Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☑
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2024
OR
☐
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission file number 001-34095
FIRST BUSINESS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Wisconsin
39-1576570
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
401 Charmany Drive
53719
Madison
(Address of Principal Executive Offices)
(Zip Code)
(608) 238-8008
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value
FBIZ
The Nasdaq Stock Market LLC
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
þ
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No þ
The number of shares outstanding of the registrant’s sole class of common stock, par value $0.01 per share, on October 21, 2024 was 8,295,017 shares.
INDEX — FORM 10-Q
PART I. Financial Information
1
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited)
Consolidated Statements of Income (Unaudited)
2
Consolidated Statements of Comprehensive Income (Unaudited)
3
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
4
Consolidated Statements of Cash Flows (Unaudited)
6
Notes to Unaudited Consolidated Financial Statements
7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
36
Item 3. Quantitative and Qualitative Disclosures about Market Risk
59
Item 4. Controls and Procedures
PART II. Other Information
60
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 5. Other Information
Item 6. Exhibits
61
Signatures
62
First Business Financial Services, Inc.
Consolidated Balance Sheets
September 30,2024
December 31,2023
(Unaudited)
(In Thousands, Except Share Data)
Assets
Cash and due from banks
$
45,302
32,348
Short-term investments
86,670
107,162
Cash and cash equivalents
131,972
139,510
Securities available-for-sale, at fair value
313,336
297,006
Securities held-to-maturity, at amortized cost
6,907
8,503
Loans held for sale
8,173
4,589
Loans and leases receivable, net of allowance for credit losses of $33,688 and $31,275, respectively
3,016,391
2,818,986
Premises and equipment, net
5,478
6,190
Repossessed assets
56
247
Right-of-use assets, net
5,789
6,559
Bank-owned life insurance
56,767
55,536
Federal Home Loan Bank stock, at cost
12,775
12,042
Goodwill and other intangible assets
11,834
12,023
Derivatives
42,539
55,597
Accrued interest receivable and other assets
103,707
91,058
Total assets
3,715,724
3,507,846
Liabilities and Stockholders’ Equity
Deposits
2,969,947
2,796,779
Federal Home Loan Bank advances and other borrowings
349,109
330,916
Lease liabilities
8,054
8,954
45,399
51,949
Accrued interest payable and other liabilities
31,233
29,660
Total liabilities
3,403,742
3,218,258
Stockholders’ equity:
Preferred stock, $0.01 par value, 2,500,000 shares authorized, 12,500 shares of 7% non-cumulative perpetual preferred stock, Series A, outstanding at September 30, 2024 and December 31, 2023
11,992
Common stock, $0.01 par value, 25,000,000 shares authorized, 9,434,444 and 9,418,463 shares issued, 8,295,017 and 8,314,778 shares outstanding at September 30, 2024 and December 31, 2023, respectively
95
Additional paid-in capital
92,650
90,616
Retained earnings
253,660
230,728
Accumulated other comprehensive loss
(15,032
)
(13,717
Treasury stock, 1,139,427 and 1,103,685 shares at September 30, 2024 and December 31, 2023, respectively, at cost
(31,383
(30,126
Total stockholders’ equity
311,982
289,588
Total liabilities and stockholders’ equity
See accompanying Notes to Unaudited Consolidated Financial Statements.
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
2024
2023
(In Thousands, Except Per Share Data)
Interest income
Loans and leases
55,506
47,868
160,947
131,962
Securities
2,976
2,198
8,823
5,601
845
875
3,250
2,604
Total interest income
59,327
50,941
173,020
140,167
Interest expense
25,290
19,803
73,802
48,774
3,030
2,542
8,159
8,344
Total interest expense
28,320
22,345
81,961
57,118
Net interest income
31,007
28,596
91,059
83,049
Provision for credit losses
2,087
1,817
6,126
5,610
Net interest income after provision for credit losses
28,920
26,779
84,933
77,439
Non-interest income
Private wealth management service fees
3,264
2,945
9,835
8,492
Gain on sale of Small Business Administration loans
460
851
1,004
1,771
Service charges on deposits
920
835
2,810
2,283
Loan fees
812
786
2,486
2,495
Increase in cash surrender value of bank-owned life insurance
416
376
1,231
1,106
Net loss on sale of securities
—
(8
(45
Swap fees
992
815
2,526
Other non-interest income
732
1,645
3,073
5,586
Total non-interest income
7,064
8,430
21,246
24,214
Non-interest expense
Compensation
15,198
15,573
47,570
46,610
Occupancy
585
575
1,785
1,809
Professional fees
1,305
1,429
4,348
4,012
Data processing
1,045
953
3,245
2,889
Marketing
922
758
2,591
2,165
Equipment
333
349
1,013
1,000
Computer software
1,608
1,289
4,581
3,668
FDIC insurance
810
680
2,032
1,653
Other non-interest expense
1,301
1,583
3,164
3,181
Total non-interest expense
23,107
23,189
70,329
66,987
Income before income tax expense
12,877
12,020
35,850
34,666
Income tax expense
2,351
2,079
6,020
7,409
Net income
10,526
9,941
29,830
27,257
Preferred stock dividend
218
656
Net income available to common shareholders
10,308
9,723
29,174
26,601
Earnings per common share
Basic
1.24
1.17
3.50
3.19
Diluted
Dividends declared per share
0.25
0.2275
0.75
0.6825
(In Thousands)
Other comprehensive (loss) income
Securities available-for-sale:
Unrealized securities gains (losses) arising during the period
9,129
(6,194
5,624
(6,446
Reclassification adjustment for net loss realized in net income
8
45
Securities held-to-maturity:
Amortization of net unrealized losses transferred from available-for-sale
Interest rate swaps:
Unrealized (losses) gains on interest rate swaps arising during the period
(11,811
5,713
(6,507
7,844
Income tax benefit (expense)
593
123
(442
(371
Total other comprehensive (loss) income
(2,088
(357
(1,315
1,076
Comprehensive income
8,438
9,584
28,515
28,333
CommonSharesOutstanding
PreferredStock
CommonStock
AdditionalPaid-inCapital
RetainedEarnings
AccumulatedOtherComprehensiveLoss
TreasuryStock
Total
Balance at December 31, 2022
8,362,085
94
87,512
203,507
(15,310
(27,155
260,640
Cumulative change in accounting principle
(1,353
Balance at January 1, 2023
202,154
259,287
8,979
Other comprehensive income
1,639
Share-based compensation - restricted shares and employee stock purchase plan
(426
634
Issuance of common stock under the employee stock purchase plan
1,005
27
Preferred stock dividends
(219
Cash dividends ($0.2275 per share)
(1,906
Treasury stock purchased
(56,394
(1,860
Balance at March 31, 2023
8,306,270
88,173
209,008
(13,671
(29,015
266,581
8,337
Other comprehensive loss
(206
45,280
1,071
1,072
1,044
28
(1,889
(37,129
(1,072
Balance at June 30, 2023
8,315,465
89,272
215,237
(13,877
(30,087
272,632
(702
643
1,134
32
(218
(1,892
(711
(23
Balance at September 30, 2023
8,315,186
89,947
223,068
(14,234
(30,110
280,758
Balance at December 31, 2023
8,314,778
8,848
1,541
6,940
665
913
31
Cash dividends ($0.25 per share)
(2,087
(16,058
(579
Balance at March 31, 2024
8,306,573
91,312
237,270
(12,176
(30,705
297,788
10,456
(768
6,494
624
949
(2,076
(19,427
(666
Balance at June 30, 2024
8,294,589
91,967
245,431
(12,944
(31,371
305,170
(145
649
830
34
(2,079
(257
(12
Balance at September 30, 2024
8,295,017
5
Operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes, net
565
(733
Depreciation, amortization and accretion, net
2,723
2,838
Share-based compensation
1,938
2,349
Net loss on disposal of fixed assets
10
73
Amortization of tax credit investments
3,888
2,882
Bank-owned life insurance policy income
(1,231
(1,106
Origination of loans for sale
(103,865
(115,925
Sale of loans originated for sale
101,285
116,160
Gain on sale of loans originated for sale
(1,004
(1,771
Net loss on repossessed assets
162
9
Return on investment in limited partnerships
1,481
3,542
Excess tax benefit expense from share-based compensation
172
185
Net payments on operating lease liabilities
(1,099
(1,061
Net decrease in accrued interest receivable and other assets
(10,465
(8,870
Net increase in accrued interest payable and other liabilities
5,003
7,474
Net cash provided by operating activities
35,527
38,958
Investing activities
Proceeds from maturities, redemptions, and paydowns of available-for-sale securities
60,688
16,536
Proceeds from maturities, redemptions, and paydowns of held-to-maturity securities
1,586
3,932
Proceeds from sale of available-for-sale securities
7,533
5,028
Purchases of available-for-sale securities
(79,066
(88,563
Proceeds from sale of repossessed assets
18
25
Net increase in loans and leases
(203,422
(321,570
Investments in limited partnerships
(1,200
Returns of investments in limited partnerships
22
Investment in tax credit investments
(13,417
(11,430
Distribution from tax credit investments
130
33
Proceeds from sale of tax credit
Investment in Federal Home Loan Bank stock
(20,555
(30,540
Proceeds from the sale of Federal Home Loan Bank stock
19,822
34,824
Purchases of leasehold improvements and equipment, net
(181
(2,574
Proceeds from sale of leasehold improvements and equipment
30
Net cash used in investing activities
(226,367
(395,398
Financing activities
Net increase in deposits
173,168
488,801
Repayment of Federal Home Loan Bank advances
(908,205
(1,536,255
Proceeds from Federal Home Loan Bank advances
921,155
1,434,375
Repayment of subordinated notes and debentures
(15,000
Proceeds from issuance of subordinated notes and debentures
20,000
15,000
Net increase (decrease) in long-term borrowed funds
243
(6,037
Cash dividends paid
(6,242
(5,687
Preferred stock dividends paid
(656
Proceeds from issuance of common stock under ESPP
96
87
Purchase of treasury stock
(1,257
(2,955
Net cash provided by financing activities
183,302
386,673
Net (decrease) increase in cash and cash equivalents
(7,538
30,233
Cash and cash equivalents at the beginning of the period
102,682
Cash and cash equivalents at the end of the period
132,915
Supplementary cash flow information
Cash paid during the period for:
Interest paid on deposits and borrowings
82,002
51,092
Net income taxes paid
853
5,022
Non-cash investing and financing activities:
Transfer of repossessed assets to loans
See accompany Notes to Unaudited Consolidated Financial Statements
Note 1 — Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
The accounting and reporting practices of First Business Financial Services, Inc. (“FBFS” or the “Corporation”), through our wholly-owned subsidiary, First Business Bank (“FBB” or the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB operates as a commercial banking institution primarily in Wisconsin and the greater Kansas City metropolitan area. The Bank provides a full range of financial services to businesses, business owners, executives, professionals, and high net worth individuals. FBB also offers bank consulting services to community financial institutions. The Bank is subject to competition from other financial institutions and service providers and is also subject to state and federal regulations. As of September 30, 2024, FBB had the following wholly-owned subsidiaries: First Business Specialty Finance, LLC (“FBSF”), First Madison Investment Corp. (“FMIC”), ABKC Real Estate, LLC (“ABKC”), FBB Real Estate 2, LLC (“FBB RE 2”), Mitchell Street Apartments Investment, LLC (“Mitchell Street”), and FBB Tax Credit Investment, LLC (“FBB Tax Credit”).
Basis of Presentation
The accompanying unaudited Consolidated Financial Statements were prepared in accordance with GAAP and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Corporation’s Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2023. The unaudited Consolidated Financial Statements include the accounts of the Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Management of the Corporation is required to make estimates and assumptions which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities and interest rate swaps, level of the allowance for credit losses, lease residuals, property under operating leases, goodwill, and income taxes. The results of operations for the three and nine months ended September 30, 2024, are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2024. Certain amounts in prior periods may have been reclassified to conform to the current presentation. Subsequent events have been evaluated through the date of the issuance of the unaudited Consolidated Financial Statements. No significant subsequent events have occurred through this date requiring adjustment to the financial statements or disclosures.
The Corporation has not changed its significant accounting and reporting policies from those disclosed in the Corporation’s Form 10-K for the year ended December 31, 2023.
Recent Accounting Pronouncements
In November 2023, the FASB issued ASU No. 2023-07, “Segment Reporting (Topic 820): Improvements to Reportable Segment Disclosures.” This update is intended to improve reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2024. The Corporation is one operating segment; therefore, we do not anticipate any material impact to the financial statements.
In December 2023, the FASB issued ASU No. 2023-09, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures.” This update enhances the transparency and decision usefulness of income tax disclosures by providing better information regarding exposure to potential changes in jurisdictional tax legislation and related forecasting and cash flow opportunities. This update is effective for fiscal years beginning after December 15, 2024. The Corporation is assessing the impact of the standard.
Note 2 — Earnings per Common Share
Earnings per common share are computed using the two-class method. Basic earnings per common share are computed by dividing net income allocated to common shares by the weighted-average number of shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends, or dividend equivalents, at the same rate as holders of the Corporation’s common stock. Diluted earnings per share are computed by dividing net income allocated to common shares adjusted for reallocation of undistributed earnings of unvested restricted shares by the weighted average number of shares determined for the basic earnings per common share computation plus the dilutive effect of common stock equivalents using the treasury stock method.
