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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
  Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2021
OR
  Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission file number 001-34095
FIRST BUSINESS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Wisconsin 39-1576570
     
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
401 Charmany Drive 53719
Madison Wisconsin  
(Address of Principal Executive Offices) (Zip Code)
(608) 238-8008
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, $0.01 par value FBIZ The Nasdaq Stock Market LLC
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer þ Non-accelerated filer ¨ Smaller reporting company Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No þ
The number of shares outstanding of the registrant’s sole class of common stock, par value $0.01 per share, on April 29, 2021 was 8,568,955 shares.


FIRST BUSINESS FINANCIAL SERVICES, INC.
INDEX — FORM 10-Q


1
1
1
2
3
4
5
7
39
61
61
61
61
62
62
62
62
62
62
62



PART I. Financial Information
Item 1. Financial Statements
First Business Financial Services, Inc.
Consolidated Balance Sheets
March 31,
2021
December 31,
2020
(Unaudited)
  (In Thousands, Except Share Data)
Assets    
Cash and due from banks $ 20,129  $ 29,538 
Short-term investments 38,745  27,371 
Cash and cash equivalents 58,874  56,909 
Securities available-for-sale, at fair value 173,261  183,925 
Securities held-to-maturity, at amortized cost
24,783  26,374 
Loans held for sale
6,576  8,695 
Loans and leases receivable, net of allowance for loan and lease losses of $28,982 and $28,521, respectively
2,206,130  2,117,449 
Premises and equipment, net 1,923  1,998 
Foreclosed properties 31  34 
Right-of-use assets, net 5,486  5,814 
Bank-owned life insurance 52,537  52,188 
Federal Home Loan Bank stock, at cost 14,941  13,578 
Goodwill and other intangible assets 12,055  12,018 
Derivatives 26,104  49,377 
Accrued interest receivable and other assets 38,017  39,478 
Total assets $ 2,620,718  $ 2,567,837 
Liabilities and Stockholders’ Equity    
Deposits $ 1,902,718  $ 1,855,516 
Federal Home Loan Bank advances and other borrowings 448,417  419,167 
Junior subordinated notes 10,065  10,062 
Lease liabilities 6,040  6,386 
Derivatives 29,565  54,927 
Accrued interest payable and other liabilities 9,422  15,617 
Total liabilities 2,406,227  2,361,675 
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, 9,320,490 and 9,234,460 shares issued, 8,638,195 and 8,566,960 shares outstanding at March 31, 2021 and December 31, 2020, respectively
93  92 
Additional paid-in capital 83,694  83,125 
Retained earnings 148,621  140,431 
Accumulated other comprehensive loss (1,038) (933)
Treasury stock, 682,295 and 667,500 shares at March 31, 2021 and December 31, 2020, respectively, at cost
(16,879) (16,553)
Total stockholders’ equity 214,491  206,162 
Total liabilities and stockholders’ equity $ 2,620,718  $ 2,567,837 

See accompanying Notes to Unaudited Consolidated Financial Statements.

1

First Business Financial Services, Inc.
Consolidated Statements of Income (Unaudited)
For the Three Months Ended March 31,
  2021 2020
  (In Thousands, Except Per Share Data)
Interest income    
Loans and leases $ 22,795  $ 21,849 
Securities 853  1,188 
Short-term investments 158  335 
Total interest income 23,806  23,372 
Interest expense    
Deposits 1,019  4,116 
Federal Home Loan Bank advances and other borrowings 1,650  1,929 
Junior subordinated notes 274  277 
Total interest expense 2,943  6,322 
Net interest income 20,863  17,050 
Provision for loan and lease losses (2,068) 3,182 
Net interest income after provision for loan and lease losses 22,931  13,868 
Non-interest income    
Private wealth management service fees 2,407  2,112 
Gain on sale of Small Business Administration loans 1,078  265 
Service charges on deposits 917  818 
Loan fees 545  485 
Increase in cash surrender value of bank-owned life insurance
350  295 
Net loss on sale of securities —  (4)
Swap fees 684  1,681 
Other non-interest income 1,214  762 
Total non-interest income 7,195  6,414 
Non-interest expense    
Compensation 12,657  11,052 
Occupancy 552  572 
Professional fees 866  819 
Data processing 770  677 
Marketing 391  461 
Equipment 246  291 
Computer software 1,115  889 
FDIC insurance 362  208 
Collateral liquidation costs 94  121 
Net loss on foreclosed properties 102 
Impairment of tax credit investments —  113 
SBA recourse (benefit) provision (130) 25 
Other non-interest expense 404  816 
Total non-interest expense 17,330  16,146 
Income before income tax expense 12,796  4,136 
Income tax expense 3,065  858 
Net income $ 9,731  $ 3,278 
Earnings per common share    
Basic $ 1.12  $ 0.38 
Diluted 1.12  0.38 
Dividends declared per share 0.18  0.165 

See accompanying Notes to Unaudited Consolidated Financial Statements.
2

First Business Financial Services, Inc.
Consolidated Statements of Comprehensive Income (Unaudited)
For the Three Months Ended March 31,
2021 2020
(In Thousands)
Net income $ 9,731  $ 3,278 
Other comprehensive (loss) income, before tax
Securities available-for-sale:
Unrealized securities (losses) gains arising during the period (2,238) 4,501 
Reclassification adjustment for net loss realized in net income — 
Securities held-to-maturity:
Amortization of net unrealized losses transferred from available-for-sale 10 
Interest rate swaps:
Unrealized gains (losses) on interest rate swaps arising during the period 2,089  (3,625)
Income tax benefit (expense) 36  (227)
     Total other comprehensive (loss) gain (105) 663 
Comprehensive income $ 9,626  $ 3,941 

See accompanying Notes to Unaudited Consolidated Financial Statements.
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First Business Financial Services, Inc.
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
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 January 1, 2020 8,566,044  $ 92  $ 81,188  $ 129,105  $ (1,348) $ (14,881) $ 194,156 
Net income —  —  —  3,278  —  —  3,278 
Other comprehensive income
—  —  —  —  663  —  663 
Share-based compensation - restricted shares, net
63,684  —  417  —  —  —  417 
Cash dividends ($0.165 per share)
—  —  —  (1,410) —  —  (1,410)
Treasury stock purchased (58,594) —  —  —  —  (1,447) (1,447)
Balance at March 31, 2020 8,571,134  $ 92  $ 81,605  $ 130,973  $ (685) $ (16,328) $ 195,657 
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 January 1, 2021 8,566,960  $ 92  $ 83,125  $ 140,431  $ (933) $ (16,553) $ 206,162 
Net income —  —  —  9,731  —  —  9,731 
Other comprehensive loss —  —  —  —  (105) —  (105)
Share-based compensation - restricted shares and employee stock purchase plan 84,255  530  —  —  —  531 
Issuance of common stock under the employee stock purchase plan 1,775  —  39  —  —  —  39 
Cash dividends ($0.18 per share)
—  —  —  (1,541) —  —  (1,541)
Treasury stock purchased (14,795) —  —  —  —  (326) (326)
Balance at March 31, 2021 8,638,195  $ 93  $ 83,694  $ 148,621  $ (1,038) $ (16,879) $ 214,491 

See accompanying Notes to Unaudited Consolidated Financial Statements.

