UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
þ
¨
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-34095
FIRST BUSINESS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Wisconsin
(State or other jurisdiction of incorporation or organization)
401 Charmany Drive, Madison, WI
(Address of principal executive offices)
39-1576570
(I.R.S. Employer Identification No.)
53719
(Zip Code)
Registrant’s telephone number, including area code: (608) 238-8008
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, $0.01 par value
Common Share Purchase Rights
Name of each exchange on which registered
The Nasdaq Stock Market LLC
The Nasdaq Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨
No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨
No þ
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 and posted pursuant to Rule 405 of Regulation S-T 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 if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
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. (Check one):
Large accelerated filer o
Accelerated filer þ
Non-accelerated filer o
(Do not check if a smaller reporting
company)
Smaller reporting company o
Emerging growth company o
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 Act). Yes ¨
No þ
The aggregate market value of the common equity held by non-affiliates computed by reference to the closing price of such common equity, as of the last business day of the registrant’s most
recently completed second fiscal quarter, was approximately $227.8 million .
As of February 25, 2019 , 8,743,109 shares of common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III – Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 2, 2019 are incorporated by reference into Part III hereof.
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PART I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accountant Fees and Services
PART IV
Item 15. Exhibits and Financial Statements Schedules
Item 16. Form 10-K Summary
Signatures
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Table of Contents
PART I.
Item 1. Business
General
BUSINESS
First Business Financial Services, Inc. (together with all of its subsidiaries, collectively referred to as the “Corporation,” “FBFS,” “we,” “us,” or “our”) is
a registered bank holding company originally incorporated in 1986 under the laws of the State of Wisconsin and is engaged in the commercial banking business
through its wholly-owned bank subsidiary, First Business Bank (“FBB”, or the “Bank”), headquartered in Madison, Wisconsin. All of our operations are conducted
through the Bank and certain subsidiaries of FBB. The Bank operates as a business bank, delivering a full line of commercial banking products and services
tailored to meet the specific needs of small and medium-sized businesses, business owners, executives, professionals, and high net worth individuals. Our products
and services include commercial lending, Small Business Administration (“SBA”) lending and servicing, asset-based lending, equipment financing, factoring, trust
and investment services, investment portfolio administrative services, asset/liability management services, treasury management services, and a broad range of
deposit products. We do not utilize a branch network to attract retail clients. Our operating philosophy is predicated on deep client relationships fostered by local
banking partners and specialized business lines where we provide skilled expertise, combined with the efficiency of centralized administrative functions, such as
information technology, loan and deposit operations, finance and accounting, credit administration, compliance, and human resources. Our focused model allows
experienced staff to provide the level of financial expertise needed to develop and maintain long-term relationships with our clients. We conduct our business
operations through one operating segment. Our chief operating decision maker, our Chief Executive Officer, evaluates the operations of the Corporation using
consolidated information for purposes of allocating resources and assessing performance.
In early 2017, the Corporation owned three separate bank charters: Alterra Bank (“Alterra”), Leawood, Kansas, First Business Bank-Milwaukee (“FBB-
Milwaukee”), Brookfield, Wisconsin and First Business Bank (“FBB”), Madison, Wisconsin. Effective June 1, 2017, Alterra and FBB-Milwaukee were merged
with and into FBB. The Corporation’s existing management structure remains unchanged, with the current roles and decision making authority retained by local
banking leaders, as well as the heads of our trust and investment management and specialty finance businesses.
As of December 31, 2018 , on a consolidated basis, we had total assets of $1.966 billion , total gross loans and leases of $1.619 billion , total deposits of
$1.455 billion , and total stockholders’ equity of $180.7 million .
Business Lines
Commercial Lending
We strive to meet the specific commercial lending needs of small- to medium-sized companies in our target markets in Wisconsin, Kansas, and Missouri
primarily through lines of credit and term loans to businesses with annual sales of up to $75 million. Through FBB, we service the Madison, Milwaukee, Northeast
Wisconsin metropolitan areas, and the Kansas City metropolitan areas. In 2014 we acquired Aslin Group, Inc. and its bank subsidiary, Alterra, to add an
established business-focused team serving similar sized businesses in the Kansas City metropolitan area. Alterra, now known as First Business Bank-Kansas City
Region (“FBB-KC”), was subsequently rebranded as a full-service banking location of FBB during the charter consolidation referenced above.
Our commercial loans are typically secured by various types of business assets, including inventory, receivables, and equipment. We also originate loans
secured by commercial real estate, including owner-occupied commercial facilities, multi-family housing, office buildings, retail centers, and, to a lesser extent,
commercial real estate construction loans. In very limited cases, we may originate loans on an unsecured basis. As of December 31, 2018 , our commercial real
estate and commercial loans – excluding asset-based lending, equipment financing, and SBA lending – represented approximately 82% of our total gross loans and
leases receivable.
Asset-Based Financing
First Business Capital Corp. (“FBCC”), a wholly-owned subsidiary of FBB, provides asset-based lending to small- to medium-sized companies. With its
sales offices located in several states, FBCC serves clients nationwide.
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FBCC primarily provides revolving lines of credit and term loans for financial and strategic acquisitions (e.g., leveraged or management buyouts), capital
expenditures, working capital to support rapid growth, bank debt refinancing, debt restructuring, corporate turnaround strategies, and debtor-in-possession
financing in the course of bankruptcy proceedings or the exit therefrom. As a bank-owned, asset-based lender with strong underwriting standards, FBCC is
positioned to provide cost-effective financing solutions to companies who do not have the established stable cash flows necessary to qualify for traditional
commercial lending products. These financings generally range between $2 million and $12 million with terms of 24 to 60 months. Asset-based lending typically
generates higher yields than traditional commercial lending. This line of business complements our traditional commercial loan portfolio and provides us with
more diverse income opportunities. As of December 31, 2018 , FBCC represented 9% of our total gross loans and leases receivable.
First Business Growth Funding (“FBGF”), formerly known as First Business Factors, a division of FBCC, provides funding to clients by purchasing
accounts receivable on a full recourse basis, also known as factoring. FBGF provides competitive rates to clients seeking growth and needing cash flow support, or
who are experiencing financial issues. Factoring typically generates higher yields than traditional commercial lending and complements our traditional commercial
portfolio. FBGF is headquartered in Chicago, Illinois and, with its sales offices located in several states, is able to serve clients nationwide. As of December 31,
2018 , FBGF represented less than 1% of our total gross loans and leases receivable.
Equipment Financing
First Business Equipment Finance, LLC (“FBEF”), a wholly-owned subsidiary of FBB, delivers a broad range of equipment finance products, including
loans and leases, to address the financing needs of commercial clients in a variety of industries. FBEF’s focus includes manufacturing equipment, industrial assets,
construction and transportation equipment, and a wide variety of other commercial equipment. These financings generally range between $250,000 and $5 million
with terms of 36 to 84 months. As of December 31, 2018 , FBEF represented approximately 4% of our total gross loans and leases receivable.
FBEF also delivers small ticket and vendor equipment financing through its proprietary, online application-only credit decision architecture. Through this
nationwide distribution channel, FBEF provides financing solutions for equipment vendors and their end users. The equipment vendors specialize primarily in
healthcare, manufacturing, technology, and specialty vehicles. The end users (i.e., our lessees and borrowers) are primarily physician group practices, other
healthcare related entities, manufacturers, veterinarians, wholesalers, and automotive related industries. These financings generally range between $25,000 and
$250,000 with terms of 36 to 84 months. As of December 31, 2018 , our small ticket and vendor equipment financing business line represented less than 1% of our
total gross loans and leases receivable.
Small Business Administration (“SBA”) Lending
The SBA guarantees loans originated by lenders to small business borrowers who meet its program eligibility and underwriting guidelines. Specific
program guidelines vary based on the SBA loan program; however, all loans must be underwritten, originated, monitored, and serviced according to the SBA’s
Standard Operating Procedures in order to maintain the guaranty under the SBA program. Generally, the SBA provides a guaranty to the lender ranging from 50%
to 90% of principal and interest as an inducement to the lender to originate the loan.
The majority of our SBA loans are originated using the 7(a) term loan program. This program typically provides a guaranty of 75% of principal and
interest. In the event of default on the loan, the bank may request that the SBA purchase the guaranteed portion of the loan for an amount equal to outstanding
principal plus accrued interest permissible under SBA guidelines. In addition, the SBA will share on a pro-rata basis in the costs of collection, subject to SBA rules
and limits, as well as the proceeds of liquidation.
We are an active participant in the SBA’s Preferred Lender Program (“PLP”). The PLP is part of the SBA's effort to streamline the procedures necessary
to provide financial assistance to the small business community. Under this program, the SBA delegates the final credit decision and most servicing and liquidation
authority and responsibility to selected PLP lenders. We leverage this expertise and capacity to package, underwrite, process, service, and liquidate, if necessary,
SBA loans throughout the Corporation’s locations.
SBA lending is designed to generate new business opportunities for the Bank by meeting the needs of clients that cannot be met with conventional bank
loans. We earn interest income from these loans, generally at variable rates. We also obtain funding and service fee income by gathering deposits from these
clients. In addition, our SBA strategy generates non-interest income from two primary sources. First, we typically sell the guaranteed portions of the SBA loans to
aggregators who securitize the assets for sale in the secondary market and receive a premium on each loan sold, resulting in the recognition of a gain in the period
of sale. Second, we receive servicing income from the holder of the securitized asset over the life of the loan. As of December 31, 2018 , the retained portion of
SBA loans represented 3% of our total gross loans and leases receivable.
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Treasury Management Services
The Bank provides comprehensive services for commercial clients to manage their cash and liquidity, including lockbox, accounts receivable collection
services, electronic payment solutions, fraud detection and protection, information reporting, reconciliation, and data integration solutions. For our clients involved
in international trade, the Bank offers international payment services, foreign exchange, and trade letters of credit. The Bank also offers a variety of deposit
accounts and balance optimization solutions.
Private Wealth Management
FBB, through its First Business Trust & Investments (“FBTI”) division, acts as fiduciary and investment manager for individual and corporate clients,
creating and executing asset allocation strategies tailored to each client’s unique situation. FBTI has full fiduciary powers and offers trust, estate, financial
planning, and investment services, acting in a trustee or agent capacity as well as employee benefit/retirement plan services. FBTI also provides brokerage and
custody-only services, for which it administers and safeguards assets, but does not provide investment advice. As of December 31, 2018 , FBTI had $1.630 billion
of assets under management and administration.
Competition
The Bank encounters strong competition across all of our lines of business. Such competition includes banks, savings institutions, mortgage banking
companies, credit unions, finance companies, equipment finance companies, mutual funds, insurance companies, brokerage firms, investment banking firms, and
FinTech companies. The Bank also competes with regional and national financial institutions, many of which have greater liquidity, higher lending limits, greater
access to capital, more established market recognition, and more resources than the Bank. We believe the experience, expertise, and responsiveness of our banking
professionals, and our focus on fostering long-lasting relationships sets us apart from our competitors.
Employees
At December 31, 2018 , we had 289 employees equating to approximately 274 full-time equivalent employees. None of our employees are represented by
a union or subject to a collective bargaining agreement.
Subsidiaries
First Business Bank
FBB is a state bank chartered in 1909 in Wisconsin under the name Kingston State Bank. In 1990, FBB relocated its home office to Madison, Wisconsin
and began focusing on providing high-quality banking services to small- to medium-sized businesses located in Madison and the surrounding area. FBB’s business
lines include commercial loans, commercial real estate loans, equipment loans and leases, commercial deposit accounts, and treasury management services. FBB
offers a variety of deposit accounts and personal loans to business owners, executives, professionals, and high net worth individuals. FBB also offers trust and
investment services through FBTI and investment portfolio administrative and asset/liability management services through First Business Consulting Services
(“FBCS”), both divisions of FBB. FBB has four full-service banking locations in Madison, Brookfield, and Appleton, Wisconsin, and Leawood, Kansas.
FBB has nine wholly-owned subsidiaries:
•
•
•
FBCC is an asset-based lending company specializing in providing lines of credit, factored receivable financing and term loans secured by accounts
receivable, inventory, equipment, and real estate assets, primarily to manufacturers and wholesale distribution companies located throughout the
country, with a concentration in the Midwest. FBCC was established in 1995 and has sales offices in several states.
FBEF is a commercial equipment finance company offering a full array of financing options to commercial clients of which the largest percentage
are currently located in Wisconsin. It offers new and replacement equipment loans and leases, debt restructuring, consolidation, and sale-lease-back
transactions through its primary banking locations in Wisconsin. FBEF was established in 1998.
Rimrock Road Investment Fund, LLC (“Rimrock”), established in 2009 and formerly known as FBB Real Estate, LLC, is a limited liability company
originally established for the purpose of holding and liquidating real estate and other assets acquired by FBB through foreclosure or other legal
proceedings. In 2014, Rimrock’s purpose was
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changed to reflect its qualified equity investment in a Madison, Wisconsin community development project, including the financing and ownership of
a property that generates federal new market tax credits.
•
BOC Investment, LLC (“BOC”), is a limited liability company established for the purpose of capturing federal historic tax credits to reduce the cost
of borrowing for a FBB client engaged in rehabilitating a historic building in Madison, Wisconsin. BOC was established in 2015.
• Mitchell Street Apartments Investment, LLC (“Mitchell”), is a limited liability company established for the purpose of capturing federal and state
historic tax credits to reduce the cost of borrowing for a FBB client engaged in rehabilitating a historic building in Milwaukee, Wisconsin. Mitchell
was established in 2016.
•
•
•
•
ABKC Real Estate, LLC (“ABKCRE”), is a limited liability company established for the purpose of holding and liquidating real estate and other
assets acquired by FBB through foreclosure or other legal proceedings. ABKCRE was established in 2017.
FBB Real Estate 2, LLC (“FBB RE 2”), is a limited liability company established for the purpose of holding and liquidating real estate and other
assets acquired by FBB through foreclosure or other legal proceedings. FBB RE 2 was established in 2018.
FBB Tax Credit Investment, LLC (“FBB Tax Credit”), established in 2012 and formerly known as FBB-Milwaukee Real Estate, LLC (“FBBMRE”),
is a limited liability company originally established for the purpose of holding and liquidating real estate and other assets acquired by FBB through
foreclosure or other legal proceedings. In 2017, FBB Tax Credit’s purpose was changed to facilitate investments in federal and state tax credits.
First Madison Investment Corp. (“FMIC”) is located in and formed under the laws of the State of Nevada, and was organized for the purpose of
managing a portion of FBB’s investment portfolio. FMIC was established in 1993.
As of December 31, 2018 , FBB had total gross loans and leases receivable of $1.619 billion , total deposits of $1.459 billion , and total stockholders’
equity of $206.7 million .
FBFS Statutory Trust II
In September 2008 , FBFS formed FBFS Statutory Trust II (“Trust II”), a Delaware business trust wholly-owned by FBFS. In 2008 , Trust II completed
the sale of $10.0 million of 10.5% fixed rate trust preferred securities. Trust II also issued common securities in the amount of $315,000 to FBFS. Trust II used the
proceeds from the offering to purchase $10.3 million of 10.5% junior subordinated notes issued by FBFS. FBFS has the right to redeem the junior subordinated
notes at each interest payment date on or after September 26, 2013 . The preferred securities are mandatorily redeemable upon the maturity of the junior
subordinated notes on September 26, 2038 . FBFS’s ownership interest in Trust II has not been consolidated into the financial statements.
Corporate Information
Our principal executive offices are located at 401 Charmany Drive, Madison, Wisconsin 53719 and our telephone number is (608) 238-8008. We
maintain an Internet website at www.firstbusiness.com. This Form 10-K and all of our other filings under the Securities Exchange Act of 1934, as amended (the
“Exchange Act”), are available through that website, including copies of our proxy statement, annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and any amendments to those reports, on the date that we electronically file those materials with, or furnish them to, the Securities
and Exchange Commission (“SEC”). The contents of our website are not incorporated by reference into this Form 10-K.
Markets
Although certain of our business lines are marketed throughout the Midwest and beyond, our primary markets lie in Wisconsin, Kansas, and Missouri.
Specifically, our three target markets in Wisconsin consist of Madison and Milwaukee, and their surrounding communities, and Northeastern Wisconsin. We serve
our target markets in Kansas and Missouri through our Leawood, Kansas office, which is located in the Kansas City metropolitan statistical area. Each of our
primary markets provides a unique set of economic and demographic characteristics which provide us with a variety of strategic opportunities. A brief description
of each of our primary markets is as follows:
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Madison
As the capital of Wisconsin and home of the University of Wisconsin-Madison, our Madison market, specifically Dane County, offers an appealing
economic environment populated by a highly educated workforce. While the economy of the Madison market is driven in large part by the government and
education sectors, there is also a diverse array of industries outside of these segments, including significant concentration of insurance companies and agricultural-
related industries. Madison is also home to a concentration of research and development related companies, which benefit from the area’s strong governmental and
academic ties, as well as several major health care systems and hospitals, which provides healthcare services to South Central Wisconsin.
Milwaukee
Our Milwaukee market, the primary commercial and industrial hub for Southeastern Wisconsin, provides a diverse economic base, with both a highly
skilled labor force and significant manufacturing base. The most prominent economic sectors in the Milwaukee market include manufacturing, financial services,
health care, diversified service companies, and education. Milwaukee is home to several major hospitals, providing health services to the greater Southeastern
Wisconsin market, several large academic institutions including the University of Wisconsin-Milwaukee and Marquette University, and a wide variety of small- to
medium-sized firms with representatives in nearly every industrial classification.
Northeastern Wisconsin
The cities of Appleton, Green Bay, Oshkosh, and Manitowoc, Wisconsin serve as the primary population centers in our Northeast Wisconsin market and
provide an attractive market to a variety of industries, including transportation, utilities, packaging, and diversified services, with the most significant economic
drivers being the manufacturing, packaging, and paper goods industries.
Kansas City
Geographically located in the center of the U.S., the greater Kansas City area includes 18 counties and more than 50 communities in Missouri and Kansas,
including a central business district located in Kansas City, Missouri and communities on both sides of the state line. The area is known for the diversity of its
economic base, with major employers in manufacturing and distribution, architecture and engineering, technology, telecommunications, financial services, and
bioscience as well as local government and higher education.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following contains certain information about the executive officers of FBFS. There are no family relationships between any directors or executive
officers of FBFS.
Corey
A.
Chambas,
age 56 ,
has served as a director of FBFS since July 2002, as Chief Executive Officer since December 2006 and as President since
February 2005. He served as Chief Operating Officer of FBFS from February 2005 to September 2006 and as Executive Vice President from July 2002 to February
2005. He served as Chief Executive Officer of FBB from July 1999 to September 2006 and as President of FBB from July 1999 to February 2005. He also
currently serves as a director of our subsidiary FMIC. Mr. Chambas has over 30 years of commercial banking experience. Prior to joining FBFS in 1993, he was a
Vice President of Commercial Lending with M&I Bank, now known as BMO Harris Bank, N.A. (“BMO Harris Bank”), in Madison, Wisconsin.
Edward
G.
Sloane,
Jr.,
age 58, has served as Chief Financial Officer of FBFS since January 2016. Mr. Sloane also serves as the Chief Financial Officer of
the Bank. Mr. Sloane has over 30 years of financial services experience including mergers and acquisitions, strategic planning and financial reporting and analysis.
Prior to joining FBFS, Mr. Sloane was Executive Vice President, Chief Financial Officer and Treasurer with Peoples Bancorp, Inc. in Marietta, Ohio from 2008 to
2015. He also served as Senior Vice President of Strategic Planning & Analysis for WesBanco, Inc. in Wheeling, West Virginia from 2006 to 2008, as Senior Vice
President and Controller from 1998 to 2006 and in various other capacities from 1989 to 1998.
Michael
J.
Losenegger,
age 61 ,
has served as Chief Credit Officer of FBFS since May 2011. Mr. Losenegger also serves as the Chief Credit Officer of
the Bank. He also currently serves as a director for our subsidiaries FBCC and FBEF. Prior to being appointed Chief Credit Officer, Mr. Losenegger served as
FBFS’s Chief Operating Officer since September 2006.
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Mr. Losenegger joined FBFS in 2003 and has held various positions with FBB, including Chief Executive Officer, Chief Operating Officer and Senior Vice
President of Business Development. Mr. Losenegger has over 30 years of experience in commercial lending. Prior to joining FBFS, Mr. Losenegger was Senior
Vice President of Lending at M&I Bank, now known as BMO Harris Bank, in Madison, Wisconsin.
Barbara
M.
Conley,
age 65 ,
has served as FBFS’s General Counsel since June 2008. Ms. Conley also serves as General Counsel of the Bank. She has
over 35 years of experience in commercial banking. Immediately prior to joining FBFS in 2007, Ms. Conley was a Senior Vice President in Corporate Banking
with Associated Bank, National Association. She had been employed at Associated Bank since May 1976.
Jodi
A.
Chandler,
age 54 ,
has served as Chief Human Resources Officer of FBFS since January 2010. Prior to that, she held the position of Senior Vice
President-Human Resources for several years. She has been an employee of FBFS for over 25 years.
Mark
J.
Meloy,
age 57, has served as Chief Executive Officer of FBB since December 2007. Mr. Meloy joined FBFS in 2000 and has held various
positions including Executive Vice President of FBB and President and Chief Executive Officer of FBB-Milwaukee. He currently serves as CEO of FBEF. He also
currently serves as a director of our subsidiaries FBB, FBCC and FBEF. Mr. Meloy has over 25 years of commercial lending experience. Prior to joining FBFS,
Mr. Meloy was a Vice President and Senior Relationship Manager with Firstar Bank, NA, in Cedar Rapids, Iowa and Milwaukee, Wisconsin, now known as
U.S. Bank, working in their financial institutions group with mergers and acquisition financing.
Daniel
S.
Ovokaitys,
age 45 ,
has served as Chief Information Officer since June 2014. Prior to joining FBFS, Mr. Ovokaitys held the position of Head of
Corporate IT (North/South America) for Merz Pharmaceuticals, located in Frankfurt, Germany, from 2010 to 2014. He also served as Director of IT for Aurora
Health Care from 2006 to 2010 and Manager of IT for the American Transmission Company from 2000 to 2006.
David
R.
Seiler,
age 54 ,
has served as Chief Operating Officer of FBFS since April 2016. He also currently serves as a director for our subsidiary FBCC.
Mr. Seiler has over 25 years of financial services experience including his previous position as Managing Director (formerly Senior Vice President/Manager) of the
Correspondent Banking Division with BMO Harris Bank in Milwaukee, Wisconsin which he held from 2007 to 2016. Prior to that, he held the position of Senior
Vice President/Team Leader, Correspondent Real Estate Division from 2005 to 2007 and Vice President, Relationship Manager, Commercial Real Estate from
2002 to 2005.
Below is a brief description of certain laws and regulations that relate to us and the Bank. This narrative does not purport to be complete and is qualified
SUPERVISION AND REGULATION
in its entirety by reference to applicable laws and regulations.
General
FDIC-insured institutions, like the Bank, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, our
growth and earnings performance may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and
state statutes and by the regulations and policies of various bank regulatory agencies, including our primary regulator, the Board of Governors of the Federal
Reserve System (“Federal Reserve”), the Bank’s state regulator, the Wisconsin Department of Financial Institutions (“WDFI”), and its primary federal regulator,
the Federal Deposit Insurance Corporation (“FDIC”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities,
accounting rules developed by the Financial Accounting Standards Board (“FASB”), securities laws administered by the SEC and state securities authorities, and
anti-money laundering laws enforced by the U.S. Department of the Treasury (“Treasury”) have an impact on our business. The effect of these statutes, regulations,
regulatory policies, and accounting rules are significant to our operations and results.
Federal and state banking laws impose a comprehensive system of supervision, regulation, and enforcement on the operations of FDIC-insured
institutions, their holding companies, and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than
stockholders. These laws, and the regulations of the bank regulatory agencies issued under them, affect, among other things, the scope of our business, the kinds
and amounts of investments the Corporation and the Bank may make, reserve requirements, required capital levels relative to assets, the nature and amount of
collateral for loans, the establishment of branches, the ability to merge, consolidate and acquire, dealings with the Corporation’s and the Bank’s insiders and
affiliates, and payment of dividends. In reaction to the global financial crisis and particularly following the passage of the Dodd-Frank Act, we experienced
heightened regulatory requirements and scrutiny.
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Although the reforms primarily targeted systemically important financial service providers, their influence filtered down in varying degrees to community banks
over time and caused our compliance and risk management processes, and the costs thereof, to increase. After the 2016 federal elections, momentum to decrease
the regulatory burden on community banks gathered strength. In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the
“Regulatory Relief Act”) was enacted to modify or remove certain financial reform rules and regulations. While the Regulatory Relief Act maintains most of the
regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less
than $10 billion, like us, and for large banks with assets of more than $50 billion that were considered systemically important under the Dodd-Frank Act solely
because of size. Many of these changes are intended to result in meaningful regulatory relief for community banks and their holding companies, including new
rules that may make the capital requirements less complex. For a discussion of capital requirements, see “The Role of Capital.” It also eliminated questions about
the applicability of certain Dodd-Frank Act reforms to community bank systems, including relieving the Bank of any requirement to engage in mandatory stress
tests, name a risk committee, or comply with the Volcker Rule’s complicated prohibitions on proprietary trading and ownership of private funds. The Corporation
believes these reforms are favorable to its operations, but the true impact remains difficult to predict until rulemaking is final and the reforms are fully
implemented.
The supervisory framework for U.S. banking organizations subjects banks and bank holding companies to regular examination by their respective
regulatory agencies, which results in examination reports and ratings that are not publicly available and that can impact the conduct and growth of their business.
These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and
performance, earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the
operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law,
or are otherwise inconsistent with laws and regulations.
The following is a summary of the material elements of the supervisory and regulatory framework applicable to the Corporation and the Bank, beginning
with a discussion of the continuing regulatory emphasis on our capital levels. It does not describe all of the statutes, regulations, and regulatory policies that apply,
nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and
regulatory provision.
The Role of Capital
Regulatory capital represents the net assets of a banking organization available to absorb losses. Because of the risks attendant to their business, FDIC-
insured institutions are generally required to hold more capital than other businesses, which directly affects our earnings capabilities. While capital has historically
been one of the key measures of the financial health of both bank holding companies and banks, its role became fundamentally more important in the wake of the
global financial crisis, as the banking regulators recognized that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses
during periods of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish capital standards for banks and bank holding
companies that are meaningfully more stringent than those in place previously.
Minimum Required Capital Levels. Banks have been required to hold minimum levels of capital based on guidelines established by the bank regulatory
agencies since 1983. The minimums have been expressed in terms of ratios of “capital” divided by “total assets.” As discussed below, bank capital measures have
become more sophisticated over the years and have focused more on the quality of capital and the risk of assets. Bank holding companies have historically had to
comply with less stringent capital standards than their bank subsidiaries and have been able to raise capital with hybrid instruments such as trust preferred
securities. The Dodd-Frank Act mandated the Federal Reserve to establish minimum capital levels for holding companies on a consolidated basis as stringent as
those required for FDIC-insured institutions. A result of this change is that the proceeds of hybrid instruments, such as trust preferred securities, were excluded
from capital over a phase-out period. However, if such securities were issued prior to May 19, 2010 by bank holding companies with less than $15 billion of assets,
they may be retained, subject to certain restrictions. Because we have assets of less than $15 billion, we are able to maintain our trust preferred proceeds as capital
but we have to comply with new capital mandates in other respects and will not be able to raise capital in the future through the issuance of trust preferred
securities.
The Basel International Capital Accords. The risk-based capital guidelines for U.S. banks since 1989 were based upon the 1988 capital accord known as
“Basel I” adopted by the international Basel Committee on Banking Supervision, a committee of central banks and bank supervisors that acts as the primary global
standard-setter for prudential regulation, as implemented by the U.S. bank regulatory agencies on an interagency basis. The accord recognized that bank assets for
the purpose of the capital ratio calculations needed to be assigned risk weights (the theory being that riskier assets should require more capital) and that off-balance
sheet exposures needed to be factored in the calculations. Basel I had a very simple formula for assigning risk weights to bank assets from 0% to 100% based on
four categories. In 2008, the banking agencies
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collaboratively began to phase-in capital standards based on a second capital accord, referred to as “Basel II,” for large or “core” international banks (generally
defined for U.S. purposes as having total assets of $250 billion or more, or consolidated foreign exposures of $10 billion or more) known as “advanced
approaches” banks. The primary focus of Basel II was on the calculation of risk weights based on complex models developed by each advanced approaches bank.
Because most banks were not subject to Basel II, the U.S. bank regulators worked to improve the risk sensitivity of Basel I standards without imposing the
complexities of Basel II. This “standardized approach” increased the number of risk-weight categories and recognized risks well above the original 100% risk
weight. It is institutionalized by the Dodd-Frank Act for all banking organizations, even for the advanced approaches banks, as a floor.
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision,
announced agreement on a strengthened set of capital requirements for banking organizations around the world, known as Basel III, to address deficiencies
recognized in connection with the global financial crisis.
The Basel III Rule . In July 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent
part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to capital requirements
historically, which were in the form of guidelines, Basel III was released in the form of enforceable regulations by each of the regulatory agencies. The Basel III
Rule is applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan
associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies” who are relieved from compliance with the
Basel III Rule. Banking organizations became subject to the Basel III Rule on January 1, 2015 and its requirements were fully phased-in as of January 1, 2019.
The Basel III Rule increased the required quantity and quality of capital and, for nearly every class of assets, it requires a more complex, detailed and
calibrated assessment of risk and calculation of risk-weight amounts.
Not only did the Basel III Rule increase most of the required minimum capital ratios in effect prior to January 1, 2015, but it introduced the concept of
Common Equity Tier 1 Capital, which consists primarily of common stock, related surplus (net of Treasury stock), retained earnings, and Common Equity Tier 1
minority interests subject to certain regulatory adjustments. The Basel III Rule also changed the definition of capital by establishing more stringent criteria that
instruments must meet to be considered Additional Tier 1 Capital (primarily non-cumulative perpetual preferred stock that meets certain requirements) and Tier 2
Capital (primarily other types of preferred stock and subordinated debt, subject to limitations). A number of instruments that qualified as Tier 1 Capital under Basel
I do not qualify, or their qualifications changed. For example, noncumulative perpetual preferred stock, which qualified as simple Tier 1 Capital under Basel I,
does not qualify as Common Equity Tier 1 Capital, but qualifies as Additional Tier 1 Capital. The Basel III Rule also constrained the inclusion of minority
interests, mortgage-servicing assets, and deferred tax assets in capital and requires deductions from Common Equity Tier 1 Capital in the event that such assets
exceed a certain percentage of a banking institution’s Common Equity Tier 1 Capital.
The Basel III Rule required minimum capital ratios as of January 1, 2015, as follows:
•
•
•
•
A ratio of minimum Common Equity Tier 1 Capital equal to 4.5% of risk-weighted assets;
An increase in the minimum required amount of Tier 1 Capital from 4% to 6% of risk-weighted assets;
A continuation of the minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8% of risk-weighted assets; and
A minimum leverage ratio of Tier 1 Capital to total quarterly average assets equal to 4% in all circumstances.
In addition, institutions that seek the freedom to make capital distributions (including for dividends and repurchases of stock) and pay discretionary
bonuses to executive officers without restriction must also maintain 2.5% in Common Equity Tier 1 Capital attributable to a capital conservation buffer (fully
phased-in as of January 1, 2019). The purpose of the conservation buffer is to ensure that banking institutions maintain a buffer of capital that can be used to absorb
losses during periods of financial and economic stress. Factoring in the conservation buffer increases the minimum ratios depicted above to 7% for Common
Equity Tier 1 Capital, 8.5% for Tier 1 Capital and 10.5% for Total Capital.
Well-Capitalized Requirements . The ratios described above are minimum standards in order for banking organizations to be considered “adequately
capitalized.” Bank regulatory agencies uniformly encourage banks to hold more capital and be “well-capitalized” and, to that end, federal law and regulations
provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a
banking organization that is well-capitalized may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of
activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept, roll-over or renew brokered deposits. Higher capital levels
could also be required if warranted by the particular circumstances or risk profiles of
8
individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate
account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any
banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions ( i.e.
, Tier 1
Capital less all intangible assets), well above the minimum levels.
Under the capital regulations of the FDIC and Federal Reserve, in order to be well‑capitalized, a banking organization must maintain:
•
•
•
•
A Common Equity Tier 1 Capital ratio to risk-weighted assets of 6.5% or more;
A ratio of Tier 1 Capital to total risk-weighted assets of 8% or more (6% under Basel I);
A ratio of Total Capital to total risk-weighted assets of 10% or more (the same as Basel I); and
A leverage ratio of Tier 1 Capital to total adjusted average quarterly assets of 5% or greater.
As of December 31, 2018: (i) the Bank is not subject to a directive from the WDFI or the FDIC to increase its capital and (ii) the Bank was well-
capitalized, as defined by FDIC regulations.
Prompt Corrective Action . The concept of an institution being “well-capitalized” is part of a regulatory enforcement regime that provides the federal
banking regulators with broad power to take “prompt corrective action” to resolve the problems of institutions based on the capital level of each particular
institution. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly
undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned,
the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting
its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting transactions between
the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits; (vi) ordering a new election of directors of the institution;
(vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks;
(ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing
a receiver for the institution.
The Potential for Community Bank Capital Simplification . Community banks have long raised concerns with bank regulators about the regulatory
burden, complexity, and costs associated with certain provisions of the Basel III Rule. In response, Congress provided a potential Basel III “off-ramp” for
institutions, like us, with total consolidated assets of less than $10 billion. Section 201 of the Regulatory Relief Act instructed the federal banking regulators to
establish a single "Community Bank Leverage Ratio" (“CBLR”) of between 8 and 10%. On November 21, 2018, the agencies proposed setting the CBLR at 9% of
tangible equity to total assets for a qualifying bank to be well-capitalized. Under the proposal, a community banking organization would be eligible to elect the new
framework if it has less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a CBLR greater than
9%. The electing institution would not be required to calculate the existing risk-based and leverage capital requirements of the Basel III Rule and would not need to
risk weight its assets for purposes of capital calculations.
The Corporation is in the process of considering the CBLR proposal and will await the final regulation to determine whether it will elect the framework.
FBFS
General. As the sole stockholder of the Bank, we are a bank holding company. As a bank holding company, we are registered with, and subject to
regulation supervision and enforcement by, the Federal Reserve under the BHCA. We are legally obligated to act as a source of financial strength to the Bank and
to commit resources to support the Bank in circumstances where we might not otherwise do so. Under the BHCA, we are subject to periodic examination by the
Federal Reserve. We are required to file with the Federal Reserve periodic reports of our operations and such additional information regarding the Corporation and
our subsidiaries as the Federal Reserve may require.
Acquisitions and Activities . The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior
approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding
company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company
to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law
limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured institution affiliates in the state in
which the target bank is located (provided that those limits do
9
not discriminate against out-of-state institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum
period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Act,
bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or acquisitions. For a discussion of the capital
requirements, see “The Role of Capital” above.
The BHCA generally prohibits the Corporation from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any
company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their
subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares
of companies engaged in, certain businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper
incident thereto.” This authority permits the Corporation to engage in a variety of banking-related businesses, including the ownership and operation of a savings
association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and
mortgage banking and brokerage services. The BHCA does not place territorial restrictions on the domestic activities of nonbank subsidiaries of bank holding
companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding
companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and
sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is
financial in nature or incidental to any such financial activity or that the Federal Reserve determines by order to be complementary to any such financial activity
and does not pose a substantial risk to the safety or soundness of FDIC-insured institutions or the financial system generally. The Corporation has not elected to
operate as a financial holding company.
Change in Control. Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding
company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the
outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership.
Capital Requirements. The Corporation has been subject to the complex consolidated capital requirements of the Basel III Rule since the U.S. federal
banking agencies approved its implementation effective January 1, 2015. Only qualifying small bank holding companies were excluded from compliance with the
Basel III Rule by virtue of the Federal Reserve’s “Small Bank Holding Company Policy Statement.” Prior to 2018, our assets were in excess of the maximum
permitted in the definition of a small bank holding company for this purpose; however, the Regulatory Relief Act expanded the category of holding companies that
may rely on the policy statement by raising the maximum amount of assets they may hold to $3 billion, and the Federal Reserve issued an interim final rule,
effective August 30, 2018, to bring the policy statement in line with the law. As a result, qualifying holding companies with assets of less than $3 billion are not
subject to the capital requirements of the Basel III Rule and are deemed to be “well-capitalized.” For a discussion of capital requirements, see “The Role of
Capital” above.
Dividend Payments. Our ability to pay dividends to our stockholders may be affected by both general corporate law considerations and policies of the
Federal Reserve applicable to bank holding companies. As a Wisconsin corporation, we are subject to the limitations of Wisconsin law, which allows it to pay
dividends unless, after giving it effect, any of the following would occur: (i) we would not be able to pay our debts as they become due in the usual course of
business or (ii) the total assets would be less than the sum of its total liabilities plus any amount that would be needed if we were to be dissolved at the time of the
dividend payment, to satisfy the preferential rights upon dissolution of stockholders whose rights are superior to the rights of the stockholders receiving the
distribution.
As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer or significantly
reduce dividends to stockholders if: (i) the company’s net income available to stockholders for the past four quarters, net of dividends previously paid during that
period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall
current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The
Federal Reserve also possesses enforcement powers over bank holding companies and their nonbank subsidiaries to prevent or remedy actions that represent unsafe
or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and
bank holding companies. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends have to maintain 2.5% in Common Equity Tier 1
Capital attributable to the capital conservation buffer. See “The Role of Capital” above.
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Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank holding companies and
their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market transactions in U.S. government securities, changes
in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. These means are used in varying combinations to influence
overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
Federal Securities Regulation. The Corporation’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the
Exchange Act. Consequently, we are subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the
Exchange Act.
Corporate Governance . The Dodd-Frank Act addressed many investor protection, corporate governance, and executive compensation matters that will
affect most U.S. publicly traded companies. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give
stockholders a nonbinding vote on executive compensation and so-called “golden parachute” payments, and authorizing the SEC to promulgate rules that would
allow stockholders to nominate and solicit voters for their own candidates using a company’s proxy materials. The legislation also directed the Federal Reserve to
promulgate rules prohibiting excessive compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.
The Bank
General. The Bank is a Wisconsin state-chartered bank. The deposit accounts of the Bank are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to
the maximum extent provided under federal law and FDIC regulations, currently $250,000 per insured depositor category. As a Wisconsin-chartered FDIC-insured
bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the WDFI, the chartering authority for Wisconsin banks, and
the FDIC, designated by federal law as the primary federal regulator of insured state banks that, like the Bank, are not members of the Federal Reserve System
(nonmember banks).
Deposit Insurance . As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has
adopted a risk-based assessment system whereby FDIC-insured institutions pay insurance premiums at rates based on their risk classification. For institutions like
the Bank that are not considered large and highly complex banking organizations, assessments are now based on examination ratings and financial ratios. The total
base assessment rates currently range from 1.5 basis points to 30 basis points. At least semi-annually, the FDIC updates its loss and income projections for the DIF
and, if needed, increases or decreases the assessment rates, following notice and comment on proposed rulemaking. The assessment base against which an FDIC-
insured institution’s deposit insurance premiums paid to the DIF has been calculated since effectiveness of the Dodd-Frank Act based on its average consolidated
total assets less its average tangible equity. This method shifted the burden of deposit insurance premiums toward those large depository institutions that rely on
funding sources other than U.S. deposits.
The reserve ratio is the FDIC insurance fund balance divided by estimated insured deposits. The Dodd-Frank Act altered the minimum reserve ratio of the
DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends
to FDIC-insured institutions when the reserve ratio exceeds certain thresholds. The reserve ratio reached 1.36% as of September 30, 2018 (most recent available),
exceeding the statutory required minimum reserve ratio of 1.35%. The FDIC will provide assessment credits to insured depository institutions, like the Bank, with
total consolidated assets of less than $10 billion for the portion of their regular assessments that contribute to growth in the reserve ratio between 1.15% and 1.35%.
The FDIC will apply the credits each quarter that the reserve ratio is at least 1.38% to offset the regular deposit insurance assessments of institutions with credits.
FICO Assessments . In addition to paying basic deposit insurance assessments, FDIC-insured institutions must pay FICO assessments. FICO is a mixed-
ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Competitive Equality Banking Act of 1987 to
function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of
approximately $8.1 billion that mature through 2019. FICO’s authority to issue bonds ended on December 12, 1991. Since 1996, federal legislation has required
that all FDIC-insured institutions pay assessments to cover interest payments on FICO’s outstanding obligations. The FICO assessment rate is adjusted quarterly
and for the fourth quarter of 2018 was 32 cents per $100 dollars of assessable deposits.
Supervisory Assessments. All Wisconsin banks are required to pay supervisory assessments to the WDFI to fund the operations of that agency. The
amount of the assessment is calculated on the basis of the Bank’s total assets.
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Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital requirements, see
“The Role of Capital” above.
Liquidity Requirements. Liquidity is a measure of the ability and ease with which bank assets may be converted to cash. Liquid assets are those that can
be converted to cash quickly if needed to meet financial obligations. To remain viable, FDIC-insured institutions must have enough liquid assets to meet their near-
term obligations, such as withdrawals by depositors. Because the global financial crisis was in part a liquidity crisis, Basel III also includes a liquidity framework
that requires FDIC-insured institutions to measure their liquidity against specific liquidity tests. One test, referred to as the LCR, is designed to ensure that the
banking entity has an adequate stock of unencumbered high-quality liquid assets that can be converted easily and immediately in private markets into cash to meet
liquidity needs for a 30-calendar day liquidity stress scenario. The other test, known as the NSFR, is designed to promote more medium- and long-term funding of
the assets and activities of FDIC-insured institutions over a one-year horizon. These tests provide an incentive for banks and holding companies to increase their
holdings in Treasury securities and other sovereign debt as a component of assets, increase the use of long-term debt as a funding source and rely on stable funding
like core deposits (in lieu of brokered deposits).
In addition to liquidity guidelines already in place, the federal bank regulatory agencies implemented the Basel III LCR in September 2014, which
requires large financial firms to hold levels of liquid assets sufficient to protect against constraints on their funding during times of financial turmoil, and in 2016
proposed implementation of the NSFR. While these rules do not apply to the Bank, it continues to review its liquidity risk management policies.
Dividend Payments. The primary source of funds for the Corporation is dividends from the Bank. Under Wisconsin law, the board of directors of a bank
may declare and pay a dividend from its undivided profits in an amount they consider expedient. The board of directors must provide for the payment of all
expenses, losses, required reserves, taxes, and interest accrued or due from the bank before the declaration of dividends from undivided profits. If dividends
declared and paid in either of the two immediately preceding years exceeded net income for either of those two years respectively, the bank may not declare or pay
any dividend in the current year that exceeds year-to-date net income except with the written consent of the division. The FDIC and the WDFI may prohibit the
payment of dividends by the Bank if either or both determine such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Rule,
institutions that seek the freedom to pay dividends will have to maintain 2.5 percent in Common Equity Tier 1 Capital attributable to the capital conservation
buffer. See “The Role of Capital” above.
State Bank Investments and Activities. The Bank is permitted to make investments and engage in activities directly or through subsidiaries as authorized
by Wisconsin law. However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or
retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC-insured
state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank
meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the DIF.
These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank and its “affiliates.”
We are an affiliate of the Bank for purposes of these restrictions, and covered transactions subject to the restrictions include extensions of credit to the Corporation,
investments in the stock or other securities of the Corporation and the acceptance of the stock or other securities of the Corporation as collateral for loans made by
the Bank. The Dodd-Frank Act enhanced the requirements for certain transactions with affiliates, including an expansion of the definition of “covered transactions”
and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.
Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of
the Corporation and its subsidiaries, to principal stockholders of the Corporation and to “related interests” of such directors, officers and principal stockholders. In
addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Corporation or the Bank, or a principal
stockholder of the Corporation, may obtain credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted operational and managerial standards to promote the
safety and soundness of FDIC-insured institutions. The standards apply to internal controls, information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
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In general, the safety and soundness standards prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own
procedures to achieve those goals. While regulatory standards do not have the force of law, if an institution operates in an unsafe and unsound manner, the FDIC-
insured institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an FDIC-insured institution
fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal
regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the
regulator may restrict the FDIC-insured institution’s rate of growth, require the FDIC-insured institution to increase its capital, restrict the rates the institution pays
on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with safety and soundness may
also constitute grounds for other enforcement action by the federal bank regulatory agencies, including cease and desist orders and civil money penalty
assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong
internal controls when evaluating the activities of the FDIC-insured institutions they supervise. Properly managing risks has been identified as critical to the
conduct of safe and sound banking activities and has become even more important as new technologies, product innovation, and the size and speed of financial
transactions have changed the nature of banking markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to,
credit, market, liquidity, operational, legal, and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk, which arises
from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in
unexpected losses. New products and services, third-party risk, incentive compensation and cybersecurity are critical sources of risk that FDIC-insured institutions
are expected to address in the current environment. The Bank is expected to have active board and senior management oversight; adequate policies, procedures,
and limits; adequate risk measurement, monitoring, and management information systems; and comprehensive internal controls.
Branching Authority . Wisconsin banks, such as the Bank, have the authority under Wisconsin law to establish branches anywhere in the State of
Wisconsin, subject to receipt of all required regulatory approvals. The establishment of new interstate branches has historically been permitted only in those states
the laws of which expressly authorize such expansion. The Dodd-Frank Act permits well-capitalized and well-managed banks to establish new interstate branches
or acquire individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) without impediments. Federal law
permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii)
state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger.
Transaction Account Reserves. Federal Reserve regulations require FDIC-insured institutions to maintain reserves against their transaction accounts
(primarily NOW and regular checking accounts). For 2019, the first $16.3 million of otherwise reservable balances are exempt from reserves and have a zero
percent reserve requirement; for transaction accounts aggregating between $16.3 million to $124.2 million, the reserve requirement is 3% of those transaction
account balances; and for net transaction accounts in excess of $124.2 million, the reserve requirement is 10% of the aggregate amount of total transaction account
balances in excess of $124.2 million. These reserve requirements are subject to annual adjustment by the Federal Reserve.
