDecember 31, 2021 . •Non-performing assets were$6.5 million or 0.25% of total assets as ofDecember 31, 2021 , compared to$26.7 million or 1.04% of total assets as ofDecember 31, 2020 . Non-performing assets to total assets, excluding net PPP loans were 0.25% as ofDecember 31, 2021 , compared to 1.14% as ofDecember 31, 2020 . •The allowance for loan and lease losses as ofDecember 31, 2021 decreased$4.2 million , or 14.7%, to$24.3 million , compared to$28.5 million as ofDecember 31, 2020 . The allowance for loan and lease losses was 1.09% of total loans as ofDecember 31, 2021 , compared to 1.33% as ofDecember 31, 2020 . Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.10% of total loans as ofDecember 31, 2021 , compared to 1.48% as ofDecember 31, 2020 . •Period-end in-market deposits atDecember 31, 2021 increased$245.3 million , or 14.6%, to$1.928 billion from$1.683 billion as ofDecember 31, 2020 . Average in-market deposits of$1.784 billion increased$215.8 million , or 13.8%, for the year endedDecember 31, 2021 , compared to$1.569 billion for the same period in 2020. •Trust assets under management and administration increased by$671.7 million , or 29.9%, to$2.921 billion atDecember 31, 2021 , compared to$2.249 billion atDecember 31, 2020 . 32
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Results of Operations
Top Line Revenue
Top line revenue, comprised of net interest income and non-interest income,
increased 8.4% for the year ended December 31, 2021 compared to the year ended
December 31, 2020 primarily due to a $7.6 million , or 9.8%, increase in net
interest income and a $1.2 million , or 4.3%, increase in non-interest income.
The increase in net interest income was driven by an increase in PPP loan
processing fees, a decrease in interest expense, and an increase in average
loans and leases outstanding and related interest income, partially offset by a
reduction in asset-based loan fees in lieu of interest. The increase in
non-interest income was primarily due to a $2.2 million increase in trust and
investment fee income, $2.2 million increase in other fee income, $1.1 million
increase in gains on the sale of SBA loans, and $680,000 increase in loan fee
income. These favorable variances in top line revenue were partially offset by a
reduction in swap fee income, which decreased $5.5 million compared to the year
ended December 31, 2020 .
The components of revenue were as follows:
For the Year Ended December 31, Change From Prior Year
2021 2020 $ Change % Change
(Dollars in Thousands)
Net interest income $ 84,662 $ 77,071 $ 7,591 9.8 %
Non-interest income 28,100 26,940 1,160 4.3
Top line revenue $ 112,762 $ 104,011 $ 8,751 8.4
Return on average assets and return on average equity
ROAA was 1.37% for the year endedDecember 31, 2021 , compared to 0.70% for the year endedDecember 31, 2020 principally due to a$22.6 million decrease in provision for loan and lease losses. Please refer to the Components of the Provision for Loan and Lease Losses included in the Provision for Loan and Lease Losses section below for further discussion on the reasons driving the improvement in profitability. 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 year endedDecember 31, 2021 was 16.21% compared to 8.64% for the year endedDecember 31, 2020 . The primary reason for the increase in ROAE is consistent with the net income variance explanation as discussed under Return on Average Assets above. 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 adjusted profit before tax and before provision
Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse benefit, impairment of tax credit investments, net 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. Management believes 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 63.49% for the year endedDecember 31, 2021 , compared to 63.09% for the year endedDecember 31, 2020 . The Corporation generated positive operating leverage as pre-tax, pre-provision adjusted earnings increased$2.8 million , or 7.2%, to$41.2 million for the year endedDecember 31, 2021 , compared to$38.4 million for the same period in 2020. The increase in operating revenue was partially offset by a$5.9 million , or 12.8%, increase in compensation. We believe the Corporation will generate positive operating leverage annually and progress towards enhancing the long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth, process improvement, and automation. These initiatives include efforts to grow our existing specialized lending revenues, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets. 33
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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 Year Ended December 31, Change From Prior Year
2021 2020 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 71,535 $ 68,898 $ 2,637 3.8 %
Less:
Net loss on foreclosed properties 15 383 (368) (96.1)
Amortization of other intangible assets 25 35 (10) (28.6)
SBA recourse benefit (76) (278) 202 (72.7)
Impairment of tax credit investments - 2,395 (2,395) NM
Loss on early extinguishment of debt - 744 (744) NM
Total operating expense (a) $ 71,571 $ 65,619 $ 5,952 9.1
Net interest income $ 84,662 $ 77,071 $ 7,591 9.8
Total non-interest income 28,100 26,940 1,160 4.3
Less:
Net gain (loss) on sale of securities 29 (4) 33 NM Adjusted non-interest income 28,071 26,944 1,127 4.2 Total operating revenue (b)$ 112,733 $ 104,015 $ 8,718 8.4 Efficiency ratio 63.49 % 63.09 % Pre-tax, pre-provision adjusted earnings (b-a)$ 41,162 $ 38,396 $ 2,766 7.2 Average total assets 2,605,008 2,419,616 185,392 7.7 Pre-tax, pre-provision adjusted return on average assets 1.58 % 1.59 % 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 table below shows average balances, interest, average rates, net interest margin and the spread between combined average rates earned on our interest-earning assets and cost of interest-bearing liabilities for the periods indicated. The average balances are derived from average daily balances. 34
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For the Year Ended December 31,
2021 2020
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
(Dollars in Thousands)
Interest-earning assets
Commercial real estate and other mortgage loans(1) $ 1,387,434 $ 51,930 3.74 % $ 1,245,886 $ 51,188 4.11 %
Commercial and industrial loans(1) 727,923 37,470 5.15 % 701,328 35,487 5.06 %
Direct financing leases(1) 19,591 872 4.45 % 26,564 1,039 3.91 %
Consumer and other loans(1) 44,206 1,572 3.56 % 37,544 1,446 3.85 %
Total loans and leases receivable(1) 2,179,154 91,844 4.21 % 2,011,322 89,160 4.43 %
Mortgage-related securities(2) 159,242 2,633 1.65 % 173,084 3,548 2.05 %
Other investment securities(3) 44,739 777 1.74 % 31,809 639 2.01 %
FHLB stock 13,066 651 4.98 % 11,576 671 5.80 %
Short-term investments 64,308 90 0.14 % 37,314 161 0.43 %
Total interest-earning assets 2,460,509 95,995 3.90 % 2,265,105 94,179 4.16 %
Non-interest-earning assets 144,499 154,511
Total assets $ 2,605,008 $ 2,419,616
Interest-bearing liabilities
Transaction accounts $ 506,693 988 0.19 % $ 392,577 1,448 0.37 %
Money market 693,608 1,183 0.17 % 651,402 2,842 0.44 %
Certificates of deposit 47,020 396 0.84 % 111,698 2,198 1.97 %
Wholesale deposits 119,831 986 0.82 % 142,591 2,434 1.71 %
Total interest-bearing deposits 1,367,152 3,553 0.26 % 1,298,268 8,922 0.69 %
FHLB advances 376,781 4,908 1.30 % 379,891 5,507 1.45 %
Federal reserve PPPLF - - - % 15,207 54 0.36 %
Other borrowings 31,935 1,759 5.51 % 24,472 1,509 6.17 %
Junior subordinated notes 10,068 1,113 11.05 % 10,054 1,116 11.10 %
Total interest-bearing liabilities 1,785,936 11,333 0.63 % 1,727,892 17,108 0.99 %
Non-interest-bearing demand deposit accounts 536,981 412,825
Other non-interest-bearing liabilities 61,580 82,337
Total liabilities 2,384,497 2,223,054
Stockholders' equity 220,511 196,562
Total liabilities and stockholders' equity $ 2,605,008 $ 2,419,616
Net interest income $ 84,662 $ 77,071
Net interest spread 3.27 % 3.17 %
Net interest-earning assets $ 674,573 $ 537,213
Net interest margin 3.44 % 3.40 %
Average interest-earning assets to average
interest-bearing liabilities 137.77 % 131.09 %
Return on average assets 1.37 % 0.70 %
Return on average equity 16.21 % 8.64 %
Average equity to average assets 8.46 % 8.12 %
Non-interest expense to average assets 2.75 % 2.85 %
(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 collected
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.