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First Business Financial Services, Inc.
Consolidated Statements of Cash Flows (Unaudited)
For the Three Months Ended March 31,
  2021 2020
(In Thousands)
Operating activities    
Net income $ 9,731  $ 3,278 
Adjustments to reconcile net income to net cash provided by operating activities:    
Deferred income taxes, net (1,242) (26)
Impairment of tax credit investments —  113 
Provision for loan and lease losses (2,068) 3,182 
SBA recourse (benefit) provision (130) 25 
Derivative credit valuation adjustment (170) — 
Depreciation, amortization and accretion, net 956  806 
Share-based compensation 531  417 
Net loss on sale of securities — 
Increase in bank-owned life insurance policies (350) (295)
Origination of loans for sale (13,674) (15,709)
Sale of SBA loans originated for sale 16,871  14,848 
Gain on sale of loans originated for sale (1,078) (265)
Net loss on foreclosed properties, including impairment valuation 102 
Excess tax benefit from share-based compensation (7) 18 
Payments on operating lease liabilities (393) (387)
Payments received on operating leases 39  28 
Net increase in accrued interest receivable and other assets (4,979) (40,050)
Net increase in accrued interest payable and other liabilities 2,789  35,138 
Net cash provided by operating activities 6,829  1,227 
Investing activities    
Proceeds from maturities, redemptions, and paydowns of available-for-sale securities 17,222  9,458 
Proceeds from maturities, redemptions, and paydowns of held-to-maturity securities 1,580  1,910 
Proceeds from sale of available-for-sale securities —  839 
Purchases of available-for-sale securities (9,030) (8,286)
Proceeds from sale of foreclosed properties —  1,148 
Net increase in loans and leases (86,613) (28,719)
Returns of investments in limited partnerships 60  — 
Investment in historic development entities —  (259)
Distribution from historic development entities 49  30 
Investment in low-income housing (1,307) — 
Investment in Federal Home Loan Bank and Federal Reserve Bank stock (3,614) (2,040)
Proceeds from the sale of Federal Home Loan Bank stock 2,250  260 
Purchases of leasehold improvements and equipment, net (89) (88)
Purchases of bank-owned life insurance policies —  (8,000)
Net cash used in investing activities (79,492) (33,747)
Financing activities    
Net increase (decrease) in deposits 47,202  (30,253)
Proceeds from Federal Home Loan Bank advances 290,300  260,000 
Repayment of Federal Home Loan Bank advances (269,000) (166,500)
Net increase in long-term borrowed funds 7,954  14 
Cash dividends paid (1,541) (1,410)
Proceeds from issuance of common stock under ESPP 39  — 
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Purchase of treasury stock (326) (1,447)
Net cash provided by financing activities 74,628  60,404 
Net decrease in cash and cash equivalents 1,965  27,884 
Cash and cash equivalents at the beginning of the period 56,909  67,102 
Cash and cash equivalents at the end of the period $ 58,874  $ 94,986 
Supplementary cash flow information    
Cash paid during the period for:
Interest paid on deposits and borrowings $ 4,856  $ 7,250 
Income taxes paid 32  (8)
See accompany Notes to Unaudited Consolidated Financial Statements
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Notes to Unaudited Consolidated Financial Statements

Note 1 — Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
The accounting and reporting practices of First Business Financial Services, Inc. (“FBFS” or the “Corporation”), through our wholly-owned subsidiary, First Business Bank (“FBB” or the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB operates as a commercial banking institution primarily in Wisconsin and the greater Kansas City Metro. The Bank provides a full range of financial services to businesses, business owners, executives, professionals, and high net worth individuals. FBB also offers private wealth management services and bank consulting services. 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 Specialty Finance, LLC (“FBSF”), First Madison Investment Corp. (“FMIC”), 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 accompanying unaudited Consolidated Financial Statements were prepared in accordance with GAAP and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Corporation’s Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020. The unaudited Consolidated Financial Statements include the accounts of the Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. 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 which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities and interest rate swaps, level of the allowance for loan and lease losses, lease residuals, property under operating leases, goodwill, level of the Small Business Administration (“SBA”) recourse reserve, and income taxes. The results of operations for the three months ended March 31, 2021, are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2021. Certain amounts in prior periods may have been reclassified to conform to the current presentation. Subsequent events have been evaluated through the date of the issuance of the unaudited Consolidated Financial Statements. No significant subsequent events have occurred through this date requiring adjustment to the financial statements or disclosures.
The Corporation has not changed its significant accounting and reporting policies from those disclosed in the Corporation’s Form 10-K for the year ended December 31, 2020.
Recent Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments- Credit Losses (Topic 326),” which is often referred to as CECL. 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 under which the Corporation has 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. In November 2019, the FASB issued ASU No. 2019-10, “Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842).” The ASU delays the effective date for the credit losses standard from January 2020 to January 2023 for certain entities, including certain Securities and Exchange Commission filers, public business entities, and private companies. As a smaller reporting company, the Corporation is eligible for the delay and will be deferring adoption. The Corporation has established a cross-functional committee and has implemented a third-party software solution to assist with the adoption of the standard. Management has gathered all necessary data and reviewed potential methods to calculate the expected credit losses. Management is currently calculating sample expected loss computations and developing the allowance
7

methodology and assumptions that will be used under the new standard. Management will continue to progress on its implementation project plan and improve the Corporation’s approach throughout the deferral period.
In March 2020, the FASB issued ASU 2020-04 "Reference Rate Reform (Topic 848)," which provides temporary, optional practical expedients and exceptions to ease the potential burden of transitioning to the new reference rates which will replace LIBOR and other reference rates expected to be discontinued. Adoption of the provisions of ASU 2020-04 is optional. The amendments are effective for all entities from the beginning of the interim period that includes the issuance date of the ASU. An entity may elect to apply the amendments prospectively through December 31, 2022. The Corporation is currently evaluating the impact of ASU 2020-04 on its financial position, results of operations and liquidity. The adoption of this standard is not expected to have a material effect on the Corporation's operating results or financial condition.
In January, 2021, the FASB released ASU 2021-01, ‘Reference Rate Reform (Topic 848),’ which clarifies that certain optional expedients and exceptions in topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition related to reference rate reform. The amendments in this update are effective immediately for all entities. An entity may elect to apply the amendments in the update on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued. The Corporation does not expect this amendment to have a material effect on its financial statements.

Note 2 — Other Events

On March 11, 2020, the World Health Organization declared COVID-19, the disease caused by the novel coronavirus, a pandemic as a result of the global spread of the coronavirus illness. In response to the outbreak, federal and state authorities in the U.S. introduced various measures to try to limit or slow the spread of the virus, including travel restrictions, nonessential business closures, stay-at-home orders, and strict social distancing. The Corporation activated its Pandemic Preparedness Plan to protect the health of employees and clients, which includes temporarily limiting lobby hours and transitioning the vast majority of the Corporation’s workforce to remote work. The Corporation has not incurred any significant disruptions to its business activities.
The full long-term impact of the COVID-19 pandemic is unknown and continues to evolve. It has caused substantial disruption in international and U.S. economies, markets, and employment. The outbreak has had a significant adverse impact on certain industries the Corporation serves, including retail, restaurants and food services, hospitality, and entertainment. As of March 31, 2021, the Corporation’s aggregate outstanding exposure in these segments was $194.5 million, or 9.9% of the Corporation’s gross loans and leases. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation’s loan portfolio.
The Corporation provided loan payment deferrals for certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation’s loan modification program. As of March 31, 2021, the Corporation had seven deferral requests outstanding, representing $13.0 million in total loans, or 0.7% of gross loans and leases, excluding gross PPP loans, compared to $27.0 million, or 1.4% of gross loans and leases, excluding gross PPP loans as of December 31, 2020. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payment at the end of the modification period and the deferred amounts will be moved to the end of the loan term. The loan will not be reported as past due during the deferral period.
On December 27, 2020, the Consolidated Appropriations Act, 2021 (“CAA”) was signed into law. The CAA is a $2.3 trillion spending bill that combines $900 billion in stimulus relief for the COVID-19 pandemic in the United States with a $1.4 trillion omnibus spending bill for the 2021 federal fiscal year and prevents a government shutdown. The CAA allows for a second draw for certain businesses under the PPP. Like the original program, loan proceeds are available to help fund payroll and group health benefit costs, as well as certain mortgage interest, rent and utilities. In addition, authorized costs now also include COVID-19 related worker protection costs, uninsured property damage costs due to looting or vandalism during 2020 and certain supplier costs and expenses for operations. The CAA also expands benefit costs to include group dental, vision, life and disability benefits. All of these changes are generally retroactive to the original CARES Act, meaning that the changes may be taken into account in processing loan forgiveness with respect to an original PPP loan. The Corporation began accepting and processing applications for second draw PPP loans on January 13, 2021.
As of March 31, 2021, the Corporation had $272.7 million in gross PPP loans outstanding and deferred processing fees outstanding of $5.1 million. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. During the three months ended March 31, 2021, $2.2 million was recognized in loans and leases interest income in the unaudited Consolidated Statements of Income. The SBA provides a
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guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.