(Dollars in Thousands, ExceptShare Data)
Basic earnings per common share
Less: preferred stock dividends
Less: earnings allocated to participating securities
228
242
682
690
Basic earnings allocated to common shareholders
10,080
9,481
28,492
25,911
Weighted-average common shares outstanding, excluding participating securities
8,111,215
8,107,641
8,149,949
8,134,587
Diluted earnings per common share
Earnings allocated to common shareholders, diluted
Weighted-average diluted common shares outstanding, excluding participating securities
Note 3 — Share-Based Compensation
The Corporation initially adopted the 2019 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2019. The Plan is administered by the Compensation Committee of the Board of Directors (the “Board”) of the Corporation and provides for the grant of equity ownership opportunities through incentive stock options and nonqualified stock options, restricted stock, restricted stock units, dividend equivalent units, and any other type of award permitted by the Plan. As of September 30, 2024, 267,439 shares were available for future grants under the Plan, as amended. Shares covered by awards that expire, terminate, or lapse will again be available for the grant of awards under the Plan.
Restricted Stock
Under the Plan, the Corporation may grant restricted stock awards (“RSA”), restricted stock units (“RSU”), and other stock-based awards to plan participants, subject to forfeiture upon the occurrence of certain events until the dates specified in the participant’s
award agreement. While restricted stock is subject to forfeiture, RSA participants may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares. RSUs do not have voting rights. RSUs granted prior to 2023 are provided dividend equivalents concurrent with dividends paid to shareholders while RSUs granted in 2023 and after will accrue dividend equivalents payable upon vesting. The restricted stock granted under the Plan is typically subject to a vesting period. Compensation expense for restricted stock is recognized over the requisite service period of generally three or four years for the entire award on a straight-line basis. Upon vesting of restricted stock, the benefit of tax deductions in excess of recognized compensation expense is reflected as an income tax benefit in the unaudited Consolidated Statements of Income.
The Corporation may also issue performance-based restricted stock units (“PRSU”). Vesting of the PRSU will be measured on the relative Total Shareholder Return (“TSR”) and relative Return on Average Equity (“ROAE”) for issuances prior to 2023 or Return on Average Common Equity (“ROACE”) for issuances after 2022, and will cliff-vest after a three-year measurement period based on the Corporation’s TSR performance and ROAE or ROACE performance compared to a broad peer group of over 100 banks. At the end of the performance period, the number of actual shares to be awarded varies between 0% and 200% of target amounts. The restricted stock awards and units issued to executive officers will vest ratably over a three-year period. Compensation expense is recognized for PRSU over the requisite service and performance period of generally three years for the entire expected award on a straight-line basis. The compensation expense for the awards expected to vest for the percentage of performance-based restricted stock units subject to the ROAE or ROACE metric will be adjusted if there is a change in the expectation of ROAE or ROACE. The compensation expense for the awards expected to vest for the percentage of PRSU subject to the TSR metric are never adjusted and are amortized utilizing the accounting fair value provided using a Monte Carlo pricing model.
Restricted stock activity for the year ended December 31, 2023 and the nine months ended September 30, 2024 was as follows:
RSA
Weighted AverageGrant Price
PRSU
RSU
Nonvested balance as of December 31, 2022
133,317
$27.95
57,435
$32.89
6,105
$25.92
196,857
$29.32
Granted (1)
34,840
35.79
54,955
34.43
89,795
34.96
Vested
(56,931)
27.03
(36,120)
31.31
(3,253)
26.06
(96,304)
28.60
Forfeited
(4,435)
30.20
(820)
36.42
(5,255)
31.17
Nonvested balance as of December 31, 2023
71,951
28.53
56,155
35.70
56,987
33.97
185,093
32.38
27,614
34.76
64,747
30.13
92,361
31.52
(34,170)
26.93
(34,139)
25.43
(31,859)
20.76
(100,168)
24.46
(5,430)
30.35
(4,857)
36.28
(10,287)
33.15
Nonvested balance as of September 30, 2024
32,351
$29.92
49,630
$42.24
85,018
$35.87
166,999
$36.61
Unrecognized compensation cost (in thousands)
$577
$1,152
$2,433
$4,162
Weighted average remaining recognition period (in years)
1.07
1.64
2.50
2.11
Employee Stock Purchase Plan
The Corporation is authorized to issue up to 250,000 shares of common stock under the employee stock purchase plan ("ESPP"). The plan qualifies as an employee stock purchase plan under section 423 of the Internal Revenue Code of 1986. Under the ESPP, eligible employees may enroll in a three month offer period that begins January, April, July, and October of each year. Employees may elect to purchase a limited number of shares of the Corporation's common stock at 90% of the fair market value on the last day of the offering period. The ESPP is treated as a compensatory item for purposes of share-based compensation expense.
During the nine months ended September 30, 2024, the Corporation issued 2,692 shares of common stock under the ESPP. As of September 30, 2024, 227,946 shares remained available for issuance under the ESPP.
Share-based compensation expense related to restricted stock and ESPP included in the unaudited Consolidated Statements of Income was as follows:
Share-based compensation expense
Note 4 — Securities
The amortized cost and fair value of securities available-for-sale and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
As of September 30, 2024
Amortized Cost
GrossUnrealized Gains
GrossUnrealized Losses
Fair Value
Available-for-sale:
U.S. treasuries
4,987
(252
4,735
U.S. government agency securities - government-sponsored enterprises
8,500
(310
8,190
Municipal securities
40,099
(4,038
36,061
Residential mortgage-backed securities - government issued
107,364
1,385
(1,985
106,764
Residential mortgage-backed securities - government-sponsored enterprises
133,898
710
(8,255
126,353
Commercial mortgage-backed securities - government issued
2,718
(372
2,346
Commercial mortgage-backed securities - government-sponsored enterprises
32,212
72
(3,397
28,887
329,778
2,167
(18,609
As of December 31, 2023
14,158
(389
13,776
27,986
35
(455
27,566
40,407
(4,526
35,881
69,441
(2,385
68,056
131,321
281
(10,769
120,833
2,995
(470
2,525
32,774
65
(4,470
28,369
319,082
1,388
(23,464
The amortized cost and fair value of securities held-to-maturity and the corresponding amounts of gross unrecognized gains and losses were as follows:
GrossUnrecognized Gains
GrossUnrecognized Losses
Held-to-maturity:
3,140
(14
3,130
931
(46
885
833
(31
802
2,003
1,958
(136
6,775
4,210
(41
4,173
1,211
(76
1,135
1,078
(53
1,025
2,004
(82
1,922
8,255
U.S. Treasuries contain treasury bonds issued by the United States Treasury. U.S. government agency securities - government-sponsored enterprises represent securities issued by Federal National Mortgage Association (“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 the Government National Mortgage Association. Residential and commercial mortgage-backed securities - government-sponsored enterprises include securities guaranteed by the Federal Home Loan Mortgage Corporation, FNMA, and the FHLB. The Corporation sold no available-for-sale securities during the three months ended September 30, 2024 and 5 available-for-sale securities during the nine months ended September 30, 2024. The Corporation sold no available-for-sale securities during the three months ended September 30, 2023 and 16 available-for-sale securities during the nine months ended September 30, 2023.
At September 30, 2024 and December 31, 2023, securities with a fair value of $39.3 million and $45.4 million, respectively, were pledged to secure various obligations, including interest rate swap contracts and municipal deposits.
11
The amortized cost and fair value of securities by contractual maturity at September 30, 2024 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay certain obligations with or without call or prepayment penalties.
Available-for-Sale
Held-to-Maturity
Due in one year or less
3,501
3,463
738
735
Due in one year through five years
20,270
19,305
2,402
2,395
Due in five through ten years
8,855
8,220
Due in over ten years
20,960
17,998
53,586
48,986
Residential mortgage-backed securities
241,262
233,117
1,764
1,687
Commercial mortgage-backed securities
34,930
The tables below show the Corporation’s gross unrealized losses and fair value of available-for-sale investments aggregated by investment category and length of time that individual investments were in a continuous loss position at September 30, 2024 and December 31, 2023. At September 30, 2024, the Corporation held 160 available-for-sale securities that were in an unrealized loss position, 155 of which have been in a continuous unrealized loss position for twelve months or greater.
The Corporation has not specifically identified available-for-sale securities in a loss position that it intends to sell in the near term and does not believe that it will be required to sell any such securities. The Corporation reviews its securities on a quarterly basis to assess declines in fair value for credit losses. Consideration is given to such factors as the credit rating of the borrower, market conditions such as current interest rates, any adverse conditions specific to the security, and delinquency status on contractual payments. For the three and nine months ended September 30, 2024 and 2023, management concluded that in all instances securities with fair value less than carrying value was due to market factors; thus, no credit loss provision was required.
A summary of unrealized loss information for securities available-for-sale, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows:
Less than 12 Months
12 Months or Longer
UnrealizedLosses
252
U.S. government agency securities - government- sponsored enterprises
3,000
3,190
309
310
4,038
3,209
20
20,108
1,965
23,317
1,985
3,710
55
75,879
8,200
79,589
372
27,861
3,397
9,919
76
170,180
18,533
180,099
18,609
12
4,595
389
13,370
3,076
425
16,446
455
4,526
13,178
160
13,819
2,225
26,997
2,385
19,925
285
78,086
10,484
98,011
10,769
470
893
26,465
4,450
27,358
4,470
47,366
495
164,447
22,969
211,813
23,464
The tables below show the Corporation’s gross unrealized losses and fair value of held-to-maturity investments, aggregated by investment category and length of time that individual investments were in a continuous loss position at September 30, 2024 and December 31, 2023. At September 30, 2024, the Corporation held 21 held-to-maturity securities that were in an unrealized loss position, 21 of which have been in a continuous loss position for twelve months or greater. Management assesses held-to-maturity securities for credit losses on a quarterly basis. The assessment includes review of credit ratings, identification of delinquency and evaluation of market factors. Based on this analysis, management concludes the decline in fair value is due to market factors, specifically changes in interest rates. Accordingly, no credit loss provision was recorded in the unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2024 and 2023.
A summary of unrecognized loss information for securities held-to-maturity, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows:
UnrecognizedLosses
$—
$2,159
$14
46
$5,804
$136
13
$1,424
$4
$2,234
$37
$3,658
$41
53
82
$6,316
$248
$7,740
$252
Note 5 — Loans, Lease Receivables, and Allowance for Credit Losses
Loan and lease receivables consist of the following:
Commercial real estate:
Commercial real estate — owner occupied
259,532
256,479
Commercial real estate — non-owner occupied
768,195
773,494
Construction
266,762
193,080
Multi-family
494,954
450,529
1-4 family
39,933
26,289
Total commercial real estate
1,829,376
1,699,871
Commercial and industrial
1,174,295
1,105,835
Consumer and other
44,312
Total gross loans and leases receivable
3,050,281
2,850,018
Less:
Allowance for credit losses
33,688
31,275
Deferred loan fees and costs, net
202
(243
Loans and leases receivable, net
Loans transferred to third parties consist of the guaranteed portions of SBA loans which the Corporation sold in the secondary market and participation interests in other, non-SBA originated loans. The total principal amount of the guaranteed portions of SBA loans sold during the three months ended September 30, 2024 and 2023, was $4.6 million and $10.7 million, respectively. The total principal amount of the guaranteed portions of SBA loans sold during the nine months ended September 30, 2024 and 2023, was $10.3 million and $20.5 million, respectively. Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred during the three and nine months ended September 30, 2024 and 2023, have been derecognized in the unaudited Consolidated Financial Statements. The guaranteed portions of SBA loans were transferred at their fair value and the related gain was recognized upon the transfer as non-interest income in the unaudited Consolidated Financial Statements. The total outstanding balance of sold SBA loans serviced by the Corporation at September 30, 2024, and December 31, 2023, was $74.6 million and $84.2 million, respectively.
The total principal amount of transferred participation interests in other, non-SBA originated loans during the three months ended September 30, 2024 and 2023, was $31.4 million and $39.2 million, respectively, all of which were treated as sales and derecognized under the applicable accounting guidance at the time of transfer. The total principal amount of transferred participation interests in other, non-SBA originated loans during the nine months ended September 30, 2024 and 2023, was $90.0 million and $93.9 million, respectively, all of which were treated as sales and derecognized under the applicable accounting guidance at the time of transfer. No gain or loss was recognized on participation interests in other, non-SBA originated loans as they were transferred at or near the date of loan origination and the payments received for servicing the portion of the loans participated represents adequate compensation. The total amount of loan participation purchased on the Corporation's Consolidated Balance Sheet as of September 30, 2024 was $2.2 million. There were no loan participation purchased on the Corporation's Consolidated Balance Sheet as of December 31, 2023. The
14
total outstanding balance of these transferred loans serviced by the Corporation at September 30, 2024, and December 31, 2023, was $332.0 million and $279.5 million, respectively. As of September 30, 2024, and December 31, 2023, the total amount of the Corporation’s retained ownership of these transferred loans was $390.1 million and $367.4 million, respectively. As of September 30, 2024 and December 31, 2023, the non-SBA originated participation portfolio contained no non-accrual loans. The Corporation does not share in the participant’s portion of any potential charge-offs.