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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 year endedDecember 31, 2021 compared to the year endedDecember 31, 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. Rate/Volume Analysis Increase (Decrease) for the Year Ended December 31, 2021 Compared to 2020 Rate Volume Net (In Thousands) Interest-earning assets Commercial real estate and other mortgage loans(1) $ (4,784)$ 5,526 $
742
Commercial and industrial loans(1) 621 1,362 1,983 Direct financing leases(1) 130 (297) (167) Consumer and other loans(1) (117) 243 126 Total loans and leases receivable(1) (4,150) 6,834
2,684
Mortgage-related securities(2) (647) (268) (915) Other investment securities (96) 234 138 FHLB Stock (100) 80 (20) Short-term investments (147) 76 (71) Total net change in income on interest-earning assets (5,140) 6,956
1,816
Interest-bearing liabilities Transaction accounts (805) 345 (460) Money market (1,832) 173 (1,659) Certificates of deposit (895) (907) (1,802) Wholesale deposits (1,107) (341) (1,448) Total deposits (4,639) (730) (5,369) FHLB advances (554) (45) (599) Federal reserve PPPLF - (54) (54) Other borrowings (174) 424 250 Junior subordinated notes (5) 2 (3) Total net change in expense on interest-bearing liabilities (5,372) (403)
(5,775)
Net change in net interest income $ 232$ 7,359 $
7,591
(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 collected in lieu of interest. (2)Includes amortized cost basis of assets available-for-sale and held-to-maturity. Net interest income increased by$7.6 million , or 9.8%, for the year endedDecember 31, 2021 , compared to the year endedDecember 31, 2020 . The increase compared to the prior year was principally due to an increase in average loans and leases outstanding, increase in PPP loan processing fees, and rate-driven decrease in interest expense. Average gross loans and leases of$2.179 billion increased by$167.8 million , or 8.3% for the year endedDecember 31, 2021 , compared to$2.011 billion for the same period in 2020. Loan fees collected in lieu of interest increased 19.8% to$11.2 million , compared to$9.3 million during the same period of comparison. Excluding PPP fee amortization, loan fees collected in lieu of interest decreased 4.6% to$3.8 million , compared to$4.0 million during the same period of comparison. Excluding net PPP loans, average gross loans and leases for the year endedDecember 31, 2021 increased$230.6 million , or 12.8%, compared to the year endedDecember 31, 2020 . Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased$6.4 million , or 9.7%. The yield on average earning assets for the year endedDecember 31, 2021 was 3.90%, a decrease of 26 basis points compared to 4.16% for the year endedDecember 31, 2020 . This decrease was principally due to the renewal of fixed-rate loans and reinvestment of security cash flows at historically low interest rates and a decrease in recurring loan fees in lieu of interest. 36 -------------------------------------------------------------------------------- Table of Contents This decrease was partially offset by the increase in PPP loan processing fees and reduction in average PPP loans earning 1% interest. Excluding the impact of recurring loan fees in lieu of interest and PPP fees in both 2021 and 2020, the yield on average earning assets for the year endedDecember 31, 2021 was 3.45%, a decrease of 30 basis points compared to 3.75% for the year endedDecember 31, 2020 . The average rate paid on interest-bearing liabilities was 0.63% for the year endedDecember 31, 2021 , a decrease of 36 basis points from 0.99% for the year endedDecember 31, 2020 . The average rate paid declined as the Corporation decreased deposit rates and renewed maturing FHLB advances at historically low fixed rates. In addition to the reduction in deposit rates and FHLB advance renewals, average wholesale deposits, which are typically longer duration and therefore a higher cost funding source than in-market deposits, decreased$22.8 million , or 16.0%. Net interest margin increased four basis points to 3.44% for the year endedDecember 31, 2021 , compared to 3.40% for the year endedDecember 31, 2020 . Adjusted net interest margin measured 3.21% for the year endedDecember 31, 2021 , compared to 3.28% for the year endedDecember 31, 2020 . Adjusted net interest margin is a non-GAAP measure representing net interest income excluding the fees in lieu of interest and other recurring but volatile components of net interest margin divided by average interest-earning assets less average net PPP loans, if any, and other recurring but volatile components of average interest-earning assets. Fees in lieu of interest are defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization. The decrease in adjusted net interest margin 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 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. Due to significant loan growth in 2021 and expectations for low double-digit loan growth in 2022, management believes excess liquidity will revert back to historical averages in 2022.
Allowance for losses on loans and leases
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 Corporation recognized a$5.8 million provision benefit for the year endedDecember 31, 2021 , compared to$16.8 million provision expense for the year endedDecember 31, 2020 . The provision benefit for the year endedDecember 31, 2021 was primarily due to a net recovery of$1.6 million , a$4.5 million reduction in the general reserve from improving historical loss rates, and a$2.2 million decrease in specific reserves. These decreases were partially offset by a$2.9 million increase in the general reserve due to loan growth.
The following table shows the components of the allowance for losses on loans and leases for the year ended
For the Year Ended December 31,
(Dollars in thousands) 2021 2020
Change in general reserve due to changes in subjective factors $
(426)$ 5,460 Change in general reserve due to historical loss factor changes (4,456) 949 Charge-offs 3,508 8,139 Recoveries (5,126) (332) Change in specific reserves on impaired loans, net (2,175) 316 Change due to loan growth, net 2,872 2,276 Total provision for loan and lease losses $
(5,803)
The addition of specific impaired loan reserves represents new specific reserves built up in the event of insufficient collateral or government guarantee defaults, while conversely the release of specific reserves represents the
37 -------------------------------------------------------------------------------- Table of Contents 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.
Non-interest income
Non-interest income increased by$1.2 million , or 4.3%, to$28.1 million for the year endedDecember 31, 2021 , from$26.9 million for the year endedDecember 31, 2020 . Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream through greater contributions from fee-based revenues. Total non-interest income accounted for 24.9% of our total revenues in 2021 compared to 25.9% in 2020. The increase in total non-interest income for the year endedDecember 31, 2021 primarily reflected record private wealth management services fee income, an increase in other non-interest income and loan fees, and a significant increase in gain on the sale of SBA loans. These favorable variances were partially offset by a decrease in commercial loan interest rate swap fee income. The components of non-interest income were as follows: For the Year Ended December 31, Change From Prior Year 2021 2020 $ Change % Change (Dollars in
Thousands)
Private wealth management services fee income$ 10,784 $ 8,611 $ 2,173 25.2 % Gain on sale of SBA loans 4,044 2,899 1,145 39.5 Service charges on deposits 3,837 3,415 422 12.4 Loan fees 2,506 1,826 680 37.2 Increase in cash surrender value of bank-owned life insurance 1,413 1,402 11 0.8 Net gain (loss) on sale of securities 29 (4) 33 NM Swap fees 1,368 6,860 (5,492) (80.1) Other non-interest income 4,119 1,931 2,188 113.3 Total non-interest income$ 28,100 $ 26,940 $ 1,160 4.3 Fee income ratio(1) 24.9 % 25.9 %
(1) Commission income ratio is commission income, as per the table above, divided by sales income (defined as net interest income plus non-interest income).
Private wealth management services fee income increased by$2.2 million , or 25.2%, to a record$10.8 million for the year endedDecember 31, 2021 compared to$8.6 million for the year endedDecember 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 equity markets. This increase was driven by growth in assets under management and administration attributable to both new client relationships and increased equity values. AtDecember 31, 2021 , our trust assets under management and administration were a record$2.921 billion , or 29.9% more than trust assets under management and administration of$2.249 billion atDecember 31, 2020 . We expect to continue to increase our revenue from assets under management and administration as we deepen existing and grow new client relationships in our less mature commercial bank markets, but market volatility may also affect the actual change in revenue. Gain on sale of SBA loans for the year endedDecember 31, 2021 totaled$4.0 million , an increase of$1.1 million , or 39.5%, from the same period in 2020. Management believes SBA 7a loan production, while variable based on timing of closings, will continue to increase annually at a measured pace.