Community Reinvestment Act Requirements. The CRA requires the Bank to have a continuing and affirmative obligation in a safe and sound manner to
help meet the credit needs of the entire community, including low- and moderate-income neighborhoods. Federal regulators regularly assess the Bank’s record of
meeting the credit needs of its communities. Applications for additional acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its
CRA requirements.
Anti-Money Laundering. The Corporation is subject to several federal laws that are designed to combat money laundering and terrorist financing, and to
restrict transactions with persons, companies, or foreign governments sanctioned by United States authorities. This category of laws includes the Bank Secrecy Act
(the “BSA”), the Money Laundering Control Act, the USA PATRIOT Act (collectively, “AML laws”) and implementing regulations as administered by the United
States Treasury Department’s Office of Foreign Assets Control (“sanctions laws”).
As implemented by federal banking and securities regulators and the Department of the Treasury, AML laws obligate depository institutions to verify
their customers’ identity, conduct customer due diligence, report on suspicious activity, file reports of transactions in currency, and conduct enhanced due diligence
on certain accounts. Sanctions laws prohibit persons of the United States from engaging in any transaction with a restricted person or restricted country. Depository
institutions are required by their respective federal regulators to maintain policies and procedures in order to ensure compliance with the above obligations. Federal
regulators regularly examine BSA/Anti–Money Laundering (“AML”) and sanctions compliance programs
13
to ensure their adequacy and effectiveness, and the frequency and extent of such examinations and the remedial actions resulting therefrom have been increasing.
Non–compliance with sanctions laws and/or AML laws or failure to maintain an adequate BSA/AML compliance program can lead to significant monetary
penalties and reputational damage, and federal regulators evaluate the effectiveness of an applicant in combating money laundering when determining whether to
approve a proposed bank merger, acquisition, restructuring, or other expansionary activity.
Privacy and Cybersecurity. The Bank is subject to many U.S. federal and state laws and regulations governing requirements for maintaining policies and
procedures to protect non-public confidential information of their customers. These laws require the Bank to periodically disclose their privacy policies and
practices relating to sharing such information and permit consumers to opt out of their ability to share information with unaffiliated third parties under certain
circumstances. They also impact the Bank’s ability to share certain information with affiliates and non-affiliates for marketing and/or non-marketing purposes, or
to contact clients with marketing offers. In addition, the Bank is required to implement a comprehensive information security program that includes administrative,
technical, and physical safeguards to ensure the security and confidentiality of customer records and information. These security and privacy policies and
procedures, for the protection of personal and confidential information, are in effect across all businesses and geographic locations.
Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any one industry or
segment. A concentration in commercial real estate is one example of regulatory concern. The interagency Concentrations in Commercial Real Estate Lending,
Sound Risk Management Practices guidance (“CRE Guidance”) provides supervisory criteria, including the following numerical indicators, to assist bank
examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny:
(i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land development
loans exceeding 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in
developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. On
December 18, 2015, the federal banking agencies issued a statement to reinforce prudent risk-management practices related to CRE lending, having observed
substantial growth in many CRE asset and lending markets, increased competitive pressures, rising CRE concentrations in banks, and an easing of CRE
underwriting standards. The federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management
practices to identify, measure, monitor, and manage the risks arising from CRE lending. In addition, FDIC-insured institutions must maintain capital commensurate
with the level and nature of their CRE concentration risk.
Consumer Financial Services. The historical structure of federal consumer protection regulation applicable to all providers of consumer financial
products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection laws. The
CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply to all providers of consumer products and services, including the
Bank, as well as the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over providers
with more than $10 billion in assets. FDIC-insured institutions with $10 billion or less in assets, like the Bank, continue to be examined by their applicable bank
regulators.
Because abuses in connection with residential mortgages were a significant factor contributing to the financial crisis, many new rules issued by the CFPB
and required by the Dodd-Frank Act addressed mortgage and mortgage-related products, their underwriting, origination, servicing and sales. The Dodd-Frank Act
significantly expanded underwriting requirements applicable to loans secured by 1-4 family residential real property and augmented federal law combating
predatory lending practices. In addition to numerous disclosure requirements, the Dodd‑Frank Act imposed new standards for mortgage loan originations on all
lenders, including banks and savings associations, in an effort to strongly encourage lenders to verify a borrower’s ability to repay, while also establishing a
presumption of compliance for certain “qualified mortgages.” The Regulatory Relief Act provided relief in connection with mortgages for banks with assets of less
than $10 billion, and, as a result, mortgages the Bank makes are now considered to be qualified mortgages if they are held in portfolio for the life of the loan.
Due to our limited consumer mortgage portfolio, the CFPB’s rules have not had a significant impact on the Bank’s operations.
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Item 1A. Risk Factors
An investment in our common stock is subject to risks inherent to our business. Before making an investment decision, you should carefully read and
consider the following risks and uncertainties. We may encounter risks in addition to those described below, including risks and uncertainties not currently known
to us or those we currently deem to be immaterial. The risks described below, as well as such additional risks and uncertainties, may impair or materially and
adversely affect our business, results of operations, and financial condition.
Credit Risks
If we do not effectively manage our credit risk, we may experience increased levels of delinquencies, non-performing loans, and charge-offs, which
would require increases in our provision for loan and lease losses.
There are risks inherent in making any loan or lease, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting
from uncertainties as to the future value of collateral and cash flows available to service debt, and risks resulting from changes in economic and market conditions.
We cannot assure you that our credit risk approval and monitoring procedures have identified or will identify all of these credit risks, and they cannot be expected
to completely eliminate our credit risks. If the overall economic climate in the U.S., generally, or our markets, specifically, deteriorates, or if the financial condition
of our borrowers otherwise declines, then our borrowers may experience difficulties in repaying their loans and leases, and the level of non-performing loans and
leases, charge-offs, and delinquencies could rise and require increases in the provision for loan and lease losses, which may adversely affect our business, results of
operations, and financial condition.
Our allowance for loan and lease losses may not be adequate to cover actual losses.
We establish our allowance for loan and lease losses and maintain it at a level considered appropriate by management based on an analysis of our
portfolio and market environment. The allowance for loan and lease losses represents our estimate of probable losses inherent in the portfolio at each balance sheet
date and is based upon relevant information available to us. The allowance contains provisions for probable losses that have been identified relating to specific
relationships, as well as probable losses inherent in our loan and lease portfolio that are not specifically identified. Additions to the allowance for loan and lease
losses, which are charged to earnings through the provision for loan and lease losses, are determined based on a variety of factors, including an analysis of our loan
and lease portfolio by segment, historical loss experience, and an evaluation of current economic conditions in our markets. The actual amount of loan and lease
losses is affected by changes in economic, operating and other conditions within our markets, which may be beyond our control, and such losses may exceed
current estimates.
At December 31, 2018 , our allowance for loan and lease losses as a percentage of total loans and leases was 1.26% and as a percentage of total non-
performing loans and leases was 80.73% . Although management believes the allowance for loan and lease losses is appropriate as of such date, we may be
required to take additional provisions for losses in the future to further supplement the allowance, either due to management’s decision, based on credit conditions,
or requirements by our banking regulators. In addition, bank regulatory agencies will periodically review our allowance for loan and lease losses and the value
attributed to non-performing loans and leases. Such regulatory agencies may require us to adjust our determination of the value for these items. Any significant
increases to the allowance for loan and lease losses may materially decrease our net income, which may adversely affect our business, results of operations, and
financial condition.
A significant portion of our loan and lease portfolio is comprised of commercial real estate loans, which involve risks specific to real estate values and
the real estate markets in general.
At December 31, 2018 we had $1.1 billion of commercial real estate loans, which represented 67.6% of our total loan and lease portfolio. Because
payments on such loans are often dependent on the successful operation or development of the property or business involved, repayment of such loans is often
more sensitive than other types of loans to adverse conditions in the real estate market or the general economy, which are outside the borrower’s control. In the
event that the cash flow from the property is reduced, the borrower’s ability to repay the loan could be negatively impacted. The deterioration of one or a few of
these loans could cause a material increase in our level of non-performing loans, which would result in a loss of revenue from these loans and could result in an
increase in the provision for loan and lease losses and an increase in charge-offs, all of which could have a material adverse impact on our net income.
Additionally, many of these loans have real estate as a primary or secondary component of collateral. The market value of real estate can fluctuate significantly in a
short period of time as a result of economic conditions. Adverse developments affecting real estate values in one or more of our markets could impact collateral
coverage associated with the commercial real estate segment of our portfolio, possibly leading to increased specific reserves or charge-offs, which may adversely
affect our business, results of operations, and financial condition.
Because of the risks associated with commercial real estate loans, we closely monitor the concentration of such loans in our portfolio. If we or our
regulators determine that this concentration is approaching or exceeds appropriate limits, we may need to reduce or cease the origination of additional commercial
real estate loans, which could adversely affect our growth
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plans and profitability. In addition, we may be required to sell existing loans in our portfolio, but there can be no assurances that we would be able to do so at
prices that are acceptable to us.
Real estate construction and land development loans are based upon estimates of costs and values associated with the completed project. These
estimates may be inaccurate and we may be exposed to significant losses on loans for these projects.
Real estate construction and land development loans, a subset of commercial real estate loans, comprised approximately $161.6 million , or 10.0% , and
$42.7 million , or 2.6% , of our gross loan and lease portfolio, respectively, as of December 31, 2018 . Such lending involves additional risks as these loans are
underwritten using the as-completed value of the project, which is uncertain prior to its completion, and costs may exceed realizable values in declining real estate
markets. Because of the uncertainties inherent in estimating construction costs and the realizable market value of the completed project, it can be relatively difficult
to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the
disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the
property, rather than the ability of the borrower or guarantor to repay principal and interest. If the appraisal of the completed project’s value proves to be overstated
or market values decline, we may have inadequate security for the repayment of the loan upon completion of construction of the project. If we are forced to
foreclose on a project prior to or at completion due to a default, we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan and
may incur related foreclosure and holding costs. In addition, we may be required to fund additional amounts to complete the project and may have to hold the
property for an unspecified period of time while we attempt to dispose of it.
A large portion of our loan and lease portfolio is comprised of commercial loans secured by various business assets, the deterioration in value of
which could increase our exposure to future probable losses.
At December 31, 2018 , approximately $462.3 million , or 28.6% , of our loan and lease portfolio was comprised of commercial loans to businesses
collateralized by general business assets, including accounts receivable, inventory, and equipment. Our commercial loans are typically larger in amount than loans
to individual consumers and therefore, have the potential for larger losses on an individual loan basis. Additionally, asset-based borrowers are usually highly
leveraged and/or have inconsistent historical earnings. Significant adverse changes in various industries could cause rapid declines in values and collectability
associated with those business assets resulting in inadequate collateral coverage that may expose us to future losses. An increase in specific reserves and charge-
offs may adversely affect our business, results of operations, and financial condition.
SBA lending is a significant part of our strategic business plan. The success of our SBA lending program is dependent upon the continued availability
of SBA loan programs, our status as a preferred lender under the SBA loan programs, our ability to effectively compete and originate new SBA loans, and our
ability to comply with applicable SBA lending requirements.
SBA loans, consisting of both commercial real estate and commercial loans, comprised approximately $45.9 million , or 2.8% , of our gross loan and
lease portfolio as of December 31, 2018 .
As an SBA Preferred Lender, we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary
for lenders that are not SBA Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things,
whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions or impose other restrictions,
including revocation of the lender’s Preferred Lender status. If we lose our status as a Preferred Lender, we may lose our ability to compete effectively with other
SBA Preferred Lenders, and as a result we could experience a material adverse effect to our financial results. Any changes to the SBA program, including changes
to the level of guaranty provided by the federal government on SBA loans or changes to the level of funds appropriated by the federal government to the various
SBA programs, may also have an adverse effect on our business, results of operations, and financial condition.
Typically we sell the guaranteed portions of our SBA 7(a) loans in the secondary market. These sales result in earning premium income and create a
stream of future servicing income. There can be no assurance that we will be able to continue originating these loans, that a secondary market will exist, or that we
will continue to realize premiums upon the sale of the guaranteed portions of these loans. When we sell the guaranteed portion of a SBA loan, we retain credit risk
on the non-guaranteed portion of the loan. If we retain the guaranteed portion of a SBA loan on our balance sheet, we have credit risk on the non-guaranteed
portion of the loan and the guaranteed portion if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated,
funded, or serviced by the Corporation.
In order for a borrower to be eligible to receive an SBA loan, the lender must establish that the borrower would not be able to secure a bank loan without
the credit enhancements provided by a guaranty under the SBA program. Accordingly, the SBA loans in our portfolio generally have weaker credit characteristics
than the rest of our portfolio, and may be at greater risk of default. In the event of a loss resulting from default and a determination by the SBA that there is a
deficiency in the manner
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in which the loan was originated, funded, or serviced by the Corporation, the SBA may require the Corporation to repurchase the previously sold portion of 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. Management has estimated losses in the outstanding guaranteed portions of SBA loans and recorded an allowance
for loan and lease losses and a recourse reserve at a level determined to be appropriate. Significant increases to the allowance for loan and leases losses and the
recourse reserve may materially decrease our net income, which may adversely affect our business, results of operations, and financial condition.
Non-performing assets take significant time to resolve, adversely affect our results of operations and financial condition, and could result in further
losses in the future.
At December 31, 2018 , our non-performing loans and leases totaled $25.3 million , or 1.56% of our gross loan and lease portfolio and our non-
performing assets (which include non-performing loans and foreclosed properties) totaled $27.8 million , or 1.42% of total assets, compared to non-performing
loans and leases of $26.4 million , or 1.76% of our gross loan and lease portfolio and non-performing assets of $27.5 million , or 1.53% of total assets, as of
December 31, 2017 . There can be no assurances that we will not experience further deterioration in our loan portfolio.
Our non-performing assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans, thereby adversely
affecting our net income and returns on assets and equity, increasing our loan administration costs, and adversely affecting our efficiency ratio. When we take
collateral in foreclosure and similar proceedings, we are required to mark the collateral to its then net realizable value, less estimated selling costs, which may
result in a loss. These non-performing loans and foreclosed properties also increase our risk profile and the capital our regulators believe is appropriate in light of
such risks. The resolution of non-performing assets requires significant time commitments from management and can be detrimental to the performance of their
other responsibilities. If we experience increases in non-performing loans and non-performing assets, our net interest income may be negatively impacted and our
loan administration costs could increase, each of which may adversely affect our business, results of operations, and financial condition.
The FASB issued an accounting standard that may require us to increase our allowance for loan losses and may have a material adverse effect on our
financial condition and results of operations.
The FASB has issued a new accounting standard that will be effective for our first fiscal year after December 15, 2019. This standard, referred to as
Current Expected Credit Loss (“CECL”), will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and leases
and recognize the expected credit losses as allowances for loan and lease losses. This will change the current method of providing allowances for loan and lease
losses that are probable, which may require us to increase our allowance for loan and lease losses, and to greatly increase the types of data we will need to collect
and review to determine the appropriate level of the allowance for loan and lease losses. Any increase in our allowance for loan and lease losses or expenses
incurred to determine the appropriate level of the allowance for loan and lease losses may have a material adverse effect on our financial condition and results of
operations.
Liquidity and Interest Rate Risks
Liquidity risks could affect operations and jeopardize our business, financial condition, and results of operations.
Our ability to implement our business strategy will depend on our liquidity and ability to obtain funding for loan originations, working capital, and other
general purposes. An inability to raise funds through deposits, borrowings, the sale of loans, and other sources could have a substantial negative effect on our
liquidity. Our preferred source of funds consists of client deposits, which we supplement with other sources, such as wholesale deposits made up of brokered
deposits and deposits gathered through internet listing services. Such account and deposit balances can decrease when clients perceive alternative investments as
providing a better risk/return profile. If clients move money out of bank deposits and into other investments, we may increase our utilization of wholesale deposits,
FHLB advances, and other wholesale funding sources necessary to fund desired growth levels. Because these funds generally are more sensitive to interest rate
changes than our targeted in-market deposits, they are more likely to move to the highest rate available. In addition, the use of brokered deposits without regulatory
approval is limited to banks that are “well capitalized” according to regulation. If the Bank is unable to maintain its capital levels at “well capitalized” minimums,
we could lose a significant source of funding, which would force us to utilize different wholesale funding or potentially sell assets at a time when pricing may be
unfavorable, increasing our funding costs and reducing our net interest income and net income.
Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors
that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about
the prospects for the financial services industry. Regional and community banks generally have less access to the capital markets than do national and super-
regional banks because of their smaller size and limited analyst coverage. During periods of economic turmoil or decline, the financial services industry and the
credit markets generally may be materially and adversely affected by declines in asset values and by diminished liquidity. Under such circumstances the liquidity
issues are often particularly acute for regional and community
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banks, as larger financial institutions may curtail their lending to regional and community banks to reduce their exposure to the risks of other banks. Correspondent
lenders may also reduce or even eliminate federal funds lines for their correspondent clients in difficult economic times.
As a result, we rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment
securities to ensure that we have adequate liquidity to fund our operations. Any decline in available funding could adversely impact our ability to originate loans,
invest in securities, meet our expenses, pay dividends to our shareholders, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal
demands, any of which could have a material adverse effect on our business, results of operations, and financial condition.
The Corporation is a bank holding company and its sources of funds necessary to meet its obligations are limited.
The Corporation is a bank holding company and its operations are primarily conducted by the Bank, which is subject to significant federal and state
regulation. Cash available to pay dividends to our shareholders, pay our obligations, and meet our debt service requirements is derived primarily from our existing
cash flow sources, our third party line of credit, dividends received from the Bank, or a combination thereof. Future dividend payments by the Bank to us will
require the generation of future earnings by the Bank and are subject to certain regulatory guidelines. If the Bank is unable to pay dividends to us, we may not have
the resources or cash flow to pay or meet all of our obligations.
Interest rate shifts may reduce net interest income and otherwise negatively impact our financial condition and results of operations.
Shifts in short-term interest rates may reduce net interest income, which is the principal component of our earnings. Net interest income is the difference
between the amounts received by us on our interest-earning assets and the interest paid by us on our interest-bearing liabilities. In certain scenarios, when interest
rates rise, the rate of interest we pay on our liabilities may rise more quickly than the rate of interest that we receive on our interest-bearing assets, which could
cause our profits to decrease. However, the structure of our balance sheet and resultant sensitivity to interest rates in various scenarios may change in the future.
Additionally, interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default. At the same
time, the marketability of underlying collateral may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate
environment, there may be an increase in prepayments on certain loans as borrowers refinance at lower rates.
Changes in interest rates also can affect the value of loans. An increase in interest rates that adversely affects the ability of borrowers to pay the principal
or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have a material adverse effect on our
results of operations and cash flows. Further, when we place a loan on non-accrual status, we reverse any accrued but unpaid interest receivable, which decreases
interest income. Subsequently, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the
associated funding expense. Thus, an increase in the amount of non-performing assets would have an adverse impact on net interest income.
Rising interest rates may also result in a decline in value of our fixed-rate debt securities. The unrealized losses resulting from holding these securities
would be recognized in other comprehensive income and reduce total stockholders’ equity. If debt securities in an unrealized loss position are sold, such losses
become realized and will reduce our regulatory capital ratios.
The transition to an alternative reference rate could cause instability and have a negative effect on financial market conditions.
The London Inter-bank Offered Rate (“LIBOR”) represents the interest rate at which banks offer to lend funds to one another in the international
interbank market for short-term loans. Beginning in 2008, concerns were expressed that some of the member banks surveyed by the British Bankers’ Association
(the “BBA”) in connection with the calculation of LIBOR rates may have been under-reporting or otherwise manipulating the interbank lending rates applicable to
them. Regulators and law enforcement agencies from a number of governments have conducted investigations relating to the calculation of LIBOR across a range
of maturities and currencies. If manipulation of LIBOR or another inter-bank lending rate occurred, it may have resulted in that rate being artificially lower (or
higher) than it otherwise would have been. Responsibility for the calculation of LIBOR was transferred to ICE Benchmark Administration Limited, as independent
LIBOR administrator, effective February 1, 2014.
On July 27, 2017, the U.K. Financial Conduct Authority announced that it will no longer persuade or compel banks to submit rates for the calculation of
LIBOR rates after 2021 (the “July 27th Announcement”). The July 27th Announcement indicates that the continuation of LIBOR on the current basis cannot and
will not be guaranteed after 2021. Consequently, at
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this time, it is not possible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any
additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Similarly, it is not possible to predict whether LIBOR will continue to be
viewed as an acceptable benchmark, what rate or rates may become accepted alternatives to LIBOR or the effect of any such changes in views or alternatives on
the value of LIBOR-linked securities.
Although the Financial Stability Oversight Council has recommended a transition to an alternative reference rate in the event LIBOR is no longer
available after 2021, such plans are still in development and, if enacted, could present challenges. Moreover, contracts linked to LIBOR are vast in number and
value, are intertwined with numerous financial products and services, and have diverse parties. The downstream effect of unwinding or transitioning such contracts
could cause instability and negatively impact the financial markets and individual institutions. The uncertainty surrounding the sustainability of LIBOR more
generally could undermine market integrity and threaten individual financial institutions and the U.S. financial system more broadly.
Operational Risks
We rely on our management and the loss of one or more of those managers may harm our business.
Our success has been and will be greatly influenced by our continuing ability to retain the services of our existing senior management and to attract and
retain additional qualified senior and middle management. The unexpected loss of key management personnel or the inability to recruit and retain qualified
personnel in the future could have an adverse effect on our business and financial results. In addition, our failure to develop and/or maintain an effective succession
plan will impede our ability to quickly and effectively react to unexpected loss of key management, and in turn, may have an adverse effect on our business, results
of operations, and financial condition.
We are subject to certain operational risks, including, but not limited to, client or employee fraud and data processing system failures and errors.
Employee errors and employee and client misconduct, including the improper disclosure or use of client information, could subject us to financial losses
or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or
unauthorized activities on behalf of our clients, or improper use of confidential information. It is not always possible to prevent employee errors and misconduct,
and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors or misconduct could also subject us to financial
claims for negligence.
We maintain a system of internal controls and insurance coverage to mitigate our operational risks, including data processing system failures and errors
and client or employee fraud. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance
limits, it could have a material adverse effect on our business, financial condition, and results of operations.
Our information systems may experience an interruption or breach in security and cyber-attacks, all of which could have a material adverse effect on
our business.
The Corporation relies heavily on internal and outsourced technologies, communications, and information systems to conduct its business. Additionally,
in the normal course of business, the Corporation collects, processes, and retains sensitive and confidential information regarding our employees and clients. As
our reliance on technology has increased, so have the potential risks of a technology-related operation interruption (such as disruptions in our client relationship
management, general ledger, deposit, loan, or other core processing systems) or the occurrence of a cyber-attack (such as unauthorized access to our systems).
These risks have increased for all financial institutions as new technologies, the use of the Internet, and telecommunications technologies (including mobile
devices) to conduct financial and other business transactions have increased, and the sophistication and activities of organized crime, perpetrators of fraud, hackers,
terrorists, and others have increased. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers
may engage in attacks against financial institutions, particularly email compromises, ransomware, and phishing attempts, which are designed to disrupt key
business services, such as wire transfer fraud, customer-facing website breaches, and identity theft attempts. We may not be able to anticipate or implement
effective preventive measures against all security breaches, especially because the techniques used change frequently and because attacks can originate from a wide
variety of sources. However, applying guidance from the Federal Financial Institutions Examination Council (“FFIEC”), the Corporation has analyzed and will
continue to analyze security related to device specific considerations, user access topics, transaction-processing, and network integrity.
We rely on our advisors, vendors, and employees to comply with our policies and procedures to safeguard confidential data. The failure of these parties to
comply with such policies and procedures could result in the loss or wrongful use of our clients’ confidential information or other sensitive information. In
addition, even if we and our advisors, vendors, and
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employees comply with our policies and procedures, persons who circumvent security measures could wrongfully use our confidential information or clients’
confidential information or cause interruptions or malfunctions in our operations.
The Corporation also faces risks related to cyber-attacks and other security breaches in connection with credit card and debit card transactions that
typically involve the transmission of sensitive information regarding our clients through various third parties, including merchant acquiring banks, payment
processors, payment card networks, and its processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because
the transactions involve third parties and environments, such as the point of sale that the Corporation does not control or secure, future security breaches or cyber-
attacks affecting any of these third parties could impact us through no fault of its own, and in some cases it may have exposure and suffer losses for breaches or
attacks relating to them. Further cyber-attacks or other breaches in the future, whether affecting us or others, could intensify consumer concern and regulatory
focus and result in reduced use of payment cards and increased costs, all of which could have a material adverse effect on our business. To the extent we are
involved in any future cyber-attacks or other breaches, our reputation could be affected, which could also have a material adverse effect on our business, financial
condition, or results of operations.
We are dependent upon third parties for certain information system, data management and processing services, and to provide key components of our
business infrastructure, which are subject to operational, security, and other risks.
We outsource certain information system, data management and processing functions to third-party providers. These third-party service providers are
sources of operational and informational security risk to us, including risks associated with operational errors, information system interruptions, or breaches and
unauthorized disclosures of sensitive or confidential client or customer information. If third-party service providers encounter any of these issues, or if we have
difficulty exchanging information with them, we could be exposed to disruption of operations, loss of service or connectivity to clients, reputational damage, and
litigation risk that could have a material adverse effect on our business, results of operations, and financial condition.
Third-party vendors provide key components of our business infrastructure, such as internet connections, network access, and core application processing.
While we have selected these third-party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of
their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to
our clients and otherwise to conduct our business.
Our business continuity plans could prove to be inadequate, resulting in a material interruption in or disruption to our business and a negative impact
on our results of operations.
We rely heavily on communications and information systems to conduct our business and our operations are dependent on our ability to protect our
systems against damage from fire, power loss, telecommunication failure, or other emergencies. The computer systems and network infrastructure we use could be
vulnerable to unforeseen problems. These problems may arise in both our internally developed systems and the systems of our third-party service providers. Any
failure or interruption of these systems could result in failures or disruptions in general ledger, deposit, loan, client relationship management, and other systems.
While we have a business continuity plan and other policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our
information systems, there can be no assurance that any such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed.
The occurrence of any failures or interruptions of our information systems could damage our reputation, result in a loss of clients, subject us to additional
regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, results of
operations, and financial condition.
New lines of business, products, and services are essential to our ability to compete but may subject us to additional risks.
Frequently, we implement new lines of business and/or offer new products and services within existing lines of business. There can be substantial risks
and uncertainties associated with these efforts, particularly in instances where the markets for such services are still developing or due diligence is not fully vetted.
In developing and marketing new lines of business and/or new products or services, we invest significant time and resources. Initial timetables for the introduction
and development of new lines of business and/or new products or services may not be achieved, and price and profitability targets may not prove feasible. New
technologies needed to support the new line of business or product may result in incremental operating costs and system defects. Compliance with regulations,
competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. In
instances of new lines of businesses offering credit services, weaknesses relating to underwriting may impact credit and capital. Delinquency may negatively affect
non-performing assets and increase the provision for loan and lease losses.
Any new line of business and/or new product or service could also have a significant impact on the effectiveness of our system of internal controls.
Failure to successfully manage these risks in the development and implementation of new lines
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of business or new products or services could have a material adverse effect on our business, results of operations, and financial condition.
Our framework for managing risks may not be effective in mitigating risk and loss to us.
Our risk management framework seeks to mitigate risk and loss to us. We have established processes and procedures intended to identify, measure,
monitor, report, and analyze the types of risk to which we are subject, including liquidity risk, credit risk, market risk, interest rate risk, operational risk,
compensation risk, legal and compliance risk, and reputational risk, among others. However, as with any risk management framework, there are inherent
limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately anticipated or identified. Our ability
to successfully identify and manage risks facing us is an important factor that can significantly impact our results. If our risk management framework proves
ineffective, we could suffer unexpected losses which could adversely affect our business, results of operations, and financial condition.
We are subject to changes in accounting principles, policies, or guidelines.
Our financial performance is impacted by accounting principles, policies, and guidelines. Some of these policies require the use of estimates and
assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management
to make difficult, subjective, and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be
reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are incorrect, we may
experience material losses.
From time to time, the FASB and SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the
preparation of our financial statements. These changes are beyond our control, can be difficult to predict, and could materially impact how we report our financial
condition and results of operations. Changes in these standards are continuously occurring, and given recent economic conditions, more drastic changes may occur.
The implementation of such changes could have a material adverse effect on our business, results of operations, and financial condition.
Our internal controls may be ineffective.
Management regularly reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures.
Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that
the objectives of the controls are met. In addition, as we continue to grow the Corporation, our controls need to be updated to keep up with such growth. Any
failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could cause us to report a material
weakness in internal control over financial reporting and conclude that our controls and procedures are not effective, which could have a material adverse effect on
our business, results of operations, and financial condition.
Strategic and External Risks
Our business may be adversely affected by conditions in the financial markets and economic conditions generally.
Our operations and profitability are impacted by general business and economic conditions in the U.S. and, to some extent, abroad. These conditions
include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity
markets, broad trends in industry and finance, the strength of the U.S. economy and uncertainty in financial markets globally, all of which are beyond our control.
A deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values, and a
decrease in demand for our products and services, among other things, any of which could have a material adverse effect on our business, results of operations, and
financial condition.
Our business is concentrated in and largely dependent upon the continued growth and welfare of the general geographical markets in which we
operate.
Our operations are heavily concentrated in the South Central region of Wisconsin and, to a lesser extent, the Southeastern and Northeastern regions of
Wisconsin and the greater Kansas City area and, as a result, our financial condition, results of operations, and cash flows are significantly impacted by changes in
the economic conditions in those areas. Our success depends to a significant extent upon the business activity, population, income levels, deposits, and real estate
activity in these markets. Although our clients’ business and financial interests may extend well beyond these markets, adverse economic conditions that affect
these markets could reduce our growth rate, affect the ability of our clients to repay their loans to us, affect the value of collateral underlying loans, and generally
affect our financial condition and results of operations. Because of our geographic concentration, we are less able than other regional or national financial
institutions to diversify our credit risks across multiple markets.
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Our financial condition and results of operations could be negatively affected if we fail to effectively execute our strategic plan or manage the growth
called for in our strategic plan.
Our strategic plan currently calls for, among other things, regaining our strong asset quality while we continue to grow loans and generate in-market
deposits to maintain our net interest margin and increasing fee income. Our ability to increase profitability in accordance with this plan will depend on a variety of
factors, including the identification of desirable business opportunities, competitive responses from financial institutions in our markets, and our ability to manage
liquidity and funding sources. While we believe we have the management resources and internal systems in place to successfully execute our strategic plan, we
cannot guarantee that opportunities will be available and that the strategic plan will be successful or effectively executed.
Although we do not have any current definitive plans to do so, in implementing our strategic plan we may expand into additional communities or attempt
to strengthen our position in our current markets through opportunistic acquisitions of similar or complementary financial services organizations. To the extent that
we do so, we may experience higher operating expenses relative to operating income from the new operations or certain one-time expenses associated with the
closure of offices, all of which may have an adverse effect on our business, results of operations, and financial condition. Other effects of engaging in such
strategies may include potential diversion of our management’s time and attention and general disruption to our business.
To the extent that we grow through new locations we cannot ensure that we will be able to adequately and profitably manage this growth. Acquiring other
banks and businesses will involve similar risks to those commonly associated with branching, but may also involve additional risks, including potential exposure to
unknown or contingent liabilities of banks and businesses we acquire and exposure to potential asset quality issues of the acquired bank or related business.
We could recognize impairment losses on securities held in our securities portfolio, goodwill or other long-lived assets.
As of December 31, 2018 , the fair value of our securities portfolio was approximately $175.8 million . Factors beyond our control can significantly
influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. For example, fixed-rate securities
acquired by us are generally subject to decreases in market value when interest rates rise. Additional factors include, but are not limited to, rating agency
downgrades of the securities, defaults by the issuer or individual mortgagors with respect to the underlying securities, and instability in the credit markets. Any of
the foregoing factors could cause other-than-temporary impairment in future periods and result in realized losses. The process for determining whether impairment
is other-than-temporary usually requires difficult, subjective judgments about the future financial performance of the issuer and any collateral underlying the
security in order to assess the probability of receiving all contractual principal and interest payments on the security. Because of changing economic and market
conditions affecting interest rates, the financial condition of issuers of the securities and the performance of the underlying collateral, we may recognize realized
and/or unrealized losses in future periods, which could have an adverse effect on our business, results of operations, and financial condition.
As of December 31, 2018 , the Corporation had goodwill of $10.7 million recorded in connection with our acquisition of Alterra. Goodwill is not
amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying amount. A decline in our stock price, decline in the performance of our acquired
operations, or the occurrence of another triggering event could, under certain circumstances, result in an impairment charge being recorded. During 2018, our
annual impairment test conducted in July indicated that the estimated fair value of the reporting unit exceeded the carrying value (including goodwill). Depending
on market conditions, economic forecasts, results of operations, additional adverse circumstances or other factors, the goodwill impairment analysis may require
additional review of assumptions and outcomes prior to our next annual impairment testing date of July 1, 2019. In the event that we conclude that all or a portion
of our goodwill may be impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on
tangible capital or regulatory capital.
We could be required to establish a deferred tax asset valuation allowance and a corresponding charge against earnings if we experience a decrease
in earnings.
Deferred tax assets are reported as assets on our balance sheet and represent the decrease in taxes expected to be paid in the future in connection with our
allowance for loan and lease losses and other matters. If it becomes more likely than not that some portion or the entire deferred tax asset will not be realized, a
valuation allowance must be recognized. The Corporation believes it will fully realize its deferred tax asset, and therefore, no valuation allowance was necessary as
of December 31, 2018. This determination was based on the evaluation of several factors, including our recent earnings history, expected future earnings, and
appropriate tax planning strategies. A decrease in earnings could adversely impact our ability to fully utilize our deferred tax assets. If we determine that it is more
likely than not that some portion or all of the deferred tax
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assets will not be realized, a valuation allowance will need to be recognized and this would result in a corresponding charge against our earnings.
Competition from other financial institutions could adversely affect our profitability.
We encounter heavy competition in attracting commercial loan, specialty finance, deposit, and trust and investment clients. We believe the principal
factors that are used to attract quality clients and distinguish one financial institution from another include value-added relationships, interest rates and rates of
return, types of accounts, service fees, flexibility, and quality of service.
Our competition includes banks, savings institutions, mortgage banking companies, credit unions, finance companies, equipment finance companies,
mutual funds, insurance companies, brokerage firms, investment banking firms, and FinTech companies. We also compete with regional and national financial
institutions that have a substantial presence in our market areas, many of which have greater liquidity, higher lending limits, greater access to capital, more
established market recognition, and more resources and collective experience than we do. In addition, some larger financial institutions that have not historically
competed with us directly have substantial excess liquidity and have sought, and may continue to seek, smaller lending relationships in our target markets.
Furthermore, tax-exempt credit unions operate in most of our market areas and aggressively price their products and services to a large portion of the market.
Finally, technology has also lowered the barriers to entry and made it possible for non-banks to offer products and services we have traditionally offered, such as
automatic funds transfer and automatic payment systems. Our profitability depends, in part, upon our ability to successfully maintain and increase market share.
Consumers and businesses are increasingly using non-banks to complete their financial transactions, which could adversely affect our business and
results of operations.
Technology and other changes are allowing consumers and businesses to complete financial transactions that historically have involved banks through
alternative methods. For example, the wide acceptance of Internet-based and person-to-person commerce has resulted in a number of alternative payment
processing systems and lending platforms in which banks play only minor roles. Consumers can now maintain funds in prepaid debit cards or digital currencies,
and pay bills and transfer funds directly without the direct assistance of banks. The diminishing role of banks as financial intermediaries has resulted, and could
continue to result, in the loss of fee income, as well as the loss of client deposits and the related income generated from those deposits. The loss of these revenue
streams and the potential loss of lower cost deposits as a source of funds could have a material adverse effect on our business, financial condition, and results of
operations.
If we are unable to keep pace with technological advances in our industry, our ability to attract and retain clients could be adversely affected.
The banking industry is constantly subject to technological changes with frequent introductions of new technology-driven products and services. In
addition to better serving clients, the effective use of technology increases our efficiency and enables us to reduce costs. Our future success will depend in part on
our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience as well as
create additional efficiencies in our operations. A number of our competitors have substantially greater resources to invest in technological improvements, as well
as significant economies of scale. There can be no assurance that we will be able to implement and offer new technology-driven products and services to our
clients. If we fail to do so, our ability to attract and retain clients may be adversely affected.
Our trust and investment services operations may be negatively impacted by changes in economic and market conditions.
Our trust and investment services operations may be negatively impacted by changes in general economic conditions and the conditions in the financial
and securities markets, including the values of assets held under management. Our management contracts generally provide for fees payable for services based on
the market value of assets under management. Because most of our contracts provide for a fee based on market values of securities, declines in securities prices
will generally have an adverse effect on our results of operations from this business. Market declines and reductions in the value of our clients’ trust and
investment services accounts could result in us losing trust and investment services clients, including those who are also banking clients.
Potential acquisitions may disrupt our business and dilute shareholder value.
While we remain committed to organic growth, we also may consider additional acquisition opportunities involving complementary financial service
organizations if the right situation were to arise. Various risks commonly associated with acquisitions include, among other things:
•
•
•
Potential exposure to unknown or contingent liabilities of the target company.
Exposure to potential asset quality issues of the target company.
Potential disruption to our business.
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•
•
•
•
•
Potential diversion of our management’s time and attention.
Possible loss of key employees and clients of the target company.
Difficulty in estimating the value of the target company.
Potential changes in banking or tax laws or regulations that may affect the target company.
Difficulty in integrating operations, personnel, technologies, services, and products of acquired companies.
Acquisitions may involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net
income per common share may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue increases, cost savings,
increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our business, financial
condition, and results of operations.
The investments we make in certain tax-advantaged projects may not generate returns as anticipated and may have an adverse impact on the
Corporation’s financial results.
We invest in certain tax-advantaged projects promoting community development. Investments in these projects are designed to generate a return primarily
through the realization of federal and state income tax credits, and other tax benefits, over specified time periods. The Corporation is subject to the risk that
previously recorded tax credits, which remain subject to recapture by taxing authorities based on compliance features required to be met at the project level, will
fail to meet certain government compliance requirements and will not be able to be realized. The possible inability to realize these tax credit and other tax benefits
could have a negative impact on the Corporation’s financial results. The risk of not being able to realize the tax credits and other tax benefits depends on many
factors outside of the Corporation’s control, including changes in the applicable tax code and the ability of the projects to be completed.
A prolonged U.S. government shutdown or default by the U.S. on government obligations would harm our results of operations.
Our results of operations, including revenue, non-interest income, expenses and net interest income, would be adversely affected in the event of
widespread financial and business disruption on account of a default by the United States on U.S. government obligations or a prolonged failure to maintain
significant U.S. government operations, including the recent partial shutdown of the U.S. government which ended on January 25, 2019. Of particular impact to the
Corporation are the operations pertaining to the SBA or the FDIC. Any such failure to maintain such U.S. government operations, and the after-effects of such
shutdown, could impede our ability to originate SBA loans and our ability to sell such loans in the secondary market, which would materially adversely affect our
business, results of operations and financial condition.
In addition, many of our investment securities are issued by and some of our loans are made to the U.S. government and government agencies and
sponsored entities. Uncertain domestic political conditions, including prior federal government shutdowns and potential future federal government shutdowns or
other unresolved political issues, may pose credit default and liquidity risks with respect to investments in financial instruments issued or guaranteed by the federal
government and loans to the federal government. Any downgrade in the sovereign credit rating of the United States, as well as sovereign debt issues facing the
governments of other countries, could have a material adverse impact on financial markets and economic conditions in the United States and worldwide. Any such
adverse impact could have a material adverse effect on our liquidity, financial condition and results of operations.
Regulatory, Compliance, Legal and Reputational Risks
We operate in a highly regulated industry and the laws and regulations that govern our operations, corporate governance, executive compensation,
and accounting principles, or changes in them, or our failure to comply with them, may adversely affect us.
We are subject to extensive regulation and supervision that govern almost all aspects of our operations. These laws and regulations, among other matters,
prescribe minimum capital requirements, impose limitations on our business activities and compensation practices, limit the dividends or distributions that we can
pay, restrict the ability of institutions to guarantee our debt, and impose certain specific accounting requirements that may be more restrictive and may result in
greater or earlier charges to earnings or reductions in our capital than generally accepted accounting principles. Compliance with laws and regulations can be
difficult and costly and changes to laws and regulations often impose additional compliance costs. Further, our failure to comply with these laws and regulations,
even if the failure was inadvertent or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any
of which could adversely affect our business, results of operations, and financial condition.
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The financial services industry, as well as the broader economy, may be subject to new legislation, regulation, and government policy.
From time to time, federal and state governments and bank regulatory agencies modify the laws and regulations that govern financial institutions and the
financial system generally. Such laws and regulations can affect our operating environment in substantial and unpredictable ways. Among other effects, such laws
and regulations can increase or decrease the cost of doing business, limit or expand the scope of permissible activities, or affect the competitive balance among
banks and other financial institutions. In addition, any changes in monetary policy, fiscal policy, tax laws, including the Act, and other policies can affect the
broader economic environment, interest rates and patterns of trade. Any of these changes could affect our company and the banking industry as a whole in ways
that are difficult to predict, and could adversely impact our business, financial condition, or results of operations.
We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The Bank Secrecy Act, the USA PATRIOT Act and other laws and regulations require financial institutions, among other duties, to institute and maintain
effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network,
established by Treasury to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has
recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement
Administration and IRS. There is also increased scrutiny of compliance with the rules enforced by the Financial Crimes Enforcement Network. Federal and state
bank regulators also focus on compliance with Bank Secrecy Act and anti-money laundering regulations.
If our policies, procedures, and systems are deemed deficient or the policies, procedures, and systems of the financial institutions that we may acquire in
the future are deficient, we would be subject to liability, including fines and regulatory actions, such as restrictions on our ability to pay dividends and the necessity
to obtain regulatory approvals to proceed with certain aspects of our business plan which would adversely affect our business, results of operations, and financial
condition. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational
consequences for us.
We are periodically subject to examination and scrutiny by a number of banking agencies and, depending upon the findings and determinations of
these agencies, we may be required to make adjustments to our business that could adversely affect us.
Federal and state banking agencies periodically conduct examinations of our business, including compliance with applicable laws and regulations. If, as a
result of an examination, a federal banking agency was to determine that the financial condition, capital resources, asset quality, asset concentration, earnings
prospects, management, liquidity, sensitivity to market risk, or other aspects of any of our operations has become unsatisfactory, or that we or our management is
in violation of any law or regulation, it could take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe
or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be
judicially enforced, to direct an increase in our capital, to restrict our growth, to change the asset composition of our portfolio or balance sheet, to assess civil
monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an
imminent risk of loss to depositors, to terminate our deposit insurance. If we become subject to such regulatory actions, our business, results of operations, and
financial condition may be adversely affected.
We are subject to claims and litigation pertaining to our fiduciary responsibilities.
Some of the services we provide, such as trust and investment services, require us to act as fiduciaries for our clients and others. From time to time, third
parties could make claims and take legal action against us pertaining to the performance of our fiduciary responsibilities. If fiduciary investment decisions are not
appropriately documented to justify action taken or trades are placed incorrectly, among other possible claims, and if these claims and legal actions are not
resolved in a manner favorable to us, we may be exposed to significant financial liability and/or our reputation could be damaged. Either of these results may
adversely impact demand for our products and services or otherwise have an adverse effect on our business, results of operations, and financial condition.
Negative publicity could damage our reputation and adversely impact our business and financial results.
Reputation risk, or the risk to our earnings and capital due to negative publicity, is inherent in our business. Negative publicity can result from our actual
or alleged conduct in a number of activities, including lending practices, information security, management actions, corporate governance, and actions taken by
government regulators and community organizations in response to those activities. Negative publicity can adversely affect our ability to keep and attract clients,
and can expose us
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to litigation and regulatory action, all of which could have a material adverse effect on our business, financial condition, and results of operations.
Risks Related to Investing in Our Common Stock
Our stock is thinly traded and our stock price can fluctuate.
Although our common stock is listed for trading on the Nasdaq Global Select Market, low volume of trading activity and volatility in the price of our
common stock may make it difficult for our shareholders to sell common stock when desired and at prices they find attractive. Our stock price can fluctuate
significantly in response to a variety of factors including, among other things:
•
•
•
•
•
•
•
actual or anticipated variations in our quarterly results of operations;
recommendations by securities analysts;
operating and stock price performance of other companies that investors deem comparable to us;
news reports relating to trends, concerns and other issues in the financial services industry;
perceptions in the marketplace regarding us or our competitors and other financial services companies;
new technology used, or services offered, by competitors; and
changes in government regulations.
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions,
interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of our operating results.
To maintain adequate capital levels, we may be required to raise additional capital in the future, but that capital may not be available when it is
needed and/or could be dilutive to our existing shareholders.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. In order to ensure our ability to support the
operations of the Bank, we may need to limit or terminate cash dividends that can be paid to our shareholders. In addition, we may need to raise capital in the
future. Our ability to raise capital, if needed, will depend in part on our financial performance and conditions in the capital markets at that time, and accordingly,
we cannot guarantee our ability to raise capital on terms acceptable to us. In addition, if we decide to raise equity capital in the future, the interests of our
shareholders could be diluted. Any issuance of common stock would dilute the ownership percentage of our current shareholders and any issuance of common
stock at prices below tangible book value would dilute the tangible book value of each existing share of our common stock held by our current shareholders. The
market price of our common stock could also decrease as a result of the sale of a large number of shares or similar securities, or the perception that such sales could
occur. If we cannot raise capital when needed, our ability to serve as a source of strength to the Bank, pay dividends, maintain adequate capital levels and liquidity,
or further expand our operations could be materially impaired.
If equity research analysts publish research or reports about our business with unfavorable commentary or downgrade our common stock, the price
and trading volume of our common stock could decline.