15
The following table illustrates ending balances of the Corporation’s loan and lease portfolio, including non-accrual loans by class of receivable, and considering certain credit quality indicators:
September 30, 2024
Term Loans Amortized Cost Basis by Origination Year
2022
2021
2020
Prior
RevolvingLoansAmortizedCost Basis
Category
I
9,514
38,462
45,346
37,126
42,580
83,902
1,747
258,677
II
III
855
IV
84,757
18,420
69,137
76,518
70,956
85,917
350,267
38,223
709,438
2,257
2,176
30,266
34,699
651
23,407
24,058
69,788
73,213
88,093
403,940
53,512
130,485
37,255
4,769
729
5,556
19,870
252,176
454
8,155
264
14,586
37,709
12,924
6,442
5,820
26,055
80,720
75,986
69,682
102,078
136,119
2,900
493,540
1,414
71,096
10,544
4,211
7,153
2,356
2,302
2,508
10,843
39,917
16
2,524
187,043
242,991
106,808
59,711
27,053
29,980
448,373
1,101,959
199
3,352
3,666
472
5,792
13,489
4,413
5,190
6,103
1,473
2,489
4,529
15,302
39,499
58
3,578
5,653
1,026
447
2,381
6,205
19,348
191,713
255,111
122,230
62,210
30,461
36,898
475,672
6,580
5,388
7,674
2,866
11,467
5,220
7,415
Total Loans
311,668
571,394
356,740
247,466
272,126
613,552
529,371
2,902,317
3,671
2,648
30,274
49,602
5,841
6,557
9,628
8,202
29,055
78,998
2,397
19,364
316,338
584,165
372,616
261,791
283,423
675,278
556,670
December 31, 2023
2019
31,637
43,156
38,803
44,704
22,078
72,774
451
253,603
260
2,616
44,964
75,390
71,857
76,689
72,660
78,212
66,262
314,970
32,478
713,128
2,252
19,838
16,274
40,666
19,700
74,962
80,464
86,100
350,944
63,660
83,161
8,542
744
433
6,528
15,011
178,079
9,289
5,712
15,001
17,831
6,456
84,932
41,068
70,054
113,294
22,925
115,243
3,013
4,242
7,684
2,672
2,359
443
2,805
6,062
26,267
2,827
302,612
144,167
85,504
38,164
20,151
26,490
415,301
1,032,389
1,496
5,280
785
353
219
5,706
13,933
1,093
7,168
1,882
5,919
3,861
3,957
15,058
38,938
1,482
6,519
1,319
321
133
1,644
9,157
20,575
306,683
163,134
89,490
44,757
24,239
32,310
445,222
5,920
8,786
3,167
12,193
2,049
3,485
8,712
564,860
404,711
281,402
289,670
134,341
542,295
481,028
2,698,307
12,376
8,577
19,932
16,493
69,860
26,273
61,254
1,666
20,597
568,931
423,678
296,979
304,487
158,267
586,727
510,949
17
Each credit is evaluated for proper risk rating upon origination, at the time of each subsequent renewal, upon receipt and evaluation of updated financial information from the Corporation’s borrowers, or as other circumstances dictate. The Corporation primarily uses a nine grade risk rating system to monitor the ongoing credit quality of its loans and leases. The risk rating grades follow a consistent definition and are then applied to specific loan types based on the nature of the loan. Each risk rating is determined based on various quantitative and qualitative factors and is subject to various levels of review and concurrence on the stated risk rating. In addition to its nine grade risk rating system, the Corporation groups loans into four loan and related risk categories which determine the level and nature of review by management.
Category I — Loans and leases in this category are performing in accordance with the terms of the contract and generally exhibit no immediate concerns regarding the security and viability of the underlying collateral, financial stability of the borrower, integrity or strength of the borrowers’ management team, or the industry in which the borrower operates. The Corporation monitors Category I loans and leases through payment performance, continued maintenance of its personal relationships with such borrowers, and continued review of such borrowers’ compliance with the terms of their respective agreements.
Category II — Loans and leases in this category are beginning to show signs of deterioration in one or more of the Corporation’s core underwriting criteria such as financial stability, management strength, industry trends, or collateral values. Management will place credits in this category to allow for proactive monitoring and resolution with the borrower to possibly mitigate the area of concern and prevent further deterioration or risk of loss to the Corporation. Category II loans are considered performing but are monitored frequently by the assigned business development officer and by asset quality review committees.
Category III — Loans and leases in this category are identified by management as warranting special attention. However, the balance in this category is not intended to represent the amount of adversely classified assets held by the Bank. Category III loans and leases generally exhibit undesirable characteristics, such as evidence of adverse financial trends and conditions, managerial problems, deteriorating economic conditions within the related industry, or evidence of adverse public filings and may exhibit collateral shortfall positions. Management continues to believe that it will collect all contractual principal and interest in accordance with the original terms of the contracts relating to the loans and leases in this category, and therefore Category III loans are considered performing with no specific reserves established for this category. Category III loans are monitored by management and asset quality review committees on a monthly basis.
Category IV — Loans and leases in this category are non-accrual loans. Management has determined that it is unlikely that the Bank will receive the contractual principal and interest in accordance with the original terms of the agreement. Non-accrual loans are individually evaluated to assess the need for the establishment of specific reserves or charge-offs. When analyzing the adequacy of collateral, the Corporation obtains external appraisals at least annually. External appraisals are obtained from the Corporation’s approved appraiser listing and are independently reviewed to monitor the quality of such appraisals. To the extent a collateral shortfall position is present, a specific reserve or charge-off will be recorded. Loans and leases in this category are monitored by management and asset quality review committees on a monthly basis.
The delinquency aging of the loan and lease portfolio by class of receivable was as follows:
30-59Days PastDue
60-89Days PastDue
GreaterThan 90Days PastDue
Total PastDue
Current
TotalLoans andLeases
(Dollars in Thousands)
Total loans and leases
Owner occupied
Non-owner occupied
375
767,820
1,555
2,835
17,497
21,887
1,152,408
1,930
22,262
3,028,019
Percent of portfolio
0.06
%
0.09
0.57
0.73
99.27
100.00
3,430
1,041
18,347
22,818
1,083,017
2,827,200
0.12
0.04
0.64
0.80
99.20
The following tables provide additional detail on loans on non-accrual status and loans past due over 89 days still accruing as of:
Non-accrualWith NoAllowance forCredit Loss
Non-accrualWith Allowancefor Credit Loss
Loans Past DueOver 89 DaysStill Accruing
8,009
11,339
Total non-accrual loans and leases
8,025
9,691
10,884
10,906
Total non-accrual loans and leases to gross loans and leases
0.63
0.72
Allowance for credit losses to gross loans and leases
1.16
Allowance for credit losses to non-accrual loans and leases
183.38
160.21
19
The following table presents the amortized cost basis of the non-accrual, collateral-dependent commercial and industrial loans as of:
Inventory
75
8,879
10,128
8,903
Real Estate
132
Accounts Receivable
6,179
278
Other
1,021
1,348
17,535
19,454
Occasionally, the Corporation modifies loans to borrowers in financial distress by providing principal forgiveness, term extension, an other-than-insignificant payment delay or interest rate reduction. When principal forgiveness is provided, the amount of forgiveness is charged-off against the allowance for credit losses.
The following table presents the amortized cost basis of loans at September 30, 2024 that were both experiencing financial difficulty and modified during the nine months ended September 30, 2024 and 2023, by class and by type of modification. The percentage of the amortized cost basis of loans that were modified to borrowers in financial distress as compared to the amortized costs basis of each class of financing receivable is also presented below.
For the Nine Months Ended September 30, 2024
Principal Forgiveness
Payment Delay
Term Extension
Interest Rate Reduction
Total Class of Financing Receivable
Commercial real estate
5,901
0.32
1,847
477
2,324
0.20
7,748
8,225
0.27
For the Nine Months Ended September 30, 2023
0.00
716
0.07
0.03
The Corporation closely monitors the performance of loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. The following table presents the performance of such loans that have been modified in the last 12 months:
360
50
410
The following table presents the financial effect of the loan modifications presented above to borrowers experiencing financial difficulty for the nine months ended September 30, 2024 and 2023:
Weighted Average Interest Rate Reduction
Weighted Average Term Extension (years)
Weighted Average Payment Delay (years)
1.01
0.67
1.42
0.50
The following table presents the amortized cost basis of loans that had a payment default during the nine months ended September 30, 2024 and 2023 and were modified in the 12 months prior to that default to borrowers experience financial difficulty:
753
Allowance for Credit Losses
The ACL is an estimate of the expected credit losses on financial assets measured at amortized cost, which is measured using relevant information about past events, including historical credit loss experience on financial assets with similar risk characteristics, current conditions, and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual term of the financial assets. A provision for credit losses is charged to operations based on management’s periodic evaluation of these and other pertinent factors as discussed within Note 1 – Nature of Operations and Summary of Significant Accounting Policies included in the Corporation’s Form 10-K for the year ended December 31, 2023.
Quantitative Considerations
21
The ACL is primarily calculated utilizing a Discounted Cash Flow (“DCF”) model. Key inputs and assumptions used in this model are discussed below:
Qualitative Considerations
In addition to the quantitative model, management considers the need for qualitative adjustment for risks not considered in the DCF. Factors that are considered by management in determining loan collectability and the appropriate level of the ACL are listed below:
ACL Activity
A summary of the activity in the allowance for credit losses by portfolio segment is as follows:
As of and for the Three Months Ended September 30, 2024
OwnerOccupied
Non-OwnerOccupied
Multi-Family
1-4 Family
CommercialandIndustrial
Consumerand Other
Beginning balance
1,531
6,415
3,045
3,752
461
19,280
466
34,950
Charge-offs
(1,619
Recoveries
84
91
Net recoveries (charge-offs)
(1,535
(1,528
70
(325
483
(17
1,911
(47
Ending balance
1,602
6,090
3,528
3,735
479
19,656
419
35,509
Components:
Allowance for credit losses on loans
1,588
6,048
2,518
439
19,010
Allowance for credit losses on unfunded credit commitments
42
1,010
40
646
44
1,821
Total ACL
As of and for the Three Months Ended September 30, 2023
1,721
5,241
2,293
3,426
249
16,223
544
29,697
(562
(490
(478
(151
26
68
(10
1,833
1,573
5,267
2,361
3,522
248
17,566
499
31,036
1,556
5,209
1,441
3,512
16,946
29,331
620
1,705
As of and for the Nine Months Ended September 30, 2024
1,540
5,636
2,125
3,571
266
19,408
32,997
(4,101
(22
(4,123
121
365
509
(3,736
(1
(3,614
1,403
164
92
3,984
As of and for the Nine Months Ended September 30, 2023
1,766
5,108
1,646
2,634
207
12,403
24,230
Impact of adopting ASC 326
(204
(242
796
(386
1,873
1,818
(1,057
386
435
(671
(622
400
(81
1,274
3,961
(6
23
ACL Summary
Loans collectively evaluated for credit losses in the following tables include all performing loans at September 30, 2024 and December 31, 2023. Loans individually evaluated for credit losses include all non-accrual loans.
The following tables provide information regarding the allowance for credit losses and balances by type of allowance methodology.
Allowance for credit losses:
Collectively evaluated for credit losses
12,671
27,349
Individually evaluated for credit loss
6,339
Loans and lease receivables:
1,154,947
3,030,917
1,525
5,596
1,244
3,562
221
12,743
395
25,286
5,967
5,989
18,710
1,085,260
2,829,421
Note 6 — Leases
The Corporation leases various office spaces and specialized lending production offices under non-cancellable operating leases which expire on various dates through 2033. The Corporation also leases office equipment. The Corporation recognizes a right-of-use asset and an operating lease liability for all leases, with the exception of short-term leases. Right-of-use assets represent the right to use an underlying asset for the lease term and lease liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. Lease expense for operating leases and short-term leases is recognized on a straight-line basis over the lease term.
The components of total lease expense were as follows:
Operating lease cost
338
1,028
1,088
Short-term lease cost
106
145
Variable lease cost
143
139
430
436
Less: sublease income
(75
Total lease cost, net
507
513
1,564
1,594
24
Quantitative information regarding the Corporation’s operating leases was as follows:
Weighted-average remaining lease term (in years)
7.20
7.70
Weighted-average discount rate
3.78
3.61
The following maturity analysis shows the undiscounted cash flows due on the Corporation’s operating lease liabilities:
367
2025
1,408
2026
1,400
2027
1,427
2028
1,113
Thereafter
3,600
Total undiscounted cash flows
9,315
Discount on cash flows
(1,261
Total lease liability
Note 7 — Other Assets
A summary of accrued interest receivable and other assets was as follows:
Accrued interest receivable
12,906
13,275
Net deferred tax asset
9,641
9,508
Investment in historic development entities
4,866
2,393
Investment in low-income housing development entities
41,059
33,303
Investment in limited partnerships
16,465
15,027
Prepaid expenses
5,425
4,269
Other assets
13,345
13,283
Total accrued interest receivable and other assets
For the nine months ended September 30, 2024 and 2023, the Corporation amortized tax credit investments of $3.9 million and $2.9 million respectively, and recognized tax credits and other benefits for the nine months ended September 30, 2024 and 2023 of $5.0 million and $4.0 million, respectively, within the income tax expense line on the unaudited Consolidated Statements of Income.
