FIRST BUSINESS FINANCIAL SERVICES, INC. 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, 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, and specifically disclaim any obligation to, update any forward-looking statements.
The following discussion and analysis is intended as a review of significant
events and factors affecting our financial condition and results of operations
for the periods indicated. The discussion should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto.
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Overview
We are a registered bank holding company incorporated under the laws of the
State of Wisconsin and are engaged in the commercial banking business through
our wholly-owned banking subsidiary, FBB. All of our operations are conducted
through FBB and First Business Specialty Finance, LLC ("FBSF"), a wholly-owned
subsidiary of FBB. We operate as a business bank focusing on delivering a full
line of commercial banking products and services tailored to meet the specific
needs of small and medium-sized businesses, business owners, executives,
professionals, and high net worth individuals. Our products and services include
those for business banking, private wealth, and bank consulting. Within business
banking, we offer commercial lending, consumer and other lending, asset-based
lending, accounts receivable financing, equipment financing, floorplan
financing, vendor financing, SBA lending and servicing, treasury management
services, and company retirement plans. Our private wealth services for
executives and individuals include trust and estate administration, financial
planning, investment management, and private banking. For other financial
institutions, our bank consulting experts provide investment portfolio
administrative services, asset liability management services, and asset
liability management process validation. We do not utilize a branch network to
attract retail clients. Our operating philosophy is predicated on deep client
relationships within our commercial bank markets and skilled expertise within
our nationwide specialty finance business lines, combined with the efficiency of
centralized administrative functions, such as information technology, loan and
deposit operations, finance and accounting, credit administration, compliance,
marketing, and human resources. Our focused model allows experienced staff to
provide the level of financial expertise needed to develop and maintain
long-term relationships with our clients.
Long-Term Strategic Plan
In early 2019, the Corporation finalized the development of its five year
strategic plan and began the implementation of strategies and initiatives that
will drive successful execution. The Corporation's objective over this five year
period is to excel by building the best team that works 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.
On March 11, 2020 , the World Health Organization declared COVID-19, the disease
caused by the novel coronavirus, a pandemic as a result of the global spread of
the coronavirus illness. In response to the outbreak, federal and state
authorities in the U.S. introduced various measures to try to limit or slow the
spread of the virus, including travel restrictions, nonessential business
closures, stay-at-home orders, and strict social distancing. The Corporation
activated its Pandemic Preparedness Plan to protect the health of employees and
clients, which includes temporarily limiting lobby hours and transitioning the
vast majority of the Corporation's workforce to remote work. The Corporation has
not incurred any significant disruptions to its business activities.
The full impact of COVID-19 remains uncertain. It has caused substantial
disruption in international and U.S. economies, markets, and employment. The
outbreak is having a significant adverse impact on certain industries the
Corporation serves, including retail, restaurants and food services,
hospitality, and entertainment. Because of the significant uncertainties related
to the ultimate duration of the COVID-19 pandemic and its effects on clients and
prospects, and on the national and local economy as a whole, there can be no
assurances as to how the crisis may ultimately affect the Corporation's
financial performance.
Despite these tremendous headwinds, in 2020 we remained focused on building and
developing our diverse team, creating efficiencies, growing deposits, and
optimizing business line performance. These efforts resulted in strong operating
performance, highlighted by record top line revenue growth and record loan and
deposit growth, excluding Paycheck Protection Program ("PPP") loans. Our key
profitability metrics of return on average equity and return on average assets
were negatively impacted by elevated provision for loan and lease losses
primarily due to the uncertainty surrounding the COVID-19 pandemic. However, we
remain steadfast in the pursuit of our long-term goals and firmly believe our
2020 performance positions the Corporation well for strong and sustainable
earnings growth in 2021 and beyond.
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The following table below shows the Corporation's performance for the years
ended December 31, 2020 and 2019 in comparison to the key performance indicators
included in the Corporation's long-term strategic plan.
Key Performance Indicators FYE 2019 FYE 2020 2023 Goal
Return on average equity ("ROAE") 12.55% 8.64% 13.50%
Return on average assets ("ROAA") 1.14% 0.70% 1.15%
Top line revenue growth (%) 9.1% 11.5% ? 10% per year In-market deposits to total bank funding (%) 75.5% 74.8% ? 70% Employee engagement (1) 82% 91% ? 80% Client satisfaction (1) 93% 96% ? 90%
(1) Anonymous surveys conducted annually
Financial Performance Summary
Results as of and for the year ended December 31, 2020 include:
•Net income for the year ended December 31, 2020 was $17.0 million , decreasing
27.2% compared to $23.3 million for the year ended December 31, 2019 .
•Diluted earnings per common share were $1.97 for the year ended December 31,
2020 , decreasing 26.5% compared to $2.68 in the prior year.
•Return on average assets and return on average equity for the year ended
December 31, 2020 were 0.70% and 8.64% respectively, compared to 1.14% and
12.55%, respectively, for 2019.
•Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and
discrete items, for the year ended December 31, 2020 was $38.4 million ,
increasing 23.2% compared to $31.2 million for the year ended December 31, 2019 .
Pre-tax, pre-provision adjusted return on average assets for the year ended
December 31, 2020 was 1.59%, compared to 1.52% for the year ended December 31,
2019 .
•Net interest margin was 3.40% for the year ended December 31, 2020 , declining
21 basis points from 3.61% for the year ended December 31, 2019 . Adjusted net
interest margin, which excludes certain one-time and discrete items, was 3.28%
for the year ended December 31, 2020 , declining five basis points from 3.33% for
the year ended December 31, 2019 .
•Fees in lieu of interest, defined as prepayment fees, asset-based loan fees,
non-accrual interest, and loan fee amortization, totaled $9.3 million for the
year ended December 31, 2020 , increasing 43.8% compared to $6.5 million for the
year ended December 31, 2019 . Loan fee amortization for the year ended
December 31, 2020 includes PPP processing fee income of $5.3 million .
•Top line revenue, which consists of net interest income and non-interest
income, grew 11.5% to $104.0 million for the year ended December 31, 2020 ,
compared to $93.3 million for the same period in 2019.
•Provision for loan and lease losses was $16.8 million for the year ended
December 31, 2020 , compared to $2.1 million for the year ended December 31,
2019 . Net charge-offs as a percentage of average loans and leases increased to
0.39% for the year ended December 31, 2020 , compared to 0.18% for the year ended
December 31, 2019 .
•In January 2021 , the Corporation received a recovery of approximately $2.0
million on a loan charged off in a prior year. While this recovery will have a
positive impact on the Company's provision for loan and lease losses in the
first quarter of 2021, it is not necessarily indicative of a trend or a
reflection of the Company's ultimate provision for the first quarter.
•Non-interest income for the year ended December 31, 2020 totaled $26.9 million ,
or 25.9% of total revenue, compared to $23.4 million , or 25.1% of total revenue
for the year ended December 31, 2019 .
•Non-interest expense for the year ended December 31, 2020 was $68.9 million ,
increasing 3.3% compared to $66.7 million for the year ended December 31, 2019 .
Operating expense, which excludes certain one-time and discrete items, totaled
$65.6 million for the year ended December 31, 2020 , increasing 5.6% compared to
$62.1 million for the year ended December 31, 2019 .
•The efficiency ratio, which excludes certain one-time and discrete items,
improved to 63.09% for the year ended December 31, 2020 , down from 66.59% for
the year ended December 31, 2019 .
•Total assets at December 31, 2020 increased $471.1 million , or 22.5%, to $2.568
billion from $2.097 billion at December 31, 2019 .
•Period-end gross loans and leases receivable at December 31, 2020 increased
$431.3 million , or 25.2%, to $2.146 billion from $1.715 billion as of
December 31, 2019 . Average gross loans and leases of $2.011
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billion increased $307.4 million , or 18.0% for the year ended December 31, 2020 ,
compared to $1.704 billion for the same period in 2019.
•Period-end gross loans and leases receivable, excluding net PPP loans, at
December 31, 2020 increased $206.0 million , or 12.01%, to $1.921 billion from
$1.715 billion as of December 31, 2019 . Average gross loans and leases,
excluding net PPP loans, of $1.796 billion increased $92.3 million , or 5.4% for
the year ended December 31, 2020 , compared to $1.704 billion for the same period
in 2019.
•PPP loans and PPP deferred processing fees were $228.9 million and $3.5
million , respectively, at December 31, 2020 . Average PPP loans, net of deferred
processing fees, were $215.0 million for the year ended December 31, 2020 .
•Non-performing assets were $26.7 million and 1.04% of total assets as of
December 31, 2020 , compared to $23.5 million and 1.12% of total assets as of
December 31, 2019 . Non-performing assets to total assets, excluding net PPP
loans was 1.14% as of December 31, 2020 .
•The allowance for loan and lease losses as of December 31, 2020 increased $9.0
million , or 46.1%, to $28.5 million , compared to $19.5 million as of
December 31, 2019 . The allowance for loan and lease losses was 1.33% of total
loans as of December 31, 2020 , compared to 1.14% as of December 31, 2019 .
Excluding net PPP loans, the allowance for loan and lease losses increased to
1.48% of total loans as of December 31, 2020 .
•Period-end in-market deposits at December 31, 2020 increased $304.1 million , or
22.1%, to $1.683 billion from $1.379 billion as of December 31, 2019 . Average
in-market deposits of $1.569 billion increased $297.4 million , or 23.4%, for the
year ended December 31, 2020 , compared to $1.271 billion for the same period in
2019.
•Trust assets under management and administration increased by $356.8 million ,
or 18.9%, to $2.249 billion at December 31, 2020 compared to $1.892 billion at
December 31, 2019 .
•On January 28, 2021 , the Board of Directors of the Company adopted a new share
repurchase program that authorizes the Company to repurchase up to $5 million of
the Company's common stock over a period of approximately twelve months, ending
on January 31, 2022 . The Company suspended its prior share repurchase program in
March 2020 due to the uncertainty surrounding the COVID-19 pandemic. Under the
previous plan, which was initiated in September 2019 and expired September 30,
2020 , the Company had repurchased $3.5 million of the $5 million authorized in
the Company's common stock.
COVID-19 Update
As of December 31, 2020 , the Corporation had $228.9 million in PPP loans
outstanding and $3.5 million in deferred processing fees outstanding. The
processing fees are deferred and recognized over the contractual life of the
loan, or accelerated when forgiven and repaid, as an adjustment of yield using
the interest method. For the year ended December 31, 2020 , the Corporation
recognized $5.3 million in PPP fees, recording 60% of the $8.8 million in
deferred Small Business Administration ("SBA") processing fees for loans
originated in 2020. The SBA provides a guaranty to the lender of 100% of
principal and interest, unless the lender violated an obligation under the
agreement. As loan losses are expected to be immaterial, if any at all, due to
the guaranty, management excluded the gross PPP loans from the allowance for
loan and lease losses calculation.
In January 2021 , the Corporation began accepting applications for the SBA's most
recent phase of the PPP program, with an emphasis on supporting in-market
businesses and non-profit organizations. As of February 1, 2021 , the Corporation
had processed and approved over 300 applications for the most recent phase of
the PPP program for approximately $85.0 million .