The trading market for our common stock could be affected by whether equity research analysts publish research or reports about us and our business and
what is included in such research or reports. If equity analysts publish research reports about us containing unfavorable commentary, downgrade our stock or cease
publishing reports about our business, the price of our stock could decline. If any analyst electing to cover us downgrades our stock, our stock price could decline
rapidly. If any analyst electing to cover us ceases coverage of us, we could lose visibility in the market, which in turn could cause our common stock price or
trading volume to decline and our common stock to be less liquid.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
The following table provides certain summary information with respect to the principal properties in which we conduct our operations, all of which were
leased, as of December 31, 2018 :
Location
Function
401 Charmany Drive, Madison, WI
Full-service banking location of FBB and office of FBFS
18500 W. Corporate Drive, Brookfield, WI
Full-service banking location of FBB - Milwaukee Region
11300 Tomahawk Creek Pkwy, Leawood, KS
Full-service banking location of FBB - Kansas City Region
3913 West Prospect Avenue, Appleton, WI
Full-service banking location of FBB - Northeast Region
Expiration
Date
2028
2020
2023
2025
For the purpose of generating business development opportunities in our specialty finance and consulting businesses, as of December 31, 2018 , office
space was also leased in several states nationwide under shorter-term lease agreements, which generally have terms of one year or less.
Item 3. Legal Proceedings
We believe that no litigation is threatened or pending in which we face potential loss or exposure which could materially affect our consolidated financial
position, consolidated results of operations, or consolidated cash flows. Since our subsidiaries act as depositories of funds, lenders, and fiduciaries, they are
occasionally named as defendants in lawsuits involving a variety of claims. This and other litigation is ordinary, routine litigation incidental to our business.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Holders
The common stock of the Corporation is traded on the Nasdaq Global Select Market under the symbol “FBIZ.” As of February 22, 2019 , there were 384
registered shareholders of record of the Corporation’s common stock. Certain of the Corporation’s shares are held in “nominee” or “street” name and the number
of beneficial owners of such shares as of February 22, 2019 was approximately 1,900 .
Dividend
Policy
It has been our practice to pay a dividend to common shareholders. Dividends historically have been declared in the month following the end of each
calendar quarter. However, the timing and amount of future dividends are at the discretion of the Board of Directors of the Corporation (the “Board”) and will
depend upon the consolidated earnings, financial condition, liquidity, and capital requirements of the Corporation and the Bank, the amount of cash dividends paid
to the Corporation by the Bank, applicable government regulations and policies, supervisory actions, and other factors considered relevant by the Board. Refer to
Item 1 - Business - Supervision and Regulation - Regulation and Supervision of the Bank - Dividend Payments for additional discussion regarding the
limitations on dividends and other capital contributions by the Bank to the Corporation. The Board anticipates it will continue to declare dividends as appropriate
based on the above factors.
Stock
Performance
Graph
The chart shown below depicts total return to shareholders during the period beginning December 31, 2013 and ending December 31, 2018 . Total return
includes appreciation or depreciation in market value of the Corporation’s common stock as well as actual cash and stock dividends paid to common stockholders.
Indices shown below, for comparison purposes only, are the Total Return Index for the Nasdaq Composite, which is a broad nationally recognized index of stock
performance by publicly traded companies, and the SNL Bank Nasdaq, which is an index that contains securities of Nasdaq-listed companies classified according
to the Industry Classification Benchmark as banks. The chart assumes that the value of the investment in FBIZ common stock and each of the three indices was
$100 on December 31, 2013, and that all dividends were reinvested in FBIZ common stock.
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Index
2013
2014
2015
2016
2017
2018
As of December 31,
First Business Financial Services, Inc.
$
100.00 $
129.80 $
138.15 $
133.96 $
127.77 $
Nasdaq Composite
SNL Bank Nasdaq
Issuer
Purchases
of
Securities
100.00
100.00
114.75
103.57
122.74
111.80
133.62
155.02
173.22
163.20
115.43
168.30
137.56
On December 14, 2018, the Corporation announced its Board of Directors approved a share repurchase program authorizing the Corporation to
repurchase up to $5 million of the Corporation’s common stock over a period of approximately twelve months, ending on December 31, 2019.
Under the share repurchase program, shares may be repurchased from time to time in the open market or through negotiated transactions at prevailing
market rates, or by other means in accordance with federal securities laws. In connection with the share repurchase program, the Corporation has implemented a
10b5-1 trading plan. The trading plan allows the Corporation to repurchase shares of its common stock at times when it otherwise might be prevented from doing
so under insider trading laws by requiring that an agent selected by the Corporation repurchase shares of common stock on the Corporation’s behalf.
The following table sets forth information about the Corporation's purchases of its common stock during the three months ended December 31, 2018 .
Period
October 1, 2018 - October 31, 2018
November 1, 2018 - November 30, 2018
December 1, 2018 - December 31, 2018
Total
Total Number of
Shares Purchased (1)
Average Price Paid Per
Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs (2)
Total Number of
Shares that May Yet
Be Purchased Under
the Plans or
Programs (3)
— $
956
11,920
12,876
—
20.76
19.69
—
—
11,920
11,920
—
—
—
244,250
(1) During the fourth quarter of 2018, the Corporation repurchased an aggregate 12,876 shares of the Corporation’s common stock in open-market transactions, of which 11,920 shares
were purchased pursuant to the repurchase program publicly announced on December 14, 2018, and of which 956 shares were surrendered to us to satisfy income tax withholding
obligations in connection with the vesting of restricted shares.
(2) As of December 31, 2018, an aggregate of 11,920 shares were purchased for a total of $234,681 since the inception of the repurchase program announced on December 14, 2018.
(3) As of December 31, 2018, the maximum number of shares that may yet be purchased under the plan is 244,250 based on the closing price of the Corporation’s common stock on
December 31, 2018 of $19.51 per share.
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Item 6. Selected Financial Data
INCOME STATEMENT:
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
Non-interest income
Non-interest expense
Income tax expense
Net income
Yield on earning assets
Cost of funds
Interest rate spread
Net interest margin
Return on average assets
Return on average equity
ENDING BALANCE SHEET:
Total assets
Securities
Loans and leases, net of deferred loan fees
In-market deposits
Wholesale deposits
FHLB advances and other borrowings
Junior subordinated notes
Stockholders’ equity
FINANCIAL CONDITION ANALYSIS:
Allowance for loan and lease losses to gross loans and leases
Allowance to non-accrual loans and leases
Net charge-offs to average loans and leases
Non-accrual loans to gross loans and leases
Average equity to average assets
STOCKHOLDERS’ DATA:
Basic earnings per common share (1)
Diluted earnings per common share (1)
Book value per share at end of period
Tangible book value per share at end of period
Dividend declared per share
Dividend payout ratio
Shares outstanding
Five Year Comparison of Selected Consolidated Financial Data
As of and for the Year Ended December 31,
2018
2017
2016
2015
2014
(Dollars in Thousands, Except Share and Per Share Data)
57,701
11,571
46,130
1,236
10,103
33,775
7,083
14,139
4.45%
1.07%
3.38%
3.56%
1.04%
$
91,275
$
75,811
$
78,117
$
72,471
$
23,933
67,342
5,492
18,167
62,363
1,351
15,202
60,609
6,172
16,665
56,871
2,326
14,789
63,328
7,818
17,988
56,433
2,156
13,831
58,640
3,386
17,011
47,374
8,377
$
16,303
$
11,905
$
14,909
$
16,514
$
5.04%
1.63%
3.41%
3.72%
0.86%
9.41%
4.47%
1.11%
3.36%
3.58%
0.67%
7.16%
4.50%
1.06%
3.44%
3.64%
0.82%
9.40%
4.52%
1.04%
3.48%
3.66%
0.97%
11.36%
11.78%
$
1,966,457
$
1,794,066
$
1,780,699
$
1,782,081
$
1,628,505
176,089
1,617,655
1,179,448
275,851
298,944
10,033
180,707
163,783
1,501,595
1,086,346
307,985
207,898
10,019
169,278
184,505
1,450,675
1,122,174
416,681
59,676
10,004
161,650
177,830
1,430,965
1,089,748
487,483
34,740
9,990
150,832
1.26%
80.73%
0.24%
1.56%
9.10%
$
1.86
1.86
20.57
19.20
0.56
1.25%
71.10%
0.57%
1.76%
9.35%
$
1.36
1.36
19.32
17.87
0.52
1.44%
83.00%
0.22%
1.74%
8.75%
$
1.71
1.71
18.55
17.08
0.48
1.14%
73.17%
0.10%
1.56%
8.54%
$
1.90
1.90
17.34
15.90
0.44
$
186,261
1,266,438
1,010,928
427,340
33,451
9,976
137,748
1.12%
146.33%
0.08%
0.76%
8.80%
1.76
1.75
15.88
14.51
0.42
30.15%
38.12%
23.93%
23.93%
23.93%
8,785,480
8,763,539
8,715,856
8,699,410
8,671,854
(1) Basic and diluted earnings per share reflect earnings per common share as calculated under the two-class method due to the existence of participating securities. All shares and per share
amounts have been adjusted to reflect the 2-for-1 stock split in the form of a 100% stock dividend completed in August 2015.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
When used in this report the words or phrases “may,” “could,” “should,” “hope,” “might,” “believe,” “expect,” “plan,” “assume,” “intend,” “estimate,”
“anticipate,” “project,” “likely,” or similar expressions are intended to identify “forward-looking statements.” Such statements are subject to risks and
uncertainties, including among other things:
•
•
•
•
•
•
•
•
•
•
Competitive pressures among depository and other financial institutions nationally and in our markets.
Adverse changes in the economy or business conditions, either nationally or in our markets.
Increases in defaults by borrowers and other delinquencies.
Our ability to manage growth effectively, including the successful expansion of our client support, administrative infrastructure and internal management
systems.
Fluctuations in interest rates and market prices.
The consequences of continued bank acquisitions and mergers in our markets, resulting in fewer but much larger and financially stronger competitors.
Changes in legislative or regulatory requirements applicable to us and our subsidiaries.
Changes in tax requirements, including tax rate changes, new tax laws and revised tax law interpretations.
Fraud, including client and system failure or breaches of our network security, including our internet banking activities.
Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portions of SBA loans.
These risks, together with the risks identified in Item 1A — Risk Factors , could cause actual results to differ materially from what we have anticipated
or projected. These risk factors and uncertainties should be carefully considered by our shareholders and potential investors. Investors should not place undue
reliance on any such forward-looking statements, which speak only as of the date made.
Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that,
while our management believes such assumptions or bases are reasonable and are made in good faith, assumed facts or bases can vary from actual results, and the
differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, an
expectation or belief is expressed as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be
no assurance that the statement of expectation or belief will be achieved or accomplished.
We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements.
The following discussion and analysis is intended as a review of significant events and factors affecting our financial condition and results of operations
for the periods indicated. The discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and the Selected
Consolidated Financial Data in this Form 10-K.
30
Table of Contents
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 the Bank and certain subsidiaries 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 commercial lending, SBA lending and
servicing, asset-based lending, equipment financing, factoring, trust and investment services, investment portfolio administrative services, asset/liability
management services, treasury management services, and a broad range of deposit products. We do not utilize a branch network to attract retail clients. Our
operating philosophy is predicated on deep client relationships fostered by local banking partners and specialized business lines where we provide skilled expertise,
combined with the efficiency of centralized administrative functions such as information technology, loan and deposit operations, finance and accounting, credit
administration, compliance, and human resources. Our focused model allows experienced staff to provide the level of financial expertise needed to develop and
maintain long-term relationships with our clients.
Performance Summary
Results as of and for the year ended December 31, 2018 include:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Total assets at December 31, 2018 increased $172.4 million , or 9.6% , to $1.966 billion from $1.794 billion at December 31, 2017 .
Net income for the year ended December 31, 2018 was $16.3 million , increasing 36.9% compared to $11.9 million for the year ended December 31, 2017
.
Diluted earnings per common share were $1.86 for the year ended December 31, 2018 , increasing 36.7% compared to $1.36 in the prior year.
Net interest margin was 3.72% for the year ended December 31, 2018 , increasing 14 basis points from 3.58% for the year ended December 31, 2017 .
Top line revenue, which consists of net interest income and non-interest income, grew 10.7% to $85.5 million for the year ended December 31, 2018 ,
compared to $77.3 million for the same period in 2017 .
Return on average assets and return on average equity for the year ended December 31, 2018 were 0.86% and 9.41% respectively, compared to 0.67% and
7.16% , respectively, for 2017 .
Provision for loan and lease losses was $5.5 million for the year ended December 31, 2018 , compared to $6.2 million for the year ended December 31,
2017 .
SBA recourse provision was $1.9 million for the year ended December 31, 2018 , compared to $2.2 million for the year ended December 31, 2017 .
Period-end gross loans and leases receivable at December 31, 2018 increased $116.1 million , or 7.7% , to $1.618 billion from $1.502 billion as of
December 31, 2017 .
Non-performing assets were $27.8 million and 1.42% of total assets as of December 31, 2018 , compared to $27.5 million and 1.53% of total assets as of
December 31, 2017 .
Net charge-offs as a percentage of average loans and leases decreased to 0.24% for the year ended December 31, 2018 , compared to 0.57% for the year
ended December 31, 2017 .
Trust assets under management and administration increased by $93.9 million , or 6.1% , to $1.630 billion at December 31, 2018 compared to $1.536
billion at December 31, 2017 .
Trust and investment service fee income increased by $1.1 million , or 16.1% , to $7.7 million for the year ended December 31, 2018 compared to $6.7
million for the year ended December 31, 2017 .
Period-end in-market deposits at December 31, 2018 increased $93.1 million , or 8.6% , to $1.179 billion from $1.086 billion as of December 31, 2017 .
31
Table of Contents
The detailed financial discussion that follows focuses on 2018 results compared to 2017 . Discussion of 2017 results compared to 2016 is
predominantly in the section captioned “ 2017 Compared to 2016 .”
Top Line Revenue
Results of Operations
Top line revenue, comprised of net interest income and non-interest income, increased 10.7% in 2018 compared to 2017 primarily due to an increase in
net interest income driven by a $117.5 million , or 8.0% , increase in average loans and leases receivable and a 14 basis point increase in net interest margin. Top
line revenue in 2018 also benefited from record trust and investment services fee income and an increase in commercial loan swap fee income.
The components of top line revenue were as follows:
For the Year Ended December 31,
Change From Prior Year
2018
2017
2016
$ Change 2018 % Change 2018 $ Change 2017 % Change 2017
(Dollars in Thousands)
Net interest income
Non-interest income
Top line revenue
$
$
67,342 $
60,609 $
63,328 $
18,167
16,665
17,988
85,509 $
77,274 $
81,316 $
6,733
1,502
8,235
11.1% $
9.0
10.7
$
(2,719)
(1,323)
(4,042)
(4.3)%
(7.4)
(5.0)
Return on Average Assets and Return on Average Equity
Return on average assets (“ROAA”) was 0.86% for the year ended December 31, 2018 compared to 0.67% for the year ended December 31, 2017 . The
increase in ROAA can be attributed principally to an increase in earnings as net income increased 36.9% during the same time period. The increase in net income
for the year ended December 31, 2018 was primarily due to an increase in net interest income, trust and investment fee income, commercial loan swap fee income,
and decreases in the provision for loan and lease losses and the corporate federal income tax rate from 35% to 21% effective January 1, 2018. These benefits were
partially offset by an increase in operating expenses. ROAA is a critical metric used by us to measure the profitability of our organization and how efficiently our
assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can
ultimately influence return on equity measures.
Return on average equity (“ROAE”) for the year ended December 31, 2018 was 9.41% compared to 7.16% for the year ended December 31, 2017 . The
primary reasons for the increase in ROAE are consistent with the net income variance explanations discussed above. We view ROAE as an important measurement
for monitoring profitability and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client relationships,
controlling our expenses, and minimizing our costs of credit.
Efficiency Ratio
Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse provision, impairment of tax credit
investments, losses or gains on foreclosed properties, 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 gains or losses on securities, if any.
The efficiency ratio increased to 67.77% for the year ended December 31, 2018 , compared to 66.48% for the year ended December 31, 2017 ,
reflecting in part the Corporation’s investment in its long-term growth strategy as management opportunistically invested in 17 new producers across multiple
business lines, including commercial lending, SBA lending, wealth management, and equipment finance. Full-time equivalent employees (“FTE”) were 274 at
December 31, 2018, increasing by 23, or 9.2% , from 251 at December 31, 2017 . Despite this reduction in operating efficiency, we believe we continue to
progress towards enhancing our long-term efficiency ratio as we focus on strategic initiatives directed toward proactive expense management and revenue growth.
These initiatives include our newly consolidated board membership, as well as efforts to increase SBA lending production, establish a vendor equipment finance
program, and increase commercial banking market share, particularly in our less mature markets, by continuing to prudently invest in production talent.
Management will continue to take proactive measures to drive positive operating leverage with the objective of moving the efficiency ratio back within the
Corporation’s long-term operating goal of 58-62%.
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Table of Contents
We believe the efficiency ratio allows investors and analysts to better assess the Corporation’s operating expenses in relation to its top line revenue by
removing the volatility that is associated with certain non-recurring and other discrete items. The efficiency ratio also allows management to benchmark
performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional
financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.
Please refer to the Non-Interest Income and Non-Interest Expense section below for discussion on additional drivers of the year-over-year change in
the efficiency ratio.
For the Year Ended December 31,
Change From Prior Year
2018
2017
2016
$ Change
2018
% Change 2018 $ Change 2017 % Change 2017
(Dollars in Thousands)
Total non-interest expense
$
62,363
$
56,871
$
56,433
$
5,492
9.7 % $
438
0.8 %
Less:
Net loss (gain) on foreclosed
properties
Amortization of other
intangible assets
SBA recourse provision
Impairment of tax credit
investments
Deconversion fees
Total operating expense
Net interest income
Total non-interest income
Less:
Net (loss) gain on sale of
securities
367
47
1,913
2,083
$
$
—
$
$
57,953
67,342
18,167
(143)
54
2,240
2,784
300
51,636
60,609
16,665
$
$
122
62
2,068
3,691
794
49,696
63,328
17,988
$
$
(4)
(403)
10
Total operating revenue
$
85,513
$
77,677
$
81,306
$
510
NM
(265)
NM
(7)
(327)
(701)
(300)
6,317
6,733
1,502
(13.0)
(14.6)
(25.2)
(100.0)
12.2
11.1
9.0
$
$
(8)
172
(907)
(494)
1,940
(2,719)
(1,323)
399
7,836
(99.0)
(413)
10.1
$
(3,629)
(12.9)%
8.3 %
(24.6)%
(62.2)%
3.9
(4.3)
(7.4)
NM
(4.5)
Efficiency ratio
NM = Not meaningful
Net Interest Income
67.77%
66.48%
61.12%
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.
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Table of Contents
The table below shows average balances, interest, average rates, net interest margin and the spread between combined average rates earned on our
interest-earning assets and cost of interest-bearing liabilities for the periods indicated. The average balances are derived from average daily balances.
For the Year Ended December 31,
2018
2017
2016
Average
Balance
Interest
Average
Yield/
Rate
Average
Balance
Interest
(Dollars in Thousands)
Average
Yield/
Rate
Average
Balance
Interest
Average
Yield/
Rate
Interest-earning assets
Commercial real estate and other mortgage
loans (1)
Commercial and industrial loans (1)
Direct financing leases (1)
Consumer and other loans (1)
Total loans and leases receivable (1)
Mortgage-related securities (2)
Other investment securities (3)
FHLB and FRB stock
Short-term investments
Total interest-earning assets
Non-interest-earning assets
Total assets
Interest-bearing liabilities
Transaction accounts
Money market
Certificates of deposit
Wholesale deposits
Total interest-bearing deposits
FHLB advances
Other borrowings
Junior subordinated notes
Total interest-bearing liabilities
Non-interest-bearing demand deposit
accounts
Other non-interest-bearing liabilities
Total liabilities
Stockholders’ equity
$
1,074,873
$
447,687
31,276
29,761
1,583,597
137,145
33,929
7,472
49,365
1,811,508
92,631
53,620
30,043
1,268
1,297
86,228
3,185
657
290
915
91,275
$
4.99% $
6.71%
4.05%
4.36%
5.45%
2.32%
1.94%
3.88%
1.85%
5.04%
961,572
447,937
28,988
27,612
1,466,109
138,528
37,085
4,231
49,113
1,695,066
84,829
$
43,452
26,165
1,231
1,112
71,960
2,466
682
103
600
75,811
4.52% $
5.84%
4.25%
4.03%
4.91%
1.78%
1.84%
2.43%
1.22%
4.47%
938,524
465,736
30,379
25,615
1,460,254
147,433
32,995
2,537
94,548
1,737,767
73,905
$
1,904,139
$
1,779,895
$
1,811,672
$
269,943
491,756
94,172
302,440
1,158,311
274,382
24,537
10,025
1,467,255
241,529
22,076
1,730,860
173,279
2,671
5,375
1,599
5,888
15,533
5,640
1,648
1,112
23,933
0.99% $
1.09%
1.70%
1.95%
1.34%
2.06%
6.72%
11.09%
1.63%
226,540
583,241
56,667
361,712
1,228,160
105,276
24,796
10,011
1,368,243
230,907
14,375
1,613,525
166,370
1,335
2,746
569
6,155
10,805
1,472
1,813
1,112
15,202
0.59% $
0.47%
1.00%
1.70%
0.88%
1.40%
7.31%
11.11%
1.11%
169,571
642,784
65,608
467,826
1,345,789
14,485
26,463
9,997
1,396,734
246,182
10,210
1,653,126
158,546
43,927
28,143
1,364
1,193
74,627
2,328
517
79
566
78,117
456
3,112
592
7,556
11,716
140
1,818
1,115
14,789
Total liabilities and stockholders’ equity
$
1,904,139
$
1,779,895
$
1,811,672
$
67,342
$
60,609
$
63,328
Net interest income
Net interest spread
Net interest-earning assets
$
344,253
Net interest margin
Average interest-earning assets to average
interest-bearing liabilities
Return on average assets
Return on average equity
Average equity to average assets
Non-interest expense to average assets
123.46%
0.86%
9.41%
9.10%
3.28%
3.41%
$
3.72%
326,823
3.36%
$
3.58%
341,033
123.89%
0.67%
7.16%
9.35%
3.20%
124.42%
0.82%
9.40%
8.75%
3.11%
4.68%
6.04%
4.49%
4.66%
5.11%
1.58%
1.57%
3.11%
0.60%
4.50%
0.27%
0.48%
0.90%
1.62%
0.87%
0.97%
6.87%
11.15%
1.06%
3.44%
3.64%
(1) The average balances of loans and leases include non-performing loans and leases and loans held for sale. Interest income related to non-performing loans and leases is recognized
when collected. Interest income includes net loan fees collected in lieu of interest.
Includes amortized cost basis of assets available-for-sale and held-to-maturity.
(2)
(3) Yields on tax-exempt municipal securities are not presented on a tax-equivalent basis in this table.
34
Table of Contents
The following table provides information with respect to: (1) the change in net interest income attributable to changes in rate (changes in rate multiplied
by prior volume); and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the year ended
December 31, 2018 compared to the year ended December 31, 2017 and for the year ended December 31, 2017 compared to the year ended December 31, 2016 .
The change in net interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) has been allocated to the rate and
volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.
Rate/Volume Analysis
Increase (Decrease) for the Year Ended December 31,
2018 Compared to 2017
2017 Compared to 2016
Rate
Volume
Net
Rate
Volume
Net
(In Thousands)
$
4,765 $
5,403 $
10,168 $
(1,538) $
1,063 $
(475)
3,893
(57)
95
8,696
744
35
81
312
(15)
94
90
3,878
37
185
(922)
(72)
(169)
5,572
14,268
(2,701)
(25)
(60)
106
3
719
(25)
187
315
284
96
(20)
395
Interest-earning assets
Commercial real estate and other mortgage loans (1)
Commercial and industrial loans (1)
Direct financing leases (1)
Consumer and other loans (1)
Total loans and leases receivable (1)
Mortgage-related securities (2)
Other investment securities
FHLB and FRB Stock
Short-term investments
Total net change in income on interest-earning assets
9,868
5,596
15,464
(1,946)
Interest-bearing liabilities
Transaction accounts
Money market
Certificates of deposit
Wholesale deposits
Total deposits
FHLB advances
Other borrowings
Junior subordinated notes
1,042
3,120
526
819
5,507
944
(146)
(2)
294
(491)
504
(1,086)
(779)
3,224
(19)
2
1,336
2,629
1,030
(267)
4,728
4,168
(165)
—
686
(84)
63
387
89
113
(5)
Total net change in expense on interest-bearing liabilities
6,303
2,428
8,731
1,249
1,052
(1,963)
Net change in net interest income
$
3,565 $
3,168 $
6,733 $
(3,195)
$
476
$
(2,719)
(1) The average balances of loans and leases include non-performing loans and leases and loans held for sale. Interest income related to non-performing loans and leases is recognized
when collected. Interest income includes net loan fees collected in lieu of interest.
Includes amortized cost basis of assets available-for-sale and held-to-maturity.
(2)
Net interest income increased by $6.7 million , or 11.1% , for the year ended December 31, 2018 , compared to the year ended December 31, 2017 . The
increase compared to the prior year was principally due to an increase in average loans and leases outstanding, average loan and lease yields, and loan fees
collected in lieu of interest. Average gross loans and leases of $1.584 billion increased by $117.5 million , or 8.0% for the year ended December 31, 2018 ,
compared to $1.466 billion for the same period in 2017 while loan fees collected in lieu of interest increased 36.9% to $5.2 million, compared to $3.8 million
during the same period of comparison. These favorable variances were partially offset by an increase in interest expense resulting from an increase in rates across
various interest-bearing products combined with the successful deposit campaigns designed to appeal to prospective private wealth management clients in local
markets. Both 2018 and 2017 benefited from increases to short-term market rates, which management defines as the daily average effective federal funds rate for
purposes of estimating interest-earning asset and interest-bearing liability betas. We define betas as the change in the yield of our average earning assets or the rate
paid on our average interest-bearing liabilities over a particular period, compared to the changes in the daily effective federal funds rate over the same period.
35
(1,056)
(1,978)
(61)
88
34
(146)
69
44
(361)
(360)
193
(282)
(86)
(133)
(81)
(2,667)
138
165
24
34
(2,306)
879
(366)
(23)
(1,788)
(1,401)
1,243
(118)
2
(836)
(911)
1,332
(5)
(3)
413
Table of Contents
The yield on average earning assets for the year ended December 31, 2018 was 5.04% , an increase of 57 basis points compared to 4.47% for the year
ended December 31, 2017 . The increase in the yield on average earning assets was principally due to the increase in short-term market rates combined with an
increase in recurring loan fees collected in lieu of interest. Excluding the impact of loan fees in lieu of interest in both 2018 and 2017, the yield on average earning
assets for the year ended December 31, 2018 was 4.75% , an increase of 50 basis points compared to 4.25% for the year ended December 31, 2017 . This increase
in yield is principally due to an increase in rates on certain variable-rate loans and investment security yields following the Federal Open Market Committee’s
(“FOMC”) decision to increase the targeted federal funds rate 100 basis points in 2018, compared to 75 basis points in 2017. The average interest-earning assets
beta for the year ended December 31, 2018 was 68.7%, compared to (0.1%) for the same period in 2017. Excluding recurring loan fees collected in lieu of interest,
the average interest-earning assets beta for the year ended December 31, 2018 was 60.8%, compared to 0.2% for the same period in 2017.
The yield on average loans and leases receivable for the year ended December 31, 2018 was 5.45% , an increase of 54 basis points compared to 4.91% for
the year ended December 31, 2017 . The primary reasons for the increase in the yield on average loans and leases receivable are consistent with the average
interest-earning asset yield variance explanations discussed above. Excluding the impact of loan fees collected in lieu of interest in both 2018 and 2017, the yield
on average loans and leases receivable for the year ended December 31, 2018 was 5.12% , an increase of 47 basis points compared to 4.65% for the year ended
December 31, 2017 .
The average rate paid on interest-bearing liabilities was 1.63% for the year ended December 31, 2018 , an increase of 52 basis points from 1.11% for the
year ended December 31, 2017 . The average interest-bearing liabilities beta for the year ended December 31, 2018 was 62.7%, compared to 0.1% for the same
period in 2017. Average interest-bearing deposit costs in 2018 increased to 1.34% , up 46 basis points from 0.88% in 2017. The average interest-bearing deposit
beta was 55.4%, compared to 0.0% in the prior year. Management believes an increase in funding costs may put downward pressure on net interest margin as the
Corporation looks to grow in-market deposits amid intense competition.
Consistent with the Corporation’s longstanding funding strategy to manage interest rate risk and use the most efficient and cost effective source of
wholesale funds, a combination of fixed rate wholesale deposits and fixed rate FHLB advances are used at various maturity terms to meet the Corporation’s
funding needs. Average FHLB advances for the year ended December 31, 2018 increased $169.1 million to $274.4 million at an average rate paid of 2.06% .
As of December 31, 2018 , the weighted average original maturity of our FHLB term advances was 2.7 years. Average wholesale deposits, consisting of brokered
certificates of deposit and deposits gathered from internet listing services, for the year ended December 31, 2018 decreased $59.3 million to $302.4 million at
an average rate paid of 1.95% . As of December 31, 2018 , the weighted average original maturity of our wholesale deposits was 4.7 years.
Net interest margin increased 14 basis points to 3.72% for the year ended December 31, 2018 , compared to 3.58% for the year ended December 31, 2017
. The increase was primarily due to the higher fees collected in lieu of interest mentioned above and the yield on average interest-earnings assets, excluding fees
collected in lieu of interest, increasing at a greater rate than the corresponding increase in the rate paid on interest-bearing liabilities.
Management believes the successful efforts to manage funding costs and profitably expand loan balances will allow the Corporation to continue to
maintain a net interest margin of 3.50% or better. However, the collection of loan fees in lieu of interest is an expected source of volatility to net interest income
and net interest margin. Net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status
or the accumulation of significant short-term deposit inflows.
Despite an uncertain rate environment, management expects to effectively manage the Corporation’s liability structure in both term and rate to deliver a
stable net interest margin within our target range. Further, we expect to attract new in-market deposit relationships which we believe will contribute to our ability
to maintain an appropriate cost of funds. Period end in-market deposits - comprised of all transaction accounts, money market accounts, and non-wholesale
deposits - were $1.179 billion at December 31, 2018 , compared to $1.086 billion for at December 31, 2017 . Average in-market deposits were $1.097 billion for
both the year ended December 31, 2018 and 2017 .
Provision for Loan and Lease Losses
We determine our provision for loan and lease losses pursuant to our allowance for loan and lease loss methodology, which is based on the magnitude of
current and historical net charge-offs recorded throughout the established look-back period, the evaluation of several qualitative factors for each portfolio category
and the amount of specific reserves established for impaired loans that present collateral shortfall positions. Refer to Allowance for Loan and Lease Losses ,
below, for further information regarding our allowance for loan and lease loss methodology.
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Table of Contents
We recorded a provision for loan and lease losses of $5.5 million for the year ended December 31, 2018 as compared to $6.2 million for the year ended
December 31, 2017 . Provision for year ended December 31, 2018 benefited from successfully liquidating collateral during the third quarter of 2018 associated
with the previously disclosed Wisconsin-based commercial and industrial loan, which decreased the provision by approximately $4.1 million. This decrease was
partially offset by provision expense primarily associated with impaired loan relationships throughout 2018, the majority of which were originated as part of our
legacy SBA loan portfolio, defined as SBA loans originated prior to 2017. The legacy on-balance sheet SBA portfolio continues to decline. As of December 31,
2018, total on-balance sheet legacy loans were $39.3 million compared to $51.7 million at December 31, 2017. Total performing on-balance sheet legacy loans
were $26.3 million at December 31, 2018, down from $40.6 million at December 31, 2017. The current year provision also reflected an increase to the general
reserve commensurate with an increase in loan and lease receivables.
The addition of specific reserves on impaired loans represents new specific reserves established when collateral shortfalls or government guaranty
deficiencies are present, while conversely the release of specific reserves represents the reduction of previously established reserves that are no longer required.
Changes in the allowance for loan and lease losses due to subjective factor changes reflect management’s evaluation of the level of risk within the portfolio based
upon several factors for each portfolio segment. Charge-offs in excess of previously established specific reserves require an additional provision for loan and lease
losses to maintain the allowance for loan and lease losses at a level deemed appropriate by management. This amount is net of the release of any specific reserve
that may have already been provided. Change in the inherent risk of the portfolio is primarily influenced by the overall growth in gross loans and leases and an
analysis of loans previously charged off, as well as movement of existing loans and leases in and out of an impaired loan classification where a specific evaluation
of a particular credit may be required rather than the application of a general reserve loss rate. Refer to Asset Quality , below, for further information regarding
the overall credit quality of our loan and lease portfolio.
Non-Interest Income
Non-interest income, consisting primarily of fees earned for trust and investment services, service charges on deposits, loan fees, commercial swap fee
income, and gains on sale of SBA loans, increased by $1.5 million , or 9.0% , to $18.2 million for the year ended December 31, 2018 , from $16.7 million for the
year ended December 31, 2017 . Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified
revenue stream through greater contribution from fee-based revenues. Total non-interest income accounted for 21.2% of our total revenues in 2018 compared to
21.6% in 2017 .
The increase in total non-interest income for the year ended December 31, 2018 primarily reflected record trust and investment fee income and an
increase in commercial swap fee income. The increase was partially offset by decreases in loan fees, gains on the sale of SBA loans, and other non-interest income.
The components of non-interest income were as follows:
For the Year Ended December 31,
Change From Prior Year
2018
2017
2016
$ Change
2018
% Change
2018
$ Change
2017
% Change
2017
(In Thousands)
Trust and investment services fee income
$
7,744
$
6,670
$
5,356
$
1,074
16.1 %
$
1,314
Gain on sale of SBA loans
Gain on sale of residential mortgage loans
Service charges on deposits
Loan fees
Increase in cash surrender value of bank-
owned life insurance
Net (loss) gain on sale of securities
Swap fees
Other non-interest income
1,451
—
3,062
1,783
1,191
(4)
1,670
1,270
1,591
26
3,013
1,988
1,250
(403)
909
1,621
4,400
590
2,990
2,430
974
10
76
1,162
(140)
(26)
49
(205)
(59)
399
761
(351)
Total non-interest income
$
18,167
$
16,665
$
17,988
$
1,502
Fee income ratio (1)
21.2%
21.6%
22.1%
(8.8)
(100.0)
1.6
(10.3)
(4.7)
(99.0) —
83.7 —
(21.7)
9.0
(2,809)
(564)
23
(442)
276
(413)
833
459
$
(1,323)
24.5 %
(63.8)%
(95.6)%
0.8
(18.2)
28.3
NM
NM
39.5
(7.4)
37
Table of Contents
(1) Fee income ratio is fee income, per the above table, divided by top line revenue (defined as net interest income plus non-interest income).
Trust and investment services fee income increased by $1.1 million , or 16.1% , to $7.7 million for the year ended December 31, 2018 compared to $6.7
million for the year ended December 31, 2017 . Trust and investment services fee income is primarily driven by the amount of assets under management and
administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility
within the capital markets. This increase was driven by growth in assets under management and administration attributable to both new client relationships and
increased equity market values. At December 31, 2018 , our trust assets under management and administration were $1.630 billion , or 6.1% more than trust assets
under management and administration of $1.536 billion at December 31, 2017 . We expect to continue to increase our revenue from assets under management and
administration, but market volatility may also affect the actual change in revenue.
Gain on sale of SBA loans for the year ended December 31, 2018 totaled $1.5 million , a decrease of $140,000 , or 8.8% , from the same period in 2017 .
The pipeline of approved SBA loans continues to grow, however, gains on the sale of SBA loans may be a source of volatility based on sale premiums and the
uncertain timing of loan closings and fundings. Gross SBA loan commitments closed for the year ended December 31, 2018 totaled $26.1 million, compared to
$11.6 million for the same period in 2017 . As of December 31, 2018, gross SBA loan commitments closed, but not ready for sale, totaled $8.4 million.
Loan fees decreased by $205,000 , or 10.3% , to $1.8 million for the year ended December 31, 2018 from $2.0 million for the year ended December 31,
2017 . The decrease in loan fees was primarily attributable to a decrease in fees associated with SBA production, specifically SBA loan packaging and servicing
fee income, as well as a decrease in miscellaneous asset-based lending fee income.
Net loss on sale of securities totaled $4,000 for the year ended December 31, 2018 , compared to net loss on sale of securities of $403,000 for the year
ended December 31, 2017 . The 2017 net loss was principally due to the strategic decision to harvest securities losses ahead of the 2018 reduction in corporate tax
rates.
Commercial loan swap fees increased by $761,000 to $1.7 million for the year ended December 31, 2018 from $909,000 for the year ended December 31,
2017 . 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. While interest rate swaps continue to be a valuable product for our commercial
borrowers, demand may moderate due to changes in the interest rate environment.
Other non-interest income decreased by $351,000 to $1.3 million for the year ended December 31, 2018 , compared to $1.6 million for the year ended
December 31, 2017 . The decrease was primarily due to a $212,000 allocation of net income received during 2017 from an equity investment in a project to
rehabilitate a historic building.
Non-Interest Expense
Non-interest expense increased by $5.5 million , or 9.7% , to $62.4 million for the year ended December 31, 2018 from $56.9 million for the comparable
period of 2017 . The increase in non-interest expense was primarily due to an increase in compensation, equipment, and computer software expense, in addition to
a net loss on foreclosed properties. The increase was partially offset by a decrease in collateral liquidation costs, impairment of tax credit investments, data
processing expense, and SBA recourse provision.
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Table of Contents
The components of non-interest expense were as follows:
For the Year Ended December 31,
Change From Prior Year
2018
2017
2016
$ Change
2018
% Change
2018
$ Change
2017
% Change
2017
$
37,439
$
31,663
$
31,545
$
5,776
18.2 % $
(Dollars in Thousands)
Compensation
Occupancy
Professional fees
Data processing
Marketing
Equipment
Computer software
FDIC insurance
Collateral liquidation costs
Net loss (gain) on foreclosed properties
Impairment on tax credit investments
SBA recourse provision
Other non-interest expense
2,192
3,869
2,362
2,135
1,434
3,015
1,478
646
367
2,083
1,913
3,430
2,088
4,063
2,701
2,109
1,211
2,723
1,388
829
(143)
2,784
2,240
3,215
2,019
4,031
3,298
2,338
1,189
2,160
1,472
262
122
3,691
2,068
2,238
104
(194)
(339)
26
223
292
90
(183)
510
(701)
(327)
215
5.0
(4.8)
(12.6)
1.2
18.4
10.7
6.5
(22.1)
NM
(25.2)
(14.6)
6.7
9.7
$
118
69
32
(597)
(229)
22
563
(84)
567
(265)
(907)
172
977
438
0.4 %
3.4
0.8
(18.1)
(9.8)
1.9
26.1
(5.7)
216.4
NM
(24.6)
8.3
43.7
0.8
Total non-interest expense
$
62,363
$
56,871
$
56,433
$
5,492
Compensation expense to total non-interest
expense
Full-time equivalent employees
60.0%
274
55.7%
251
55.9%
257
Compensation expense increased by $5.8 million , or 18.2% , to $37.4 million for the year ended December 31, 2018 from $31.7 million for the year
ended December 31, 2017 . The increase reflects new hires, annual merit increases, growth in employee benefit costs, and an increase in performance-based
incentive compensation. Full time equivalent employees as of December 31, 2018 were 274 , up 23 , or 9.2% from 251 at December 31, 2017 . The meaningful
increase in FTE is a reflection of our opportunistic approach to talent acquisition as we added 17 new producers across multiple business lines, including
commercial lending, SBA lending, wealth management, and equipment finance. We expect to continue investing in talent to support our strategic growth efforts,
both in the form of additional business development and operational staff.
Data processing expense decreased by $339,000 , or 12.6% , to $2.4 million for the year ended December 31, 2018 from $2.7 million for the year ended
December 31, 2017 . The decrease is primarily due to a reduction in non-recurring expense related to our core banking system conversion. During 2017, we
recognized $199,000 in final deconversion costs related to FBB-KC’s core banking system. These one-time fees are expected to be more than offset by savings
recognized over the life of the renegotiated contract extended through the year 2022.
Equipment expense increased by $223,000 , or 18.4% , to $1.4 million for the year ended December 31, 2018 from $1.2 million for the year ended
December 31, 2017 .
Computer software expense increased by $292,000 , or 10.7% , to $3.0 million for the year ended December 31, 2018 from $2.7 million for the year
ended December 31, 2017 . The increase was principally due to investments in technology platforms, continuing our strategic focus on scaling the Corporation to
efficiently execute our growth strategy.
Collateral liquidation costs for the year ended December 31, 2018 were $646,000 compared to $829,000 for the same period in 2017. The decrease
primarily reflected our workout process related to two non-performing loans and the subsequent reimbursement of previously expensed liquidation costs.
Net loss on foreclosed properties increased $510,000 to a net loss of $367,000 for the year ended December 31, 2018 , compared to a net gain of $143,000
for the year ended December 31, 2017 . The increase reflects a $547,000 gain on the sale of the Overland Park full-service banking location in 2017, partially
offset by a reduction in the fair value of the remaining foreclosed property.
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Table of Contents
Impairment on tax credit investments decreased $701,000 , or 25.2% , to $2.1 million for the year ended December 31, 2018 , compared to $2.8 million
for the year ended December 31, 2017 . The decrease reflects $1.4 million of impairment associated with the recognition of a $2.3 million federal historic tax credit
in 2018 , compared to $2.3 million of impairment associated with the recognition of a $3.0 million federal historic tax credit in 2017 .
SBA recourse provision for the year ended December 31, 2018 was $1.9 million compared to $2.2 million for the same period in 2017. The total
recourse reserve balance was $3.0 million, or 3.6% of total sold SBA loans outstanding, at December 31, 2018, compared to $2.8 million, or 2.8% of total sold
SBA loans outstanding, at December 31, 2017. The balance of sold legacy SBA loans, which is defined as sold SBA loans originated prior to 2017, continues to
decline. Total sold legacy SBA loans decreased $31.6 million, or 33.8%, to $62.0 million at December 31, 2018, compared to $93.6 million at December 31, 2017.
Total performing sold legacy SBA loans decreased $35.8 million, or 42.2%, to $49.0 million at December 31, 2018, down from $84.8 million at December 31,
2017. Changes to SBA recourse reserves may be a source of non-interest expense volatility in the future, though the magnitude of this volatility should diminish
over time.
Other non-interest expense increased by $215,000 , or 6.7% , to $3.4 million for the year ended December 31, 2018 from $3.2 million for the year
ended December 31, 2017 . The increase was primarily due to an increase in various general and administrative expenses such as supplies, postage, and travel
expense.
Income Taxes
Income tax expense was $1.4 million for the year ended December 31, 2018 , compared to $2.3 million for the year ended December 31, 2017 . Effective
January 1, 2018, the Act reduced the corporate federal income tax rate to 21% from 35%, which required the Corporation to revalue its deferred taxes as of
December 31, 2017. The revaluation resulted in an additional $629,000 income tax expense during the fourth quarter of 2017. The Corporation also recognized a
federal historic tax credit in both 2018 and 2017, which reduced income tax expense by $2.3 million and $3.0 million, respectively. The effective tax rate for the
year ended December 31, 2018 was 7.7% compared to 16.3% for the year ended December 31, 2017 .
General
FINANCIAL CONDITION
At December 31, 2018 total assets were $1.966 billion , representing an increase of $172.4 million , or 9.6% , from $1.794 billion at December 31, 2017 .
The increase in total assets was primarily driven by an increase in loans and leases receivable, securities available-for-sale, and excess cash held at the Federal
Reserve Bank (“FRB”).
Short-term investments
Short-term investments increased by $27.7 million to $63.2 million at December 31, 2018 from $35.5 million at December 31, 2017 . Short-term
investments primarily consist of interest-bearing deposits held at the FRB, which increased by $25.9 million to $43.6 million at December 31, 2018 . We value the
safety and soundness provided by the FRB, and therefore, we incorporate short-term investments in our on-balance-sheet liquidity program. Although the majority
of short-term investments consist of deposits with the FRB, we also make investments in commercial paper. We approach decisions to purchase commercial paper
with similar rigor and underwriting standards applied to our loan and lease portfolio. The original maturities of the commercial paper are typically 60 days or less
and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall
investment portfolio which we believe is necessary to benefit from a short-term repricing opportunity should rates continue to rise. As of December 31, 2018 , our
total investment in commercial paper was $19.3 million as compared to $17.4 million at December 31, 2017 . In general, the level of short-term investments is
influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits and FHLB advances, funding of loan and lease growth, and the level of
our securities portfolio. Please refer to the section entitled Liquidity and Capital Resources for further discussion.
Securities
Total securities, including available-for-sale and held-to-maturity, increased by $12.3 million to $176.1 million at December 31, 2018 from $163.8
million at December 31, 2017 . As of December 31, 2018 , our total securities portfolio had a weighted average estimated maturity of approximately 4.1 years. The
investment portfolio primarily consists of mortgage backed securities and is used to provide a source of liquidity, including the ability to pledge securities for
possible future cash advances, while contributing to the earnings potential of the Bank. The overall duration of the securities portfolio is established and maintained
to further mitigate interest rate risk present within our balance sheet as identified through asset/liability simulations. We purchase investment securities intended to
protect net interest margin while maintaining an acceptable risk profile. In addition, we will purchase investments to utilize our cash position effectively within
appropriate policy guidelines
40
Table of Contents
and estimates of future cash demands. While mortgage backed securities present prepayment risk and extension risk, we believe the overall credit risk associated
with these investments is minimal, as the majority of the securities we hold are guaranteed by the Federal National Mortgage Association (“FNMA”), the Federal
Home Loan Mortgage Corporation (“FHLMC”), or the Government National Mortgage Association (“GNMA”), a U.S. government agency. The estimated
repayment streams associated with this portfolio also allow us to better match short-term liabilities. The Bank’s investment policies allow for various types of
investments, including tax-exempt municipal securities. The ability to invest in tax-exempt municipal securities provides for further opportunity to improve our
overall yield on the securities portfolio. We evaluate the credit risk of the municipal securities prior to purchase and generally limit exposure to general obligation
issuances from municipalities, primarily in Wisconsin.