Note 8 — Deposits
The composition of deposits is shown below. Average balances represent year-to-date averages.
Balance
AverageBalance
Average Rate
Non-interest-bearing transaction accounts
428,012
440,182
445,376
453,930
Interest-bearing transaction accounts
930,252
869,511
3.93
895,319
689,500
3.44
Money market accounts
817,129
809,593
4.05
711,245
681,336
3.25
Certificates of deposit
207,337
246,267
4.65
287,131
273,387
4.10
Wholesale deposits
587,217
488,543
4.08
457,708
346,285
4.14
Total deposits
2,854,096
3.45
2,444,438
2.92
A summary of annual maturities of core and wholesale certificates of deposit at September 30, 2024 is as follows:
Maturities during the year ended December 31,
431,326
92,189
57,587
73,517
12,821
7,072
674,512
Wholesale deposits include $467.2 million and $120.0 million of wholesale certificates of deposit and non-reciprocal interest-bearing transaction accounts, respectively, at September 30, 2024, compared to $407.7 million and $50.0 million of wholesale certificates of deposit and non-reciprocal interest-bearing transaction accounts, respectively, at December 31, 2023. The Corporation has entered into derivative contracts hedging a portion of the certificates of deposit included in the 2024 maturities above. As of September 30, 2024, the notional amount of derivatives designated as cash flow hedges totaled $431.3 million with a weighted average remaining maturity of 3.77 years and a weighted average rate of 3.83%.
Certificates of deposit and wholesale deposits denominated in amounts greater than $250,000 were $85.9 million at September 30, 2024 and $120.2 million at December 31, 2023.
Note 9 — FHLB Advances, Other Borrowings and Subordinated Notes and Debentures
The composition of borrowed funds is shown below. Average balances represent year-to-date averages.
WeightedAverageBalance
WeightedAverageRate
Federal funds purchased
6.31
5.37
FHLB advances
294,450
286,454
2.68
281,500
351,990
2.52
Line of credit
1,642
7.76
38
7.26
Other borrowings
600
8.33
Subordinated notes and debentures
54,659
48,208
6.37
49,396
38,250
5.16
336,316
3.23
390,881
2.79
A summary of annual maturities of borrowings at September 30, 2024 is as follows:
116,000
48,000
65,000
10,000
10,450
99,659
As of September 30, 2024, the Corporation has no other borrowings. As of December 31, 2023, the Corporation had other borrowings of $20,000, which consisted of sold tax credit investments accounted for as secured borrowings because they did not qualify for true sale accounting. The Corporation has entered into derivative contracts hedging a portion of the borrowings included in the 2024 maturities above. As of September 30, 2024, the notional amount of derivatives designated as cash flow hedges totaled $68.4 million with a weighted average remaining maturity of 2.55 years and a weighted average rate of 1.98%.
As of September 30, 2024 and December 31, 2023, the Corporation was in compliance with its debt covenants under its third-party secured senior line of credit. On February 20, 2024, the credit line was renewed for one additional year with pricing terms of 1-month term SOFR + 2.36% and a maturity date of February 19, 2025.
The Corporation issued new subordinated notes payable as of September 13, 2024. The aggregate principal amount of the newly issued subordinated notes payable was $20.0 million which qualified as Tier 2 capital. The subordinated notes payable bear a fixed interest rate of 7.5% with a maturity date of September 13, 2034. The Corporation may, at its option, redeem the notes payable, in whole or part, at anytime after the fifth anniversary of the issuance. As of August 15, 2024, the $15.0 million subordinated notes payable that bore a fixed interest rate of 5.5% were redeemed, and the remaining unamortized debt issuance cost was accelerated due to the early redemption. As of September 30, 2024, $341,000 of debt issuance costs remain in the subordinated note and debentures payable balance, of which $56,000 is related to the recently issued subordinated debentures.
Note 10 — Preferred Stock
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 Corporation expects to pay dividends on the Series A Preferred Stock when and if declared by the 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 three and nine months ended September 30, 2024, the Board of Directors declared an aggregate preferred stock dividend of $218,000 and $656,000, respectively. 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.
Note 11 — Commitments and Contingencies
In the normal course of business, various legal proceedings involving the Corporation are pending. Management, based upon advice from legal counsel, does not anticipate any significant losses as a result of these actions. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations, and cash flows.
The Corporation sells the guaranteed portions of SBA 7(a) and 504 loans, as well as participation interests in other, non-SBA originated, loans to third parties. The Corporation has a continuing involvement in each of the transferred lending arrangements by way of relationship management and servicing the loans, as well as being subject to normal and customary requirements of the SBA loan program and standard representations and warranties related to sold amounts. In the event of a loss resulting from default and a determination by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Corporation, the SBA may require the Corporation to repurchase the loan, deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from the Corporation. The Corporation must comply with applicable SBA regulations in order to maintain the guaranty. In addition, the Corporation retains the option to repurchase the sold guaranteed portion of an SBA loan if the loan defaults.
Management has assessed estimated losses inherent in the outstanding guaranteed portions of SBA loans sold in accordance with ASC 450, Contingencies, and determined a recourse reserve based on the probability of future losses for these loans to be $1.3 million at September 30, 2024, which is reported in accrued interest payable and other liabilities on the unaudited Consolidated Balance Sheets.
The summary of the activity in the SBA recourse reserve is as follows:
As of and for the Three MonthsEnded September 30,
As of and for the Nine Months Ended September 30,
Balance at the beginning of the period
906
752
955
441
SBA recourse
583
Charge-offs, net
(40
(11
Balance at the end of the period
1,332
983
Note 12 — Fair Value Disclosures
The Corporation determines the fair values of its financial instruments based on the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is defined as the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date and is based on exit prices. Fair value includes assumptions about risk, such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. The standard describes three levels of inputs that may be used to measure fair value.
Level 1 — Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date.
Level 2 — Level 2 inputs are inputs, other than quoted prices included with Level 1, that are observable for the asset or liability either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 — Level 3 inputs are supported by little or no market activity and are significant to the fair value of the assets or liabilities.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy level, are summarized below:
Fair Value Measurements Using
Level 1
Level 2
Level 3
Assets:
Residential mortgage-backed securities - government- sponsored enterprises
Commercial mortgage-backed securities - government- sponsored enterprises
Interest rate swaps
Liabilities:
For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the three and nine months ended September 30, 2024 or the year ended December 31, 2023 related to the above measurements.
Assets and liabilities measured at fair value on a non-recurring basis, segregated by fair value hierarchy are summarized below:
Collateral-dependent loans
6,201
Loan servicing rights
1,167
4,917
1,356
Collateral-dependent loans were written down to the fair value of their underlying collateral less costs to sell of $6.2 million and $4.9 million at September 30, 2024 and December 31, 2023, respectively, through the establishment of specific reserves or by recording charge-offs when the carrying value exceeded the fair value of the underlying collateral of individually evaluated loans. Valuation techniques consistent with the market approach, income approach, or cost approach were used to measure fair value. These techniques included observable inputs for the collateral dependent loans being evaluated, such as current appraisals, recent sales of similar assets, or other observable market data, and unobservable inputs, typically when discounts are applied to appraisal values to adjust such values to current market conditions or to reflect net realizable values. The quantification of unobservable inputs for Level 3 individually evaluated loan values range from 10% - 100% as of the measurement date of September 30, 2024. The weighted average of those unobservable inputs was 42%. The majority of the individually evaluated loans are considered collateral dependent loans or are supported by an SBA guaranty.
Repossessed assets are measured and reported at fair value through a charge-off to the allowance for credit losses, if deemed necessary. The fair value of a repossessed asset, upon initial recognition, is estimated using a market approach or based on observable market data, such as a current appraisal, recent sale price of similar assets, or based upon assumptions specific to the individual property or equipment, such as management applied discounts used to further reduce values to a net realizable value when observable inputs become stale.
29
Loan servicing rights represent the asset retained upon sale of the guaranteed portion of certain SBA loans. When SBA loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The servicing rights are subsequently measured using the amortization method, which requires amortization into interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.
The Corporation periodically reviews this portfolio for impairment and engages a third-party valuation firm to assess the fair value of the overall servicing rights portfolio. Loan servicing rights do not trade in an active, open market with readily observable prices. While sales of loan servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Corporation utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its loan servicing rights. The valuation model incorporates prepayment assumptions to project loan servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the loan servicing rights. The valuation model considers portfolio characteristics of the underlying serviced portion of the SBA loans and uses the following significant unobservable inputs: (1) constant prepayment rate (“CPR”) assumptions based on the SBA sold pools historical CPR as quoted in Bloomberg and (2) a discount rate. Due to the nature of the valuation inputs, loan servicing rights are classified in Level 3 of the fair value hierarchy.
Fair Value of Financial Instruments
The Corporation is required to disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions, consistent with exit price concepts for fair value measurements, are set forth below:
CarryingAmount
Financial assets:
Securities available-for-sale
Securities held-to-maturity
8,827
Loans and lease receivables, net
2,998,254
Federal Home Loan Bank stock
N/A
Financial liabilities:
2,966,694
2,295,436
671,258
344,004
Accrued interest payable
10,820
Off-balance sheet items:
Standby letters of credit
216
N/A = The fair value is not applicable due to restrictions placed on transferability
4,956
2,789,731
2,795,463
2,101,939
693,524
320,287
10,860
190
Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the unaudited Consolidated Balance Sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Corporation.
Securities: The fair value measurements of investment securities are determined by a third-party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information, and the securities’ terms and conditions, among other things. The fair value measurements are subject to independent verification by another pricing source on a quarterly basis to review for reasonableness. Any significant differences in pricing are reviewed with appropriate members of management who have the relevant technical expertise to assess the results. The Corporation has determined that these valuations are classified in Level 2 of the fair value hierarchy. When the independent pricing service does not provide a fair value measurement for a particular security, the Corporation will estimate the fair value based on specific information about each security. Fair values derived in this manner are classified in Level 3 of the fair value hierarchy.
Loans Held for Sale: Loans held for sale, which consist of the guaranteed portions of SBA 7(a) loans, are carried at the lower of cost or estimated fair value. The estimated fair value is based on what secondary markets are currently offering for portfolios with similar characteristics.
Derivatives: The carrying amount and fair value of existing derivative financial instruments are based upon independent valuation models, which use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative contract. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Corporation considers the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Limitations: Fair value estimates are made at a discrete point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the
Corporation’s entire holding of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and are not considered in the estimates.
Note 13 — Derivative Financial Instruments
The Corporation offers interest rate swap products directly to qualified commercial borrowers. The Corporation economically hedges client derivative transactions by entering into offsetting interest rate swap contracts executed with a third party. Derivative transactions executed as part of this program are not considered hedging instruments and are marked-to-market through earnings each period. The derivative contracts have mirror-image terms, which results in the positions’ changes in fair value offsetting through earnings each period. The credit risk and risk of non-performance embedded in the fair value calculations is different between the dealer counterparties and the commercial borrowers which may result in a difference in the changes in the fair value of the mirror-image swaps. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the counterparty’s risk in the fair value measurements. When evaluating the fair value of its derivative contracts for the effects of non-performance and credit risk, the Corporation considered the impact of netting and any applicable credit enhancements such as collateral postings, thresholds, and guarantees. As of September 30, 2024 and December 31, 2023, the credit valuation allowance was $38,000 and $117,000, respectively.
The Corporation receives fixed rates and pays floating rates based upon designated benchmark interest rates used on the swaps with commercial borrowers. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. The Corporation pays fixed rates and receives floating rates based upon designated benchmark interest rates used on the swaps with dealer counterparties. Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported on the unaudited Consolidated Balance Sheet. The gross amount of dealer counterparty swaps, without regard to the enforceable master netting agreement, was a gross derivative asset of $39.8 million and gross derivative liability of $11.4 million as of September 30, 2024.
All changes in fair value of these instruments are recorded in other non-interest income. Given the mirror-image terms of the outstanding derivative portfolio, the change in fair value for the three and nine months ended September 30, 2024 and 2023 had an insignificant impact on the unaudited Consolidated Statements of Income.
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 related to cash outflows attributable to future wholesale deposit or short-term FHLB advance borrowings. 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 affect earnings. A pre-tax unrealized loss of $11.6 million and $6.5 million was recognized in other comprehensive income for the three and nine months ended September 30, 2024, respectively, and there were no ineffective portions of the hedges. A pre-tax unrealized gain of $5.3 million and $7.5 million was recognized in other comprehensive income for the three and nine months ended September 30, 2023, respectively, and there were no ineffective portions of the hedges.