Liquidity Sources
Management has reviewed all primary and secondary sources of liquidity in
preparation for any unforeseen funding needs due to the COVID-19 pandemic and
prioritized based on available capacity, term flexibility, and cost. As of
December 31, 2020 , the Corporation had the following sources of liquidity,
including the Corporation's ability to participate in the Federal Reserve's
Paycheck Protection Program Liquidity Facility ("PPPLF"):
As of
December 31, December 31,
(in thousands) 2020 2019
Short-term investments $ 27,371 $ 50,995
PPPLF availability 225,323 -Collateral value of unencumbered loans (FHLB borrowing availability)
250,127 212,516
Market value of unencumbered securities (Fed Discount Window and
FHLB borrowing availability) 137,357 174,661
Total sources of liquidity $ 640,178 $ 438,172
33-------------------------------------------------------------------------------- Table of Contents In addition to the above primary sources of liquidity, as ofDecember 31, 2020 , the Corporation also had access to$53.5 million in federal funds lines with various correspondent banks and significant experience accessing the highly liquid brokered deposit market. Capital Strength The Corporation's capital ratios continued to exceed the highest required regulatory benchmark levels. •Total capital to risk-weighted assets atDecember 31, 2020 was 11.25%, tier 1 capital to risk-weighted assets was 8.96%, tier 1 leverage capital to adjusted average assets was 7.99%, and common equity tier 1 capital to risk-weighted assets was 8.53%. Tangible common equity to tangible assets was 7.60%. Excluding net PPP loans, tier 1 leverage capital to adjusted average assets and tangible common equity to tangible assets were 8.97% and 8.33%, respectively. •As previously announced, during the fourth quarter of 2020, the Corporation's Board of Directors declared a regular quarterly dividend of$0.165 per share. The dividend was paid onNovember 12, 2020 to shareholders of record at the close of business onNovember 2, 2020 . Measured against fourth quarter 2020 diluted earnings per share of$0.71 , the dividend represents a 23.2% payout ratio. The Board of Directors routinely considers dividend declarations as part of its normal course of business. •OnJanuary 29, 2021 , the Corporation's Board of Directors declared a quarterly cash dividend on its common stock of$0.18 per share. The quarterly dividend represents a 9% increase over the quarterly dividend declared inOctober 2020 , and, based on fourth quarter 2020 earnings per share, a dividend payout ratio of 25.4%. Deferral Requests The Corporation provided loan modifications deferring payments up to six months to certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation's loan modification program. As ofDecember 31, 2020 , the Corporation had deferred loans outstanding of$27.0 million , or 1.4% of gross loans and leases, excluding gross PPP loans, compared to$131.5 million , or 7.1% as ofSeptember 30, 2020 and$323.2 million , or 18.6% as ofJune 30, 2020 . The following tables represent a breakdown of the deferred loan balances by industry segment and collateral type: As of (Dollars in thousands) December 31, 2020 Collateral Type Non Real Industries Description Balance Real Estate Estate Accommodation and Food Services$ 12,229 $ 12,229 $ - Real Estate and Rental and Leasing 5,975 5,975 - Manufacturing 3,398 - 3,398 Arts, Entertainment, and Recreation 3,095 1,051 2,044 Transportation and Warehousing 573 - 573 Construction 447 447 - Professional, Scientific, and Technical Services 383 383 Other Services (except Public Administration) 367 212 155 Health Care and Social Assistance 205 - 205 Educational Services 195 195 - Administrative and Support and Waste Management and Remediation Services 143 143 Total deferred loan balances$ 27,010 $ 20,109 $ 6,901 34
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The following table is a further breakdown of the deferred loan balances by
certain credit quality indicators. Please refer to Note 5 - Loan and Lease
Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses
for the risk category definitions.
As of
December 31, 2020
Category
(Dollars in thousands) I II III IV Total
Total deferred loan balances $ 13,466 $ 13,448 $ 58 $ 38 $ 27,010
% of Total 49.9 % 49.8 % 0.2 % 0.1 % 100.0 %
As of
September 30, 2020
Category
(Dollars in thousands) I II III IV Total
Total deferred loan balances $ 69,984 $ 40,371 $ 20,045 $ 1,069 $ 131,469
% of Total 53.2 % 30.7 % 15.2 % 0.8 % 100.0 %
Exposure to Stressed Industries
Certain industries have been and are expected to be particularly impacted by
social distancing, quarantines, and the economic impact of the COVID-19
pandemic, such as the following:
As of
(Dollars in thousands) December 31, 2020 September 30, 2020 June 30, 2020
% Gross Loans % Gross Loans % Gross Loans
Industries: Balance and Leases (1) Balance and Leases (1) Balance and Leases (1)
Retail (2) $ 62,719 3.3 % $ 66,696 3.6 % $ 70,028 4.0 %
Hospitality 80,832 4.2 % 78,786 4.3 % 73,502 4.2 %
Entertainment 14,208 0.7 % 16,323 0.9 % 16,675 1.0 %
Restaurants & Food Service 24,854 1.3 % 26,728 1.4 % 24,884 1.4 %
Total outstanding exposure $ 182,613 9.5 % $ 188,533 10.2 % $ 185,089 10.6 %
(1)Excluding net PPP loans.
(2)Includes $48.9 million , $52.0 million , and $51.7 million in loans secured by
commercial real estate as of December 31, 2020 , September 30, 2020 , and June 30,
2020 , respectively.
As of December 31, 2020 , the Corporation had no meaningful direct exposure to
the energy sector, airline industry, or retail consumer, and does not
participate in shared national credits.
Because of the significant uncertainties related to the ultimate duration of the
COVID-19 pandemic and its effects on our clients and prospects, and on the
national and local economy as a whole, there can be no assurances as to how the
pandemic may ultimately affect the Corporation's loan portfolio.
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Results of OperationsTop Line Revenue
Top line revenue, comprised of net interest income and non-interest income, increased 11.5% for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 primarily due to a$7.2 million , or 10.3%, increase in net interest income and a$3.5 million , or 15.0%, increase in non-interest income. The increase in net interest income was driven by an increase in average loans and leases outstanding, and loan fees collected in lieu of interest, while the increase in non-interest income was primarily a result of a$2.7 million increase in swap fees and a$1.4 million increase in gains on the sale of SBA loans. These favorable variances in top line revenue were partially offset by a reduction in net interest margin which decreased 21 basis points to 3.40% for the year endedDecember 31, 2020 compared to 3.61% in the prior year.
The components of top line revenue were as follows:
For the Year Ended December 31, Change From Prior Year
2020 2019 $ Change % Change
(Dollars in Thousands)
Net interest income $ 77,071 $ 69,856 $ 7,215 10.3 %
Non-interest income 26,940 23,423 3,517 15.0
Top line revenue $ 104,011 $ 93,279 $ 10,732 11.5
Return on Average Assets and Return on Average Equity
Return on average assets ("ROAA") was 0.70% for the year ended December 31,
2020 compared to 1.14% for the year ended December 31, 2019 . The decrease in
ROAA can be attributed principally to a $14.7 million increase in provision for
loan and lease losses during the same time period. The increase in the provision
for loan and lease losses for the year ended December 31, 2020 was primarily
driven by $7.8 million of net charge-offs, a $6.4 million increase in general
reserve related to the uncertainty of the economic conditions resulting from the
COVID-19 pandemic, and a $2.3 million increase in the general reserve due to
loan growth. Please refer to the Components of the Provision for Loan and Lease
Losses included in the Provision for Loan and Lease Losses discussion below. The
COVID-19 related credit headwind in 2020 was partially offset by record top line
revenue. 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.
Return on average equity ("ROAE") for the year ended December 31, 2020 was
8.64% compared to 12.55% for the year ended December 31, 2019 . The primary
reasons for the increase in ROAE are consistent with the net income variance
explanations 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 Pre-Tax, Pre-Provision Adjusted Earnings
Efficiency ratio is a non-GAAP measure representing non-interest expense
excluding the effects of the SBA recourse benefit or provision, impairment of
tax credit investments, net gains or losses on foreclosed properties,
amortization of other intangible assets, losses on early extinguishment of debt,
and other discrete items, if any, divided by operating revenue, which is equal
to net interest income plus non-interest income less realized net gains or
losses on securities, if any. Pre-tax, pre-provision adjusted earnings is
defined as operating revenue less operating expense. In the judgment of the
Corporation's management, the adjustments made to non-interest expense and
non-interest income allow investors and analysts to better assess the
Corporation's operating expenses in relation to its core operating revenue by
removing the volatility that is associated with certain one-time items and other
discrete items.
The efficiency ratio improved to 63.09% for the year ended December 31, 2020 ,
compared to 66.59% for the year ended December 31, 2019 . This improvement was
the result of exceptional 2020 operating revenue attributable to above average
fee income generated by the Corporation's commercial loan interest rate swap
program and SBA loan sales, as well as an increase in net interest income driven
by an 18.0% increase in average loans and leases receivable and $2.8 million , or
43.8%, increase in fees in lieu of interest. The increase in fees in lieu of
interest included $5.3 million in PPP fees. The increase in operating revenue
was partially offset by a $3.8 million , or 9.1%, increase in compensation
expense reflecting in part the Corporation's continued investment in its growth
strategy. Full-time equivalent employees ("FTE") were 301 as of December 31,
2020 , increasing by 13, or 4.5%, from 288 as of December 31, 2019 . The
period-end increase in FTEs as of
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December 31, 2020 consisted of six net new production positions and seven net
new support positions across multiple business lines. We believe we will
continue to generate modest positive operating leverage and progress towards
enhancing our long-term efficiency ratio at a measured pace as we focus on
strategic initiatives directed toward revenue growth. These initiatives include
efforts to expand our specialty finance lines of business, increase our
commercial banking market share, and scale our private wealth management
business in our less mature commercial banking markets.
We believe the efficiency ratio and pre-tax, pre-provision adjusted earnings
allow investors and analysts to better assess the Corporation's operating
expenses in relation to its top line revenue by removing the volatility that is
associated with certain non-recurring and other discrete items. The efficiency
ratio and pre-tax, pre-provision adjusted earnings also allow management to
benchmark performance of our model to our peers without the influence of the
loan loss provision and tax considerations, which will ultimately influence
other traditional financial measurements, including ROAA and ROAE. The
information provided below reconciles the efficiency ratio to its most
comparable GAAP measure.
Please refer to the Non-Interest Income and Non-Interest Expense sections
below for discussion on additional drivers of the year-over-year change in the
efficiency ratio.
