Forward-Looking Statements
When used in this report the words or phrases "may," "could," "should," "hope," "might," "believe," "expect," "plan," "assume," "intend," "estimate," "anticipate," "project," "likely," or similar expressions are intended to identify "forward-looking statements." Such statements are subject to risks and uncertainties, including among other things: •Adverse changes in the economy or business conditions, either nationally or in our markets, including, without limitation, inflation, supply chain issues, labor shortages, wage pressures, and the adverse effects of the COVID-19 pandemic on the global, national, and local economy. •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. •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 stockholders 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. 33
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Overview We are a registered bank holding company incorporated under the laws of theState of Wisconsin and are engaged in the commercial banking business through our wholly-owned banking subsidiary, FBB. All of our operations are conducted throughFBB and First Business Specialty Finance, LLC ("FBSF"), a wholly-owned subsidiary of FBB. FBB operates as a business bank, 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 are focused on business banking, private wealth, and bank consulting. Within business banking, we offer commercial lending, asset-based lending, accounts receivable financing, equipment financing, floorplan financing, vendor financing,Small Business Administration ("SBA") lending and servicing, treasury management solutions, and company retirement services. Our private wealth management services include trust and estate administration, financial planning, investment management, and private banking for executives and owners of our business banking clients and others. Our bank consulting experts provide investment portfolio administrative services, asset liability management services, and asset liability management process validation for other financial institutions. We do not utilize a branch network to attract retail clients. Our operating model is predicated on deep client relationships, financial expertise, and an efficient, centralized administration function delivering best in class client satisfaction. Our focused model allows experienced staff to provide the level of financial expertise needed to develop and maintain long-term relationships with our clients. Long-Term Strategic Plan In early 2019, management finalized the development of its five year strategic plan and began the implementation of strategies and initiatives that drive successful execution. Management's objective over this five year period is to excel by building an expert team with diverse experiences who work together to impact client success more than any other financial partner. To meet this objective, we identified four key strategies which are linked to corporate financial goals, all business lines, and centralized administration functions to ensure communication and execution are consistent at all levels of the Corporation. These four strategies are described below: •We will identify, attract, develop, and retain a diverse, high performing team to positively impact the overall performance and efficiency of the Corporation. •We will increase internal efficiencies, deliver a differentiated client experience, and drive client experience utilizing technology where possible. •We will diversify and grow our deposit base. •We will optimize our business lines for diversification and performance.
Throughout 2023, the last year of the existing plan, management intends to
undertake an extensive process to reassess its key strategies and performance
indicators to create a new long-term strategic plan.
The table below shows the Corporation’s performance for the years ended
indicators included in the Corporation’s 2019 strategic plan.
As of December 31, Key Performance Indicators 2020 2021 2022 Strategic Plan Return on average common equity ("ROACE") 8.64% 16.21% 16.79%
13.50%
Return on average assets ("ROAA") 0.70% 1.37% 1.46%
1.15%
Top line revenue growth 11.5% 8.4% 13.4% ? 10% per year In-market deposits to total bank funding 74.8% 82.9% 76.1% ? 75% Employee engagement (1) 91% 87% 87% ? 80% Client satisfaction (1) 96% 93% 95% ? 90%
(1) Anonymous surveys conducted annually
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Financial Performance Summary
Results as of and for the year ended
•Net income available to common shareholders for the year endedDecember 31, 2022 was$40.2 million , increasing 12.4% compared to$35.8 million for the year endedDecember 31, 2021 . •Diluted earnings per common share were$4.75 for the year endedDecember 31, 2022 , increasing 13.9% compared to$4.17 in the prior year. •Return on average assets ("ROA") for the year endedDecember 31, 2022 was 1.46% compared to 1.37% for 2021. •Return on average common equity ("ROACE"), which is defined as net income available to common shareholders divided by average equity reduced by average preferred stock, if any. ROACE was 16.79% for the year endedDecember 31, 2022 , compared to 16.21% for the year endedDecember 31, 2021 . •Pre-tax, pre-provision ("PTPP") adjusted earnings, which excludes certain one-time and discrete items, and PTPP ROA were$47.9 million and 1.74%, respectively, for the year endedDecember 31, 2022 , increasing$6.7 million and 16 bps, from year endedDecember 31, 2021 . Excluding PPP interest and fee income, PTPP adjusted earnings and ROA were$47.3 million and 1.72%, respectively, for the year endedDecember 31, 2022 , increasing$15.0 million and 40 bps fromDecember 31, 2021 . •Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled$5.3 million for the year endedDecember 31, 2022 , decreasing 52.7% compared to$11.2 million for the year endedDecember 31, 2021 . PPP fee income, included in loan fee amortization, was$509,000 and$7.3 million for the years endedDecember 31, 2022 andDecember 31, 2021 , respectively. •Net interest margin was 3.82% for the year endedDecember 31, 2022 , increasing 38 bps from 3.44% for the year endedDecember 31, 2021 . Adjusted net interest margin, which excludes certain one-time and discrete items, was 3.64% for the year endedDecember 31, 2022 , increasing 43 bps from 3.21% for the year endedDecember 31, 2021 . •Top line revenue, defined as net interest income plus non-interest income, grew 13.4% to$127.9 million for the year endedDecember 31, 2022 , compared to$112.8 million for the year endedDecember 31, 2021 . Excluding PPP interest income and fees, top line revenue increased 22.4% to$127.2 million for the year endedDecember 31, 2022 , compared to$103.9 million for the year endedDecember 31, 2021 . •Effective tax rate was 21.79% for the year endedDecember 31, 2022 compared to 23.97% for the year endedDecember 31, 2021 . •Provision for loan and lease losses was a net benefit of$3.9 million for the year endedDecember 31, 2022 , compared to a net provision benefit of$5.8 million for the year endedDecember 31, 2021 . Net recoveries as a percentage of average loans and leases were 0.16% for the year endedDecember 31, 2022 , compared to net recoveries of 0.07% for the year endedDecember 31, 2021 . •Total assets atDecember 31, 2022 increased$323.7 million , or 12.2%, to$2.977 billion from$2.653 billion atDecember 31, 2021 . •Period-end gross loans and leases receivable atDecember 31, 2022 increased$203.7 million , or 9.1%, to$2.443 billion from$2.239 billion as ofDecember 31, 2021 . Average gross loans and leases of$2.305 billion increased$125.8 million , or 5.8% for the year endedDecember 31, 2022 , compared to$2.179 billion for the same period in 2021. •Period-end gross loans and leases receivable, excluding net PPP loans, atDecember 31, 2022 increased$230.4 million , or 10.42%, to$2.443 billion from$2.212 billion as ofDecember 31, 2021 . Average gross loans and leases, excluding net PPP loans, of$2.295 billion increased$268.4 million , or 13.2% for the year endedDecember 31, 2022 , compared to$2.027 billion for the same period in 2021. •PPP loans and PPP deferred processing fees were$554,000 and$48,000 , respectively, atDecember 31, 2022 , compared to$27.9 million and$557,000 , respectively, atDecember 31, 2021 . Average PPP loans, net of deferred processing fees, were$9.7 million and$152.3 million for the year endedDecember 31, 2022 and 2021, respectively. •Non-performing assets decreased to$3.8 million as ofDecember 31, 2022 , compared to$6.5 million as ofDecember 31, 2021 . Non-performing assets to total assets, both including and excluding net PPP loans, improved to 0.13% as ofDecember 31, 2022 , from 0.25% as ofDecember 31, 2021 . •The allowance for loan and lease losses as ofDecember 31, 2022 decreased$106,000 , or 0.4%, to$24.2 million , compared to$24.3 million as ofDecember 31, 2021 . The allowance for loan and lease losses was 0.99% of total loans as ofDecember 31, 2022 , compared to 1.09% as ofDecember 31, 2021 . •Period-end in-market deposits atDecember 31, 2022 increased$37.7 million , or 2.0%, to$1.966 billion from$1.928 billion as ofDecember 31, 2021 . Average in-market deposits of$1.929 billion increased$144.5 million , or 8.1%, for the year endedDecember 31, 2022 , compared to$1.784 billion for the same period in 2021. •Private wealth and trust assets under management and administration decreased by$260.7 million , or 8.9%, to$2.660 billion atDecember 31, 2022 , compared to$2.921 billion atDecember 31, 2021 . Private wealth management service 35 -------------------------------------------------------------------------------- Table of Contents fees increased$97,000 , or 0.90%, for the year endedDecember 31, 2022 , compared to the year endedDecember 31, 2021 . The detailed financial discussion that follows focuses on 2022 results compared to 2021. Information pertaining to 2021 in comparison to 2020 was included in the Corporation's Annual Report on Form 10-K for the year endedDecember 31, 2021 on page 30 under Part II, Item 7, "Management's Discussion and Analysis of Financial and Results of Operations," which was filed with theSEC onFebruary 23, 2022 . Results of Operations Top Line Revenue Top line revenue, comprised of net interest income and non-interest income, increased 13.4% for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 primarily due to a$13.8 million , or 16.3%, increase in net interest income and a$1.3 million , or 4.7%, increase in non-interest income. The increase in net interest income was driven by net interest margin expansion combined with an increase in average loans and leases outstanding and related interest income, partially offset by a reduction in PPP loan fee income. The increase in non-interest income was primarily due to a$1.0 million increase in other fee income, a$504,000 increase in loan fee income, and a$425,000 increase in swap fee income. These favorable variances were partially offset by a$1.5 million decrease in gains on the sale of SBA loans during the year endedDecember 31, 2022 .