Note 3 — Earnings per Common Share
Earnings per common share are computed using the two-class method. Basic earnings per common share are computed by dividing net income allocated to common shares by the weighted-average number of shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends, or dividend equivalents, at the same rate as holders of the Corporation’s common stock. Diluted earnings per share are computed by dividing net income allocated to common shares adjusted for reallocation of undistributed earnings of unvested restricted shares by the weighted average number of shares determined for the basic earnings per common share computation plus the dilutive effect of common stock equivalents using the treasury stock method.
For the Three Months Ended March 31,
  2021 2020
(Dollars in Thousands, Except Share Data)
Basic earnings per common share    
Net income $ 9,731  $ 3,278 
Less: earnings allocated to participating securities 251  78 
Basic earnings allocated to common shareholders $ 9,480  $ 3,200 
Weighted-average common shares outstanding, excluding participating securities
8,429,149  8,388,666 
Basic earnings per common share $ 1.12  $ 0.38 
Diluted earnings per common share    
Earnings allocated to common shareholders, diluted $ 9,480  $ 3,200 
Weighted-average diluted common shares outstanding, excluding participating securities
8,429,149  8,388,666 
Diluted earnings per common share $ 1.12  $ 0.38 

Note 4 — Share-Based Compensation
The Corporation adopted the 2019 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2019. The Plan is administered by the Compensation Committee of the Board of Directors of the Corporation and provides for the grant of equity ownership opportunities through incentive stock options and nonqualified stock options (“Stock Options”), restricted stock, restricted stock units, dividend equivalent units, and any other type of award permitted by the Plan. As of March 31, 2021, 40,953 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 awards, 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 award 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 for restricted stock is recognized over the requisite service period of generally three or four years for the entire award on a straight-line basis. Upon vesting of restricted stock, the benefit of tax deductions in excess of recognized compensation expense is reflected as an income tax benefit in the unaudited Consolidated Statements of Income.
The Corporation may issue a combination of performance-based restricted stock units and restricted stock awards to its executive officers. Vesting of the performance based restricted stock units will be measured on Total Shareholder Return
9

(“TSR”) and Return on Average Equity (“ROAE”) and will cliff-vest after a three-year measurement period based on the Corporation’s performance relative to a custom peer group. At the end of the performance period, the number of actual shares to be awarded varies between 0% and 200% of target amounts. The restricted stock awards issued to executive officers will vest ratably over a three-year period. Compensation expense is recognized for performance-based restricted stock units over the requisite service and performance period of generally three years for the entire expected award on a straight-line basis. The compensation expense for the awards expected to vest for the percentage of performance-based restricted stock units subject to the ROAE metric will be adjusted if there is a change in the expectation of ROAE. The compensation expense for the awards expected to vest for the percentage of performance based restricted stock units subject to the TSR metric are never adjusted, and are amortized utilizing the accounting fair value provided using a Monte Carlo pricing model.
Restricted stock activity for the year ended December 31, 2020 and the three months ended March 31, 2021 was as follows:
Number of
Restricted Shares
Weighted Average
Grant-Date
Fair Value
Nonvested balance as of January 1, 2020 176,935  $ 22.51 
Granted (1)
78,775  25.82 
Vested (56,904) 22.26 
Forfeited (11,002) 22.86 
Nonvested balance as of December 31, 2020 187,804  24.29 
Granted (1)
85,435  23.18 
Vested (25,897) 24.04 
Forfeited (1,180) 23.12 
Nonvested balance as of March 31, 2021 246,162  $ 23.94 
(1)The number of restricted shares/units shown includes the shares that would be granted if the target level of performance is achieved related to the performance based restricted stock units. The number of shares actually issued may vary.

As of March 31, 2021, the Corporation had $4.7 million of unvested compensation expense, which the Corporation expects to recognize over a weighted-average period of approximately 2.54 years.

Employee Stock Purchase Plan
During 2020, an employee stock purchase plan ("ESPP") was approved by the Corporation’s shareholders and is offered to all qualifying employees, the Company is authorized to issue up to 250,000 shares under the ESPP. The plan qualifies as an employee stock purchase plan under section 423 of the Internal Revenue Code of 1986. Under the ESPP, eligible employees may enroll in a three month offer period that begins January, April, July, and October of each year. Employees may elect to purchase a limited number of shares on the Corporation's common stock at 90% of the fair market value on the last day of the offering period. The ESPP is treated as a compensatory item for purposes of share-based compensation expense.
During the three months ended March 31, 2021, the Corporation issued 1,775 shares of common stock under the ESPP. As of March 31, 2021, 244,258 shares remained available for issuance under the ESPP.
For the three months ended March 31, 2021 and 2020, share-based compensation expense related to restricted stock and the ESPP included in the unaudited Consolidated Statements of Income was $531,000 and $417,000, respectively.

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Note 5 — Securities
The amortized cost and fair value of securities available-for-sale and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
  As of March 31, 2021
Amortized Cost Gross
Unrealized Gains
Gross
Unrealized Losses
Fair Value
  (In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises
$ 22,431  $ $ (203) $ 22,235 
Municipal securities 23,986  419  (130) 24,275 
Residential mortgage-backed securities - government issued 8,951  431  —  9,382 
Residential mortgage-backed securities - government-sponsored enterprises 89,139  1,867  (401) 90,605 
Commercial mortgage-backed securities - government issued 4,689  120  —  4,809 
Commercial mortgage-backed securities - government-sponsored enterprises 19,754  367  (432) 19,689 
Other securities
2,205  61  —  2,266 
  $ 171,155  $ 3,272  $ (1,166) $ 173,261 
  As of December 31, 2020
Amortized Cost Gross
Unrealized Gains
Gross
Unrealized Losses
Fair Value
  (In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises
$ 22,699  $ $ (79) $ 22,629 
Municipal securities 24,067  716  (4) 24,779 
Residential mortgage-backed securities - government issued 9,894  509  —  10,403 
Residential mortgage-backed securities - government-sponsored enterprises
102,843  2,212  (49) 105,006 
Commercial mortgage-backed securities - government issued 5,289  175  —  5,464 
Commercial mortgage-backed securities - government-sponsored enterprises 12,584  781  —  13,365 
Other securities
2,205  74  —  2,279 
  $ 179,581  $ 4,476  $ (132) $ 183,925 

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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 March 31, 2021
Amortized Cost Gross
Unrealized Gains
Gross
Unrealized Losses
Fair Value
  (In Thousands)
Held-to-maturity:
Municipal securities $ 16,197  $ 342  $ (19) $ 16,520 
Residential mortgage-backed securities - government issued 3,105  93  —  3,198 
Residential mortgage-backed securities - government-sponsored enterprises
3,470  125  —  3,595 
Commercial mortgage-backed securities - government-sponsored enterprises 2,011  213  —  2,224 
  $ 24,783  $ 773  $ (19) $ 25,537 
  As of December 31, 2020
Amortized Cost Gross
Unrealized Gains
Gross
Unrealized Losses
Fair Value
  (In Thousands)
Held-to-maturity:
Municipal securities $ 17,106  $ 417  $ (15) $ 17,508 
Residential mortgage-backed securities - government issued 3,564  112  —  3,676 
Residential mortgage-backed securities - government-sponsored enterprises
3,693  163  —  3,856 
Commercial mortgage-backed securities - government-sponsored enterprises
2,011  282  —  2,293 
  $ 26,374  $ 974  $ (15) $ 27,333 

U.S. government agency securities - government-sponsored enterprises represent securities issued by Federal National Mortgage Association (“FNMA”) and the SBA. Municipal securities include securities issued by various municipalities located primarily within Wisconsin and are primarily general obligation bonds that are tax-exempt in nature. Residential and commercial mortgage-backed securities - government issued represent securities guaranteed by the Government National Mortgage Association. Residential and commercial mortgage-backed securities - government-sponsored enterprises include securities guaranteed by the Federal Home Loan Mortgage Corporation, FNMA, and the FHLB. Other securities represent certificates of deposit of insured banks and savings institutions with an original maturity greater than three months. There were no sales of available-for-sale securities that occurred during the three months ended March 31, 2021 and one sale of available-for-sale securities that occurred during the three months ended March 31, 2020.

At March 31, 2021 and December 31, 2020, securities with a fair value of $29.7 million and $73.7 million, respectively, were pledged to secure various obligations, including interest rate swap contracts and municipal deposits.
12

The amortized cost and fair value of securities by contractual maturity at March 31, 2021 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay certain obligations with or without call or prepayment penalties.
Available-for-Sale Held-to-Maturity
  Amortized Cost Fair Value Amortized Cost Fair Value
(In Thousands)
Due in one year or less $ —  $ —  $ 2,663  $ 2,672 
Due in one year through five years 8,575  8,770  11,129  11,306 
Due in five through ten years 41,310  42,045  8,754  9,213 
Due in over ten years 121,270  122,446  2,237  2,346 
  $ 171,155  $ 173,261  $ 24,783  $ 25,537 

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 March 31, 2021 and December 31, 2020. At March 31, 2021, the Corporation held 26 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 March 31, 2021, the Corporation held four 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 unaudited Consolidated Statements of Income for the three months ended March 31, 2021 and 2020.

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:
  As of March 31, 2021
  Less than 12 Months 12 Months or Longer Total
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
  (In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises
$ 3,374  $ 126  $ 14,357  $ 77  $ 17,731  $ 203 
Municipal securities
10,192  130  —  —  10,192  130 
Residential mortgage-backed securities - government-sponsored enterprises
18,247  401  —  —  18,247  401 
Commercial mortgage-backed securities - government-sponsored enterprises
8,832  432  —  —  8,832  432 
  $ 40,645  $ 1,089  $ 14,357  $ 77  $ 55,002  $ 1,166 
13

  As of December 31, 2020
  Less than 12 Months 12 Months or Longer Total
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
  (In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises
$ 11,602  $ 45  $ 4,031  $ 34  $ 15,633  $ 79 
Municipal securities
2,863  —  —  2,863 
Residential mortgage-backed securities - government-sponsored enterprises
19,078  49  —  —  19,078  49 
  $ 33,543  $ 98  $ 4,031  $ 34  $ 37,574  $ 132 

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 March 31, 2021 and December 31, 2020. At March 31, 2021, the Corporation held three 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 two held-to-maturity securities that had been in a continuous loss position for twelve months or greater as of March 31, 2021. 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 unaudited Consolidated Statements of Income for the three months ended March 31, 2021 and 2020.