For the Year Ended December 31, Change From Prior Year
2020 2019 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 68,898 $ 66,695 $ 2,203 3.3 %
Less:
Net loss on foreclosed properties 383 224 159 71.0
Amortization of other intangible assets 35 40 (5) (12.5)
SBA recourse (benefit) provision (278) 188 (466) NM
Impairment of tax credit investments 2,395 4,094 (1,699) (41.5)
Loss on early extinguishment of debt 744 - 744 NM
Total operating expense $ 65,619 $ 62,149 $ 3,470 5.6
Net interest income $ 77,071 $ 69,856 $ 7,215 10.3
Total non-interest income 26,940 23,423 3,517 15.0
Less:
Net loss on sale of securities (4) (46) 42 (91.3) Adjusted non-interest income 26,944 23,469 3,475 14.8 Total operating revenue$ 104,015 $ 93,325 $ 10,690 11.5 Efficiency ratio 63.09 % 66.59 % Pre-tax, pre-provision adjusted earnings$ 38,396 $ 31,176 $ 7,220 23.2 Average total assets 2,419,616 2,049,035 370,581 18.1 Pre-tax, pre-provision adjusted return on average assets 1.59 % 1.52 % 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. 37
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For the Year Ended December 31,
2020 2019
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) $ 1,245,886 $ 51,188 4.11 % $ 1,142,201 $ 58,330 5.11 %
Commercial and industrial loans(1) 701,328 35,487 5.06 % 500,058 35,251 7.05 %
Direct financing leases(1) 26,564 1,039 3.91 % 30,462 1,276 4.19 %
Consumer and other loans(1) 37,544 1,446 3.85 % 31,250 1,372 4.39 %
Total loans and leases receivable(1) 2,011,322 89,160 4.43 % 1,703,971 96,229 5.65 %
Mortgage-related securities(2) 173,084 3,548 2.05 % 161,969 4,069 2.51 %
Other investment securities(3) 31,809 639 2.01 % 26,661 568 2.13 %
FHLB stock 11,576 671 5.80 % 7,398 357 4.83 %
Short-term investments 37,314 161 0.43 % 35,344 817 2.31 %
Total interest-earning assets 2,265,105 94,179 4.16 % 1,935,343 102,040 5.27 %
Non-interest-earning assets 154,511 113,692
Total assets $ 2,419,616 $ 2,049,035
Interest-bearing liabilities
Transaction accounts $ 392,577 1,448 0.37 % $ 222,244 3,408 1.53 %
Money market 651,402 2,842 0.44 % 617,341 10,576 1.71 %
Certificates of deposit 111,698 2,198 1.97 % 156,048 3,852 2.47 %
Wholesale deposits 142,591 2,434 1.71 % 225,302 5,122 2.27 %
Total interest-bearing deposits 1,298,268 8,922 0.69 % 1,220,935 22,958 1.88 %
FHLB advances 379,891 5,507 1.45 % 286,464 6,219 2.17 %
Federal reserve PPPLF 15,207 54 0.36 % - - - %
Other borrowings 24,472 1,509 6.17 % 25,236 1,895 7.51 %
Junior subordinated notes 10,054 1,116 11.10 % 10,040 1,112 11.08 %
Total interest-bearing liabilities 1,727,892 17,108 0.99 % 1,542,675 32,184 2.09 %
Non-interest-bearing demand deposit accounts 412,825 275,495
Other non-interest-bearing liabilities 82,337 45,047
Total liabilities 2,223,054 1,863,217
Stockholders' equity 196,562 185,818
Total liabilities and stockholders' equity $ 2,419,616 $ 2,049,035
Net interest income $ 77,071 $ 69,856
Net interest spread 3.17 % 3.19 %
Net interest-earning assets $ 537,213 $ 392,668
Net interest margin 3.40 % 3.61 %
Average interest-earning assets to average
interest-bearing liabilities 131.09 % 125.45 %
Return on average assets 0.70 % 1.14 %
Return on average equity 8.64 % 12.55 %
Average equity to average assets 8.12 % 9.07 %
Non-interest expense to average assets 2.85 % 3.25 %
(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, 2020 compared to the year endedDecember 31, 2019 . 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, 2020 Compared to 2019 Rate Volume Net (In Thousands) Interest-earning assets Commercial real estate and other mortgage loans(1) $ (12,109)$ 4,967 $ (7,142) Commercial and industrial loans(1) (11,598) 11,834 236 Direct financing leases(1) (81) (156) (237) Consumer and other loans(1) (181) 255 74 Total loans and leases receivable(1) (23,969) 16,900 (7,069) Mortgage-related securities(2) (786) 265 (521) Other investment securities (34) 105 71 FHLB Stock 83 231 314 Short-term investments (700) 44 (656) Total net change in income on interest-earning assets (25,406) 17,545 (7,861) Interest-bearing liabilities Transaction accounts (3,575) 1,615 (1,960) Money market (8,288) 554 (7,734) Certificates of deposit (689) (965) (1,654) Wholesale deposits (1,087) (1,601) (2,688) Total deposits (13,639) (397) (14,036) FHLB advances (2,406) 1,694 (712) Federal reserve PPPLF - 54 54 Other borrowings (330) (56) (386) Junior subordinated notes 2 2 4 Total net change in expense on interest-bearing liabilities (16,373) 1,297 (15,076) Net change in net interest income $ (9,033)$ 16,248 $ 7,215 (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$7.2 million , or 10.3%, for the year endedDecember 31, 2020 , compared to the year endedDecember 31, 2019 . The increase compared to the prior year was principally due to an increase in average loans and leases outstanding and loan fees collected in lieu of interest. Average gross loans and leases of$2.011 billion increased by$307.4 million , or 18.0% for the year endedDecember 31, 2020 , compared to$1.704 billion for the same period in 2019, while loan fees collected in lieu of interest increased 43.8% to$9.3 million , compared to$6.5 million during the same period of comparison. These favorable variances were partially offset by net interest margin compression as the decline in rate across all interest-earning assets, in particular total loans and leases receivable, was greater than the decline in rate across all interest-bearing liabilities. Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased$2.2 million , or 3.5%. Excluding net PPP loans, average gross loans and leases for the year endedDecember 31, 2020 increased$92.3 million , or 5.4%, compared to the year endedDecember 31, 2019 . The yield on average earning assets for the year endedDecember 31, 2020 was 4.16%, a decrease of 111 basis points compared to 5.27% for the year endedDecember 31, 2019 . This decrease was principally due to the decrease in LIBOR and Prime rates and related impact on variable-rate loans, in addition to the renewal of fixed-rate loans and reinvestment of security 39 -------------------------------------------------------------------------------- Table of Contents cash flows at historically low interest rates. This decrease was partially offset by the increase in recurring loan fees collected in lieu of interest. Excluding the impact of loan fees in lieu of interest in both 2020 and 2019, the yield on average earning assets for the year endedDecember 31, 2020 was 3.75%, a decrease of 119 basis points compared to 4.94% for the year endedDecember 31, 2019 . The yield on average loans and leases receivable for the year endedDecember 31, 2020 was 4.43%, a decrease of 122 basis points compared to 5.65% for the year endedDecember 31, 2019 . The primary reasons for this decrease are consistent with the average interest-earning asset yield variance explanations discussed above. Excluding the impact of loan fees collected in lieu of interest in both 2020 and 2019, the yield on average loans and leases receivable for the year endedDecember 31, 2020 was 3.97%, a decrease of 130 basis points compared to 5.27% for the year endedDecember 31, 2019 . The average rate paid on interest-bearing liabilities was 0.99% for the year endedDecember 31, 2020 , a decrease of 110 basis points from 2.09% for the year endedDecember 31, 2019 . The average rate paid declined as the Corporation decreased deposit rates in response to theFederal Open Market Committee's ("FOMC") decision to lower the target federal funds rate 225 basis points fromJuly 2019 toMarch 2020 . For the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 , the average target federal funds rate decreased 174 basis points. In addition to the reduction in deposit rates, average wholesale deposits, which are typically longer duration and therefore a higher cost funding source than in-market deposits, decreased$82.7 million , or 36.7%. Consistent with the Corporation's longstanding funding strategy to manage interest rate risk and use the most efficient and cost effective source of wholesale funds, a combination of fixed rate wholesale deposits and fixed rate FHLB advances are used at various maturity terms to meet the Corporation's funding needs. Average FHLB advances for the year endedDecember 31, 2020 increased$93.4 million to$379.9 million at an average rate paid of 1.45%. As ofDecember 31, 2020 , the weighted average original maturity of our FHLB term advances was 5.5 years, compared to 5.4 years as ofDecember 31, 2019 . Average wholesale deposits, consisting of brokered certificates of deposit and deposits gathered from internet listing services, for the year endedDecember 31, 2020 decreased$82.7 million to$142.6 million at an average rate paid of 1.71%. As ofDecember 31, 2020 , the weighted average original maturity of our wholesale deposits was 4.1 years, compared to 5.3 years as ofDecember 31, 2019 . The rate paid on average wholesale funding is greater than the cost of in-market deposits and changes more gradually because the portfolio includes longer original maturities as the Corporation match-funds its longer-term fixed rate loans to mitigate interest rates risk. Net interest margin decreased 21 basis points to 3.40% for the year endedDecember 31, 2020 , compared to 3.61% for the year endedDecember 31, 2019 . Excluding fees collected in lieu of interest, PPP loan interest income,Federal Reserve interest income, and FHLB dividends net interest margin measured 3.28% for the year endedDecember 31, 2020 , compared to 3.33% for the year endedDecember 31, 2019 . The decrease was primarily due to the decrease in average yield on loans and leases receivable partially offset by a decrease in the average rate paid on in-market deposits and wholesale funding. Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in existing higher-yielding specialty finance lines of business will allow the Corporation to achieve a net interest margin of at least 3.50%, on average, over the long-term. However, the collection of loan fees in lieu of interest is an expected source of volatility to quarterly net interest income and net interest margin, particularly given the nature of the Corporation's asset-based lending business and the Corporation's participation in the PPP. Net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status or the accumulation of significant short-term deposit inflows. Despite an uncertain rate environment, management expects to effectively manage the Corporation's liability structure in both term and rate. Further, we expect to attract new in-market deposit relationships which we believe will contribute to our ability to maintain an appropriate cost of funds. Period end in-market deposits - comprised of all transaction accounts, money market accounts, and non-wholesale deposits - increased$304.1 million , or 22.1%, to$1.683 billion atDecember 31, 2020 , compared to$1.379 billion atDecember 31, 2019 . Average in-market deposits increased$297.4 million , or 23.4%, to$1.569 billion for the year endedDecember 31, 2020 , compared to$1.271 billion for the year endedDecember 31, 2019 . This significant increase in deposits was due to successful business development efforts combined with excess liquidity resulting from our clients participation in the PPP. Provision for Loan and Lease Losses We determine our provision for loan and lease losses pursuant to our allowance for loan and lease loss methodology, which is based on the magnitude of current and historical net charge-offs recorded throughout the established look-back period, the evaluation of several qualitative factors for each portfolio category, and the amount of specific reserves established for impaired loans that present collateral shortfall positions. Refer to Allowance for Loan and Lease Losses, below, for further information regarding our allowance for loan and lease loss methodology. 40 -------------------------------------------------------------------------------- Table of Contents The full impact of COVID-19 remains uncertain. It has caused substantial disruption in international andU.S. economies, markets, and employment. The outbreak is having a significant adverse impact on certain industries the Corporation serves, including retail, hospitality, entertainment, and restaurants and food services. Due to COVID-19 and the economic impact it could have on the Corporation's loan portfolio, additional detail about certain exposure to stressed industries is included in the section titled COVID-19 Update, above. Provision for loan and lease losses increased to$16.8 million for the year endedDecember 31, 2020 compared to$2.1 million for the year endedDecember 31, 2019 . The increase in provision for loan and lease losses included$8.1 million in charge-offs, partially offset by the release of$5.2 million in related specific reserves. 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. In addition, changes in the general reserve increased the provision for loan and lease losses$949,000 due to historical loss rate updates from net charge-off activity,$5.5 million due to qualitative factor changes related to the uncertainty of the economic conditions during the COVID-19 pandemic, and$2.3 million commensurate with an increase in loan and lease receivables. The following table shows the components of the provision for loan and lease losses for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . For the Year Ended December 31, (Dollars in thousands) 2020 2019
Change in general reserve due to subjective factor changes $
5,460 $ (378)
Change in general reserve due to historical loss factor
changes 949 (391)
Charge-offs 8,139 3,356
Recoveries (332) (366)
Change in specific reserves on impaired loans, net 316 (1,032)
Change due to loan growth, net 2,276 896
Total provision for loan and lease losses $
16,808
The legacy on-balance sheet SBA portfolio, defined as SBA 7(a) and Express loans originated in 2016 and prior, has been a source of elevated non-performing assets. Additional information on our legacy SBA portfolio is as follows:
December 31, December 31,
2020 2019
(In Thousands)
Performing loans:
Off-balance sheet loans $ 23,354 $ 35,029
On-balance sheet loans 11,117 19,697
Gross loans 34,471 54,726
Non-performing loans:
Off-balance sheet loans 1,931 7,290
On-balance sheet loans 7,435 12,037
Gross loans 9,366 19,327
Total loans:
Off-balance sheet loans 25,285 42,319
On-balance sheet loans 18,552 31,734
Gross loans $ 43,837 $ 74,053
The addition of specific reserves on impaired loans represents new specific
reserves established when collateral shortfalls or government guaranty
deficiencies are present, while conversely the release of specific reserves
represents the reduction of previously established reserves that are no longer
required. Changes in the allowance for loan and lease losses due to subjective
factor changes reflect management's evaluation of the level of risk within the
portfolio based upon several factors for each portfolio segment. Charge-offs in
excess of previously established specific reserves require an additional
provision for loan and lease losses to maintain the allowance for loan and lease
losses at a level deemed appropriate by management. This amount is net of the
release of any specific reserve that may have already been provided. Change in
the inherent risk of the portfolio is primarily influenced by the overall growth
in gross loans and leases and an analysis of loans previously charged off, as
well as movement of existing loans and leases in and out of an impaired loan
classification where a specific evaluation of a
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particular credit may be required rather than the application of a general
reserve loss rate. Refer to Asset Quality, below, for further information
regarding the overall credit quality of our loan and lease portfolio.