The components of top line revenue were as follows:
For the Year Ended December 31, Change From Prior Year $ Change 2022 2021 2020 $ Change 2022 % Change 2022 2021 % Change 2021 (Dollars in Thousands) Net interest income$ 98,422 $ 84,662 $ 77,071 $ 13,760 16.3 %$ 7,591 9.8 % Non-interest income 29,428 28,100 26,940 1,328 4.7 1,160 4.3 % Top line revenue$ 127,850 $ 112,762 $ 104,011 $ 15,088 13.4$ 8,751 8.4 %
Return on Average Assets and Return on Average Common Equity
ROAA was 1.46% for the year endedDecember 31, 2022 , compared to 1.37% for the year endedDecember 31, 2021 principally due to a$13.8 million increase in net interest income partially offset by an increase in operating expenses. Please refer to the operating results analysis below for further discussion on the reasons driving the increase in profitability. We consider ROA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed. ROA 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. ROACE for the year endedDecember 31, 2022 was 16.79% compared to 16.21% for the year endedDecember 31, 2021 . The primary reason for the change in ROACE is consistent with the net income variance explanation as discussed under Return on Average Assets above. We view ROACE 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 measured 62.31% and 63.49% for the years endedDecember 31, 2022 and 2021, respectively. Efficiency ratio is a non-GAAP measure representing operating expense divided by operating revenue. Operating expense is defined as non-interest expense excluding the effects of the SBA recourse benefit or provision, impairment of tax credit investments, net gains or losses on repossessed assets, amortization of other intangible assets, and other discrete items, if any. Operating revenue is defined as net interest income plus non-interest income less realized net gains or losses on securities, if any, and other discrete items. PTPP adjusted earnings for the year endedDecember 31, 2022 was$47.9 million , compared to$41.2 million for the year endedDecember 31, 2021 . PTPP adjusted earnings is a non-GAAP measure defined as operating revenue less operating expense. In the judgment of the Corporation's management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation's operating expenses in relation to its core operating revenue by removing the volatility associated with certain one-time items and other discrete items. PTPP adjusted earnings allows management to benchmark performance of our model to our peers without the influence of the loan loss provision and 36 -------------------------------------------------------------------------------- Table of Contents tax considerations, which will ultimately influence other traditional financial measurements, including ROA and ROACE. 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 and PTPP adjusted earnings.
For the Year Ended December 31, Change From Prior Year % Change $ Change 2022 2021 2020 $ Change 2022 2022 2021 % Change 2021 (Dollars in Thousands) Total non-interest expense$ 79,474 $ 71,535 $ 68,898 $ 7,939 11.1 %$ 2,637 3.8 %
Less:
Net loss on repossessed assets 49 15 383 34 NM (368) (96.1) Amortization of other intangible assets - 25 35 (25) NM (10) (28.6) SBA recourse benefit (188) (76) (278) (112) NM 202 (72.7) Contribution to First Business Charitable Foundation 809 - - 809 NM - NM Impairment of tax credit investments (351) - 2,395 (351) NM (2,395) NM Loss on early extinguishment of debt - - 744 - NM (744) NM Total operating expense (a)$ 79,155 $ 71,571 $ 65,619 $ 7,584 10.6$ 5,952 9.1 Net interest income$ 98,422 $ 84,662 $ 77,071 $ 13,760 16.3 7,591 9.8 Total non-interest income 29,428 28,100 26,940 1,328 4.7 1,160 4.3
Less:
Bank-owned life insurance claim 809 - - 809 NM - NM Net gain (loss) on sale of securities - 29 (4) (29) NM 33 NM Adjusted non-interest income 28,619 28,071 26,944 548 2.0 1,127 4.2 Total operating revenue (b)$ 127,041 $ 112,733
$ 104,015 $ 14,308 12.7$ 8,718 8.4 Efficiency ratio 62.31 % 63.49 % 63.09 % Pre-tax, pre-provision adjusted earnings (b-a)$ 47,886 $ 41,162 $ 38,396 $ 6,724 16.3$ 2,766 7.2 Average total assets 2,752,916 2,605,008 2,419,616 147,908 5.7 185,392 7.7 Pre-tax, pre-provision adjusted return on average assets 1.74 % 1.58 % 1.59 % NM = Not meaningful 37
-------------------------------------------------------------------------------- Table of Contents PPP loans, related fees, and interest income had a material impact on the prior period comparisons in the table above. As this economic stimulus was non-recurring, we believe these key performance indicators are a better indicator of current operating performance of the Corporation, excluding PPP loans and related fee and interest income. The table below includes the efficiency ratio, and PTPP adjusted earnings and return on average assets, excluding average net PPP loans, fee income, and interest income. For the Year Ended December 31, Change From Prior Year 2022 2021 2020 $ Change 2022 % Change 2022 $ Change 2021 % Change 2021 (Dollars in Thousands) Total non-interest expense$ 79,474 $ 71,535 $ 68,898 $ 7,939 11.1 %$ 2,637 3.8 %
Less:
Net loss on repossessed assets 49 15 383 34 NM (368) (96.1) Amortization of other intangible assets - 25 35 (25) NM (10) (28.6) SBA recourse benefit (188) (76) (278) (112) NM 202 (72.7) Contribution to First Business Charitable Foundation 809 - - 809 NM - NM Impairment of tax credit investments (351) - 2,395 (351) NM (2,395) NM Loss on early extinguishment of debt - - 744 - NM (744) NM Total operating expense (a)$ 79,155 $ 71,571 $ 65,619 $ 7,584 10.6$ 5,952 9.1 Net interest income$ 98,422 $ 84,662 $ 77,071 $ 13,760 16.3 7,591 9.8 Less: PPP interest income 97 1,524 2,198 (1,427) (93.6) (674) (30.7) PPP loan fee amortization 509 7,312 5,283 (6,803) (93.0) 2,029 38.4 Adjusted net interest income 97,816 75,826 69,590 21,990 29.0 6,236 9.0 Total non-interest income 29,428 28,100 26,940 1,328 4.7 1,160 4.3 Less: Bank-owned life insurance claim 809 - - 809 NM - NM Net gain (loss) on sale of securities - 29 (4) (29) NM 33 NM
Adjusted non-interest income 28,619 28,071 26,944 548 2.0 1,127 4.2 Total operating revenue (b)$ 126,435 $ 103,897 $ 96,534 $ 22,538 21.7$ 7,363 7.6 Efficiency ratio 62.61 % 68.89 % 67.98 % Pre-tax, pre-provision adjusted earnings (b-a)$ 47,280 $ 32,326 $ 30,915 $ 14,954 46.3$ 1,411 4.6 Average total assets 2,752,916 2,605,008 2,419,616 147,908 5.7 185,392 7.7 Average PPP loans, net 9,740 152,264 215,025 (142,524) (93.6) (62,761) (29.2) Adjusted average total assets$ 2,743,176 $ 2,452,744 $ 2,204,591 $ 290,432 11.8$ 248,153 11.3 Pre-tax, pre-provision adjusted return on average assets 1.72 % 1.32 % 1.40 % 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. 38
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Table of Contents For the Year Ended December 31, 2022 2021 2020 Average Average Average Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate (Dollars in Thousands) Interest-earning assets Commercial real estate and other mortgage loans(1)$ 1,484,239 $ 66,917 4.51 %$ 1,387,434 $ 51,930 3.74 %$ 1,245,886 $ 51,188 4.11 % Commercial and industrial loans(1) 755,837 45,893 6.07 % 727,923 37,470 5.15 % 701,328 35,487 5.06 %
Direct financing leases(1) 15,219 682 4.48 % 19,591 872 4.45 % 26,564 1,039 3.91 % Consumer and other loans(1) 49,695 1,876 3.78 % 44,206 1,572
3.56 % 37,544 1,446 3.85 % Total loans and leases receivable(1) 2,304,990 115,368 5.01 % 2,179,154 91,844 4.21 % 2,011,322 89,160 4.43 % Mortgage-related securities(2) 173,495 3,486 2.01 % 159,242 2,633 1.65 % 173,084 3,548 2.05 % Other investment securities(3) 51,700 986 1.91 % 44,739 777 1.74 % 31,809 639 2.01 % FHLB stock 16,462 989 6.01 % 13,066 651 4.98 % 11,576 671 5.80 % Short-term investments 30,845 542 1.76 % 64,308 90 0.14 % 37,314 161 0.43 % Total interest-earning assets 2,577,492 121,371 4.71 % 2,460,509 95,995 3.90 % 2,265,105 94,179 4.16 % Non-interest-earning assets 175,424 144,499 154,511 Total assets$ 2,752,916 $ 2,605,008 $ 2,419,616 Interest-bearing liabilities Transaction accounts$ 503,668 3,963 0.79 %$ 506,693 988
0.19 %$ 392,577 1,448 0.37 % Money market accounts 761,469 6,241 0.82 % 693,608 1,183 0.17 % 651,402 2,842 0.44 % Certificates of deposit 97,448 1,358 1.39 % 47,020 396 0.84 % 111,698 2,198 1.97 % Wholesale deposits 48,825 1,616 3.31 % 119,831 986 0.82 % 142,591 2,434 1.71 % Total interest-bearing deposits 1,411,410 13,178 0.93 % 1,367,152 3,553 0.26 % 1,298,268 8,922 0.69 % FHLB advances 414,191 7,024 1.70 % 376,781 4,908 1.30 % 379,891 5,507 1.45 % Other borrowings 43,818 2,243 5.12 % 31,935 1,759 5.51 % 24,472 1,509 6.17 % Junior subordinated notes 2,429 504 20.75 % 10,068 1,113 11.05 % 10,054 1,116 11.10 % Total interest-bearing liabilities 1,871,848 22,949 1.23 % 1,785,936 11,333 0.63 % 1,727,892 17,108 0.99 % Non-interest-bearing demand deposit accounts 566,230 536,981 412,825 Other non-interest-bearing liabilities 65,611 61,580 82,337 Total liabilities 2,503,689 2,384,497 2,223,054 Stockholders' equity 249,227 220,511 196,562 Total liabilities and stockholders' equity$ 2,752,916 $ 2,605,008 $ 2,419,616 Net interest income$ 98,422 $ 84,662 $ 77,071 Net interest spread 3.48 % 3.27 % 3.17 % Net interest-earning assets$ 705,644 $ 674,573 $ 537,213 Net interest margin 3.82 % 3.44 % 3.40 % Average interest-earning assets to average interest-bearing liabilities 137.70 % 137.77 % 131.09 % Return on average assets 1.46 % 1.37 % 0.70 % Return on average equity 16.79 % 16.21 % 8.64 % Average equity to average assets 9.05 % 8.46 % 8.12 % Non-interest expense to average assets 2.89 % 2.75 % 2.85 % (1)The average balances of loans and leases include non-accrual loans and leases and loans held for sale. Interest income related to non-accrual loans and leases is recognized when collected. Interest income includes net loan fees 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. 39
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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, 2022 compared to the year endedDecember 31, 2021 . 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, 2022 Compared to 2021 2021 Compared to 2020 Rate Volume Net Rate Volume Net (In Thousands) Interest-earning assets Commercial real estate and other mortgage loans(1)$ 11,176
Commercial and industrial loans(1)
6,941 1,482 8,423 621 1,362
1,983
Direct financing leases(1) 6 (196) (190) 130 (297)
(167)
Consumer and other loans(1) 101 203 304 (117) 243
126
Total loans and leases receivable(1) 18,224 5,300 23,524 (4,150) 6,834
2,684
Mortgage-related securities(2) 602 251 853 (647) (268)
(915)
Other investment securities 81 128 209 (96) 234 138 FHLB Stock 149 189 338 (100) 80 (20) Short-term investments 522 (70) 452 (147) 76 (71) Total net change in income on interest-earning assets 19,578 5,798 25,376 (5,140) 6,956