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:
  As of March 31, 2021
  Less than 12 Months 12 Months or Longer Total
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
  (In Thousands)
Held-to-maturity:
Municipal securities
$ —  $ —  $ 484  $ 19  $ 484  $ 19 
Residential mortgage-backed securities - government issued
—  —  —  — 
  $ $ —  $ 484  $ 19  $ 489  $ 19 
  As of December 31, 2020
  Less than 12 Months 12 Months or Longer Total
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
Fair Value Unrealized
Losses
  (In Thousands)
Held-to-maturity:
Municipal securities
$ 276  $ 13  $ 213  $ $ 489  $ 15 

14

Note 6 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses

Loan and lease receivables consist of the following:
March 31,
2021
December 31,
2020
  (In Thousands)
Commercial real estate:    
Commercial real estate — owner occupied
$ 256,812  $ 253,882 
Commercial real estate — non-owner occupied
592,090  564,532 
Land development
46,544  49,839 
Construction
151,345  141,043 
Multi-family
322,384  311,556 
1-4 family
23,319  38,284 
Total commercial real estate
1,392,494  1,359,136 
Commercial and industrial 784,305  732,318 
Direct financing leases 19,616  22,331 
Consumer and other:    
Home equity and second mortgages
6,719  7,833 
Other
38,266  28,897 
Total consumer and other
44,985  36,730 
Total gross loans and leases receivable
2,241,400  2,150,515 
Less:    
   Allowance for loan and lease losses 28,982  28,521 
   Deferred loan fees 6,288  4,545 
Loans and leases receivable, net
$ 2,206,130  $ 2,117,449 
As of March 31, 2021 and December 31, 2020, the Corporation had $272.7 million and $228.9 million, respectively, in gross PPP loans outstanding included in the commercial and industrial loan category and deferred processing fees outstanding of $5.1 million and $3.5 million, respectively, included in deferred loan fees. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any at all, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.
The total amount of the Corporation’s ownership of SBA loans comprised of the following:
March 31,
2021
December 31,
2020
(In Thousands)
SBA 7(a) loans $ 33,870  $ 36,266 
SBA 504 loans 30,004  26,327 
SBA Express loans and lines of credit 910  1,251 
SBA PPP loans 272,664  228,870 
Total SBA loans $ 337,448  $ 292,714 
As of March 31, 2021 and December 31, 2020, $8.6 million and $9.3 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 and participation interests in other, non-SBA originated loans. The total principal amount of the guaranteed portions of SBA loans sold during the three months ended March 31, 2021, and 2020, was $10.6 million and $2.7 million, respectively.
15

Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred during the three months ended March 31, 2021, and 2020, have been derecognized in the unaudited Consolidated Financial Statements. The guaranteed portions of SBA loans were transferred at their fair value and the related gain was recognized upon the transfer as non-interest income in the unaudited Consolidated Financial Statements. The total outstanding balance of sold SBA loans at March 31, 2021, and December 31, 2020, was $82.7 million and $79.5 million, respectively.

The total principal amount of transferred participation interests in other, non-SBA originated loans during the three months ended March 31, 2021, and 2020, was $5.2 million and $11.9 million, respectively, all of which were treated as sales and derecognized under the applicable accounting guidance at the time of transfer. No gain or loss was recognized on participation interests in other, non-SBA originated loans as they were transferred at or near the date of loan origination and the payments received for servicing the portion of the loans participated represents adequate compensation. The total outstanding balance of these transferred loans at March 31, 2021, and December 31, 2020, was $151.3 million and $153.6 million, respectively. As of March 31, 2021, and December 31, 2020, the total amount of the Corporation’s partial ownership of these transferred loans on the unaudited Consolidated Balance Sheets was $259.9 million and $276.5 million, respectively. As of March 31, 2021 and December 31, 2020, the non-SBA originated participation portfolio contained an impaired loan totaling $3.0 million with a sold portion of $4.2 million. The Corporation does not share in the participant’s portion of any potential charge-offs. There were no loan participations purchased on the unaudited Consolidated Balance Sheets as of March 31, 2021, and the total of loan participations purchased as of December 31, 2020 was $410,000.

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:
March 31, 2021
  Category  
I II III IV Total
  (Dollars in Thousands)
Commercial real estate:          
Commercial real estate — owner occupied $ 204,135  $ 26,314  $ 24,194  $ 2,169  $ 256,812 
Commercial real estate — non-owner occupied 467,823  75,026  46,225  3,016  592,090 
Land development 45,022  1,340  182  —  46,544 
Construction 111,372  11,988  27,985  —  151,345 
Multi-family 280,736  31,623  10,025  —  322,384 
1-4 family 20,113  415  2,298  493  23,319 
      Total commercial real estate 1,129,201  146,706  110,909  5,678  1,392,494 
Commercial and industrial 696,621  25,239  49,670  12,775  784,305 
Direct financing leases, net 13,239  678  5,650  49  19,616 
Consumer and other:        
Home equity and second mortgages 6,104  —  81  534  6,719 
Other 38,087  164  —  15  38,266 
      Total consumer and other 44,191  164  81  549  44,985 
Total gross loans and leases receivable $ 1,883,252  $ 172,787  $ 166,310  $ 19,051  $ 2,241,400 
Category as a % of total portfolio 84.02  % 7.71  % 7.42  % 0.85  % 100.00  %
16

December 31, 2020
  Category  
I II III IV Total
  (Dollars in Thousands)
Commercial real estate:          
Commercial real estate — owner occupied $ 185,943  $ 34,917  $ 27,593  $ 5,429  $ 253,882 
Commercial real estate — non-owner occupied 432,053  90,942  37,754  3,783  564,532 
Land development 47,777  987  185  890  49,839 
Construction 104,083  26,444  10,516  —  141,043 
Multi-family 278,145  23,386  10,025  —  311,556 
1-4 family 35,053  620  2,315  296  38,284 
      Total commercial real estate 1,083,054  177,296  88,388  10,398  1,359,136 
Commercial and industrial 623,346  27,201  65,616  16,155  732,318 
Direct financing leases, net 15,597  730  5,955  49  22,331 
Consumer and other:          
Home equity and second mortgages 7,206  496  91  40  7,833 
Other 28,701  175  —  21  28,897 
      Total consumer and other 35,907  671  91  61  36,730 
Total gross loans and leases receivable $ 1,757,904  $ 205,898  $ 160,050  $ 26,663  $ 2,150,515 
Category as a % of total portfolio 81.75  % 9.57  % 7.44  % 1.24  % 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 asset quality review committees.
Category III — Loans and leases in this category are identified by management as warranting special attention. However, the balance in this category is not intended to represent the amount of adversely classified assets held by the Bank. Category III loans and leases generally exhibit undesirable characteristics, such as evidence of adverse financial trends and conditions, managerial problems, deteriorating economic conditions within the related industry, or evidence of adverse public filings and may exhibit collateral shortfall positions. Management continues to believe that it will collect all contractual principal and interest in accordance with the original terms of the contracts relating to the loans and leases in this category, and therefore Category III loans are considered performing with no specific reserves established for this category. Category III loans are monitored by management and asset quality review committees on a monthly basis.
Category IV — Loans and leases in this category are 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 that the Bank will receive the contractual principal and interest in accordance with the original terms of the agreement. Impaired
17

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 asset quality review committees on a monthly basis.
The delinquency aging of the loan and lease portfolio by class of receivable was as follows:
18