Loan fees have increased
38 -------------------------------------------------------------------------------- Table of Contents curtailment fees and an increase in SBA servicing fee income commensurate with the Corporation's growing SBA sold portfolio. Other non-interest income increased by$2.2 million to$4.1 million for the year endedDecember 31, 2021 , compared to$1.9 million for the year endedDecember 31, 2020 . The increase was primarily due to an above average increase in returns from the Corporation's investments in mezzanine funds. Commercial loan interest rate swap fee income was$1.4 million for the year endedDecember 31, 2021 , compared to$6.9 million for the year endedDecember 31, 2020 as it became less advantageous for clients to secure long-term, fixed-rate financing with an interest rate swap relative to other fixed-rate alternatives. 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$640.6 million as ofDecember 31, 2021 , compared to$629.1 million as ofDecember 31, 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.
Non-interest charges
Non-interest expense increased by$2.6 million , or 3.8%, to$71.5 million for the year endedDecember 31, 2021 from$68.9 million for the year endedDecember 31, 2020 . Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased$6.0 million , or 9.1%, to$71.6 million for the year endedDecember 31, 2021 compared to$65.6 million for the year endedDecember 31, 2020 . The increase in operating expense was primarily due to an increase in compensation, marketing, and data processing. These increases were partially offset by a decrease in other non-interest expense.
The components of non-interest expense were as follows:
For the Year Ended December 31, Change From Prior Year
2021 2020 $ Change % Change
(Dollars in Thousands)
Compensation $ 51,710 $ 45,850 $ 5,860 12.8 %
Occupancy 2,180 2,252 (72) (3.2)
Professional fees 3,736 3,530 206 5.8
Data processing 3,087 2,734 353 12.9
Marketing 2,022 1,580 442 28.0
Equipment 990 1,199 (209) (17.4)
Computer software 4,260 3,900 360 9.2
FDIC insurance 1,143 1,238 (95) (7.7)
Collateral liquidation costs 265 328 (63) (19.2)
Net loss on foreclosed properties 15 383 (368) (96.1)
Impairment on tax credit investments - 2,395 (2,395) NM
SBA recourse (benefit) provision (76) (278) 202 (72.7)
Loss on early extinguishment of debt - 744 (744) NM
Other non-interest expense 2,203 3,043 (840) (27.6)
Total non-interest expense $ 71,535 $ 68,898 $ 2,637 3.8
Total operating expense(1) $ 71,571 $ 65,619 $ 5,952 9.1
Full-time equivalent employees 304 301 3 1.0
NM = Not meaningful
(1) Total operating expenses represent 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 increased by$5.9 million , or 12.8%, to$51.7 million for the year endedDecember 31, 2021 from$45.9 million for the year endedDecember 31, 2020 principally due to an increase in average FTEs, annual merit increases, growth in employee benefit costs and increase in incentive compensation. The increase reflects a$2.1 million , or 39 -------------------------------------------------------------------------------- Table of Contents 7.0%, increase in employee salaries and a$2.3 million , or 35.5%, increase in individual and corporate performance-based incentive compensation accruals reflecting strong company performance relative to bonus criteria. Average FTEs were 307 for the year endedDecember 31, 2021 , increasing by 16, or 5.5%, from 291 for the year endedDecember 31, 2020 . Performance-based incentive compensation accruals will reset to target performance at the start of 2022 and will be evaluated quarterly and increased or decreased based on management's forecast of full year performance for the Corporation. Marketing expense increased by$442,000 , or 28.0%, to$2.0 million for the year endedDecember 31, 2021 from$1.6 million for the year endedDecember 31, 2020 . During 2020, the Corporation's adherence to COVID-19 restrictions resulted in a reduction in marketing expenses, such as meals and entertainment, and advertisement expense. 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. Data processing expense increased by$353,000 , or 12.91%, to$3.1 million for the year endedDecember 31, 2021 from$2.7 million for the year endedDecember 31, 2020 . The increase in data processing expense was due to the increase in services associated with deposit accounts, as well as 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. Other non-interest expense decreased by$840,000 , or 27.6%, to$2.2 million for the year endedDecember 31, 2021 from$3.0 million for the year endedDecember 31, 2020 . The decrease was principally due to 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. The CVA was$191,000 as ofDecember 31, 2021 , compared to$461,000 as ofDecember 31, 2020 . 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. Management believes this strategy helped stabilize net interest margin during the extended low interest rate environment in 2021. No tax credits or related impairment was recognized for the year endedDecember 31, 2021 . The impairment on tax credit investments for the year endedDecember 31, 2020 were related to a new market and historic tax credits. The impairment on tax credits were more than offset by a reduction to income tax expense resulting in a net benefit to earnings in the year the credits are earned in 2020.
Income taxes
Income tax expense was$11.3 million for the year endedDecember 31, 2021 , compared to$1.3 million for the year endedDecember 31, 2020 . The Corporation recognized federal historic tax credits in 2020 which reduced income tax expense by$2.8 million . No tax credits were recognized in 2021. The effective tax rate for the year endedDecember 31, 2021 was 24.0% compared to 7.2% for the year endedDecember 31, 2020 . The effective tax rate, excluding tax credits and other discrete items, for the year endedDecember 31, 2020 was 19.5%. For 2022, the Company expects to report an effective tax rate of 22%-23%, excluding discrete items, as management intends to continue actively pursuing tax credit opportunities. 40
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FINANCIAL CONDITION
General
Total assets increased by $85.1 million , or 3.3%, to $2.653 billion as of
December 31, 2021 compared to $2.568 billion at December 31, 2020 . The increase
in total assets was primarily driven by an increase in loans and leases
receivable, securities available-for-sale, and short-term investments, partially
offset by a decrease in cash and derivatives. Total liabilities increased by
$58.8 million , or 2.5%, to $2.420 billion as of December 31, 2021 compared to
$2.362 billion at December 31, 2020 . The increase in total liabilities was
principally due to an increase in deposits, partially offset by a decrease in
FHLB advances and derivatives.
Cash and cash equivalents
Cash and cash equivalents include short-term investments and cash and due from banks. Short-term investments increased by$20.0 million to$47.4 million atDecember 31, 2021 from$27.4 million atDecember 31, 2020 . The increase in short-term investments was offset by a decrease in cash and due from banks driven by a reduction in cash letter in transit. Short-term investments primarily consist of interest-bearing deposits held at theFederal Reserve Bank ("FRB"). We value the safety and soundness provided by the FRB, and therefore, we incorporate short-term investments in our on-balance sheet liquidity program. As ofDecember 31, 2021 and 2020, interest-bearing deposits held at the FRB were$47.0 million and$26.7 million , respectively. In general, the level of our cash and 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$15.1 million to$225.4 million atDecember 31, 2021 from$210.3 million atDecember 31, 2020 . As ofDecember 31, 2021 and 2020, our total securities portfolio had a weighted average estimated maturity of approximately 5.7 years and 5.0 years, respectively. The investment portfolio primarily consists of mortgage-backed securities and is used to provide a source of liquidity, including the ability to pledge securities for possible future cash advances, while contributing to the earnings potential of the Bank. The overall duration of the securities portfolio is established and maintained to further mitigate interest rate risk present within our balance sheet as identified through asset/liability simulations. We purchase investment securities intended to protect net interest margin while maintaining an acceptable risk profile. In addition, we will purchase investment securities to utilize our cash position effectively within appropriate policy guidelines and estimates of future cash demands. While mortgage-backed securities present prepayment risk and extension risk, we believe the overall credit risk associated with these investments is minimal, as the majority of the securities we hold are guaranteed by the Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC"), or theGovernment National Mortgage Association ("GNMA"), aU.S. government agency. The estimated repayment streams associated with this portfolio also allow us to better match short-term liabilities. The Bank's investment policies allow for various types of investments, including tax-exempt municipal securities. The ability to invest in tax-exempt municipal securities provides for further opportunity to improve our overall yield on the securities portfolio. We evaluate the credit risk of the municipal securities prior to purchase and generally limit exposure to general obligation issuances from municipalities, primarily inWisconsin . The majority of the securities we hold have active trading markets; therefore, we have not experienced difficulties in pricing our securities. We use a third-party pricing service as our primary source of market prices for the securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification of the portfolio, data integrity validation through comparison of current price to prior period prices, and an expectation-based analysis of movement in prices based upon the changes in the related yield curves and other market factors. On a periodic basis, we review the third-party pricing vendor's methodology for pricing relevant securities and the results of its internal control assessments. Our securities portfolio is sensitive to fluctuations in the interest rate environment and has limited sensitivity to credit risk due to the nature of the issuers and guarantors of the securities as previously discussed. If interest rates decline and the credit quality of the securities remains constant or improves, the fair value of our debt securities portfolio would likely improve, thereby increasing total comprehensive income. If interest rates increase and the credit quality of the securities remains constant or deteriorates, the fair value of our debt securities portfolio would likely decline and therefore decrease total comprehensive income. The magnitude of the fair value change will be based upon the duration of the portfolio. A securities portfolio with a longer average duration will exhibit greater market price volatility than a securities portfolio with a shorter average duration in a changing rate environment. During the year endedDecember 31, 2021 , we recognized unrealized holding losses of$4.3 million before income taxes through other comprehensive income. These losses were the result of a decrease in interest rates. No securities within our portfolio were deemed to be other-than-temporarily impaired as ofDecember 31, 2021 . We sold approximately$15.0 million of securities during the year endedDecember 31, 2021 to proactively manage our securities portfolio and meet our long-term investment objectives. As ofDecember 31, 2021 no securities were classified as 41
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trading securities. AtDecember 31, 2021 ,$70.3 million of our securities were pledged to secure various obligations, including interest rate swap contracts and municipal deposits.