1,816
Interest-bearing liabilities Transaction accounts 2,981 (6) 2,975 (805) 345 (460) Money market 4,931 127 5,058 (1,832) 173 (1,659) Certificates of deposit 364 598 962 (895) (907) (1,802) Wholesale deposits 1,503 (873) 630 (1,107) (341) (1,448) Total deposits 9,779 (154) 9,625 (4,639) (730) (5,369) FHLB advances 1,593 523 2,116 (554) (45) (599) Federal reserve PPPLF - - - - (54) (54) Other borrowings (131) 615 484 (174) 424 250 Junior subordinated notes 579 (1,188) (609) (5) 2
(3)
Total net change in expense on interest-bearing liabilities 11,820 (204) 11,616 (5,372) (403)
(5,775)
Net change in net interest income$ 7,758
(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. The change in yield of the respective interest-earning asset or the rate paid on interest-bearing liability compared to the change in short-term market rates is commonly referred to as a beta. The table below displays the beta calculations for loans and leases, total interest earning assets, in-market deposits, interest-bearing deposits and total interest-bearing liabilities for the year endedDecember 31, 2022 and 2021. Additionally, adjusted total loans and leases and total interest-earning assets excludes the volatile impact of fees in lieu of interest. 40
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Table of Contents Asset and Liability Beta Analysis For the Year Ended December 31, 2022 Compared to 2021 Compared to 2022 2021 2020 2021 2020 Average Yield/Rate (4) Increase (Decrease) Total loans and leases receivable (a) 5.01 % 4.21 % 4.43 % 0.80 % (0.22) Total interest-earning assets(b) 4.71 % 3.90 4.16 % 0.81 (0.26) Adjusted total loans and leases receivable (1)(c) 4.79 % 3.91 4.32 % 0.88 (0.41) Adjusted total interest-earning assets (1)(d) 4.52 % 3.61 4.03 % 0.91 (0.42) Total in-market deposits(e) 0.60 % 0.14 0.56 % 0.46 (0.42) Total bank funding(2)(f) 0.84 % 0.37 0.86 % 0.47 (0.49) Net interest margin(g) 3.82 % 3.44 3.40 % 0.38 0.04 Adjusted net interest margin(h) 3.64 3.21 3.28 0.43 (0.07) Effective fed funds rate (3)(i) 1.69 % 0.08 % 0.37 % 1.61 % (0.29) % Beta Calculations: Total loans and leases receivable(a)/(i) 49.69 % 75.86 % Total interest-earning assets(b)/(i) 50.15 % 89.66 % Adjusted total loans and leases receivable (1)(c)/(i) 54.66 % 141.38 % Adjusted total interest-earning assets (1)(d)/(i) 56.39 % 144.83 % Total in-market deposits(e)/(i) 28.57 % 144.83 % Total bank funding(2)(f)/(i) 29.19 % 168.97 % Net interest margin(g)/(i) 23.60 % NM Adjusted net interest margin(h)/(i) 26.71 % 24.14 % NM = Not meaningful (1)Excluding average net PPP loans, PPP loan interest income, and fees in lieu of interest. (2)Total bank funding represents total deposits, plus FHLB advances, and Federal Reserve PPPLF advances. (3)Board of Governors of theFederal Reserve System (US), Effective Federal Funds Rates [DFF]. retrieved from FRED,Federal Reserve Bank of St. Louis . (4)Represents annualized yields/rates. Net interest income increased by$13.8 million , or 16.3%, for the year endedDecember 31, 2022 , compared to the year endedDecember 31, 2021 . The increase was principally due to net interest margin expansion combined with an increase in average loans and leases outstanding, which was partially offset by a decrease in PPP loan processing fees. Average gross loans and leases of$2.305 billion increased by$125.8 million , or 5.8% for the year endedDecember 31, 2022 , compared to$2.179 billion for the same period in 2021. Excluding net PPP loans, average gross loans and leases for the year endedDecember 31, 2022 increased$268.4 million , or 13.2%, compared to the year endedDecember 31, 2021 . Loan fees collected in lieu of interest decreased 52.7% to$5.3 million , compared to$11.2 million during the same period of comparison. Excluding PPP fee amortization, loan fees collected in lieu of interest increased 24.1% to$4.8 million , compared to$3.8 million during the same period of comparison. Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased$21.1 million , or 29.3%. The yield on average earning assets for the year endedDecember 31, 2022 was 4.71%, an increase of 81 basis points compared to 3.90% for the year endedDecember 31, 2021 . This increase was principally due to the rising interest rates on variable-rate loans and investment in securities at higher interest rates. These increases were partially offset by the decrease in PPP loan processing fees. Excluding the impact of recurring loan fees in lieu of interest and PPP fees in both 2022 and 2021, the yield on average earning assets for the year endedDecember 31, 2022 was 4.52%, an increase of 91 basis points compared to 3.61% for the year endedDecember 31, 2021 . The average rate paid on interest-bearing liabilities was 1.23% for the year endedDecember 31, 2022 , an increase of 60 basis points from 0.63% for the year endedDecember 31, 2021 . The average rate paid increased as the Corporation increased deposit rates and secured wholesale funding, which consists of wholesale deposits and FHLB advances, at elevated fixed rates. Partially offset the increase in deposit and wholesale funding rates, average wholesale funding decreased$33.6 million , or 6.8%, which is typically a higher cost funding source than in-market deposits, . 41
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Net interest margin increased 38 basis points to 3.82% for the year endedDecember 31, 2022 , compared to 3.44% for the year endedDecember 31, 2021 . Adjusted net interest margin measured 3.64% for the year endedDecember 31, 2022 , compared to 3.21% for the year endedDecember 31, 2021 . Adjusted net interest margin is a non-GAAP measure representing net interest income excluding the fees in lieu of interest and other recurring but volatile components of net interest margin divided by average interest-earning assets less average net PPP loans, if any, and other recurring but volatile components of average interest-earning assets. The increase in adjusted net interest margin was primarily due to the increase in average yield on loans and leases receivable and investment securities, partially offset by an increase in the average rate paid total bank funding. For the Year Ended December 31, December 31, December 31, (Dollars in thousands) 2022 2021 2020 Interest income$ 121,371 $ 95,995 $ 94,179 Interest expense 22,949 11,333 17,108 Net interest income (a) 98,422 84,662 77,071 Less: Fees in lieu of interest 5,283 11,160 9,315 PPP loan interest income 97 1,524 2,198 FRB interest income and FHLB dividend income 1,525 741 789
Add:
FRB PPPLF interest expense - - 54 Adjusted net interest income (b)$ 91,517 $ 71,237 $ 64,823 Average interest-earning assets (c)$ 2,577,492 $ 2,460,509 $ 2,265,105 Less: Average net PPP loans 9,740 152,264 215,025 Average FRB cash and FHLB stock 46,708 76,880 46,595 Average non-accrual loans and leases 5,011 14,172 27,656 Adjusted average interest-earning assets (d)$ 2,516,033 $ 2,217,193 $ 1,975,829 Net interest margin (a / c) 3.82 % 3.44 % 3.40 % Adjusted net interest margin (b / d) 3.64 % 3.21 % 3.28 % Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in existing higher-yielding commercial lending products will allow the Corporation to achieve a net interest margin that supports our long-term profitability goals. 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. In addition, 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.
Provision for Loan and Lease Losses
We determined our provision for loan and lease losses pursuant to our allowance for loan and lease loss methodology, which is based on the magnitude of current and historical net charge-offs recorded throughout the established look-back period, the evaluation of several qualitative factors for each portfolio category, and the amount of specific reserves established for impaired loans that present collateral shortfall positions. Refer to Allowance for Loan and Lease Losses, below, for further information regarding our allowance for loan and lease loss methodology. The Corporation recognized a$3.9 million provision benefit for the year endedDecember 31, 2022 , compared to$5.8 million provision benefit for the year endedDecember 31, 2021 . The provision benefit for the year endedDecember 31, 2022 was primarily due to a net recovery of$3.8 million and a$2.0 million reduction in the general reserve from improving historical loss rates. These decreases were partially offset by a$2.1 million increase in the general reserve due to loan growth. The net recovery for the year endedDecember 31, 2022 included a$4.1 million principal recovery relating to a legacy SBA relationship originated inMay 2016 and fully charged-off inDecember 2020 . 42 -------------------------------------------------------------------------------- Table of Contents The following table shows the components of the provision for loan and lease losses. For the Year Ended December 31, (Dollars in thousands) 2022 2021 2020
Change in general reserve due to subjective factor
changes
$ (384) $ (426) $ 5,460 Change in general reserve due to historical loss factor changes (2,012) (4,456) 949 Charge-offs 979 3,508 8,139 Recoveries (4,741) (5,126) (332) Change in specific reserves on impaired loans, net 146 (2,175) 316 Change due to loan growth, net 2,144 2,872 2,276 Total provision for loan and lease losses$ (3,868)
The addition of specific reserves on impaired loans represents new specific reserves established when collateral shortfalls or government guaranty deficiencies are present, while conversely the release of specific reserves represents the reduction of previously established reserves that are no longer required. Changes in the allowance for loan and lease losses due to subjective factor changes reflect management's evaluation of the level of risk within the portfolio based upon several factors for each portfolio segment. Charge-offs in excess of previously established specific reserves require an additional provision for loan and lease losses to maintain the allowance for loan and lease losses at a level deemed appropriate by management. This amount is net of the release of any specific reserve that may have already been provided. Change in the inherent risk of the portfolio is primarily influenced by the overall growth in gross loans and leases and an analysis of loans previously charged off, as well as movement of existing loans and leases in and out of an impaired loan classification where a specific evaluation of a particular credit may be required rather than the application of a general reserve loss rate. Refer to Asset Quality, below, for further information regarding the overall credit quality of our loan and lease portfolio.