March 31, 2021
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 $ —  $ —  $ —  $ —  $ 254,643  $ 254,643 
Non-owner occupied —  —  —  —  589,074  589,074 
Land development —  —  —  —  46,544  46,544 
Construction —  —  —  —  151,345  151,345 
Multi-family —  —  —  —  322,384  322,384 
1-4 family —  —  —  —  22,826  22,826 
Commercial and industrial 1,349  570  —  1,919  769,670  771,589 
Direct financing leases, net —  —  —  —  19,567  19,567 
Consumer and other:          
Home equity and second mortgages —  —  —  —  6,185  6,185 
Other —  —  —  —  38,251  38,251 
Total 1,349  570  —  1,919  2,220,489  2,222,408 
Non-accruing loans and leases            
Commercial real estate:            
Owner occupied —  —  272  272  1,897  2,169 
Non-owner occupied —  —  —  —  3,016  3,016 
Land development —  —  —  —  —  — 
Construction —  —  —  —  —  — 
Multi-family —  —  —  —  —  — 
1-4 family —  —  247  247  246  493 
Commercial and industrial 3,991  366  5,911  10,268  2,448  12,716 
Direct financing leases, net —  —  —  —  49  49 
Consumer and other:            
Home equity and second mortgages —  496  —  496  38  534 
Other —  —  15  15  —  15 
Total 3,991  862  6,445  11,298  7,694  18,992 
Total loans and leases            
Commercial real estate:            
Owner occupied —  —  272  272  256,540  256,812 
Non-owner occupied —  —  —  —  592,090  592,090 
Land development —  —  —  —  46,544  46,544 
Construction —  —  —  —  151,345  151,345 
Multi-family —  —  —  —  322,384  322,384 
1-4 family —  —  247  247  23,072  23,319 
Commercial and industrial 5,340  936  5,911  12,187  772,118  784,305 
Direct financing leases, net —  —  —  —  19,616  19,616 
Consumer and other:          
Home equity and second mortgages —  496  —  496  6,223  6,719 
Other —  —  15  15  38,251  38,266 
Total $ 5,340  $ 1,432  $ 6,445  $ 13,217  $ 2,228,183  $ 2,241,400 
Percent of portfolio 0.24  % 0.06  % 0.29  % 0.59  % 99.41  % 100.00  %
19

December 31, 2020
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 $ —  $ —  $ —  $ —  $ 248,453  $ 248,453 
Non-owner occupied —  —  —  —  560,749  560,749 
Land development 7,784  —  —  7,784  41,165  48,949 
Construction —  —  —  —  141,043  141,043 
Multi-family —  —  —  —  311,556  311,556 
1-4 family —  46  —  46  37,988  38,034 
Commercial and industrial 663  111  —  774  715,389  716,163 
Direct financing leases, net —  —  —  —  22,282  22,282 
Consumer and other:            
Home equity and second mortgages —  —  —  —  7,793  7,793 
Other —  —  —  —  28,876  28,876 
Total 8,447  157  —  8,604  2,115,294  2,123,898 
Non-accruing loans and leases            
Commercial real estate:            
Owner occupied —  —  272  272  5,157  5,429 
Non-owner occupied —  —  3,783  3,783  —  3,783 
Land development 890  —  —  890  —  890 
Construction —  —  —  —  —  — 
Multi-family —  —  —  —  —  — 
1-4 family —  —  —  —  250  250 
Commercial and industrial 103  342  7,557  8,002  8,153  16,155 
Direct financing leases, net —  —  —  —  49  49 
Consumer and other:            
Home equity and second mortgages —  —  —  —  40  40 
Other —  —  21  21  —  21 
Total 993  342  11,633  12,968  13,649  26,617 
Total loans and leases            
Commercial real estate:            
Owner occupied —  —  272  272  253,610  253,882 
Non-owner occupied —  —  3,783  3,783  560,749  564,532 
Land development 8,674  —  —  8,674  41,165  49,839 
Construction —  —  —  —  141,043  141,043 
Multi-family —  —  —  —  311,556  311,556 
1-4 family —  46  —  46  38,238  38,284 
Commercial and industrial 766  453  7,557  8,776  723,542  732,318 
Direct financing leases, net —  —  —  —  22,331  22,331 
Consumer and other:            
Home equity and second mortgages —  —  —  —  7,833  7,833 
Other —  —  21  21  28,876  28,897 
Total $ 9,440  $ 499  $ 11,633  $ 21,572  $ 2,128,943  $ 2,150,515 
Percent of portfolio 0.44  % 0.02  % 0.54  % 1.00  % 99.00  % 100.00  %
20

The Corporation’s total impaired assets consisted of the following:
March 31,
2021
December 31,
2020
  (In Thousands)
Non-accrual loans and leases    
Commercial real estate:    
Commercial real estate — owner occupied $ 2,169  $ 5,429 
Commercial real estate — non-owner occupied 3,016  3,783 
Land development —  890 
Construction —  — 
Multi-family —  — 
1-4 family 493  250 
Total non-accrual commercial real estate 5,678  10,352 
Commercial and industrial 12,716  16,155 
Direct financing leases, net 49  49 
Consumer and other:    
Home equity and second mortgages 534  40 
Other 15  21 
Total non-accrual consumer and other loans 549  61 
Total non-accrual loans and leases 18,992  26,617 
Foreclosed properties, net 31  34 
Total non-performing assets 19,023  26,651 
Performing troubled debt restructurings 59  46 
Total impaired assets $ 19,082  $ 26,697 
March 31,
2021
December 31,
2020
Total non-accrual loans and leases to gross loans and leases 0.85  % 1.24  %
Total non-performing assets to total gross loans and leases plus foreclosed properties, net 0.85  1.24 
Total non-performing assets to total assets 0.73  1.04 
Allowance for loan and lease losses to gross loans and leases 1.29  1.33 
Allowance for loan and lease losses to non-accrual loans and leases 152.60  107.15 
As of March 31, 2021, and December 31, 2020, $4.8 million and $6.5 million of the non-accrual loans and leases were considered troubled debt restructurings, respectively. The Corporation has allocated $765,000 and $760,000 of specific reserves to troubled debt restructurings as of March 31, 2021 and December 31, 2020, respectively. There were no unfunded commitments associated with troubled debt restructured loans and leases as of March 31, 2021.
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.

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:
21

For the Three Months Ended March 31,
2020
Number of Loans Pre-Modification
Recorded
Investment
Post-Modification
Recorded
Investment
  (Dollars in Thousands)
Commercial real estate:      
Commercial real estate — owner occupied
2 $ 299  $ 299 
Commercial and industrial 4 1,426  1,413 
Total 6 $ 1,725  $ 1,712 

During the three months ended March 31, 2021, no loans were modified to a troubled debt restructuring.

Restructured loan modifications may include payment schedule modifications, interest rate concessions, maturity date extensions, principal reduction, or some combination of these concessions. During the three months ended March 31, 2020, the modification of terms primarily consisted of payment schedule modifications or principal reductions.

There were no loans modified in troubled debt restructurings during the previous 12 months which subsequently defaulted during the three months ended March 31, 2021. There was one commercial and industrial loan for $2.1 million and two owner-occupied commercial real estate loans for $3.6 million modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the three months ended March 31, 2020.

22

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 Three Months Ended March 31, 2021
Recorded
Investment
(1)
Unpaid
Principal
Balance
Impairment
Reserve
Average
Recorded
Investment
(2)
Foregone
Interest
Income
Interest
Income
Recognized
Net
Foregone
Interest
Income
  (In Thousands)
With no impairment reserve recorded:
             
Commercial real estate:              
Owner occupied $ 1,139  $ 1,166  $ —  $ 3,227  $ 75  $ —  $ 75 
Non-owner occupied 3,016  5,795  —  3,221  133  15  118 
Land development
—  —  —  30  —  —  — 
Construction
—  —  —  —  —  —  — 
Multi-family —  —  —  —  —  —  — 
1-4 family 493  252  —  291  43  40 
Commercial and industrial 5,232  6,392  —  8,136  133  43  90 
Direct financing leases, net —  —  —  —  —  —  — 
Consumer and other:              
Home equity and second mortgages
496  496  —  — 
Other 15  682  —  18  — 
Total 10,391  14,783  —  14,929  399  61  338 
With impairment reserve recorded:              
Commercial real estate:              
Owner occupied 1,030  1,030  485  1,044  60  —  60 
Non-owner occupied —  —  —  —  —  —  — 
Land development
—  —  —  —  —  —  — 
Construction —  —  —  —  —  —  — 
Multi-family —  —  —  —  —  —  — 
1-4 family —  —  —  —  —  —  — 
Commercial and industrial 7,543  8,680  2,947  6,030  141  134 
Direct financing leases, net 49  49  49  49  — 
Consumer and other:              
Home equity and second mortgages
38  38  39  — 
Other —  —  —  —  —  —  — 
Total 8,660  9,797  3,487  7,162  204  197 
Total:              
Commercial real estate:              
Owner occupied 2,169  2,196  485  4,271  135  —  135 
Non-owner occupied 3,016  5,795  —  3,221  133  15  118 
Land development
—  —  —  30  —  —  — 
Construction —  —  —  —  —  —  — 
Multi-family —  —  —  —  —  —  — 
1-4 family 493  252  —  291  43  40 
Commercial and industrial 12,775  15,072  2,947  14,166  274  50  224 
Direct financing leases, net 49  49  49  49  — 
Consumer and other:              
Home equity and second mortgages 534  534  45  — 
Other 15  682  —  18  — 
Grand total $ 19,051  $ 24,580  $ 3,487  $ 22,091  $ 603  $ 68  $ 535 
(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.
23