The tables below present information regarding the amortized cost and fair values of our securities.
As of December 31,
2021 2020
Amortized Cost Fair Value Amortized Cost Fair Value
(In Thousands)
Available for sale :
U.S. Treasuries $ 4,971$ 4,914 $ - $ -U.S. government agency securities - government-sponsored enterprises 19,797 19,935 22,699 22,629 Municipal securities 30,828 30,957 24,067 24,779
Residential Mortgage Backed Securities – Government Issued
19,563 19,661 9,894 10,403 Residential mortgage-backed securities - government-sponsored enterprises 85,748 85,705 102,843 105,006
Commercial mortgage-backed securities – government issued
5,801 5,771 5,289 5,464
Commercial mortgage-backed securities -
government-sponsored enterprises 36,786 36,531 12,584 13,365
Other securities 2,205 2,228 2,205 2,279
$ 205,699 $ 205,702 $ 179,581 $ 183,925
As of December 31,
2021 2020
Amortized Cost Fair Value Amortized Cost Fair Value
(In Thousands)
Held to maturity:
Municipal securities$ 13,009
Residential Mortgage Backed Securities – Government Issued
2,226 2,266 3,564 3,676
Residential mortgage-backed securities -
government-sponsored issued 2,502 2,578 3,693 3,856
Commercial mortgage-backed securities -
government-sponsored enterprises 2,009 2,204 2,011 2,293
$ 19,746 $ 20,276 $ 26,374 $ 27,333
U.S. Treasuries represent treasury bonds issued by the United States Treasury.
U.S. government agency securities - government-sponsored enterprises represent
securities issued by FNMA and the SBA. Municipal securities include securities
issued by various municipalities located primarily within Wisconsin and are
primarily general obligation bonds that are tax-exempt in nature. Residential
and commercial mortgage-backed securities - government issued represent
securities guaranteed by GNMA. Residential and commercial mortgage-backed
securities - government-sponsored enterprises include securities guaranteed by
FHLMC, FNMA , and the FHLB. Other securities represent certificates of deposit of
insured banks and savings institutions with an original maturity greater than
three months. As of December 31, 2021 , no issuer's securities exceeded 10% of
our total stockholders' equity.
The following table sets forth the contractual maturity and weighted average
yield characteristics of the fair value of our available-for-sale securities and
the amortized cost of our held-to-maturity securities at December 31, 2021 ,
classified by remaining contractual maturity. Actual maturities may differ from
contractual maturities because issuers have the right to call or prepay
securities without call or prepayment penalties. Yields on tax-exempt securities
have not been computed on a tax equivalent basis.
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Less than One Year One to Five Years Five to Ten Years Over Ten Years
Weighted Weighted Weighted Weighted
Average Average Average Average
Fair Value Yield Fair Value Yield Fair Value Yield Fair Value Yield
Total
(Dollars in Thousands)
Available-for-sale:
U.S. treasuries $ - - % $ 4,914 1.00 % $ - - % $ - - % $ 4,914
U.S. government agency securities -
government-sponsored enterprises - - 978 0.56 4,726 0.93 14,231 0.80 19,935
Municipal securities 496 0.30 2,951 1.33 11,839 1.41 15,671 1.85 30,957
Residential mortgage-backed securities -
government issued - - - - 2,273 2.94 17,388 1.89 19,661
Residential mortgage-backed securities -
government-sponsored enterprises - - 1,216 2.34 13,271 2.09 71,218 1.72 85,705
Commercial mortgage-backed securities -
government issued - - - - 1,658 3.10 4,113 1.60 5,771
Commercial mortgage-backed securities -
government-sponsored enterprises - - 1,878 2.41 24,703 1.63 9,950 1.53 36,531
Other securities 2,228 2.38 - - - - - - 2,228
$ 2,724 $ 11,937 $ 58,470 $ 132,571 $ 205,702
Less than One Year One to Five Years Five to Ten Years Over Ten Years
Weighted Weighted Weighted Weighted
Average Average Average Average
Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Total
(Dollars in Thousands)
Held-to-maturity:
Municipal securities $ 3,793 2.13 % $ 7,289 2.27 % $ 1,927 2.67 % $ - - % $ 13,009
Residential mortgage-backed securities -
government issued - - - - 1,491 2.00 735 2.14 2,226
Residential mortgage-backed securities -
government-sponsored enterprises - - - - 1,796 1.68 706 3.35 2,502
Commercial mortgage-backed securities -
government-sponsored enterprises - - - - 2,009 3.27 - - 2,009
$ 3,793 $ 7,289 $ 7,223 $ 1,441 $ 19,746
Derivatives
The Bank's investment policies allow the Bank to participate in hedging
strategies or to use financial futures, options, forward commitments, or
interest rate swaps with prior approval from the Board. The Bank utilizes, from
time to time, derivative instruments in the course of its asset/liability
management. As of December 31, 2021 and 2020, the Bank did not hold any
derivative instruments that were designated as fair value hedges. The
Corporation offers interest rate swap products directly to qualified commercial
borrowers. The Corporation economically hedges client derivative transactions by
entering into offsetting interest rate swap contracts executed with a third
party. Derivative transactions executed as part of this program are not
considered hedging instruments and are marked-to-market through earnings each
period. The derivative contracts have mirror-image terms, which results in the
positions' changes in fair value offsetting through earnings each period.
As of December 31, 2021 , the aggregate amortizing notional value of interest
rate swaps with various commercial borrowers was approximately $640.6 million ,
compared to $629.1 million as of December 31, 2020 . We receive fixed rates and
pay floating rates based upon LIBOR on the swaps with commercial borrowers.
These swaps mature between January 2024 and March 2038 . Commercial borrower
swaps are completed independently with each borrower and are not subject to
master netting arrangements. As of December 31, 2021 , the commercial borrower
swaps were reported on the Consolidated Balance Sheet as a derivative asset of
$26.3 million and as a derivative liability of $6.6 million compared to a
derivative asset and liability of $49.4 million and $58,000 , respectively, as of
December 31, 2020 . On the offsetting swap contracts with dealer counterparties,
we pay fixed rates and receive floating rates based upon LIBOR. These interest
rate swaps also have maturity dates between January 2024 and March 2038 . Dealer
counterparty swaps are subject to master netting agreements among the contracts
within our Bank and were reported on the Consolidated Balance Sheet as a net
derivative liability of $19.7 million as of December 31, 2021 , compared to $49.3
million as of December 31, 2020 . The gross amount of dealer counterparty swaps
as of December 31, 2021 , without regard to the enforceable master netting
agreement, was a gross derivative liability of $26.3 million and a gross
derivative asset of $6.6 million , compared to a gross derivative liability and
asset of $49.4 million and
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$58,000 , respectively, as ofDecember 31, 2020 . The decrease in derivative asset and liabilities as ofDecember 31, 2021 compared toDecember 31, 2020 is due to the fluctuation in interest rates. The Corporation also enters into interest rate swaps to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The instruments are designated as cash flow hedges as the receipt of floating rate interest from the counterparty is used to manage interest rate risk associated with forecasted issuances of short-term FHLB advances. The change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings. As ofDecember 31, 2021 , the aggregate notional value of interest rate swaps designated as cash flow hedges was$106.0 million . These interest rate swaps mature betweenDecember 2022 andDecember 2027 . A pre-tax unrealized loss of$3.6 million was recognized in other comprehensive income for the year endedDecember 31, 2021 and there was no ineffective portion of these hedges.
