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.
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Overview
We are a registered bank holding company incorporated under the laws of the
State of Wisconsin and are engaged in the commercial banking business through
our wholly-owned banking subsidiary, FBB. All of our operations are conducted
through FBB and First Business Specialty Finance, LLC ("FBSF"), a wholly-owned
subsidiary of FBB. 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
December 31, 2022, 2021, and 2020 in comparison to the key performance
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 December 31, 2022 include:
•Net income available to common shareholders for the year ended December 31,
2022 was $40.2 million, increasing 12.4% compared to $35.8 million for the year
ended December 31, 2021.
•Diluted earnings per common share were $4.75 for the year ended December 31,
2022, increasing 13.9% compared to $4.17 in the prior year.
•Return on average assets ("ROA") for the year ended December 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 ended December 31, 2022,
compared to 16.21% for the year ended December 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 ended December 31, 2022, increasing $6.7 million and
16 bps, from year ended December 31, 2021. Excluding PPP interest and fee
income, PTPP adjusted earnings and ROA were $47.3 million and 1.72%,
respectively, for the year ended December 31, 2022, increasing $15.0 million and
40 bps from December 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 ended December 31, 2022, decreasing 52.7% compared to $11.2 million for the
year ended December 31, 2021. PPP fee income, included in loan fee amortization,
was $509,000 and $7.3 million for the years ended December 31, 2022 and
December 31, 2021, respectively.
•Net interest margin was 3.82% for the year ended December 31, 2022, increasing
38 bps from 3.44% for the year ended December 31, 2021. Adjusted net interest
margin, which excludes certain one-time and discrete items, was 3.64% for the
year ended December 31, 2022, increasing 43 bps from 3.21% for the year ended
December 31, 2021.
•Top line revenue, defined as net interest income plus non-interest income, grew
13.4% to $127.9 million for the year ended December 31, 2022, compared to $112.8
million for the year ended December 31, 2021. Excluding PPP interest income and
fees, top line revenue increased 22.4% to $127.2 million for the year ended
December 31, 2022, compared to $103.9 million for the year ended December 31,
2021.
•Effective tax rate was 21.79% for the year ended December 31, 2022 compared to
23.97% for the year ended December 31, 2021.
•Provision for loan and lease losses was a net benefit of $3.9 million for the
year ended December 31, 2022, compared to a net provision benefit of $5.8
million for the year ended December 31, 2021. Net recoveries as a percentage of
average loans and leases were 0.16% for the year ended December 31, 2022,
compared to net recoveries of 0.07% for the year ended December 31, 2021.
•Total assets at December 31, 2022 increased $323.7 million, or 12.2%, to $2.977
billion from $2.653 billion at December 31, 2021.
•Period-end gross loans and leases receivable at December 31, 2022 increased
$203.7 million, or 9.1%, to $2.443 billion from $2.239 billion as of
December 31, 2021. Average gross loans and leases of $2.305 billion
increased $125.8 million, or 5.8% for the year ended December 31, 2022, compared
to $2.179 billion for the same period in 2021.
•Period-end gross loans and leases receivable, excluding net PPP loans, at
December 31, 2022 increased $230.4 million, or 10.42%, to $2.443 billion from
$2.212 billion as of December 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 ended December 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, at December 31, 2022, compared to $27.9 million and $557,000,
respectively, at December 31, 2021. Average PPP loans, net of deferred
processing fees, were $9.7 million and $152.3 million for the year ended
December 31, 2022 and 2021, respectively.
•Non-performing assets decreased to $3.8 million as of December 31, 2022,
compared to $6.5 million as of December 31, 2021. Non-performing assets to total
assets, both including and excluding net PPP loans, improved to 0.13% as of
December 31, 2022, from 0.25% as of December 31, 2021.
•The allowance for loan and lease losses as of December 31, 2022 decreased
$106,000, or 0.4%, to $24.2 million, compared to $24.3 million as of
December 31, 2021. The allowance for loan and lease losses was 0.99% of total
loans as of December 31, 2022, compared to 1.09% as of December 31, 2021.