As of and for the Year Ended December 31, 2020
Recorded
Investment(1)
Unpaid
Principal
Balance
Impairment
Reserve
Average
Recorded
Investment(2)
Foregone
Interest
Income
Interest
Income
Recognized
Net
Foregone
Interest
Income
  (In Thousands)
With no impairment reserve recorded:
             
Commercial real estate:              
   Owner occupied $ 4,338  $ 4,365  $ —  $ 4,565  $ 291  $ 72  $ 219 
   Non-owner occupied 3,783  6,563  —  1,519  486  —  486 
   Land development 890  5,187  —  1,192  14  —  14 
   Construction —  —  —  —  —  —  — 
   Multi-family —  —  —  —  —  —  — 
   1-4 family 46  51  —  307  31  141  (110)
Commercial and industrial 9,888  12,337  —  13,951  1,219  423  796 
Direct financing leases, net —  —  —  89  —  —  — 
Consumer and other:              
   Home equity and second mortgages
—  —  —  —  —  — 
   Other 21  688  —  85  41  —  41 
      Total 18,966  29,191  —  21,709  2,082  636  1,446 
With impairment reserve recorded:              
Commercial real estate:              
   Owner occupied 1,091  4,792  471  2,349  384  —  384 
   Non-owner occupied —  —  —  —  —  —  — 
   Land development —  —  —  —  —  —  — 
   Construction —  —  —  —  —  —  — 
   Multi-family —  —  —  —  —  —  — 
   1-4 family 250  250  29  21  —  —  — 
Commercial and industrial 6,267  6,972  3,125  3,585  324  —  324 
Direct financing leases, net 49  49  49  39  — 
Consumer and other:              
   Home equity and second mortgages
40  40  —  — 
   Other —  —  —  —  —  —  — 
      Total 7,697  12,103  3,681  5,994  712  —  712 
Total:              
Commercial real estate:              
   Owner occupied 5,429  9,157  471  6,914  675  72  603 
   Non-owner occupied 3,783  6,563  —  1,519  486  —  486 
   Land development 890  5,187  —  1,192  14  —  14 
   Construction —  —  —  —  —  —  — 
   Multi-family —  —  —  —  —  —  — 
   1-4 family 296  301  29  328  31  141  (110)
Commercial and industrial 16,155  19,309  3,125  17,536  1,543  423  1,120 
Direct financing leases, net 49  49  49  128  — 
Consumer and other:            
Home equity and second mortgages
40  40  — 
Other 21  688  —  85  41  —  41 
      Grand total $ 26,663  $ 41,294  $ 3,681  $ 27,703  $ 2,794  $ 636  $ 2,158 
(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.
24

The difference between the recorded investment of loans and leases and the unpaid principal balance of $5.5 million and $14.6 million as of March 31, 2021, and December 31, 2020, respectively, represents partial charge-offs of loans and leases resulting from losses due to the valuation of the collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $59,000 and $46,000 of loans as of March 31, 2021, and December 31, 2020, 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:
  As of and for the Three Months Ended March 31, 2021
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
  (In Thousands)
Beginning balance $ 17,157  $ 10,593  $ 771  $ 28,521 
Charge-offs —  (144) —  (144)
Recoveries 2,219  453  2,673 
Net recoveries 2,219  309  2,529 
Provision for loan and lease losses (931) (1,358) 221  (2,068)
Ending balance $ 18,445  $ 9,544  $ 993  $ 28,982 
  As of and for the Three Months Ended March 31, 2020
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
  (In Thousands)
Beginning balance $ 10,852  $ 8,078  $ 590  $ 19,520 
Charge-offs —  (125) (6) (131)
Recoveries 176  —  177 
Net recoveries (charge-offs) 51  (6) 46 
Provision for loan and lease losses 1,744  1,193  245  3,182 
Ending balance $ 12,597  $ 9,322  $ 829  $ 22,748 

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The following tables provide information regarding the allowance for loan and lease losses and balances by type of allowance methodology.
  As of March 31, 2021
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
  (In Thousands)
Allowance for loan and lease losses:        
Collectively evaluated for impairment $ 17,960  $ 6,548  $ 987  $ 25,495 
Individually evaluated for impairment 485  2,996  3,487 
Total $ 18,445  $ 9,544  $ 993  $ 28,982 
Loans and lease receivables:        
Collectively evaluated for impairment $ 1,386,816  $ 791,097  $ 44,436  $ 2,222,349 
Individually evaluated for impairment 5,678  12,824  549  19,051 
Total $ 1,392,494  $ 803,921  $ 44,985  $ 2,241,400 
  As of December 31, 2020
Commercial
Real Estate
Commercial
and
Industrial
Consumer
and Other
Total
  (In Thousands)
Allowance for loan and lease losses:        
Collectively evaluated for impairment $ 16,657  $ 7,419  $ 764  $ 24,840 
Individually evaluated for impairment 500  3,174  3,681 
Total $ 17,157  $ 10,593  $ 771  $ 28,521 
Loans and lease receivables:        
Collectively evaluated for impairment $ 1,348,738  $ 738,445  $ 36,669  $ 2,123,852 
Individually evaluated for impairment 10,398  16,204  61  26,663 
Total $ 1,359,136  $ 754,649  $ 36,730  $ 2,150,515 


Note 7 — Leases
The Corporation leases various office spaces and specialty financing production offices under non-cancellable operating leases which expire on various dates through 2028. The Corporation also leases office equipment. The Corporation recognizes a right-of-use asset and an operating lease liability for all leases, with the exception of short-term leases. Right-of-use assets represent the right to use an underlying asset for the lease term and lease liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. Lease expense for operating leases and short-term leases is recognized on a straight-line basis over the lease term.
The Corporation entered into a sublease for vacated office space which expires in 2023.
26

The components of total lease expense were as follows:
For the Three Months Ended March 31,
2021 2020
(In Thousands)
Operating lease cost
$ 375  $ 372 
Short-term lease cost
39  74 
Variable lease cost
129  127 
Less: sublease income
(39) (28)
Total lease cost, net
$ 504  $ 545 

Quantitative information regarding the Corporation’s operating leases was as follows:
March 31, 2021 December 31, 2020
Weighted-average remaining lease term (in years)
5.66 5.80
Weighted-average discount rate
3.06  % 3.03  %
The following maturity analysis shows the undiscounted cash flows due on the Corporation’s operating lease liabilities:
(In Thousands)
2021 $ 1,163 
2022 1,373 
2023 1,015 
2024 756 
2025 666 
Thereafter 1,641 
Total undiscounted cash flows 6,614 
Discount on cash flows (574)
Total lease liability $ 6,040 


Note 8 — Other Assets
A summary of accrued interest receivable and other assets was as follows:
  March 31, 2021 December 31, 2020
  (In Thousands)
Accrued interest receivable $ 7,794  $ 8,564 
Net deferred tax asset 7,234  7,217 
Investment in historic development entities 2,307  2,356 
Investment in low-income housing development entity 1,307  — 
Investment in a community development entity 5,306  5,306 
Investment in limited partnerships 7,361  6,673 
Investment in Trust II 315  315 
Prepaid expenses 2,947  2,165 
Other assets 3,446  6,882 
Total accrued interest receivable and other assets $ 38,017  $ 39,478 

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Note 9 — Deposits
The composition of deposits is shown below. Average balances represent year to date averages.
  March 31, 2021 December 31, 2020
Balance Average
Balance
Average Rate Balance Average
Balance
Average Rate
  (Dollars in Thousands)
Non-interest-bearing transaction accounts
$ 496,877  $ 485,863  —  % $ 472,818  $ 412,825  —  %
Interest-bearing transaction accounts
561,466  521,130  0.19  503,992  392,576  0.37 
Money market accounts 632,065  657,690  0.17  641,504  651,402  0.44 
Certificates of deposit 46,818  57,424  1.23  64,694  111,698  1.97 
Wholesale deposits 165,492  166,752  0.76  172,508  142,591  1.71 
Total deposits $ 1,902,718  $ 1,888,859  0.22  $ 1,855,516  $ 1,711,092  0.52 

A summary of annual maturities of in-market and wholesale certificates of deposit at March 31, 2021 is as follows:
(In Thousands)
Maturities during the year ended December 31,  
2021 $ 60,465 
2022 24,319 
2023 1,796 
2024 369 
2025 360 
Thereafter
$ 87,310 

Wholesale deposits include $40.5 million and $125.0 million of wholesale certificates of deposit and non-reciprocal interest-bearing transaction accounts, respectively, at March 31, 2021, compared to $47.5 million and $125.0 million of wholesale certificates of deposit and non-reciprocal interest-bearing transaction accounts, respectively, at December 31, 2020.

Deposits include $12.9 million and $28.7 million of certificates of deposit and wholesale deposits which are denominated in amounts of $250,000 or more at March 31, 2021 and December 31, 2020, respectively.