The majority of the securities we hold have active trading markets; therefore, we have not experienced difficulties in pricing our securities. We use a
third-party pricing service as our primary source of market prices for the securities portfolio. On a quarterly basis, we validate the reasonableness of prices received
from this source through independent verification of the portfolio, data integrity validation through comparison of current price to prior period prices and an
expectation-based analysis of movement in prices based upon the changes in the related yield curves and other market factors. On a periodic basis, we review the
third-party pricing vendor’s methodology for pricing relevant securities and the results of its internal control assessments. Our securities portfolio is sensitive to
fluctuations in the interest rate environment and has limited sensitivity to credit risk due to the nature of the issuers and guarantors of the securities as previously
discussed. If interest rates decline and the credit quality of the securities remains constant or improves, the fair value of our debt securities portfolio would likely
improve, thereby increasing total comprehensive income. If interest rates increase and the credit quality of the securities remains constant or deteriorates, the fair
value of our debt securities portfolio would likely decline and therefore decrease total comprehensive income. The magnitude of the fair value change will be based
upon the duration of the portfolio. A securities portfolio with a longer average duration will exhibit greater market price volatility movements than a securities
portfolio with a shorter average duration in a changing rate environment. During the year ended December 31, 2018 , we recognized unrealized holding losses of
$662,000 before income taxes through other comprehensive income. These losses were the result of an increase in interest rates. No securities within our portfolio
were deemed to be other-than-temporarily impaired as of December 31, 2018 . As of December 31, 2018 no securities were classified as trading securities.
At December 31, 2018 , $11.5 million of our mortgage-related securities were pledged to secure various obligations, including interest rate swap contracts
and municipal deposits.
41
Table of Contents
The table below sets forth information regarding the amortized cost and fair values of our securities.
2018
As of December 31,
2017
2016
Amortized Cost Fair Value
Amortized Cost Fair Value
Amortized Cost Fair Value
(In Thousands)
Available-for-sale:
U.S. government agency securities - government-
sponsored enterprises
Municipal securities
Asset-backed securities
$
999 $
990 $
999 $
1,000 $
6,298 $
5,953
—
5,886
—
9,494
—
9,414
—
8,246
1,116
6,295
8,156
1,081
Mortgage backed securities - government issued
20,007
19,628
22,313
22,249
30,936
31,213
Mortgage backed securities - government-sponsored
enterprises
Other securities
Held-to-maturity:
U.S. government agency securities - government-
sponsored enterprises
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored
enterprises
110,928
109,478
2,450
2,376
91,480
3,040
90,305
3,037
99,865
99,148
—
—
$
140,337 $
138,358 $
127,326 $
126,005 $
146,461 $
145,893
2018
As of December 31,
2017
2016
Amortized Cost Fair Value
Amortized Cost Fair Value
Amortized Cost Fair Value
(In Thousands)
$
— $
— $
1,499 $
1,490 $
1,497 $
21,066
7,358
21,079
7,186
21,680
9,072
21,822
8,943
21,173
9,148
1,494
21,157
9,127
9,307
9,144
5,527
5,441
6,794
6,742
$
37,731 $
37,409 $
37,778 $
37,696 $
38,612 $
38,520
U.S. government agency securities - government-sponsored enterprises represent securities issued by the FHLB, FHLMC and FNMA. Municipal
securities include securities issued by various municipalities located primarily within the State of Wisconsin and are primarily general obligation bonds that are
tax-exempt in nature. Asset-backed securities represent securities issued by the Student Loan Marketing Association (“SLMA”) which are 97% guaranteed by the
U.S. government. Mortgage backed securities - government issued represent securities guaranteed by GNMA. Mortgage backed securities - government-sponsored
enterprises include securities guaranteed by FHLMC and the FNMA. Other securities represent certificates of deposit of insured banks and savings institutions with
an original maturity greater than three months. As of December 31, 2018 , no issuer's securities exceeded 10% of our total stockholders' equity.
The following table sets forth the contractual maturity and weighted average yield characteristics of the fair value of our available-for-sale securities and
the amortized cost of our held-to-maturity securities at December 31, 2018 , classified by remaining contractual maturity. Actual maturities may differ from
contractual maturities because issuers have the right to call or prepay securities without call or prepayment penalties. Yields on tax-exempt securities have not been
computed on a tax equivalent basis.
42
Table of Contents
Less than One Year
One to Five Years
Five to Ten Years
Over Ten Years
Fair Value
Weighted
Average
Yield
Fair Value
Weighted
Average
Yield
Fair Value
Weighted
Average
Yield
Fair Value
Weighted
Average
Yield
Total
(Dollars in Thousands)
Available-for-sale:
U.S. government agency securities -
government-sponsored enterprises
$
Municipal securities
Mortgage backed securities - government
issued
Mortgage backed securities - government-
sponsored enterprises
Other securities
$
—
1,556
—
—
244
1,800
—% $
2.00
990
2,517
2.02% $
1.30
—
—
1.25
$
—
—
15,388
2,132
21,027
2.18
2.30
$
—
1,813
4,500
20,223
—
26,536
—% $
1.86
2.60
2.26
—
$
—
—
—% $
—
990
5,886
15,128
73,867
—
88,995
2.49
2.69
19,628
109,478
—
2,376
$ 138,358
Less than One Year
One to Five Years
Five to Ten Years
Over Ten Years
Amortized Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Total
(Dollars in Thousands)
771
—
—
771
2.14
11,834
2.01
—
—
$
—
—
11,834
—
—
$
8,461
3,330
7,262
19,053
2.31
1.86
2.22
$
—
—
21,066
4,028
2,045
6,073
2.19
3.42
7,358
9,307
$
37,731
$
Held-to-maturity:
Municipal securities
Mortgage backed securities - government
issued
Mortgage backed securities - government-
sponsored enterprises
Derivative Activities
The Bank’s investment policies allow the Bank to participate in hedging strategies or to use financial futures, options, forward commitments, or interest
rate swaps with prior approval from the Board. The Bank utilizes, from time to time, derivative instruments in the course of their asset/liability management. As of
December 31, 2018 and 2017 , the Bank did not hold any derivative instruments that were designated as fair value hedges. The derivative portfolio includes interest
rate swaps offered directly to qualified commercial borrowers, which allow the Bank to provide a fixed rate alternative to their clients while mitigating interest rate
risk by keeping a variable rate loan in their portfolios. The Bank economically hedges client derivative transactions by entering into equal and offsetting interest
rate swap contracts executed with dealer counterparties. The economic hedge with the dealer counterparties allows the Bank to primarily offset the fixed rate
interest rate risk. Derivative transactions executed through this program are not designated as accounting hedge relationships and are marked to market through
earnings each period.
As of December 31, 2018 , the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was approximately $144.4
million . We receive fixed rates and pay floating rates based upon LIBOR on the swaps with commercial borrowers. These swaps mature between April 2019 and
July 2034 . Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial
borrower swaps were reported on the Consolidated Balance Sheet as a derivative asset of $4.6 million , included in accrued interest receivable and other assets, and
as a derivative liability of $70,000 , included in accrued interest payable and other liabilities. On the offsetting swap contracts with dealer counterparties, we pay
fixed rates and receive floating rates based upon LIBOR. These interest rate swaps also have maturity dates between April 2019 and July 2034 . Dealer
counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported on the Consolidated Balance Sheet as a net
derivative liability of $4.5 million , included in accrued interest payable and other liabilities. The gross amount of dealer counterparty swaps, without regard to the
enforceable master netting agreement, was a gross derivative liability of $4.6 million and a gross derivative asset of $70,000 .
The Corporation also enters into interest rate swaps to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans.
These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life
of the agreement, without the exchange of the underlying notional value. The instruments are designated as cash flow hedges as the receipt of floating rate interest
from the counterparty is used to manage interest rate risk associated with forecasted issuances of short-term FHLB advances. The
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change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the
period that the hedged transactions affects earnings.
As of December 31, 2018 , the aggregate notional value of interest rate swaps designated as cash flow hedges was $54.0 million . These interest rate
swaps mature between December 2021 and December 2027 . A pre-tax unrealized loss of $20,000 was recognized in other comprehensive income for the year
ended December 31, 2018 and there was no ineffective portion of these hedges information about the balance sheet location and fair value of the Corporation’s
derivative instruments to qualified commercial borrowers as of December 31, 2018 and 2017 .
Loans and Leases Receivable
Loans and leases receivable, net of allowance for loan and lease losses, increased by $114.4 million , or 7.7% , to $1.597 billion at December 31, 2018
from $1.483 billion at December 31, 2017 . Construction, multi-family, and commercial and industrial loans (“C&I”) were the largest contributor to loan growth in
2018. There continues to be a concentration in commercial real estate (“CRE”) loans, however, in general our composition of total loans and leases has remained
relatively consistent due to balanced growth across our product offerings. CRE loans represented 67.6% and 67.7% of our total loans and leases as of
December 31, 2018 and December 31, 2017 , respectively. As of December 31, 2018 , approximately 18.6% of the CRE loans were owner-occupied CRE. We
consider owner-occupied CRE more characteristic of the Corporation’s C&I portfolio as, in general, the client’s primary source of repayment is the cash flow from
the operating entity occupying the commercial real estate property.
Our C&I portfolio increased $33.3 million , or 7.8% , to $462.3 million at December 31, 2018 from $429.0 million at December 31, 2017 reflecting
growth in both conventional lending and specialty finance. C&I loans represented 28.6% and 28.5% of our total loans and leases as of December 31, 2018 and
December 31, 2017 , respectively. We will continue to emphasize actively pursuing C&I loans across the Corporation as this segment of our loan and lease
portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management,
and trust and investment relationships which generate additional fee revenue.
Credit underwriting primarily through a committee process is a key component of our operating philosophy. Business development officers have
relatively low individual lending authority limits, and thus, a significant portion of our new credit extensions require approval from a loan approval committee
regardless of the type of loan or lease, amount of the credit, or the related complexities of each proposal. In addition, we make every reasonable effort to ensure
that there is appropriate collateral or a government guarantee at the time of origination to protect our interest in the related loan or lease. To monitor the ongoing
credit quality of our loans and leases, each credit is evaluated for proper risk rating using a nine grade risk rating system at the time of origination, subsequent
renewal, evaluation of updated financial information from our borrowers, or as other circumstances dictate.
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The following table presents information concerning the composition of the Bank’s consolidated loans and leases receivable.
As of December 31,
2018
2017
2016
2015
2014
Amount
Outstanding
% of Total
Loans and
Leases
Amount
Outstanding
% of Total
Loans and
Leases
Amount
Outstanding
% of Total
Loans and
Leases
Amount
Outstanding
% of Total
Loans and
Leases
Amount
Outstanding
% of Total
Loans and
Leases
(Dollars in Thousands)
$
203,476
12.6% $
200,387
13.3% $
176,459
12.2% $
176,322
12.3% $
163,884
12.8%
484,427
42,666
161,562
167,868
34,340
1,094,339
462,321
33,170
8,438
20,789
29,227
29.9
2.6
10.0
10.4
2.1
67.6
28.6
2.0
0.5
1.3
1.8
470,236
40,154
125,157
136,978
44,976
1,017,888
429,002
30,787
7,262
18,099
25,361
31.3
2.7
8.3
9.1
3.0
67.7
28.5
2.1
0.5
1.2
1.7
473,158
56,638
101,206
92,762
45,651
945,874
450,298
30,951
8,412
16,329
24,741
32.6
3.9
7.0
6.4
3.1
65.2
31.0
2.1
0.6
1.1
1.7
436,901
59,779
100,625
80,254
50,304
904,185
472,193
31,093
8,237
16,319
24,556
30.5
4.2
7.0
5.6
3.5
63.1
33.0
2.2
0.6
1.1
1.7
417,962
56,836
64,324
72,578
36,182
811,766
416,654
34,165
7,866
11,341
19,207
32.6
4.4
5.0
5.7
2.8
63.3
32.5
2.7
0.6
0.9
1.5
1,619,057
100.0%
1,503,038
100.0%
1,451,864
100.0%
1,432,027
100.0%
1,281,792
100.0%
Commercial real estate:
Commercial real estate —
owner occupied
Commercial real estate —
non-owner occupied
Land development
Construction
Multi-family
1-4 family
Total commercial real
estate
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second
mortgage
Other
Total consumer and other
Total gross loans and
leases receivable
Less:
Allowance for loan and
lease losses
Deferred loan fees
Loans and leases
receivable, net
20,425
1,402
18,763
1,443
20,912
1,189
16,316
1,062
14,329
1,025
$
1,597,230
$
1,482,832
$
1,429,763
$
1,414,649
$
1,266,438
The following table shows the scheduled contractual maturities of the Bank’s consolidated gross loans and leases receivable, as well as the dollar amount
of such loans and leases which are scheduled to mature after one year which have fixed or adjustable interest rates, as of December 31, 2018 .
Amounts Due
In One Year
or Less
After One
Year through
Five Years
After Five
Years
Interest Terms On Amounts Due after
One Year
Total
Fixed Rate
Variable
Rate
(In Thousands)
$
11,553 $
128,267 $
63,656 $
203,476 $
142,551 $
53,571
18,868
27,181
21,165
7,992
173,279
5,132
13,047
303,021
127,835
23,184
35,377
87,825
25,003
223,291
20,732
14,964
614
99,004
58,878
1,345
65,751
7,306
1,216
484,427
42,666
161,562
167,868
34,340
462,321
33,170
29,227
316,657
8,887
31,887
104,681
25,929
121,550
28,038
11,867
49,372
114,200
14,911
102,494
42,022
419
167,491
—
4,313
$
331,788 $
861,664 $
425,605 $
1,619,057 $
792,047 $
495,222
Commercial real estate:
Owner-occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases
Consumer and other
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Commercial Real Estate. The Bank originates owner-occupied and non-owner-occupied commercial real estate loans which have fixed or adjustable rates
and generally terms of up to five years and amortizations of up to 30 years on existing commercial real estate and new construction. The Bank also originates loans
to construct commercial properties and complete land development projects. The Bank’s construction loans generally have terms of six to 24 months with fixed or
adjustable interest rates and fees that are due at the time of origination. Loan proceeds are disbursed in increments as construction progresses and as project
inspections warrant.
Commercial real estate lending typically involves larger loan principal amounts than residential mortgage loans or consumer loans and, therefore, have
the potential for larger losses on a per loan basis. The repayment of these loans generally is dependent on sufficient income from the properties securing the loans
to cover operating expenses and debt service. Payments on commercial real estate loans are often dependent on external market conditions impacting the successful
operation or development of the property or business involved. Therefore, repayment of such loans is often more sensitive than other types of loans to adverse
conditions in the real estate market or the general economy, which are outside the borrower’s control. In the event that the cash flow from the property is reduced,
the borrower’s ability to repay the loan could be negatively impacted. The deterioration of one or a few of these loans could cause a material increase in our level
of nonperforming loans, which would result in a loss of revenue from these loans and could result in an increase in the provision for loan and lease losses and an
increase in charge-offs, all of which could have a material adverse impact on our net income. Additionally, many of these loans have real estate as a primary or
secondary component of collateral. The market value of real estate can fluctuate significantly in a short period of time as a result of economic conditions. Adverse
developments affecting real estate values in one or more of our markets could impact collateral coverage associated with the commercial real estate segment of our
portfolio, possibly leading to increased specific reserves or charge-offs, which would adversely affect profitability. Of the $1.094 billion of commercial real estate
loans outstanding as of December 31, 2018 , $23.7 million were originated by our asset-based lending subsidiary.
Commercial and Industrial. The Bank’s commercial and industrial loan portfolio is comprised of loans for a variety of purposes which principally are
secured by inventory, accounts receivable, equipment, machinery, and other corporate assets and are advanced within limits prescribed by our loan policy. The
majority of such loans are secured and typically backed by personal guarantees of the owners of the borrowing business. Of the $462.3 million of commercial and
industrial loans outstanding as of December 31, 2018 , $119.5 million were originated by our asset-based lending subsidiary, $14.4 million were originated by our
factored receivable business line and $24.6 million were originated by our equipment finance and leasing subsidiary. The asset-based loans, including accounts
receivable purchased on a full recourse basis, are typically secured by the borrower’s accounts receivable and inventory. These loans generally have higher interest
rates and non-origination fees collected in lieu of interest and the collateral supporting the credit is closely monitored. The equipment finance loans may provide
100% financing.
Our commercial loans, with the exception of our small ticket vendor finance program, are typically larger in amount than loans to individual consumers
and, therefore, have the potential for larger losses on a per loan basis. Additionally, asset-based borrowers are usually highly leveraged and/or have inconsistent
historical earnings. Significant adverse changes in various industries could cause rapid declines in values and collectability associated with those business assets
resulting in inadequate collateral coverage that may expose us to future losses. An increase in specific reserves and charge-offs may have a material adverse impact
on our results of operations.
Small Business Administration. As an SBA Preferred Lender, the Bank originates loans partially guaranteed by the SBA to small businesses under the
7(a) Loan Program. Historically we have sold the guaranteed portions of our SBA 7(a) loans in the secondary market and retained the non-guaranteed
portions. SBA lending is a significant part of our strategic business plan. The success of our SBA lending program is dependent upon the continued availability of
SBA loan programs, our status as a preferred lender, our ability to effectively compete and originate new SBA loans, and our ability to comply with applicable
SBA lending requirements. As of December 31, 2018 , the Corporation’s ownership of SBA loans that were included in the commercial and industrial loan
portfolio was $34.6 million , while the amount included in the commercial real estate loan portfolio was $11.3 million .
Direct Financing Leases. Direct financing leases initiated through FBEF are originated with a fixed rate and typically a term of seven years or less. It is
customary in the leasing industry to provide 100% financing; however, FBEF will, from time-to-time, require a down payment or lease deposit to provide a credit
enhancement. As of December 31, 2018 , the Bank had $33.2 million in net direct financing receivables outstanding.
FBEF leases machinery and equipment to clients under leases which qualify as direct financing leases for financial reporting and as operating leases for
income tax purposes. Under the direct financing method of accounting, the minimum lease payments to be received under the lease contract, together with the
estimated unguaranteed residual value (approximating 3% to 20% of the cost of the related equipment), are recorded as lease receivables when the lease is signed
and the lease property is delivered to the client. The excess of the minimum lease payments and residual values over the cost of the equipment is
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recorded as unearned lease income. Unearned lease income is recognized over the term of the lease on a basis which results in a level rate of return on the
unrecovered lease investment. Lease payments are recorded when due under the lease contract. Residual value is the estimated fair market value of the equipment
on lease at lease termination. In estimating the equipment’s fair value, FBEF relies on historical experience by equipment type and manufacturer, published sources
of used equipment pricing, internal evaluations and, when available, valuations by independent appraisers, adjusted for known trends.
Our commercial leases, with the exception of our small ticket vendor finance program, are typically larger in amount than leases to individual consumers
and, therefore, have the potential for larger losses on an individual lease basis. Significant adverse changes in various industries could cause rapid declines in
values of leased equipment resulting in inadequate collateral coverage that may expose us to future losses. An increase in specific reserves and charge-offs may
have a material adverse impact on our results of operations.
Consumer and Other. The Bank originates a small amount of consumer loans consisting of home equity, second mortgage, credit card, and other personal
loans for professional and executive clients of the Bank.
Asset Quality
Non-performing loans decreased $1.1 million , or 4.1% , to $25.3 million at December 31, 2018 compared to $26.4 million at December 31, 2017 .
Our total impaired assets consisted of the following.
Non-accrual loans and leases
Commercial real estate:
Commercial real estate – owner occupied
Commercial real estate – non-owner occupied
Land development
Construction
Multi-family
1-4 family
Total non-accrual commercial real estate
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgage
Other
Total non-accrual consumer and other loans
Total non-accrual loans and leases
Foreclosed properties, net
Total non-performing assets
Performing troubled debt restructurings
Total impaired assets
As of December 31,
2018
2017
2016
2015
2014
(Dollars in Thousands)
$
5,663
$
7,021
$
2,223
$
2,907
$
31
2,213
—
—
—
7,907
17,104
34
2,626
2,872
1,609
3,440
2,918
—
—
1,161
13,714
12,321
1,937
12,127
12,463
—
—
—
—
—
—
290
290
25,301
2,547
27,848
180
354
354
26,389
1,069
27,458
332
604
604
25,194
1,472
26,666
717
1,678
4,393
397
2
2,550
11,927
9,136
38
542
655
1,197
22,298
1,677
23,975
1,735
$
28,028
$
27,790
$
27,383
$
25,710
$
500
286
4,932
—
17
690
6,425
2,318
—
329
720
1,049
9,792
1,693
11,485
2,003
13,488
Total non-accrual loans and leases to gross loans and leases
1.56%
1.76%
1.74%
1.56%
1.61%
Total non-performing assets to gross loans and leases plus foreclosed
properties, net
Total non-performing assets to total assets
Allowance for loan and lease losses to gross loans and leases
1.72%
1.42%
1.26%
1.83%
1.53%
1.25%
1.83%
1.50%
1.44%
1.67%
1.35%
1.14%
Allowance for loan and lease losses to non-accrual loans and leases
80.73%
71.10%
83.00%
73.17%
1.65%
1.28%
1.42%
87.68%
As of December 31, 2018 and 2017 , $7.6 million and $8.8 million of the non-accrual loans were considered troubled debt restructurings, respectively. As
noted in the table above, non-performing assets consisted of non-accrual loans and leases and foreclosed properties totaling $27.8 million , or 1.42% of total assets,
as of December 31, 2018 , an increase in non-
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performing assets of $390,000 , or 1.4% , from December 31, 2017 . Impaired loans and leases as of December 31, 2018 and 2017 also included $180,000 and
$332,000 , respectively, of loans that are performing troubled debt restructurings, which are considered impaired due to the concession in terms, but are meeting
the restructured payment terms and therefore are not on non-accrual status.
We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final
conclusion as to the asset quality of the portfolio. Non-performing assets as a percentage of total assets decreased to 1.42% at December 31, 2018 from 1.53% at
December 31, 2017 .
As of December 31, 2018 , the payment performance of our loans and leases did not point to any new areas of concern, as approximately 97.6% of the
total portfolio was in a current payment status. We also monitor our asset quality through our established categories as defined in Note 4 of our Consolidated
Financial Statements. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which
the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to
sell the underlying collateral, inadequate cash flow from the operations of the underlying businesses, liquidation events, or bankruptcy filings. We are proactively
working with our impaired loan borrowers to find meaningful solutions to difficult situations that are in the best interests of the Bank.
In 2018 , as well as in all previous reporting periods, there were no loans over 90 days past due and still accruing interest. Loans and leases greater than
90 days past due are considered impaired and are placed on non-accrual status. Cash received while a loan or a lease is on non-accrual status is generally applied
solely against the outstanding principal. If collectability of the contractual principal and interest is not in doubt, payments received may be applied to both interest
due on a cash basis and principal.
Additional information about impaired loans is as follows:
2018
2017
2016
2015
2014
As of December 31,
(In Thousands)
Impaired loans and leases with no impairment reserves
$
10,802 $
16,975 $
11,345 $
15,175 $
11,270
Impaired loans and leases with impairment reserves required
Total impaired loans and leases
Less: Impairment reserve (included in allowance for loan and lease losses)
14,679
25,481
4,396
9,746
26,721
4,491
14,566
25,911
5,599
8,858
24,033
1,113
Net impaired loans and leases
Average impaired loans and leases
$
$
21,085 $
22,230 $
20,312 $
22,920 $
26,431 $
33,164 $
22,986 $
11,443 $
525
11,795
290
11,505
14,474
For the years ended December 31,
2018
2017
2016
2015
2014
(In Thousands)
Interest income attributable to impaired loans and leases
$
3,478 $
2,695 $
1,617 $
750 $
Less: Interest income recognized on impaired loans and leases
1,304
454
614
87
Net foregone interest income on impaired loans and leases
$
2,174 $
2,241 $
1,003 $
663 $
870
740
130
Loans with no specific reserves required represent impaired loans where the collateral, based upon current information, is deemed to be sufficient or that
have been partially charged-off to reflect our net realizable value of the loan. When analyzing the adequacy of collateral, we obtain external appraisals as
appropriate. Our policy regarding commercial real estate appraisals requires the utilization of appraisers from our approved list, the performance of independent
reviews to monitor the quality of such appraisals, and receipt of new appraisals for impaired loans at least annually, or more frequently as circumstances warrant.
We make adjustments to the appraisals for appropriate selling costs. In addition, the ordering of appraisals and review of the appraisals are performed by
individuals who are independent of the business development process. Based on the specific evaluation of the collateral of each impaired loan, we believe the
reserve for impaired loans was appropriate at December 31, 2018 . However, we cannot provide assurance that the facts and circumstances surrounding each
individual impaired loan will not change and that the specific reserve or current carrying value will not be different in the future, which may require additional
charge-offs or specific reserves to be recorded.
Foreclosed properties are recorded at fair value of the underlying property, less costs to sell. If, at the time of foreclosure, the fair value less cost to sell is
lower than the carrying value of the loan, the difference is charged to the allowance
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for loan and lease losses prior to the transfer to foreclosed property. The fair value is based on an appraisal, discounted cash flow analysis (the majority of which is
based on current occupancy and lease rates) or a verifiable offer to purchase. After foreclosure, valuation allowances or future write-downs to net realizable value
are charged directly to non-interest expense. Foreclosed properties were $2.5 million as of December 31, 2018 , compared to $1.1 million as of December 31, 2017
. We recorded impairment losses of approximately $339,000 , $403,000 , and $7,000 for the years ended December 31, 2018 , 2017 , and 2016 , respectively. Net
loss on sales of existing foreclosed property inventory was $28,000 for the year ended December 31, 2018 . Net gain on the sale of existing foreclosed property
was $547,000 for the year ended December 31, 2017 , which reflected the sale of the Corporation’s previously disclosed Overland Park full-service banking
location during the fourth quarter of 2017, compared to a net loss of $115,000 for the year ended December 31, 2016 . We continue to evaluate possible exit
strategies on our impaired loans when foreclosure action may be probable and our level of foreclosed assets may increase in the future. Loans are transferred to
foreclosed properties when we claim ownership rights to the properties.
A summary of foreclosed properties activity is as follows:
Balance at the beginning of the period
Transfer of loans to foreclosed properties, at fair value
Impairment adjustments
Net book value of properties sold
Balance at the end of the period
Allowance for Loan and Lease Losses
For the Year Ended December 31,
2018
2017
2016
$
1,069 $
1,472 $
(In Thousands)
2,202
(339)
(385)
1,112
(403)
(1,112)
$
2,547 $
1,069 $
1,677
—
(7)
(198)
1,472
The allowance for loan and lease losses as a percentage of gross loans and leases was 1.26% as of December 31, 2018 and 1.25% as of December 31,
2017 . Non-accrual loans and leases as a percentage of gross loans and leases decreased to 1.56% at December 31, 2018 compared to 1.76% at December 31, 2017
. During the year ended December 31, 2018 , we recorded net charge-offs on impaired loans and leases of approximately $3.8 million , which included $6.1 million
of charge-offs and $2.3 million of recoveries. During the year ended December 31, 2017 , we recorded net charge-offs on impaired loans and leases of
approximately $8.3 million , which included $8.8 million of charge-offs and $519,000 of recoveries.
As of December 31, 2018 and 2017 , our allowance for loan and lease losses to total non-accrual loans and leases was 80.73% and 71.10% , respectively.
This ratio increased primarily due to the collateral positions related to additional non-accrual loans and leases outstanding during 2018. Impaired loans and leases
exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases
may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing
monitoring efforts, we try to ensure that we have appropriate collateral to protect our interest in the related loan or lease. As a result of this practice, a significant
portion of our outstanding balance of non-performing loans or leases either does not require additional specific reserves or requires only a minimal amount of
required specific reserve, as we believe the loans and leases are adequately collateralized as of the measurement period. In addition, management is proactive in
recording charge-offs to bring loans to their net realizable value in situations where it is determined with certainty that we will not recover the entire amount of our
principal. This practice may lead to a lower allowance for loan and lease loss to non-accrual loans and leases ratio as compared to our peers or industry
expectations. As asset quality strengthens, our allowance for loan and lease losses is measured more through general characteristics, including historical loss
experience, of our portfolio rather than through specific identification and we would therefore expect this ratio to rise. Conversely, if we identify further impaired
loans, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve. Given our business practices and
evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as of
December 31, 2018 .
To determine the level and composition of the allowance for loan and lease losses, we break out the portfolio by segments with similar risk
characteristics. First, we evaluate loans and leases for potential impairment classification. We analyze each loan and lease identified as impaired on an individual
basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of
expected cash flows. For each segment of loans and leases that has not been individually evaluated, management segregates the Bank’s loss factors into a
quantitative general reserve component based on historical loss rates throughout the defined look back period. The quantitative general reserve component also
considers an estimate of the historical loss emergence period, which is the period of time between the event that triggers the loss to the charge-off of that loss. The
methodology also focuses on evaluation of several qualitative factors for each portfolio category, including but not limited to: management’s ongoing review
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and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, existing economic
conditions, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations of loans to specific
industries, and other qualitative factors that could affect credit losses.
When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for loan
and lease loss reserve to bring the loan or lease to its net realizable value. Many of the impaired loans as of December 31, 2018 are collateral dependent. It is
typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment at least annually, or more
frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, we have found that in general real estate values have been
stable or improved; however, in specific situations current fair values collateralizing certain impaired loans were inadequate to support the entire amount of the
outstanding debt. Foreclosure actions may have been initiated on certain of these commercial real estate and other mortgage loans.
As a result of our review process, we have concluded that an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was
$20.4 million , or 1.26% of gross loans and leases, at December 31, 2018 . Taking into consideration net charge-offs of $3.8 million , the required provision for
loan and lease losses was $5.5 million for the year ended December 31, 2018 . However, given ongoing complexities with current workout situations and the
uncertainty surrounding future economic conditions, further charge-offs, and increased provisions for loan and lease losses may be recorded if additional facts and
circumstances lead us to a different conclusion. In addition, various federal and state regulatory agencies review the allowance for loan and lease losses. These
agencies could require certain loan and lease balances to be classified differently or charged off when their credit evaluations differ from those of management,
based on their judgments about information available to them at the time of their examination.
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A summary of the activity in the allowance for loan and lease losses follows:
Allowance at beginning of period
Charge-offs:
Commercial real estate
Commercial real estate — owner occupied
Commercial real estate — non-owner occupied
Construction and land development
Multi-family
1-4 family
Commercial and industrial
Direct financing leases
Consumer and other
Home equity and second mortgage
Other
Total charge-offs
Recoveries:
Commercial real estate
Commercial real estate — owner occupied
Commercial real estate — non-owner occupied
Construction and land development
Multi-family
1-4 family
Commercial and industrial
Direct financing leases
Consumer and other
Home equity and second mortgage
Other
Total recoveries
Net charge-offs
Provision for loan and lease losses
Allowance at end of period
Year Ended December 31,
2018
2017
2016
2015
2014
(Dollars in Thousands)
$
18,763
$
20,912
$
16,316
$
14,329
$
13,901
(3,124)
—
(1,372)
—
(5)
(1,545)
(9)
(80)
—
—
(38)
(8,621)
(41)
—
(948)
—
(205)
(2,273)
—
(653)
—
—
(120)
(701)
—
—
—
—
—
(55)
—
(92)
(6,101)
(8,840)
(114)
(13)
(3,594)
(32)
(7)
(1,513)
(1,233)
—
(631)
—
—
—
(600)
—
—
(2)
4
2
5
42
2
102
—
74
129
—
—
—
163
2,022
1
73
1
2,271
(3,830)
5,492
7
323
71
91
—
—
3
40
519
(8,321)
6,172
4
3
372
(3,222)
7,818
2
—
70
—
32
5
—
4
1
114
(1,399)
3,386
8
5
—
14
17
369
—
12
—
425
(808)
1,236
$
20,425
$
18,763
$
20,912
$
16,316
$
14,329
Net charge-offs as a percent of average gross loans and leases
0.24%
0.57%
0.22%
0.10%
0.08%
We review our methodology and periodically adjust allocation percentages of the allowance by segment, as reflected in the following table. Within the
specific categories, certain loans or leases have been identified for specific reserve allocations as well as the whole category of that loan type or lease being
reviewed for a general reserve based on the foregoing analysis of trends and overall balance growth within that category.
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The table below shows our allocation of the allowance for loan and lease losses by loan portfolio segments. The allocation of the allowance by segment
is management’s best estimate of the inherent risk in the respective loan segments. Despite the specific allocation noted in the table below, the entire allowance is
available to cover any loss.
2018
2017
2016
2015
2014
Balance
(a)
Balance
(a)
Balance
(a)
Balance
(a)
Balance
(a)
(Dollars in Thousands)
As of December 31,
Loan and lease segments:
Commercial real estate
Commercial and industrial
Consumer and other
Total allowance for loan and lease losses
$ 11,662
8,079
684
$ 20,425
1.07% $ 10,131
8,225
1.63%
2.34%
407
1.26% $ 18,763
1.00% $ 12,384
7,970
1.79%
1.60%
558
1.25% $ 20,912
1.31% $ 11,220
4,387
1.66%
2.26%
709
1.44% $ 16,316
1.24% $ 8,619
5,492
0.87%
2.89%
218
1.14% $ 14,329
1.06%
1.22%
1.14%
1.12%
(a) Allowance for loan losses category as a percentage of total loans by category.
Although we believe the allowance for loan and lease losses was appropriate based on the current level of loan and lease delinquencies, non-accrual loans
and leases, trends in charge-offs, economic conditions, and other factors as of December 31, 2018 , there can be no assurance that future adjustments to the
allowance will not be necessary.
Deposits
As of December 31, 2018 , deposits increased by $61.0 million to $1.455 billion from $1.394 billion at December 31, 2017 . The increase in deposits was
primarily due to an increase in certificates of deposit, which increased by $76.8 million to $153.0 million at December 31, 2018 from $76.2 million at
December 31, 2017 . The successful introduction of certificate of deposit campaigns and indexed money market accounts complemented our traditional strength in
commercial banking and wealth management, contributing to in-market deposit growth during 2018.
Consistent with the Corporation’s longstanding funding strategy to manage interest rate risk and use the most efficient and cost-effective source of
wholesale funds, management intends to maintain a ratio of in-market deposits to total bank funding sources in line with the Corporation’s target range of 60%-
70%. In 2017 we shifted from brokered certificate of deposits to FHLB advances as our primary source of wholesale funding in order to lower our FDIC
assessment rate. While we continued this strategy through a portion of 2018, we returned later in the year to using brokered certificates of deposits to maintain an
adequate level of excess borrowing capacity in our FHLB advances for liquidity and contingency funding purposes.
The following table presents the composition of the Bank’s consolidated deposits.
As of December 31,
2018
2017
2016
2015
2014
Balance
% of Total
Deposits
Balance
% of Total
Deposits
Balance
% of Total
Deposits
Balance
% of Total
Deposits
Balance
% of Total
Deposits
(Dollars in Thousands)
Non-interest-
bearing
transaction
accounts
Interest-bearing
transaction
accounts
Money market
accounts
Certificates of
deposit
Wholesale
deposits
Total deposits
$
280,769
19.3% $
277,445
19.9% $
252,638
16.4% $
231,199
14.7% $
204,328
14.2%
229,612
516,045
153,022
15.8
35.4
10.5
217,625
515,077
76,199
15.6
36.9
5.5
183,992
627,090
58,454
12.0
40.8
3.8
165,921
612,642
79,986
10.5
38.8
5.1
104,199
575,766
126,635
275,851
1,455,299
19.0
100.0%
307,985
1,394,331
22.1
100.0%
416,681
1,538,855
27.1
100.0%
487,483
1,577,231
30.9
100.0%
427,340
1,438,268
7.2
40.0
8.8
29.8
100.0%
Deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and
our ability to service and maintain existing and new client relationships. Deposits continue to be the primary source of the Bank’s funding for lending and other
investment activities. A variety of accounts are designed to attract both short- and long-term deposits. These accounts include non-interest-bearing transaction
accounts, interest-bearing transaction accounts, money market accounts, and time deposits. Deposit terms offered by the Bank vary according to the minimum
balance required, the time period the funds must remain on deposit, the rates and products offered by competitors, and the interest rates charged on other sources of
funds, among other factors.
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Table of Contents
Our strategic efforts continue to be focused on adding in-market relationships. The successful introduction of certificate of deposit campaigns in certain
markets and indexed money market accounts complemented our traditional strength in commercial banking and wealth management, contributing to in-market
deposit growth during 2018. We measure the success of in-market deposit gathering efforts based on the average balances of our deposit accounts as compared to
ending balances due to the volatility of some of our larger relationships. Our Bank’s in-market deposits are obtained primarily from the South Central,
Northeastern and Southeastern regions of Wisconsin and the greater Kansas City area. Average in-market deposits for the year ended December 31, 2018 were
approximately $1.097 billion , or 65.55% of total bank funding. Total bank funding is defined as total deposits plus FHLB advances. This compares to average in-
market deposits of $1.097 billion , or 70.15% of total bank funding, for 2017 . Refer to Note 8 - Deposits in our Consolidated Financial Statements for additional
information regarding our deposit composition.
The following table sets forth the amount and maturities of the Bank’s certificates of deposit and wholesale deposits at December 31, 2018 .
Interest Rate
0.00% to 0.99%
1.00% to 1.99%
2.00% to 2.99%
3.00% to 3.99%
Three Months and
Less
Over Three Months
Through Six Months
Over Six Months
Through Twelve
Months
(In Thousands)
Over Twelve Months
Total
$
3,020 $
619 $
676 $
108 $
12,265
23,323
—
35,186
23,238
245
43,869
81,373
1,125
80,859
95,907
27,060
$
38,608 $
59,288 $
127,043 $
203,934 $
4,423
172,179
223,841
28,430
428,873
At December 31, 2018 , time deposits included $61.9 million of certificates of deposit and wholesale deposits in denominations greater than or equal to
$250,000. Of these certificates, $14.7 million are scheduled to mature in three months or less, $8.7 million in greater than three through six months, $24.0 million
in greater than six through twelve months and $14.5 million in greater than twelve months.
Of the total time deposits outstanding as of December 31, 2018 , $224.9 million are scheduled to mature in 2019 , $119.9 million in 2020 , $34.3 million
in 2021 , $24.1 million in 2022 , $5.8 million in 2023 and $19.8 million thereafter. As of December 31, 2018 , we have $38.5 million of wholesale certificates of
deposit which the Bank has the right to call prior to the scheduled maturity. These certificates have original maturities ranging from 6-18 years with options to call
after the first six to twelve months of issuing the certificates with monthly, quarterly or semi-annually call options thereafter.
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Table of Contents
Borrowings
We had total borrowings of $309.0 million as of December 31, 2018 , an increase of $91.1 million , or 41.8% , from $217.9 million at December 31, 2017
. The primary reason for the increase in borrowings was due to the increase in FHLB advances consistent with our funding philosophy to match-fund long-term
fixed rate loans with the most efficient and cost effective source of wholesale funds.
Consistent with our funding philosophy to manage interest rate risk and use the most efficient and cost effective source of wholesale funds, we expect the
balance of wholesale deposits to increase in future periods. We will utilize FHLB advances to the extent we maintain an adequate level of excess borrowing
capacity for liquidity and contingency funding purposes. Our operating range of wholesale funds to total bank funding is 30%-40%. Wholesale funds include
brokered certificates of deposit, deposits gathered from internet listing services, and FHLB advances. Total bank funding is defined as total deposits plus FHLB
advances. At December 31, 2018 , the ratio of wholesale funds to total bank funding was 31.8% . 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.
The following table sets forth the outstanding balances, weighted average balances, and weighted average interest rates for our borrowings (short-term
and long-term) as indicated.
December 31, 2018
December 31, 2017
December 31, 2016
Weighted
Average
Balance
Weighted
Average
Rate
Weighted
Average
Balance
Weighted
Average
Rate
Balance
Balance
Weighted
Average
Balance
Weighted
Average
Rate
Balance
(Dollars in Thousands)
Federal funds purchased
$
— $
119
2.43% $
— $
66
1.22% $
— $
178
0.92%
FHLB advances
Line of credit
Other borrowings (1)
Subordinated notes payable
Junior subordinated notes
274,500
274,382
—
675
23,769
10,033
3
675
23,739
10,025
2.06
4.47
7.94
6.64
11.10
183,500
105,276
10
675
23,713
10,019
328
1,241
23,161
10,011
308,977 $ 308,943
2.72
$ 217,917 $ 140,083
Short-term borrowings
Long-term borrowings
$
$
136,500
172,477
$
308,977
$
37,010
180,907
$ 217,917
1.40
3.64
14.50
6.93
11.11
3.14
$
$
33,578
14,485
1,010
2,590
22,498
10,004
2,079
1,739
22,467
9,997
69,680 $
50,945
20,588
49,092
$
69,680
0.97
3.26
7.64
7.13
11.07
6.03
(1) Weighted average rate of other borrowings reflects the cost of prepaying a secured borrowing during the second quarter of 2017.
The following table sets forth maximum amounts outstanding at each month-end for specific types of short-term borrowings for the periods indicated. The
maximum month-end balance has been the result of using advances with original maturities of up to 30 days to accommodate the orderly issuance of permanent
wholesale funds, either in the form of brokered certificates of deposit or FHLB advances.
Maximum month-end balance:
FHLB advances
Stockholders’ Equity
Year Ended December 31,
2018
2017
2016
(In Thousands)
$
52,500 $
49,000 $
45,500
As of December 31, 2018 , stockholders’ equity was $180.7 million , or 9.2% of total assets, compared to stockholders’ equity of $169.3 million , or 9.4%
of total assets, as of December 31, 2017 . Stockholders’ equity increased by $11.4 million during the year ended December 31, 2018 attributable to net income of
$16.3 million for the year ended December 31, 2018 , partially offset by dividend declarations of $4.9 million .
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On December 14, 2018, the Corporation announced its Board of Directors approved a share repurchase program authorizing the Corporation to
repurchase up to $5 million of the Corporation’s common stock over a period of approximately twelve months, ending on December 31, 2019. As of February 26,
2019, an aggregate of 60,304 shares were purchased for a total value of $1.2 million since the inception of the repurchase program. The Corporation has $3.8
million of buyback authority remaining as of February 26, 2019.
Non-bank Consolidated Subsidiaries
First Madison Investment Corp. FMIC is a wholly-owned operating subsidiary of FBB incorporated in the State of Nevada in 1993. FMIC was
organized for the purpose of managing a portion of FBB’s investment portfolio. FMIC invests in marketable securities and tax-exempt loans. As an operating
subsidiary, FMIC’s results of operations are consolidated with FBB’s for financial and regulatory purposes. FBB’s investment in FMIC was $156.4 million at
December 31, 2018 , short-term investments were $20.0 million , securities were $95.9 million , gross loans outstanding were $39.1 million , and net income for
the year ended December 31, 2018 was $2.4 million . This compares to a total investment of $154.3 million , $668,000 short-term investments, $122.5 million
securities, $29.9 million gross loans, and net income of $1.8 million at and for the year ended December 31, 2017 .
First Business Capital Corp. FBCC is a wholly-owned subsidiary of FBB formed in 1995 and headquartered in Madison, Wisconsin. FBCC is an asset-
based financing company established to meet the financing needs of companies that are generally unable to obtain traditional commercial lending products. FBCC
underwrites its loans with additional emphasis placed on collateral coverage as the companies it finances are growing rapidly, highly leveraged, or undergoing a
turn-around period. Through its FBGF division, FBCC purchases accounts receivable on a full recourse basis as an alternative to meet the financing needs of its
client base. FBB’s investment in FBCC at December 31, 2018 was $43.3 million , gross loans outstanding were $157.7 million and net income for the year ended
December 31, 2018 was $4.6 million . This compares to a total investment of $38.7 million , gross loans of $147.1 million and net income of $3.1 million at and
for the year ended December 31, 2017 .
First Business Equipment Finance, LLC. FBEF, headquartered in Madison, Wisconsin, was formed in 1998 for the purpose of originating leases and
extending credit in the form of loans to small- and medium-sized companies nationwide and is a wholly-owned subsidiary of FBB. FBB’s total investment in
FBEF at December 31, 2018 was $10.1 million , gross loans and leases outstanding were $57.8 million and net income of $3.1 million for the year ended
December 31, 2018 . This compares to a total investment of $7.1 million , gross loans and leases outstanding of $40.4 million and net loss of $55,000 at and for the
year ended December 31, 2017 .
Rimrock Road Investment Fund, LLC . Rimrock, formerly known as FBB Real Estate, LLC, is a wholly-owned subsidiary of FBB and was originally
formed in 2009 for the purpose of holding and liquidating real estate and other assets acquired through foreclosure or other legal proceedings. In 2014, Rimrock’s
purpose was changed to reflect its qualified equity investment in a Madison, Wisconsin community development project, including the financing and ownership of
a property that generates federal new market tax credits. FBB’s total investment in Rimrock at December 31, 2018 was $2.7 million and Rimrock had a net loss of
$103,000 for the year ended December 31, 2018 . This compares to a total investment of $2.8 million and net income of $15,000 at and for the year ended
December 31, 2017 .
BOC Investment, LLC. BOC is a wholly-owned subsidiary of FBB and was formed in 2015 for the purpose of holding its equity investment in a
Madison, Wisconsin historic development project. The investment provided federal historic tax credits upon the completion of the restoration project. FBB’s total
investment in BOC at December 31, 2018 was $4.0 million and BOC had net income of $24,000 for the year ended December 31, 2018 . This compares to a total
investment of $4.0 million and a net income of $131,000 at and for the year ended December 31, 2017 .
Mitchell Street Apartments Investment, LLC. Mitchell is a wholly-owned subsidiary of FBB and was formed in 2016 for the purpose of holding its
equity investment in a Milwaukee, Wisconsin historic development project. The investment provided federal and state historic tax credits upon the completion of
the restoration project. FBB’s total investment in Mitchell was $1.4 million with a net loss of $188,000 at and for the year ended December 31, 2018 . This
compares to a total investment of $1.4 million and net income of $803,000 at and for the year ended December 31, 2017 .