Because of the significant uncertainties related to the ultimate duration of the
COVID-19 pandemic and its potential effects on clients and prospects, and on the
national and local economy as a whole, there can be no assurances as to how the
crisis may ultimately affect the Corporation's loan portfolio.
Non-Interest Income
Non-interest income increased by $3.5 million , or 15.0%, to $26.9 million for
the year ended December 31, 2020 , from $23.4 million for the year ended
December 31, 2019 . Management continues to focus on revenue growth from multiple
non-interest income sources in order to maintain a diversified revenue stream
through greater contribution from fee-based revenues. Total non-interest income
accounted for 25.9% of our total revenues in 2020 compared to 25.1% in 2019,
exceeding our long-term goal of 25% for the second consecutive year.
The increase in total non-interest income for the year ended December 31,
2020 primarily reflected record commercial loan interest rate swap fee income
and a significant increase in gains on the sale of SBA loans, partially offset
by a decrease in other non-interest income.
The components of non-interest income were as follows:
For the Year Ended December 31, Change From Prior Year
2020 2019 $ Change % Change
(Dollars inThousands)
Private wealth management services fee income $ 8,611$ 8,197 $ 414 5.1 % Gain on sale of SBA loans 2,899 1,459 1,440 98.7 Service charges on deposits 3,415 3,104 311 10.0 Loan fees 1,826 1,767 59 3.3 Increase in cash surrender value of bank-owned life insurance 1,402 1,198 204 17.0 Net loss on sale of securities (4) (46) 42 (91.3) Swap fees 6,860 4,165 2,695 64.7 Other non-interest income 1,931 3,579 (1,648) (46.0) Total non-interest income$ 26,940 $ 23,423 $ 3,517 15.0 Fee income ratio(1) 25.9 % 25.1 %
(1)Fee income ratio is fee income, per the above table, divided by top line revenue (defined as net interest income plus non-interest income).
Private wealth management services fee income increased by$414,000 , or 5.1%, to a record$8.6 million for the year endedDecember 31, 2020 compared to$8.2 million for the year endedDecember 31, 2019 . Private wealth management services fee income is primarily driven by the amount of assets under management and administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets. This increase was driven by growth in assets under management and administration attributable to both new client relationships and increased equity market values. AtDecember 31, 2020 , our trust assets under management and administration were a record$2.249 billion , or 18.9% more than trust assets under management and administration of$1.892 billion atDecember 31, 2019 . 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. Commercial loan swap fees increased by$2.7 million to$6.9 million for the year endedDecember 31, 2020 from$4.2 million for the year endedDecember 31, 2019 . 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$629.1 million as ofDecember 31, 2020 , compared to$326.9 million as ofDecember 31, 2019 . Interest rate swaps continue to be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter. 42 -------------------------------------------------------------------------------- Table of Contents Gain on sale of SBA loans for the year endedDecember 31, 2020 totaled$2.9 million , an increase of$1.4 million , or 98.7%, from the same period in 2019. Gross SBA loan commitments closed for the year endedDecember 31, 2020 totaled$42.5 million , compared to$24.4 million for the same period in 2019. Based on this recent activity, an enhanced business development team, and a growing pipeline of new business, management believes the annual gain on sale of SBA loans will continue to increase at a measured pace moving forward. Other non-interest income decreased by$1.6 million to$1.9 million for the year endedDecember 31, 2020 , compared to$3.6 million for the year endedDecember 31, 2019 . The prior year period included above average returns from the Corporation's investments in mezzanine funds and gains recognized on end-of-term buyout agreements related to the Corporation's equipment finance business line.
Non-Interest Expense
Non-interest expense increased by$2.2 million , or 3.3%, to$68.9 million for the year endedDecember 31, 2020 from$66.7 million for the year endedDecember 31, 2019 . Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased$3.5 million , or 5.6%, to$65.6 million for the year endedDecember 31, 2020 compared to$62.1 million for the year endedDecember 31, 2019 . The increase in operating expense was primarily due to an increase in compensation, computer software expense,FDIC insurance, and collateral liquidation costs. These increases were partially offset by a decrease in marketing and other non-interest expense.
The components of non-interest expense were as follows:
For the Year Ended December 31, Change From Prior Year
2020 2019 $ Change % Change
(Dollars in Thousands)
Compensation $ 45,850 $ 42,021 $ 3,829 9.1 %
Occupancy 2,252 2,293 (41) (1.8)
Professional fees 3,530 3,703 (173) (4.7)
Data processing 2,734 2,562 172 6.7
Marketing 1,580 2,221 (641) (28.9)
Equipment 1,199 1,230 (31) (2.5)
Computer software 3,900 3,414 486 14.2
FDIC insurance 1,238 641 597 93.1
Collateral liquidation costs 328 119 209 NM
Net loss on foreclosed properties 383 224 159 71.0
Impairment on tax credit investments 2,395 4,094 (1,699) (41.5)
SBA recourse (benefit) provision (278) 188 (466) NM
Loss on early extinguishment of debt 744 - 744 NM
Other non-interest expense 3,043 3,985 (942) (23.6)
Total non-interest expense $ 68,898 $ 66,695 $ 2,203 3.3
Total operating expense(1) $ 65,619 $ 62,149 $ 3,470 5.6
Full-time equivalent employees 301 288 13 4.5
NM = Not meaningful
(1)Total operating expense represents total non-interest expense, adjusted to
exclude the impact of discrete items as previously defined in the non-GAAP
efficiency ratio calculation above.
Compensation expense increased by $3.8 million , or 9.1%, to $45.9 million for
the year ended December 31, 2020 from $42.0 million for the year ended
December 31, 2019 . The increase reflects new hires, annual merit increases,
growth in employee benefit costs, and an increase in individual incentive
compensation. Average full-time equivalent employees ("FTE") were 301 for the
three months ended December 31, 2020 , increasing by 16, or 5.6%, from 285 for
the three months ended December 31, 2019 . We believe we will continue to
generate modest positive operating leverage and progress towards enhancing our
long-term efficiency ratio at a measured pace as we focus on strategic
initiatives directed toward revenue growth.
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These initiatives include efforts to expand our specialty finance lines of
business, increase our commercial banking market share, and scale our private
wealth management business in our less mature commercial banking markets. We
expect to continue investing in talent, both in the form of additional business
development and operational staff, to support our long-term strategic plan.
Computer software expense increased by $486,000 , or 14.2%, to $3.9 million for
the year ended December 31, 2020 from $3.4 million for the year
ended December 31, 2019 . The increase was principally due to investments in
technology platforms to improve the client experience and continuing our
strategic focus on scaling the Corporation to efficiently execute our growth
strategy.
FDIC insurance expense increased $597,000 , or 93.1%, to $1.2 million for the
year ended December 31, 2020 from $641,000 for the year ended December 31, 2019 .
FDIC insurance expense for the year ended December 31, 2019 benefited from a
reduction in FDIC insurance expense as the Deposit Insurance Fund ("DIF")
reached 1.38%, exceeding the statutorily required minimum ratio of 1.35% and
requiring the FDIC to distribute assessment credits to small banks for their
portion of their assessments that contributed to the growth in the reserve
ratio. The Corporation received a credit of $458,000 during the year ended
December 31, 2019 . Management expects FDIC insurance expense to increase
commensurate with asset growth going forward.
Collateral liquidation costs for the year ended December 31,
2020 were $328,000 compared to $119,000 for the year ended December 31, 2019 .
The increase primarily reflects our special assets team's continued efforts to
exit impaired legacy SBA loans.
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 will help stabilize net interest margin with the expectation of a low
interest rate environment for an extended period of time.
Marketing expense decreased by $641,000 , or 28.9%, to $1.6 million for the year
ended December 31, 2020 from $2.2 million for the year ended December 31, 2019 .
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.
Other non-interest expense decreased by $942,000 , or 23.6%, to $3.0 million for
the year ended December 31, 2020 from $4.0 million for the year
ended December 31, 2019 . The decrease was principally due to a decrease in
general business-related expenses due to the Corporation's adherence to COVID-19
restrictions. In addition, the prior year included a one-time right-of-use
impairment of $299,000 from vacating and subleasing unused office space in our
Kansas City market. The decline in other non-interest expense was partially
offset by a $461,000 credit valuation adjustment ("CVA") related to the
commercial loan interest rate swap program. The CVA represents a change in the
market value of the Company's commercial loan interest rate swaps to estimate
potential borrower credit risk within the portfolio. The CVA can vary from
period to period based on the size of the portfolio, credit metrics, and the
interest rate environment in any given quarter. There was no CVA for the year
ended December 31, 2019 .
Impairment on tax credit investments decreased $1.7 million , or 41.5%, to $2.4
million for the year ended December 31, 2020 , compared to $4.1 million for the
year ended December 31, 2019 . The impairment on tax credit investments is
related to historic rehabilitation tax credits and new market tax credits that
are more than offset by a reduction to income tax expense, which, including the
aforementioned gain on state tax credits, results in a net benefit to earnings.
The Corporation recognized $1.9 million of impairment associated with the
recognition of $2.8 million in federal historic tax credits in 2020, compared to
$3.6 million of impairment associated with the recognition of $5.2 million in
federal historic tax credits in 2019.
SBA recourse provision for the year ended December 31, 2020 was a benefit of
$278,000 compared to expense of $188,000 for the year ended December 31, 2019 .
The total recourse reserve balance was $723,000 , or 0.9% of total sold SBA loans
outstanding, at December 31, 2020 , compared to $1.3 million , or 1.8% of total
sold SBA loans outstanding, at December 31, 2019 . Changes to SBA recourse
reserves may be a source of non-interest expense volatility in future quarters,
though the magnitude of this volatility should continue to diminish over time as
the outstanding balance of sold legacy SBA loans continues to decline.
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Income Taxes
Income tax expense was $1.3 million for the year ended December 31, 2020 ,
compared to $1.2 million for the year ended December 31, 2019 . The Corporation
recognized federal historic tax credits in both 2020 and 2019, which reduced
income tax expense by $2.8 million and $5.2 million , respectively. The effective
tax rate for the year ended December 31, 2020 was 7.2% compared to 4.8% for the
year ended December 31, 2019 . The effective tax rate, excluding tax credits and
other discrete items, for the year ended December 31, 2020 was 19.5% compared to
22.1% for the year ended December 31, 2019 .
FINANCIAL CONDITIONGeneral
AtDecember 31, 2020 total assets were$2.568 billion , representing an increase of$471.1 million , or 22.5%, from$2.097 billion atDecember 31, 2019 . The increase in total assets was primarily driven by an increase in loans and leases receivable, other assets, and securities available-for-sale, partially offset by a decrease in short-term investments. The increase in loans and leases receivable was principally due to the Corporation's participation in the PPP program and an increase in commercial real estate loans. As ofDecember 31, 2020 , the Corporation had$228.9 million in PPP loans outstanding and$3.5 million in deferred processing fees outstanding. Short-term investments Short-term investments decreased by$23.6 million to$27.4 million atDecember 31, 2020 from$51.0 million atDecember 31, 2019 . Short-term investments primarily consist of interest-bearing deposits held at theFederal Reserve Bank ("FRB") and commercial paper. 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, 2020 and 2019, interest-bearing deposits held at the FRB were$26.7 million and$44.4 million , respectively. Although the majority of short-term investments consist of deposits with the FRB, we also make investments in commercial paper. As ofDecember 31, 2020 , we did not hold any commercial paper, compared to a total of$5.9 million as ofDecember 31, 2019 . Due to current economic conditions, we decided to temporarily exit this short-term investment. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio. The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to be in a position to benefit from an anticipated change in the yield curve level and shape. In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio. Please refer to the section entitled Liquidity and Capital Resources for further discussion. Securities Total securities, including available-for-sale and held-to-maturity, increased by$4.5 million to$210.3 million atDecember 31, 2020 from$205.8 million atDecember 31, 2019 . As ofDecember 31, 2020 and 2019, our total securities portfolio had a weighted average estimated maturity of approximately 5.0 years and 4.4 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 45 -------------------------------------------------------------------------------- Table of Contents 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, 2020 , we recognized unrealized holding gains of$3.5 million before income taxes through other comprehensive income. These gains 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, 2020 . We sold approximately$839,000 of securities during the year endedDecember 31, 2020 to proactively manage our securities portfolio and meet our long-term investment objectives. As ofDecember 31, 2020 no securities were classified as trading securities. AtDecember 31, 2020 ,$73.7 million of our securities were pledged to secure various obligations, including interest rate swap contracts and municipal deposits.