Loans and leases receivable
Loans and leases receivable, net of allowance for loan and lease losses, increased by$97.6 million , or 4.6%, to$2.215 billion atDecember 31, 2021 from$2.117 billion atDecember 31, 2020 . Excluding net PPP loans, loans and leases receivable, net of allowance for loan and lease losses, increased by$295.6 million , or 15.63%, to$2.188 billion atDecember 31, 2021 from$1.892 billion atDecember 31, 2020 . Excluding PPP loans, commercial and industrial ("C&I") loans, non-owner-occupied commercial real estate ("CRE"), and construction loans were the largest contributors to loan growth as ofDecember 31, 2021 , increasing$196.5 million ,$96.9 million , and$38.8 million , respectively, fromDecember 31, 2020 . There continues to be a concentration in CRE loans which represented 65.7% and 70.6% of our total loans, excluding net PPP loans, as ofDecember 31, 2021 andDecember 31, 2020 , respectively. As ofDecember 31, 2021 , approximately 16.2% 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. Our C&I portfolio decreased$1.5 million , or 0.2%, to$730.8 million atDecember 31, 2021 from$732.3 million atDecember 31, 2020 . Excluding net PPP loans, C&I loans increased$196.5 million , or 38.8%, to$703.5 million from$507.0 million atDecember 31, 2020 . Management does not believe this loan growth rate is sustainable and anticipates it will moderate to low double-digits as the Company's specialized lending products scale over time. The Corporation experienced significant C&I loan growth in 2021, led by conventional commercial lending, as well as specialized commercial lending which represented 20.0% of total loans as ofDecember 31, 2021 , up from 17.0% as ofDecember 31, 2020 . Management believes the timely prior-period investments in the Corporation's specialized lending business lines, such as dealer floorplan financing, small-ticket equipment vendor financing, accounts receivable financing, and asset based lending have positioned C&I lending for strong and sustainable growth in 2022 and beyond. 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. 44
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The following table presents information regarding the composition of the Bank’s consolidated loans and contracts receivable.
As of December 31,
2021 2020
Amount % of Total Loans Amount % of Total Loans
Outstanding and Leases Outstanding and Leases
(Dollars in Thousands)
Commercial real estate:
Commercial real estate - owner
occupied $ 235,589 10.5 % $ 253,882 11.8 %
Commercial real estate - non-owner
occupied 661,423 29.5 564,532 26.3
Land development 42,792 1.9 49,839 2.3
Construction 179,841 8.0 141,043 6.6
Multi-family 320,072 14.3 311,556 14.5
1-4 family 14,911 0.7 38,284 1.8
Total commercial real estate 1,454,628 64.9 1,359,136 63.2
Commercial and industrial 730,819 32.6 732,318 34.0
Direct financing leases, net 15,743 0.7 22,331 1.1
Consumer and other:
Home equity and second mortgage 4,223 0.2 7,833 0.4
Other 35,518 1.6 28,897 1.3
Total consumer and other 39,741 1.8 36,730 1.7
Total gross loans and leases
receivable 2,240,931 100.0 % 2,150,515 100.0 %
Less:
Allowance for loan and lease losses 24,336 28,521
Deferred loan fees 1,523 4,545
Loans and leases receivable, net $ 2,215,072 $ 2,117,449
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The following table shows the scheduled contractual maturities of the Bank's consolidated gross loans and leases receivable, as well as the dollar amount of such loans and leases which are scheduled to mature after one year and have fixed or adjustable interest rates, as ofDecember 31, 2021 . Amounts Due Interest Terms On Amounts Due after One Year After One In One Year Year through After Five Variable or Less Five Years Years Total Fixed Rate Rate (In Thousands) Commercial real estate: Owner-occupied$ 14,481 $
112,813
$ 57,034 Non-owner occupied 83,881 294,650 282,892 661,423 310,930 266,612 Land development 17,074 23,964 1,754 42,792 8,432 17,286 Construction 34,103 30,941 114,797 179,841 56,351 89,387 Multi-family 23,216 98,516 198,340 320,072 99,619 197,237 1-4 family 3,013 7,587 4,311 14,911 11,755 143 Commercial and industrial 235,189 418,358 77,272 730,819 304,426 191,204 Direct financing leases 1,239 13,992 512 15,743 14,504 - Consumer and other 4,367 34,418 956 39,741 30,055 5,319$ 416,563 $ 1,035,239 $ 789,129 $ 2,240,931 $ 1,000,146 $ 824,222 Commercial Real Estate . The Bank originates owner-occupied and non-owner-occupied commercial real estate loans which have fixed or adjustable rates and generally terms of three to 10 years and amortizations of up to 30 years on existing commercial real estate. The Bank also originates loans to construct commercial properties and complete land development projects. The Bank's construction loans generally have terms of six to 24 months with fixed or adjustable interest rates and fees that are due at the time of origination. Loan proceeds are disbursed in increments as construction progresses and as project inspections warrant. The repayment of commercial real estate loans generally is dependent on sufficient income from the properties securing the loans to cover operating expenses and debt service. Payments on commercial real estate loans are often dependent on external market conditions impacting the successful operation or development of the property or business involved. Therefore, repayment of such loans is often sensitive to conditions in the real estate market or the general economy, which are outside the borrower's control. In the event that the cash flow from the property is reduced, the borrower's ability to repay the loan could be negatively impacted. The deterioration of one or a few of these loans could cause a material increase in our level of nonperforming loans, which would result in a loss of revenue from these loans and could result in an increase in the provision for loan and lease losses and an increase in charge-offs, all of which could have a material adverse impact on our net income. Additionally, many of these loans have real estate as a primary or secondary component of collateral. The market value of real estate can fluctuate significantly in a short period of time as a result of economic conditions. Adverse developments affecting real estate values in one or more of our markets could impact collateral coverage associated with the commercial real estate segment of our portfolio, possibly leading to increased specific reserves or charge-offs, which would adversely affect profitability. Of the$1.455 billion of commercial real estate loans outstanding as ofDecember 31, 2021 ,$25.8 million were originated by our asset-based lending subsidiary, as part of a larger asset-based lending relationship. Commercial and Industrial. The Bank's commercial and industrial loan portfolio is comprised of loans for a variety of purposes which principally are secured by inventory, accounts receivable, equipment, machinery, and other corporate assets and are advanced within limits prescribed by our loan policy. The majority of such loans are secured and typically backed by personal guarantees of the owners of the borrowing business. Of the$730.8 million of C&I loans outstanding as ofDecember 31, 2021 ,$354.2 million were conventional C&I loans and$447.1 million were specialized lending C&I loans. Specialized lending consists of asset-based lending, accounts receivable financing, floorplan financing, equipment financing, and SBA lending. Direct Financing Leases. Direct financing leases initiated through FBSF are originated with a fixed rate and typically a term of seven years or less. It is customary in the leasing industry to provide 100% financing; however, FBSF will, from time-to-time, require a down payment or lease deposit to provide a credit enhancement. As ofDecember 31, 2021 , the Bank had$15.7 million in net direct financing receivables outstanding. 46
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FBSF leases machinery and equipment to clients under leases which qualify as direct financing leases for financial reporting and as operating leases for income tax purposes. Under the direct financing method of accounting, the minimum lease payments to be received under the lease contract, together with the estimated unguaranteed residual value (approximating 3% to 20% of the cost of the related equipment), are recorded as lease receivables when the lease is signed and the lease property is delivered to the client. The excess of the minimum lease payments and residual values over the cost of the equipment is recorded as unearned lease income. Unearned lease income is recognized over the term of the lease on a basis which results in a level rate of return on the unrecovered lease investment. Lease payments are recorded when due under the lease contract. Residual value is the estimated fair market value of the equipment on lease at lease termination and was estimated to be$3.6 million as ofDecember 31, 2021 . In estimating the equipment's fair value, FBSF relies on historical experience by equipment type and manufacturer, published sources of used equipment pricing, internal evaluations and, when available, valuations by independent appraisers, adjusted for known trends.