•Period-end in-market deposits at December 31, 2022 increased $37.7 million, or
2.0%, to $1.966 billion from $1.928 billion as of December 31, 2021. Average
in-market deposits of $1.929 billion increased $144.5 million, or 8.1%, for the
year ended December 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 at December 31, 2022, compared to
$2.921 billion at December 31, 2021. Private wealth management service
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fees increased $97,000, or 0.90%, for the year ended December 31, 2022, compared
to the year ended December 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 ended December 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 the SEC on February
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 ended December 31, 2022 compared to the year ended
December 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 ended
December 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 ended December 31, 2022, compared to 1.37% for the year ended December 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 ended December 31, 2022 was 16.79% compared to 16.21% for the year ended December 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 ended December 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 ended December 31, 2022 was $47.9 million,
compared to $41.2 million for the year ended December 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
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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
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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.
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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.
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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 ended
December 31, 2022 compared to the year ended December 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
$ 3,811 $ 14,987 $ (4,784) $ 5,526 $ 742
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
$ 6,002 $ 13,760 $ 232 $ 7,359 $ 7,591
(1)The average balances of loans and leases include non-accrual loans and leases
and loans held for sale. Interest income related to non-accrual loans and leases
is recognized when collected. Interest income includes net loan fees collected
in lieu of interest.
(2)Includes amortized cost basis of assets available-for-sale and
held-to-maturity.
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 ended December 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.
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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 the Federal 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 ended
December 31, 2022, compared to the year ended December 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 ended December 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 ended December 31, 2022
increased $268.4 million, or 13.2%, compared to the year ended December 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 ended December 31, 2022 was
4.71%, an increase of 81 basis points compared to 3.90% for the year ended
December 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 ended December 31, 2022 was 4.52%, an increase of 91 basis points compared
to 3.61% for the year ended December 31, 2021.
The average rate paid on interest-bearing liabilities was 1.23% for the year
ended December 31, 2022, an increase of 60 basis points from 0.63% for the year
ended December 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, .
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Net interest margin increased 38 basis points to 3.82% for the year ended
December 31, 2022, compared to 3.44% for the year ended December 31, 2021.
Adjusted net interest margin measured 3.64% for the year ended December 31,
2022, compared to 3.21% for the year ended December 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 ended
December 31, 2022, compared to $5.8 million provision benefit for the year ended
December 31, 2021. The provision benefit for the year ended December 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 ended December 31, 2022 included a
$4.1 million principal recovery relating to a legacy SBA relationship originated
in May 2016 and fully charged-off in December 2020.
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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)
$ (5,803) $ 16,808
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 ended December 31, 2022, from $28.1 million for the year ended
December 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 ended December 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
ended December 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 ended December 31, 2022 compared to the
previous record of $10.8 million for the year ended December 31, 2021. Private
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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. At December 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 at
December 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
ended December 31, 2022, compared to $4.1 million for the year ended
December 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 ended
December 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 $814,000, or 57.6%, to $2.2
million for the year ended December 31, 2022, compared to $1.4 million for the
year ended December 31, 2021. The increase was due to the recognition of a
$809,000 insurance claim.
Commercial loan interest rate swap fee income was $1.8 million for the year
ended December 31, 2022, compared to $1.4 million for the year ended
December 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 of December 31, 2022,
compared to $640.6 million as of December 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 ended December 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 ended December 31, 2022 from $71.5 million for the year ended
December 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 ended December 31, 2022
compared to $71.6 million for the year ended December 31, 2021. The increase in
operating expense was primarily due to an increase in compensation, professional
fees, marketing, and occupancy.