Non-Interest Income
Non-interest income increased by$1.3 million , or 4.7%, to$29.4 million for the year endedDecember 31, 2022 , from$28.1 million for the year endedDecember 31, 2021 . Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream through greater contributions from fee-based revenues. Total non-interest income accounted for 23.0% of our total revenues in 2022 compared to 24.9% in 2021. The increase in total non-interest income for the year endedDecember 31, 2022 primarily reflected an increase in other non-interest income, led by mezzanine fund investment income and gains recognized on end-of-term buyout agreements, an increase in loan fee income, and commercial loan swap fee income. Additionally, a bank-owned life insurance claim was recognized during the year endedDecember 31, 2022 . These increases were partially offset by a decrease in gains on the sale of SBA loans. The components of non-interest income were as follows: For the Year Ended December 31, Change From Prior Year $ Change 2022 2021 2020 $ Change 2022 % Change 2022 2021 % Change 2021 (Dollars in Thousands) Private wealth management services fee income$ 10,881 $ 10,784 $ 8,611 $ 97 0.9 %$ 2,173 25.2 Gain on sale of SBA loans 2,537 4,044 2,899 (1,507) (37.3) 1,145 39.5 Service charges on deposits 3,849 3,837 3,415 12 0.3 422 12.4 Loan fees 3,010 2,506 1,826 504 20.1 680 37.2 Bank-owned life insurance income 2,227 1,413 1,402 814 57.6 11 0.8 Net gain (loss) on sale of securities - 29 (4) (29) NM 33 (825.0) Swap fees 1,793 1,368 6,860 425 31.1 (5,492) (80.1) Other non-interest income 5,131 4,119 1,931 1,012 24.6 2,188 113.3 Total non-interest income$ 29,428 $ 28,100 $ 26,940 $ 1,328 4.7$ 1,160 4.3 Fee income ratio(1) 23.0 % 24.9 % 25.9 %
(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$97,000 , or 0.9%, to a record$10.9 million for the year endedDecember 31, 2022 compared to the previous record of$10.8 million for the year endedDecember 31, 2021 . Private 43 -------------------------------------------------------------------------------- Table of Contents wealth management services fee income is primarily driven by the amount of trust assets under management and administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility within the equity and fixed income markets. This increase was driven by an increase in average trust assets under management and administration, which is attributable to both new client relationships and new money from existing client relationships. AtDecember 31, 2022 , our trust assets under management and administration were$2.660 billion , or 8.9% less than trust assets under management and administration of$2.921 billion atDecember 31, 2021 . During 2022, the equity and fixed income market values decreased and more than offset the new money received during the year. We expect to continue to increase our revenue from trust 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. Other non-interest income increased by$1.0 million to$5.1 million for the year endedDecember 31, 2022 , compared to$4.1 million for the year endedDecember 31, 2021 . The increase was primarily due to strong returns from the Corporation's investments in mezzanine funds and gains recognized on end-of-term buyout agreements related to the Corporation's equipment financing business line. Loan fees increased$504,000 , or 20.1%, to$3.0 million for the year endedDecember 31, 2022 , compared to$2.5 million for the same period in 2021. The increase was driven by an increase in equipment finance lending, floorplan finance lending, and conventional lending activity generating additional service fee income.
Bank-owned life insurance income increased by
million
year ended
Commercial loan interest rate swap fee income was$1.8 million for the year endedDecember 31, 2022 , compared to$1.4 million for the year endedDecember 31, 2021 . 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$744.2 million as ofDecember 31, 2022 , compared to$640.6 million as ofDecember 31, 2021 . Interest rate swaps can be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter. Gain on sale of SBA loans for the year endedDecember 31, 2022 totaled$2.5 million , a decrease of$1.5 million , or 37.3%, from the same period in 2021. Reduced premiums was the primary factor for the lower income. Given current premium levels, the Bank may reduce sales activity and retain the guaranteed portion on the balance sheet. Non-Interest Expense Non-interest expense increased by$7.9 million , or 11.1%, to$79.5 million for the year endedDecember 31, 2022 from$71.5 million for the year endedDecember 31, 2021 . Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased$7.6 million , or 10.6%, to$79.2 million for the year endedDecember 31, 2022 compared to$71.6 million for the year endedDecember 31, 2021 . The increase in operating expense was primarily due to an increase in compensation, professional fees, marketing, and occupancy. 44
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Table of Contents The components of non-interest expense were as follows: For the Year Ended December 31, Change From Prior Year $ Change 2022 2021 2020 $ Change 2022 % Change 2022 2021 % Change 2021 (Dollars in Thousands) Compensation$ 57,742 $ 51,710 $ 45,850 $ 6,032 11.7 %$ 5,860 12.8 Occupancy 2,358 2,180 2,252 178 8.2 (72) (3.2) Professional fees 4,881 3,736 3,530 1,145 30.6 206 5.8 Data processing 3,197 3,087 2,734 110 3.6 353 12.9 Marketing 2,354 2,022 1,580 332 16.4 442 28.0 Equipment 1,091 990 1,199 101 10.2 (209) (17.4) Computer software 4,416 4,260 3,900 156 3.7 360 9.2 FDIC insurance 1,042 1,143 1,238 (101) (8.8) (95) (7.7) Other non-interest expense 2,393 2,407 3,911 (14) (0.6) (1,504) (38.5) Total non-interest expense$ 79,474 $ 71,535 $ 68,589 $ 7,939 11.1$ 2,946 4.3 Total operating expense(1)$ 79,155 $ 71,571 $ 65,619 $ 7,584 10.6$ 5,952 9.1 Full-time equivalent employees 337 304 301 33 10.9 3 1.0 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$6.0 million , or 11.7%, to$57.7 million for the year endedDecember 31, 2022 from$51.7 million for the year endedDecember 31, 2021 principally due to an increase in average FTEs, annual merit increases, growth in employee benefit costs and increase in incentive compensation. The increase reflects a$3.4 million , or 10.7%, increase in employee salaries and a$1.4 million , or 16.3%, increase in individual and corporate performance-based incentive compensation accruals reflecting strong company performance relative to bonus criteria. The Bank's compensation philosophy is to provide base salaries competitive with the market. Average FTEs were 325 for the year endedDecember 31, 2022 , increasing by 18, or 5.9%, from 307 for the year endedDecember 31, 2021 . Performance-based incentive compensation accruals will reset to target performance at the start of 2023 and will be evaluated quarterly and increased or decreased based on management's forecast of full year performance for the Corporation. Professional fees increased$1.1 million , or 30.6%, for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 . The increase was primarily due to an increase in recruiting expense, audit expenses, legal expense, and a general increase in other professional consulting services for various projects. Marketing expense increased by$332,000 , or 16.4%, to$2.4 million for the year endedDecember 31, 2022 from$2.0 million for the year endedDecember 31, 2021 . The increase was primarily due to an increase in business development efforts as the Corporation returns to pre-pandemic activity levels. Occupancy expense increased by$178,000 , or 8.2%, to$2.4 million for the year endedDecember 31, 2022 from$2.2 million for the year endedDecember 31, 2021 . DuringNovember 2022 , the Corporation relocated theSoutheast Wisconsin office location to accommodate growth in the number of employees.
Income Taxes
Income tax expense was$11.4 million for the year endedDecember 31, 2022 , compared to$11.3 million for the year endedDecember 31, 2021 . The income tax expense included a$338,000 net benefit from tax credit investments. The effective tax rate for the year endedDecember 31, 2022 was 21.8% compared to 24.0% for the year endedDecember 31, 2021 . For 2023, the Corporation expects to report an effective tax rate of 21%-22% as management anticipates increased tax credit activity. 45
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Table of Contents FINANCIAL CONDITION General Total assets increased by$323.7 million , or 12.2%, to$2.977 billion as ofDecember 31, 2022 compared to$2.653 billion atDecember 31, 2021 . The increase in total assets was primarily driven by an increase in loans and leases receivable, cash and cash equivalents, derivatives, and other assets. Total liabilities increased by$295.5 million , or 12.2%, to$2.716 billion as ofDecember 31, 2022 compared to$2.420 billion atDecember 31, 2021 . The increase in total liabilities was principally due to an increase in deposits, FHLB advances, and interest rate swap derivatives.
Cash and cash equivalents
Cash and cash equivalents include short-term investments and cash and due from banks. Short-term investments increased by$29.5 million to$76.9 million atDecember 31, 2022 from$47.4 million atDecember 31, 2021 . Both short-term investments and cash and due from banks increased during 2022. Short-term investments primarily consist of interest-bearing deposits held at theFederal Reserve Bank ("FRB"). We value the safety and soundness provided by the FRB, and therefore, we incorporate short-term investments in our on-balance sheet liquidity program. As ofDecember 31, 2022 and 2021, interest-bearing deposits held at the FRB were$76.5 million and$47.0 million , respectively. In general, the level of our cash and short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio. Please refer to the section entitled Liquidity and Capital Resources for further discussion.