Consumer and Other. The Bank issues small amount of consumer loans consisting of home equity, first and second mortgages and other personal loans to the Bank’s business and executive clients.
Asset quality
Unexpected loans and leases decreased
Our total impaired assets consisted of the following:
As of December 31,
2021 2020
(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied $ 348 $ 5,429
Commercial real estate - non-owner occupied - 3,783
Land development - 890
Construction - -
Multi-family - -
1-4 family 339 250
Total non-accrual commercial real estate 687 10,352
Commercial and industrial 5,572 16,155
Direct financing leases, net 99 49
Consumer and other:
Home equity and second mortgage - 40
Other - 21
Total non-accrual consumer and other loans - 61
Total non-accrual loans and leases 6,358 26,617
Foreclosed properties, net 164 34
Total non-performing assets 6,522 26,651
Performing troubled debt restructurings 217 46
Total impaired assets $ 6,739 $ 26,697
Total non-accrual loans and leases to gross loans and leases 0.28 % 1.24 %
Total non-performing assets to gross loans and leases plus foreclosed assets, net
0.29 % 1.24 % Total non-performing assets to total assets 0.25 % 1.04 % Allowance for loan and lease losses to gross loans and leases 1.09 % 1.33 %
Allowance for losses on loans and leases on unaccrued loans and leases
382.76 % 107.15 % As ofDecember 31, 2021 and 2020,$627,000 and$6.5 million of the non-accrual loans were considered troubled debt restructurings, respectively. As noted in the table above, non-performing assets consisted of non-accrual loans and leases and foreclosed properties totaling$6.5 million , or 0.25% of total assets, as ofDecember 31, 2021 , a decrease in non-performing 47
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assets of$20.1 million , or 75.5%, fromDecember 31, 2020 . Impaired loans and leases as ofDecember 31, 2021 and 2020 also included$217,000 and$46,000 , respectively, of loans classified as performing troubled debt restructurings, which are considered impaired due to the concession in terms, but are meeting the restructured payment terms and therefore are not on non-accrual status. The following asset quality ratios exclude net PPP loans as they are fully guaranteed by the SBA: As of December 31, 2021 2020 (In Thousands) Total non-accrual loans and leases to gross loans and leases 0.29 % 1.38 %
Total non-performing assets to gross loans and leases plus foreclosed assets, net
0.29 1.38 Total non-performing assets to total assets 0.25 1.14 Allowance for loan and lease losses to gross loans and leases 1.10 1.48 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 0.25% atDecember 31, 2021 from 1.04% atDecember 31, 2020 . As ofDecember 31, 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 ofDecember 31, 2020 . We also monitor asset quality through our established categories as defined in Note 4 - 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. In 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. Additional information about impaired loans is as follows: As of December 31, 2021 2020 (In Thousands) Impaired loans and leases with no impairment reserves $ 4,419$ 18,966 Impaired loans and leases with impairment reserves required 2,156 7,697 Total impaired loans and leases 6,575 26,663
Less: Allowance for impairment (included in allowance for loan and lease losses)
1,505 3,681 Net impaired loans and leases $ 5,070$ 22,982 Average impaired loans and leases $ 14,260$ 27,703 For the years ended December 31, 2021 2020 (In Thousands) Interest income attributable to impaired loans and leases $ 1,104$ 2,794 Less: Interest income recognized on impaired loans and leases 454 636 Net foregone interest income on impaired loans and leases $ 650$ 2,158 Loans and leases with no impairment reserves represent impaired loans where the collateral, based upon current information, is deemed to be sufficient or that have been partially charged-off to reflect our net realizable value of the loan. 48
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When analyzing the adequacy of collateral, we obtain external appraisals as appropriate. Our policy regarding commercial real estate appraisals requires the utilization of appraisers from our approved list, the performance of independent reviews to monitor the quality of such appraisals, and receipt of new appraisals for impaired loans at least annually, or more frequently as circumstances warrant. We make adjustments to the appraised values for appropriate selling costs. In addition, the ordering of appraisals and review of the appraisals are performed by individuals who are independent of the business development process. Based on the specific evaluation of the collateral of each impaired loan, we believe the reserve for impaired loans was appropriate atDecember 31, 2021 . However, we cannot provide assurance that the facts and circumstances surrounding each individual impaired loan will not change and that the specific reserve or current carrying value will not be different in the future, which may require additional charge-offs or specific reserves to be recorded.
Allowance for losses on loans and leases
The allowance for loan and lease losses decreased$4.2 million , or 14.7%, to$24.3 million as ofDecember 31, 2021 from$28.5 million as ofDecember 31, 2020 . The allowance for loan and lease losses as a percentage of gross loans and leases also decreased to 1.09% as ofDecember 31, 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 1.10% as ofDecember 31, 2021 from 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 by an increase in general reserve commensurate with loan growth. In addition to the commercial real estate recovery, all other loan segments experienced a reduction in historical loss factors as the look-back period began to roll off the Corporations higher loss rates from the Great Recession. Management believes this will continue in 2022, allowing for additional reserve release throughout the year. During the year endedDecember 31, 2021 , we recorded net recoveries on impaired loans and leases of approximately$1.6 million , which included$3.5 million of charge-offs and$5.1 million of recoveries. During the year endedDecember 31, 2020 , we recorded net charge-offs on impaired loans and leases of approximately$7.8 million , which included$8.1 million of charge-offs and$332,000 of recoveries. The 2020 charge-off activity was principally driven by a$3.3 million charge-off for a previously reserved legacy SBA loan in the restaurant industry and a$2.8 million charge-off for a previously reserved conventional loan in the hospitality industry. As ofDecember 31, 2021 and 2020, our allowance for loan and lease losses to total non-accrual loans and leases was 382.76% and 107.15%, respectively. This ratio increased primarily due to the substantial decrease in non-accrual loans and leases discussed above, in comparison to the decrease in the allowance for loan and leases losses. 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 may not require additional specific reserves or require only a minimal amount of required specific reserve. 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 ofDecember 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, 49
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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 ofDecember 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 annually, or more frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, 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$24.3 million , or 1.09% of gross loans and leases, atDecember 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. 50
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Here is a summary of the activity in the allowance for loan losses and leases:
Year Ended December 31,
2021 2020
(Dollars in Thousands)
Allowance at beginning of period $ 28,521 $ 19,520
Dump :
Commercial real estate Commercial real estate - owner occupied (11) (3,339) Commercial real estate - non-owner occupied - (2,780) Construction and land development - - Multi-family - - 1-4 family (245) - Commercial and industrial (3,227) (1,951) Direct financing leases - (56) Consumer and other Home equity and second mortgage - - Other (25) (13) Total charge-offs (3,508) (8,139) Recoveries: Commercial real estate Commercial real estate - owner occupied 435 1 Commercial real estate - non-owner occupied 1,422 3 Construction and land development 2,078 - Multi-family - - 1-4 family - - Commercial and industrial 1,168 325 Direct financing leases - - Consumer and other Home equity and second mortgage 2 1 Other 21 2 Total recoveries 5,126 332 Net charge-offs 1,618 (7,807) Provision for loan and lease losses (5,803) 16,808 Allowance at end of period$ 24,336 $ 28,521 Net charge-offs as a percent of average gross loans and leases (0.07) % 0.39 % We review our methodology and periodically adjust allocation percentages of the allowance by segment, as reflected in the following table. Within the specific categories, certain loans or leases have been identified for specific reserve allocations as well as the whole category of that loan type or lease being reviewed for a general reserve based on the foregoing analysis of trends and overall balance growth within that category. 51
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The table below shows our allocation of the allowance for loan and lease
losses by loan portfolio segments. The allocation of the allowance by segment is
management's best estimate of the inherent risk in the respective loan segments.