ABKC Real Estate, LLC. ABKCRE is a wholly-owned subsidiary of FBB and was formed for the purpose of holding and liquidating real estate and
other assets acquired by FBB through foreclosure or other legal proceedings. ABKCRE was established in 2017. FBB’s total investment in ABKCRE at
December 31, 2018 was $1.4 million and ABKCRE had a net loss of $269,000 for the year ended December 31, 2018 . This compares to a total investment of $1.2
million and a $238,000 net loss at and for the year ended December 31, 2017 .
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FBB Tax Credit Investment, LLC. FBB Tax Credit, formerly known as FBB-Milwaukee Real Estate, LLC, is a wholly-owned subsidiary of FBB and
was originally formed in 2012 for the purpose of holding and liquidating real estate and other assets acquired by FBB through foreclosure or other legal
proceedings. In 2017, FBB Tax Credit’s purpose was changed to facilitate investments in federal and state tax credits. FBB’s total investment in FBB Tax Credit at
December 31, 2018 was $3.2 million and FBB Tax Credit had a net income of $761,000 for the year ended December 31, 2018 .
FBB Real Estate 2, LLC. FBB RE 2 is a wholly-owned subsidiary of FBB and was formed for the purpose of holding and liquidating real estate and
other assets acquired by FBB through foreclosure or other legal proceedings. FBB RE 2 was established in 2018. FBB’s total investment in FBB RE 2 at
December 31, 2018 was $1.1 million .
LIQUIDITY AND CAPITAL RESOURCES
We expect to meet our liquidity needs through existing cash on hand, established cash flow sources, our third party senior line of credit, and dividends
received from the Bank. While the Bank is subject to certain regulatory limitations regarding their ability to pay dividends to the Corporation, we do not believe
that the Corporation will be adversely affected by these dividend limitations. The Corporation’s principal liquidity requirements at December 31, 2018 were the
interest payments due on subordinated and junior subordinated notes. During 2018 and 2017 , FBB declared and paid dividends totaling $10.0 million and $14.5
million , respectively. The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect on December 31, 2018 , and continue to
meet the heightened requirements imposed by Basel III, including the capital conservation buffer that went into effect January 1, 2016. The Corporation’s and the
Bank’s respective Boards of Directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions,
including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.
The Bank maintains liquidity by obtaining funds from several sources. The Bank’s primary source of funds are principal and interest payments on loans
receivable and mortgage-related securities, deposits, and other borrowings, such as federal funds and FHLB advances. The scheduled payments of loans and
mortgage-related securities are generally a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest
rates, economic conditions, and competition.
We view on-balance-sheet liquidity as a critical element to maintaining adequate liquidity to meet our cash and collateral obligations. We define our on-
balance-sheet liquidity as the total of our short-term investments, our unencumbered securities available-for-sale, and our unencumbered pledged loans. As of
December 31, 2018 and 2017 , our immediate on-balance-sheet liquidity was $390.9 million and $401.1 million , respectively. At December 31, 2018 and 2017 ,
the Bank had $43.6 million and $17.7 million on deposit with the FRB recorded in short-term investments, respectively. Any excess funds not used for loan
funding or satisfying other cash obligations were maintained as part of our on-balance-sheet liquidity in our interest-bearing accounts with the FRB, as we value
the safety and soundness provided by the FRB. We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow run off
of maturing wholesale certificates of deposit or invest in securities to maintain adequate liquidity at an improved margin.
We had $550.4 million of outstanding wholesale funds at December 31, 2018 , compared to $491.5 million of wholesale funds as of December 31, 2017 ,
which represented 31.8% and 31.1% , respectively, of ending balance total bank funding. Wholesale funds include FHLB advances, brokered certificates of
deposit, and deposits gathered from internet listing services. Total bank funding is defined as total deposits plus FHLB advances. We are committed to raising in-
market deposits while maintaining our overall target mix of wholesale funds and in-market deposits. Wholesale funds continue to be an efficient and cost effective
source of funding for the Bank and allows it to gather funds across a larger geographic base at price levels and maturities that are more attractive than local time
deposits when required to raise a similar level of in-market deposits within a short time period. Access to such deposits and borrowings allows us the flexibility to
refrain from pursuing single service deposit relationships in markets that have experienced unfavorable pricing levels. In addition, the administrative costs
associated with wholesale funds are considerably lower than those that would be incurred to administer a similar level of local deposits with a similar maturity
structure. During the time frames necessary to accumulate wholesale funds in an orderly manner, we will use short-term FHLB advances to meet our temporary
funding needs. The short-term FHLB advances will typically have terms of one week to one month to cover the overall expected funding demands.
Our in-market relationships remain stable; however, deposit balances associated with those relationships will fluctuate. We expect to establish new client
relationships and continue marketing efforts aimed at increasing the balances in existing clients’ deposit accounts. Nonetheless, we will continue to use wholesale
funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management
process or in shorter time periods if in-market deposit balances decline. In order to provide for ongoing liquidity and funding, all of our wholesale funds are
certificates of deposit which do not allow for withdrawal at the option of the depositor before the stated
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maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other
in-market deposits) and FHLB advances with contractual maturity terms and no call provisions. The Bank limits the percentage of wholesale funds to total bank
funds in accordance with liquidity policies approved by its Board of Directors. The Corporation’s overall operating range of wholesale funds to total bank funds is
30%-40%. The Bank was in compliance with its policy limits as of December 31, 2018 .
The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the year ended
December 31, 2018 . In the event that there is a disruption in the availability of wholesale funds at maturity, the Bank has managed the maturity structure, in
compliance with our approved liquidity policy, so at least one year of maturities could be funded through on-balance-sheet liquidity. These potential funding
sources include deposits maintained at the FRB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as
collateral. As of December 31, 2018 , the available liquidity was in excess of the stated policy minimum. We believe the Bank will also have access to the unused
federal funds lines, cash flows from borrower repayments, and cash flows from security maturities. The Bank also has the ability to raise local market deposits by
offering attractive rates to generate the level required to fulfill its liquidity needs.
The Bank is required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. We believe that the Bank has sufficient
liquidity to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows.
During the year ended December 31, 2018 , operating activities resulted in a net cash inflow of $25.7 million . Operating cash flows included net income
of $16.3 million and a provision for loan and leases losses of $5.5 million . Net cash used in investing activities for the year ended December 31, 2018 was $138.3
million which consisted of cash outflows to fund net loan growth and reinvestment of cash flows within purchases of additional securities, partially offset by cash
inflows from maturities, redemptions and paydowns of available-for-sale and held-to-maturity securities. Net cash provided by financing activities for the year
ended December 31, 2018 was $146.6 million . Financing cash flows included a $61.0 million net increase in deposits and a $91.0 million net increase in FHLB
advances used predominantly to fund net loan growth.
In August 2018, the Federal Reserve published a final rule revising the Small Bank Holding Company Policy Statement (“Policy Statement”) that raised
the total consolidated asset limit from $1 billion to $3 billion. Based on the criteria in the Policy Statement, effective immediately, the Corporation is no longer
subject to the capital requirements of the Basel III Rule and is deemed to be “well-capitalized.” However, the Corporation continues to calculate consolidated
capital ratios in accordance with the regulatory framework. See below for a summary of the Corporation’s capital ratios at December 31, 2018 and 2017 :
Total capital (to risk-weighted assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital (to risk-weighted assets)
Tier 1 leverage capital (to adjusted assets)
Tangible common equity (to tangible assets)
As of and for the Year Ended December
31,
2018
2017
11.85%
11.98%
9.41%
8.89%
9.33%
8.63%
9.45%
8.89%
9.54%
8.79%
Refer to Note 10 - Stockholders’ Equity and Regulatory Capital for additional information regarding the Corporation’s and the Bank’s capital ratios
and the ratios required by their federal regulators at December 31, 2018 and 2017 .
Commitments
OFF-BALANCE-SHEET ARRANGEMENTS
As of December 31, 2018 , the Bank had outstanding commitments to originate $553.8 million of loans and commitments to extend funds to or on behalf
of clients pursuant to standby letters of credit of $12.4 million . As of December 31, 2018 , the Bank had $329.5 million of commitments to extend funds which
extend beyond one year. We do not expect any losses as a result of these funding commitments. We have evaluated outstanding commitments associated with loans
that were identified as impaired loans and concluded that there are no additional losses required to be recorded with these unfunded commitments as of
December 31, 2018 . We believe that additional commitments will not be granted or additional collateral will be provided to support any additional funds
advanced. The Bank also utilizes interest rate swaps for the purposes of interest rate risk management, as described further in Note 17 – Derivative Financial
Instruments to the Consolidated Financial Statements.
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Additionally the Corporation has remaining commitments of $1.5 million to Aldine Capital Fund II, LP (“Aldine II”), and $4.8 million to Aldine Capital
Fund III, LP (“Aldine III”), which are private equity mezzanine funding limited partnerships in which we have invested. Aldine II began its operations in March
2013, and Aldine III began its operations in October 2018.
We believe adequate capital and liquidity are available from various sources to fund projected commitments.
Contractual Obligations
The following table summarizes our contractual cash obligations at December 31, 2018 :
Operating lease obligations
Time deposits
Subordinated notes payable
Junior subordinated notes
FHLB advances
Other borrowings
Total contractual obligations
SBA Recourse
Less than
1 Year
Payments Due by Period
1-3 Years
4-5 Years
(In Thousands)
More than 5
Years
Total
$
1,690 $
3,047 $
2,424 $
3,063 $
224,939
154,194
29,954
—
—
—
—
136,500
124,500
—
—
—
—
13,500
—
19,786
23,769
10,033
—
675
10,224
428,873
23,769
10,033
274,500
675
$
363,129 $
281,741 $
45,878 $
57,326 $
748,074
In the ordinary course of business, the Corporation sells the guaranteed portions of SBA loans to third parties. In the event of a loss resulting from default
and a determination by the SBA that there is a 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.
Management has assessed the estimated losses inherent in the outstanding guaranteed portions of SBA loans sold in accordance with ASC 450,
Contingencies
, and determined a recourse reserve based on the probability of future losses for these loans to be $3.0 million at December 31, 2018 . The recourse
reserve is reported in accrued interest payable and other liabilities on the Consolidated Balance Sheets. See Note 18 – Commitments and Contingencies for
additional information on the SBA recourse reserve.
2017 COMPARED TO 2016
Top Line Revenue
In 2017, top line revenue decreased 5.0% compared to the prior year primarily due to a reduction in gains from the sale of the guaranteed portions of SBA
loans and a decline in recurring loan fees collected in lieu of interest. Based on management’s second quarter 2016 decision to rebuild the SBA operations and
production platforms, gains on the sale of SBA loans decreased $2.8 million to $1.6 million in 2017, compared to $4.4 million in 2016. Loan fees collected in lieu
of interest decreased $2.4 million to $4.4 million in 2017, compared to $6.8 million in 2016.
These 2017 revenue headwinds were partially offset by record trust and investment services fee income, an increase in loan swap fee income and
successful efforts to manage in-market deposit rates and utilize an efficient mix of wholesale funding sources, despite a rising interest rate environment.
Return on Average Assets and Return on Average Equity
Return on average assets (“ROAA”) was 0.67% for the year ended December 31, 2017 compared to 0.82% for the year ended December 31, 2016. The
decrease in ROAA can be attributed principally to a decrease in earnings as net income decreased 20.1% during the same time period. The reasons for the decrease
in net income are consistent with top line revenue explanations discussed above. In addition, continued investments in technology and an increase in collateral
liquidation costs in 2017 reduced ROAA compared to 2016, partially offset by a $1.6 million reduction in provision for loan and leases losses. ROAA is a critical
metric used by us to measure the profitability of our organization and how efficiently our
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assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can
ultimately influence return on equity measures.
Return on average equity (“ROAE”) for the year ended December 31, 2017 was 7.16% compared to 9.40% for the year ended December 31, 2016. The
primary reasons for the decrease in ROAE are consistent with the net income variance explanations discussed above. We view ROAE as an important
measurement for monitoring profitability and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client
relationships, controlling our expenses and minimizing our costs of credit.
Efficiency Ratio
The efficiency ratio deteriorated to 66.48% for the year ended December 31, 2017, compared to 61.12% for the year ended December 31, 2016. The
decrease in operating efficiency primarily reflected lower gains from SBA and residential mortgage loan sales stemming from the Corporation’s decision to rebuild
its SBA platform and to exit all secondary market residential mortgage loan origination activity. The decrease was partially offset by record trust and investment
services fee income, an increase in loan swap fee income and an increase in bank-owned life insurance (“BOLI”) fee income driven by a $9.8 million purchase of
additional BOLI in December 2016.
Please refer to the Non-Interest Income and Non-Interest Expense sections below for discussion on the primary drivers of the year-over-year change
in the efficiency ratio.
Net Interest Income
Net interest income decreased by $2.7 million, or 4.3%, for the year ended December 31, 2017 compared to the same period in 2016. The decrease in net
interest income was primarily attributable to a $2.4 million decrease in recurring loan fees collected in lieu of interest, combined with a shift in the mix of loan
originations toward lower-yielding conventional commercial loans. This decrease in interest income was partially muted by successful efforts to manage in-market
deposit rates and reinvestment of certain investment security cash flows amid a rising interest rate environment.
The yield on average earning assets for the year ended December 31, 2017 was 4.47% compared to 4.50% for the year ended December 31, 2016. The
decrease in the yield on average earning assets was principally due to a decrease in recurring loan fees collected in lieu of interest. Excluding the impact of loan
fees in lieu of interest in both 2017 and 2016, the yield on average earning assets for the year ended December 31, 2017 was 4.21% compared to 4.10% for the year
ended December 31, 2016. This increase in yield is principally due to a reduction in lower yielding short-term investments, as average cash held at the Federal
Reserve decreased $46.3 million, combined with an increase in investment security yields and the increase in rates on certain variable-rate loans following the
Federal Open Market Committee’s (“FOMC”) increases in the targeted federal funds rate since December 2016.
The yield on average loans and leases receivable for the year ended December 31, 2017 was 4.91% compared to 5.11% for the year ended December 31,
2016. The decrease in yield was principally due to a decrease in recurring loan fees collected in lieu of interest. Excluding the impact of loan fees in lieu of interest
in both 2017 and 2016, the yield on average loans and leases receivable for the year ended December 31, 2017 was 4.61% compared to 4.64% for the year
ended December 31, 2016.
The average rate paid on interest-bearing liabilities was 1.11% for the year ended December 31, 2017, an increase of five basis points from 1.06% for the
year ended December 31, 2016. We were successful in limiting the increase in average rate paid during 2017, despite a rising rate environment, as the weighted
average rate paid on interest-bearing liabilities continued to benefit from a relatively stable level of low cost in-market interest-bearing deposits. In addition, the
increase in the average rate paid was tempered due to a favorable change in our wholesale funding mix as maturing fixed rate wholesale deposits were replaced
with more efficient and cost effective fixed rate FHLB advances. Average FHLB advances for the year ended December 31, 2017 increased $90.8
million to $105.3 million at an average rate paid of 1.40%. As of December 31, 2017, the weighted average original maturity of our FHLB term advances
was 3.7 years.
Average in-market deposits - comprised of all transaction accounts, money market accounts and non-wholesale deposits - decreased 2.4% to $1.097
billion for the year ended December 31, 2017 from $1.124 billion for the year ended December 31, 2016.
Provision for Loan and Lease Losses
We recorded a provision for loan and lease losses of $6.2 million for the year ended December 31, 2017 as compared to $7.8 million for the year
ended December 31, 2016. Provision for the year ended December 31, 2017 primarily reflected $5.0 million of estimated losses related to the previously disclosed
$6.7 million Wisconsin-based commercial and industrial impaired loan. The provision for the year ended December 31, 2017 also reflected $5.0 million in charge-
offs related to the
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Corporation’s remaining energy sector exposure, of which $2.3 million was specifically reserved for as of December 31, 2016. These 2017 increases were partially
offset by the reversal of a $1.8 million specific reserve based on the full repayment of a previously disclosed impaired construction loan originated in our Kansas
City market. Provision for the year ended December 31, 2016 primarily reflected $8.2 million in specific reserves and net charge-offs related to five discrete
Kansas City-based loan relationships.
Non-Interest Income
Non-interest income, consisting primarily of fees earned for trust and investment services, service charges on deposits, loan fees and gains on sale of SBA
loans, decreased by $1.3 million, or 7.4%, to $16.7 million for the year ended December 31, 2017, from $18.0 million for the year ended December 31, 2016. Total
non-interest income accounted for 21.6% of our total revenues in 2017 compared to 22.1% in 2016.
The decrease in total non-interest income for the year ended December 31, 2017 primarily reflected lower gains from SBA and residential mortgage loans
sales stemming from the Corporation’s decision to rebuild its SBA platform and to exit all secondary market residential mortgage loan origination activity. The
decrease was partially offset by record trust and investment services fee income, an increase in loan swap fee income and an increase in bank-owned life insurance
(“BOLI”) fee income driven by a $9.8 million purchase of additional BOLI in December 2016.
Trust and investment services fee income increased by $1.3 million, or 24.5%, to $6.7 million for the year ended December 31, 2017 compared to $5.4
million for the year ended December 31, 2016. Trust and investment services fee income is primarily driven by the amount of assets under management and
administration as well as the mix of business at different fee structures and can be positively or negatively influenced by the timing and magnitude of volatility
within the capital markets. At December 31, 2017, our trust assets under management were $1.350 billion, or 38.2% more than the trust assets under management
of $977.0 million at December 31, 2016, while our assets under administration decreased approximately 18.0%, to $186.4 million at December 31,
2017 from $227.4 million at December 31, 2016. The decrease in assets under administration reflected the transfer of client assets from assets under administration
to assets under management.
Gain on sale of SBA loans for the year ended December 31, 2017 totaled $1.6 million, a decrease of $2.8 million, or 63.8%, from the same period
in 2016 resulting from management’s decision during the second quarter of 2016 to temporarily slow SBA production while making investments to enhance the
infrastructure, processes, capacity and scalability of the SBA platform.
Loan fees decreased by $442,000, or 18.2%, to $2.0 million for the year ended December 31, 2017 from $2.4 million for the year ended December 31,
2016. The decrease in loan fees was primarily attributable to a decrease in fees associated with SBA production, specifically SBA loan packaging fee income, as
well as a decrease asset-based lending audit fee income.
Net loss on sale of securities totaled $403,000 for the year ended December 31, 2017, compared to net gain on sale of securities of $10,000 for the year
ended December 31, 2016. This was principally due to the strategic decision to harvest securities losses ahead of the 2018 reduction in corporate tax rates. We
reinvested the cash into securities within the portfolio’s existing risk profile while adding approximately 130 basis points in yield.
Swap fees increased by $833,000 to $909,000 for the year ended December 31, 2017 from $76,000 for the year ended December 31, 2016. We originate
commercial real estate loans in which we offer clients a floating rate and interest rate swap and then offset the client’s swap with a counter-party dealer.
Other non-interest income increased by $459,000 to $1.6 million for the year ended December 31, 2017, compared to $1.2 million for the year
ended December 31, 2016. The increase was primarily due to historically reflecting our quarterly allocation of net income/loss from equity investments in two
mezzanine funds in other non-interest expense. Due to the underlying funds being in an earnings position for a sustained period of time, we recognized our share of
earnings in other non-interest income for the year ended December 31, 2017.
Non-Interest Expense
Non-interest expense increased by $438,000, or 0.8%, to $56.9 million for the year ended December 31, 2017 from $56.4 million for the comparable
period of 2016. The increase in non-interest expense was primarily due to an increase in other non-interest expense, collateral liquidation costs and computer
software expense. The increase was partially offset by a decrease in impairment of tax credit investments, data processing expense and marketing expense.
Compensation expense increased by $118,000, or 0.4%, to $31.7 million for the year ended December 31, 2017 from $31.5 million for the year
ended December 31, 2016. The increase reflects annual merit increases and growth in
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employee benefit costs. Full time equivalent employees as of December 31, 2017 were 251, down 2.3% from 257 at December 31, 2016.
Data processing expense decreased by $597,000, or 18.1%, to $2.7 million for the year ended December 31, 2017 from $3.3 million for the year
ended December 31, 2016. The decrease was primarily due to a reduction in non-recurring expense related to our recent core banking system conversion. During
the fourth quarter of 2017 we recognized $199,000 in final deconversion costs related to FBB-KC’s core banking system, compared to $794,000 in one-time fees
recognized in the fourth quarter of 2016 to terminate its core banking system vendor agreement. These one-time fees are expected to be more than offset by savings
recognized over the life of the renegotiated contract extended through the year 2022.
Marketing expense decreased by $229,000, or 9.8%, to $2.1 million for the year ended December 31, 2017 from $2.3 million for the year
ended December 31, 2016. The decrease was primarily due to a reduction of certain advertising initiatives as management continues to align expense growth with
revenue production.
Computer software expense increased by $563,000, or 26.1%, to $2.7 million for the year ended December 31, 2017 from $2.2 million for the year
ended December 31, 2016. The increase was principally due to investments in technology platforms, continuing our strategic focus on scaling the Corporation to
efficiently execute our growth strategy.
FDIC insurance expense decreased by $84,000, or 5.7%, to $1.4 million for the year ended December 31, 2017 from $1.5 million for the year
ended December 31, 2016. Consistent with our funding philosophy to match-fund long-term fixed rate loans with the most cost effective source of wholesale
funds, in 2017 we began replacing maturing brokered certificates of deposit with the more cost effective FHLB advances in order to lower our FDIC assessment
rate.
Collateral liquidation costs for the year ended December 31, 2017 were $829,000 compared to $262,000 for the same period in 2016. The increase
primarily reflected our workout process related to two non-performing loans.
Net loss on foreclosed properties decreased $265,000 to a net gain of $143,000 for the year ended December 31, 2017, compared to a net loss
of $122,000 for the year ended December 31, 2016. The decrease reflects a $547,000 gain on the sale of the Overland Park full-service banking location in 2017,
partially offset by a reduction in the fair value of the remaining foreclosed property.
Impairment on tax credit investments decreased $907,000, or 24.6%, to $2.8 million for the year ended December 31, 2017, compared to $3.7 million for
the year ended December 31, 2016. The decrease reflects $2.3 million of impairment associated with the recognition of a $3.0 million federal historic tax credit in
2017, compared to $3.2 million of impairment associated with a $3.6 million credit in 2016.
SBA recourse provision for the year ended December 31, 2017 was $2.2 million compared to $2.1 million for the same period in 2016. The increase
reflected refinements to the recourse reserve estimate due to the migration of certain credits with potential guaranty eligibility issues during the year.
Other non-interest expense increased by $977,000, or 43.7%, to $3.2 million for the year ended December 31, 2017 from $2.2 million for the year
ended December 31, 2016. The increase was primarily due to historically reflecting our quarterly allocation of net income/loss from equity investments in two
mezzanine funds in other non-interest expense. Due to the underlying funds being in an earnings position for a sustained period of time, we recognized our share of
earnings in other non-interest income for the year ended December 31, 2017.
Income Taxes
Income tax expense was $2.3 million for the year ended December 31, 2017, compared to $2.2 million for the year ended December 31, 2016. Effective
January 1, 2018, the Act reduced the corporate federal income tax rate to 21% from 35%, which required the Corporation to revalue its deferred taxes as of
December 31, 2017. The revaluation resulted in an additional $629,000 income tax expense during the fourth quarter of 2017. The Corporation also recognized a
federal historic tax credit in both 2017 and 2016, which reduced income tax expense by $3.0 million and $3.6 million, respectively. The effective tax rate for the
year ended December 31, 2017 was 16.3% compared to 12.6% for the year ended December 31, 2016.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. By their nature, changes in these assumptions and estimates could significantly affect the Corporation’s financial position or
results of operations. Actual results could differ from those estimates. Discussed below are certain policies that are critical to the Corporation. We view critical
accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates
and assumptions could have a significant impact on the financial statements.
Allowance for Loan and Lease Losses. The allowance for loan and lease losses represents our recognition of the risks of extending credit and our
evaluation of the quality of the loan and lease portfolio and as such, requires the use of judgment as well as other systematic objective and quantitative methods
which may include additional assumptions and estimates. The risks of extending credit and the accuracy of our evaluation of the quality of the loan and lease
portfolio are neither static nor mutually exclusive and could result in a material impact on our Consolidated Financial Statements. We may over-estimate the
quality of the loan and lease portfolio, resulting in a lower allowance for loan and lease losses than necessary, overstating net income and equity. Conversely, we
may under-estimate the quality of the loan and lease portfolio, resulting in a higher allowance for loan and lease losses than necessary, understating net income and
equity. The allowance for loan and lease losses is a valuation allowance for probable credit losses, increased by the provision for loan and lease losses and
decreased by charge-offs, net of recoveries. We estimate the allowance reserve balance required and the related provision for loan and lease losses based on
quarterly evaluations of the loan and lease portfolio, with particular attention paid to loans and leases that have been specifically identified as needing additional
management analysis because of the potential for further problems. During these evaluations, consideration is also given to such factors as the level and
composition of impaired and other non-performing loans and leases, historical loss experience, results of examinations by regulatory agencies, independent loan
and lease reviews, our estimate of the fair value of the underlying collateral taking into consideration various valuation techniques and qualitative adjustments to
inputs to those estimates of fair value, the strength and availability of guarantees, concentration of credits, and other factors. Allocations of the allowance may be
made for specific loans or leases, but the entire allowance is available for any loan or lease that, in our judgment, should be charged off. Loan and lease losses are
charged against the allowance when we believe that the uncollectability of a loan or lease balance is confirmed. See Note 1 – Nature of Operations and
Summary of Significant Accounting Policies in the Consolidated Financial Statements for further discussion of the allowance for loan and lease losses.
We also continue to exercise our legal rights and remedies as appropriate in the collection and disposal of non-performing assets, and adhere to rigorous
underwriting standards in our origination process in order to achieve strong asset quality. Although we believe that the allowance for loan and lease losses was
appropriate as of December 31, 2018 based upon the evaluation of loan and lease delinquencies, non-performing assets, charge-off trends, economic conditions,
and other factors, there can be no assurance that future adjustments to the allowance will not be necessary. If the quality of loans or leases deteriorates, then the
allowance for loan and lease losses would generally be expected to increase relative to total loans and leases. If loan or lease quality improves, then the allowance
would generally be expected to decrease relative to total loans and leases.
Goodwill Impairment Assessment. Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently
if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill.
The Corporation conducted its annual impairment test on July 1, 2018, utilizing a qualitative assessment, and concluded that it is more likely than not the estimated
fair value of the reporting unit exceeded its carrying value. Although no goodwill impairment was noted, there can be no assurances that future goodwill
impairment will not occur. See Note 1 – Nature of Operations and Summary of Significant Accounting Policies for the Corporation's accounting policy on
goodwill and see Note 6 – Goodwill and Other Intangible Assets in the Consolidated Financial Statements for a detailed discussion of the factors considered by
management in the assessment.
Income Taxes. The Corporation and its wholly owned subsidiaries file a consolidated federal income tax return and a combined Wisconsin state tax
return. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. The determination of current and deferred income taxes is based on complex analysis of many factors,
including the interpretation of federal and state income tax laws, the difference between the tax and financial reporting basis of assets and liabilities (temporary
differences), estimates of amounts currently due or owed, such as the timing of reversals of temporary differences, and current accounting standards. We apply a
more likely than not approach to each of our tax positions when determining the amount of tax benefit to record in our Consolidated Financial Statements. Deferred
tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are
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expected to be recovered or settled. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date.
Effective January 1, 2018, the enactment of the Act reduced the corporate federal income tax rate to 21% from 35%, which required the Corporation to revalue its
deferred taxes as of December 31, 2017. The revaluation resulted in a $629,000 reduction to the Corporation’s net deferred tax assets with a corresponding increase
to income tax expense during the year ended December 31, 2017 .
We have made our best estimate of valuation allowances utilizing available evidence and evaluation of sources of taxable income including tax planning
strategies and expected reversals of timing differences to determine if valuation allowances were needed for deferred tax assets. Realization of deferred tax assets
over time is dependent on our ability to generate sufficient taxable earnings in future periods and a valuation allowance may be necessary if management
determines that it is more likely than not that the deferred asset will not be utilized. These estimates and assumptions are subject to change. Changes in these
estimates and assumptions could adversely affect future consolidated results of operations. The Corporation believes the tax assets and liabilities are properly
recorded in the Consolidated Financial Statements. See also Note 16 – Income Taxes in the Consolidated Financial Statements.
The Corporation also invests in certain development entities that generate federal and state historic tax credits. The tax benefits associated with these
investments are accounted for under the flow-through method and are recognized when the respective project is placed in service.
The federal and state taxing authorities who make assessments based on their determination of tax laws may periodically review our interpretation of
federal and state income tax laws. Tax liabilities could differ significantly from the estimates and interpretations used in determining the current and deferred
income tax liabilities based on the completion of examinations by taxing authorities.
SBA Recourse Reserve . The SBA recourse reserve represents management’s estimate of losses associated with the guaranteed portions of sold SBA
loans. 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. We estimate the SBA recourse reserve balance and the related SBA recourse provision
by individually analyzing the eligibility of the guaranty for impaired loans that present a collateral shortfall, as well as by evaluating several factors to estimate
probable losses within the remaining performing portion of the sold portfolio.
Although we believe that the SBA recourse reserve was appropriate as of December 31, 2018 , future adjustments may be necessary based on changes to
impaired loans, the fair value estimate of the underlying collateral, and the Corporation’s ability to originate, fund, or service sold SBA loans in accordance with
SBA regulations. In addition, the SBA’s ultimate conclusion on the eligibility of a guaranty may be inconsistent with management’s best estimate. See Note 1 -
Nature of Operations and Summary of Significant Accounting Policies in the Consolidated Financial Statements for further discussion of the SBA recourse
reserve.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
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 favorable match 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.
We use two techniques to measure interest rate risk. The first 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 implemented. These assumptions are modeled under different rate scenarios that
include a parallel, instantaneous, and sustained change in interest rates. Key assumptions include:
•
•
•
the behavior of interest rates and pricing spreads;
the changes in product balances; and
the behavior of loan and deposit clients in different rate environments.
This analysis incorporates several assumptions, the most material of which relate to the re-pricing characteristics and balance fluctuations of deposits with
indeterminate or non-contractual maturities.
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The sensitivity analysis included below is measured as a percentage change in net interest income for the next 12 months due to instantaneous movements
in benchmark interest rates from a baseline scenario. Estimated changes set forth below are dependent upon material assumptions such as those previously
discussed. The reduction in expected benefit from instantaneous rate changes up (and the increase in expected benefit from instantaneous rate changes down) is
principally due to the larger short-term liability gap assumed in 2018 compared to 2017 (in conjunction with the re-pricing assumption for the non-contractual
maturities deposits).
Instantaneous Rate Change in Basis Points
Down 100
Down 50
No Change
Up 100
Up 200
Impact on Net Interest Income as of December 31,
2018
2017
0.21%
0.11%
—%
1.12%
2.18%
NA
(0.16)%
— %
1.38 %
3.01 %
NA = Not Applicable. Down 100 Instantaneous Rate Change analysis was not completed as of December 31, 2017 due to the assumed unlikelihood of a declining rate environment during 2018.
The earnings simulation analysis does not incorporate any management actions that may be used to mitigate negative consequences of actual interest rate
movement. For that reason and others, they do not reflect the likely actual results but serve as conservative estimates of interest rate risk. This simulation analysis
is not comparable to actual results disclosed elsewhere or directly predictive of future values of other measures provided.
The second measurement technique used is static gap analysis. Gap analysis involves measurement of the difference in asset and liability repricing on a
cumulative basis within a specified time frame. In general, a positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature
in a time frame and a negative gap indicates the opposite. As shown in the cumulative gap position in the table presented below, at December 31, 2018 , our
interest-bearing liabilities have the general characteristics that will allow them to reprice faster than interest-earning assets over the next 12 months while our
interest-earning assets will reprice faster than interest-bearing-liabilities thereafter. In addition to the gap position, other determinants of net interest income are the
shape of the yield curve, general rate levels and the corresponding effect of contractual interest rate floors, reinvestment spreads, balance sheet growth and mix,
and interest rate spreads. Our success in attracting in-market deposits adds to the interest rate liability sensitivity of the organization.
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. Wholesale certificates of deposit and FHLB advances are a significant source of our funding and we use a variety of maturities to
augment our management of interest rate exposure. In addition, management has the authorization, as permitted within applicable approved policies, and ability to
utilize various derivative instruments should they be appropriate to manage interest rate exposure.
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The following tables illustrate our static gap position:
Assets:
Short-term investments
Investment securities
Commercial loans
Real estate loans
Asset-based loans
Lease receivables
Consumer loans
Total earning assets (1)
Liabilities:
Interest-bearing transaction
Money market accounts
Time deposits under $250,000
Time deposits $250,000 and over
FHLB advances
Short-term borrowings
Long-term debt (2)
Total interest-bearing liabilities
Interest rate gap
Cumulative interest rate gap
Within 3 Months
3-12 Months
1-5 Years
After 5 Years
Total
Estimated Maturity or Repricing at December 31, 2018
(Dollars in Thousands)
$
63,227
$
— $
— $
— $
4,526
206,577
393,760
154,312
1,387
2,508
24,403
36,885
62,887
101,367
100,339
430,532
—
—
6,423
291
16,301
319
47,152
12,718
169,591
—
3,155
—
63,227
177,448
356,519
1,056,770
154,312
27,266
3,118
826,297
$
130,889
$
648,858
$
232,616
$
1,838,660
229,612
$
516,045
19,744
6,419
17,000
—
—
788,820
37,477
37,477
$
$
$
— $
—
159,584
38,941
72,500
—
15,000
286,025
(155,136)
(117,659)
$
$
$
— $
—
170,853
13,326
148,500
—
675
333,354
315,504
197,845
$
$
$
229,612
516,045
369,967
58,686
274,500
—
35,080
$
$
1,483,890
354,770
— $
—
19,786
—
36,500
—
19,405
75,691
156,925
354,770
$
$
$
$
$
Cumulative interest rate gap to total earning assets
2.04%
(6.40)%
10.76%
19.30%
(1) Excludes non-interest sensitive balances and balances with indeterminate maturities.
(2) Excludes debt issuance costs.
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Assets:
Short-term investments
Investment securities
Commercial loans
Real estate loans
Asset-based loans
Lease receivables
Consumer loans
Total earning assets (1)
Liabilities:
Interest-bearing transaction
Money market accounts
Time deposits under $250,000
Time deposits $250,000 and over
FHLB advances
Short-term borrowings
Long-term debt (2)
Total interest-bearing liabilities
Interest rate gap
Cumulative interest rate gap
Within 3 Months
3-12 Months
1-5 Years
After 5 Years
Total
Estimated Maturity or Repricing at December 31, 2017
(Dollars in Thousands)
$
35,481
$
— $
— $
— $
6,544
218,017
333,742
145,388
878
2,008
26,503
28,088
86,250
93,744
75,968
385,445
—
—
5,297
337
13,824
499
37,872
6,283
177,524
—
2,234
—
35,481
164,663
328,356
982,961
145,388
22,233
2,844
742,058
$
146,475
$
569,480
$
223,913
$
1,681,926
217,625
$
515,078
14,854
998
5,000
10
—
753,565
(11,507)
(11,507)
$
$
$
— $
—
149,610
6,509
10,000
—
—
166,119
(19,644)
(31,151)
$
$
$
— $
—
182,068
5,157
133,000
—
15,675
335,900
233,580
202,429
$
$
$
217,625
515,078
371,520
12,664
183,500
10
35,080
$
$
1,335,477
346,449
— $
—
24,988
—
35,500
—
19,405
79,893
144,020
346,449
$
$
$
$
$
Cumulative interest rate gap to total earning assets
(0.68)%
(1.85)%
12.04%
20.60%
(1) Excludes non-interest sensitive balances and balances with indeterminate maturities.
(2) Excludes debt issuance costs.
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Table of Contents
Item 8.
Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF FIRST BUSINESS FINANCIAL SERVICES
Consolidated Financial Statements
Page No.
Consolidated Balance Sheets as of December 31, 2018 and 2017
Consolidated Statements of Income for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
67
68
69
70
71
72
74
122
Table of Contents
First Business Financial Services, Inc.
Consolidated Balance Sheets
Assets
Cash and due from banks
Short-term investments
Cash and cash equivalents
Securities available-for-sale, at fair value
Securities held-to-maturity, at amortized cost
Loans held for sale
Loans and leases receivable, net of allowance for loan and lease losses of $20,425 and $18,763,
December 31,
2018
December 31,
2017
(In Thousands, Except Share Data)
$
23,319 $
63,227
86,546
138,358
37,731
5,287
17,059
35,480
52,539
126,005
37,778
2,194
respectively
Premises and equipment, net
Foreclosed properties
Bank-owned life insurance
Federal Home Loan Bank stock, at cost
Goodwill and other intangible assets
Accrued interest receivable and other assets
Total assets
Liabilities and Stockholders’ Equity
Deposits
Federal Home Loan Bank advances and other borrowings
Junior subordinated notes
Accrued interest payable and other liabilities
Total liabilities
Stockholders’ equity:
Preferred stock, $0.01 par value, 2,500,000 shares authorized, none issued or outstanding
Common stock, $0.01 par value, 25,000,000 shares authorized, 9,069,199 and 9,021,985 shares issued,
8,785,480 and 8,763,539 shares outstanding at December 31, 2018 and 2017, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock, 283,719 and 258,446 shares at December 31, 2018 and 2017, respectively, at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
$
1,597,230
1,482,832
3,284
2,547
41,538
7,240
12,045
34,651
3,156
1,069
40,323
5,670
12,652
29,848
1,966,457 $
1,794,066
1,455,299 $
298,944
10,033
21,474
1,785,750
—
91
79,623
110,310
(1,684)
(7,633)
180,707
1,394,331
207,898
10,019
12,540
1,624,788
—
90
78,620
98,906
(1,238)
(7,100)
169,278
1,794,066
See accompanying Notes to Consolidated Financial Statements.
68
$
1,966,457 $
Table of Contents
Interest income
Loans and leases
Securities
Short-term investments
Total interest income
Interest expense
Deposits
Federal Home Loan Bank advances and other borrowings
Junior subordinated notes
Total interest expense
Net interest income
Provision for loan and lease losses
Net interest income after provision for loan and lease losses
Non-interest income
Trust and investment service fees
Gain on sale of Small Business Administration loans
Gain on sale of residential mortgage loans
Service charges on deposits
Loan fees
Increase in cash surrender value of bank-owned life insurance
Net (loss) gain on sale of securities
Swap fees
Other non-interest income
Total non-interest income
Non-interest expense
Compensation
Occupancy
Professional fees
Data processing
Marketing
Equipment
Computer software
FDIC insurance
Collateral liquidation costs
Net loss (gain) on foreclosed properties
Impairment of tax credit investments
SBA recourse provision
Other non-interest expense
Total non-interest expense
Income before income tax expense
Income tax expense
Net income
Earnings per common share:
Basic
Diluted
Dividends declared per share
First Business Financial Services, Inc.
Consolidated Statements of Income
For the Year Ended December 31,
2018
2017
2016
(In Thousands, Except Share Data)
$
$
$
86,228 $
3,842
1,205
91,275
15,533
7,288
1,112
23,933
67,342
5,492
61,850
7,744
1,451
—
3,062
1,783
1,191
(4)
1,670
1,270
71,960 $
3,148
703
75,811
10,805
3,285
1,112
15,202
60,609
6,172
54,437
6,670
1,591
26
3,013
1,988
1,250
(403)
909
1,621
18,167
16,665
37,439
31,663
2,192
3,869
2,362
2,135
1,434
3,015
1,478
646
367
2,083
1,913
3,430
62,363
17,654
1,351
16,303 $
1.86 $
1.86
0.56
2,088
4,063
2,701
2,109
1,211
2,723
1,388
829
(143)
2,784
2,240
3,215
56,871
14,231
2,326
11,905 $
1.36 $
1.36
0.52
74,627
2,845
645
78,117
11,716
1,958
1,115
14,789
63,328
7,818
55,510
5,356
4,400
590
2,990
2,430
974
10
76
1,162
17,988
31,545
2,019
4,031
3,298
2,338
1,189
2,160
1,472
262
122
3,691
2,068
2,238
56,433
17,065
2,156
14,909
1.71
1.71
0.48
See accompanying Notes to Consolidated Financial Statements.
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Table of Contents
First Business Financial Services, Inc.
Consolidated Statements of Comprehensive Income
Net income
Other comprehensive loss, before tax
Securities available-for-sale:
Unrealized securities losses arising during the period
Reclassification adjustment for net loss (gain) realized in net income
Securities held-to-maturity:
Amortization of net unrealized losses transferred from available-for-sale
Interest rate swaps:
Unrealized losses on interest rate swaps arising during the period
Income tax benefit
Total other comprehensive loss
Comprehensive income
For the Year Ended December 31,
2018
2017
2016
(In Thousands)
$
16,303 $
11,905 $
14,909
(662)
4
70
(20)
179
(429)
(1,156)
403
102
(122)
279
(494)
(902)
(10)
159
—
311
(442)
$
15,874 $
11,411 $
14,467
See accompanying Notes to Consolidated Financial Statements.
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Table of Contents
First Business Financial Services, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
Common Shares
Outstanding
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
Treasury
Stock
Total
(In Thousands, Except Share Data)
Balance at December 31, 2015
8,699,410 $
89 $
76,549 $
80,584 $
(80)
$
(6,310) $
150,832
Net income
Other comprehensive loss
Share-based compensation - restricted shares
Cash dividends ($0.48 per share)
Treasury stock purchased
Balance at December 31, 2016
Net income
Other comprehensive loss
Share-based compensation - restricted shares
Cash dividends ($0.52 per share)
Treasury stock purchased
Deferred tax revaluation adjustment
Balance at December 31, 2017
Net income
Other comprehensive loss
Share-based compensation - restricted shares
Cash dividends ($0.56 per share)
Treasury stock purchased
Deferred tax revaluation adjustment
Balance at December 31, 2018
—
—
36,864
—
(20,418)
8,715,856
—
—
62,746
—
(15,063)
—
8,763,539
—
—
47,214
—
(25,273)
—
—
—
1
—
—
90
—
—
—
—
—
—
90
—
—
1
—
—
—
—
—
993
—
—
77,542
—
—
1,078
—
—
—
78,620
—
—
1,003
—
—
—
14,909
—
—
(4,176)
—
91,317
11,905
—
—
(4,538)
—
222
98,906
16,303
—
—
(4,916)
—
17
—
(442)
—
—
—
(522)
—
(494)
—
—
—
(222)
(1,238)
—
(429)
—
—
—
(17)
—
—
—
—
(467)
14,909
(442)
994
(4,176)
(467)
(6,777)
161,650
—
—
—
—
(323)
—
11,905
(494)
1,078
(4,538)
(323)
—
(7,100)
169,278
—
—
—
—
(533)
—
16,303
(429)
1,004
(4,916)
(533)
—
8,785,480 $
91
$
79,623
$
110,310
$
(1,684)
$
(7,633)
$
180,707
See accompanying Notes to Consolidated Financial Statements.
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Table of Contents
First Business Financial Services, Inc.
Consolidated Statements of Cash Flows
Operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes, net
Impairment of tax credit investments
Provision for loan and lease losses
Depreciation, amortization and accretion, net
Share-based compensation
Net loss (gain) on sale of available-for-sale securities
Gain on sale of historic development entity state tax credit
Increase in value of bank-owned life insurance policies
Origination of loans for sale
Sale of loans originated for sale
Gain on sale of loans originated for sale
Net loss (gain) on foreclosed properties, including impairment valuation
Loan servicing right impairment valuation
Excess tax benefit from share-based compensation
Returns on investments in limited partnerships
Net increase in accrued interest receivable and other assets
Net increase in accrued interest payable and other liabilities
Net cash provided by operating activities
Investing activities
Proceeds from maturities, redemptions and paydowns of available-for-sale securities
Proceeds from maturities, redemptions and paydowns of held-to-maturity securities
Proceeds from sale of available-for-sale securities
Purchases of available-for-sale securities
Purchases of held-to-maturity securities
Proceeds from sale of foreclosed properties
Net increase in loans and leases
Investments in limited partnerships
Returns of investments in limited partnerships
Investment in historic development entities
Distribution from historic development entities
Proceeds from sale of historic development entity state tax credit
Investment in Federal Home Loan Bank and Federal Reserve Bank Stock
Proceeds from the sale of Federal Home Loan Bank Stock
Purchases of leasehold improvements and equipment, net
Purchases of bank owned life insurance policies
Premium payment on bank owned life insurance policies
Net cash used in investing activities
Financing activities
Net increase (decrease) in deposits
Repayment of Federal Home Loan Bank advances
Proceeds from Federal Home Loan Bank advances
Proceeds from issuance of subordinated notes payable
Repayment of subordinated notes payable
Net decrease in short-term borrowed funds
Net increase (decrease) in long-term borrowed funds
For the Year Ended December 31,
2018
2017
2016
(In Thousands)
$
16,303 $
11,905 $
14,909
(432)
2,083
5,492
1,477
1,004
4
—
(1,191)
(91,122)
89,480
(1,451)
367
69
(46)
413
(4,428)
7,672
25,694
33,225
4,860
6,207
(52,763)
(4,867)
357
(122,014)
(188)
316
(905)
69
—
(9,018)
7,448
(969)
—
(24)
1,747
2,784
6,172
1,562
1,078
403
(210)
(1,250)
(69,966)
70,500
(1,617)
(143)
—
(66)
459
(2,857)
1,907
22,408
38,241
3,808
40,144
(60,399)
(3,016)
1,659
(59,033)
(500)
97
(5,312)
—
2,764
(16,275)
12,736
(1,242)
—
(25)
(1,108)
3,691
7,818
1,515
994
(10)
—
(974)
(71,965)
78,546
(4,990)
122
—
(142)
250
(3,861)
1,367
26,162
43,745
3,882
5,227
(56,356)
(5,191)
83
(22,385)
(750)
541
(3,456)
—
—
(1,308)
2,020
(584)
(9,750)
(26)
(138,266)
(46,353)
(44,308)
60,968
(804,100)
895,100
—
—
—
60
(144,486)
(656,916)
806,916
9,090
(7,875)
(1,000)
(1,901)
(38,256)
(4,500)
30,000
—
—
(1,500)
998
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Table of Contents
First Business Financial Services, Inc.