Securities
Total securities, including available-for-sale and held-to-maturity, decreased by$789,000 to$224.7 million atDecember 31, 2022 from$225.4 million atDecember 31, 2021 . As ofDecember 31, 2022 and 2021, our total securities portfolio had a weighted average estimated maturity of approximately 6.3 years and 5.7 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 United States Treasury, the Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC"), or theGovernment National Mortgage Association ("GNMA"), aU.S. government agency. The estimated repayment streams associated with this portfolio also allow us to better match short-term liabilities. The Bank's investment policies allow for various types of investments, including tax-exempt municipal securities. The ability to invest in tax-exempt municipal securities provides for further opportunity to improve our overall yield on the securities portfolio. We evaluate the credit risk of the municipal securities prior to purchase and generally limit exposure to general obligation issuances from municipalities, primarily inWisconsin . The majority of the securities we hold have active trading markets; therefore, we have not experienced difficulties in pricing our securities. We use a third-party pricing service as our primary source of market prices for the securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification of the portfolio, data integrity validation through comparison of current price to prior period prices, and an expectation-based analysis of movement in prices based upon the changes in the related yield curves and other market factors. On a periodic basis, we review the third-party pricing vendor's methodology for pricing relevant securities and the results of its internal control assessments. Our securities portfolio is sensitive to fluctuations in the interest rate environment and has limited sensitivity to credit risk due to the nature of the issuers and guarantors of the securities as previously discussed. If interest rates decline and the credit quality of the securities remains constant or improves, the fair value of our debt securities portfolio would likely improve, thereby increasing total comprehensive income. If interest rates increase and the credit quality of the securities remains constant or deteriorates, the fair value of our debt securities portfolio would likely decline and therefore decrease total comprehensive income. The magnitude of the fair value change will be based upon the duration of the portfolio. A securities portfolio with a longer average duration will exhibit greater market price volatility than a securities portfolio with a shorter average duration in a changing rate environment. During the year endedDecember 31, 2022 , we recognized unrealized holding losses of$27.7 million before income taxes through other comprehensive income. These losses were the result of an increase in interest rates. No securities within our portfolio were deemed to be other-than-temporarily impaired as ofDecember 31, 2022 , and we sold no securities during the year endedDecember 31, 2022 . As ofDecember 31, 2022 no securities were classified as trading securities. AtDecember 31, 2022 ,$35.9 million of our securities were pledged to secure various obligations, including interest rate swap contracts and municipal deposits. 46
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The tables below set forth information regarding the amortized cost and fair
values of our securities.
As of December 31, 2022 2021 Amortized Cost Fair Value Amortized Cost Fair Value (In Thousands)
Available-for-sale:
U.S. Treasuries $ 4,977
government-sponsored enterprises
13,666 13,205 19,797 19,935 Municipal securities 45,088 39,311 30,828 30,957
Residential mortgage-backed securities – government
issued
21,790 19,431 19,563 19,661 Residential mortgage-backed securities - government-sponsored enterprises 119,265 106,323 85,748 85,705
Commercial mortgage-backed securities – government
issued
3,450 2,932 5,801 5,771 Commercial mortgage-backed securities - government-sponsored enterprises 31,515 26,377 36,786 36,531 Other securities - - 2,205 2,228$ 239,751 $ 212,024 $ 205,699 $ 205,702 As of December 31, 2022 2021 Amortized Cost Fair Value Amortized Cost Fair Value (In Thousands)
Held-to-maturity:
Municipal securities $ 7,467
Residential mortgage-backed securities – government
issued
1,625 1,518 2,226 2,266 Residential mortgage-backed securities - government-sponsored issued 1,537 1,444 2,502 2,578 Commercial mortgage-backed securities - government-sponsored enterprises 2,006 1,904 2,009 2,204$ 12,635 $ 12,270 $ 19,746 $ 20,276 U.S. Treasuries represent treasury bonds issued by the United States Treasury.U.S. government agency securities - government-sponsored enterprises represent securities issued byFNMA and the SBA. Municipal securities include securities issued by various municipalities located primarily withinWisconsin and are primarily general obligation bonds that are tax-exempt in nature. Residential and commercial mortgage-backed securities - government issued represent securities guaranteed by GNMA. Residential and commercial mortgage-backed securities - government-sponsored enterprises include securities guaranteed by FHLMC,FNMA , and the FHLB. Other securities represent certificates of deposit of insured banks and savings institutions with an original maturity greater than three months. As ofDecember 31, 2022 , 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 atDecember 31, 2022 , 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. 47
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Table of Contents Less than One Year One to Five Years Five to Ten Years Over Ten Years Weighted Weighted Weighted Weighted Average Average Average Average Fair Value Yield Fair Value Yield Fair Value Yield Fair Value Yield Total (Dollars in Thousands) Available-for-sale:U.S. treasuries $ - - % $ 4,445 1.00 % $ - - % $ - - %$ 4,445 U.S. government agency securities - government-sponsored enterprises - - 904 0.56 3,942 2.22 8,359 3.73 13,205 Municipal securities 491 0.36 5,853 1.35 8,231 1.75 24,736 2.19 39,311 Residential mortgage-backed securities - government issued - - 542 2.68 - - 18,889 2.64 19,431 Residential mortgage-backed securities - government-sponsored enterprises 102 2.55 1,739 2.39 15,592 1.94 88,890 2.52 106,323 Commercial mortgage-backed securities - government issued - - - - - - 2,932 1.58 2,932 Commercial mortgage-backed securities - government-sponsored enterprises - - 401 2.25 20,376 1.68 5,600 1.65 26,377 $ 593 $ 13,884$ 48,141 $ 149,406 $ 212,024 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 $ 2,146 2.11 % $ 4,403 2.46 % $ 918 2.79 % $ - - %$ 7,467 Residential mortgage-backed securities - government issued - - 1,095 2.02 - - 530 2.14 1,625 Residential mortgage-backed securities - government-sponsored enterprises - - 308 1.49 899 1.78 330 3.35 1,537 Commercial mortgage-backed securities - government-sponsored enterprises - - - - 2,006 3.29 - - 2,006 $ 2,146 $ 5,806 $ 3,823 $ 860$ 12,635 48
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Derivatives
The Board approved Bank policies allow the Bank to participate in hedging strategies or to use financial futures, options, forward commitments, or interest rate swaps. The Bank utilizes, from time to time, derivative instruments in the course of its asset/liability management. The Corporation's derivative financial instruments, under which the Corporation is required to either receive cash from or pay cash to counterparties depending on changes in interest rates applied to notional amounts, are carried at fair value on the consolidated balance sheets. As ofDecember 31, 2022 , the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was approximately$744.2 million , compared to$640.6 million as ofDecember 31, 2021 . We receive fixed rates and pay floating rates based upon designated benchmark interest rates on the swaps with commercial borrowers. These swaps mature betweenMay 2024 andJune 2039 . Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. As ofDecember 31, 2022 , the commercial borrower swaps were reported on the Consolidated Balance Sheet as a derivative liability and asset of$61.4 million and$1.0 million , respectively, compared to a derivative asset and liability of$26.3 million and$6.6 million , respectively, as ofDecember 31, 2021 . On the offsetting swap contracts with dealer counterparties, we pay fixed rates and receive floating rates based upon designated benchmark interest rates. These interest rate swaps also have maturity dates betweenMay 2024 andJune 2039 . Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and were reported on the Consolidated Balance Sheet as a net derivative asset of$60.4 million as ofDecember 31, 2022 , compared to a net derivative liability of$19.7 million as ofDecember 31, 2021 . The gross amount of dealer counterparty swaps as ofDecember 31, 2022 , without regard to the enforceable master netting agreement, was a gross derivative asset and liability of$61.4 million and$1.0 million , compared to a gross derivative liability of$26.3 million and gross derivative asset of$6.6 million as ofDecember 31, 2021 . The Corporation also enters into interest rate swaps to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The instruments are designated as cash flow hedges as the receipt of floating rate interest from the counterparty is used to manage interest rate risk associated with forecasted issuances of short-term FHLB advances. The change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings. As ofDecember 31, 2022 , the aggregate notional value of interest rate swaps designated as cash flow hedges was$116.4 million compared to$106.0 million as ofDecember 31, 2021 . These interest rate swaps mature betweenDecember 2022 andMarch 2034 . As ofDecember 31, 2022 , the interest rate swaps were reported on the Consolidated Balance Sheet as a derivative asset of$6.6 million , compared to a derivative liability of$1.9 million as ofDecember 31 , 2021.Pre-tax unrealized gains of$8.5 million and$3.6 million were recognized in other comprehensive income for the years endedDecember 31, 2022 and 2021, respectively, and there were no ineffective portion of these hedges. The Corporation also enters into interest rate swaps to mitigate market value volatility on certain long-term fixed-rate securities. The objective of the hedge is to protect the Corporation against changes in fair value due to changes in benchmark interest rates. The instruments are designated as fair value hedges as the changes in the fair value of the interest rate swap are expected to offset changes in the fair value of the hedged item attributable to changes in the SOFR swap rate, the designated benchmark interest rate. 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 change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings. As ofDecember 31, 2022 , the aggregate notional value of interest rate swaps designated as fair value hedges was$12.5 million and there were no fair value hedges as ofDecember 31, 2021 . These interest rate swaps mature betweenFebruary 2031 andOctober 2034 . A pre-tax unrealized gain of$602,000 was recognized in other comprehensive income for the year endedDecember 31, 2022 and there was no ineffective portion of these hedges. No pre-tax unrealized gain or loss was recognized in other comprehensive income for the years endedDecember 31, 2021 and 2020.
For further information and discussion of our derivatives, see Note 17 –
Derivative Financial Instruments of the Consolidated Financial Statements.
Loans and Leases Receivable
Loans and leases receivable, net of allowance for loan and lease losses, increased by$203.8 million , or 9.2%, to$2.419 billion atDecember 31, 2022 from$2.215 billion atDecember 31, 2021 . Excluding net PPP loans, loans and leases receivable, net of allowance for loan and lease losses, increased by$230.6 million , or 10.5%, to$2.418 billion atDecember 31 , 49
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2022 from$2.188 billion atDecember 31, 2021 . Excluding PPP loans, loan growth was across all categories with the highest growth in commercial and industrial ("C&I") loans increasing$137.2 million fromDecember 31, 2021 . There continues to be a concentration in CRE loans which represented 63.1% and 65.7% of our total loans, excluding net PPP loans, as ofDecember 31, 2022 andDecember 31, 2021 , respectively. As ofDecember 31, 2022 , approximately 17.4% of the CRE loans were owner-occupied CRE, compared to 16.2% as ofDecember 31, 2021 . We consider owner-occupied CRE more characteristic of the Corporation's C&I portfolio as, in general, the client's primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property. Our C&I portfolio increased$110.4 million , or 15.1%, to$841.2 million atDecember 31, 2022 from$730.8 million atDecember 31, 2021 . Excluding net PPP loans, C&I loans increased$137.2 million , or 19.5%, to$840.7 million from$703.5 million atDecember 31, 2021 . The Corporation experienced significant C&I loan growth in 2022, due to growth across products and geographies. Management believes the investment in the Corporation's C&I product lines has positioned the Corporation for strong and sustainable growth in 2023 and beyond. We 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. 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. 50
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The following table presents information concerning the composition of the
Bank’s consolidated loans and leases receivable.