Despite the specific allocation noted in the table below, the entire allowance
is available to cover any loss.
As of December 31,
2021 2020
Balance (a) Balance (a)
(Dollars in Thousands)
Loan and lease segments:
Commercial real estate $ 15,110 1.04 % $ 17,157 1.26 %
Commercial and industrial 8,413 1.13 10,593 1.40
Consumer and other 813 2.05
771 2.10 Total allowance for losses on loans and leases
(a) Loan loss allowance category as a percentage of total loans by category.
Although we believe the allowance for loan and lease losses was appropriate based on the current level of loan and lease delinquencies, non-accrual loans and leases, trends in charge-offs, economic conditions, and other factors as ofDecember 31, 2021 , there can be no assurance that future adjustments to the allowance will not be necessary.
Deposits
As ofDecember 31, 2021 , deposits increased by$102.4 million to$1.958 billion from$1.856 billion atDecember 31, 2020 . The increase in deposits was primarily due to a$143.0 million and$112.9 million increase in transaction accounts and money market accounts, respectively partially offset by a decrease in wholesale deposits and certificates of deposit of$142.9 million and$10.6 million , respectively. The large increase in in-markets deposits was primarily due to successful business development efforts and PPP loan proceeds. The following table presents the composition of the Bank's consolidated deposits. As of December 31, 2021 2020 % of Total Balance Deposits Balance % of Total Deposits (Dollars in Thousands) Non-interest-bearing transaction accounts$ 589,559 30.1 %$ 472,818 25.4 % Interest-bearing transaction accounts 530,225 27.1 503,992 27.2 Money market accounts 754,410 38.5 641,504 34.6 Certificates of deposit 54,091 2.8 64,694 3.5 Wholesale deposits 29,638 1.5 172,508 9.3 Total deposits$ 1,957,923 100.0 %$ 1,855,516 100.0 % 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 service and maintain existing and new client relationships. Deposits continue to be the primary source of the Bank's funding for lending and other investment activities. A variety of accounts are designed to attract both short- and long-term deposits. These accounts include non-interest-bearing transaction accounts, interest-bearing transaction accounts, money market accounts, and certificates of deposit. Deposit terms offered by the Bank vary according to the minimum balance required, the time period the funds must remain on deposit, the rates and products offered by competitors, and the interest rates charged on other sources of funds, among other factors. Our Bank's in-market deposits are obtained primarily from the South Central, Northeast and Southeast regions ofWisconsin and the greaterKansas City Metro. We measure the success of in-market deposit gathering efforts based on the average balances of our deposit accounts as compared to ending balances due to the volatility of some of our larger relationships. Average in-market deposits for the year endedDecember 31, 2021 were approximately$1.784 billion , or 78.23% of total bank funding. Total bank funding is defined as total deposits plus FHLB advances and Federal Reserve PPPLF advances. This compares to average in-market deposits of 52 -------------------------------------------------------------------------------- Table of Contents$1.569 billion , or 75.01% of total bank funding, for 2020. Refer to Note 9 - Deposits in the Consolidated Financial Statements for additional information regarding our deposit composition.
The following table shows the amount and maturities of the Bank’s certificates of deposit and wholesale term deposits at
Over Three Months Over Six Months
Three Months Through Six Through Twelve Over Twelve
Interest Rate and Less Months Months Months Total
(In Thousands)
0.00% to 0.99% $ 36,821 $ 6,797 $ 4,343 $ 4,897 $ 52,858
1.00% to 1.99% 370 - 300 403 1,073
2.00% to 2.99% - - - 112 112
3.00% to 3.99% 9,389 - 10,000 297 19,686
$ 46,580 $ 6,797 $ 14,643 $ 5,709 $ 73,729
At December 31, 2021 , time deposits included $7.9 million of certificates of
deposit and wholesale deposits in denominations greater than or equal to
$250,000 . Of these certificates, $3.0 million are scheduled to mature in three
months or less, $2.1 million in greater than three through six months, $251,000
in greater than six through twelve months and $2.6 million in greater than
twelve months.
Of the total time deposits outstanding as of December 31, 2021 , $68.0 million
are scheduled to mature in 2022, $4.5 million in 2023, $349,000 in 2024,
$324,000 in 2025, and $488,000 in 2026. As of December 31, 2021 , we have no
wholesale certificates of deposit which the Bank has the right to call prior to
the scheduled maturity.
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Loans
We had total borrowings of$413.5 million as ofDecember 31, 2021 , a decrease of$15.7 million , or 3.7%, from$429.2 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 our maturing brokered certificates of deposit with FHLB advances at lower rates, if 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 PPPLF advances. As ofDecember 31, 2021 andDecember 31, 2020 , the Corporation had other borrowings of$10.4 million and$920,000 , respectively, which consisted of sold loans accounted for as secured borrowings because they did not qualify for true sale accounting, as well as borrowings associated with our investment in a community development entity. During the second quarter of 2020, management tested the availability of the Federal Reserve PPPLF due to the uncertainty of when PPP loans would be required to close and fund and obtained a$29.6 million PPPLF advance. As ofDecember 31, 2021 , the Corporation had no PPPLF advances outstanding. 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. Management believes this strategy helped stabilize net interest margin during the extended low interest rate environment. 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.
The following table shows the outstanding balances, weighted average balances and weighted average interest rates of our borrowings (short-term and long-term) as indicated.
December 31, 2021 December 31, 2020
Weighted Weighted Weighted Weighted
Average Average Average Average
Balance Balance Rate Balance Balance Rate
(Dollars in Thousands)
Federal funds purchased $ - $ - - % $ - $ 71 0.69 %
Federal Reserve PPPLF - - - - 15,207 0.35
FHLB advances 368,800 376,781 1.30 394,500 379,891 1.45
Line of credit 500 78 2.90 - - -
Other borrowings 10,363 8,090 4.11 920 676 12.60
Subordinated notes payable 23,788 23,766 5.94 23,747 23,725 5.95
Junior subordinated notes 10,076 10,068 11.05 10,062 10,054 11.09
$ 413,527 $ 418,783 1.86 $ 429,229 $ 429,624 1.91
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A summary of the annual maturities of borrowings in
(In Thousands) Maturities during the year endedDecember 31, 2022 $ 173,500 2023 37,300 2024 35,500 2025 23,363 2026 - Thereafter 143,864$ 413,527 The subordinated notes payable consist of two series of notes, each of which qualifies as Tier II capital. AtDecember 31, 2021 ,$15.0 million bore a fixed interest rate of 5.50% with a maturity date ofAugust 15, 2029 and$9.1 million bore a fixed interest rate of 6.00% with a maturity date ofApril 15, 2027 . The Corporation may, at its option, redeem the 5.50% notes, in whole or part, at any time afterAugust 15, 2024 , and may redeem the 6.00% notes any time afterJune 15, 2022 . The 5.50% notes will begin to lose Tier II capital treatment at a rate of 20% per year effectiveAugust 15, 2024 , while the 6.00% note will begin to lose Tier II capital treatment at a rate of 20% per year effectiveJune 15, 2022 . Given the historically low interest rate environment, management continues to evaluate options to optimize the Corporation's capital structure and reduce borrowing costs, wherein we may redeem and replace various notes at the next earliest redemption periods. Refer to Note 10 - FHLB Advances, Other Borrowings and Junior Subordinated Notes in the Consolidated Financial Statements for additional information on the terms of Corporation's current debt instruments.