The tables below set forth information regarding the amortized cost and fair values of our securities.
As of December 31,
2020 2019
Amortized Cost Fair Value Amortized Cost Fair Value
(In Thousands)Available-for-sale:
U.S. government agency securities - government-sponsored enterprises$ 22,699
24,067 24,779 160 160
Residential mortgage-backed securities - government issued
9,894 10,403 16,119 16,348
Residential mortgage-backed securities -
government-sponsored enterprises 102,843 105,006 111,561 112,002
Commercial mortgage-backed securities - government issued
5,289 5,464 6,705 6,663
Commercial mortgage-backed securities -
government-sponsored enterprises 12,584 13,365 11,953 11,967
Other securities 2,205 2,279 2,205 2,235
$ 179,581 $ 183,925 $ 172,319 $ 173,133
As of December 31,
2020 2019
Amortized Cost Fair Value Amortized Cost Fair Value
(In Thousands)
Held-to-maturity:
Municipal securities$ 17,106
3,564 3,676 5,776 5,786
Residential mortgage-backed securities -
government-sponsored issued 3,693 3,856 5,183 5,211
Commercial mortgage-backed securities -
government-sponsored enterprises 2,011 2,293 2,014 2,137
$ 26,374 $ 27,333 $ 32,700 $ 33,188
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 -
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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, 2020 , 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, 2020 ,
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.
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. government agency securities -
government-sponsored enterprises $ - - % $ 995 0.56 % $ 5,592 0.93 % $ 16,042 0.81 % $ 22,629
Municipal securities - - 2,214 1.05 7,083 1.43 15,482 1.81 24,779
Residential mortgage-backed securities -
government issued - - - - 2,920 2.97 7,483 2.84 10,403
Residential mortgage-backed securities -
government-sponsored enterprises - - 1,547 2.35 17,092 2.60 86,367 1.88 105,006
Commercial mortgage-backed securities -
government issued - - - - - - 5,464 2.31 5,464
Commercial mortgage-backed securities -
government-sponsored enterprises - - 2,093 2.40 6,955 2.28 4,317 1.78 13,365
Other securities - - 2,279 2.38 - - - - 2,279
$ - $ 9,128 $ 39,642 $ 135,155 $ 183,925
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 2,299 2.01 12,110 2.13 2,697 2.54 - - 17,106
Residential mortgage-backed securities -
government issued - - - - 2,086 1.97 1,478 2.21 3,564
Residential mortgage-backed securities -
government-sponsored enterprises - - - - 2,629 1.67 1,064 3.26 3,693
Commercial mortgage-backed securities -
government-sponsored enterprises - - - - 2,011 3.25 - - 2,011
$ 2,299 $ 12,110 $ 9,423 $ 2,542 $ 26,374
Derivative Activities
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 their asset/liability
management. As of December 31, 2020 and 2019, 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. The
credit risk and risk of non-performance embedded in the fair value calculations
is different between the dealer counterparties and the commercial borrowers
which may result in a difference in the changes in the fair value of the
mirror-image swaps. The Corporation incorporates credit valuation adjustments
("CVA") to appropriately reflect both its own non-performance risk and the
counterparty's risk in the fair value measurements. When evaluating the fair
value of its derivative contracts for the effects of non-performance and credit
risk, the Corporation considered the impact of netting and any applicable credit
enhancements
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such as collateral postings, thresholds, and guarantees. As of December 31,
2020 , the CVA reflecting the non-performance risk of the borrower was $461,000 .
There was no CVA as of December 31, 2019 .
As of December 31, 2020 , the aggregate amortizing notional value of interest
rate swaps with various commercial borrowers was approximately $629.1 million .
We receive fixed rates and pay floating rates based upon LIBOR on the swaps with
commercial borrowers. These swaps mature between March 2021 and December 2037 .
Commercial borrower swaps are completed independently with each borrower and are
not subject to master netting arrangements. These commercial borrower swaps were
reported on the Consolidated Balance Sheet as a derivative asset of $49.4
million , included in accrued interest receivable and other assets, and as a
derivative liability of $58,000 , included in accrued interest payable and other
liabilities. 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 March 2021 and December 2037 . Dealer
counterparty swaps are subject to master netting agreements among the contracts
within our Bank and are reported on the Consolidated Balance Sheet as a net
derivative liability of $49.3 million , included in accrued interest payable and
other liabilities. The gross amount of dealer counterparty swaps, without regard
to the enforceable master netting agreement, was a gross derivative liability of
$49.4 million and a gross derivative asset of $58,000 .
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 of December 31, 2020 ,
the aggregate notional value of interest rate swaps designated as cash flow
hedges was $114.0 million . These interest rate swaps mature between December
2021 and December 2027 . A pre-tax unrealized loss of $3.0 million was recognized
in other comprehensive income for the year ended December 31, 2020 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 $422.3 million , or 24.9%, to $2.117 billion at December 31, 2020
from $1.695 billion at December 31, 2019 . Excluding net PPP loans, loans and
leases receivable, net of allowance for loan and lease losses, increased by
$197.0 million , or 11.62%, to $1.892 billion at December 31, 2020 from $1.695
billion at December 31, 2019 . Multifamily, commercial real estate non-owner
occupied, and construction loans were the largest contributors to CRE loan
growth as of December 31, 2020 , increasing $94.2 million , $47.9 million , and
$32.0 million , respectively, from December 31, 2019 .
There continues to be a concentration in CRE loans which represented 70.6% and
67.3% of our total loans, excluding net PPP loans, as of December 31, 2020 and
December 31, 2019 , respectively. As of December 31, 2020 , approximately 18.7% of
the CRE loans were owner-occupied CRE, compared to 19.6% as of December 31,
2019 . We consider owner-occupied CRE more characteristic of the Corporation's
C&I portfolio as, in general, the client's primary source of repayment is the
cash flow from the operating entity occupying the commercial real estate
property. Management has elevated its underwriting standards during the COVID-19
pandemic to ensure business owners and guarantors have robust liquidity,
operating performance, and collateral positions. Even with these higher
standards, the Corporation has been able to grow loans and deepen banking
relationships.
Our C&I portfolio increased $228.9 million , or 45.5%, to $732.3 million at
December 31, 2020 from $503.4 million at December 31, 2019 . Excluding net PPP
loans, C&I loans increased $3.6 million to $507.0 million from $503.4 million at
December 31, 2019 . C&I growth in 2020 was impacted by the COVID-19 pandemic and
related government stimulus, which reduced the line of credit usage we typically
see from our existing C&I clients, specifically our asset-based and accounts
receivable clients. C&I lines of credit usage decreased $41.7 million , or 14.7%,
to $241.2 million at December 31, 2020 from $282.9 million at December 31, 2019 .
Some of our specialty finance products have historically experienced counter
cyclical growth, growing during times of economic stress and uncertainty. While
the Corporation did not experience asset-based loan growth in 2020, management
expects asset-based loans and accounts receivable financing volume to increase
in 2021. We will continue to actively pursue C&I loans across the Corporation as
this segment of our loan and lease portfolio provides an attractive yield
commensurate with an appropriate level of credit risk and creates opportunities
for in-market deposit, treasury management, and private wealth management
relationships which generate additional fee revenue.
Underwriting of new credit is primarily through approval from a serial
sign-off or committee process and is a key component of our operating
philosophy. Business development officers have no individual lending authority
limits, and thus, a significant portion of our new credit extensions require
approval from a loan approval committee regardless of the type of loan or lease,
amount of the credit, or the related complexities of each proposal. In addition,
we make every reasonable effort to ensure that there is appropriate collateral
or a government guarantee at the time of origination to protect our interest in
the
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related loan or lease. To monitor the ongoing credit quality of our loans and
leases, each credit is evaluated for proper risk rating using a nine grade risk
rating system at the time of origination, subsequent renewal, evaluation of
updated financial information from our borrowers, or as other circumstances
dictate.
While we continue to experience significant competition from banks operating
in our primary geographic areas, we remain committed to our underwriting
standards and will not deviate from those standards for the sole purpose of
growing our loan and lease portfolio. We continue to expect our new loan and
lease activity to be adequate to replace normal amortization, allowing us to
continue growing in future years.
The following table presents information concerning the composition of the Bank's consolidated loans and leases receivable.
As of December 31,
2020 2019
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 $ 253,882 11.8 % $ 226,614 13.2 %
Commercial real estate - non-owner
occupied 564,532 26.3 516,652 30.1
Land development 49,839 2.3 51,097 3.0
Construction 141,043 6.6 109,057 6.4
Multi-family 311,556 14.5 217,322 12.7
1-4 family 38,284 1.8 33,359 1.9
Total commercial real estate 1,359,136 63.2 1,154,101 67.3
Commercial and industrial 732,318 34.0 503,402 29.4
Direct financing leases, net 22,331 1.1 28,092 1.6
Consumer and other:
Home equity and second mortgage 7,833 0.4 7,006 0.4
Other 28,897 1.3 22,664 1.3
Total consumer and other 36,730 1.7 29,670 1.7
Total gross loans and leases
receivable 2,150,515 100.0 % 1,715,265 100.0 %
Less:
Allowance for loan and lease losses 28,521 19,520
Deferred loan fees 4,545 630
Loans and leases receivable, net $ 2,117,449 $ 1,695,115
49-------------------------------------------------------------------------------- Table of Contents 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, 2020 . 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$ 15,636 $ 156,761 $ 81,485 $ 253,882 $ 162,297$ 75,949 Non-owner occupied 79,087 258,400 227,045 564,532 281,909 203,536 Land development 24,190 23,748 1,901 49,839 10,489 15,160 Construction 17,898 3,862 119,283 141,043 28,620 94,525 Multi-family 16,131 96,283 199,142 311,556 84,731 210,694 1-4 family 7,433 29,080 1,771 38,284 30,421 430 Commercial and industrial 176,156 489,455 66,707 732,318 430,810 125,352 Direct financing leases 1,931 17,639 2,761 22,331 20,400 - Consumer and other 7,577 25,994 3,159 36,730 22,693 6,460$ 346,039 $ 1,101,222 $ 703,254 $ 2,150,515 $ 1,072,370 $ 732,106 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$1.359 billion of commercial real estate loans outstanding as ofDecember 31, 2020 ,$28.7 million were originated by our asset-based lending subsidiary. 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$732.3 million of C&I loans outstanding as ofDecember 31, 2020 ,$290.3 million were conventional C&I loans,$228.9 million were PPP loans,$85.8 million were asset-based loans,$73.1 million were equipment finance loans,$37.2 million were purchased accounts receivable, and$17.1 million were floorplan loans. The asset-based loans, including accounts receivable purchased on a full recourse basis, are typically secured by the borrower's accounts receivable and inventory. These loans generally have higher interest rates and non-origination fees collected in lieu of interest and the collateral supporting the credit is closely monitored. Additionally, asset-based borrowers are usually highly-leveraged and/or have inconsistent historical earnings. Significant adverse changes in various industries could cause rapid declines in values and collectability associated with those business assets resulting in inadequate collateral coverage that may expose us to future losses. 50
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SBA Lending. SBA loans are made through programs designed by the federal government to assist the small business community in obtaining financing. As an SBA Preferred Lender, our loans (excluding PPP loans) fall into three categories: loans originated under the SBA's 7(a) term loan program; loans originated under the SBA's 504 program; and SBA Express loans and lines of credit. The majority of our SBA loans are originated under the 7(a) term loan program. Historically we have sold the guaranteed portions of our SBA 7(a) loans in the secondary market and retained the non-guaranteed portions. SBA lending is a significant part of our strategic business plan. The success of our SBA lending program is dependent upon the continued availability of SBA loan programs, our status as a Preferred Lender, our ability to effectively compete and originate new SBA loans, and our ability to comply with applicable SBA lending requirements. As ofDecember 31, 2020 , the on-balance sheet portion of SBA loans, excluding PPP loans, that were included in the commercial and industrial loan portfolio was$33.2 million , commercial real estate loan portfolio was$12.6 million , and consumer and other was$451,000 . 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, 2020 , the Bank had$22.3 million in net direct financing receivables outstanding. 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$5.4 million as ofDecember 31, 2020 . 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 originates a small amount of consumer loans consisting of home equity, first and second mortgages, and other personal loans for professional and executive clients of the Bank.