The Corporation also enters into interest rate swaps to mitigate market value volatility on certain long-term fixed 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 affect earnings. A pre-tax unrealized loss of $246,000 and $24,000 was recognized in other comprehensive income for the three and nine months ended September 30, 2024, respectively, and there was no ineffective portion of these hedges. A pre-tax unrealized gain of $421,000 and $353,000 was recognized in other comprehensive income for the three and nine months ended September 30, 2023, respectively, and there was no ineffective portion of these hedges.
Number ofInstruments
NotionalAmount
WeightedAverageMaturity(In Years)
FairValue
Included in Derivative assets
Derivatives not designated as hedging instruments
Interest rate swap agreements on loans with commercial loan clients
377,041
5.12
11,352
Interest rate swap agreements on loans with third-party counterparties
975,845
5.49
28,444
Derivatives designated as hedging instruments
Interest rate swap related to AFS securities
12,500
7.53
601
Interest rate swap related to wholesale funding
68,400
2.55
2,142
Included in Derivative liabilities
598,803
5.73
39,796
41
431,255
3.77
5,603
249,454
6.33
7,904
Interest rate swap agreements on loans with third-party counter parties
939,156
6.06
43,234
8.28
96,400
2.47
3,835
81
689,702
5.96
51,138
306,255
3.89
811
Note 14 — Regulatory Capital
The Corporation and the Bank are subject to various regulatory capital requirements administered by Federal and Wisconsin banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions on the part of regulators, that if undertaken, could have a direct material effect on the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory practices. The Corporation’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Corporation regularly reviews and updates, when appropriate, its capital and liquidity action plans, which is designed to help ensure appropriate capital adequacy, to plan for future capital needs, and to ensure that the Corporation serves as a source of financial strength to the Bank. The
Corporation’s and the Bank’s Board and management teams adhere to the appropriate regulatory guidelines on decisions which affect their respective capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.
As a bank holding company, the Corporation’s ability to pay dividends is affected by the policies and enforcement powers of the Board of Governors of the Federal Reserve system (the “Federal Reserve”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring, or significantly reducing dividends if: (i) net income available to common shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividend; (ii) the prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios. Management intends, when appropriate under regulatory guidelines, to consult with the Federal Reserve Bank (“FRB”) of Chicago and provide it with information on the Corporation’s then-current and prospective earnings and capital position in advance of declaring any cash dividends. As a Wisconsin corporation, the Corporation is subject to the limitations of the Wisconsin Business Corporation Law, which prohibit the Corporation from paying dividends if such payment would: (i) render the Corporation unable to pay its debts as they become due in the usual course of business, or (ii) result in the Corporation’s assets being less than the sum of its total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of any shareholders with preferential rights superior to those shareholders receiving the dividend.
The Bank is also subject to certain legal, regulatory, and other restrictions on their ability to pay dividends to the Corporation. As a bank holding company, the payment of dividends by the Bank to the Corporation is one of the sources of funds the Corporation could use to pay dividends, if any, in the future and to make other payments. Future dividend decisions by the Bank and the Corporation will continue to be subject to compliance with various legal, regulatory, and other restrictions as defined from time to time.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of Total Common Equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to adjusted total assets. These risk-based capital requirements presently address credit risk related to both recorded and off-balance sheet commitments and obligations.
As of September 30, 2024, the Corporation’s capital levels exceeded the regulatory minimums and the Bank’s capital levels remained characterized as well capitalized under the regulatory framework. The following tables summarize both the Corporation’s and the Bank’s capital ratios and the ratios required by their federal regulators:
Actual (1)
Minimum Requiredfor CapitalAdequacy Purposes
For CapitalAdequacy PurposesPlus CapitalConservation Buffer
Minimum Requiredto Be WellCapitalized UnderPrompt CorrectiveAction Requirements
Amount
Ratio
Total capital (to risk-weighted assets)
Consolidated
407,421
11.72
278,219
8.00
365,162
10.50
First Business Bank
402,567
11.57
278,257
365,212
347,821
10.00
Tier 1 capital (to risk-weighted assets)
316,792
9.11
208,664
6.00
295,607
8.50
366,597
10.54
208,692
295,648
Common equity tier 1 capital (to risk-weighted assets)
304,800
8.76
156,498
4.50
243,441
7.00
156,519
243,474
226,083
6.50
Tier 1 leverage capital (to adjusted assets)
8.68
145,944
4.00
10.05
145,914
182,393
5.00
375,440
11.19
268,500
352,406
376,310
11.21
268,595
352,531
335,744
293,338
8.74
201,375
285,281
343,604
10.23
201,446
285,382
281,346
8.38
151,031
234,937
151,085
235,021
218,233
8.43
139,145
9.87
139,262
174,077
General
Unless otherwise indicated or unless the context requires otherwise, all references in this Report to the “Corporation,” “we,” “us,” “our,” or similar references mean First Business Financial Services, Inc. together with our subsidiary. “FBB” or the “Bank” refers to our subsidiary, First Business Bank.
Forward-Looking Statements
This report may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect our current views with respect to future events and financial performance. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results, or other developments. Forward-looking statements are based on management’s expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Such statements are subject to risks and uncertainties, including among other things:
These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our shareholders and potential investors. See Part I, Item 1A — Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2023, and in this report, below, for discussion relating to risk factors impacting us. Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. These factors could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods.
Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that, while our management believes such assumptions or bases are reasonable and are made in good faith, assumed facts or bases can vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, an expectation or belief is expressed as to future
results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements.
The following discussion and analysis is intended as a review of significant events and factors affecting our financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with the unaudited Consolidated Financial Statements and the Notes thereto presented in this Form 10-Q.
Overview
We are a registered bank holding company incorporated under the laws of the State of Wisconsin and are engaged in the commercial banking business through our wholly-owned banking subsidiary, FBB. All of our operations are conducted through FBB and First Business Specialty Finance, LLC (“FBSF”), a wholly-owned subsidiary of FBB. We operate as a business bank focusing on delivering a full line of commercial banking products and services tailored to meet the specific needs of small and medium-sized businesses, business owners, executives, professionals, and high net worth individuals. Our products and services include those for business banking, private wealth, and bank consulting. Within business banking, we offer commercial lending, asset-based lending, accounts receivable financing, equipment financing, floorplan financing, vendor financing, SBA lending and servicing, treasury management services, and company retirement plans. Our private wealth 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.
Financial Performance Summary
Results as of and for the three and nine months ended September 30, 2024 include:
37
Results of Operations
Top Line Revenue
Top line revenue, comprised of net interest income and non-interest income, increased $1.0 million, or 2.8%, for the three months ended September 30, 2024, compared to the same period in 2023, due to a 8.4% increase in net interest income, partially offset by a 16.2% decrease in non-interest income. The increase in net interest income primarily reflects an increase in average gross loans and leases and an increase in fees in lieu of interest, partially offset by net interest margin compression. The decrease in non-interest income was due to decreases in returns on investments in Small Business Investment Company ("SBIC") mezzanine funds, commercial loan swap fee income, and gains on the sale of SBA loans.
Top line revenue increased $5.0 million, or 4.7%, for the nine months ended September 30, 2024, compared to the same period in 2023, due to a 9.6% increase in net interest income partially offset by a 12.3% decrease in non-interest income. The increase in net interest income was driven by an increase in average loans and leases outstanding. The decrease in non-interest income was due to decreases in returns on investments in SBIC mezzanine funds, commercial loan swap fee income, and gains on the sale of SBA loans; partially offset by increases in Private wealth fee income.
The components of top line revenue were as follows:
$ Change
% Change
2,411
8.4
8,010
9.6
(1,366
(16.2
(2,968
(12.3
Top line revenue
38,071
37,026
2.8
112,305
107,263
5,042
4.7
Annualized Return on Average Assets (“ROAA”) and Annualized Return on Average Common Equity (“ROACE”)
ROAA for the three and nine months ended September 30, 2024 was 1.13% and 1.08%, respectively, compared to 1.19% and 1.13% for the three and nine months ended September 30, 2023. The decrease in ROAA for the three and the nine months ended was due to the decrease in non-interest income, partially offset by an increase in net interest income and decrease in the effective tax rate. We consider ROAA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures.
ROACE for the three and nine months ended September 30, 2024 was 13.8% and 13.4% respectively, compared to 14.6% and 13.7% for the three and nine months ended September 30, 2023. The reasons for the change in ROACE are consistent with the net income variance explanation as discussed under ROAA 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 59.4% and 62.0% for the three and nine months ended September 30, 2024, compared to 62.0% and 61.9% for the three and nine months ended September 30, 2023, respectively. For the three month period comparison, the percentage increase in top line revenue exceeded the percentage increase in operating expenses, resulting in positive quarterly operating leverage. Revenue increased for the reasons stated above in the Top Line Revenue section, while operating expenses remained relatively consistent in the periods of comparison. For the nine month period comparison, the efficiency ratio was relatively consistent as revenue and expenses grew commensurately. Efficiency ratio is a non-GAAP measure representing operating expense, which is non-interest expense excluding the effects of the SBA recourse benefit or provision, net gains or losses on repossessed assets, amortization of other intangible assets, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized net gains or losses on securities, if any.
39
PTPP adjusted earnings for three and nine months ended September 30, 2024 were $15.4 million and $42.7 million, respectively, compared to $14.1 million and $40.9 million for the three and nine months ended September 30, 2023, respectively. PTPP adjusted earnings is defined as operating revenue less operating expense. The increase in PTPP adjusted earnings for both periods was primarily driven by an increase in net interest income partially offset by a decrease in non-interest income. 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 provision for credit losses and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA 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.
$23,107
$23,189
$(82)
(0.4)%
$70,329
$66,987
$3,342
5.0%
Net (gain) loss on repossessed assets
NM
154
SBA recourse provision
224
Total operating expense (a)
$22,630
$22,943
$(313)
(1.4)
$69,584
$66,414
$3,170
4.8
$31,007
$28,596
$2,411
$91,059
$83,049
$8,010
(1,366)
(16.2)
(2,968)
(12.3)
(8)
(45)
Adjusted non-interest income
21,254
24,259
(3,005)
(12.4)
Operating revenue (b)
$38,071
$37,026
$1,045
$112,313
$107,308
$5,005
Efficiency ratio
59.44%
61.96%
61.89%
Pre-tax, pre-provision adjusted earnings (b-a)
$15,441
$14,083
$1,358
$42,729
$40,894
$1,835
4.5
Average total assets
$3,636,887
$3,276,240
$360,647
11.0
$3,585,868
$3,130,426
$455,442
14.5
Pre-tax, pre-provision adjusted return on average assets
1.70%
1.72%
1.59%
1.74%
The Corporation's atypically high net interest margin in 2023 creates a temporary, positive operating leverage headwind as net interest margin returns to normalized levels in 2024. We believe the Corporation will generate positive operating leverage on an annual basis and progress towards enhancing the long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth, process improvement, and automation.
Net Interest Income
Net interest income levels depend on the amount of and yield on interest-earning assets as compared to the amount of and rate paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes.
The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three and nine months ended September 30, 2024 compared to the same period in 2023. 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.
Increase (Decrease) for the Three MonthsEnded September 30,
Increase (Decrease) for the Nine MonthsEnded September 30,
2024 Compared to 2023
Rate
Volume
Net
Interest-earning assets
Commercial real estate and other mortgage loans(1)
3,303
4,717
6,791
9,957
16,748
Commercial and industrial loans(1)
406
2,440
2,846
2,117
9,744
11,861
Consumer and other loans(1)
270
Total loans and leases receivable
1,856
5,782
7,638
9,178
19,807
28,985
Mortgage-related securities
606
981
1,694
3,175
Other investment securities
(92
(110
(202
(28
47
FHLB and FRB Stock
(183
(38
205
(298
(93
146
739
Total net change in income on interest-earning assets
2,290
6,096
8,386
11,085
21,768
32,853
Interest-bearing liabilities
Transaction accounts
390
1,287
1,677
3,719
5,846
9,565
1,006
1,903
2,909
5,875
3,750
9,625
318
(720
(402
1,347
(799
548
1,245
1,303
(148
5,438
5,290
1,772
3,715
5,487
10,793
14,235
25,028
1,593
(1,651
(58
561
(1,841
(1,280
302
244
546
462
633
1,095
Total net change in expense on interest-bearing liabilities
3,667
2,308
5,975
11,816
13,027
24,843
Net change in net interest income
(1,377
3,788
(731
8,741
The tables below show our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three and nine months ended September 30, 2024 and 2023. The average balances are derived from average daily balances.