As of December 31, 2022 2021 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$ 268,354 11.0 %$ 235,589 10.5 % Commercial real estate - non-owner occupied 687,091 28.1 661,423 29.5 Land development 50,803 2.1 42,792 1.9 Construction 167,948 6.9 179,841 8.0 Multi-family 350,026 14.3 320,072 14.3 1-4 family 17,728 0.7 14,911 0.7 Total commercial real estate 1,541,950 63.1 1,454,628 64.9 Commercial and industrial 841,178 34.4 730,819 32.6 Direct financing leases, net 12,149 0.5 15,743 0.7 Consumer and other: Home equity and second mortgage 6,761 0.3 4,223 0.2 Other 41,177 1.7 35,518 1.6 Total consumer and other 47,938 2.0 39,741 1.8 Total gross loans and leases receivable 2,443,215 100.0 % 2,240,931 100.0 % Less: Allowance for loan and lease losses 24,230 24,336 Deferred loan fees 149 1,523 Loans and leases receivable, net$ 2,418,836 $ 2,215,072 51
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The following table shows the scheduled contractual maturities of the Bank's consolidated gross loans and leases receivable, as well as the dollar amount of such loans and leases which are scheduled to mature after one year and have fixed or adjustable interest rates, as ofDecember 31, 2022 . 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$ 11,476 $ 151,768 $ 105,110 $ 268,354 $ 184,822 $ 72,056 Non-owner occupied 64,200 355,273 267,618 687,091 316,145 306,746 Land development 34,245 16,250 308 50,803 8,521 8,037 Construction 24,988 41,474 101,486 167,948 58,705 84,255 Multi-family 32,355 143,392 174,279 350,026 85,089 232,582 1-4 family 2,407 8,474 6,847 17,728 15,066 255 Commercial and industrial 234,699 503,782 102,697 841,178 188,154 418,325 Direct financing leases 2,462 7,808 1,879 12,149 9,687 - Consumer and other 6,836 36,794 4,308 47,938 31,440 9,662$ 413,668 $ 1,265,015 $ 764,532 $ 2,443,215 $ 897,629 $ 1,131,918 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 occupants of 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$1.542 billion of commercial real estate loans outstanding as ofDecember 31, 2022 ,$26.8 million were originated by the FBSF subsidiary, as part of a larger asset-based lending relationship. Commercial and Industrial. The Bank's commercial and industrial loan portfolio is comprised of loans for a variety of purposes which principally are secured by inventory, accounts receivable, equipment, machinery, and other corporate assets and are advanced within limits prescribed by our loan policy. The majority of such loans are secured and typically backed by personal guarantees of the owners of the borrowing business. Of the$841.2 million of C&I loans outstanding as ofDecember 31, 2022 ,$373.6 million were conventional C&I loans and$467.6 million were originated by the FBSF subsidiary. FBSF products consists of equipment financing, asset-based lending, accounts receivable financing, SBA lending, and floorplan financing. Direct Financing Leases. Direct financing leases initiated through FBSF are originated with a fixed implicit 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, 2022 , the Bank had$12.1 million in net direct financing receivables outstanding. 52
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FBSF leases machinery and equipment to clients under leases which qualify as direct financing leases for financial reporting and as operating leases for income tax purposes. Under the direct financing method of accounting, the minimum lease payments to be received under the lease contract, together with the estimated unguaranteed residual value (approximating 3% to 20% of the cost of the related equipment), are recorded as lease receivables when the lease is signed and the lease property is delivered to the client. The excess of the minimum lease payments and residual values over the cost of the equipment is recorded as unearned lease income. Unearned lease income is recognized over the term of the lease on a basis which results in a level rate of return on the unrecovered lease investment. Lease payments are recorded when due under the lease contract. Residual value is the estimated fair market value of the equipment on lease at lease termination and was estimated to be$2.8 million as ofDecember 31, 2022 . 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.
Asset Quality
Non-accrual loans and leases decreased
at
Our total impaired assets consisted of the following: As of December 31, 2022 2021 (Dollars in Thousands) Non-accrual loans and leases Commercial real estate: Commercial real estate - owner occupied $ -$ 348 Commercial real estate - non-owner occupied - - Land development - - Construction - - Multi-family - - 1-4 family 30 339 Total non-accrual commercial real estate 30 687 Commercial and industrial 3,629 5,572 Direct financing leases, net - 99 Consumer and other: Home equity and second mortgage - - Other - - Total non-accrual consumer and other loans - - Total non-accrual loans and leases 3,659 6,358 Repossessed assets, net 95 164 Total non-performing assets 3,754 6,522 Performing troubled debt restructurings 156 217 Total impaired assets$ 3,910 $ 6,739 Total non-accrual loans and leases to gross loans and leases 0.15 % 0.28 %
Total non-performing assets to gross loans and leases plus
repossessed assets, net
0.15 % 0.29 % Total non-performing assets to total assets 0.13 % 0.25 % Allowance for loan and lease losses to gross loans and leases 0.99 % 1.09 %
Allowance for loan and lease losses to non-accrual loans and leases
662.20 % 382.76 % As ofDecember 31, 2022 and 2021,$30,000 and$627,000 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 repossessed assets totaling$3.8 million , or 0.13% of total assets, as ofDecember 31, 2022 , a decrease in non-performing assets 53
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of$2.8 million , or 42.4%, fromDecember 31, 2021 . Impaired loans and leases as ofDecember 31, 2022 and 2021 also included$156,000 and$217,000 , respectively, of loans classified as performing troubled debt restructurings, which are considered impaired due to the concession in terms, but are meeting the restructured payment terms and therefore are not on non-accrual status. The following asset quality ratios exclude net PPP loans as they are fully guaranteed by the SBA: As of December 31, 2022 2021 (In Thousands) Total non-accrual loans and leases to gross loans and leases 0.15 % 0.29 %
Total non-performing assets to gross loans and leases plus
repossessed assets, net
0.15 0.29 Total non-performing assets to total assets 0.13 0.25 Allowance for loan and lease losses to gross loans and leases 0.99 1.10 We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio. Non-performing assets as a percentage of total assets decreased to 0.13% atDecember 31, 2022 from 0.25% atDecember 31, 2021 . As ofDecember 31, 2022 , the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.8% of the total portfolio was in a current payment status, similar toDecember 31, 2021 . We also monitor asset quality through our established categories as defined in Note 4 - Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses of the Consolidated Financial Statements. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to sell the underlying collateral, inadequate cash flow from the operations of the underlying businesses, liquidation events, or bankruptcy filings. We are proactively working with our impaired loan borrowers to find meaningful solutions to difficult situations that are in the best interests of the Bank. In 2022, 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, 2022 2021 (In Thousands) Impaired loans and leases with no impairment reserves $ 1,223$ 4,419 Impaired loans and leases with impairment reserves required 2,592 2,156 Total impaired loans and leases 3,815 6,575
Less: Impairment reserve (included in allowance for loan and lease
losses)
1,650 1,505 Net impaired loans and leases $ 2,165$ 5,070 Average impaired loans and leases $ 5,084$ 14,260 For the years ended December 31, 2022 2021 (In Thousands) Interest income attributable to impaired loans and leases $ 400$ 1,104 Less: Interest income recognized on impaired loans and leases 1,436 454 Net foregone interest income on impaired loans and leases $ (1,036)$ 650 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. 54
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When analyzing the adequacy of collateral, we obtain external appraisals as appropriate. Our policy regarding commercial real estate appraisals requires the utilization of appraisers from our approved list, the performance of independent reviews to monitor the quality of such appraisals, and receipt of new appraisals for impaired loans at least annually, or more frequently as circumstances warrant. We make adjustments to the appraised values for appropriate selling costs. In addition, the ordering of appraisals and review of the appraisals are performed by individuals who are independent of the business development process. Based on the specific evaluation of the collateral of each impaired loan, we believe the reserve for impaired loans was appropriate atDecember 31, 2022 . However, we cannot provide assurance that the facts and circumstances surrounding each individual impaired loan will not change and that the specific reserve or current carrying value will not be different in the future, which may require additional charge-offs or specific reserves to be recorded.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses decreased$106,000 , or 0.4%, to$24.2 million as ofDecember 31, 2022 from$24.3 million as ofDecember 31, 2021 . The allowance for loan and lease losses as a percentage of gross loans and leases also decreased to 0.99% as ofDecember 31, 2022 from 1.09% as ofDecember 31, 2021 . The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 0.99% as ofDecember 31, 2022 from 1.10% as ofDecember 31, 2021 . The decrease in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by significant commercial real estate loan recoveries, and the related impact it had on our commercial real estate historical loss factors. In addition to the commercial real estate recovery, all other loan segments experienced a reduction in historical loss factors as the look-back period began to roll off the Corporation's higher loss rates from the Great Recession. These general releases were partially offset by an increase in general reserve commensurate with loan growth. The Corporation will adopt ASU No. 2016-13, "Financial Instruments- Credit Losses (Topic 326)", onJanuary 1st, 2023 and anticipates an initial increase in reserves, including unfunded commitments reserves, of approximately$1.0 million to$4.0 million . During the year endedDecember 31, 2022 , we recorded net recoveries on impaired loans and leases of approximately$3.8 million , which included$979,000 of charge-offs and$4.7 million of recoveries. During the year endedDecember 31, 2021 , we recorded net recoveries on impaired loans and leases of approximately$1.6 million , which included$3.5 million of charge-offs and$5.1 million of recoveries. As ofDecember 31, 2022 and 2021, our allowance for loan and lease losses to total non-accrual loans and leases was 662.20% and 382.76%, respectively. This ratio increased primarily due to the substantial decrease in non-accrual loans and leases discussed above, in comparison to the decrease in the allowance for loan and leases losses. Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we try to ensure that we have sufficient collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases may not require additional specific reserves or require only a minimal amount of required specific reserve. Management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined with certainty that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease loss to non-accrual loans and leases ratio as compared to our peers or industry expectations. As asset quality strengthens, our allowance for loan and lease losses is measured more through general characteristics, including historical loss experience, of our portfolio rather than through specific identification and we would therefore expect this ratio to rise. Conversely, if we identify further impaired loans, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as ofDecember 31, 2022 . 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. 55
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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, 2022 are collateral dependent. It is typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment annually, or more frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, in specific situations current fair values collateralizing certain impaired loans were inadequate to support the entire amount of the outstanding debt. . As a result of our review process, we have concluded an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was$24.2 million , or 0.99% of gross loans and leases, atDecember 31, 2022 . However, given ongoing complexities with current workout situations and the uncertainty surrounding future economic conditions, further charge-offs, and increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion. In addition, various federal and state regulatory agencies review the allowance for loan and lease losses. These agencies could require certain loan and lease balances to be classified differently or charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. 56
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A summary of the activity in the allowance for loan and lease losses follows:
Year Ended December 31, 2022 2021 (Dollars in Thousands) Allowance at beginning of period$ 24,336 $ 28,521
Charge-offs:
Commercial real estate Commercial real estate - owner occupied - (11) Commercial real estate - non-owner occupied - - Construction and land development - - Multi-family - - 1-4 family - (245) Commercial and industrial (909) (3,227) Direct financing leases (49) - Consumer and other Home equity and second mortgage - - Other (21) (25) Total charge-offs (979) (3,508) Recoveries: Commercial real estate Commercial real estate - owner occupied 4,260 435 Commercial real estate - non-owner occupied 2 1,422 Construction and land development - 2,078 Multi-family - - 1-4 family - - Commercial and industrial 437 1,168 Direct financing leases - - Consumer and other Home equity and second mortgage - 2 Other 42 21 Total recoveries 4,741 5,126 Net charge-offs 3,762 1,618 Provision for loan and lease losses (3,868) (5,803) Allowance at end of period$ 24,230 $ 24,336 Net charge-offs as a percent of average gross loans and leases (0.16) % (0.07) % 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. 57
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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, 2022 2021 Balance (a) Balance (a) (Dollars in Thousands) Loan and lease segments: Commercial real estate$ 12,560 0.81 %$ 15,110 1.04 % Commercial and industrial 11,128 1.30 8,413 1.13 Consumer and other 542 1.13
813 2.05
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, 2022 , there can be no assurance that future adjustments to the allowance will not be necessary.