Equity
As ofDecember 31, 2021 , stockholders' equity was$232.4 million , or 8.76% of total assets, compared to stockholders' equity of$206.2 million , or 8.03% of total assets, as ofDecember 31, 2020 . Excluding PPP loans, stockholders' equity was 8.85% of total assets as ofDecember 31, 2021 , compared to 8.80%. Stockholders' equity increased by$26.3 million during the year endedDecember 31, 2021 attributable to net income of$35.8 million for the year endedDecember 31, 2021 , partially offset by dividend declarations of$6.2 million and stock repurchases of$5.0 million authorized under the repurchase program discussed below. OnJanuary 28, 2021 , the Board of Directors of the Corporation approved a new share repurchase program. The program authorized the repurchase by the Corporation of up to$5 million of its total outstanding shares of common stock over a period of approximately twelve months, endingJanuary 31, 2022 . The Corporation completed the$5 million repurchase program inOctober 2021 , repurchasing a total of 182,151 shares during the year at a weighted average price of$27.40 per share. The Corporation did not have an active share repurchase plan as ofDecember 31, 2021 . Under the share repurchase program, shares were repurchased from time to time in the open market or negotiated transactions at prevailing market rates, or by other means in accordance with federal securities laws. In connection with the share repurchase program, the Corporation implemented a 10b5-1 trading plan. The trading plan allowed the Corporation to repurchase shares of its common stock at times when it otherwise might have been prevented from doing so under insider trading laws by requiring that an agent selected by the Corporation repurchase shares of common stock on the Corporation's behalf on pre-determined terms. 55
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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 December 31, 2021 were the interest payments due on subordinated
and junior subordinated notes. During 2021 and 2020, FBB declared and paid
dividends totaling $8.5 million and $12.0 million , respectively. The capital
ratios of the Bank met all applicable regulatory capital adequacy requirements
in effect on December 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 and FHLB 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 December 31, 2021 and 2020, our immediate on-balance sheet liquidity was
$529.5 million and $640.2 million , respectively. At December 31, 2021 and 2020,
the Bank had $47.0 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 to invest in securities to
maintain adequate liquidity at an improved margin.
We had $398.4 million of outstanding wholesale funds at December 31, 2021 ,
compared to $567.0 million of wholesale funds as of December 31, 2020 , which
represented 17.1% and 25.2%, respectively, of period end 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 $245.3 million , or 14.6%, to $1.928
billion at December 31, 2021 from $1.683 billion at December 31, 2020 as
in-market deposit balances increased due to successful business development
efforts and PPP loan proceeds. 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 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
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
December 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 December 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
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at the FRB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As ofDecember 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 regulations to maintain sufficient liquidity to ensure safe and sound operations. We believe the Bank has sufficient liquidity to balance the balance of net withdrawable deposits and short-term borrowings given current economic conditions and deposit flows.
During the year endedDecember 31, 2021 , operating activities resulted in a net cash inflow of$36.0 million driven by net income of$35.8 million . Net cash used in investing activities for the year endedDecember 31, 2021 was$111.0 million which consisted of$86.7 million in cash outflows to fund net loan growth and$20.3 million in net cash outflows to purchase available-for-sale securities. Net cash provided by financing activities for the year endedDecember 31, 2021 was$75.2 million . Financing cash flows included a$102.4 million net increase in deposits, partially offset by a$25.7 million net decrease in FHLB advances, cash dividends paid of$6.2 million , and authorized share repurchases of$5.0 million , respectively. Refer to Note 11 -Regulatory Capital for additional information regarding the Corporation's and the Bank's capital ratios and the ratios required by their federal regulators atDecember 31, 2021 and 2020. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. By their nature, changes in these assumptions and estimates could significantly affect the Corporation's financial position or results of operations. Actual results could differ from those estimates. Discussed below are certain policies that are critical to the Corporation. We view critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Allowance for Loan and Lease Losses. The allowance for loan and lease losses represents our recognition of the risks of extending credit and our evaluation of the quality of the loan and lease portfolio and as such, requires the use of judgment as well as other systematic objective and quantitative methods which may include additional assumptions and estimates. The risks of extending credit and the accuracy of our evaluation of the quality of the loan and lease portfolio are neither static nor mutually exclusive and could result in a material impact on our Consolidated Financial Statements. We may over-estimate the quality of the loan and lease portfolio, resulting in a lower allowance for loan and lease losses than necessary, overstating net income and equity. Conversely, we may under-estimate the quality of the loan and lease portfolio, resulting in a higher allowance for loan and lease losses than necessary, understating net income and equity. The allowance for loan and lease losses is a valuation allowance for probable credit losses, increased by the provision for loan and lease losses and decreased by charge-offs, net of recoveries. We estimate the allowance reserve balance required and the related provision for loan and lease losses based on quarterly evaluations of the loan and lease portfolio, with particular attention paid to loans and leases that have been specifically identified as needing additional management analysis because of the potential for further problems. During these evaluations, consideration is also given to such factors as the level and composition of impaired and other non-performing loans and leases, historical loss experience, results of examinations by regulatory agencies, independent loan and lease reviews, our estimate of the fair value of the underlying collateral taking into consideration various valuation techniques and qualitative adjustments to inputs to those estimates of fair value, the strength and availability of guarantees, concentration of credits, and other factors. Allocations of the allowance may be made for specific loans or leases, but the entire allowance is available for any loan or lease that, in our judgment, should be charged off. Loan and lease losses are charged against the allowance when we believe that the uncollectability of a loan or lease balance is confirmed. See Note 1 - Nature of Operations and Summary of Significant Accounting Policies and Note 4 - Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses in the Consolidated Financial Statements for further discussion of the allowance for loan and lease losses. We also continue to exercise our legal rights and remedies as appropriate in the collection and disposal of non-performing assets, and adhere to rigorous underwriting standards in our origination process in order to achieve strong asset quality. Although we believe that the allowance for loan and lease losses was appropriate as ofDecember 31, 2021 based upon the evaluation of loan and lease delinquencies, non-performing assets, charge-off trends, economic conditions, and other factors, there can be no assurance that future adjustments to the allowance will not be necessary. If the quality of loans or leases 57
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deteriorates, then the allowance for loan and lease losses would generally be expected to increase relative to total loans and leases. If loan or lease quality improves, then the allowance would generally be expected to decrease relative to total loans and leases. Goodwill Impairment Assessment.Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill. The Corporation conducted its annual impairment test as ofAugust 1, 2021 , utilizing a qualitative assessment, and concluded that it was more likely than not the estimated fair value of the reporting unit exceeded its carrying value, resulting in no impairment. Although no goodwill impairment was noted, there can be no assurances that future goodwill impairment will not occur. See Note 1 - Nature of Operations and Summary of Significant Accounting Policies for the Corporation's accounting policy on goodwill and see Note 7 -Goodwill and Other Intangible Assets in the Consolidated Financial Statements for a detailed discussion of the factors considered by management in the assessment. Income Taxes. The Corporation and its wholly owned subsidiaries file a consolidated federal income tax return and a combinedWisconsin state tax return. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The determination of current and deferred income taxes is based on complex analysis of many factors, including the interpretation of federal and state income tax laws, the difference between the tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts currently due or owed, such as the timing of reversals of temporary differences, and current accounting standards. We apply a more likely than not approach to each of our tax positions when determining the amount of tax benefit to record in our Consolidated Financial Statements. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We have made our best estimate of valuation allowances utilizing available evidence and evaluation of sources of taxable income including tax planning strategies and expected reversals of timing differences to determine if valuation allowances were needed for deferred tax assets. Realization of deferred tax assets over time is dependent on our ability to generate sufficient taxable earnings in future periods and a valuation allowance may be necessary if management determines that it is more likely than not that the deferred asset will not be utilized. These estimates and assumptions are subject to change. Changes in these estimates and assumptions could adversely affect future consolidated results of operations. The Corporation believes the tax assets and liabilities are properly recorded in the Consolidated Financial Statements. See also Note 15 - Income Taxes in the Consolidated Financial Statements. The Corporation also invests in certain development entities that generate federal and state historic and low income housing tax credits. The tax benefits associated with these investments are accounted for either under the flow-through method, equity method, or proportional amortization method and are recognized when the respective project is placed in service or over the investment term. The federal and state taxing authorities who make assessments based on their determination of tax laws may periodically review our interpretation of federal and state income tax laws. Tax liabilities could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities based on the completion of examinations by taxing authorities.
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