Consolidated Statements of Cash Flows
Cash dividends paid
Purchase of treasury stock
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
Cash and cash equivalents at the end of the period
Supplementary cash flow information
Cash paid during the period for:
Interest paid on deposits and borrowings
Income taxes paid
Non-cash investing and financing activities:
Transfer of loans from held-to-maturity to held-for-sale
Transfer of loans to foreclosed properties
Transfer from premises and equipment to foreclosed properties
For the Year Ended December 31,
2018
2017
2016
(In Thousands)
(4,916)
(533)
146,579
34,007
52,539
(4,538)
(323)
(1,033)
(24,978)
77,517
$
86,546 $
52,539 $
$
22,332 $
1,055
14,872 $
2,160
—
2,202
12,896
—
—
1,113
(4,176)
(467)
(17,901)
(36,047)
113,564
77,517
14,790
5,554
11,504
—
—
See accompanying Notes to Consolidated Financial Statements.
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Table of Contents
First Business Financial Services, Inc.
NOTES TO 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. (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 the Wisconsin and greater Kansas City markets. FBB also offers trust and investment services through
First Business Trust & Investments (“FBTI”) and investment portfolio administrative and asset/liability management services through First Business Consulting
Services (“FBCS”), both divisions of FBB. The Bank provides a full range of financial services to businesses, business owners, executives, professionals, and high
net worth individuals. The Bank is subject to competition from other financial institutions and service providers, and is also subject to state and federal regulations.
FBB has the following wholly-owned subsidiaries: First Business Capital Corp. (“FBCC”), First Madison Investment Corp. (“FMIC”), First Business Equipment
Finance, LLC (“FBEF”), ABKC Real Estate, LLC (“ABKC”), FBB Real Estate 2, LLC (“FBB RE 2”), Rimrock Road Investment Fund, LLC (“Rimrock Road”),
BOC Investment, LLC (“BOC”), Mitchell Street Apartments Investment, LLC (“Mitchell Street”), and FBB Tax Credit Investment LLC (“FBB Tax Credit”).
FMIC is located in and was formed under the laws of the state of Nevada.
Basis of Presentation. The 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. In accordance with the provisions of Accounting Standards Codification (“ASC”)
Topic 810, the Corporation’s ownership interest in FBFS Statutory Trust II (“Trust II”) has not been consolidated into the financial statements.
Management of the Corporation is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements 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 rates swaps,
level of the allowance for loan and lease losses, lease residuals, property under operating leases, goodwill, level of the Small Business Administration (“SBA”)
recourse reserve and income taxes. 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 Consolidated Financial Statements. No significant subsequent events have occurred through this date
requiring adjustment to the financial statements or disclosures.
Cash and Cash Equivalents. The Corporation considers federal funds sold, interest-bearing deposits and short-term investments that have original maturities of
three months or less to be cash equivalents.
Securities. The Corporation classifies its investment and mortgage-related securities as available-for-sale, held-to-maturity, and trading. Debt securities that the
Corporation has the positive intent and ability to hold to maturity are classified as held-to-maturity and are stated at amortized cost. Debt securities bought
expressly for the purpose of selling in the near term are classified as trading securities and are measured at fair value with unrealized gains and losses reported in
earnings. Debt securities not classified as held-to-maturity or as trading are classified as available-for-sale. Available-for-sale securities are measured at fair value
with unrealized gains and losses reported as a separate component of stockholders’ equity, net of tax. Realized gains and losses, and declines in value deemed to be
other than temporary, are included in the Consolidated Statements of Income as a component of non-interest income. The cost of securities sold is based on the
specific identification method. The Corporation did not hold any trading securities at December 31, 2018 or 2017 .
Discounts and premiums on securities are accreted and amortized into interest income using the effective yield method over the estimated life (based on maturity
date, call date, or weighted average life) of the related security.
Declines in the fair value of investment securities (with certain exceptions for debt securities noted below) that are deemed to be other-than-temporary are charged
to earnings as a realized loss and a new cost basis for the securities is established. In evaluating other-than-temporary impairment, management considers the
length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of
the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Declines in
the fair value of debt securities below amortized cost are deemed to be other-than-temporary in circumstances where: (1) the Corporation has the intent to sell a
security; (2) it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis; or (3) the Corporation
does not expect to recover the entire amortized cost basis of the security. If the Corporation intends to sell a security or if it is more likely than not that the
Corporation will be required to sell the security before recovery, an other-than-temporary impairment write-down is recognized in earnings equal to the difference
between the security’s amortized cost basis and its fair value. If the Corporation does not
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Table of Contents
intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-
down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to all other factors, which is recognized in other
comprehensive income.
Loans Held for Sale. Residential real estate loans and the guaranteed portions of SBA loans which are originated and intended for sale in the secondary market are
classified as held for sale. These loans are carried at the lower of cost or fair value in the aggregate. Unrealized losses on such loans are recognized through a
valuation allowance by a charge to other non-interest income. Gains and losses on the sale of loans are also included in other non-interest income. As assets
specifically originated for sale, the origination of, disposition of, and gain/loss on these loans are classified as operating activities in the Consolidated Statement of
Cash Flows. Fees received from the borrower and direct costs to originate the loans are deferred and recognized as part of the gain or loss on sale. There was $5.3
million and $2.2 million in loans held for sale outstanding at December 31, 2018 and 2017 , respectively.
Loans and Leases. Loans and leases which management has the intent and ability to hold for the foreseeable future or until maturity are reported at their
outstanding principal balance with adjustments for partial charge-offs, the allowance for loan and lease losses, deferred fees or costs on originated loans and leases,
and unamortized premiums or discounts on any purchased loans.
A loan or a lease is accounted for as a troubled debt restructuring if the Corporation, for economic or legal reasons related to the borrower’s financial condition,
grants a concession to the borrower that it would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial
or full satisfaction of the loan or lease or a modification of terms, such as a reduction of the stated interest rate or face amount of the loan or lease, a reduction of
accrued interest, an extension of the maturity date at a stated interest rate lower than the current market rate for a new loan or lease with similar risk, or some
combination of these concessions. Restructured loans can involve loans remaining on non-accrual, moving to non-accrual, or continuing on accrual status,
depending on individual facts and circumstances. Non-accrual restructured loans are included and treated with all other non-accrual loans. In addition, all accruing
restructured loans are reported as troubled debt restructurings which are considered and accounted for as impaired loans. Generally, restructured loans remain on
non-accrual until the borrower has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months).
However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can
meet the new terms and whether the loan should be returned to or maintained on accrual status. If the borrower’s ability to meet the revised payment schedule is
not reasonably assured, the loan remains on non-accrual.
Interest on non-impaired loans and leases is accrued and credited to income on a daily basis based on the unpaid principal balance and is calculated using the
effective interest method. Per policy, a loan or a lease is considered impaired and placed on non-accrual status when it becomes 90 days past due or it is doubtful
that contractual principal and interest will be collected in accordance with the terms of the contract. A loan or lease is determined to be past due if the borrower
fails to meet a contractual payment and will continue to be considered past due until all contractual payments are received. When a loan or lease is placed on non-
accrual, the interest accrual is discontinued and previously accrued but uncollected interest is deducted from interest income. If collectability of the contractual
principal and interest is in doubt, payments received are first applied to reduce the loan principal. If collectability of the contractual payments is not in doubt,
payments may be applied to interest for interest amounts due on a cash basis. As soon as it is determined with certainty that the principal of an impaired loan or
lease is uncollectable, either through collections from the borrower or disposition of the underlying collateral, the portion of the carrying balance that exceeds the
estimated measurement value of the loan or lease is charged off. Loans or leases are returned to accrual status when they are brought current in terms of both
principal and accrued interest due, have performed in accordance with contractual terms for a reasonable period of time and when the ultimate collectability of total
contractual principal and interest is no longer doubtful.
Transfers of assets, including but not limited to the guaranteed portions of SBA loans and participation interests in other originated loans, that upon completion of
the transfer satisfy the conditions to be reported as a sale, including legal isolation, are derecognized from the Consolidated Financial Statements. Transfers of
assets that upon completion of the transfer do not meet the conditions of a sale are recorded on a gross basis with a secured borrowing identified to reflect the
amount of the transferred interest.
Loan and lease origination fees as well as certain direct origination costs are deferred and amortized as an adjustment to loan yields over the stated term of the loan
or lease. Loans or leases that result from a refinance or restructuring, other than a troubled debt restructuring, where terms are at least as favorable to the
Corporation as the terms for comparable loans to other borrowers with similar collection risks and result in an essentially new loan or lease, are accounted for as a
new loan or lease. Any unamortized net fees, costs or penalties are recognized when the new loan or lease is originated. Unamortized net loan or lease fees or costs
for loans and leases that result from a refinance or restructure with only minor modifications to the original loan or lease contract are carried forward as a part of
the net investment in the new loan or lease. For troubled debt
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restructurings, all fees received in connection with a modification of terms are applied as a reduction of the loan or lease and any related costs, including direct loan
origination costs, are charged to expense as incurred.
Allowance for Loan and Lease Losses. The allowance for loan and lease losses is maintained at a level that management deems appropriate to absorb probable
and estimable losses inherent in the loan and lease portfolios. The methodology applied for determining inherent losses stems from current risk characteristics of
the loan and lease portfolio, an assessment of individual impaired loans and leases, actual loss experience and adverse situations that may affect the borrower’s
ability to repay. The methodology also focuses on evaluation of several factors for each portfolio category, including but not limited to: management’s ongoing
review and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, existing economic
conditions, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations of loans to specific
industries, and other qualitative and quantitative factors that could affect credit losses. Impaired and other loans and leases have risk characteristics that are unique
to an individual borrower and the loss must be estimated on an individual basis. Loans and leases that are not individually reviewed and measured for impairment
are aggregated and historical loss statistics are primarily used to determine the risk of loss.
The measurement of the estimate of loss is reliant upon historical experience, information about the ability of the individual debtor to pay, and the appraisal of loan
collateral in light of current economic conditions. An estimate of loss is an approximation of what portion of all amounts receivable, according to the contractual
terms of that receivable, is deemed uncollectible. Determination of the allowance is inherently subjective because it requires estimation of amounts and timing of
expected future cash flows on impaired loans and leases, estimation of losses on types of loans and leases based on historical losses, and consideration of current
economic trends, both local and national. Based on management’s periodic review using all previously mentioned pertinent factors, a provision for loan and lease
losses is charged to expense when it is determined an increase in the allowance for loan and lease losses is appropriate. A negative provision for loan and lease
losses may be recognized if management determines a reduction in the level of allowance for loan and lease losses is appropriate. Loan and lease losses are
charged against the allowance and recoveries are credited to the allowance.
The allowance for loan and lease losses contains specific allowances established for expected losses on impaired loans and leases. Impaired loans and leases are
defined as loans and leases for which, based on current information and events, it is probable that the Corporation will be unable to collect scheduled principal and
interest payments according to the contractual terms of the loan or lease agreement. Loans and leases subject to impairment are defined as non-accrual and
restructured loans and leases.
Impaired loans and leases are evaluated on an individual basis to determine the amount of specific reserve or charge-off required, if any. The measurement value of
impaired loans and leases is determined based on the present value of expected future cash flows discounted at the loan’s effective interest rate (the contractual
interest rate adjusted for any net deferred loan fees or costs, premium or discount existing at the origination or acquisition of the loan), the market price of the loan
or lease, or the fair value of the underlying collateral less costs to sell, if the loan or lease is collateral dependent. A loan or lease is collateral dependent if
repayment is expected to be provided principally by the underlying collateral. A loan’s effective interest rate may change over the life of the loan based on
subsequent changes in rates or indices, or may be fixed at the rate in effect at the date the loan was determined to be impaired.
Subsequent to the initial impairment, any significant change in the amount or timing of an impaired loan or lease’s future cash flows will result in a reassessment
of the valuation allowance to determine if an adjustment is necessary. Measurements based on observable market price or fair value of the collateral may change
over time and require a reassessment of the allowance if there is a significant change in either measurement base. Any increase in the present value of expected
future cash flows attributable to the passage of time is recorded as interest income accrued on the net carrying amount of the loan or lease at the effective interest
rate used to discount the impaired loan or lease’s estimated future cash flows. Any change in present value attributable to changes in the amount or timing of
expected future cash flows is recorded as loan loss expense in the same manner in which impairment was initially recognized or as a reduction of loan loss expense
that otherwise would be reported. Where the level of loan or lease impairment is measured using observable market price or fair value of collateral, any decrease in
the observable market price of an impaired loan or lease or fair value of the collateral of an impaired collateral-dependent loan or lease is recorded as loan loss
expense in the same manner in which impairment was initially recognized. Any increase in the observable market value of the impaired loan or lease or fair value
of the collateral of an impaired collateral-dependent loan or lease is recorded as a reduction in the amount of loan loss expense that otherwise would be reported.
Net Investment in Direct Financing Leases. The net investment in direct financing lease agreements represents total undiscounted payments plus estimated
unguaranteed residual value (approximating 3% to 20% of the cost of the related equipment) and is recorded as lease receivables when the lease is signed and the
leased property is delivered to the client. The excess of the minimum lease payments and residual values over the cost of the equipment is recorded as unearned
lease income. Unearned lease income is recognized over the term of the lease on a basis which results in an approximate level rate of
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return on the unrecovered lease investment. Lease payments are recorded when due under the lease contract. Residual values are established at lease inception
equal to the estimated value to be received from the equipment following termination of the initial lease and such estimated value considers all relevant
information and circumstances regarding the equipment. In estimating the equipment’s fair value at lease termination, the Corporation relies on internally or
externally prepared appraisals, published sources of used equipment prices and historical experience adjusted for known current industry and economic trends. The
Corporation’s estimates are periodically reviewed to ensure reasonableness; however, the amounts the Corporation will ultimately realize could differ from the
estimated amounts. When there are other than temporary declines in the Corporation’s carrying amount of the unguaranteed residual value, the carrying value is
reduced and charged to non-interest expense.
Operating Leases. Machinery and equipment are leased to clients under operating leases and are recorded at cost. Equipment under such leases is depreciated over
the estimated useful life or term of the lease, if shorter. The impairment loss, if any, would be charged to expense in the period it becomes evident. Rental income
is recorded on the straight-line accrual basis as other non-interest income.
Premises and Equipment, net. The cost of capitalized leasehold improvements is amortized on the straight-line method over the lesser of the term of the
respective lease or estimated economic life. Equipment is stated at cost less accumulated depreciation and amortization which is calculated by the straight-line
method over the estimated useful lives of three to ten years. Maintenance and repair costs are charged to expense as incurred. Improvements which extend the
useful life are capitalized and depreciated over the remaining useful life of the assets.
Foreclosed Properties. Property acquired by repossession, foreclosure, or by deed in lieu of foreclosure is recorded at the fair value of the underlying property,
less costs to sell. This fair value becomes the new cost basis for the foreclosed property. Any write-down in the carrying value of a loan or lease at the time of
acquisition is charged to the allowance for loan and lease losses. Any subsequent write-downs to reflect current fair value, as well as gains and losses on
disposition and revenues are recorded in non-interest expense. Costs relating to the development and improvement of the property are capitalized while holding
period costs are charged to other non-interest expense.
Bank-Owned Life Insurance. Bank-owned life insurance (“BOLI”) is reported at the amount that would be realized if the life insurance policies were surrendered
on the balance sheet date. BOLI policies owned by the Bank are purchased with the objective to fund certain future employee benefit costs with the death benefit
proceeds. The cash surrender value of such policies is recorded in bank-owned life insurance on the Consolidated Balance Sheets and changes in the value are
recorded in non-interest income. The total death benefit of all BOLI policies was $97.8 million and $97.7 million as of December 31, 2018 and 2017 , respectively.
There are no restrictions on the use of BOLI proceeds nor are there any contractual restrictions on the ability to surrender the policy. As of each of December 31,
2018 and 2017 , there were no borrowings against the cash surrender value of the BOLI policies.
Federal Home Loan Bank Stock. The Bank is required to maintain Federal Home Loan Bank (“FHLB”) stock as members of the FHLB, and in amounts as
required by the FHLB. This equity security is “restricted” in that it can only be sold back to the FHLB or another member institution at par. Therefore, it is less
liquid than other marketable equity securities and the fair value is equal to cost. At December 31, 2018 and 2017 , the Bank had FHLB stock of $7.2 million and
$5.7 million , respectively. The Corporation periodically evaluates its holding in FHLB stock for impairment. Should the stock be impaired, it would be written
down to its estimated fair value. There were no impairments recorded on FHLB stock during the year ended December 31, 2018 or 2017 .
Goodwill and Other Intangible Assets. Goodwill and other intangible assets consist primarily of goodwill, core deposit intangibles, and loan servicing rights.
Core deposit intangibles have estimated finite lives and are amortized on an accelerated basis to expense over a period of seven years. Loan servicing rights, when
originated, are initially recorded at fair value and subsequently amortized in proportion to and over the period of estimated net servicing income. The Corporation
reviews other intangible assets for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable, in which case an impairment charge would be recorded.
Goodwill is not amortized but is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would
more likely than not reduce the fair value of the reporting unit below its carrying amount (including goodwill). An initial qualitative evaluation is made to assess
the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates
that impairment is more likely than not, quantitative testing is required whereby the fair value of each reporting unit is calculated and compared to the recorded
book value, “step one.” If the calculated fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and “step two” is not
considered necessary. If the carrying value of a reporting unit exceeds its calculated fair value, the impairment test continues (“step two”) by comparing the
carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets and liabilities of the
reporting unit to current fair value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the
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goodwill. An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill. See Note 6 for additional information
on goodwill and other intangible assets.
SBA Recourse Reserve. The Corporation establishes SBA recourse reserves on the guaranteed portions of sold SBA loans when it is probable that the guarantee
may be ineligible. The recourse reserve is reported in accrued interest payable and other liabilities on the Consolidated Balance Sheets and consists of two
components: (1) specific reserves for individually evaluated impaired loans that present a collateral shortfall where the guaranty associated with the sold portion of
the SBA loan is determined to most likely be ineligible; and (2) general reserves for estimated probable losses on the remaining sold portfolio. The general reserve
methodology is based on the evaluation of several factors, including but not limited to: credit quality trends within the SBA portfolio, changes in underlying
collateral, and the Corporation’s ability to originate, fund, or service sold SBA loans in accordance with SBA regulations.
In the ordinary course of business, the Corporation sells the guaranteed portions of SBA loans to third parties. The Corporation has a continuing involvement in
each of the transferred lending arrangements by way of relationship management, servicing the loans, as well as being subject to normal and customary
requirements of the SBA loan program; however, there are no further obligations to the third-party participant required of the Corporation, other than 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. See Note 18 for additional information on the SBA recourse reserve.
Other Investments. The Corporation owns certain equity investments in other corporate organizations which are not consolidated because the Corporation does
not own more than a 50% interest or exercise control over the organization. Investments in corporations representing at least a 20% interest are generally accounted
for using the equity method and investments in corporations representing less than 20% interest are generally accounted for at cost. Investments in limited
partnerships representing from at least a 3% up to a 50% interest in the entity are generally accounted for using the equity method and investments in limited
partnerships representing less than 3% are generally accounted for at cost. All of these investments are periodically evaluated for impairment. Should an
investment be impaired, it would be written down to its estimated fair value. The equity investments are reported in other assets and the income and expense from
such investments, if any, is reported in non-interest income and non-interest expense.
Derivative Instruments. The Corporation uses derivative instruments to protect against the risk of adverse price or interest rate movements on the value of certain
assets, liabilities, future cash flows and economic hedges for written client derivative contracts. Derivative instruments represent contracts between parties that
usually require little or no initial net investment and result in one party delivering cash to the other party based on a notional amount and an underlying variable, as
specified in the contract, and may be subject to master netting agreements.
Market risk is the risk of loss arising from an adverse change in interest rates, exchange rates, or equity prices. The Corporation’s primary market risk is interest
rate risk. Instruments designed to manage interest rate risk include interest rate swaps, interest rate options, and interest rate caps and floors with indices that relate
to the pricing of specific assets and liabilities. The nature and volume of the derivative instruments used to manage interest rate risk depend on the level and type of
assets and liabilities on the balance sheet and the risk management strategies for the current and anticipated rate environments. Counterparty risk with respect to
derivative instruments occurs when a counterparty to a derivative contract with an unrealized gain fails to perform according to the terms of the agreement.
Counterparty risk is managed by limiting the counterparties to highly rated dealers, requiring collateral postings when values are in deficit positions, applying
uniform credit standards to all activities with credit risk and monitoring the size and the maturity structure of the derivative portfolio.
All derivative instruments are to be carried at fair value on the Consolidated Balance Sheets. The accounting for the gain or loss due to changes in the fair value of
a derivative instrument depends on whether the derivative instrument qualifies as a hedge. If the derivative instrument does not qualify as a hedge, the gains or
losses are reported in earnings when they occur. However, if the derivative instrument qualifies as a hedge, the accounting varies based on the type of risk being
hedged. In 2018 and 2017, the Corporation utilized interest rate swaps offered directly to qualified commercial borrowers, which did not qualify for hedge
accounting, and therefore, all changes in fair value and gains and losses on these instruments were reported in earnings as they occurred. The effects of netting
arrangements are disclosed within the Notes of the Consolidated Financial Statements.
In the fourth quarter of 2017, the Corporation began entering 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 are designated as a cash flow hedge as the receipt of floating interest from the counterparty is used to manage
interest rate risk associated with forecasted issuances of
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short-term FHLB advances. The change in fair value of the hedging instrument is recorded in accumulated other comprehensive income.
Income Taxes. Deferred income tax assets and liabilities are computed for temporary differences in timing between the financial statement and tax basis of assets
and liabilities that result in taxable or deductible amounts in the future based on enacted tax law and rates applicable to periods in which the differences are
expected to affect taxable income. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date. The
ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences
become deductible. Management considers the scheduled reversals of deferred tax liabilities, appropriate tax planning strategies and projections for future taxable
income over the period which the deferred tax assets are deductible. When necessary, valuation allowances are established to reduce deferred tax assets to the
realizable amount. Management believes it is more likely than not that the Corporation will realize the benefits of these deductible differences, net of the existing
valuation allowances.
Income tax expense or benefit represents the tax payable or tax refundable for a period, adjusted by the applicable change in deferred tax assets and liabilities for
that period. The Corporation also invests in certain development entities that generate federal and state historic tax credits. The tax benefits associated with these
investments are accounted for under the flow-through method and are recognized when the respective project is placed in service. The Corporation and its
subsidiaries file a consolidated federal income tax return and separate state income tax returns. Tax sharing agreements allocate taxes to each legal entity for the
settlement of intercompany taxes. The Corporation applies a more likely than not standard to each of its tax positions when determining the amount of tax expense
or benefit to record in its financial statements. Unrecognized tax benefits are recorded in other liabilities. The Corporation recognizes accrued interest relating to
unrecognized tax benefits in income tax expense and penalties in other non-interest expense.
Other Comprehensive Income or Loss. Comprehensive income or loss, shown as a separate financial statement, includes net income or loss, changes in
unrealized gains and losses on available-for-sale securities, changes in deferred gains and losses on investment securities transferred from available-for-sale to
held-to-maturity, if any, changes in unrealized gains and losses associated with cash flow hedging instruments, if any, and the amortization of deferred gains and
losses associated with terminated cash flow hedges, if any. For the year ended December 31, 2018 and 2017 , realized securities losses of $4,000 and $403,000
were reclassified out of accumulated other comprehensive income, respectively.
Earnings Per Common Share. Earnings per common share (“EPS”) is computed using the two-class method. Basic EPS is computed by dividing net income
allocated to common shares by the weighted average number of common shares outstanding for the period, excluding any participating securities. Participating
securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-
forfeitable dividends at the same rate as the holders of the Corporation’s common stock. Diluted EPS is 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 common shares determined for the basic
EPS plus the dilutive effect of common stock equivalents using the treasury stock method based on the average market price for the period.
Segments and Related Information. The Corporation is required to report each operating segment based on materiality thresholds of ten percent or more of
certain amounts, such as revenue. Additionally, the Corporation is required to report separate operating segments until the revenue attributable to such segments is
at least 75 percent of total consolidated revenue. The Corporation provides a broad range of financial services to individuals and companies. These services include
demand, time and savings products, the sale of certain non-deposit financial products and commercial and retail lending, leasing and trust services. While the
Corporation’s chief decision-maker monitors the revenue streams of the various products, services and locations, operations are managed and financial
performance is evaluated on a corporate-wide basis. The Corporation’s business units have similar basic characteristics in the nature of the products, production
processes and type or class of client for products or services; therefore, these business units are considered one operating segment.
Share-Based Compensation. The Corporation early adopted ASU No. 2016-09, “ Compensation-Stock
Compensation
(Topic
718):
Improvements
to
Employee
Share-Based
Payment
Accounting,
” on October 1, 2016 with an effective date of January 1, 2016. Upon vesting of restricted share awards subject to ASU No.
2016-09, the benefit of tax deductions in excess of recognized compensation expense is reflected as an income tax benefit in the Consolidated Statements of
Income. Excess tax benefits are included in other operating activities and taxes paid related to net share settlement of equity awards in financing activities within
the Consolidated Statements of Cash Flows. The Corporation elected to account for forfeitures as they occur. While restricted stock is subject to forfeiture,
restricted stock participants may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares.
Restricted stock units do not have voting rights and are provided dividend equivalents. The restricted stock granted under the Plan is typically subject to a vesting
period. Compensation expense is recognized over the requisite service period of generally four years for the entire award on a straight-line basis. See Note 12 for
additional information on share-based compensation.
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Adoption of New Accounting Standards. In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “ Revenue
from
Contracts
with
Customers
(Topic
606),
” with an original effective date for annual reporting periods beginning after December 15, 2016. The ASU is a converged
standard between the FASB and the IASB that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and
industries. The primary objective of the ASU is revenue recognition that represents the transfer of promised goods or services to customers in an amount that
reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14,
which deferred the effective date of ASU 2014-09 to annual and interim reporting periods in fiscal years beginning after December 15, 2017. In March 2016, the
FASB issued ASU No. 2016-08, “ Revenue
from
Contracts
with
Customers
(Topic
606):
Principal
versus
Agent
Considerations
(Reporting
Revenue
Gross
versus
Net).”
The ASU intends to improve the operability and understandability of the implementation guidance of ASU 2014-09 on principal versus agent
considerations. In April, May and December 2016, the FASB also issued ASU No. 2016-10, No. 2016-12 and No. 2016-20, respectively, related to Topic 606. The
amendments do not change the core principles of the previously issued guidance, but instead further clarify and provide implementation guidance for certain
aspects of the original ASU.
During the first quarter of 2018, the Corporation adopted ASU 2014-09 and all subsequent amendments to the ASU (collectively, “ASC 606”) using the modified
retrospective method. The majority of the Corporation’s revenues are derived from interest income and other sources that are outside the scope of ASC 606. The
primary revenue streams subject to the guidance include trust and investment services fee income, service charges on deposits and the sale of foreclosed properties.
The Corporation completed an assessment and evaluated contracts to assess and quantify accounting methodology changes resulting from these standards.
Trust and investment service fees : The Corporation earns fees from contracts with customers for investment management, trust and estate management, company
retirement plan and brokerage services to manage assets for investment and/or transact on their accounts. These fees are primarily earned over time as the
Corporation provides the contracted monthly, quarterly or annual services and are generally assessed based on a tiered scale of the market value of assets under
management or administration at the end of the period. Fees that are transaction-based are recognized at the point in time that the transaction is executed.
Service charges on deposits : The Corporation earns fees from deposit customers for account maintenance, information reporting, account reconciliation and
transaction-based activity, such as overdraft and service fees. Transaction-based fees are recognized at the time the transaction is executed as that is the point in
time the Corporation fulfills the customer’s request. All other fees are earned over the course of a month, representing the period over which the Corporation
satisfies the performance obligation.
Gain or loss on foreclosed properties : The Corporation records a gain or loss from the sale of foreclosed property when control of the property transfers to the
buyer. If the Corporation finances the sale of the property to the buyer, the Corporation assesses whether the buyer is committed to perform their obligations under
the contract and whether collectability of the transaction price is probable. Once these criteria are met, the foreclosed property is derecognized and the gain or loss
on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Corporation adjusts the transaction price
and related gain or loss on sale if a significant financing component is present.
The adoption of ASC 606 did not result in a change to the current accounting practices for any of the in-scope revenue streams; as such, no cumulative effect
adjustment was recorded.
In January 2016, the FASB issued ASU No. 2016-01, “ Financial
Instruments
(Subtopic
825-10).
” The ASU amends certain aspects of recognition, measurement,
presentation and disclosure of financial instruments. This amendment supersedes the guidance to classify equity securities with readily determinable fair values
into different categories, requires equity securities to be measured at fair value with changes in the fair value recognized through net income and simplifies the
impairment assessment of equity investments without readily determinable fair values. The amendment requires public business entities that are required to
disclose the fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using the exit price notion. The
amendment requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a
change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option. The
amendment requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in
the accompanying notes to the financial statements. The amendment reduces diversity in current practice by clarifying that an entity should evaluate the need for a
valuation allowance on a deferred tax asset related to available for sale securities in combination with the entity’s other deferred tax assets. This amendment is
effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities should apply the amendment by means of
a cumulative-effect adjustment as of the beginning of the fiscal year of adoption, with the exception of the amendment related to equity securities without readily
determinable fair values, which should be applied prospectively to
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equity investments that exist as of the date of adoption. The Corporation adopted the accounting standard during the first quarter of 2018 and modified its fair value
disclosure of financial instruments to reflect an exit price notion. The modifications were substantially related to loans and lease receivables, deposits, Federal
Home Loan Bank advances and other borrowings. The Corporation did not have any equity securities subject to the fair value adjustment. The adoption of the
standard did not have a material impact on the Corporation’s results of operations, financial position, and liquidity.
In March 2017, the FASB issued ASU No. 2017-08, “ Receivables—Nonrefundable
Fees
and
Other
Costs
(Subtopic
310-20)
.” The ASU requires that certain
purchased callable debt securities held at a premium be amortized to the earliest call date. The amendments do not require an accounting change for securities held
at a discount, which continue to be amortized to maturity. The ASU is effective for all entities for fiscal years beginning after December 15, 2018, and interim
periods within those fiscal years, with early adoption permitted. The Corporation adopted the standard in the first quarter of 2018 with no material impact on its
results of operations, financial position, and liquidity.
In May 2017, the FASB issued ASU No. 2017-09, “ Compensation-
Stock
Compensation
(Topic
718).
” The ASU provides clarity about which changes to the
terms or conditions of a share-based payment award require an entity to apply modification accounting. The ASU is effective for all entities for fiscal years
beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Corporation adopted the standard in the
first quarter of 2018 with no material impact on its results of operations, financial position, and liquidity.
In February 2018, the FASB issued ASU No. 2018-02, “ Income
Statement-
Reporting
Comprehensive
Income
(Topic
220).
” The ASU allowed a reclassification
from accumulated comprehensive income to retained earnings for stranded effects resulting from the Tax Cuts and Jobs Act. The ASU is effective for all entities
for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The Corporation early adopted the
standard in the fourth quarter of 2017, which resulted in a $17,000 and $222,000 reclassification from accumulated comprehensive income to retained earnings
during the year ended December 31, 2018 and 2017 , respectively.
Recent Accounting Pronouncements. In February 2016, the FASB issued ASU No. 2016-02, “ Leases
(Topic
842).
” The ASU intends to increase transparency
and comparability among organizations by recognizing lease assets and lease liabilities and disclosing key information about leasing arrangements. The ASU will
require lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessees’
obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s
right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted
improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic
606,
Revenue
from
Contracts
with
Customers
.
The new lease guidance simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities.
Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) may apply a modified retrospective transition approach
for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective
approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may also elect to
apply the amendments in the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the
guidance is effective. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal
years, with early adoption permitted. The Corporation will adopt the accounting standard prospectively during the first quarter of 2019. The Corporation leases
office space, loan production offices and specialty financing production offices under noncancelable operating leases which expire on various dates through 2028.
The Corporation also leases office equipment. The implementation efforts are completed, including the review of our leases and related accounting policies. As
part of the adoption, we will elect certain optional practical expedients, including not recognizing short-term leases on the Consolidated Balance Sheets. The
Corporation does not expect the accounting standard to have a material impact on its results of operations and liquidity. The estimated impact on its financial
position is an $8.8 million lease liability with an offsetting $8.5 million right-of-use asset net of $312,000 of lease incentives and a $687,000 cumulative-effect
adjustment to increase retained earnings on the Consolidated Balance Sheets.
In June 2016, the FASB issued ASU No. 2016-13, “ Financial
Instruments-
Credit
Losses
(Topic
326).
” The ASU replaces the incurred loss impairment
methodology for recognizing credit losses with a methodology that reflects all expected credit losses. The ASU also requires consideration of a broader range of
information to inform credit loss estimates, including such factors as past events, current conditions, and reasonable and supportable forecasts that affect the
collectability of the reported amount. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures,
and any other financial asset not excluded from the scope that have the contractual right to receive cash. Entities will apply the amendments in the ASU through a
cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The ASU is effective for
public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the
fiscal years beginning after
81
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December 15, 2018. The Corporation intends to adopt the accounting standard during the first quarter of 2020, as required, and is currently evaluating the impact
on its results of operations, financial position and liquidity. A cross-functional committee has been established and a third-party software solution has been
implemented to assist with the adoption of the standard. Management is in the process of gathering necessary data, reviewing potential methods to calculate the
expected credit losses, and plans to calculate sample expected loss computations through 2019.
In June 2018, the FASB issued ASU No. 2018-07, “Compensation-
Stock
Compensation
(Topic
718).”
The ASU expands the scope of Topic 718 to include share-
based payment transactions for acquiring goods and services from nonemployees. The ASU is effective for public companies for fiscal years beginning after
December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Corporation has evaluated adoption of this standard and
determined it will not have any impact on its results of operations, financial position, and liquidity.
In August 2018, the FASB issued ASU No. 2018-15, “Intangibles-Goodwill
and
Other
Internal-Use
Software
(Subtopic
350-40).”
The ASU aligns the
requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing
implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Implementation
costs incurred in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and
post implementation stages are expensed as the activities are performed. The amendment also requires entities to expense the capitalized implementation costs of a
hosting arrangement that is a service contract over the term of the hosting arrangement and in the same income statement line item as the fees associated with the
hosting element. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is
permitted. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on its results of
operations, financial position, and liquidity.
Note 2 – Cash and Cash Equivalents
Cash and due from banks was approximately $23.3 million and $17.1 million at December 31, 2018 and 2017 , respectively. Required reserves in the form of
either vault cash or deposits held at the FRB were $9.9 million and $16.8 million at December 31, 2018 and 2017 , respectively. FRB balances were $43.6 million
and $17.7 million at December 31, 2018 and 2017 , respectively, and are included in short-term investments on the Consolidated Balance Sheets. Short-term
investments, considered cash equivalents, were $63.2 million and $35.5 million at December 31, 2018 and 2017 , respectively.
Note 3 – 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:
Amortized Cost
As of December 31, 2018
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises
$
999 $
— $
(9) $
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored enterprises
Other securities
5,953
20,007
110,928
2,450
2
47
279
—
(69)
(426)
(1,729)
(74)
$
140,337 $
328 $
(2,307) $
82
Fair Value
990
5,886
19,628
109,478
2,376
138,358
Table of Contents
Amortized Cost
As of December 31, 2017
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In Thousands)
Fair Value
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises
$
999 $
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored enterprises
Other securities
9,494
22,313
91,480
3,040
1 $
2
149
24
3
— $
(82)
(213)
(1,199)
(6)
1,000
9,414
22,249
90,305
3,037
$
127,326 $
179 $
(1,500) $
126,005
The amortized cost and fair value of securities held-to-maturity and the corresponding amounts of gross unrealized gains and losses were as follows:
As of December 31, 2018
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In Thousands)
Fair Value
72 $
—
2
74 $
(59)
$
(172)
(165)
(396)
$
21,079
7,186
9,144
37,409
As of December 31, 2017
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In Thousands)
Fair Value
1,490
21,822
8,943
5,441
37,696
Held-to-maturity:
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored enterprises
Amortized Cost
$
21,066 $
7,358
9,307
$
37,731 $
Amortized Cost
Held-to-maturity:
U.S. government agency securities - government-sponsored enterprises
$
1,499 $
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored enterprises
21,680
9,072
5,527
— $
176
1
—
(9)
$
(34)
(130)
(86)
$
37,778 $
177 $
(259)
$
U.S. government agency securities - government-sponsored enterprises represent securities issued by the Federal Home Loan Bank (“FHLB”), the Federal Home
Loan Mortgage Corporation (“FHLMC”), and the Federal National Mortgage Association (“FNMA”). Municipal securities include securities issued by various
municipalities located primarily within the State of Wisconsin and are primarily general obligation bonds that are tax-exempt in nature. Mortgage backed securities
- government issued represent securities guaranteed by the Government National Mortgage Association. Mortgage backed securities - government-sponsored
enterprises include securities guaranteed by FHLMC and FNMA. Other securities represent certificates of deposit of insured banks and savings institutions with an
original maturity greater than three months.
Total proceeds and gross realized gains and losses from sales of securities available-for-sale were as follows:
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Table of Contents
Gross gains
Gross losses
Net (losses) gains on sale of available-for-sale securities
Proceeds from sale of available-for-sale securities
For the Year Ended December 31,
2018
2017
2016
$
$
$
(In Thousands)
22 $
(26)
(4) $
92 $
(495)
(403) $
10
—
10
6,207 $
40,144 $
5,227
At December 31, 2018 and 2017 , securities with a fair value of $11.5 million and $2.8 million , respectively, were pledged to secure various obligations, including
interest rate swap contracts and municipal deposits.
The amortized cost and fair value of securities by contractual maturity at December 31, 2018 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.
Due in one year or less
Due in one year through five years
Due in five through ten years
Due in over ten years
Available-for-Sale
Held-to-Maturity
Amortized
Cost
Fair Value
Amortized Cost
Fair Value
(In Thousands)
$
1,801 $
1,800 $
771 $
21,353
26,957
90,226
21,027
26,536
88,995
11,834
19,053
6,073
$
140,337 $
138,358 $
37,731 $
771
11,822
18,839
5,977
37,409
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 December 31, 2018 and 2017 . At December 31, 2018 , the Corporation held 135 available-
for-sale securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have primarily declined in
value due to the current interest rate environment. At December 31, 2018 , the Corporation held 128 available-for-sale securities that had been in a continuous
unrealized loss position for twelve months or greater.
The Corporation also 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 monitor its exposure to other-than-temporary impairment.
Consideration is given to such factors as the length of time and extent to which the security has been in an unrealized loss position, changes in security ratings, and
an evaluation of the present value of expected future cash flows, if necessary. Based on the Corporation’s evaluation, it is expected that the Corporation will
recover the entire amortized cost basis of each security. Accordingly, no other-than-temporary impairment was recorded in the Consolidated Statements of Income
for the years ended December 31, 2018 and 2017 .
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Table of Contents
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:
Available-for-sale:
U.S. Government agency securities - government-
sponsored enterprises
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored
enterprises
Other securities
Less than 12 Months
December 31, 2018
12 Months or Longer
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
(In Thousands)
$
— $
— $
990 $
9 $
990 $
—
—
8,178
238
—
—
46
7
4,371
13,748
69,602
2,138
69
426
1,683
67
4,371
13,748
77,780
2,376
$
8,416 $
53 $
90,849 $
2,254 $
99,265 $
9
69
426
1,729
74
2,307
Less than 12 Months
December 31, 2017
12 Months or Longer
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
(In Thousands)
Available-for-sale:
Municipal securities
$
6,132 $
43 $
2,755 $
39 $
8,887 $
Mortgage backed securities - government issued
7,104
40
6,715
173
13,819
Mortgage backed securities - government-sponsored
enterprises
Other securities
59,256
1,954
476
6
28,004
—
723
—
87,260
1,954
$
74,446 $
565 $
37,474 $
935 $
111,920 $
82
213
1,199
6
1,500
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 December 31, 2018 and 2017 . At December 31, 2018 , the Corporation held 63 held-to-
maturity securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have primarily declined
in value due to the current interest rate environment. There were 37 held-to-maturity securities that had been in a continuous loss position for twelve months or
greater as of December 31, 2018 . It is expected that the Corporation will recover the entire amortized cost basis of each held-to-maturity security based upon an
evaluation of aforementioned factors. Accordingly, no other-than-temporary impairment was recorded in the Consolidated Statements of Income for the years
ended December 31, 2018 and 2017 .
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Table of Contents
A summary of unrealized 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:
Less than 12 Months
December 31, 2018
12 Months or Longer
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
(In Thousands)
Held-to-maturity:
Municipal securities
$
6,876 $
14 $
4,364 $
45 $
11,240 $
Mortgage backed securities - government issued
—
—
7,186
172
7,186
Mortgage backed securities - government-
sponsored enterprises
4,038
24
4,338
141
8,376
$
10,914 $
38 $
15,888 $
358 $
26,802 $
59
172
165
396
Held-to-maturity:
U.S. government agency securities - government-
sponsored enterprises
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-
sponsored enterprises
Less than 12 Months
December 31, 2017
12 Months or Longer
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
(In Thousands)
$
— $
— $
1,499 $
9 $
1,499 $
3,723
3,868
27
51
259
4,677
7
79
3,982
8,545
—
—
5,527
86
5,527
$
7,591 $
78 $
11,962 $
181 $
19,553 $
9
34
130
86
259
86
Table of Contents
Note 4 – Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses
Loan and lease receivables consist of the following:
Commercial real estate:
Commercial real estate — owner occupied
Commercial real estate — non-owner occupied
Land development
Construction
Multi-family
1-4 family
Total commercial real estate
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total consumer and other
December 31,
2018
December 31,
2017
(In Thousands)
$
203,476 $
484,427
42,666
161,562
167,868
34,340
1,094,339
462,321
33,170
8,438
20,789
29,227
200,387
470,236
40,154
125,157
136,978
44,976
1,017,888
429,002
30,787
7,262
18,099
25,361
Total gross loans and leases receivable
1,619,057
1,503,038
Less:
Allowance for loan and lease losses
Deferred loan fees
Loans and leases receivable, net
The total amount of the Corporation’s ownership of SBA loans comprised of the following:
Retained, unguaranteed portions of sold SBA loans
Other SBA loans (1)
Total SBA loans
20,425
1,402
18,763
1,443
$
1,597,230 $
1,482,832
December 31,
2018
December 31,
2017
$
$
(In Thousands)
23,898 $
22,024
45,922 $
30,071
22,254
52,325
(1) Primarily consisted of SBA CAPLine, Express and impaired loans that were repurchased from the secondary market, all of which were not saleable as of December 31, 2018 and
2017.
As of December 31, 2018 and 2017 , $13.2 million and $11.1 million of SBA loans were considered impaired, respectively.
Loans transferred to third parties consist of the guaranteed portions of SBA loans which the Corporation sold in the secondary market, participation interests in
other originated loans and residential real estate loans. The total principal amount of the guaranteed portions of SBA loans sold during the year ended
December 31, 2018 and 2017 was $14.1 million and $16.5 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 year ended December 31, 2018 and 2017 have been derecognized in the 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 Consolidated Financial Statements. The total outstanding balance of sold SBA loans at December 31, 2018 and 2017 was $83.3 million and $100.3 million ,
respectively.
The total principal amount of transferred participation interests in other originated commercial loans during the year ended December 31, 2018 and 2017 was $73.9
million and $63.6 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
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Table of Contents
interests in other 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 outstanding balance of these transferred loans at December 31, 2018 and 2017 was $129.7 million and
$106.4 million , respectively. As of December 31, 2018 and 2017 , the total amount of the Corporation’s partial ownership of these transferred loans on the
Consolidated Balance Sheets was $208.9 million and $181.7 million , respectively. No loans in this participation portfolio were considered impaired as of
December 31, 2018 and 2017 . The Corporation does not share in the participant’s portion of any potential charge-offs. The total amount of loan participations
purchased on the Consolidated Balance Sheets as of December 31, 2018 and 2017 was $569,000 and $650,000 , respectively.
The Corporation also previously sold residential real estate loans, servicing released, in the secondary market. The Corporation did not sell any residential real
estate loans during the year ended December 31, 2018 . The total principal amount of residential real estate loans sold during the year ended December 31, 2017
was $1.6 million . Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred have been
derecognized in the Consolidated Financial Statements. The loans were transferred at their fair value and the related gain was recognized as non-interest income
upon the transfer in the Consolidated Financial Statements.
Certain of the Corporation’s executive officers, directors and their related interests are loan clients of the Bank. These loans to related parties are summarized
below:
Balance at beginning of year
New loans
Repayments
Change due to status of executive officers and directors
Balance at end of year
December 31, 2018 December 31, 2017
(In Thousands)
$
10,513 $
5,014
(6,304)
(7,368)
$
1,855 $
6,332
8,269
(4,088)
—
10,513
The following tables illustrate ending balances of the Corporation’s loan and lease portfolio, including impaired loans by class of receivable, and considering
certain credit quality indicators:
December 31, 2018
Category
I
II
III
IV
Total
(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied
$
177,222
$
15,085
$
5,506
$
5,663
$
Commercial real estate — non-owner occupied
Land development
Construction
Multi-family
1-4 family
Total commercial real estate
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total consumer and other
458,185
39,472
161,360
167,868
32,004
1,036,111
374,371
26,013
8,385
20,499
28,884
24,873
981
—
—
1,451
42,390
19,370
6,090
3
—
3
1,338
—
202
—
707
7,753
51,474
1,067
50
—
50
31
2,213
—
—
178
8,085
17,106
—
—
290
290
203,476
484,427
42,666
161,562
167,868
34,340
1,094,339
462,321
33,170
8,438
20,789
29,227
Total gross loans and leases receivable
$
1,465,379
$
67,853
$
60,344
$
25,481
$
1,619,057
Category as a % of total portfolio
90.51%
4.19%
3.73%
1.57%
100.00%
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Table of Contents
December 31, 2017
Category
I
II
III
IV
Total
(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied
$
166,018
$
18,442
$
8,850
$
7,077
$
Commercial real estate — non-owner occupied
Land development
Construction
Multi-family
1-4 family
Total commercial real estate
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total consumer and other
441,246
36,470
121,528
136,978
34,598
936,838
341,875
28,866
7,250
17,745
24,995
27,854
1,057
757
—
7,735
55,845
25,344
342
8
—
8
1,102
—
—
—
1,220
11,172
49,453
1,579
—
—
—
34
2,627
2,872
—
1,423
14,033
12,330
—
4
354
358
200,387
470,236
40,154
125,157
136,978
44,976
1,017,888
429,002
30,787
7,262
18,099
25,361
Total gross loans and leases receivable
$
1,332,574
$
81,539
$
62,204
$
26,721
$
1,503,038
Category as a % of total portfolio
88.66%
5.42%
4.14%
1.78%
100.00%
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 subjective and, depending on the size and nature of the credit, 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 subcommittees of the Bank’s Loan Committee.