Deposits
As ofDecember 31, 2022 , deposits increased by$210.3 million to$2.168 billion from$1.958 billion atDecember 31, 2021 . The increase in deposits was primarily due to an increase in wholesale deposits and certificates of deposit of$172.6 million and$99.7 million , respectively, partially offset by a decrease of$55.9 million and$6.1 million in money market accounts and transaction accounts, respectively. The large increase in wholesale deposits is primarily driven by a shift from FHLB advances to wholesale deposits to manage interest rate risk and liquidity by utilizing the most efficient and cost-effective source of wholesale funds to match-fund our fixed-rate loan portfolio. Additionally, certificate of deposit accounts saw an increase primarily due to an increase in interest rates. The following table presents the composition of the Bank's consolidated deposits. As of December 31, 2022 2021 % of Total Balance Deposits Balance % of Total Deposits (Dollars in Thousands) Non-interest-bearing transaction accounts$ 537,107 24.8 %$ 589,559 30.1 % Interest-bearing transaction accounts 576,601 26.6 530,225 27.1 Money market accounts 698,505 32.2 754,410 38.5 Certificates of deposit 153,757 7.1 54,091 2.8 Wholesale deposits 202,236 9.3 29,638 1.5 Total deposits$ 2,168,206 100.0 %$ 1,957,923 100.0 % Period-end deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to service and maintain existing and new client relationships. Deposits continue to be the primary source of the Bank's funding for lending and other investment activities. A variety of accounts are designed to attract both short- and long-term deposits. These accounts include non-interest-bearing transaction accounts, interest-bearing transaction accounts, money market accounts, and certificates of deposit. Deposit terms offered by the Bank vary according to the minimum balance required, the time period the funds must remain on deposit, the rates and products offered by competitors, and the interest rates charged on other sources of funds, among other factors. Our Bank's in-market deposits are obtained primarily from the South Central, Northeast and Southeast regions ofWisconsin and the greaterKansas City Metro. We measure the success of in-market deposit gathering efforts based on the average balances of our deposit accounts as compared to ending balances due to the volatility of some of our larger relationships. Average in-market deposits for the year 58 -------------------------------------------------------------------------------- Table of Contents endedDecember 31, 2022 were approximately$1.929 billion , or 80.6% of total bank funding. Total bank funding is defined as total deposits plus FHLB advances. This compares to average in-market deposits of$1.784 billion , or 78.2% of total bank funding, for 2021. Refer to Note 9 - Deposits in the Consolidated Financial Statements for additional information regarding our deposit composition.
The following table sets forth the amount and maturities of the Bank’s
certificates of deposit and term wholesale deposits at
Over Three Over Six Months Three Months Months Through Through Twelve Over Twelve Interest Rate and Less Six Months Months Months Total (In Thousands) 0.00% to 0.99%$ 4,812 $ 7,554 $ 1,998 $ 2,240 $ 16,604 1.00% to 1.99% 11,042 845 2,775 2,529 17,191 2.00% to 2.99% 4,056 1,512 8,767 10,302 24,637 3.00% to 3.99% 55,049 7,594 3,231 1,706 67,580 4.00% to 4.99% 80,770 9,678 35,067 89,466 214,981$ 155,729 $ 27,183 $ 51,838 $ 106,243 $ 340,993 AtDecember 31, 2022 , time deposits included$81.6 million of certificates of deposit and wholesale deposits in denominations greater than or equal to$250,000 . Of these certificates,$31.3 million are scheduled to mature in three months or less,$9.7 million in greater than three through six months,$38.6 million in greater than six through twelve months and$2.0 million in greater than twelve months. Of the total time deposits outstanding as ofDecember 31, 2022 ,$234.8 million are scheduled to mature in 2023,$12.8 million in 2024,$14.4 million in 2025,$25.5 million in 2026, and$51.4 million in 2027. As ofDecember 31, 2022 , we have no wholesale certificates of deposit which the Bank has the right to call prior to the scheduled maturity. 59
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Borrowings
We had total borrowings of$456.8 million as ofDecember 31, 2022 , an increase of$43.3 million , or 10.5%, from$413.5 million atDecember 31, 2021 . Total wholesale funding as a percentage of total bank funding has increased due to significant wholesale deposit growth as part of the Bank's strategy to mitigate interest rate risk by match-funding fixed rate loans with the most cost effective form of wholesale funding. Total bank funding is defined as total deposits plus FHLB advances. As ofDecember 31, 2022 andDecember 31, 2021 , the Corporation had other borrowings of$6.1 million and$10.4 million , respectively, which consisted of sold loans accounted for as secured borrowings because they did not qualify for true sale accounting, as well as borrowings associated with our investment in a community development entity. Consistent with our funding philosophy to manage interest rate risk, we will use the most efficient and cost effective source of wholesale funds. We 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, 2022 December 31, 2021 Weighted Weighted Weighted Weighted Average Average Average Average Balance Balance Rate Balance Balance Rate (Dollars in Thousands) Federal funds purchased $ -$ 14 7.42 % $ - $ - - % FHLB advances 416,380 414,191 1.70 368,800 376,781 1.30 Line of credit - 85 2.78 500 78 2.90 Other borrowings 6,088 8,624 5.23 10,363 8,090 4.11 Subordinated notes payable 34,340 35,095 5.06 23,788 23,766
5.94
Junior subordinated notes(1) - 2,429 20.75 10,076 10,068 11.05$ 456,808 $ 460,438 2.12$ 413,527 $ 418,783 1.86 (1) Weighted average rate of junior subordinated notes reflects the accelerated amortization of subordinated debt issuance costs as a result of the early redemption of the junior subordinated notes during the first quarter of 2022.
A summary of annual maturities of borrowings at
(In Thousands) Maturities during the year endedDecember 31, 2023 $ 236,880 2024 35,500 2025 56,000 2026 60,000 2027 28,000 Thereafter 40,428$ 456,808 OnMarch 4, 2022 , the Corporation completed a private placement of$20.0 million in new subordinated debt to one institutional investor. Management used a portion of the proceeds during the second quarter of 2022 to redeem$9.1 million of subordinated notes bearing a fixed interest rate of 6.00%. The remainder of the proceeds were designed to be used for general corporate purposes, including to support the Bank's growth strategy, and to fund share repurchases. The subordinated note bears a fixed interest rate of 3.50% with a maturity date ofMarch 15, 2032 and has certain financial performance covenants 60
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with which the Corporation was in compliance as ofSeptember 30, 2022 . The Corporation may, at its option, redeem the note, in whole or part, after the fifth anniversary of issuance. Additionally, atDecember 31, 2022 , subordinated notes included a$15.0 million note which bore a fixed interest rate of 5.50% with a maturity date ofAugust 15, 2029 . The Corporation may, at its option, redeem the 5.50% notes, in whole or part, at any time afterAugust 15, 2024 . The 5.50% notes will begin to lose Tier II capital treatment at a rate of 20% per year effectiveAugust 15, 2024 . Refer to Note 10 - FHLB Advances, Other Borrowings and Junior Subordinated Notes in the Consolidated Financial Statements for additional information on the terms of Corporation's current debt instruments.