Interest
AverageYield/Rate(4)
1,805,020
30,340
6.72
1,605,464
25,623
6.38
1,177,112
24,481
8.32
1,059,512
21,635
8.17
49,748
685
5.51
46,875
610
5.21
Total loans and leases receivable(1)
3,031,880
7.32
2,711,851
7.06
Mortgage-related securities(2)
269,842
2,662
3.95
204,291
1,681
3.29
Other investment securities(3)
51,446
315
2.45
67,546
517
3.06
FHLB and FRB stock
11,960
9.53
14,770
323
8.75
40,406
559
5.53
40,318
552
5.48
Total interest-earning assets
3,405,534
6.97
3,038,776
6.71
Non-interest-earning assets
231,353
237,464
3,636,887
3,276,240
864,936
8,451
3.91
731,529
6,774
3.70
850,590
8,780
4.13
657,183
5,871
3.57
219,315
2,584
4.71
282,674
2,986
4.23
531,472
5,475
4.12
410,494
4,172
4.07
Total interest-bearing deposits
2,466,313
2,081,880
3.80
278,103
2,059
2.96
342,117
2.48
50,642
971
7.67
34,745
4.89
Total interest-bearing liabilities
2,795,058
2,458,742
3.64
Non-interest-bearing demand deposit accounts
440,161
434,330
Other non-interest-bearing liabilities
91,520
105,079
3,326,739
2,998,151
Stockholders’ equity
310,148
278,089
Interest rate spread
3.07
Net interest-earning assets
610,476
580,034
Net interest margin
3.76
Average interest-earning assets to average interest-bearing liabilities
121.84
123.59
Return on average assets(4)
1.13
1.19
Return on average common equity(4)
13.83
14.62
Average equity to average assets
8.53
8.49
Non-interest expense to average assets(4)
2.54
2.83
1,764,133
87,759
6.63
1,556,988
71,011
6.08
1,146,495
71,074
8.27
988,359
59,213
7.99
50,386
2,114
5.59
47,594
1,738
4.87
2,961,014
7.25
2,592,941
6.79
257,914
7,547
3.90
193,196
4,372
3.02
60,037
1,276
61,396
1,229
2.67
12,294
859
9.32
15,904
952
7.98
58,040
2,391
43,437
1,652
5.07
3,349,299
6.89
2,906,874
6.43
236,569
223,552
3,585,868
3,130,426
25,635
657,155
16,070
3.26
24,609
663,284
14,984
3.01
8,597
271,684
8,049
14,961
311,038
9,671
2,413,914
1,903,161
3.42
5,750
368,913
7,030
49,863
2,409
6.44
35,351
1,314
4.96
2,750,231
3.97
2,307,425
3.30
455,653
93,430
96,883
3,283,843
2,859,961
302,025
270,465
2.91
3.13
599,068
599,449
3.62
3.81
121.78
125.98
1.08
13.41
13.72
8.42
8.64
2.62
2.85
Comparison of Net Interest Income for the Three and Nine Months Ended September 30, 2024 and 2023
Net interest income increased $2.4 million, or 8.4%, and $8.0 million, or 9.6% during the three and nine months ended September 30, 2024, compared to the three and nine months ended September 30, 2023. The increase in net interest income reflected an increase in average gross loans and leases and an increase in fees in lieu of interest, partially offset by net interest margin compression. Fees in lieu of interest, which vary from quarter to quarter, totaled $942,000 and $3.0 million for the three and nine months ended September 30, 2024, compared to $582,000 and $2.2 million for the same periods in 2023. Excluding fees in lieu of interest, net interest income for the three and nine months ended September 30, 2024 increased $2.1 million, or 7.32%, and $7.2 million, or 8.92%, respectively. Average gross loans and leases for the three and nine months ended September 30, 2024 increased
43
$320.0 million, or 11.8%, and $368.1 million, or 14.2%, respectively, compared to the three and nine months ended September 30, 2023.
The yield on average loans and leases for the three and nine months ended September 30, 2024 was 7.32% and 7.25%, respectively, compared to 7.06% and 6.79% for the three and nine months ended September 30, 2023. Excluding the impact of loan fees in lieu of interest, the yield on average loans and leases for the three and nine months ended September 30, 2024 was 7.20% and 7.11%, respectively, compared to 6.97% and 6.67% for the three and nine months ended September 30, 2023. The yield on average interest-earning assets for the three and nine months ended September 30, 2024 measured 6.97% and 6.89%, respectively, compared to 6.71% and 6.43% for the three and nine months ended September 30, 2023. Excluding loan fees in lieu of interest, the yield on average interest-earning assets for the three and nine months ended September 30, 2024 was 6.86% and 6.77%, respectively, compared to 6.63% and 6.33% for the three and nine months ended September 30, 2023. The increase in yields was primarily due to the reinvestment of cash flows from fixed-rate loan portfolios and securities in a higher rate environment. Compared to the prior year quarter, the quarter's daily average effective federal funds rate for the remained flat at 5.26%. The daily average effective federal funds rate for the nine months ended September 30, 2024 increased 39 basis points.
The rate paid on average interest-bearing core deposits for the three and nine months ended September 30, 2024 increased to 4.10% and 4.07%, respectively, from 3.74% and 3.27% for the three and nine months ended September 30, 2023. The average rate paid on total interest-bearing liabilities for the three and nine months ended September 30, 2024 increased to 4.05% and 3.97%, respectively, from 3.64% and 3.30% for the three and nine months ended September 30, 2023. Total interest-bearing liabilities may include interest-bearing deposits, federal funds purchased, FHLB advances, subordinated and junior subordinated notes and debentures payable, and other borrowings. The average rates paid increased due to the increase in short-term market rates, the replacement of maturing wholesale funds at higher fixed rates, and client movement from non-interest bearing to interest bearing core deposit products. The daily average effective federal funds rate for the three months ended September 30, 2024 remained flat.
Net interest margin decreased to 3.64% and 3.62%, respectively, for the three and nine months ended September 30, 2024, compared to 3.76% and 3.81% for the three and nine months ended September 30, 2023. The primary driver of the reduction in net interest margin was increased funding costs, partially offset by an increase in earning asset yields. Adjusted net interest margin measured 3.51% and 3.47% for the three and nine months ended September 30, 2024, compared to 3.66% and 3.68% for the three and nine months ended September 30, 2023. Adjusted net interest margin is a non-GAAP measure representing net interest income excluding the impact of fees in lieu of interest, and other recurring, but volatile, components of net interest margin divided by average interest-earning assets less other recurring, but volatile, components of average interest-earning assets.
Management believes its success in growing core 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. 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. The Corporation maintains a long-term target for net interest margin in the range of 3.60% - 3.65%. Performance in future quarters will vary due to factors such as the level of fees in lieu of interest and the timing, pace, and scale of future interest rate changes.
Provision for Credit Losses
We determine our provision for credit losses pursuant to our allowance for credit loss methodology. It is based on a reasonable and supportable forecast as well as considerations for composition, risk, and performance indicators in our credit portfolio. Refer to Allowance for Credit Losses, below, for further information regarding our allowance for credit loss methodology.
The Corporation recognized $2.1 million and $6.1 million of provision expense for the three and nine months ended September 30, 2024, respectively, compared to expense of $1.8 million and $5.6 million for the three and nine months ended September 30, 2023. The provision expense for the three months ended September 30, 2024 of $2.1 million consisted of $1.5 million of net charge-offs, $616,000 due to loan growth, and a $757,000 net increase in specific reserves, partially offset by decreases of $444,000 and $330,000 due to quantitative and qualitative factor changes, respectively.
The following table shows the components of the provision for credit losses for the three and nine months ended September 30, 2024 compared to the same periods in 2023.
Change in qualitative factors
(444
506
793
465
Change in quantitative factors
(330
(1,372
(380
(1,193
1,619
562
4,123
1,057
(91
(84
(509
(435
Change in reserves on individually evaluated loans, net
757
1,265
348
2,322
Change due to loan growth, net
616
817
3,023
Change in unfunded credit commitment reserves
99
371
Total provision for credit losses
The addition of specific reserves on individually evaluated loans represents new specific reserves established when collateral shortfalls or government guaranty deficiencies are present, while the release of specific reserves represents the reduction of previously established reserves that are no longer required. Qualitative factor changes reflect management’s evaluation of the level of risk within the portfolio based upon several factors for each portfolio segment. Quantitative factor changes reflect the change in the reasonable and supportable forecast as well as other model assumptions. Charge-offs in excess of previously established specific reserves require an additional provision for credit losses to maintain the allowance for credit 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. Refer to Asset Quality, below, for further information regarding the overall credit quality of our loan and lease portfolio.
Comparison of Non-Interest Income for the Three and Nine Months Ended September 30, 2024 and 2023
Non-Interest Income
Non-interest income decreased $1.4 million, or 16.2%, to $7.1 million for the three months ended September 30, 2024 compared to $8.4 million for the same period in 2023. The decrease in total non-interest income for the three months ended September 30, 2024 was primarily due to decreases in returns on investments of SBIC mezzanine funds and commercial loan swap fee income, offset by an increase in Private wealth fee income. Non-interest income for the nine months ended September 30, 2024 decreased $3.0 million, or 12.3%, to $21.2 million compared to $24.2 million for the same period in 2023. The decrease in total non-interest income for the nine months ended September 30, 2024 was driven by decreases in returns on investments in SBIC mezzanine funds, commercial loan swap fee income, and gains on the sale of SBA loans, partially offset by an increase in Private Wealth fee income and service charges on deposits.
Management continues to focus on revenue growth from multiple non-interest income sources to maintain a diversified revenue stream. Contribution from fee-based revenue sources can be variable and driven by changes in the interest rate environment, client activity, and the value of underlying investments. Total non-interest income accounted for 18.6% and 18.9% of total revenues for the three and nine months ended September 30, 2024, respectively, compared to 22.8% and 22.6% for the three and nine months ended September 30, 2023.
The components of non-interest income were as follows:
Private wealth management services fee income
$3,264
$2,945
$319
10.8%
$9,835
$8,492
$1,343
15.8%
Gain on sale of SBA loans
(391)
(45.9)
(767)
(43.3)
85
10.2
527
23.1
3.3
(9)
(0.4)
10.6
125
11.3
(82.2)
(532)
(53.6)
(1,711)
(67.7)
(913)
(55.5)
(2,513)
(45.0)
$7,064
$8,430
$(1,366)
$21,246
$24,214
$(2,968)
Fee income ratio(1)
18.6%
22.8%
18.9%
22.6%
Private wealth fee income increased $319,000, or 10.8%, and $1.3 million, or 15.8%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. Private wealth fee income is up compared to prior year primarily due to an increase in assets under management and administration, increases in fee rates across the client base, and non-recurring transaction fees in the 2024 period. Private wealth fee income can vary due to the mix of business at different fee structures and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets. As of September 30, 2024, Private wealth and trust assets under management and administration totaled $3.398 billion, increasing $483.3 million, or 16.6%, compared to $2.915 billion as of September 30, 2023, due to an increase in market values, new clients, and new money from existing clients.
Service charges on deposits increased $85,000, or 10.2%, and $527,000, or 23.1%, for the three and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. The increase is primarily driven by new and expanded core deposit relationships. Treasury management business development efforts remain robust as gross treasury management service charges increased $145,000, or 9.9%, and $473,000, or 11.0%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. Management believes growth in gross analyzed service charges is a strong indicator of success for the Corporation given the direct correlation to adding and expanding core business relationships.
Commercial loan interest rate swap fee income decreased $532,000, or 53.6%, and $1.7 million, or 67.7%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. 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 $975.8 million as of September 30, 2024, compared to $939.2 million and $908.6 million as of December 31, 2023 and September 30, 2023, respectively. Interest rate swaps can be an attractive product for our commercial borrowers, although associated fee income varies from period to period based on loan activity and the interest rate environment.
Gain on sale of SBA loans decreased $391,000, or 45.9%, and $767,000, or 43.3%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. Management expects the SBA loan sales to increase as production increases and previously closed commitments fully fund and become eligible for sale, due to additions to the business development team.
Other non-interest income decreased $913,000, or 55.5%, and $2.5 million, or 45.0%, for the three and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. The decreases for the three and nine months ended September 30, 2024, was primarily due to the lower returns on the Corporation's investments in SBIC mezzanine funds. Income from
SBIC mezzanine funds varies from period to period based on changes in the realized and unrealized fair value of underlying investments.
Comparison of Non-Interest Expense for the Three and Nine Months Ended September 30, 2024 and 2023
Non-Interest Expense
Non-interest expense for the three and nine months ended September 30, 2024 decreased by $82,000, or 0.4% and increased $3.3 million, or 5.0%, respectively, compared to the same period in 2023. Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, decreased $313,000, or 1.4%, and increased $3.2 million, or 4.8%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. For the three month period, the decrease in operating expense was primarily due to decreases in compensation, other non-interest expense, and professional fees; partially offset by increases in computer software expense, marketing expense, and FDIC insurance. For the nine month period, the increase in operating expense was primarily due to an increase in compensation expense, computer software expense, and FDIC insurance.
The components of non-interest expense were as follows:
(375
(2.4
)%
960
2.1
1.7
(24
(1.3
(124
(8.7
336
9.7
356
12.3
21.6
426
19.7
(16
(4.6
1.3
319
24.7
24.9
19.1
379
22.9
(282
(17.8
(0.5
(0.4
3,342
5.0
Total operating expense(1)
22,630
22,943
(313
(1.4
69,584
66,414
3,170
Actual full-time equivalent employees
Compensation expense for the three and nine months ended September 30, 2024 decreased $375,000, or 2.4%, and increased $960,000, or 2.1%, respectively, compared to the same periods in 2023. For the three month period, the decrease in compensation expense was primarily due to a cash bonus accrual adjustment decrease and an increase in capitalized software development compensation. For the nine month period, the increase in compensation expense was primarily due to an increase in average FTEs, annual merit increases, and promotions. These increases were partially offset by decreases in incentive compensation and share-based compensation. Successful hiring efforts to secure talent resulted in average full-time equivalent employees for the three months ended September 30, 2024 increasing to 355, up 1.7%, compared to 349 for the three months ended September 30, 2023.