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 subcommittees of the Bank’s Loan Committee on a monthly basis.
Category IV — Loans and leases in this category are considered to be impaired. Impaired loans and leases, with the exception of performing troubled debt
restructurings, have been placed on non-accrual as management has determined that it is unlikely
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Table of Contents
that the Bank will receive the contractual principal and interest in accordance with the original terms of the agreement. Impaired 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 for impaired loans and leases. 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 to reflect the
magnitude of the impairment. Loans and leases in this category are monitored by management and subcommittees of the Bank’s Loan Committee on a monthly
basis.
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Table of Contents
The delinquency aging of the loan and lease portfolio by class of receivable was as follows:
December 31, 2018
30-59
Days Past Due
60-89
Days Past Due
Greater
Than 90
Days Past Due
Total Past Due
Current
Total Loans and
Leases
(Dollars in Thousands)
Accruing loans and leases
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
Non-accruing loans and leases
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
Total loans and leases
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
$
157
$
— $
— $
157
$
197,656
$
—
—
14,824
—
363
826
—
—
—
2,272
—
—
—
60
247
—
—
—
16,170
2,579
483
—
—
—
—
—
2,322
—
—
—
2,805
640
—
—
14,824
—
363
3,148
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
2,272
—
—
—
60
247
—
—
—
—
—
—
—
—
—
—
—
—
—
5,180
31
119
—
—
—
2,272
—
14,824
—
423
1,073
—
—
—
482,124
40,453
146,738
167,868
33,917
444,144
33,170
8,438
20,499
197,813
484,396
40,453
161,562
167,868
34,340
445,217
33,170
8,438
20,499
18,749
1,575,007
1,593,756
5,663
31
119
—
—
—
12,108
14,430
—
—
279
17,717
5,180
31
119
—
—
—
12,108
—
—
279
—
—
279
20,522
5,820
2,303
119
14,824
—
423
15,503
—
—
279
—
—
2,094
—
—
—
2,674
—
—
11
4,779
197,656
482,124
42,547
146,738
167,868
33,917
446,818
33,170
8,438
20,510
5,663
31
2,213
—
—
—
17,104
—
—
290
25,301
203,476
484,427
42,666
161,562
167,868
34,340
462,321
33,170
8,438
20,789
$
18,975
$
2,579
$
17,717
$
39,271
$
1,579,786
$
1,619,057
Percent of portfolio
1.17%
0.16%
1.09%
2.42%
97.58%
100.00%
91
Table of Contents
Accruing loans and leases
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
Non-accruing loans and leases
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
Total loans and leases
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
December 31, 2017
30-59
Days Past Due
60-89
Days Past Due
Greater
Than 90
Days Past Due
Total Past Due
Current
Total Loans and
Leases
(Dollars in Thousands)
$
— $
— $
— $
— $
193,366
$
—
—
—
—
496
1,169
—
106
—
1,771
405
—
—
—
—
—
782
—
—
—
1,187
405
—
—
—
—
496
1,951
—
106
—
—
—
196
—
—
197
—
—
—
393
—
—
—
—
—
—
—
—
—
—
—
—
—
—
196
—
—
197
—
—
—
—
—
—
—
—
—
—
—
—
—
4,836
—
—
2,872
—
948
7,349
—
—
345
16,350
4,836
—
—
2,872
—
948
7,349
—
—
345
—
—
196
—
496
1,366
—
106
—
470,202
37,528
122,089
136,978
43,319
415,315
30,787
7,156
17,745
193,366
470,202
37,528
122,285
136,978
43,815
416,681
30,787
7,262
17,745
2,164
1,474,485
1,476,649
5,241
—
—
2,872
—
948
8,131
—
—
345
17,537
5,241
—
—
3,068
—
1,444
9,497
—
106
345
1,780
34
2,626
—
—
213
4,190
—
—
9
8,852
195,146
470,236
40,154
122,089
136,978
43,532
419,505
30,787
7,156
17,754
7,021
34
2,626
2,872
—
1,161
12,321
—
—
354
26,389
200,387
470,236
40,154
125,157
136,978
44,976
429,002
30,787
7,262
18,099
$
2,958
$
393
$
16,350
$
19,701
$
1,483,337
$
1,503,038
Percent of portfolio
0.20%
0.03%
1.09%
1.32%
98.68%
100.00%
92
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The Corporation’s total impaired assets consisted of the following:
Non-accrual loans and leases
Commercial real estate:
Commercial real estate — owner occupied
Commercial real estate — non-owner occupied
Land development
Construction
Multi-family
1-4 family
Total non-accrual commercial real estate
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total non-accrual consumer and other loans
Total non-accrual loans and leases
Foreclosed properties, net
Total non-performing assets
Performing troubled debt restructurings
Total impaired assets
Total non-accrual loans and leases to gross loans and leases
Total non-performing assets to total gross loans and leases plus foreclosed properties, net
Total non-performing assets to total assets
Allowance for loan and lease losses to gross loans and leases
Allowance for loan and lease losses to non-accrual loans and leases
December 31,
2018
December 31,
2017
(In Thousands)
$
5,663 $
31
2,213
—
—
—
7,907
17,104
—
—
290
290
25,301
2,547
27,848
180
$
28,028 $
7,021
34
2,626
2,872
—
1,161
13,714
12,321
—
—
354
354
26,389
1,069
27,458
332
27,790
December 31,
2018
December 31,
2017
1.56%
1.76%
1.72
1.42
1.26
80.73
1.83
1.53
1.25
71.10
As of December 31, 2018 and 2017 , $7.6 million and $8.8 million of the non-accrual loans and leases were considered troubled debt restructurings, respectively.
There were no unfunded commitments associated with troubled debt restructured loans and leases as of December 31, 2018 .
All loans and leases modified as a troubled debt restructuring are measured for impairment. The nature and extent of the impairment of restructured loans,
including those which have experienced a default, is considered in the determination of an appropriate level of the allowance for loan and lease losses.
93
Table of Contents
During the year ended December 31, 2018 , no loans were modified to a troubled debt restructuring. The following table provides the number of loans modified in
a troubled debt restructuring and the pre- and post-modification recorded investment by class of receivable:
Commercial and industrial
Consumer and other
Total
For the Year Ended December 31, 2017
Number of
Loans
Pre-Modification
Recorded
Investment
Post-Modification
Recorded
Investment
4 $
1
5 $
(Dollars in Thousands)
4,374 $
17
4,391 $
4,344
17
4,361
There were no loans and leases modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the year ended
December 31, 2018 .
94
Table of Contents
The following represents additional information regarding the Corporation’s impaired loans and leases, including performing troubled debt restructurings, by class:
As of and for the Year Ended December 31, 2018
Recorded
Investment (1)
Unpaid
Principal
Balance
Impairment
Reserve
Average
Recorded
Investment (2)
(In Thousands)
Foregone
Interest
Income
Interest
Income
Recognized
Net Foregone
Interest
Income
With no impairment reserve recorded:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
With impairment reserve recorded:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
Total:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
$
1,273 $
31
2,213
—
—
178
6,828
—
1,273 $
72
6,510
—
—
183
7,527
—
—
279
10,802
4,390
—
—
—
—
—
10,278
—
—
11
14,679
5,663
31
2,213
—
—
178
17,106
—
—
945
16,510
5,749
—
—
—
—
—
10,278
—
—
11
16,038
7,022
72
6,510
—
—
183
17,805
—
— $
—
—
—
—
—
—
—
—
—
—
675
—
—
—
—
—
3,710
—
—
11
4,396
675
—
—
—
—
—
3,710
—
6,638 $
33
2,366
2,148
—
808
8,809
—
1
305
21,108
635
—
—
—
—
—
4,687
—
—
1
5,323
7,273
33
2,366
2,148
—
808
13,496
—
756 $
2
68
219
—
42
1,058
—
—
55
2,200
182
—
—
—
—
—
1,096
—
—
—
1,278
938
2
68
219
—
42
2,154
—
197 $
—
—
—
—
81
980
—
46
—
1,304
—
—
—
—
—
—
—
—
—
—
—
197
—
—
—
—
81
980
—
Home equity and second mortgages
Other
Grand total
—
290
25,481 $
—
956
32,548 $
—
11
4,396 $
1
306
26,431 $
—
55
3,478 $
46
—
1,304 $
$
(1) The recorded investment represents the unpaid principal balance net of any partial charge-offs.
(2) Average recorded investment is calculated primarily using daily average balances.
95
559
2
68
219
—
(39)
78
—
(46)
55
896
182
—
—
—
—
—
1,096
—
—
—
1,278
741
2
68
219
—
(39)
1,174
—
(46)
55
2,174
Table of Contents
$
With no impairment reserve
recorded:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
With impairment reserve recorded:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
Total:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
As of and for the Year Ended December 31, 2017
Recorded
Investment (1)
Unpaid
Principal
Balance
Impairment
Reserve
Average
Recorded
Investment (2)
(In Thousands)
Foregone
Interest
Income
Interest
Income
Recognized
Net Foregone
Interest
Income
7,077 $
34
2,627
—
—
1,423
5,465
—
$
7,077
75
5,297
— —
—
1,706
6,502
—
4
345
16,975
3
1,011
21,671
—
—
—
2,872
—
—
6,865
—
—
9
9,746
7,077
34
2,627
2,872
—
1,423
12,330
—
—
—
— —
2,872 —
—
—
8,813
—
—
9
11,694
7,077
75
5,297
2,872
—
1,706
15,315
—
3
1,020
33,365
$
$
—
—
—
— —
—
—
—
—
—
—
—
—
—
— —
415 —
—
—
4,067
—
—
9
4,491
—
—
—
415
—
—
4,067
—
—
9
4,491
$
$
5,549
1,830
3,092
2,000 —
1
2,146
3,634
—
7
365
18,624
—
—
— —
2,252 —
—
—
12,288
—
—
—
14,540
5,549
1,830
3,092
4,252
1
2,146
15,922
—
7
365
33,164
$
$
613
97
84
134 —
—
53
858
—
—
59
1,898
—
—
— —
158 —
—
—
639
—
—
—
797
613
97
84
292
—
53
1,497
—
—
59
2,695
$
— $
226
—
214
—
7
7
—
—
—
454
—
—
—
—
—
—
—
—
—
—
—
—
226
—
214
—
7
7
—
—
—
454 $
613
(129)
84
(80)
—
46
851
—
—
59
1,444
—
—
—
158
—
—
639
—
—
—
797
613
(129)
84
78
—
46
1,490
—
—
59
2,241
Home equity and second mortgages
Other
Grand total
4
354
26,721 $
$
(1) The recorded investment represents the unpaid principal balance net of any partial charge-offs.
(2) Average recorded investment is calculated primarily using daily average balances.
96
Table of Contents
With no impairment reserve recorded:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
With impairment reserve recorded:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Total
Total:
Commercial real estate:
Owner occupied
Non-owner occupied
Land development
Construction
Multi-family
1-4 family
Commercial and industrial
Direct financing leases, net
Consumer and other:
Home equity and second mortgages
Other
Grand total
As of and for the Year Ended December 31, 2016
Recorded
Investment (1)
Unpaid
Principal
Balance
Impairment
Reserve
Average
Recorded
Investment (2)
(In Thousands)
Foregone
Interest
Income
Interest
Income
Recognized
Net Foregone
Interest
Income
$
1,788 $
1,609
3,440
436
—
2,379
1,307
—
1,788 $
1,647
6,111
438
—
2,379
1,307
—
8
378
11,345
499
—
—
2,482
—
193
11,166
—
—
226
14,566
2,287
1,609
3,440
2,918
—
2,572
12,473
—
8
1,044
14,722
499
—
—
2,482
—
199
11,166
—
—
226
14,572
2,287
1,647
6,111
2,920
—
2,578
12,473
—
— $
—
—
—
—
—
—
—
—
—
—
3,577 $
1,318
3,898
291
—
2,755
709
6
307
510
13,371
70
—
—
1,790
—
39
3,700
—
—
—
5,599
70
—
—
1,790
—
39
3,700
—
111
—
—
834
—
203
8,448
—
—
19
9,615
3,688
1,318
3,898
1,125
—
2,958
9,157
6
328 $
91
107
20
1
125
79
—
16
71
838
28
—
—
45
—
5
701
—
—
—
779
356
91
107
65
1
130
780
—
8
604
25,911 $
8
1,270
29,294 $
—
—
5,599 $
307
529
22,986 $
16
71
1,617 $
$
118 $
79
—
—
134
94
62
—
127
—
614
—
—
—
—
—
—
—
—
—
—
—
118
79
—
—
134
94
62
—
127
—
614 $
210
12
107
20
(133)
31
17
—
(111)
71
224
28
—
—
45
—
5
701
—
—
—
779
238
12
107
65
(133)
36
718
—
(111)
71
1,003
(1) The recorded investment represents the unpaid principal balance net of any partial charge-offs.
(2) Average recorded investment is calculated primarily using daily average balances.
The difference between the recorded investment of loans and leases and the unpaid principal balance of $7.1 million , $6.6 million , and $3.4 million as of
December 31, 2018 , 2017 , and 2016 , respectively, represents partial charge-offs of loans and leases resulting from losses due to the appraised value of the
collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $180,000 , $332,000 , and
$717,000 of loans as of
97
Table of Contents
December 31, 2018 , 2017 , and 2016 , respectively, that were performing troubled debt restructurings, and although not on non-accrual, were reported as impaired
due to the concession in terms. When a loan is placed on non-accrual, interest accrual is discontinued and previously accrued but uncollected interest is deducted
from interest income. Cash payments collected on non-accrual loans are first applied to such loan’s principal. Foregone interest represents the interest that was
contractually due on the loan but not received or recorded. To the extent the amount of principal on a non-accrual loan is fully collected and additional cash is
received, the Corporation will recognize interest income.
To determine the level and composition of the allowance for loan and lease losses, the Corporation categorizes the portfolio into segments with similar risk
characteristics. First, the Corporation evaluates loans and leases for potential impairment classification. The Corporation analyzes each loan and lease determined
to be impaired on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or
alternatively, the present value of expected cash flows. The Corporation applies historical trends from established risk factors to each category of loans and leases
that has not been individually evaluated for the purpose of establishing the general portion of the allowance.
A summary of the activity in the allowance for loan and lease losses by portfolio segment is as follows:
Beginning balance
Charge-offs
Recoveries
Net (charge-offs) recoveries
Provision for loan and lease losses
Ending balance
Beginning balance
Charge-offs
Recoveries
Net recoveries (charge-offs)
Provision for loan and lease losses
Ending balance
Beginning balance
Charge-offs
Recoveries
Net charge-offs
Provision for loan and lease losses
Ending balance
As of and for the Year Ended December 31, 2018
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
$
10,131 $
8,225
$
407
$
(In Thousands)
(4,501)
174
(4,327)
5,858
(1,545)
2,023
478
(624)
$
11,662 $
8,079
$
(55)
74
19
258
684
$
18,763
(6,101)
2,271
(3,830)
5,492
20,425
As of and for the Year Ended December 31, 2017
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
$
12,384 $
7,970
$
558
$
(In Thousands)
(127)
153
26
(2,279)
(8,621)
323
(8,298)
8,553
(92)
43
(49)
(102)
$
10,131 $
8,225
$
407
$
20,912
(8,840)
519
(8,321)
6,172
18,763
As of and for the Year Ended December 31, 2016
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
$
11,220 $
4,387
$
709
$
(In Thousands)
(1,194)
274
(920)
2,084
(2,273)
91
(2,182)
5,765
(127)
7
(120)
(31)
$
12,384 $
7,970
$
558
$
16,316
(3,594)
372
(3,222)
7,818
20,912
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Table of Contents
The following tables provide information regarding the allowance for loan and lease losses and balances by type of allowance methodology:
Allowance for loan and lease losses:
Collectively evaluated for impairment
Individually evaluated for impairment
Loans acquired with deteriorated credit quality
Total
Loans and lease receivables:
Collectively evaluated for impairment
Individually evaluated for impairment
Loans acquired with deteriorated credit quality
Total
Allowance for loan and lease losses:
Collectively evaluated for impairment
Individually evaluated for impairment
Loans acquired with deteriorated credit quality
Total
Loans and lease receivables:
Collectively evaluated for impairment
Individually evaluated for impairment
Loans acquired with deteriorated credit quality
Total
The Corporation’s net investment in direct financing leases consists of the following:
Minimum lease payments receivable
Estimated unguaranteed residual values in leased property
Initial direct costs
Unearned lease and residual income
Investment in commercial direct financing leases
December 31, 2018
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
(In Thousands)
$
10,987 $
4,369 $
673 $
675
—
3,710
—
11
—
$
11,662 $
8,079 $
684 $
16,029
4,396
—
20,425
$
1,086,254 $
478,385 $
28,937
1,593,576
7,914
171
17,104
2
290
—
25,308
173
$
1,094,339 $
495,491 $
29,227 $
1,619,057
December 31, 2017
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
(In Thousands)
$
9,716 $
4,158 $
398 $
415
—
4,067
—
9
—
$
10,131 $
8,225 $
407 $
14,272
4,491
—
18,763
$
1,003,855 $
447,459 $
25,003 $
1,476,317
13,506
527
12,324
6
358
—
26,188
533
$
1,017,888 $
459,789 $
25,361 $
1,503,038
December 31,
2018
December 31,
2017
(In Thousands)
$
26,700
$
9,330
73
(2,933)
$
33,170
$
24,898
8,312
76
(2,499)
30,787
There were no impairments of residual value of leased property during the years ended December 31, 2018 , 2017 , and 2016 .
The Corporation leases equipment under direct financing leases expiring in future years. Some of these leases provide for additional rents based on use in excess of
a stipulated minimum number of hours and generally allow the lessees to purchase the equipment for fair value at the end of the lease term.
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Table of Contents
Future aggregate maturities of minimum lease payments to be received are as follows:
(In Thousands)
Maturities during year ended December 31,
2019
2020
2021
2022
2023
Thereafter
$
$
8,995
6,676
4,271
3,285
1,970
1,503
26,700
Note 5 – Premises and Equipment
A summary of premises and equipment was as follows:
Leasehold improvements
Furniture and equipment
Less: accumulated depreciation
Total premises and equipment, net
As of December 31,
2018
2017
(In Thousands)
$
2,622 $
7,021
9,643
(6,359)
$
3,284 $
2,550
6,442
8,992
(5,836)
3,156
Depreciation expense was $835,000 , $744,000 , and $767,000 for the years ended December 31, 2018 , 2017 , and 2016 , respectively.
Note 6 – Goodwill and Other Intangible Assets
Goodwill
Goodwill is not amortized, but is subject to impairment tests on an annual basis and more frequently if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying amount (including goodwill). At December 31, 2018 and 2017 , the Corporation had
goodwill of $10.7 million , which was related to the acquisition of Alterra in 2014.
The Corporation conducted its annual impairment test on July 1, 2018, utilizing a qualitative assessment, and concluded that it was more likely than not the
estimated fair value of the reporting unit exceeded its carrying value, resulting in no impairment. Management determined no changes to factors occurred through
December 31, 2018 that would negatively impact the goodwill test.
Other
Intangible
Assets
The Corporation has intangible assets that are amortized consisting of loan servicing rights and core deposit intangibles.
Loan servicing rights are recognized upon sale of the guaranteed portions of SBA loans with servicing rights retained. 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. Loan servicing assets are subsequently measured using the
amortization method, which requires servicing rights to be amortized into interest income in proportion to, and over the period of, the estimated future net servicing
income of the underlying loans. For the years ended December 31, 2018 , 2017 , and 2016 , loan servicing asset amortization totaled $786,000 , $388,000 , and
$639,000 , respectively.
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The estimated fair value of the Corporation’s loan servicing asset was $1.3 million and $1.8 million as of December 31, 2018 and 2017 , respectively. 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. During the year ended December 31, 2018 , a $69,000 valuation allowance was established.
The core deposit intangible has a finite life and is amortized over a period of seven years. The net book value of the core deposit intangible was $100,000 and
$147,000 as of December 31, 2018 and 2017 , respectively. For the years ended December 31, 2018 , 2017 , and 2016 , amortization totaled $47,000 , $55,000 ,
and $62,000 , respectively.
Note 7 – Other Assets
The Corporation is a limited partner in several limited partnership investments. The Corporation is not the general partner, does not have controlling ownership and
is not the primary beneficiary in any of these limited partnerships and the limited partnerships have not been consolidated. These investments are accounted for
using the equity method of accounting and are evaluated for impairment at the end of each reporting period.
Historic
Rehabilitation
Tax
Credits
In 2015, the Corporation invested in a development entity through BOC, a wholly-owned subsidiary of FBB, to acquire, rehabilitate and operate a historic building
in Madison, Wisconsin. At December 31, 2018 and 2017 , the net carrying value of the investment was $104,000 and $174,000 , respectively. During 2016, the
Corporation contributed an additional $2.8 million to the project, recognized $3.8 million in historic tax credits related to this investment and $3.3 million in
impairment to the underlying investment.
In 2016, the Corporation also invested in a development entity through Mitchell Street, a wholly-owned subsidiary of FBB, to rehabilitate a historic building in
Milwaukee, Wisconsin. At December 31, 2018 and 2017 , the net carrying value of the investment was $570,000 . The Corporation contributed an additional
$217,000 and $4.9 million to the project in 2018 and 2017, respectively. During 2017, the Corporation recognized $3.0 million in federal historic tax credits related
to this investment and sold the state historic tax credits associated with the investment to a third party for a pre-tax gain of $210,000 . During 2018 and 2017 the
Corporation recognized $217,000 and $2.3 million , respectively, in impairment to the underlying investment.
In 2017, the Corporation also invested in a development entity through FBB Tax Credit, a wholly-owned subsidiary of FBB, to rehabilitate a historic building in
Kenosha, Wisconsin. At December 31, 2018 and 2017 , the net carrying value of the investment was $417,000 . The aggregate capital contributions to the project
will depend upon the final amount of the certified project costs, but are expected to approximate $2.1 million . The credits will be taken when the project is placed
in service and are subject to a five-year recapture period.
In 2018, the Corporation also invested in a development entity through FBB Tax Credit, to rehabilitate a county courthouse in Waukesha, Wisconsin. At
December 31, 2018 , the net carrying value of the investment was $238,000 . The aggregate capital contributions to the project will depend upon the final amount
of the certified project costs, but are expected to approximate $2.2 million . During 2018, the project was partially in service, and therefore, the Corporation
recognized $868,000 in federal historic tax credits related to this investment and $544,000 in impairment to the underlying investment.
In 2018, the Corporation also invested in a development entity through FBB Tax Credit, to rehabilitate two buildings in Milwaukee, Wisconsin. At December 31,
2018 , the net carrying value of the investment was $324,000 . The aggregate capital contributions to the project will depend upon the final amount of the certified
project costs, but are expected to approximate $4.6 million . During 2018, the project was partially in service, and therefore, the Corporation recognized $1.3
million in federal historic tax credits related to this investment and $873,000 in impairment to the underlying investment.
New
Market
Tax
Credits
The Corporation invested in a community development entity (“CDE”) through Rimrock Road, a wholly-owned subsidiary of FBB, to develop and operate a real
estate project located in a low-income community. At December 31, 2018 and 2017 , Rimrock Road had one CDE investment with a net carrying value of $6.1
million and $6.6 million respectively. The investment provides federal new market tax credits over the seven year compliance period through 2020. The remaining
federal new market tax credit to be utilized was $900,000 as of December 31, 2018 . The Corporation’s use of the federal new market tax credit during the years
ended December 31, 2018 and 2017 was $450,000 .
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Other
Investments
The Corporation has an equity investment in Aldine Capital Fund, LP, a mezzanine fund, of $600,000 and $904,000 recorded as of December 31, 2018 and 2017 ,
respectively. The Corporation’s equity investment in Aldine Capital Fund II, LP, also a mezzanine fund, totaled $3.4 million as of December 31, 2018 and 2017 .
The Corporation’s equity investment in Aldine Capital Fund III, LP, also a mezzanine fund, totaled $188,000 as of December 31, 2018 . The Corporation’s share
of these partnerships’ income included in the Consolidated Statements of Income for the years ended December 31, 2018 and 2017 was $459,000 and $354,000 ,
respectively.
The Corporation is the sole owner of $315,000 of common securities issued by Trust II. The purpose of Trust II was to complete the sale of $10.0 million of
10.50% fixed rate preferred securities. Trust II, a wholly owned subsidiary of the Corporation, is not consolidated into the financial statements of the Corporation.
The investment in Trust II of $315,000 as of December 31, 2018 and 2017 is included in accrued interest receivable and other assets.
A summary of accrued interest receivable and other assets was as follows:
December 31, 2018
December 31, 2017
Accrued interest receivable
Net deferred tax asset
Investment in historic development entities
Investment in a community development entity
Investment in limited partnerships
Investment in Trust II
Fair value of interest rate swaps
Prepaid expenses
Other assets
(In Thousands)
$
5,684 $
3,172
1,653
6,081
4,176
315
4,637
2,894
6,039
Total accrued interest receivable and other assets
$
34,651 $
Note 8 – Deposits
The composition of deposits was as follows:
5,019
2,584
1,161
6,591
4,261
315
942
3,091
5,884
29,848
December 31, 2018
December 31, 2017
Balance
Average
Balance
Average Rate
Balance
Average
Balance
Average Rate
Non-interest-bearing transaction accounts
$
280,769 $
Interest-bearing transaction accounts
Money market accounts
Certificates of deposit
Wholesale deposits
Total deposits
229,612
516,045
153,022
275,851
241,529
269,943
491,756
94,172
302,440
$
1,455,299 $
1,399,840
102
(Dollars in Thousands)
—% $
277,445 $
217,625
515,077
76,199
307,985
230,907
226,540
583,241
56,667
361,712
$
1,394,331 $
1,459,067
0.99
1.09
1.70
1.95
1.11
—%
0.59
0.47
1.00
1.70
0.74
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A summary of annual maturities of certificates of deposit outstanding and wholesale deposits at December 31, 2018 is as follows:
(In Thousands)
Maturities during the year ended December 31,
2019
2020
2021
2022
2023
Thereafter
$
$
224,939
119,881
34,313
24,145
5,809
19,786
428,873
Deposits include approximately $61.9 million and $13.4 million of certificates of deposit and wholesale deposits which are denominated in amounts of $250,000 or
more at December 31, 2018 and 2017 , respectively.
Note 9 – FHLB Advances, Other Borrowings and Junior Subordinated Notes
The composition of borrowed funds was as follows:
December 31, 2018
December 31, 2017
Balance
Weighted
Average
Balance
Weighted
Average
Rate
Balance
Weighted
Average
Balance
Weighted
Average
Rate
(Dollars in Thousands)
Federal funds purchased
$
— $
119
2.43% $
— $
66
1.22%
FHLB advances
Line of credit
Other borrowings (1)
Subordinated notes payable
Junior subordinated notes
Short-term borrowings
Long-term borrowings
274,500
274,382
—
675
23,769
10,033
3
675
23,739
10,025
308,977 $
308,943
136,500
172,477
308,977
$
$
$
2.06
4.47
7.94
6.64
11.10
2.72
$
$
$
183,500
105,276
10
675
23,713
10,019
328
1,241
23,161
10,011
217,917 $
140,083
37,010
180,907
217,917
1.40
3.64
14.50
6.93
11.11
3.14
(1) Weighted average rate of other borrowings reflects the cost of prepaying a secured borrowing during the second quarter of 2017.
The Corporation has a $435.2 million FHLB line of credit available for advances and open line borrowings which is collateralized as noted below. At
December 31, 2018 , $160.7 million of this line remained unused. There were no advances outstanding on the Corporation’s open line at December 31, 2018 and
2017 . There were $274.5 million of term FHLB advances outstanding at December 31, 2018 with stated fixed interest rates ranging from 1.29% to 2.75%
compared to $183.5 million of term FHLB advances outstanding at December 31, 2017 with stated fixed interest rates ranging from 1.20% to 2.42% . The term
FHLB advances outstanding at December 31, 2018 are due at various dates through August 2024.
The Corporation is required to maintain as collateral mortgage-related securities, unencumbered first mortgage loans and secured small business loans in its
portfolio aggregating at least the amount of outstanding advances from the FHLB. Loans totaling approximately $435.2 million and $388.2 million were pledged
as collateral at December 31, 2018 and 2017 , respectively.
The Corporation has a senior line of credit with a third-party financial institution of $10.5 million . As of December 31, 2018 , the line of credit carried an interest
rate of LIBOR + 2.75% with an interest rate floor of 3.125% that matured on February 20, 2019 and had certain performance debt covenants of which the
Corporation was in compliance. The Corporation pays a commitment fee on this senior line of credit. For the years ended December 31, 2018 and 2017 the
Corporation incurred $13,000 additional interest expense due to this fee. On February 19, 2019 , the credit line was renewed for one additional year
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with pricing terms of LIBOR + 2.75% and a maturity date of February 20, 2020 . There was no outstanding balance on the line of credit as of December 31, 2018 .
The Corporation has subordinated notes payable. At December 31, 2018 , the amount of subordinated notes payable outstanding was $23.8 million , which
qualified for Tier 2 capital. At December 31, 2018 , $15.0 million bore a fixed interest rate of 6.50% with a maturity date of September 1, 2024 and $9.1 million
bore a fixed interest rate of 6.00% with a maturity date of April 15, 2027. There are no debt covenants on the subordinated notes payable. The Corporation may, at
its option, redeem the notes, in whole or part, at any time after the fifth anniversary of issuance. As of December 31, 2018 , $321,000 of debt issuance costs remain
in the subordinated notes payable balance.
In September 2008 , Trust II completed the sale of $10.0 million of 10.50% fixed rate trust preferred securities (“Preferred Securities”). Trust II also issued
common securities of $315,000 . Trust II used the proceeds from the offering to purchase $10.3 million of 10.50% junior subordinated notes (“Notes”) of the
Corporation. The Preferred Securities are mandatorily redeemable upon the maturity of the Notes on September 26, 2038 . The Preferred Securities qualify under
the risk-based capital guidelines as Tier 1 capital for regulatory purposes. Per the provisions of the Dodd-Frank Act, bank holding companies with total assets of
less than $15 billion are not required to phase out trust preferred securities as an element of Tier 1 capital as other, larger institutions must. The Corporation used
the proceeds from the sale of the Notes for general corporate purposes including providing additional capital to its subsidiaries. As of December 31, 2018 ,
$282,000 of debt issuance costs remain reflected in junior subordinated notes on the Consolidated Balance Sheets.
The Corporation has the right to redeem the Notes at each interest payment date on or after September 26, 2013 . The Corporation also has the right to redeem the
Notes, in whole but not in part, after the occurrence of certain special events. Special events are limited to: (1) a change in capital treatment resulting in the
inability of the Corporation to include the Notes in Tier 1 capital, (2) a change in laws or regulations that could require Trust II to register as an investment
company under the Investment Company Act of 1940, as amended; and (3) a change in laws or regulations that would require Trust II to pay income tax with
respect to interest received on the Notes or, prohibit the Corporation from deducting the interest payable by the Corporation on the Notes or result in greater than a
de minimis amount of taxes for Trust II.
Note 10 – Regulatory Capital
The Corporation and the Bank are subject to various regulatory capital requirements administered by Federal and the State of 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 Plan, 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
Boards of Directors 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” or “FRB”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring or
significantly reducing dividends if: (i) net income available to common stockholders 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 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 stockholders with preferential rights superior to those
stockholders 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
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Bank and the Corporation will continue to be subject to compliance with various legal, regulatory and other restrictions as defined from time to time.
Qualitative 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.
In July 2013, the FRB and the Federal Deposit Insurance Corporation approved the final rules implementing the Basel Committee on Banking Supervision’s
capital guidelines for U.S. banks. These rules are applicable to all financial institutions that are subject to minimum capital requirements, including federal and
state banks and savings and loan associations, as well as bank and savings and loan holding companies other than “small bank holding companies” (generally non-
publicly traded bank holding companies with consolidated assets of less than $1 billion). Under the final rules, minimum requirements increased for both the
quantity and quality of capital held by the Corporation. The rules include a new Common Equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%,
raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and
require a minimum Tier 1 leverage ratio of 4.0%. The rules also permit banking organizations with less than $15 billion in assets to retain, through a one-time
election, the past treatment for accumulated other comprehensive income, which did not affect regulatory capital. The Corporation elected to retain this treatment,
which reduces the volatility of regulatory capital ratios. A new capital conservation buffer, comprised of Common Equity Tier 1 capital, was also established above
the regulatory minimum capital requirements. This capital conservation buffer is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and
increases each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019.
In August 2018, the Federal Reserve published a final rule revising the Small Bank Holding Company Policy Statement (“Policy Statement”) that raised the total
consolidated asset limit from $1 billion to $3 billion. Based on the criteria in the Policy Statement, effective immediately, the Corporation is no longer subject to
the capital requirements of the Basel III Rule and is deemed to be “well-capitalized”. Therefore, the consolidated capital ratios have been excluded from the below
table as of December 31, 2018 . Additionally, the Corporation is no longer required to file quarterly consolidated holding company reports with the Federal
Reserve. Beginning December 31, 2018 , the Corporation is required to submit holding company only reports on a bi-annual basis.
As of December 31, 2018 , the Bank’s capital levels remained characterized as well capitalized under the regulatory framework. The following tables summarizes
the Bank’s capital ratios and the ratios required by their federal regulator at December 31, 2018 :
Actual
Minimum Required for
Capital Adequacy Purposes
For Capital Adequacy
Purposes Plus Capital
Conservation Buffer
Minimum Required to Be Well
Capitalized Under Prompt
Corrective Action
Requirements
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
(Dollars in Thousands)
As of December 31, 2018
First Business Bank
Total capital (to risk-
weighted assets)
Tier 1 capital (to risk-
weighted assets)
Common equity tier 1 capital
(to risk-weighted assets)
Tier 1 leverage capital (to
adjusted assets)
$
220,474
11.49% $
153,456
8.00% $
189,422
9.875% $
191,820
10.00%
197,093
10.27
115,092
6.00
151,058
7.88
153,456
8.00
197,093
10.27
86,319
4.50
122,285
6.375
124,683
6.50
197,093
10.20
77,301
4.00
77,301
4.00
96,626
5.00
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The following table summarizes both the Corporation’s and Bank’s capital ratios and the ratios required by their federal regulators at December 31, 2017:
Actual
Minimum Required for Capital
Adequacy Purposes
For Capital Adequacy
Purposes Plus Capital
Conservation Buffer
Minimum Required to Be Well
Capitalized Under Prompt
Corrective Action
Requirements
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
(Dollars in Thousands)
As of December 31, 2017
Total capital
(to risk-weighted assets)
Consolidated
$
214,501
11.98% $
First Business Bank
207,986
11.66
143,219
142,736
8.00% $
165,597
9.250%
N/A
N/A
8.00
165,038
9.250
$
178,420
10.00%
Tier 1 capital
(to risk-weighted assets)
Consolidated
$
169,176
9.45% $
First Business Bank
186,374
10.45
107,414
107,052
6.00% $
129,792
7.250%
N/A
6.00
129,354
7.250
$
142,736
Common equity tier 1 capital
(to risk-weighted assets)
Consolidated
$
159,157
8.89% $
First Business Bank
186,374
10.45
Tier 1 leverage capital
(to adjusted assets)
Consolidated
$
169,176
9.54% $
First Business Bank
186,374
10.56
80,561
80,289
70,920
70,617
4.50% $
102,939
5.750%
N/A
4.50
102,591
5.750
$
115,973
4.00% $
70,920
4.00%
N/A
4.00
70,617
4.00
$
88,272
The following table reconciles stockholders’ equity to federal regulatory capital at December 31, 2018 and 2017 , respectively:
Stockholders’ equity of the Corporation
Net unrealized and accumulated losses on specific items
Disallowed servicing assets
Disallowed goodwill and other intangibles
Junior subordinated notes
Tier 1 capital
Allowable general valuation allowances and subordinated debt
Total capital
Note 11 – Earnings per Common Share
As of December 31,
2018
2017
(In Thousands)
$
180,707 $
1,684
(751)
(10,498)
10,033
181,175
47,150
$
228,325 $
N/A
8.00%
N/A
6.50%
N/A
5.00%
169,278
1,238
(848)
(10,511)
10,019
169,176
45,325
214,501
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.
There were no anti-dilutive employee share-based awards for the years ended December 31, 2018 , 2017 , and 2016.
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For the Year Ended December 31,
2018
2017
2016
(Dollars in Thousands, Except Share Data)
Basic
earnings
per
common
share
Net income
Less: earnings allocated to participating securities
Basic earnings allocated to common shareholders
Weighted-average common shares outstanding, excluding participating securities
Basic earnings per common share
Diluted
earnings
per
common
share
Earnings allocated to common shareholders, diluted
$
$
$
$
16,303 $
240
16,063 $
11,905 $
162
11,743 $
8,640,198
8,612,770
1.86 $
1.36 $
16,063 $
11,743 $
Weighted-average diluted common shares outstanding, excluding participating securities
8,640,198
8,612,770
Diluted earnings per common share
$
1.86 $
1.36 $
14,909
219
14,690
8,573,722
1.71
14,690
8,573,722
1.71
Note 12 – Share-Based Compensation
The Corporation adopted the 2012 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2012. The Plan is administered by the Compensation
Committee of the Board of Directors 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
December 31, 2018 , 164,621 shares were available for future grants under the Plan. Shares covered by awards that expire, terminate or lapse will again be
available for the grant of awards under the Plan. The Corporation may issue new shares and shares from its treasury stock for shares delivered under the Plan.
Restricted Stock
Under the Plan, the Corporation may grant restricted stock, restricted stock units 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, restricted stock
participants may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares. Restricted stock units do
not have voting rights and are provided dividend equivalents. The restricted stock granted under the Plan is typically subject to a vesting period. Compensation
expense is recognized over the requisite service period of generally 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 Consolidated Statements of Income.
Restricted stock activity was as follows:
Nonvested balance at beginning of year
Granted
Vested
Forfeited
Nonvested balance as of end of year
For the Year Ended December 31,
2018
2017
2016
Number of
Restricted
Shares
Weighted
Average
Grant-Date
Fair Value
Number of
Restricted
Shares
Weighted
Average
Grant-Date
Fair Value
Number of
Restricted
Shares
Weighted
Average
Grant-Date
Fair Value
130,441 $
66,498
(46,034)
(19,284)
131,621
21.43
20.57
21.01
22.25
21.02
116,245 $
71,130
(48,550)
(8,384)
130,441
21.13
21.67
21.51
21.65
21.43
135,471 $
60,415
(56,090)
(23,551)
116,245
20.13
22.74
18.71
20.90
21.13
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As of December 31, 2018 , the Corporation had $2.5 million of deferred unvested compensation expense, which the Corporation expects to recognize over a
weighted-average period of approximately 2.9 years.
Share-based compensation expense related to restricted stock included in the Consolidated Statements of Income was as follows:
For the Year Ended December 31,
2018
2017
2016
(In Thousands)
Share-based compensation expense
$
1,004 $
1,078 $
994
Note 13 – Employee Benefit Plans
The Corporation maintains a contributory 401(k) defined contribution plan covering substantially all employees. The Corporation matches 100% of amounts
contributed by each participating employee, up to 3.0% of the employee’s compensation. The Corporation may also make discretionary contributions up to an
additional 6.0% of salary. Contributions are expensed in the period incurred and recorded in compensation expense in the Consolidated Statements of Income. The
Corporation made a matching contribution of 3.0% to all eligible employees which totaled $700,000 , $626,000 , and $621,000 for the years ended December 31,
2018 , 2017 , and 2016 , respectively. Discretionary contributions of 1.0% , or $180,000 , 1.0% , or $183,000 , and 1.2% , or $207,000 , were made in 2018 , 2017 ,
and 2016 , respectively.
As of December 31, 2018 , 2017 , and 2016 , the Corporation had a deferred compensation plan under which it provided contributions to supplement the retirement
income of one executive. Under the terms of the plan, benefits to be received are generally payable within six months of the date of the termination of employment
with the Corporation. The expense associated with the deferred compensation plan for the years ended December 31, 2018 , 2017 , and 2016 was $150,000 ,
$132,000 , and $124,000 , respectively. The present value of future payments under the remaining plan of $1.3 million and $1.1 million at December 31, 2018 and
2017 , respectively, is included in accrued interest payable and other liabilities on the Consolidated Balance Sheets.
The Corporation owned life insurance policies on the life of the executive covered by the deferred compensation plan, which had cash surrender values and death
benefits of approximately $2.5 million and $5.9 million , respectively, at December 31, 2018 and cash surrender values and death benefits of approximately $2.4
million and $5.9 million , respectively, at December 31, 2017 . The remaining balance of the cash surrender value of bank-owned life insurance of $39.0 million
and $37.9 million as of December 31, 2018 and 2017 , respectively, is related to policies on a number of then-qualified individuals affiliated with the Bank.
Note 14 – Leases
The Corporation leases various office spaces, loan production offices and specialty financing production offices under noncancelable operating leases which expire
on various dates through 2028. The Corporation’s total rent expense was $2.1 million , $1.9 million , and $1.8 million for the years ended December 31, 2018 ,
2017 , and 2016 , respectively. Rent expense is recognized on a straight-line basis. The Corporation also leases other office equipment. Rental expense for these
operating leases was $159,000 , $129,000 , and $136,000 for the years ended December 31, 2018 , 2017 , and 2016 , respectively.
Future minimum lease payments for noncancelable operating leases for each of the five succeeding years and thereafter are as follows:
(In Thousands)
2019
2020
2021
2022
2023
Thereafter
$
$
1,690
1,613
1,434
1,410
1,014
3,063
10,224
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Note 15 - Other Non-Interest Expense
A summary of other non-interest expenses is as follows:
General and administrative expenses
Travel and other employee expenses
Partnership income (1)
Other expenses
Total other non-interest expense
Year Ended December 31,
2018
2017
2016
$
(In Thousands)
1,877 $
1,530
—
23
1,905 $
1,298
—
12
$
3,430 $
3,215 $
1,545
1,354
(790)
129
2,238
(1) Partnership income was recorded in other non-interest income for the years ended December 31, 2018 and 2017.
Note 16 – Income Taxes
Income tax expense consists of the following:
Current:
Federal
State
Current tax expense
Deferred:
Federal
State
Deferred tax (benefit) expense
Total income tax expense
Year Ended December 31,
2018
2017
2016
(In Thousands)
$
729 $
1,054
1,783
(367)
(65)
(432)
131 $
448
579
1,657
90
1,747
$
1,351 $
2,326 $
2,839
425
3,264
(1,000)
(108)
(1,108)
2,156
Deferred income tax assets and liabilities reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial
reporting purposes and their tax basis. Deferred tax assets and liabilities are measured using enacted tax rates to apply to taxable income in the period in which the
temporary differences are expected to be recovered or settled. Effective January 1, 2018, the enactment of the Tax Cuts and Jobs Act (the “Act”) reduced the
corporate federal income tax rate to 21% from 35%, which required the Corporation to revalue its deferred taxes as of December 31, 2017. The revaluation resulted
in a $629,000 reduction to the Corporation’s net deferred tax assets with a corresponding increase to income tax expense during the year ended December 31, 2017
. Net deferred tax assets are included in accrued interest receivable and other assets in the Consolidated Balance Sheets.
On December 22, 2017, the SEC issued Staff Accounting Bulletin 118 (“SAB 118”), which provides guidance on accounting for the Act’s impact. SAB 118
provides a measurement period, which in no case should extend beyond one year from the Act’s enactment, during which a company acting in good faith may
complete the accounting for the impacts of the Act. In accordance with SAB 118, a company will reflect the income tax effects of the Act in the reporting period in
which the accounting is complete.
The significant components of the Corporation’s deferred tax assets and liabilities were as follows:
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Deferred tax assets:
Allowance for loan and lease losses
SBA recourse reserve
Deferred compensation
State net operating loss carryforwards
Tax credit carryforwards
Non-accrual loan interest
Capital loss carryforwards
Unrealized losses on securities
Other
Total deferred tax assets before valuation allowance
Valuation allowance
Total deferred tax assets
Deferred tax liabilities:
Leasing and fixed asset activities
Loan servicing asset
Other
Total deferred tax liabilities
Net deferred tax asset
December 31, 2018 December 31, 2017
(In Thousands)
$
5,424 $
4,795
785
1,045
571
1,373
1,472
22
579
68
11,339
—
11,339
6,965
358
844
8,167
3,172 $
729
482
615
—
942
21
423
450
8,457
—
8,457
5,338
471
64
5,873
2,584
$
The tax effects of unrealized gains and losses on securities are components of other comprehensive income. A reconciliation of the change in net deferred tax
assets to deferred tax expense is as follows:
Change in net deferred tax assets
Deferred taxes allocated to other comprehensive income
Deferred income tax benefit (expense)
December 31, 2018
December 31, 2017 December 31, 2016
$
$
(In Thousands)
588
$
(1,468)
$
(156)
(279)
432
$
(1,747)
$
1,419
(311)
1,108
Realization of the deferred tax asset over time is dependent upon the Corporation generating sufficient taxable earnings in future periods. In making the
determination that the realization of the deferred tax was more likely than not, the Corporation considered several factors including its recent earnings history, its
expected earnings in the future, appropriate tax planning strategies and expiration dates associated with operating loss carry forwards.
The Corporation had state net operating loss carryforwards of approximately $9.1 million and $9.9 million at December 31, 2018 and 2017 , respectively, which
can be used to offset future state taxable income. The Corporation believes it will be able to fully utilize its Wisconsin state net operating losses under this law and
therefore no valuation allowance has been established as of December 31, 2018 .