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Asset Quality
Non-accrual loans and leases increased
Our total impaired assets consisted of the following:
As of December 31,
2020 2019
(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied $ 5,429 $ 4,032
Commercial real estate - non-owner occupied 3,783 -
Land development 890 1,526
Construction - -
Multi-family - -
1-4 family 250 333
Total non-accrual commercial real estate 10,352 5,891
Commercial and industrial 16,155 14,575
Direct financing leases, net 49 -
Consumer and other:
Home equity and second mortgage 40 -
Other 21 147
Total non-accrual consumer and other loans 61 147
Total non-accrual loans and leases 26,617 20,613
Foreclosed properties, net 34 2,919
Total non-performing assets 26,651 23,532
Performing troubled debt restructurings 46 140
Total impaired assets $ 26,697 $ 23,672
Total non-accrual loans and leases to gross loans and leases 1.24 % 1.20 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
1.24 % 1.37 %
Total non-performing assets to total assets 1.04 % 1.12 %
Allowance for loan and lease losses to gross loans and leases 1.33 % 1.14 %
Allowance for loan and lease losses to non-accrual loans and leases
107.15 % 94.70 %
As of December 31, 2020 and 2019, $6.5 million and $15.6 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 $26.7 million , or 1.04% of total
assets, as of December 31, 2020 , an increase in non-performing assets of $3.1
million , or 13.3%, from December 31, 2019 . Impaired loans and leases as of
December 31, 2020 and 2019 also included $46,000 and $140,000 , respectively, of
loans that are 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.
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The following asset quality ratios exclude net PPP loans as they are fully
guaranteed by the SBA:
As of December 31,
2020 2019
(In Thousands)
Total non-accrual loans and leases to gross loans and leases 1.38 % 1.20 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
1.38 1.37
Total non-performing assets to total assets 1.14 1.12
Allowance for loan and lease losses to gross loans and leases 1.48 1.14
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 1.04% at December 31, 2020 from 1.12% at
December 31, 2019 . As of December 31, 2020 , the payment performance of our loans
and leases did not point to any new areas of concern, as approximately 99.0% of
the total portfolio was in a current payment status, compared to 99.1% as of
December 31, 2019 . We also monitor asset quality through our established
categories as defined in Note 5 - 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 2020, 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,
2020 2019
(In Thousands)
Impaired loans and leases with no impairment reserves $ 18,966 $ 7,312
Impaired loans and leases with impairment reserves required 7,697 13,441
Total impaired loans and leases 26,663 20,753
Less: Impairment reserve (included in allowance for loan and lease losses)
3,681 3,365
Net impaired loans and leases $ 22,982 $ 17,388
Average impaired loans and leases $ 27,703 $ 24,090
For the years ended December 31,
2020 2019
(In Thousands)
Interest income attributable to impaired loans and leases $ 2,794 $ 2,693
Less: Interest income recognized on impaired loans and leases 636 793
Net foregone interest income on impaired loans and leases $ 2,158 $ 1,900
Impaired 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. 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.
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Based on the specific evaluation of the collateral of each impaired loan, we
believe the reserve for impaired loans was appropriate at December 31, 2020 .
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.
Foreclosed properties are recorded at fair value of the underlying property,
less costs to sell. If, at the time of foreclosure, the fair value less cost to
sell is lower than the carrying value of the loan, the difference is charged to
the allowance for loan and lease losses prior to the transfer to foreclosed
property. The fair value is based on an appraisal, discounted cash flow analysis
(the majority of which is based on current occupancy and lease rates) or a
verifiable offer to purchase. After foreclosure, valuation allowances or future
write-downs to net realizable value are charged directly to non-interest
expense. Foreclosed properties of $34,000 were outstanding as of December 31,
2020 , compared to $2.9 million as of December 31, 2019 . We recorded impairment
losses of approximately $363,000 and $224,000 for the years ended December 31,
2020 and 2019, respectively. We recorded a net loss of $20,000 on the sale of
existing foreclosed properties for the year ended December 31, 2020 , compared to
no sales of existing foreclosed property for the year ended December 31, 2019 .
We continue to evaluate possible exit strategies on our impaired loans when
foreclosure action may be probable and our level of foreclosed assets may
increase in the future. Loans are transferred to foreclosed properties when we
claim ownership rights to the properties.
A summary of foreclosed properties activity is as follows:
For the Year Ended
2020 2019
(In Thousands)
Balance at the beginning of the period $ 2,919 $ 2,547
Transfer of loans to foreclosed properties, at fair value 80 596
Impairment adjustments (363) (224)
Net book value of properties sold (2,602) -
Balance at the end of the period $ 34 $ 2,919 Allowance for Loan and Lease Losses
The allowance for loan and lease losses increased$9.0 million , or 46.1%, to$28.5 million as ofDecember 31, 2020 from$19.5 million as ofDecember 31, 2019 . The allowance for loan and lease losses as a percentage of gross loans and leases also increased to 1.33% as ofDecember 31, 2020 from 1.14% as ofDecember 31, 2019 . The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.48% as ofDecember 31, 2020 . The increase in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by COVID-19 and the economic impact it is having on the Corporation's loan portfolio. For year endedDecember 31, 2020 , the increase in the allowance for loan and lease losses was in large part due to an increase in several qualitative factors after careful evaluation by management. Most notably, a$5.5 million increase was due to the economic conditions caused by the pandemic, including the increase in the unemployment rate, management's ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, and the level of loans and leases subject to more frequent review by management. Additionally, the general reserve increased$2.3 million commensurate with loan growth, and$949,000 due to historical loss rate updates to include current year net charge-off activity. 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. During the year endedDecember 31, 2019 , we recorded net charge-offs on impaired loans and leases of approximately$3.0 million , which included$3.4 million of charge-offs and$366,000 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, 2020 and 2019, our allowance for loan and lease losses to total non-accrual loans and leases was 107.15% and 94.70%, respectively. This ratio increased primarily due to the increase in allowance for loan and lease losses discussed above. Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we try to ensure that we have sufficient collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases either does not require additional 54 -------------------------------------------------------------------------------- Table of Contents specific reserves or requires only a minimal amount of required specific reserve, as we believe the loans and leases are adequately collateralized as of the measurement period. In addition, management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined with certainty that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease loss to non-accrual loans and leases ratio as compared to our peers or industry expectations. As asset quality strengthens, our allowance for loan and lease losses is measured more through general characteristics, including historical loss experience, of our portfolio rather than through specific identification and we would therefore expect this ratio to rise. Conversely, if we identify further impaired loans, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as ofDecember 31, 2020 . To determine the level and composition of the allowance for loan and lease losses, we break out the portfolio by segments with similar risk characteristics. First, we evaluate loans and leases for potential impairment classification. We analyze each loan and lease identified as impaired on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of expected cash flows. For each segment of loans and leases that has not been individually evaluated, management segregates the Bank's loss factors into a quantitative general reserve component based on historical loss rates throughout the defined look back period. The quantitative general reserve component also considers an estimate of the historical loss emergence period, which is the period of time between the event that triggers the loss to the charge-off of that loss. The methodology also focuses on evaluation of several qualitative factors for each portfolio category, including but not limited to: management's ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, existing economic conditions, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations of loans to specific industries, and other qualitative factors that could affect credit losses. When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for loan and lease loss reserve to bring the loan or lease to its net realizable value. Many of the impaired loans as ofDecember 31, 2020 are collateral dependent. It is typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment at least annually, or more frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, we have found that in general real estate values have been stable or improved; however, in specific situations current fair values collateralizing certain impaired loans were inadequate to support the entire amount of the outstanding debt. Foreclosure actions may have been initiated on certain of these commercial real estate and other mortgage loans. As a result of our review process, we have concluded an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was$28.5 million , or 1.33% of gross loans and leases, atDecember 31, 2020 . 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. 55
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A summary of the activity in the allowance for loan and lease losses follows:
Year Ended December 31,
2020 2019
(Dollars in Thousands)
Allowance at beginning of period $ 19,520 $ 20,425 Charge-offs:
Commercial real estate Commercial real estate - owner occupied (3,339) - Commercial real estate - non-owner occupied (2,780) - Construction and land development - - Multi-family - - 1-4 family - - Commercial and industrial (1,951) (3,347) Direct financing leases (56) - Consumer and other Home equity and second mortgage - (2) Other (13) (7) Total charge-offs (8,139) (3,356) Recoveries: Commercial real estate Commercial real estate - owner occupied 1 2 Commercial real estate - non-owner occupied 3 73 Construction and land development - - Multi-family - - 1-4 family - - Commercial and industrial 325 262 Direct financing leases - - Consumer and other Home equity and second mortgage 1 26 Other 2 3 Total recoveries 332 366 Net charge-offs (7,807) (2,990) Provision for loan and lease losses 16,808 2,085 Allowance at end of period$ 28,521 $ 19,520 Net charge-offs as a percent of average gross loans and leases 0.39 % 0.18 % 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. 56
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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,
2020 2019
Balance (a) Balance (a)
(Dollars in Thousands)
Loan and lease segments:
Commercial real estate $ 17,157 1.26 % $ 10,852 0.94 %
Commercial and industrial 10,593 1.40 8,078 1.52
Consumer and other 771 2.10
590 1.99
Total allowance for loan and lease losses
(a)Allowance for loan losses 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, 2020 , there can be no assurance that future adjustments to the allowance will not be necessary. The following tables illustrate ending balances of the Corporation's gross loan and lease receivable portfolio, segregated byCommercial Real Estate and All Other Loans, and considering certain credit quality indicators. Refer to Note 5 - Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses for risk category definitions. December 31, 2020 Category I II III IV Total (Dollars in Thousands) Total commercial real estate$ 1,083,054 $ 177,296 $ 88,388 $ 10,398 $ 1,359,136 All other loans 674,850 28,602 71,662 16,265 791,379
Total gross loans and leases receivable
81.75 % 9.57 % 7.44 % 1.24 % 100.00 %
December 31, 2019
Category
I II III IV Total
(Dollars in Thousands)
Total commercial real estate $ 1,040,674 $ 87,833 $ 19,563 $ 6,031 $ 1,154,101
All other loans 448,445 35,665 62,332 14,722 561,164
Total gross loans and leases receivable
86.82 % 7.20 % 4.77 % 1.21 % 100.00 %
Management's ongoing review and grading of the loan and lease portfolio during
the COVID-19 pandemic resulted in an increase of $82.4 million in Category II
and $78.2 million increase in Category III loans from December 31, 2019 ,
primarily due to migration of our commercial real estate portfolio. The
commercial real estate loans are to borrowers operating within certain
industries which have been and are expected to be particularly impacted by
social distancing, quarantines, and the economic impact of the COVID-19
pandemic, such as retail, hospitality, entertainment, and restaurants and food
service. In general, our commercial real estate loans within these stressed
industries are well-collateralized and include strong project sponsors. As a
result of this process, we have concluded an appropriate allowance for loan and
lease losses for the commercial real estate loan segment was $17.2 million , or
1.26% of total commercial real estate loans, at December 31, 2020 , up from $10.9
million , or 0.94% of total commercial real estate loans, at December 31, 2019 .