Computer software expense increased $319,000, or 24.7%, and $913,000, or 24.9%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. The increase was primarily due to our commitment to innovative technology to support growth initiatives, enhance productivity, and improve the client experience.
Marketing expense increased $164,000, or 21.6%, and $426,000, or 19.7%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. The increase was primarily due to an increase in business development efforts and advertising projects related to the Company’s growth initiatives.
FDIC insurance for the three and nine months ended September 30, 2024 increased $130,000, or 19.1%, and $379,000, or 22.9%, respectively, compared to the same period in 2023. The increase was primarily due to an increase in total assets and use of brokered deposits.
Data processing expense increased $92,000, or 9.7%, and $356,000, or 12.3%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023, primarily due to an increase in core processing costs due to loan and deposit account growth, private wealth asset growth, and various project implementations.
Professional fees decreased $124,000, or 8.7%, and increased $336,000, or 8.4%, for the three and nine months ended September 30, 2024, respectively, compared to the same period in 2023. For the three month period, the decrease was primarily due to a decrease in recruiting expense and professional consulting services for various projects. For the nine month period, the increase was primarily due to an increase in recruiting expense and professional consulting services for various projects.
Other non-interest expense for the three and nine months ended September 30, 2024 decreased $282,000, or 17.8%, and $17,000, or 0.5%, respectively, compared to the same period in 2023. The decrease was primarily due to a decrease in liquidation expenses.
Income Taxes
Income tax expense totaled $6.0 million for the nine months ended September 30, 2024 compared to $7.4 million for the same period in 2023. Income tax expense included a $1.1 million net benefit from tax credit investments in both periods. The effective tax rate for the nine months ended September 30, 2024 was 16.8% compared to 21.4% for the same period in 2023. The decrease in effective tax rate is primarily due to a change in Wisconsin state tax legislation which reduced the Corporation's state taxable income. The Corporation expects to report an effective tax rate between 16% and 18% for 2024.
Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. The rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change.
48
Financial Condition
Total assets increased by $207.9 million, or 7.9%, to $3.716 billion as of September 30, 2024 compared to $3.508 billion at December 31, 2023. The increase in total assets was primarily driven by an increase in loans and leases receivable and available-for-sale securities, partially offset by a reduction in short-term investments. Total liabilities increased by $185.5 million, or 7.7%, to $3.404 billion at September 30, 2024 compared to $3.218 billion at December 31, 2023. The increase in total liabilities was principally due to an increase in deposits. Total stockholders’ equity increased by $22.4 million, or 10.3%, to $312.0 million at September 30, 2024 compared to $289.6 million at December 31, 2023. The increase in total stockholders’ equity was due to retention of earnings and unrealized gains on available-for-sale securities, partially offset by dividends paid to common and preferred stockholders and unrealized losses on interest rate swaps.
Cash and Cash Equivalents
Cash and cash equivalents include short-term investments and cash and due from banks. Cash and due from banks increased $13.0 million to $45.3 million at September 30, 2024 from $32.3 million at December 31, 2023. Short-term investments decreased by $20.5 million to $86.7 million at September 30, 2024 from $107.2 million at December 31, 2023. Our short-term investments primarily consist of interest-bearing deposits held at the FRB. We value the safety and soundness provided by the FRB, and therefore, we incorporate short-term investments in our readily accessible liquidity program. As of September 30, 2024 and December 31, 2023, interest-bearing deposits held at the FRB were $85.7 million and $106.8 million, respectively.
Total securities, including available-for-sale and held-to-maturity, increased by $14.7 million, or 6.4%, to $320.2 million, or 8.6% of total assets at September 30, 2024 compared to $305.5 million or 8.7% of total assets at December 31, 2023. During the nine months ended September 30, 2024, the Corporation recognized unrealized gains of $5.6 million before income taxes through other comprehensive income, compared to unrealized losses of $6.4 million for the same period in 2023. The unrealized gains in the current period were driven by the decrease in market interest rates. As of September 30, 2024 and December 31, 2023, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 5.1 years and 5.6 years, respectively. Our investment philosophy remains as stated in our most recent Annual Report on Form 10-K.
We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, data integrity validation primarily through comparison of current price to an expectation-based analysis of movement in prices based upon the changes in the related yield curves, and other market factors. We did not recognize any credit losses in the securities portfolio as of September 30, 2024.
Loans and Leases Receivable
Period-end loans and leases receivable, net of allowance for credit losses, increased by $197.4 million, or 9.3% annualized, to $3.016 billion at September 30, 2024 from $2.819 billion at December 31, 2023 primarily driven by commercial loan growth. Management expects to manage loan growth towards our long term target of 10%.
Total commercial real estate (“CRE”) loans increased $129.5 million, or 10.2% annualized, to $1.829 billion. The increase was primarily due to an increase in the construction and multifamily loan portfolios.
CRE loans represented 60.0% and 59.6% of our total loans as of September 30, 2024 and December 31, 2023, respectively. As of September 30, 2024, 14.2% of the CRE loans were owner-occupied CRE, compared to 15.1% as of December 31, 2023. 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.
Commercial and Industrial ("C&I") loans increased $68.5 million, or 8.3% annualized, to $1.174 billion. The increase was due to growth in traditional commercial lending, Equipment Finance, and Floorplan Financing loan portfolios.
49
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 core 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. 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 competition from banks operating in our primary geographic areas, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to expect our new loan and lease activity to be adequate to replace normal amortization, allowing us to continue growing in future years. The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K.
The following table presents information concerning the composition of the Bank’s consolidated loans and leases receivable.
As of September 30,
As of December 31,
AmountOutstanding
% of TotalLoans andLeases
8.5
9.0
25.2
27.1
8.8
6.8
16.2
15.8
0.9
60.0
59.6
38.5
38.8
1.5
1.6
100.0
Below is a view of selected loan portfolios disaggregated by North American Industry Classification (“NAICs”) code as of September 30, 2024:
WholesaleandManufacturing
Retail andHospitality
TransportationandWarehousing
6%
28%
17%
13%
36%
100%
Commercial real estate — non- owner occupied
71% (1)
1%
11%
2%
15%
3%
32%
16%
10%
39%
See Asset Quality for further discussion of industry-specific risks.
Deposit composition
As of
(in thousands)
June 30,2024
March 31,2024
September 30,2023
406,804
400,267
430,011
841,146
818,080
779,789
837,569
813,467
694,199
224,116
266,029
285,265
575,548
457,563
467,743
2,885,183
2,755,406
2,657,007
Uninsured deposits
1,088,496
1,011,977
995,428
994,687
916,083
Less: uninsured deposits collateralized by pledged assets
10,755
34,810
16,622
17,051
28,873
Total uninsured, net collateralized deposits
1,077,741
977,167
978,806
977,636
887,210
% of total deposits
36.3
33.9
35.5
35.0
33.4
As of September 30, 2024, total period-end deposits increased by $173.2 million to $2.970 billion from $2.797 billion at December 31, 2023, primarily due to increases of $129.5 million, $105.9 million, and $34.9 million in wholesale deposits, money market accounts, and interest-bearing transaction accounts, respectively. These increases were partially offset by decreases of $79.8 million and $17.4 million in certificates of deposits and non-interest-bearing transaction accounts, respectively.
As of September 30, 2024, total period-end core deposits increased $43.7 million, or 2.5% annualized, to $2.383 billion, compared to $2.339 billion at December 31, 2023. The increase in period-end balances is due to increases of $105.9 million and $34.9 million in money market accounts and interest bearing transaction accounts, respectively, offset by decreases of $79.8 million and $17.4 million in certificates of deposit and non-interest-bearing transaction accounts, respectively. Management believes the Bank’s deposit-centric sales strategy, led by treasury management sales, will continue to contribute to a net increase in deposits; however, period-end deposit balances associated with core relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to maintain existing and acquire new client relationships. Therefore, we believe average balances are a better indicator of our deposit growth.
Our strategic efforts remain focused on adding core deposit relationships. We measure the success of core deposit gathering efforts based on the number and average balances of our deposit accounts as compared to ending balances due to the variability of some of our larger relationships. The Bank’s average core deposits, consisting of all transaction accounts, money market accounts, and certificates of deposit, increased $317.8 million, or 15.5%, to $2.366 billion for the nine months ended September 30, 2024 compared to $2.048 billion for the nine months ended September 30, 2023.
FHLB Advances and Other Borrowings
As of September 30, 2024, FHLB advances and other borrowings increased by $18.2 million, or 7.3%, to $349.1 million from $330.9 million at December 31, 2023. As average deposit balances have increased, we have been able to reduce our usage of FHLB advances as a percentage of total funding. In addition, we have strategically reduced our usage of FHLB advances in favor of wholesale deposits to increase the Bank’s readily accessible liquidity. We will continue to utilize FHLB advances and wholesale deposits to manage interest rate risk, liquidity, and contingency funding.
As of September 30, 2024, the Corporation has no other borrowings. As of December 31, 2023, the Corporation had other borrowings of $20,000, which consisted of a sold tax credit investments accounted for as secured borrowings because they did not qualify for true sale accounting.
As of August 15, 2024, the $15.0 million subordinated notes payable that bore a fixed interest rate of 5.5% were redeemed. The Corporation issued new subordinated notes payable on September 13, 2024. The aggregate principal amount of the newly issued subordinated notes payable was $20.0 million. The subordinated notes payable bear a fixed interest rate of 7.5% with a maturity date of September 13, 2034.
51
Consistent with our funding philosophy to manage interest rate risk, we will use the most efficient and cost effective source of wholesale funds. We will utilize FHLB advances to the extent we maintain an adequate level of excess borrowing capacity for liquidity and contingency funding purposes and pricing remains favorable in comparison to the wholesale deposit alternative. We will use FHLB advances and/or brokered certificates of deposit in specific maturity periods needed, typically three to five years, to match-fund fixed rate loans and effectively mitigate the interest rate risk measured through our asset/liability management process and to support asset growth initiatives while taking into consideration our operating goals and desired level of usage of wholesale funds. Please refer to the section entitled Liquidity and Capital Resources, below, for further information regarding our use and monitoring of wholesale funds.
Preferred Stock
The Corporation has 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”) outstanding as of September 30, 2024 and December 31, 2023.
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 three and nine months ended September 30, 2024, the Corporation paid $218,000 and $656,000, respectively, in cash dividends with respect to the Series A Preferred Stock. 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.
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 September 30, 2024, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was approximately $975.8 million, compared to $939.2 million as of December 31, 2023. We receive fixed rates and pay floating rates based upon designated benchmark interest rates on the swaps with commercial borrowers. These swaps mature between June 2025 and July 2041. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. As of September 30, 2024, the commercial borrower swaps were reported on the Consolidated Balance Sheet as a derivative asset of $11.4 million and liability of $39.8 million compared to a derivative asset of $7.9 million and liability of $51.1 million as of December 31, 2023. 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 June 2025 and July 2041. 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 $28.4 million as of September 30, 2024, compared to a net derivative asset of $43.2 million as of December 31, 2023. The gross amount of dealer counterparty swaps as of September 30, 2024, without regard to the enforceable master netting agreement, was a gross derivative liability of $11.4 million and gross derivative asset of $39.8 million, compared to a gross derivative liability of $7.9 million and gross derivative asset of $51.1 million as of December 31, 2023.
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 interest payments on short-term FHLB advances or wholesale deposits. 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 affect earnings. As of September 30, 2024, the aggregate notional value of interest
52
rate swaps designated as cash flow hedges was $499.7 million. These interest rate swaps mature between October 2024 and February 2041. A pre-tax unrealized loss of $11.6 million and $6.5 million was recognized in other comprehensive income for the three and nine months ended September 30, 2024, respectively, and there was no ineffective portion of these hedges.
The Corporation also enters into interest rate swaps to mitigate market value volatility on certain long-term fixed 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 affect earnings. As of September 30, 2024, the aggregate notional value of interest rate swaps designated as fair value hedges was $12.5 million. These interest rate swaps mature between February 2031 and October 2034. A pre-tax unrealized loss of $246,000 and $24,000 was recognized in other comprehensive income for the three and nine months ended September 30, 2024, respectively, and there was no ineffective portion of these hedges.
For further information and discussion of our derivatives, see Note 13 — Derivative Financial Instruments of the Consolidated Financial Statements.