Note 10 — FHLB Advances, Other Borrowings and Junior Subordinated Notes
The composition of borrowed funds is shown below. Average balances represent year to date averages.
  March 31, 2021 December 31, 2020
Balance Weighted Average
Balance
Weighted
Average Rate
Balance Weighted Average
Balance
Weighted
Average Rate
  (Dollars in Thousands)
Federal funds purchased $ —  $ —  —  % $ —  $ 71  0.69  %
Federal Reserve PPPLF
—  —  —  —  15,207  0.35 
FHLB advances
415,800  366,670  1.36  394,500  379,891  1.45 
Other borrowings 8,860  3,545  5.05  920  676  12.60 
Subordinated notes payable 23,757  23,751  5.94  23,747  23,725  5.95 
Junior subordinated notes 10,065  10,063  10.91  10,062  10,054  11.09 
  $ 458,482  $ 404,029  1.91  $ 429,229  $ 429,624  1.91 
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A summary of annual maturities of borrowings at March 31, 2021 is as follows:
(In Thousands)
Maturities during the year ended December 31,  
2021 $ 171,260 
2022 29,000 
2023 37,300 
2024 35,500 
2025 20,925 
Thereafter 164,497 
$ 458,482 
During the second quarter of 2020, the Corporation tested its ability to borrow from the Federal Reserve Paycheck Protection Program Liquidity Facility (“PPPLF”) in the event funding was required to support the Banks PPP lending efforts. On April 28, 2020, the Corporation borrowed $29.6 million from the PPPLF at a rate of 0.35%. The borrowing was fully collateralized by a tranche of PPP loans originated by the Bank on April 15, 2020 and matures on April 15, 2022, or when the tranche of PPP loans utilized to collateralize the PPPLF borrowing are forgiven, whichever comes first. As of November 2, 2020, the borrowing was paid in full.
As of March 31, 2021 and December 31, 2020, the Corporation had other borrowings of $8.9 million and $920,000 respectively, which consisted of $7.9 million of sold loans accounted for as secured borrowings because they did not qualify for true sale accounting, and borrowings associated with our investment in a community development entity.
As of March 31, 2021 and December 31, 2020, the Corporation was in compliance with its debt covenants under its third-party secured senior line of credit. Per the promissory note dated February 19, 2021, the Corporation pays a fee on this line of credit. During both the three months ended March 31, 2021 and 2020, the Corporation incurred interest expense of $3,000 due to this fee.

Note 11 — Commitments and Contingencies
In the normal course of business, various legal proceedings involving the Corporation are pending. Management, based upon advice from legal counsel, does not anticipate any significant losses as a result of these actions. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations, and cash flows.

The Corporation sells the guaranteed portions of SBA 7(a) loans, as well as participation interests in other, non-SBA originated, loans to third parties. The Corporation has a continuing involvement in each of the transferred lending arrangements by way of relationship management and servicing the loans, as well as being subject to normal and customary requirements of the SBA loan program and standard representations and warranties related to sold amounts. In the event of a loss resulting from default and a determination by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Corporation, the SBA may require the Corporation to repurchase the loan, deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from the Corporation. The Corporation must comply with applicable SBA regulations in order to maintain the guaranty. In addition, the Corporation retains the option to repurchase the sold guaranteed portion of an SBA loan if the loan defaults.

Management has assessed estimated losses inherent in the outstanding guaranteed portions of SBA loans sold in accordance with ASC 450, Contingencies, and determined a recourse reserve based on the probability of future losses for these loans to be $593,000 at March 31, 2021, which is reported in accrued interest payable and other liabilities on the unaudited Consolidated Balance Sheets.

29

The summary of the activity in the SBA recourse reserve is as follows:
As of and for the Three Months Ended March 31,
2021 2020
  (In Thousands)
Balance at the beginning of the period $ 723  $ 1,345 
SBA recourse (benefit) provision (130) 25 
Charge-offs, net —  (284)
Balance at the end of the period $ 593  $ 1,086 

Note 12 — Fair Value Disclosures
The Corporation determines the fair values of its financial instruments based on the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is defined as the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date and is based on exit prices. Fair value includes assumptions about risk, such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. The standard describes three levels of inputs that may be used to measure fair value.
Level 1 — Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date.

Level 2 — Level 2 inputs are inputs, other than quoted prices included with Level 1, that are observable for the asset or liability either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 — Level 3 inputs are supported by little or no market activity and are significant to the fair value of the assets or liabilities.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
30

Assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy level, are summarized below:
March 31, 2021
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 $ —  $ 22,235  $ —  $ 22,235 
Municipal securities —  24,275  —  24,275 
Residential mortgage-backed securities - government issued —  9,382  —  9,382 
Residential mortgage-backed securities - government-sponsored enterprises —  90,605  —  90,605 
Commercial mortgage-backed securities - government issued —  4,809  —  4,809 
Commercial mortgage-backed securities - government-sponsored enterprises —  19,689  —  19,689 
Other securities —  2,266  —  2,266 
Interest rate swaps —  26,104  —  26,104 
Liabilities:      
Interest rate swaps —  29,565  —  29,565 
December 31, 2020
  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 $ —  $ 22,629  $ —  $ 22,629 
Municipal securities —  24,779  —  24,779 
Residential mortgage-backed securities - government issued —  10,403  —  10,403 
Residential mortgage-backed securities - government-sponsored enterprises —  105,006  —  105,006 
Commercial mortgage-backed securities - government issued —  5,464  —  5,464 
Commercial mortgage-backed securities - government-sponsored enterprises —  13,365  —  13,365 
Other securities —  2,279  —  2,279 
Interest rate swaps —  49,377  —  49,377 
Liabilities:  
Interest rate swaps —  54,927  —  54,927 

For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the three months ended March 31, 2021 or the year ended December 31, 2020 related to the above measurements.
31

Assets and liabilities measured at fair value on a non-recurring basis, segregated by fair value hierarchy are summarized below:
March 31, 2021
  Fair Value Measurements Using
  Level 1 Level 2 Level 3 Total
  (In Thousands)
Impaired loans $ —  $ —  $ 12,935  $ 12,935 
Foreclosed properties —  —  31  31 
Loan servicing rights —  —  1,370  1,370 
December 31, 2020
  Fair Value Measurements Using
  Level 1 Level 2 Level 3 Total
  (In Thousands)
Impaired loans $ —  $ —  $ 17,203  $ 17,203 
Foreclosed properties —  —  34  34 
Loan servicing rights —  —  1,325  1,325 

Impaired loans were written down to the fair value of their underlying collateral less costs to sell of $12.9 million and $17.2 million at March 31, 2021 and December 31, 2020, 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. These techniques 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 unobservable inputs, typically when discounts are applied to appraisal values to adjust such values to current market conditions or to reflect net realizable values. The quantification of unobservable inputs for Level 3 impaired loan values range from 10% - 91% as of the measurement date of March 31, 2021. The weighted average of those unobservable inputs was 29%. The majority of the impaired loans are considered collateral dependent loans or are supported by an 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 based on observable market data, typically a current appraisal, or based upon assumptions specific to the individual property or equipment, such as management applied discounts used to further reduce values to a net realizable value when observable inputs become stale.
Loan servicing rights represent the asset retained upon sale of the guaranteed portion of certain SBA loans. When SBA loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The servicing rights are subsequently measured using the amortization method, which requires amortization into interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.
The Corporation periodically reviews this portfolio for impairment and engages a third-party valuation firm to assess the fair value of the overall servicing rights portfolio. Loan servicing rights do not trade in an active, open market with readily observable prices. While sales of loan servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Corporation utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its loan servicing rights. The valuation model incorporates prepayment assumptions to project loan servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the loan servicing rights. The valuation model considers portfolio characteristics of the underlying serviced portion of the SBA loans and uses the following significant unobservable inputs: (1) constant prepayment rate (“CPR”) assumptions based on the SBA sold pools historical CPR as quoted in Bloomberg and (2) a discount rate. Due to the nature of the valuation inputs, loan servicing rights are classified in Level 3 of the fair value hierarchy.