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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 ended December 31, 2022 from $51.7 million for the year ended December 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 ended December 31, 2022, increasing by 18, or 5.9%, from 307 for the year ended December 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 ended December 31, 2022 compared to the year ended December 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 ended December 31, 2022 from $2.0 million for the year ended December 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 ended December 31, 2022 from $2.2 million for the year ended December 31, 2021. During November 2022, the Corporation relocated the Southeast Wisconsin office location to accommodate growth in the number of employees.
Income Taxes
Income tax expense was $11.4 million for the year ended December 31, 2022,
compared to $11.3 million for the year ended December 31, 2021. The income tax
expense included a $338,000 net benefit from tax credit investments. The
effective tax rate for the year ended December 31, 2022 was 21.8% compared to
24.0% for the year ended December 31, 2021. For 2023, the Corporation expects to
report an effective tax rate of 21%-22% as management anticipates increased tax
credit activity.
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FINANCIAL CONDITION
General
Total assets increased by $323.7 million, or 12.2%, to $2.977 billion as of
December 31, 2022 compared to $2.653 billion at December 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 of
December 31, 2022 compared to $2.420 billion at December 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 at
December 31, 2022 from $47.4 million at December 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 the Federal
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 of December 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 at December 31, 2022 from $225.4 million at
December 31, 2021. As of December 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 the Government National Mortgage
Association ("GNMA"), a U.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 in Wisconsin.
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 ended December 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 of December 31, 2022, and we sold no securities during the year
ended December 31, 2022. As of December 31, 2022 no securities were classified
as trading securities. At December 31, 2022, $35.9 million of our securities
were pledged to secure various obligations, including interest rate swap
contracts and municipal deposits.
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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
$ 4,445 $ 4,971 $ 4,914
U.S. government agency securities –
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
$ 7,404 $ 13,009 $ 13,228
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 by FNMA and the SBA. Municipal securities include securities
issued by various municipalities located primarily within Wisconsin and are
primarily general obligation bonds that are tax-exempt in nature. Residential
and commercial mortgage-backed securities - government issued represent
securities guaranteed by GNMA. Residential and commercial mortgage-backed
securities - government-sponsored enterprises include securities guaranteed by
FHLMC, FNMA, and the FHLB. Other securities represent certificates of deposit of
insured banks and savings institutions with an original maturity greater than
three months. As of December 31, 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 at December 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.
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Less than One Year One to Five Years Five to Ten Years Over Ten Years
Weighted Weighted Weighted Weighted
Average Average Average Average
Fair Value Yield Fair Value Yield Fair Value Yield Fair Value Yield Total
(Dollars in Thousands)
Available-for-sale:
U.S. treasuries $ - - % $ 4,445 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
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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 of December 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 of December 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 between May 2024 and June 2039. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. As of December 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 of December 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 between May 2024 and June 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 of December 31, 2022, compared to a net derivative liability of $19.7 million as of December 31, 2021. The gross amount of dealer counterparty swaps as of December 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 of December 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 of December 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 of December 31, 2021. These interest rate swaps mature between December 2022 and March 2034. As of December 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 of December 31, 2021.Pre-tax unrealized gains of $8.5 million and $3.6 million were recognized in other comprehensive income for the years ended December 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 of December 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 of December 31, 2021. These interest rate swaps mature between February 2031 and October 2034. A pre-tax unrealized gain of $602,000 was recognized in other comprehensive income for the year ended December 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 ended December 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 at December 31, 2022
from $2.215 billion at December 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 at December 31,
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2022 from $2.188 billion at December 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 from December 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 of December 31, 2022 and
December 31, 2021, respectively. As of December 31, 2022, approximately 17.4% of
the CRE loans were owner-occupied CRE, compared to 16.2% as of December 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 at
December 31, 2022 from $730.8 million at December 31, 2021. Excluding net PPP
loans, C&I loans increased $137.2 million, or 19.5%, to $840.7 million from
$703.5 million at December 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.
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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
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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 of December 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 of December 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 of
December 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 of December 31, 2022, the Bank had $12.1
million in net direct financing receivables outstanding.