Although we believe the allowance for loan and lease losses related to the
commercial real estate portfolio was appropriate based on the current level of
loan and lease
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delinquencies, non-accrual loans and leases, trends in charge-offs, economic
conditions, and other factors as of December 31, 2020 , there can be no assurance
that future adjustments to the allowance will not be necessary.
Deposits
As ofDecember 31, 2020 , deposits increased by$325.1 million to$1.856 billion from$1.530 billion atDecember 31, 2019 . The increase in deposits was primarily due to an increase in transaction accounts, partially offset by a decrease in money market accounts and certificates of deposit. Transaction accounts increased$409.3 million to$976.8 million atDecember 31, 2020 from$567.5 million atDecember 31, 2019 . Money market accounts decreased$32.9 million to$641.5 million atDecember 31, 2020 from$674.4 million atDecember 31, 2019 . Transaction account balances increased primarily due to the influx of PPP loan proceeds and successful business development efforts. Management attributes the transition from money market accounts to reciprocal transaction accounts with fullFDIC insurance to our clients' preferences for liquidity and safety and soundness amid the economic uncertainty created by the COVID-19 pandemic. Certificates of deposit decreased$72.3 million to$64.7 million atDecember 31, 2020 from$137.0 million atDecember 31, 2019 as client preferences shifted away from term deposits due to the low interest rate environment. The decrease in certificates of deposit was partially offset by a$21.0 million increase in wholesale deposits, mainly due to adding non-maturity reciprocal deposits at a favorable rate compared to alternative funding sources. Excluding these deposits, wholesale deposits decreased as the existing portfolio runoff was replaced by in-market deposits and lower cost FHLB advances to match-fund long-term fixed rate loans and fund loan growth. Our strategic efforts remain focused on adding in-market deposit relationships. Successful deposit campaigns supporting our private wealth management strategy complemented our traditional strength in commercial banking and treasury management, contributing to substantial in-market deposit growth during 2020. The following table presents the composition of the Bank's consolidated deposits. As of December 31, 2020 2019 % of Total Balance Deposits Balance % of Total Deposits (Dollars in Thousands) Non-interest-bearing transaction accounts$ 472,818 25.4 %$ 293,573 19.2 % Interest-bearing transaction accounts 503,992 27.2 273,909 17.9 Money market accounts 641,504 34.6 674,409 44.1 Certificates of deposit 64,694 3.5 137,012 8.9 Wholesale deposits 172,508 9.3 151,476 9.9 Total deposits 1,855,516 100.0 % 1,530,379 100.0 % 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, 2020 were approximately$1.569 billion , or 74.47% of total bank funding. Total bank funding is defined as total deposits plus FHLB advances, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances. This compares to average in-market deposits of$1.271 billion , or 71.30% of total bank funding, for 2019. Refer to Note 10 - Deposits in the Consolidated Financial Statements for additional information regarding our deposit composition. 58
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The following table sets forth the amount and maturities of the Bank's
certificates of deposit and term wholesale deposits at
Over Three Over Six Months
Three Months Months Through Through Twelve Over Twelve
Interest Rate and Less Six Months Months Months Total
(In Thousands)
0.00% to 0.99% $ 9,271 $ 4,383 $ 13,663 $ 1,750 $ 29,067
1.00% to 1.99% 17,552 8,098 4,066 4,024 33,740
2.00% to 2.99% 3,102 13,809 579 4,155 21,645
3.00% to 3.99% 7,513 - 19,686 551 27,750
$ 37,438 $ 26,290 $ 37,994 $ 10,480 $ 112,202
At December 31, 2020 , time deposits included $28.7 million of certificates of
deposit and wholesale deposits in denominations greater than or equal to
$250,000 . Of these certificates, $17.2 million are scheduled to mature in three
months or less, $2.8 million in greater than three through six months, $6.8
million in greater than six through twelve months and $1.9 million in greater
than twelve months.
Of the total time deposits outstanding as of December 31, 2020 , $101.7 million
are scheduled to mature in 2021, $6.2 million in 2022, $1.2 million in 2023,
$263,000 in 2024, $1.7 million in 2025 and $1.0 million thereafter. As of
December 31, 2020 , we have no wholesale certificates of deposit which the Bank
has the right to call prior to the scheduled maturity.
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Borrowings
We had total borrowings of $429.2 million as of December 31, 2020 , an increase
of $99.8 million , or 30.3%, from $329.4 million at December 31, 2019 . The
primary reason for the increase in borrowings was due to an increase in FHLB
advances. While total wholesale funding as a percentage of total bank funding
has decreased meaningfully overall due to significant in-market deposit growth,
we continue to replace the majority of our maturing brokered certificates of
deposit with FHLB advances at lower rates, as needed, to match-fund fixed rate
loans and mitigate interest rate risk. Total bank funding is defined as total
deposits plus FHLB advances, Federal Reserve Discount Window advances, and
Federal Reserve PPPLF advances. 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 of December 31, 2020 , 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 will help stabilize net interest margin with the expectation of a low
interest rate environment for an extended period of time.
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 sets forth the outstanding balances, weighted average
balances, and weighted average interest rates for our borrowings (short-term and
long-term) as indicated.
December 31, 2020 December 31, 2019
Weighted Weighted Weighted Weighted
Average Average Average Average
Balance Balance Rate Balance Balance Rate
(Dollars in Thousands)Federal funds purchased $ -$ 71 0.69 % $ -$ 59 2.45 % Federal Reserve PPPLF - 15,207 0.35 - - - FHLB advances 394,500 379,891 1.45 295,000 286,464 2.17 Other borrowings 920 676 12.60 675 675 8.11 Subordinated notes payable(1) 23,747 23,725 5.95 23,707 24,502 7.45 Junior subordinated notes 10,062 10,054 11.09 10,047 10,040 11.08$ 429,229 $ 429,624 1.91$ 329,429 $ 321,740 2.87 (1)Weighted average rate of subordinated notes payable reflects the accelerated amortization of subordinated debt issuance costs as a result of the early redemption of a subordinated note during the third quarter of 2019. A summary of annual maturities of borrowings atDecember 31, 2020 is as follows: (In Thousands) Maturities during the year ended December 31, 2021$ 210,000 2022 29,000 2023 7,000 2024 25,500 2025 13,000 Thereafter 144,729$ 429,229 60
-------------------------------------------------------------------------------- Table of Contents OnAugust 15, 2019 , we issued an aggregate principal amount of$15,000,000 of subordinated notes to three qualified institutional buyers in a private placement. The subordinated notes, which were structured to qualify as Tier 2 capital, have a maturity date ofAugust 15, 2029 and will bear interest at a fixed rate of 5.50% up to, but not including,August 15, 2024 . From and includingAugust 15, 2024 to the maturity date, the interest rate will reset quarterly, equal to the Floating Interest Rate (as defined in the Subordinated Note Purchase Agreement) of the applicable interest period plus 407 basis points. We used the net proceeds from the sale of the notes to fund the redemption of$15,000,000 in aggregate principal amount of outstanding 6.50% Fixed-to-Floating Rate Subordinated Notes dueSeptember 1, 2024 , which also were structured to qualify as Tier 2 capital. The following table sets forth maximum amounts outstanding at each month-end for specific types of short-term borrowings for the periods indicated. The maximum month-end balance has been the result of using advances with original maturities of up to 30 days to accommodate the orderly issuance of permanent wholesale funds, either in the form of brokered certificates of deposit or FHLB advances. Year Ended December 31, 2020 2019 (In Thousands) Maximum month-end balance: FHLB advances$ 72,500 $ 25,000 Stockholders' Equity As ofDecember 31, 2020 , stockholders' equity was$206.2 million , or 8.0% of total assets, compared to stockholders' equity of$194.2 million , or 9.3% of total assets, as ofDecember 31, 2019 . Excluding PPP loans, stockholders' equity was 8.8% of total assets. Stockholders' equity increased by$12.0 million during the year endedDecember 31, 2020 attributable to net income of$17.0 million for the year endedDecember 31, 2020 , partially offset by dividend declarations of$5.7 million and stock repurchases of$1.7 million . InAugust 2019 , the Corporation completed a$5 million share repurchase program which was initiated inDecember 2018 and had a termination date ofDecember 31, 2019 . The Corporation repurchased 223,149 shares under the repurchase program at an average price of$22.36 per share. OnSeptember 20, 2019 , the Corporation announced its Board approved a new share repurchase program. The program authorized the repurchase by the Corporation of up to$5 million in aggregate value of its outstanding shares of common stock over a period of approximately twelve months, ending onSeptember 30, 2020 . The Corporation suspended this share repurchase program inMarch 2020 due to the uncertainty surrounding the COVID-19 pandemic. Prior to suspending the program, the Corporation had repurchased$3.5 million of the$5 million authorized in the Company's common stock. OnJanuary 28, 2021 , the Board of Directors of the Corporation approved a new share repurchase program. The program authorizes the repurchase by the Corporation of up to$5.0 million of its total outstanding shares of common stock over a period of approximately twelve months, endingJanuary 31, 2022 . Under the new share repurchase program, shares may be 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 allows the Corporation to repurchase shares of its common stock at times when it otherwise might be 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.