Asset Quality
Non-performing Assets
Total non-performing assets consisted of the following at September 30, 2024 and December 31, 2023, respectively:
Non-accrual loans and leases
Commercial real estate - owner occupied
Commercial real estate - non-owner occupied
Total non-accrual commercial real estate
Repossessed assets, net
Total non-performing assets
19,420
20,844
Total non-accrual loans to gross loans and leases plus repossessed assets, net
Total non-performing assets to total assets
0.52
0.59
Non-accrual loans decreased $1.2 million, to $19.4 million at September 30, 2024, compared to $20.6 million at December 31, 2023. The Corporation’s non-accrual loans as a percentage of total gross loans and leases measured 0.63% and 0.72% at September 30, 2024 and December 31, 2023, respectively. The change in non-accrual loans was driven by charge-offs in the Equipment Finance pool and a paydown in the Asset-Based Lending ("ABL") pool both within the C&I portfolio segment, partially offset by newly defaulted loans in Equipment Finance and SBA lending pools. While we continue to expect full repayment of the one ABL loan that defaulted during the second quarter of 2023, the liquidation process has transitioned into Chapter 7 bankruptcy, likely delaying final resolution until late 2024 or 2025. Through our collections efforts, the current balance of this loan is $6.2 million, down from $10.9 million in the prior year quarter. Excluding this credit, non-performing assets totaled $13.2 million, or 0.36% of total assets in the current quarter and $12.6 million, or 0.35% of total assets in the prior quarter.
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 was 0.52% and 0.59% at September 30, 2024 and December 31, 2023, respectively. As of September 30, 2024 and December 31, 2023, the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.4% and 99.2%, respectively, of the total portfolio at the end of each period was in a current payment status.
We reviewed loans and leases with exposure to certain industries:
We also monitor asset quality through our established categories as defined in Note 5 – Loans, Lease Receivables, and Allowance for Credit 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 proactively work with our loan borrowers experiencing financial difficulty to find meaningful solutions to difficult situations that are in the best interests of the Bank.
As of September 30, 2024, 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 placed on non-accrual status and individually evaluated for reserve requirement. 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.
54
The following represents additional information regarding our non-accrual loans and leases:
As of and for the Nine MonthsEnded September 30,
As of andfor theYear EndedDecember 31,
Individually evaluated loans and leases with no specific reserves required
11,381
Individually evaluated loans and leases with specific reserves required
6,247
Total individually evaluated loans and leases
17,628
Less: Specific reserves (included in allowance for credit losses)
3,982
Net non-accrual loans and leases
13,025
13,646
14,608
Average non-accrual loans and leases
19,761
7,702
The allowance for credit losses, including unfunded commitment reserves, increased $2.5 million, or 10.2% annualized, to $35.5 million as of September 30, 2024 from $33.0 million as of December 31, 2023. The allowance for credit losses as a percentage of gross loans and leases was 1.16% as of September 30, 2024 compared to 1.16% as of December 31, 2023.
During the nine months ended September 30, 2024, we recorded net charge-offs of $3.6 million, comprised of $4.1 million of charge-offs and $509,000 of recoveries. We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed. Loans and leases with previously established specific reserves, may ultimately result in a charge-off under a variety of scenarios.
As of September 30, 2024 and December 31, 2023, our ratio of allowance for credit losses to total non-accrual loans and leases was 183.38% and 160.21%, respectively. This ratio increased because of paydowns on non-accrual loans and an increase in general reserves primarily due to loan growth. Non-accrual loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease; however, the evaluation of non-accrual loans and leases may not always result in a specific reserve included in the allowance for credit 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-accrual 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 credit loss to non-accrual loans and leases ratio as compared to our peers or industry expectations. As asset quality strengthens, our allowance for credit losses is measured more through collective characteristics of our portfolio rather than through specific identification and we would therefore expect this ratio to rise. Conversely, if we identify further non-accrual loans, this ratio could fall if the non-accrual 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 September 30, 2024.
To determine the level and composition of the allowance for credit losses, we break out the portfolio by segments with similar risk characteristics. First, we evaluate loans and leases for non-accrual classification. We analyze each loan and lease identified as non-accrual 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 efficiency, smaller dollar value loans within the Equipment Finance pool are reserved based on a past-due criteria. Accruing loans may be evaluated individually. All loans not evaluated individually are evaluated collectively as part of a portfolio segment or portfolio segment and class. These collective evaluations utilized a reasonable and supportable forecast which includes projections of credit losses based on one of two established methods: discounted cash flow or weighted average remaining maturity. Each model includes a set of assumptions which are evaluated not less than annually by management. The methodology also focuses on evaluation of several qualitative factors for each portfolio segment or portfolio segment and class, including but not limited to: product growth rates, 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, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations in specific industries, and other qualitative factors that could affect credit losses.
When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for credit loss reserve to bring the loan or lease to its net realizable value. It is typically part of our process to obtain appraisals on individually evaluated loans and leases that are primarily secured by real estate. As we complete new appraisals and/or market evaluations, in specific situations current fair values collateralizing certain collateral-dependent loans are inadequate to support the entire amount of the outstanding debt.
As a result of our review process, we have concluded an appropriate allowance for credit losses for the funded loan and lease portfolio was $33.7 million, or 1.1% of gross loans and leases, at September 30, 2024. Given ongoing complexities with current workout situations and the uncertainty surrounding future economic conditions, further charge-offs, and increased provisions for credit losses may be recorded if additional facts and circumstances lead us to a different conclusion. Various federal and state regulatory agencies review the allowance for credit 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.
A summary of the activity in the allowance for credit losses follows:
As of and for the ThreeMonths Ended September 30,
As of and for the NineMonths Ended September 30,
Allowance at beginning of period
Impact of adoption of ASC 326
Charge-offs:
Total charge-offs
Recoveries:
Total recoveries
Net charge-offs
Allowance at end of period
Annualized net charge offs (recoveries) as a percent of average gross loans and leases
0.16
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 September 30, 2024 were the interest payments due on subordinated notes and debentures and cash dividends payable to both common and preferred stockholders. The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect on September 30, 2024, 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 sources 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 and industry conditions, and competition.
Sources of liquidity
54,680
46,984
109,612
Collateral value of unencumbered pledged loans
397,852
401,602
340,639
367,471
315,067
Market value of unencumbered securities
279,191
289,104
288,965
259,791
236,618
Readily accessible liquidity
763,713
745,386
676,588
734,424
661,297
Fed fund lines
45,000
Excess brokered CD capacity1
1,102,767
1,051,678
1,166,661
1,231,791
1,090,864
Total liquidity
1,911,480
1,842,064
1,888,249
2,011,215
1,797,161
Total uninsured, net of collateralized deposits
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. Our readily accessible liquidity increased quarter over quarter. At September 30, 2024 and December 31, 2023, the Bank had $85.7 million and $106.8 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, allow run off of maturing wholesale certificates of deposit or invest in securities to maintain adequate liquidity at an improved margin.
We had $881.7 million of outstanding wholesale funds at September 30, 2024, compared to $739.2 million of wholesale funds as of December 31, 2023, which represented 27.0% and 24.0%, respectively, of ending balance total bank funding. Wholesale funds include FHLB advances and brokered certificates of deposit. Total bank funding is defined as total deposits plus FHLB advances. We are committed to raising core deposits while utilizing wholesale funds to mitigate interest rate risk. Wholesale funds continue to be an efficient and cost effective source of funding for the Bank and allows it to gather funds across a larger geographic base at price levels and maturities that are more attractive than local time deposits when required to raise a similar level of core deposits within a short time period. Access to such deposits and borrowings allows us the flexibility to refrain from pursuing single service deposit relationships in markets that have experienced unfavorable pricing levels. 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. Wholesale funds are also stable as each issuance has a structured maturity date and may only be redeemed in
57
certain limited circumstances. 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 core deposits increased $43.7 million as of September 30, 2024, compared to December 31, 2023. The increase was primarily due to increases of $105.9 million and $34.9 million in money market accounts and interest bearing transaction accounts, respectively. These increases were partially offset by a $79.8 million and $17.4 million decrease in certificates of deposit and non-interest-bearing transaction accounts, respectively. 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 core deposit balances decline. In order to provide for ongoing liquidity and funding, none of our wholesale certificates of deposit allow for withdrawal at the option of the depositor before the stated maturity date and FHLB advances have contractual maturity terms. 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 September 30, 2024.
The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the quarter ended September 30, 2024. In the event that there is a disruption in the availability of wholesale funds at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through readily accessible 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 September 30, 2024, the accessible 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 a shelf registration statement on file 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 Corporation has in recent years, and may from time to time in the future, raise capital through the sale of debt or equity securities in private placements exempt from registration under federal securities laws.
During the nine months ended September 30, 2024, operating activities resulted in a net cash inflow of $35.5 million, which included net income of $29.8 million. Net cash used by investing activities for the nine months ended September 30, 2024 was $226.4 million primarily due to net loan disbursements, investments made in securities available for sale, and additional investments in federal home loan bank stock. Net cash provided by financing activities was $183.3 million for the nine months ended September 30, 2024 primarily due to a net increase in deposits. Please refer to the Consolidated Statements of Cash Flows included in PART I., Item 1 for further details regarding significant sources of cash flow for the Corporation.
Contractual Obligations and Off-Balance Sheet Arrangements
As of September 30, 2024, there were no material changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023. We continue to believe that we have adequate capital and liquidity accessible from various sources to fund projected contractual obligations and commitments.
Our primary market risk is interest rate risk, which arises from exposure of our financial position to changes in interest rates. It is our strategy to reduce the impact of interest rate risk on net interest margin by maintaining a largely match-funded position between the maturities and repricing dates of interest-earning assets and interest-bearing liabilities. This strategy is monitored by the Bank’s Asset/Liability Management Committee, in accordance with policies approved by the Bank’s Board. The committee meets regularly to review the sensitivity of the Bank’s assets and liabilities to changes in interest rates, liquidity needs and sources, and pricing and funding strategies.
The primary technique we use to measure interest rate risk is simulation of earnings. In this measurement technique the balance sheet is modeled as an ongoing entity whereby future growth, pricing, and funding assumptions are utilized. These assumptions are modeled under different rate scenarios that include a simultaneous, instant, and sustained change in interest rates. During the third quarter of 2024, the Corporation’s interest rate risk exposure model incorporated updated assumptions regarding the level of interest rate, including indeterminable maturity deposits (non-interest bearing deposits, interest bearing transaction accounts and money market accounts). In the current environment of changing short-term rates, deposit pricing can vary by product and client. These assumptions have been developed through a combination of historical analysis and projection of future expected pricing behavior. This modeling indicated interest rate sensitivity as follows:
Impact on Net Interest Income as of
Instantaneous Rate Change in Basis Points
Down 300
(1.43
Down 200
(0.45
Down 100
(0.17
No Change
Up 100
(0.08
Up 200
Up 300
0.21
Management believes market risk is well managed with minimal impact on net interest income in simulated instantaneous rate shock scenarios, and we will continually monitor and adjust the balance sheet for optimal positioning as new data becomes available. The simulations used to manage market risk are based on numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows and client behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions, client behavior and management strategies, among other factors.
We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity, and/or repricing characteristics based on market conditions. FHLB advances and wholesale deposits are a significant source of funds. We use a variety of maturities to augment our management of interest rate exposure. Management has the authorization, as permitted within applicable approved policies, and ability to utilize derivatives should they be appropriate to manage interest rate exposure.
Disclosure Controls and Procedures
The Corporation’s management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has evaluated the Corporation’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures were effective as of September 30, 2024.
Changes in Internal Control over Financial Reporting
There was no change in the Corporation’s internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) that occurred during the quarter ended September 30, 2024 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
From time to time, the Corporation and its subsidiaries are engaged in legal proceedings in the ordinary course of their respective businesses. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations, or cash flows.
There were no material changes to the risk factors previously disclosed in Item 1A. to Part I of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2023.
Issuer Purchases of Securities
As previously announced, on April 26, 2024, the Corporation’s Board of Directors authorized the repurchase by the Corporation of shares of its common stock with a maximum aggregate purchase price of $5.0 million, in such quantities, at such prices and on such other terms and conditions as the Corporation’s Chief Executive Officer or Chief Financial Officer determine in their discretion to be in the best interests of the Corporation and its shareholders, any time with no expiration date. As of September 30, 2024, the Corporation has not repurchased any shares under this repurchase program.
The following table sets forth information about the Corporation's purchases of its common stock during the three months ended September 30, 2024.
Period
Total Numberof SharesPurchased(1)
Average PricePaid Per Share
Total Numberof SharesPurchased asPart of PubliclyAnnounced Plansor Programs
Total Number ofShares that MayYet Be PurchasedUnder the Plansor Programs
July 1, 2024 - July 31, 2024
August 1, 2024 - August 31, 2024
257
42.96
September 1, 2024 - September 30, 2024
109,673
During the three months ended September 30, 2024, no director or “officer” of the Corporation adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K.
4.1
Form of 7.5% Subordinated Debenture (incorporated by reference to Exhibit 4.1 to the Current Report on Form 8-K filed on September 19, 2024).
31.1
Certification of the Chief Executive Officer
31.2
Certification of the Chief Financial Officer
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101
The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2024, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of September 30, 2024 and December 31, 2023, (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2024 and 2023, (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2024 and 2023, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2024 and 2023, (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2024 and 2023, and (vi) the Notes to Unaudited Consolidated Financial Statements
104
The cover page from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2024 has been formatted in Inline XBRL and contained in Exhibit 101.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
October 25, 2024
/s/ Corey A. Chambas
Corey A. Chambas
Chief Executive Officer
/s/ Brian D. Spielmann
Brian D. Spielmann
Chief Financial Officer
(principal financial officer)