The provision for income taxes differs from that computed at the federal statutory corporate tax rate as follows:
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Income before income tax expense
Tax expense at statutory federal rate of 21%, 35% and 35% applied to income before income tax
expense, respectively
State income tax, net of federal effect
Tax-exempt security and loan income, net of TEFRA adjustments
$
$
Bank-owned life insurance
Tax credits, net
Deferred tax revaluation adjustment
Other
Total income tax expense
Effective tax rate
Year Ended December 31,
2018
2017
2016
(Dollars in Thousands)
17,654
$
14,231
$
17,065
3,707
$
4,981
$
803
(847)
(250)
(2,157)
—
95
511
(1,045)
(438)
(2,390)
629
78
$
1,351
$
2,326
$
7.65%
16.34%
5,973
206
(1,114)
(341)
(2,696)
—
128
2,156
12.63%
There were no uncertain tax positions outstanding as of December 31, 2018 and 2017 . As of December 31, 2018 , tax years remaining open for the State of
Wisconsin tax were 2014 through 2017 . Federal tax years that remained open were 2015 through 2017 . As of December 31, 2018 , there were also no
unrecognized tax benefits that are expected to significantly increase or decrease within the next twelve months.
Note 17 – 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.
At December 31, 2018 , the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $144.4 million . The Corporation
receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These interest rate swaps mature between April 2019 and
July 2034 . Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial
borrower swaps were reported on the Consolidated Balance Sheet as a derivative asset of $4.6 million , included in accrued interest receivable and other assets, and
as a derivative liability of $70,000 , included in accrued interest payable and other liabilities. As of December 31, 2018 , no interest rate swaps were in default.
At December 31, 2018 , the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $144.4 million . The Corporation pays
fixed rates and receives floating rates based upon LIBOR on the swaps with dealer counterparties. These interest rate swaps mature in April 2019 through July
2034 . Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported on the Consolidated Balance
Sheet as a net derivative liability of $4.5 million , included in accrued interest payable and other liabilities. The gross amount of dealer counterparty swaps, without
regard to the enforceable master netting agreement, was a gross derivative liability of $4.6 million and a gross derivative asset of $70,000 . No right of offset
existed with the dealer counterparty swaps as of December 31, 2018 .
All changes in the 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 years ended December 31, 2018 and 2017 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
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exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The instruments
are designated as cash flow hedges as the receipt of floating rate interest from the counterparty is used to manage interest rate risk associated with forecasted
issuances of short-term FHLB advances. The change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is
subsequently reclassified into earnings in the period that the hedged transactions affects earnings.
As of December 31, 2018 , the aggregate notional value of interest rate swaps designated as cash flow hedges was $54.0 million . These interest rate swaps mature
between December 2021 and December 2027 . A pre-tax unrealized loss of $20,000 was recognized in other comprehensive income for the year ended
December 31, 2018 and there was no ineffective portion of these hedges information about the balance sheet location and fair value of the Corporation’s derivative
instruments to qualified commercial borrowers as of December 31, 2018 and 2017 .
Derivatives not designated as hedging instruments
Interest Rate Swap Contracts
Asset Derivatives
Liability Derivatives
Balance Sheet Location
Fair Value
Balance Sheet
Location
Fair Value
(In Thousands)
Accrued interest
receivable and other
assets
Accrued interest
receivable and other
assets
$
4,637
$
942
Accrued interest
payable and other
liabilities
Accrued interest
payable and other
liabilities
$
4,637
$
942
December 31, 2018
December 31, 2017
December 31, 2018
December 31, 2017
Derivatives designated as hedging instruments
Accumulated other
comprehensive income
(1)
Accumulated other
comprehensive income
(1)
$
$
Accrued interest
payable and other
liabilities
Accrued interest
payable and other
liabilities
142
122
$
$
142
122
(1) The fair value of derivatives designated as hedging instruments included in accumulated other comprehensive income represent pre-tax amounts, which are reported net of tax on the
unaudited Consolidated Balance Sheets.
Note 18 – Commitments and Contingencies
The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of clients. These financial
instruments include commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of
the amounts recognized in the Consolidated Financial Statements. The contract amounts reflect the extent of involvement the Bank has in these particular classes of
financial instruments.
In the event of non-performance, the Bank’s exposure to credit loss for commitments to extend credit and standby letters of credit is represented by the contractual
amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for instruments reflected in the
Consolidated Financial Statements. An accrual for credit losses on financial instruments with off-balance-sheet risk would be recorded separate from any valuation
account related to any such recognized financial instrument. As of December 31, 2018 and 2017 , there were no accrued credit losses for financial instruments with
off-balance-sheet risk.
Financial instruments whose contract amounts represent potential credit risk were as follows:
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Commitments to extend credit, primarily commercial loans
$
Standby letters of credit
At December 31,
2018
2017
(In Thousands)
553,801 $
12,436
497,993
13,845
Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may have a fixed interest rate or a rate which varies with the prime rate or other market indices and may require
payment of a fee. Since some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements
of the Bank. The Bank evaluates the creditworthiness of each client on a case-by-case basis and generally extends credit only on a secured basis. Collateral
obtained varies but consists primarily of commercial real estate, accounts receivable, inventory, equipment and securities. There is generally no market for
commercial loan commitments, the fair value of which would approximate the present value of any fees expected to be received as a result of the commitment.
These are not considered to be material to the financial statements.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a client to a third party. Generally, standby letters of
credit expire within one year and are collateralized by accounts receivable, equipment, inventory and commercial properties. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan facilities to clients. The fair value of standby letters of credit is recorded as a liability
when the standby letter of credit is issued. The fair value has been estimated to approximate the fees received by the Bank for issuance. The fees are recorded into
income and the fair value of the guarantee is decreased ratably over the term of the standby letter of credit.
The Corporation sells the guaranteed portions of SBA loans, as well as participation interests in other 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 $3.0 million and $2.8 million at December 31, 2018 and 2017 ,
respectively, which is reported in accrued interest payable and other liabilities on the Consolidated Balance Sheets.
The summary of the activity in the SBA recourse reserve is as follows:
Balance at the beginning of the period
SBA recourse provision
Charge-offs, net
Balance at the end of the period
As of and For the Year Ended December 31,
2018
2017
(In Thousands)
2,849 $
1,913
(1,806)
2,956 $
1,750
2,240
(1,141)
2,849
$
$
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.
Note 19 – Fair Value Disclosures
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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.
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Assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy level, are summarized below:
December 31, 2018
Fair Value Measurements Using
Level 1
Level 2
Level 3
Total
(In Thousands)
Assets:
Securities available-for-sale:
U.S. government agency securities - government-sponsored enterprises
$
— $
990 $
— $
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored enterprises
Other securities
Interest rate swaps
Liabilities:
Interest rate swaps
Assets:
Securities available-for-sale:
—
—
—
—
—
—
5,886
19,628
109,478
2,376
4,637
4,779
—
—
—
—
—
—
990
5,886
19,628
109,478
2,376
4,637
4,779
December 31, 2017
Fair Value Measurements Using
Level 1
Level 2
Level 3
Total
(In Thousands)
U.S. government agency securities - government-sponsored enterprises
$
— $
1,000 $
— $
Municipal securities
Mortgage backed securities - government issued
Mortgage backed securities - government-sponsored enterprises
Other securities
Interest rate swaps
Liabilities:
Interest rate swaps
—
—
—
—
—
—
9,414
22,249
90,305
3,037
942
1,064
—
—
—
—
—
—
1,000
9,414
22,249
90,305
3,037
942
1,064
For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the year ended December 31, 2018 or 2017
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:
Impaired loans
Foreclosed properties
Loan servicing rights
December 31, 2018
Fair Value Measurements Using
Level 1
Level 2
Level 3
Total
(In Thousands)
$
— $
13,935 $
1,771 $
—
—
2,547
—
—
1,278
15,706
2,547
1,278
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Impaired loans
Foreclosed properties
December 31, 2017
Fair Value Measurements Using
Level 1
Level 2
Level 3
Total
(In Thousands)
$
— $
—
10,063 $
5,084 $
1,069
—
15,147
1,069
Impaired loans were written down to the fair value of their underlying collateral less costs to sell of $15.7 million and $15.1 million at December 31, 2018 and
2017 , 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 impaired loans. Valuation techniques consistent with the market approach, income approach or cost approach were used to measure fair value and
primarily included observable inputs for the individual impaired loans being evaluated such as current appraisals, recent sales of similar assets or other observable
market data, and are reflected within Level 2 of the hierarchy. In cases where an input is unobservable, typically when discounts are applied to appraisal values to
adjust such values to current market conditions or to reflect net realizable value, the impaired loan balance is reflected within Level 3 of the hierarchy. The
quantification of unobservable inputs for Level 3 impaired loan values range from 15% - 50% as of the measurement date of December 31, 2018 . The weighted
average of those unobservable inputs was 34% . The majority of the impaired loans in the Level 3 category are considered collateral dependent loans or are
supported by a SBA guaranty.
Foreclosed properties, upon initial recognition, are remeasured and reported at fair value through a charge-off to the allowance for loan and lease losses, if deemed
necessary, based upon the fair value of the foreclosed property. The fair value of a foreclosed property, upon initial recognition, is estimated using a market
approach or Level 2 inputs based on observable market data, typically a current appraisal, or Level 3 inputs based upon assumptions specific to the individual
property or equipment. Level 3 inputs typically include unobservable inputs such as management applied discounts used to further reduce values to a net realizable
value and may be used in situations when observable inputs become stale. Foreclosed property fair value inputs may transition to Level 1 upon receipt of an
accepted offer for the sale of the related foreclosed property.
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 of 10%. Due to the nature of the valuation inputs, loan servicing rights are classified in Level 3 of the fair value hierarchy.
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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:
Carrying
Amount
December 31, 2018
Fair Value
Total
Level 1
Level 2
Level 3
(In Thousands)
Financial assets:
Cash and cash equivalents
Securities available-for-sale
Securities held-to-maturity
Loans held for sale
Loans and lease receivables, net
Federal Home Loan Bank stock
Accrued interest receivable
Interest rate swaps
Financial liabilities:
Deposits
Federal Home Loan Bank advances and other
borrowings
Junior subordinated notes
Accrued interest payable
Interest rate swaps
Off-balance-sheet items:
$
86,546 $
86,546 $
67,246 $
19,300 $
138,358
37,731
5,287
138,358
37,409
5,816
1,597,230
1,589,323
7,240
5,684
4,637
N/A
5,684
4,637
—
—
—
—
N/A
5,684
—
138,358
37,409
5,816
13,935
N/A
—
4,637
1,455,299
1,453,482
1,026,648
426,834
298,944
10,033
3,696
4,779
294,127
9,955
3,696
4,779
—
—
3,696
—
294,127
—
—
4,779
Standby letters of credit
59
N/A = The fair value is not applicable due to restrictions placed on transferability
59
—
—
117
—
—
—
—
1,575,388
N/A
—
—
—
—
9,955
—
—
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Financial assets:
Cash and cash equivalents
Securities available-for-sale
Securities held-to-maturity
Loans held for sale
Loans and lease receivables, net
Federal Home Loan Bank stock
Accrued interest receivable
Interest rate swaps
Financial liabilities:
Deposits
Federal Home Loan Bank advances and other
borrowings
Junior subordinated notes
Accrued interest payable
Interest rate swaps
Off-balance-sheet items:
Carrying
Amount
December 31, 2017
Fair Value
Total
Level 1
Level 2
Level 3
(In Thousands)
$
52,539 $
52,539 $
35,114 $
17,425 $
126,005
37,778
2,194
126,005
37,696
2,413
1,482,832
1,482,664
5,670
5,019
942
N/A
5,019
942
—
—
—
—
N/A
5,019
—
126,005
37,696
2,413
10,063
N/A
—
942
1,394,331
1,391,801
1,010,147
381,654
207,898
10,019
2,095
1,064
191,441
8,836
2,095
1,064
—
—
2,095
—
191,441
—
—
1,064
—
—
—
—
1,472,601
N/A
—
—
—
—
8,836
—
—
75
Standby letters of credit
75
N/A = The fair value is not applicable due to restrictions placed on transferability
75
—
—
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
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 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.
Interest Rate Swaps: 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
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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 20 – Condensed Parent Only Financial Information
The following represents the condensed financial information of FBFS only:
Condensed Balance Sheets
December 31,
2018
December 31,
2017
(In Thousands)
Assets
Cash and due from banks
Investments in subsidiaries, at equity
Leasehold improvements and equipment, net
Other assets
Total assets
Liabilities and Stockholders’ Equity
Borrowed funds
Other liabilities
Total liabilities
Stockholders’ equity
$
$
$
3,699 $
206,973
2,036
5,444
218,152 $
33,802 $
3,643
37,445
180,707
Total liabilities and stockholders’ equity
$
218,152 $
119
1,472
196,810
2,067
5,993
206,342
33,742
3,322
37,064
169,278
206,342
Table of Contents
Interest expense
Non-interest income
Condensed Statements of Income
For the Year Ended December 31,
2018
2017
2016
(In Thousands)
$
2,703 $
2,744 $
2,799
Consulting and rental income from consolidated subsidiaries
20,267
19,139
16,036
Other non-interest income
Total non-interest income
Non-interest expense
Loss before income tax benefit and equity in undistributed net income of consolidated subsidiaries
Income tax benefit
Loss before equity in undistributed net income of consolidated subsidiaries
Equity in undistributed net income of consolidated subsidiaries
Net income
Condensed Statements of Cash Flows
33
20,300
22,866
5,269
1,478
3,791
34
19,173
21,575
5,146
1,965
3,181
20,094
15,086
$
16,303 $
11,905 $
33
16,069
19,250
5,980
2,170
3,810
18,719
14,909
Operating activities
Net income
Adjustments to reconcile net income to net cash used in operating activities:
Equity in undistributed earnings of consolidated subsidiaries
Share-based compensation
Excess tax benefit from share-based compensation
Net increase (decrease) in other liabilities
Other, net
Net cash used in operating activities
Investing activities
Dividends received from subsidiaries
Capital contributions to subsidiaries
Net cash provided by investing activities
Financing activities
Net increase (decrease) in short-term borrowed funds
Proceeds from issuance of subordinated notes payable
Repayment of subordinated notes payable
Purchase of treasury stock
Cash dividends paid
Net cash used in financing activities
Net increase (decrease) in cash and due from banks
Cash and due from banks at the beginning of the period
Cash and due from banks at the end of the period
For the Year Ended December 31,
2018
2017
2016
(In Thousands)
$
16,303 $
11,905 $
14,909
(15,086)
(18,719)
(20,094)
1,004
(24)
321
72
(2,418)
10,034
—
10,034
60
—
—
(533)
(4,916)
(5,389)
2,227
1,472
1,078
(37)
(4,170)
(2,233)
(8,543)
14,534
—
14,534
(1,000)
9,090
(7,875)
(323)
(4,538)
(4,646)
1,345
127
994
(83)
1,198
(3,162)
(4,863)
13,534
(3,500)
10,034
(1,500)
—
—
(467)
(4,176)
(6,143)
(972)
1,099
127
$
3,699 $
1,472 $
120
Table of Contents
Note 21 – Condensed Quarterly Earnings (unaudited)
2018
2017
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
$
24,522 $
23,563 $
22,468 $
20,722 $
19,504 $
18,634 $
19,225 $
18,447
(Dollars in Thousands, Except Per Share Data)
7,407
6,469
5,537
4,520
4,146
3,751
3,746
17,115
17,094
16,931
16,202
15,358
14,883
15,479
983
4,648
(546)
4,871
2,579
3,982
2,476
4,667
473
3,525
1,471
4,339
3,656
4,738
3,559
14,888
572
4,063
18,244
15,746
14,467
13,907
14,859
14,231
14,221
13,560
$
$
2,536
(1,528)
6,765
1,464
3,867
578
4,486
837
3,551
(486)
3,520
936
2,340
454
4,064
$
5,301
$
3,289 $
3,649
$
4,037 $
2,584 $
1,886 $
0.46 $
0.60 $
0.38 $
0.42 $
0.46 $
0.30 $
0.22 $
0.46
0.14
0.60
0.14
0.38
0.14
0.42
0.14
0.46
0.13
0.30
0.13
0.22
0.13
4,819
1,422
3,397
0.39
0.39
0.13
Interest income
Interest expense
Net interest income
Provision for loan and lease
losses
Non-interest income
Non-interest expense
Income before income tax
expense
Income tax (benefit) expense
Net income
Per common share:
Basic earnings
Diluted earnings
Dividends declared
121
Table of Contents
Shareholders and the Board of Directors
First Business Financial Services, Inc.
Madison, Wisconsin
Report of Independent Registered Public Accounting Firm
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheet of First Business Financial Services, Inc. (the "Company") as of December 31, 2018, the related
consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes
(collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018,
based on criteria established in Internal Control - Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018,
and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of
America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based
on criteria established in Internal Control - Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment
of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial
Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial
reporting based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and
are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the
Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial
reporting was maintained in all material respects.
Our audit of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and
disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our
audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
122
Table of Contents
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
We have served as the Company’s auditor since 2017, which is the year the engagement letter was signed for the audit of the 2018 financial statements.
/s/ Crowe LLP
Oak Brook, Illinois
February 28, 2019
123
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
First Business Financial Services, Inc.:
Opinion
on
the
Consolidated
Financial
Statements
We have audited the accompanying consolidated balance sheet of First Business Financial Services, Inc. and subsidiaries (the Company) as of December 31, 2017,
the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years ended December 31, 2017 and
2016, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for the years ended December 31, 2017
and 2016, in conformity with U.S. generally accepted accounting principles.
Basis
for
Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States)
(PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing
procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that
respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall
presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
We served as the Company’s auditor from 1999 to 2017.
Chicago, Illinois
March 9, 2018
/s/ KPMG LLP
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Table of Contents
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
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 December 31, 2018 .
Changes in Internal Control over Financial Reporting
There was no change in the Corporation’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Securities and Exchange Act of 1934, as amended) that occurred during the quarter ended December 31, 2018 that has materially affected, or is reasonably likely to
materially affect, the Corporation’s internal control over financial reporting.
Management’s Annual Report on Internal Control over Financial Reporting
The Corporation’s management is responsible for establishing and maintaining adequate internal control 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. The Corporation’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Corporation’s financial statements for external
purposes in accordance with generally accepted accounting principles.
Management, under the supervision of the Chief Executive Officer and the Chief Financial Officer, assessed the effectiveness of the Corporation’s
internal control over financial reporting based on criteria for effective internal control over financial reporting established in Internal
Control
–
Integrated
Framework
(2013)
, issued by the Committee of Sponsoring Organization of the Treadway Commission (COSO). Based on this assessment, management has
determined that the Corporation’s internal control over financial reporting was effective as of December 31, 2018 .
Crowe LLP, the independent registered public accounting firm that audited the Consolidated Financial Statements of the Corporation included in this
Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Corporation’s internal control over financial reporting as of December 31,
2018 . The report, which expresses an unqualified opinion on the effectiveness of the Corporation’s internal control over financial reporting as of December 31,
2018 , is included under the heading “Report of Independent Registered Public Accounting Firm.”
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Table of Contents
Item 9B. Other Information
None.
PART III.
Item 10. Directors, Executive Officers and Corporate Governance
(a) Directors
of
the
Registrant
. The information included in the definitive Proxy Statement for the Annual Meeting of the Shareholders to be held on
May 2, 2019 under the captions “Item 1 - Election of Directors,” “Corporate Governance Principles and Practices” and “Section 16(a) Beneficial
Ownership Reporting Compliance” is incorporated herein by reference.
(b) Executive
Officers
of
the
Registrant
. The information presented in Item 1 of this document is incorporated herein by reference.
(c) Code
of
Ethics
. The Corporation has adopted a code of ethics applicable to all employees, including the principal executive officer, principal financial
officer and principal accounting officer of the Corporation. The FBFS Code of Ethics is posted on the Corporation’s website at
www.firstbusiness.com. The Corporation intends to satisfy the disclosure requirements under Item 5.05(c) of Form 8-K regarding any amendment to
or waiver of the code with respect to its Chief Executive Officer, Chief Financial Officer, principal accounting officer, and persons performing similar
functions, by posting such information to the Corporation’s website.
Item 11. Executive Compensation
Information with respect to compensation for our directors and officers included in the definitive Proxy Statement for the Annual Meeting of the
Shareholders to be held on May 2, 2019 under the captions “Executive Compensation,” “Summary Compensation Table,” “Long Term Incentive Plans,”
“Outstanding Equity Awards at December 31, 2018 ,” “Disclosure Regarding Termination and Change in Control Provisions” and “Director Compensation” is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information with respect to security ownership of certain beneficial owners and management included in the definitive Proxy Statement for the Annual
Meeting of the Shareholders to be held on May 2, 2019 under the caption “Principal Shareholders” is incorporated herein by reference.
Equity
Compensation
Plan
Information
The following table summarizes certain information with respect to compensation plans under which equity securities of the Corporation are authorized
for issuance as of December 31, 2018 .
Plan category
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(a)
(b)
(c)
— $
—
—
—
164,621
—
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information with respect to certain relationships and related transactions included in the definitive Proxy Statement for the Annual Meeting of the
Shareholders to be held on May 2, 2019 under the captions “Related Party Transactions” and “Corporate Governance Principles and Practices” is incorporated
herein by reference.
126
Table of Contents
Item 14. Principal Accountant Fees and Services
Information with respect to principal accounting fees and services included in the definitive Proxy Statement for the Annual Meeting of the Shareholders
to be held on May 2, 2019 under the caption “Miscellaneous” is incorporated herein by reference.
127
Table of Contents
PART IV.
Item 15. Exhibits and Financial Statement Schedules
The Consolidated Financial Statements listed on the Index included under “ Item 8. Financial Statements and Supplementary Data ” are filed as a part
of this Form 10-K. All financial statement schedules have been included in the Consolidated Financial Statements or are either not applicable or not significant.
Exhibit Index
Exhibit No.
Exhibit Name
3.1
3.2
4.1
4.2
10.1 *
10.2 *
10.3 *
10.4 *
10.5 *
10.6 *
10.7 *
Amended and Restated Articles of Incorporation of First Business Financial Services, Inc. (Incorporated by reference to Exhibit 3.1 to
the Annual Report on Form 10-K filed on March 10, 2017)
Amended and Restated Bylaws of First Business Financial Services, Inc. (incorporated by reference to Exhibit 3.1 to the Current
Report on Form 8-K filed on October 31, 2018)
Pursuant
to
Item
601(b)(4)(iii)
of
Regulation
S-K,
the
Registrant
agrees
to
furnish
to
the
Securities
and
Exchange
Commission,
upon
request,
any
instrument
defining
the
rights
of
holders
of
long-term
debt
not
being
registered
that
is
not
filed
as
an
exhibit
to
this
Annual
Report
on
Form
10-K.
No
such
instrument
authorizes
securities
in
excess
of
10%
of
the
total
assets
of
the
Registrant.
Rights Agreement, dated as of June 5, 2008, between the Registrant and Computershare Trust Company, N.A. (incorporated by
reference to Exhibit 4.1 to the Annual Report on Form 10-K filed on March 10, 2017)
Form of Common Stock Certificate (incorporated by reference to Exhibit 4.3 to Amendment No. 1 to the Registration Statement on
Form S-1 filed on November 26, 2012)
2012 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q filed on July 27, 2012)
Form of Restricted Stock Agreement (incorporated by reference to Exhibit 4.5 to the Registration Statement on Form S-8 filed on
August 13, 2012)
Form of Executive Change-in-Control and Severance Agreement (incorporated by reference to Exhibit 10.3 to the Annual Report on
Form 10-K filed on March 10, 2017)
Amended and Restated Agreement effective December 22, 2014 between First Business Bank and Corey A. Chambas (incorporated
by reference to Exhibit 10.8 of the Registrant’s Annual Report on Form 10-K filed on March 16, 2015)
First Amendment of Agreement by and between First Business Bank and Corey Chambas (Amended and Restated December 22,
2014)(incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed on December 29, 2016)
Annual Cash Bonus Plan, effective January 1, 2019 (filed herewith in accordance with Item 10(d) of Regulation S-K)
Offer Letter between the Company and David R. Seiler. accepted March 25, 2016 (incorporated by reference to Exhibit 99.1 to the
Current Report on Form 8-K filed on April 8, 2016)
128
Table of Contents
10.8*
Form of Performance-Based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 to the Current Report on
Form 8-K filed February 20, 2019)
21
23.1
23.2
31.1
31.2
32
101
Subsidiaries of the Registrant
Consent of Crowe LLP
Consent of KPMG LLP
Certification of the Chief Executive Officer
Certification of the Chief Financial Officer
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
The following financial information from First Business Financial Services, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of December
31, 2018 and December 31, 2017, (ii) Consolidated Statements of Income for the years ended December 31, 2018, 2017 and 2016,
(iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2018, 2017 and 2016, (iv) Consolidated
Statements of Changes in Stockholders’ Equity for the years ended December 31, 2018, 2017 and 2016, (v) Consolidated Statements
of Cash Flows for the years ended December 31, 2018, 2017 and 2016, and (vi) the Notes to Consolidated Financial Statements
*
Management contract or compensatory plan.
Item 16. Form 10-K Summary
None.
129
Table of Contents
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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.
February 28, 2019
FIRST BUSINESS FINANCIAL SERVICES, INC.
/s/ Corey A. Chambas
Corey A. Chambas
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
130
Table of Contents
Signature
/s/ Corey A. Chambas
Corey A. Chambas
/s/ Edward G. Sloane, Jr.
Edward G. Sloane, Jr.
/s/ Peggy J. Stebbins
Peggy J. Stebbins
/s/ Gerald L. Kilcoyne
Gerald L. Kilcoyne
/s/ Laurie S. Benson
Laurie S. Benson
/s/ Mark D. Bugher
Mark D. Bugher
/s/ Carla C. Chavarria
Carla C. Chavarria
/s/ Jan A. Eddy
Jan A. Eddy
/s/ John J. Harris
John J. Harris
/s/ Ralph R. Kauten
Ralph R. Kauten
/s/ Timothy J. Keane
Timothy J. Keane
/s/ W. Kent Lorenz
W. Kent Lorenz
/s/ Daniel P. Olszewski
Daniel P. Olszewski
/s/ Carol P. Sanders
Carol P. Sanders
Title
Date
Chief Executive Officer
February 28, 2019
(principal executive officer)
Chief Financial Officer
(principal financial officer)
February 28, 2019
Chief Accounting Officer & Controller
February 28, 2019
(principal accounting officer)
Chair of the Board of Directors
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
Director
February 28, 2019
131
Exhibit 10.6
1.
Background and Purpose .
ANNUAL CASH BONUS PLAN
1.1. Purpose . The purpose of the Annual Cash Bonus Plan (the “ Plan ”) is to motivate and reward eligible employees by
making a portion of their cash compensation dependent on the achievement of certain corporate, business unit and individual performance
goals.
1.2. Effective Date . The Plan is effective as of January 1, 2019 (the “ Effective Date ”), and shall remain in effect until it
has been terminated pursuant to Section 8.6 .
2. Definitions . The following terms shall have the following meanings:
2.1. “ Affiliate ” means any corporation or other entity controlled by the Company.
2.2. “ Award ” means an award granted pursuant to the Plan, the payment of which shall be contingent on the attainment
of Performance Goals with respect to a Performance Period, as determined by the Committee pursuant to Section 6.1 .
2.3. “ Base Salary ” means the Participant’s base salary or commission draw earned during the Performance Period before
(a) deductions for taxes or benefits and (b) deferrals of compensation pursuant to any Company or Affiliate-sponsored plans.
2.4. “ Board ” means the Board of Directors of the Company, as constituted from time to time.
2.5. “ Cause ” means:
provides for a definition of Cause, the definition contained therein; or
(a) If the Participant is a party to an employment agreement with the Company or an Affiliate and such agreement
(b) If no such agreement exists, or if such agreement does not define Cause:
incapacity due to physical or mental illness);
(i) the Participant’s willful failure to perform his or her duties (other than any such failure resulting from
each case, materially injurious to the Company or its Affiliates;
(ii) the Participant’s willful engagement in dishonesty, illegal conduct or gross misconduct, which is, in
employment with the Company;
(iii) the Participant’s embezzlement, misappropriation or fraud, whether or not related to the Participant’s
(or state law equivalent) or a crime that constitutes a misdemeanor involving moral turpitude; or
(iv) the Participant’s conviction of or plea of guilty or nolo contendere to a crime that constitutes a felony
Company or the Company’s Code of Conduct.
(v) the Participant’s violation of any restrictive covenants entered into between the Participant and the
2.6. “ Code ” means the U.S. Internal Revenue Code of 1986, as amended from time to time, including any regulations or
authoritative guidance promulgated thereunder and successor provisions thereto.
2.7. “ Committee ” means the committee appointed by the Board to administer the Plan pursuant to Section 3.1 .
2.8. “ Company ” means First Business Financial Services, Inc., a State of Wisconsin corporation, and any successor
thereto.
2.9. “ Exchange Act ” means the Securities Exchange Act of 1934.
2.10. “ Participant ” means as to any Performance Period, the employees of the Company or an Affiliate who are
designated by the Committee to participate in the Plan for that Performance Period.
2.11. “ Performance Criteria ” means the performance criteria upon which the Performance Goals for a particular
Performance Period are based, which may include revenue growth goals, operating profitability goals and/or goals related to strategic
objectives as determined by the Committee in accordance with Section 5.2.
Such Performance Criteria may relate to the performance of the Company as a whole, a business unit, division, department,
individual or any combination of these and may be applied on an absolute basis and/or relative to one or more peer group companies or
indices, or any combination thereof, as the Committee shall determine.
2.12. “ Performance Goals ” means the goals selected by the Committee, in its discretion, to be applicable to a Participant
for any Performance Period. Performance Goals shall be based upon one or more Performance Criteria. Performance Goals may include a
threshold level of performance below which no Award will be paid and levels of performance at which specified percentages of the Target
Award will be paid and may also include a maximum level of performance above which no additional Award amount will be paid.
2.13. “ Performance Period ” means the period for which performance is calculated, which unless otherwise indicated by
the Committee, shall be the Plan Year.
2.14. “ Plan ” means the Annual Cash Bonus Plan, as hereafter amended from time to time.
2.15. “ Plan Year ” means the Company’s fiscal year, which commences on January 1st and ends on December 31st.
2.16. “ Target Award ” means the target award payable under the Plan to a Participant for a particular Performance
Period, expressed as a percentage of the Participant’s Base Salary. In special circumstances, the target award may be expressed as a fixed
amount of cash.
3. Administration .
3.1. Administration by the Committee . The Plan shall be administered by the Committee. The Committee shall be
selected by the Board, provided
that the Committee shall consist of two or more members of the Board, each of whom is a “non-
employee director” (within the meaning of Rule 16b-3 promulgated under the Exchange Act) and an “independent director” (within
the meaning of the rules of the securities exchange which then constitutes the principal listing for the Shares), in each case to the
extent required by the Exchange Act or the applicable rules of the securities exchange which then constitutes the principal listing for
the Company’s shares, respectively. Subject to the applicable rules of any securities exchange or similar entity, if the Committee
does not exist, or for any other reason determined by the Board, the Board may take any action under the Plan that would otherwise
be the responsibility of the Committee .
3.2. Authority of the Committee . Subject to the provisions of the Plan and applicable law, the Committee shall have the
power, in addition to other express powers and authorizations conferred on the Committee by the Plan, to: (a) designate Participants; (b)
determine the terms and conditions of any Award; (c) determine whether,
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to what extent, and under what circumstances Awards may be forfeited or suspended; (d) interpret, administer, reconcile any inconsistency,
correct any defect and/or supply any omission in the Plan or any instrument or agreement relating to, or Award granted under, the Plan; (e)
establish, amend, suspend, or waive any rules for the administration, interpretation and application of the Plan; and (g) make any other
determination and take any other action that the Committee deems necessary or desirable for the administration of the Plan.
3.3. Decisions Binding . All determinations and decisions made by the Committee, the Board, and any delegate of the
Committee pursuant to the provisions of the Plan shall be final, conclusive and binding on all persons, and shall be given the maximum
deference permitted by law.
3.4. Delegation by the Committee . Except to the extent prohibited by applicable law, the applicable rules of any
securities exchange or similar entity, the Plan, or the charter of the Committee, the Committee may allocate all or any portion of its
responsibilities and powers to any one or more of its members and may delegate all or any part of its responsibilities and powers
under the Plan to any person or persons selected by it. The acts of such delegates shall be treated under the Plan as acts of the
Committee. Any such allocation or delegation may be revoked by the Committee at any time . Notwithstanding the foregoing, unless
otherwise determined by the Board, (a) the Board shall make all determinations under the Plan with respect to any Award granted to the
Company’s chief executive officer, (b) the Committee shall make all determinations under the Plan with respect to any Award granted to any
other “executive officer” (as designated from time to time by the Board), and (c) the senior executive officers of the Company shall make all
determinations under the Plan with respect to any Award granted to any other employee of the Company or any Affiliate.
3.5. Agents; Limitation of Liability . The Committee may appoint agents to assist in administering the Plan. The
Committee and each member thereof shall be entitled to, in good faith, rely or act upon any report or other information furnished to it or him
by any officer or employee of the Company, the Company’s certified public accountants, consultants or any other agent assisting in the
administration of the Plan. Members of the Committee and any officer or employee of the Company acting at the direction or on behalf of the
Committee shall not be personally liable for any action or determination taken or made in good faith with respect to the Plan, and shall, to the
extent permitted by law, be fully indemnified and protected by the Company with respect to any such action or determination.
4. Eligibility and Participation .
4.1. Eligibility . Employees of the Company and its participating Affiliates, who work 30 or more hours per week, are
eligible to participate in the Plan.
4.2. Participation . The Committee, in its discretion, shall select the persons who shall be Participants for each Performance
Period. Only eligible individuals who are designated by the Committee to participate in the Plan with respect to a particular Performance
Period may participate in the Plan for that Performance Period. An individual who is designated as a Participant for a given Performance
Period is not guaranteed or assured of being selected for participation in any subsequent Performance Period.
4.3. New Hires; Newly Eligible Participants . A newly hired or newly eligible Participant will be eligible to receive a pro-
rated Award if the Participant’s start date is on or before October 1 of the Plan Year.
4.4. Promotion. If a Participant is promoted on or before October 1 of the Plan Year, the Participant will be eligible to
receive the bonus target commensurate with the new position for the full Plan Year.
5. Terms of Awards .
5.1. Determination of Target Awards . Prior to, or reasonably promptly following the commencement of each Performance
Period, the Committee, in its sole discretion, shall establish the Target Award
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for each Participant, the payment of which shall be conditioned on the achievement of the Performance Goals for the Performance Period.
5.2. Determination of Performance Goals and Performance Formula . Prior to, or reasonably promptly following the
commencement of, each Performance Period, the Committee, in its sole discretion, shall establish in writing the Performance Goals for the
Performance Period and shall prescribe a formula for determining the percentage of the Target Award which may be payable based upon the
level of attainment of the Performance Goals for the Performance Period. The Performance Goals shall be based on one or more Performance
Criteria, each of which may carry a different weight, and which may differ from Participant to Participant. The Committee is authorized to
adjust or modify the calculation of a Performance Goal for a Performance Period in its sole discretion.
6. Payment of Awards .
6.1. Determination of Awards .
(a) Following the completion of each Performance Period, the Committee shall determine the extent to which the
Performance Goals have been achieved or exceeded. Subject to Section 6.1(c), if the minimum Performance Goals established by the
Committee are not achieved, then no payment will be made.
Performance Goals applicable to each Participant have been achieved and shall then determine the amount of each Participant’s Award.
(b) To the extent that the Performance Goals are achieved, the Committee shall determine the extent to which the
Award if, in its sole discretion, such reduction, elimination or increase is appropriate.
(c) In determining the amount of each Award, the Committee may reduce, eliminate or increase the amount of an
Performance Criteria Threshold level for any Plan Year before any Award can be paid under the Plan.
(d) The Company has a funding safeguard in that it must meet or exceed one-half of the Return on Asset (ROA)
6.2. Form and Timing of Payment . Except as otherwise provided herein, as soon as practicable following the Committee’s
determination pursuant to Section 6.1 for the applicable Performance Period, each Participant shall receive a cash lump sum payment of his
or her Award, less required withholding. In no event shall such payment be made later than March 15 following the end of the Performance
Period.
6.3. Employment Requirement . Except as otherwise provided in Section 7 , no Award shall be paid to any Participant who
is not actively employed by the Company or an Affiliate on the date that Awards are paid.
7. Termination of Employment .
7.1. Employment Requirement . Except as otherwise provided in Section 7.2, if a Participant’s employment terminates for
any reason prior to the date that Awards are paid, all of the Participant’s rights to an Award for the Performance Period shall be forfeited.
Notwithstanding the foregoing, if a Participant’s employment is terminated for Cause, the Participant shall in all cases forfeit any Award not
already paid.
8. General Provisions .
8.1. Compliance with Legal Requirements . The Plan and the granting of Awards shall be subject to all applicable federal
and state laws, rules and regulations, and to such approvals by any regulatory or governmental agency as may be required.
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8.2. Non-transferability . A person’s rights and interests under the Plan, including any Award previously made to such
person or any amounts payable under the Plan may not be assigned, pledged, or transferred.
8.3. No Right to Employment . Nothing in the Plan or in any notice of Award shall confer upon any person the right to
continue in the employment of the Company or any Affiliate or affect the right of the Company or any Affiliate to terminate the employment
of any Participant.
8.4. No Right to Award . Unless otherwise expressly set forth in an employment agreement signed by the Company and a
Participant, a Participant shall not have any right to any Award under the Plan until such Award has been paid to such Participant and
participation in the Plan in one Performance Period does not connote any right to become a Participant in the Plan in any future Performance
Period.
8.5. Withholding . The Company shall have the right to withhold from any Award, any federal, state or local income
and/or payroll taxes required by law to be withheld and to take such other action as the Committee may deem advisable to enable the
Company and Participants to satisfy obligations for the payment of withholding taxes and other tax obligations relating to an Award.
8.6. Amendment or Termination of the Plan . The Board or the Committee may, at any time, amend, suspend or terminate
the Plan in whole or in part. Notwithstanding the foregoing, no amendment shall adversely affect the rights of any Participant to Awards
allocated prior to such amendment, suspension or termination.
8.7. Unfunded Status . Nothing contained in the Plan, and no action taken pursuant to its provisions, shall create or be
construed to create a trust of any kind or a fiduciary relationship between the Company and any Participant, beneficiary or legal
representative or any other person. To the extent that a person acquires a right to receive payments under the Plan, such right shall be no
greater than the right of an unsecured general creditor of the Company. All payments to be made hereunder shall be paid from the general
funds of the Company and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of
such amounts except as expressly set forth in the Plan. The Plan is not intended to be subject to the Employee Retirement Income Security
Act of 1974, as amended (ERISA).
8.8. Governing Law . The Plan shall be construed, administered and enforced in accordance with the laws of Wisconsin
without regard to conflicts of law.
8.9. Section 409A of the Code . It is intended that payments under the Plan qualify as short-term deferrals exempt from the
requirements of Section 409A of the Code. In the event that any Award does not qualify for treatment as an exempt short-term deferral, it is
intended that such amount will be paid in a manner that satisfies the requirements of Section 409A of the Code. The Plan shall be interpreted
and construed accordingly.
8.10. Expenses . All costs and expenses in connection with the administration of the Plan shall be paid by the Company.
8.11. Section Headings . The headings of the Plan have been inserted for convenience of reference only and in the event of
any conflict, the text of the Plan, rather than such headings, shall control.
8.12. Severability . In the event that any provision of the Plan shall be considered illegal or invalid for any reason, such
illegality or invalidity shall not affect the remaining provisions of the Plan, but shall be fully severable, and the Plan shall be construed and
enforced as if such illegal or invalid provision had never been contained therein.
8.13. Gender and Number . Except where otherwise indicated by the context, wherever used, the masculine pronoun
includes the feminine pronoun; the plural shall include the singular, and the singular shall include the plural.
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8.14. Non-Exclusive . Nothing in the Plan shall limit the authority of the Company, the Board or the Committee to adopt
such other compensation arrangements, as it may deem desirable for any Participant.
8.15. Notice . Any notice to be given to the Company or the Committee pursuant to the provisions of the Plan shall be in
writing and directed to the Chief Human Resources Officer of the Company at 401 Charmany Drive, Madison, WI 53719.
8.16. Successors . All obligations of the Company under the Plan with respect to Awards granted hereunder shall be
binding upon any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger,
consolidation or otherwise, of all or substantially all of the assets of the Company.
8.17. Clawback . Any Award received under the Plan shall be subject to potential cancellation, recoupment, rescission,
payback or other similar action in accordance with any applicable Company clawback policy (the “ Policy ”) or any applicable law.
Notwithstanding the foregoing, until such time as the Company adopts the Policy, in the event of a material restatement of the Company’s
financial results, other than a restatement due to changes in accounting principles or applicable law or interpretations thereof, the Board will
review the facts and circumstances that led to the requirement for the restatement and will take such actions, including clawback of any
Award, as it deems necessary or appropriate. The Board will consider whether an “executive officer” (as designated from time to time by the
Board) received a payment with respect to any Award based on the original financial statements because it appeared he or she achieved
Performance Goals which in fact were not achieved based on the restatement. The Board will consider the accountability of any executive
officer whose acts or omissions were responsible in whole or in part for the events that led to the restatement and whether such acts or
omissions constituted misconduct.
8.18. Governing Law . The Plan, all Awards, and all actions taken in connection herewith and therewith shall be governed
by and construed in accordance with the laws of the State of Wisconsin without reference to principles of conflict of laws, except as
superseded by applicable federal law; and any court action commenced to enforce this Agreement shall have as its sole and exclusive venue
the County of Dane, Wisconsin.
8.19. Waiver of Jury Trial . EXCEPT TO THE EXTENT PROHIBITED BY STATE LAW, AS A CONDITION TO THE
GRANTING OR PAYMENT OF AN AWARD PURSUANT TO THIS PLAN, EACH PARTICIPANT AND THE COMPANY
IRREVOCABLY AND UNCONDITIONALLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY
RIGHT IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL ACTION, PROCEEDING, CAUSE OF ACTION OR
COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS PLAN, INCLUDING ANY EXHIBITS, SCHEDULES, AND
APPENDICES ATTACHED TO THIS PLAN. EACH PARTY CERTIFIES AND ACKNOWLEDGES THAT (A) NO REPRESENTATIVE
OF THE OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT THE OTHER PARTY WOULD NOT SEEK
TO ENFORCE THE FOREGOING WAIVER IN THE EVENT OF A LEGAL ACTION, (B) IT HAS CONSIDERED THE
IMPLICATIONS OF THIS WAIVER, (C) IT MAKES THIS WAIVER KNOWINGLY AND VOLUNTARILY, AND (D) IT HAS
DECIDED TO ENTER INTO THIS PLAN IN CONSIDERATION OF, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND
CERTIFICATIONS IN THIS SECTION.
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Subsidiaries of the Registrant
Subsidiary
First Business Bank
First Business Capital Corp.
First Business Equipment Finance, LLC
Rimrock Road Investment Fund, LLC
BOC Investment, LLC
Mitchell Street Apartments Investment, LLC
ABKC Real Estate, LLC
FBB Real Estate 2, LLC
FBB Tax Credit Investment, LLC
First Madison Investment Corp.
FBFS Statutory Trust II
Exhibit 21
State of Incorporation or
Organization
Wisconsin
Wisconsin
Wisconsin
Wisconsin
Wisconsin
Wisconsin
Kansas
Kansas
Wisconsin
Nevada
Delaware
Consent of Independent Registered Public Accounting Firm
Exhibit 23.1
The Board of Directors
First Business Financial Services, Inc.:
We consent to the incorporation by reference in Registration Statement No. 333-183274 on Form S-8 and 333-221387 on Form S-3 of First Business Financial
Services, Inc. of our report dated February 28, 2019 relating to the financial statements and effectiveness of internal control over financial reporting, appearing in
this Annual Report on Form 10-K.
Oak Brook, Illinois
February 28, 2019
/s/ Crowe LLP
Consent of Independent Registered Public Accounting Firm
Exhibit 23.2
The Board of Directors
First Business Financial Services, Inc.:
We consent to the incorporation by reference in the registration statements (No. 333-183274 on Form S-8 and No. 333-221387 on Form S-3) of First Business
Financial Services, Inc. of our report dated March 9, 2018, with respect to the consolidated balance sheet of First Business Financial Services, Inc. as of December
31, 2017, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years ended December 31,
2017 and 2016, and the related notes, which report appears in the December 31, 2018 Annual Report on Form 10-K of First Business Financial Services, Inc.
Chicago, Illinois
February 28, 2019
/s/ KPMG LLP
I, Corey A. Chambas, certify that:
1.
I have reviewed this Annual Report on Form 10-K of First Business Financial Services, Inc.;
Certifications
Exhibit 31.1
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent
fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a. Any significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control
over financial reporting.
/s/ Corey A. Chambas
Corey A. Chambas
Chief Executive Officer
February 28, 2019
I, Edward G. Sloane, Jr., certify that:
1.
I have reviewed this Annual Report on Form 10-K of First Business Financial Services, Inc.;
Certifications
Exhibit 31.2
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent
fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a. Any significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control
over financial reporting.
/s/ Edward G. Sloane, Jr.
Edward G. Sloane, Jr.
Chief Financial Officer
February 28, 2019
Certification of the Chief Executive Officer and the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
Solely for the purposes of complying with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, we, the undersigned
Chief Executive Officer and Chief Financial Officer, of First Business Financial Services, Inc., a Wisconsin Corporation (the “Corporation”), hereby certify, based
on our knowledge that the Annual Report on Form 10-K of the Corporation for the year ended December 31, 2018 (the “Report”) fully complies with the
requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended, and that information contained in the Report fairly presents, in
all material respects, the financial condition and results of operations of the Corporation.
Exhibit 32
/s/ Corey A. Chambas
Corey A. Chambas
Chief Executive Officer
February 28, 2019
/s/ Edward G. Sloane, Jr.
Edward G. Sloane, Jr.
Chief Financial Officer
February 28, 2019