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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 of December 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 $2.7 million, or 42.5%, to $3.7 million
at December 31, 2022 compared to $6.4 million at December 31, 2021.
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 of December 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 of
December 31, 2022, a decrease in non-performing assets
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of $2.8 million, or 42.4%, from December 31, 2021. Impaired loans and leases as
of December 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% at December 31, 2022 from 0.25% at
December 31, 2021. As of December 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 to December 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.
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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 at December 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 of December 31, 2022 from $24.3 million as of December 31, 2021. The
allowance for loan and lease losses as a percentage of gross loans and leases
also decreased to 0.99% as of December 31, 2022 from 1.09% as of December 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 of December 31, 2022 from 1.10% as
of December 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)", on January 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 ended December 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 ended December 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 of December 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 of December 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.
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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 of December 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, at December 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.
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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.
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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 $ 24,230 0.99 % $ 24,336 1.09 %
(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 of December 31, 2022, there can be no assurance that future adjustments to the allowance will not be necessary.
Deposits
As of December 31, 2022, deposits increased by $210.3 million to $2.168
billion from $1.958 billion at December 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 of Wisconsin and the greater
Kansas 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
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ended December 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 December 31, 2022.
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
At December 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 of December 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 of December 31, 2022, we
have no wholesale certificates of deposit which the Bank has the right to call
prior to the scheduled maturity.
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Borrowings
We had total borrowings of $456.8 million as of December 31, 2022, an increase
of $43.3 million, or 10.5%, from $413.5 million at December 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 of December 31, 2022 and December 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 December 31, 2022 is as follows:
(In Thousands)
Maturities during the year ended December 31,
2023 $ 236,880
2024 35,500
2025 56,000
2026 60,000
2027 28,000
Thereafter 40,428
$ 456,808
On March 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 of
March 15, 2032 and has certain financial performance covenants
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with which the Corporation was in compliance as of September 30, 2022. The Corporation may, at its option, redeem the note, in whole or part, after the fifth anniversary of issuance. Additionally, at December 31, 2022, subordinated notes included a $15.0 million note which bore a fixed interest rate of 5.50% with a maturity date of August 15, 2029. The Corporation may, at its option, redeem the 5.50% notes, in whole or part, at any time after August 15, 2024. The 5.50% notes will begin to lose Tier II capital treatment at a rate of 20% per year effective August 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 of December 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 of December 31, 2021. Stockholders' equity increased by $28.2
million during the year ended December 31, 2022 attributable to net income of
$40.9 million for the year ended December 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.
On March 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, on March 15, June 15, September 15 and December 15 of
each year up to, but excluding, March 15, 2027. For each dividend period from
and including March 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 ended December 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 after March 15, 2027 or within 90 days following a regulatory
capital treatment event, in accordance with the terms of the Series A Preferred
Stock.
On March 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, ending March 4, 2023. As of December 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.
On January 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, ending January 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.
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LIQUIDITY AND CAPITAL RESOURCES
The Corporation expects to meet its liquidity needs through existing cash on
hand, established cash flow sources, its third party senior line of credit, and
dividends received from the Bank. While the Bank is subject to certain generally
applicable regulatory limitations regarding its ability to pay dividends to the
Corporation, we do not believe that the Corporation will be adversely affected
by these dividend limitations. The Corporation's principal liquidity
requirements at December 31, 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 on December 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 of December 31, 2022
and 2021, our readily accessible liquidity was $449.6 million and $529.5
million, respectively. At December 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 at December 31, 2022,
compared to $398.4 million of wholesale funds as of December 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 at December 31, 2022 from $1.928 billion at December 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 of December 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 ended December 31,
2022. In the event that there is a disruption in the availability of wholesale
funds
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at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through 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 of December 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 the Securities 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 ended December 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 ended December 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 ended
December 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 at December 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 ended December 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 the SEC on February
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
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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 of December 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 of July 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 combined Wisconsin 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.
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