Stockholders’ Equity
As ofDecember 31, 2022 , stockholders' equity was$260.6 million , or 8.8% of total assets, compared to stockholders' equity of$232.4 million , or 8.8% of total assets, as ofDecember 31, 2021 . Stockholders' equity increased by$28.2 million during the year endedDecember 31, 2022 attributable to net income of$40.9 million for the year endedDecember 31, 2022 , partially offset by preferred and common stock dividend declarations of$683,000 and$6.7 million , respectively, and stock repurchases of$5.0 million authorized under the repurchase program discussed below. OnMarch 4, 2022 , the Corporation issued 12,500 shares, or$12.5 million in aggregate liquidation preference, of 7.0% Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A, par value$0.01 per share, with a liquidation preference of$1,000 per share (the "Series A Preferred Stock") in a private placement to institutional investors. The net proceeds received from the issuance of the Series A Preferred Stock were$12.0 million . The proceeds were used to redeem$10.1 million of junior subordinated notes in the first quarter of 2022. The Corporation expects to pay dividends on the Series A Preferred Stock when and if declared by its Board, at a fixed rate of 7.0% per annum, payable quarterly, in arrears, onMarch 15 ,June 15 ,September 15 andDecember 15 of each year up to, but excluding,March 15, 2027 . For each dividend period from and includingMarch 15, 2027 , dividends will be paid at a floating rate of Three-Month Term SOFR plus a spread of 539 basis points per annum. During the year endedDecember 31, 2022 , the Corporation paid$683,000 in preferred cash dividends. The Series A Preferred Stock is perpetual and has no stated maturity. The Corporation may redeem the Series A Preferred Stock at its option at a redemption price equal to$1,000 per share, plus any declared and unpaid dividends (without regard to any undeclared dividends), subject to regulatory approval, on or afterMarch 15, 2027 or within 90 days following a regulatory capital treatment event, in accordance with the terms of the Series A Preferred Stock. OnMarch 4, 2022 , the Corporation's Board approved a share repurchase program. The program authorized the repurchase by the Corporation of up to$5 million of its total outstanding shares of common stock over a period of approximately twelve months, endingMarch 4, 2023 . As ofDecember 16, 2022 , the Corporation had completed the share repurchase program, purchasing a total of 142,074 shares for approximately$5.0 million at an average cost of$35.14 per share. OnJanuary 27, 2023 , the Board of Directors of the Corporation approved a new share repurchase program. The program authorized the repurchase by the Corporation of up to$5 million of its total outstanding shares of common stock over a period of approximately twelve months, endingJanuary 31, 2024 . Under the new share repurchase program, shares are 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 has implemented a trading plan intended to satisfy the affirmative defense conditions of Rule 10b5-1 under the Securities Exchange Act. The trading plan allows the Corporation to repurchase shares of its common stock at times when it otherwise might have been prevented from doing so under insider trading laws by requiring that an agent selected by the Corporation repurchase shares of common stock on the Corporation's behalf on pre-determined terms. 61
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Table of Contents LIQUIDITY AND CAPITAL RESOURCES The Corporation expects to meet its liquidity needs through existing cash on hand, established cash flow sources, its third party senior line of credit, and dividends received from the Bank. While the Bank is subject to certain generally applicable regulatory limitations regarding its ability to pay dividends to the Corporation, we do not believe that the Corporation will be adversely affected by these dividend limitations. The Corporation's principal liquidity requirements atDecember 31, 2022 were the interest payments due on subordinated notes and cash dividends payable to both common and preferred stockholders. During 2022 and 2021, FBB declared and paid dividends totaling$2.0 million and$8.5 million , respectively. The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect onDecember 31, 2022 , and continue to meet the heightened requirements imposed by Basel III, including the capital conservation buffer. The Corporation's Board and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness. The Bank maintains liquidity by obtaining funds from several sources. The Bank's primary source of funds are principal and interest payments on loans receivable and mortgage-related securities, deposits, and other borrowings, such as federal funds and FHLB advances. The scheduled payments of loans and mortgage-related securities are generally a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest rates, economic conditions, and competition. We view readily accessible liquidity as a critical element to meet our cash and collateral obligations. We define our readily accessible liquidity as the total of our short-term investments, our unencumbered securities available-for-sale, and our unencumbered pledged loans. As ofDecember 31, 2022 and 2021, our readily accessible liquidity was$449.6 million and$529.5 million , respectively. AtDecember 31, 2022 and 2021, the Bank had$76.5 million and$47.0 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 readily accessible 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, pay down FHLB advances, allow run off of maturing wholesale certificates of deposit or to invest in securities to maintain adequate liquidity at an improved margin. We had$618.6 million of outstanding wholesale funds atDecember 31, 2022 , compared to$398.4 million of wholesale funds as ofDecember 31, 2021 , which represented 23.9% and 17.1%, respectively, of period end total bank funding. Wholesale funds include FHLB advances, brokered certificates of deposit, and deposits gathered from internet listing services. Total bank funding is defined as total deposits plus FHLB advances. We are committed to raising in-market deposits while utilizing wholesale funds to match-fund our loan portfolio and 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 less desirable deposit relationships. 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$37.7 million , or 2.0%, to$1.966 billion atDecember 31, 2022 from$1.928 billion atDecember 31, 2021 as in-market deposit balances increased due to successful business development efforts, partially offset by deposit movement from money market accounts to, alternative investment options, and clients funding their normal course of business. In addition, in-market deposit balances were negatively impacted by the outflow of client funds previously accumulated as part of their participation in the Paycheck Protection Program. Our in-market relationships continue to grow; however, deposit balances associated with those relationships will fluctuate. We expect to establish new client relationships and continue marketing efforts aimed at increasing the balances in existing clients' deposit accounts. Nonetheless, we will continue to use wholesale funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management process or in shorter time periods if in-market deposit balances decline. In order to provide for ongoing liquidity and funding, all of our wholesale funds are certificates of deposit which do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual maturity terms and no call provisions. The Bank limits the percentage of wholesale funds to total bank funds in accordance with liquidity policies approved by its Board. The Bank was in compliance with its policy limits as ofDecember 31, 2022 . 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, 2022 . In the event that there is a disruption in the availability of wholesale funds 62
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at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through readily available 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, 2022 , 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 Corporation has filed a shelf registration with theSecurities and Exchange Commission that would allow the Corporation to offer and sell, from time to time and in one or more offerings, up to$75.0 million in aggregate initial offering price of common and preferred stock, debt securities, warrants, subscription rights, units, or depository shares, or any combination thereof.
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, 2022 , operating activities resulted in a net cash inflow of$38.6 million driven by net income of$40.9 million . Net cash used in investing activities for the year endedDecember 31, 2022 was$245.3 million which consisted of$199.5 million in cash outflows to fund net loan growth and$27.8 million in net cash outflows to purchase available-for-sale securities. Net cash provided by financing activities for the year endedDecember 31, 2022 was$252.2 million . Financing cash flows included a$210.3 million net increase in deposits and a$47.6 million net increase in FHLB advances, partially offset by cash dividends paid of$6.7 million , and authorized share repurchases of$5.0 million , respectively. Refer to Note 11 -Regulatory Capital for additional information regarding the Corporation's and the Bank's capital ratios and the ratios required by their federal regulators atDecember 31, 2022 and 2021. 2021 COMPARED TO 2020 Information pertaining to 2021 in comparison to 2020 was included in the Corporation's Annual Report on Form 10-K for the year endedDecember 31, 2021 on page 30 under Part II, Item 7, "Management's Discussion and Analysis of Financial and Results of Operations," which was filed with theSEC onFebruary 23, 2022 . 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 63
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estimate of the fair value of the underlying collateral taking into consideration various valuation techniques and qualitative adjustments to inputs to those estimates of fair value, the strength and availability of guarantees, concentration of credits, and other factors. Allocations of the allowance may be made for specific loans or leases, but the entire allowance is available for any loan or lease that, in our judgment, should be charged off. Loan and lease losses are charged against the allowance when we believe that the uncollectability of a loan or lease balance is confirmed. See Note 1 - Nature of Operations and Summary of Significant Accounting Policies and Note 4 - Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses in the Consolidated Financial Statements for further discussion of the allowance for loan and lease losses. We also continue to exercise our legal rights and remedies as appropriate in the collection and disposal of non-performing assets, and adhere to rigorous underwriting standards in our origination process in order to achieve strong asset quality. Although we believe that the allowance for loan and lease losses was appropriate as ofDecember 31, 2022 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. The Corporation conducted its annual impairment test as ofJuly 1, 2022 , utilizing a qualitative assessment, and concluded that it was more likely than not the estimated fair value of the reporting unit exceeded its carrying value, resulting in no impairment. Although no goodwill impairment was noted, there can be no assurances that future goodwill impairment will not occur. See Note 1 - Nature of Operations and Summary of Significant Accounting Policies for the Corporation's accounting policy on goodwill and see Note 7 -Goodwill and Other Intangible Assets in the Consolidated Financial Statements for a detailed discussion of the factors considered by management in the assessment. Income Taxes. The Corporation and its wholly owned subsidiaries file a consolidated federal income tax return and a combinedWisconsin state tax return. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The determination of current and deferred income taxes is based on complex analysis of many factors, including the interpretation of federal and state income tax laws, the difference between the tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts currently due or owed, such as the timing of reversals of temporary differences, and current accounting standards. We apply a more likely than not approach to each of our tax positions when determining the amount of tax benefit to record in our Consolidated Financial Statements. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We have made our best estimate of valuation allowances utilizing available evidence and evaluation of sources of taxable income including tax planning strategies and expected reversals of timing differences to determine if valuation allowances were needed for deferred tax assets. Realization of deferred tax assets over time is dependent on our ability to generate sufficient taxable earnings in future periods and a valuation allowance may be necessary if management determines that it is more likely than not that the deferred asset will not be utilized. These estimates and assumptions are subject to change. Changes in these estimates and assumptions could adversely affect future consolidated results of operations. The Corporation believes the tax assets and liabilities are properly recorded in the Consolidated Financial Statements. See also Note 16 - Income Taxes in the Consolidated Financial Statements. The Corporation also invests in certain development entities that generate federal and state historic and low income housing tax credits. The tax benefits associated with these investments are accounted for either under the flow-through method, equity method, or proportional amortization method and are recognized when the respective project is placed in service or over the investment term. The federal and state taxing authorities who make assessments based on their determination of tax laws may periodically review our interpretation of federal and state income tax laws. Tax liabilities could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities based on the completion of examinations by taxing authorities. 64
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