Non-bank Consolidated Subsidiaries
First Madison Investment Corp ("FMIC"). FMIC is a wholly-owned operating subsidiary of FBB incorporated in theState of Nevada in 1993. FMIC was organized for the purpose of managing a portion of FBB's investment portfolio. FMIC invests in marketable securities and tax-exempt loans. As an operating subsidiary, FMIC's results of operations are consolidated with FBB's for financial and regulatory purposes. FBB's investment in FMIC was$165.9 million atDecember 31, 2020 , short-term investments were$6.7 million , securities were$118.6 million , gross loans outstanding were$40.1 million , and net income for the year endedDecember 31, 2020 was$3.1 million . This compares to a total investment of$161.0 million ,$5.2 million short-term investments,$112.6 million securities,$41.3 million gross loans, and net income of$3.4 million at and for the year endedDecember 31, 2019 . 61 -------------------------------------------------------------------------------- Table of Contents EffectiveJanuary 13, 2021 ,First Business Capital Corp. ("FBCC") was merged with and intoFirst Business Equipment Finance, LLC ("FBEF"), after which time FBEF's name was changed toFirst Business Specialty Finance, LLC ("FBSF").First Business Equipment Finance, LLC . FBEF was a wholly-owned subsidiary of FBB as ofDecember 31, 2020 , formed in 1998 and headquartered inMadison, Wisconsin . FBB's total investment in FBEF atDecember 31, 2020 was$11.0 million , gross loans and leases outstanding were$113.7 million and net income was$751,000 for the year endedDecember 31, 2020 . This compares to a total investment of$10.3 million , gross loans and leases outstanding of$79.3 million and net income of$103,000 at and for the year endedDecember 31, 2019 .First Business Capital Corp. FBCC was a wholly-owned subsidiary of FBB as ofDecember 31, 2020 , formed in 1995 and headquartered inMadison, Wisconsin . FBB's investment in FBCC atDecember 31, 2020 was$50.0 million , gross loans outstanding were$151.8 million and net income for the year endedDecember 31, 2020 was$1.7 million . This compares to a total investment of$48.2 million , gross loans of$167.8 million and net income of$4.8 million at and for the year endedDecember 31, 2019 .First Business Specialty Finance, LLC ("FBSF"). FBSF, formerly known asFirst Business Equipment Finance, LLC , headquartered inMadison, Wisconsin , was formed in 1998 for the purpose of originating leases and extending credit in the form of loans to small- and medium-sized companies nationwide and is a wholly-owned subsidiary of FBB. EffectiveJanuary 13, 2021 , FBSF's purpose and name were changed to reflect the origination and servicing of asset-based loans, purchasing accounts receivable, financing auto dealership floorplans, and originating equipment leases and extending credit in the form of loans to small- and medium-sized companies nationwide. FBB's pro-forma total investment in FBSF atDecember 31, 2020 was$61.1 million , gross loans and leases outstanding were$265.5 million and net income was$2.4 million for the year endedDecember 31, 2020 . This compares to a pro-forma total investment of$58.5 million , gross loans and leases outstanding of$247.1 million and net income of$4.9 million at and for the year endedDecember 31, 2019 .Rimrock Road Investment Fund, LLC ("Rimrock"). Rimrock is a wholly-owned subsidiary of FBB and was formed in 2009 for the purpose of holding and liquidating real estate and other assets acquired through foreclosure or other legal proceedings. In 2014, Rimrock's purpose was changed to reflect its equity investment in an urban revitalization fund. The investment provided federal new market tax credits over a seven year period. FBB's total investment in Rimrock atDecember 31, 2020 was$2.8 million and Rimrock had a net loss of$2,000 for the year endedDecember 31, 2020 . This compares to a total investment of$2.8 million and net income of$24,000 at and for the year endedDecember 31, 2019 .BOC Investment, LLC ("BOC"). BOC is a wholly-owned subsidiary of FBB and was formed in 2015 for the purpose of holding its equity investment in aMadison, Wisconsin historic development project. The investment provided federal historic tax credits upon the completion of the restoration project. FBB's total investment in BOC atDecember 31, 2020 was$4.0 million . This compares to a total investment of$4.0 million and no income or loss at and for the year endedDecember 31, 2019 .Mitchell Street Apartments Investment, LLC ("Mitchell"). Mitchell is a wholly-owned subsidiary of FBB and was formed in 2016 for the purpose of holding its equity investment in aMilwaukee, Wisconsin historic development project. The investment provided federal and state historic tax credits upon the completion of the restoration project. FBB's total investment in Mitchell was$1.4 million atDecember 31, 2020 . This compares to a total investment of$1.4 million and no income or loss at and for the year endedDecember 31, 2019 .ABKC Real Estate, LLC ("ABKCRE"). ABKCRE is a wholly-owned subsidiary of FBB and was formed for the purpose of holding and liquidating real estate and other assets acquired by FBB through foreclosure or other legal proceedings. ABKCRE was established in 2017. FBB's total investment in ABKCRE atDecember 31, 2020 was$1.5 million and ABKCRE had a net loss of$254,000 for the year endedDecember 31, 2020 . This compares to a total investment of$1.7 million and a$179,000 net loss at and for the year endedDecember 31, 2019 .FBB Tax Credit Investment, LLC ("FBB Tax Credit"). FBB Tax Credit, formerly known asFBB-Milwaukee Real Estate, LLC , is a wholly-owned subsidiary of FBB and was originally formed in 2012 for the purpose of holding and liquidating real estate and other assets acquired by FBB through foreclosure or other legal proceedings. In 2017, FBB Tax Credit's purpose was changed to facilitate investments in federal and state tax credits. FBB's total investment in FBB Tax Credit atDecember 31, 2020 was$11.7 million and FBB Tax Credit had a net income of$923,000 for the year endedDecember 31, 2020 . This compares to a total investment of$8.9 million and net income of$1.7 million at and for the year endedDecember 31, 2019 .FBB Real Estate 2, LLC ("FBB RE 2"). FBB RE 2 is a wholly-owned subsidiary of FBB and was formed for the purpose of holding and liquidating real estate and other assets acquired by FBB through foreclosure or other legal proceedings. 62 -------------------------------------------------------------------------------- Table of Contents FBB's total investment in FBB RE 2 atDecember 31, 2020 was$1.1 million and FBB RE 2 had net income$12,000 . This compares to a total investment of$1.1 million and no income or loss at and for the year endedDecember 31, 2019 . LIQUIDITY AND CAPITAL RESOURCES We expect to meet our liquidity needs through existing cash on hand, established cash flow sources, our third party senior line of credit, and dividends received from the Bank. While the Bank is subject to certain regulatory limitations regarding their 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 atDecember 31, 2020 were the interest payments due on subordinated and junior subordinated notes. During 2020 and 2019, FBB declared and paid dividends totaling$12.0 million and$14.0 million , respectively. The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect onDecember 31, 2020 , and continue to meet the heightened requirements imposed by Basel III, including the capital conservation buffer that was fully phased-in as ofJanuary 1, 2019 . The Corporation's Board and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness. The Bank maintains liquidity by obtaining funds from several sources. The Bank's primary source of funds are principal and interest payments on loans receivable and mortgage-related securities, deposits, and other borrowings, such as federal funds, FHLB advances, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances. The scheduled payments of loans and mortgage-related securities are generally a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest rates, economic conditions, and competition. Please refer to the section titled COVID-19 Update for additional information on the Bank's primary and secondary sources of available liquidity the during the COVID-19 pandemic. 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 ofDecember 31, 2020 and 2019, our immediate on-balance sheet liquidity was$640.2 million and$438.2 million , respectively. The significant increase as ofDecember 31, 2020 compared toDecember 31, 2019 is principally due to the Banks ability to pledge PPP loans and borrow from the Federal Reserve PPPLF. Excluding Federal Reserve PPPLF availability, immediate on-balance sheet liquidity as ofDecember 31, 2020 was$414.9 million . This decline in on-balance sheet liquidity compared to 2019 is primarily due to the Banks increased use of FHLB advances to replace maturing brokered certificates of deposit. AtDecember 31, 2020 and 2019, the Bank had$26.7 million and$44.4 million on deposit with the FRB recorded in short-term investments, respectively. Any excess funds not used for loan funding or satisfying other cash obligations were maintained as part of our on-balance sheet liquidity in our interest-bearing accounts with the FRB, as we value the safety and soundness provided by the FRB. We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow run off of maturing wholesale certificates of deposit or invest in securities to maintain adequate liquidity at an improved margin. We had$567.0 million of outstanding wholesale funds atDecember 31, 2020 , compared to$446.5 million of wholesale funds as ofDecember 31, 2019 , which represented 25.2% and 24.5%, respectively, of ending balance total bank funding. Wholesale funds include FHLB advances, Federal Reserve PPPLF advances, brokered certificates of deposit, and deposits gathered from internet listing services. Total bank funding is defined as total deposits plus FHLB advances and Federal Reserve PPPLF advances. We are committed to raising in-market deposits while utilizing wholesale funds to mitigate interest rate risk. Wholesale funds continue to be an efficient and cost effective source of funding for the Bank and allows it to gather funds across a larger geographic base at price levels and maturities that are more attractive than local time deposits when required to raise a similar level of in-market deposits within a short time period. Access to such deposits and borrowings allows us the flexibility to refrain from pursuing single service deposit relationships in markets that have experienced unfavorable pricing levels. In addition, the administrative costs associated with wholesale funds are considerably lower than those that would be incurred to administer a similar level of local deposits with a similar maturity structure. During the time frames necessary to accumulate wholesale funds in an orderly manner, we will use short-term FHLB advances to meet our temporary funding needs. The short-term FHLB advances will typically have terms of one week to one month to cover the overall expected funding demands. Period-end in-market deposits increased$304.1 million , or 22.1%, to$1.683 billion atDecember 31, 2020 from$1.379 billion atDecember 31, 2019 as in-market deposit balances increased due to PPP loan proceeds and successful business development efforts. Our in-market relationships remain stable; however, deposit balances associated with those relationships will fluctuate. We expect to establish new client relationships and continue marketing efforts aimed at increasing the balances in existing clients' deposit accounts. Nonetheless, we will continue to use wholesale funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management process 63 -------------------------------------------------------------------------------- Table of Contents 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 ofDecember 31, 2020 . The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the year endedDecember 31, 2020 . In the event that there is a disruption in the availability of wholesale funds at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through on-balance sheet liquidity. These potential funding sources include deposits maintained at the FRB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As ofDecember 31, 2020 , the available liquidity was in excess of the stated policy minimum. We believe the Bank will also have access to the unused federal funds lines, cash flows from borrower repayments, and cash flows from security maturities. The Bank also has the ability to raise local market deposits by offering attractive rates to generate the level required to fulfill its liquidity needs.
The Bank is required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. We believe that the Bank has sufficient liquidity to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows.
During the year endedDecember 31, 2020 , operating activities resulted in a net cash inflow of$26.6 million . Operating cash flows included net income of$17.0 million and a provision for loan and leases losses of$16.8 million , partially offset by a net increase in loans originated for sale and sold. Net cash used in investing activities for the year endedDecember 31, 2020 was$454.5 million which consisted of cash outflows to fund net loan growth and the purchase of$8.0 million in additional bank-owned life insurance and the increase of$5.6 million in FHLB stock. Net cash provided by financing activities for the year endedDecember 31, 2020 was$417.7 million . Financing cash flows included a$325.1 million net increase in deposits and a$98.8 million net increase in FHLB advances used predominantly to fund net loan growth, partially offset by cash dividends paid and share repurchases of$5.7 million and$1.7 million , respectively. Refer to Note 12 -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, 2020 and 2019. OFF-BALANCE SHEET ARRANGEMENTS
Commitments
As ofDecember 31, 2020 , the Bank had outstanding commitments to originate$654.1 million of loans and commitments to extend funds to or on behalf of clients pursuant to standby letters of credit of$8.1 million , which includes$300.2 million of commitments to extend funds beyond one year. We do not expect any losses as a result of these funding commitments. We have evaluated outstanding commitments associated with loans that were identified as impaired loans and concluded that there are no additional losses required to be recorded with these unfunded commitments as ofDecember 31, 2020 . We believe that additional commitments will not be granted or additional collateral will be provided to support any additional funds advanced. The Bank also utilizes interest rate swaps for the purposes of interest rate risk management, as described further in Note 17 - Derivative Financial Instruments in the Consolidated Financial Statements. Additionally the Corporation has remaining commitments of$1.3 million toAldine Capital Fund II, LP ("Aldine II"),$2.1 million toAldine Capital Fund III, LP ("Aldine III"), and$725,000 toDane Workforce Housing Fund, LLC ("Workforce Fund "). Aldine II and Aldine III are private equity mezzanine funding limited partnerships in which we have invested. Aldine II began its operations inMarch 2013 and Aldine III began its operations inOctober 2018 .The Workforce Fund was organized in 2020 to originate and administer investments for the purpose of alleviating the shortage ofAffordable Workforce Housing Units inDane County, Wisconsin . We believe adequate capital and liquidity are available from various sources to fund projected commitments. SBA Recourse In the ordinary course of business, the Corporation sells the guaranteed portions of SBA loans to third parties. In the event of a loss resulting from default and a determination by the SBA that there is a compliance deficiency in the manner in which the loan was originated, funded, or serviced by the Corporation, the SBA may require the Corporation to repurchase the 64 -------------------------------------------------------------------------------- Table of Contents loan, deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from the Corporation. The Corporation must comply with applicable SBA regulations in order to maintain the guaranty. Management has assessed the estimated losses inherent in the outstanding guaranteed portions of SBA loans sold in accordance with ASC 450, Contingencies, and determined a recourse reserve based on the probability of future losses for these loans to be$723,000 atDecember 31, 2020 . The recourse reserve is reported in accrued interest payable and other liabilities on the Consolidated Balance Sheets. See Note 18 - Commitments and Contingencies in the Consolidated Financial Statements for additional information on the SBA recourse reserve. 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 5 - 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, 2020 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 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. As part of the Corporation's qualitative assessment of goodwill impairment, management considered the triggering event of the COVID-19 pandemic and determined that the significant change in the general economic environment and financial markets, including the Corporation's market capitalization, represents an interim impairment indicator requiring continued evaluation. The Corporation performed Step 1, 65
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Table of Contents quantitative goodwill impairment testing, as ofAugust 1, 2020 . Based on the analysis performed, management concluded the Corporation's goodwill was not impaired as ofAugust 1, 2020 . The Corporation conducted a subsequent impairment test as ofDecember 31, 2020 , 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 8 -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 16 - Income Taxes in the Consolidated Financial Statements. The Corporation also invests in certain development entities that generate federal and state historic tax credits. The tax benefits associated with these investments are accounted for under the flow-through method and are recognized when the respective project is placed in service. 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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