32

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:
March 31, 2021
Carrying
Amount
Fair Value
Total Level 1 Level 2 Level 3
  (In Thousands)
Financial assets:    
Cash and cash equivalents $ 58,874  $ 58,874  $ 58,874  $ —  $ — 
Securities available-for-sale 173,261  173,261  —  173,261  — 
Securities held-to-maturity 24,783  25,537  —  25,537  — 
Loans held for sale 6,576  7,167  —  7,167  — 
Loans and lease receivables, net 2,206,130  2,210,391  —  —  2,210,391 
Federal Home Loan Bank stock
14,941  N/A N/A N/A N/A
Accrued interest receivable 7,794  7,794  7,794  —  — 
Interest rate swaps 26,104  26,104  —  26,104  — 
Financial liabilities:  
Deposits 1,902,718  1,903,873  1,815,408  88,465  — 
Federal Home Loan Bank advances and other borrowings 448,417  459,775  —  459,775  — 
Junior subordinated notes 10,065  9,990  —  —  9,990 
Accrued interest payable 969  969  969  —  — 
Interest rate swaps 29,565  29,565  —  29,565  — 
Off-balance sheet items:  
Standby letters of credit 134  134  —  —  134 
N/A = The fair value is not applicable due to restrictions placed on transferability
33

  December 31, 2020
Carrying
Amount
Fair Value
Total Level 1 Level 2 Level 3
  (In Thousands)
Financial assets:    
Cash and cash equivalents $ 56,909  $ 56,909  $ 56,909  $ —  $ — 
Securities available-for-sale 183,925  183,925  —  183,925  — 
Securities held-to-maturity 26,374  27,333  —  27,333  — 
Loans held for sale 8,695  9,478  —  9,478  — 
Loans and lease receivables, net 2,117,449  2,121,107  —  —  2,121,107 
Federal Home Loan Bank stock
13,578  N/A N/A N/A N/A
Accrued interest receivable 8,564  8,564  8,564  —  — 
Interest rate swaps 49,377  49,377  —  49,377  — 
Financial liabilities:  
Deposits 1,855,516  1,856,910  1,743,314  113,596  — 
Federal Home Loan Bank advances and other borrowings
419,167  429,347  —  429,347  — 
Junior subordinated notes 10,062  9,986  —  —  9,986 
Accrued interest payable 1,578  1,578  1,578  —  — 
Interest rate swaps 54,927  54,927  —  54,927  — 
Off-balance sheet items:  
Standby letters of credit 75  75  —  —  75 

N/A = The fair value is not applicable due to restrictions placed on transferability
Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the unaudited Consolidated Balance Sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Corporation.
Securities: The fair value measurements of investment securities are determined by a third-party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information, and the securities’ terms and conditions, among other things. The fair value measurements are subject to independent verification by another pricing source on a quarterly basis to review for reasonableness. Any significant differences in pricing are reviewed with appropriate members of management who have the relevant technical expertise to assess the results. The Corporation has determined that these valuations are classified in Level 2 of the fair value hierarchy. When the independent pricing service does not provide a fair value measurement for a particular security, the Corporation will estimate the fair value based on specific information about each security. Fair values derived in this manner are classified in Level 3 of the fair value hierarchy.

Loans Held for Sale: Loans held for sale, which consist of the guaranteed portions of SBA 7(a) loans, are carried at the lower of cost or estimated fair value. The estimated fair value is based on what secondary markets are currently offering for portfolios with similar characteristics.
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
34

respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Corporation considers the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Limitations: Fair value estimates are made at a discrete point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holding of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and are not considered in the estimates.

Note 13 — Derivative Financial Instruments
The Corporation offers interest rate swap products directly to qualified commercial borrowers. The Corporation economically hedges client derivative transactions by entering into offsetting interest rate swap contracts executed with a third party. Derivative transactions executed as part of this program are not considered hedging instruments and are marked-to-market through earnings each period. The derivative contracts have mirror-image terms, which results in the positions’ changes in fair value offsetting through earnings each period. The credit risk and risk of non-performance embedded in the fair value calculations is different between the dealer counterparties and the commercial borrowers which may result in a difference in the changes in the fair value of the mirror-image swaps. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the counterparty’s risk in the fair value measurements. When evaluating the fair value of its derivative contracts for the effects of non-performance and credit risk, the Corporation considered the impact of netting and any applicable credit enhancements such as collateral postings, thresholds, and guarantees. During the three months ended March 31, 2021, a credit valuation adjustment was recognized resulting in a $170,000 benefit.
At March 31, 2021, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $645.1 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 January 2024 and March 2038. 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 unaudited Consolidated Balance Sheet as a derivative asset of $26.1 million and a derivative liability of $10.8 million.
At March 31, 2021, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $645.1 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 January 2024 through March 2038. Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported on the unaudited Consolidated Balance Sheet as a net derivative liability of $15.3 million. The gross amount of dealer counterparty swaps, without regard to the enforceable master netting agreement, was a gross derivative liability of $26.1 million and $10.8 million gross derivative asset. No right of offset existed with dealer counterparty swaps as of March 31, 2021.

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 three months ended March 31, 2021 and 2020 had an insignificant impact on the unaudited Consolidated Statements of Income.

The Corporation also enters into interest rate swaps to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The instruments are designated as cash flow hedges as the receipt of floating rate interest from the counterparty is used to manage interest rate risk 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.

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As of March 31, 2021, the aggregate notional value of interest rate swaps designated as cash flow hedges was $114.0 million. These interest rate swaps mature between December 2021 and December 2027. A pre-tax unrealized gain of $2.1 million was recognized in other comprehensive income for the three months ended March 31, 2021, and there was no ineffective portion of these hedges.
Information about the balance sheet location and fair value of the Corporation’s derivative instruments below:
  Interest Rate Swap Contracts
Asset Derivatives Liability Derivatives
  Balance Sheet Location Fair Value Balance Sheet Location Fair Value
  (In Thousands)
Derivatives not designated as hedging instruments        
March 31, 2021 Derivatives $ 26,104  Derivatives $ 26,104 
December 31, 2020 Derivatives $ 49,377  Derivatives $ 49,377 
Derivatives designated as hedging instruments        
March 31, 2021
Accumulated other comprehensive income (1)
$ 3,461  Derivatives $ 3,461 
December 31, 2020
Accumulated other comprehensive income (1)
$ 5,550  Derivatives $ 5,550 
(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 14 — Regulatory Capital

The Corporation and the Bank are subject to various regulatory capital requirements administered by Federal and Wisconsin banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions on the part of regulators, that if undertaken, could have a direct material effect on the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory practices. The Corporation’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Corporation regularly reviews and updates, when appropriate, its Capital and Liquidity Action 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”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring, or significantly reducing dividends if: (i) net income available to common shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividend; (ii) the prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios. Management intends, when appropriate under regulatory guidelines, to consult with the Federal Reserve Bank of Chicago and provide it with information on the Corporation’s then-current and prospective earnings and capital position in advance of declaring any cash dividends. As a Wisconsin corporation, the Corporation is subject to the limitations of the Wisconsin Business Corporation Law, which prohibit the Corporation from paying dividends if such payment would: (i) render the Corporation unable to pay its debts as they become due in the usual course of business, or (ii) result in the Corporation’s assets being less than the sum of its total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of any shareholders with preferential rights superior to those shareholders receiving the dividend.
The Bank is also subject to certain legal, regulatory, and other restrictions on their ability to pay dividends to the Corporation. As a bank holding company, the payment of dividends by the Bank to the Corporation is one of the sources of funds the
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Corporation could use to pay dividends, if any, in the future and to make other payments. Future dividend decisions by the Bank and the Corporation will continue to be subject to compliance with various legal, regulatory, and other restrictions as defined from time to time.
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.
As of March 31, 2021, the Corporation’s capital levels exceeded the regulatory minimums and the Bank’s capital levels remained characterized as well capitalized under the regulatory framework. The following tables summarize both the Corporation’s and the Bank’s capital ratios and the ratios required by their federal regulators:
As of March 31, 2021
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)
Total capital
(to risk-weighted assets)
Consolidated $ 267,291  11.52  % $ 185,682  8.00  % $ 243,708  10.50  % N/A N/A
First Business Bank 260,529  11.24  185,412  8.00  243,354  10.50  231,765  10.00  %
Tier 1 capital
(to risk-weighted assets)
Consolidated $ 214,510  9.24  % $ 139,262  6.00  % $ 197,288  8.50  % N/A N/A
First Business Bank 231,547  9.99  139,059  6.00  197,001  8.50  185,412  8.00 
Common equity tier 1 capital
(to risk-weighted assets)
Consolidated $ 204,445  8.81  % $ 104,446  4.50  % $ 162,472  7.00  % N/A N/A
First Business Bank 231,547  9.99  104,294  4.50  162,236  7.00  150,648  6.50 
Tier 1 leverage capital
(to adjusted assets)
Consolidated $ 214,510  8.37  % $ 102,499  4.00  % $ 102,499  4.00  % N/A N/A
First Business Bank 231,547  9.08  102,027  4.00  102,027  4.00  127,534  5.00 
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As of December 31, 2020
  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)
Total capital
(to risk-weighted assets)
           
Consolidated $ 258,607  11.25  % $ 183,965  8.00  % $ 241,454  10.50  % N/A N/A
First Business Bank 251,116  10.97  183,053  8.00  240,257  10.50  228,816  10.00  %
Tier 1 capital
(to risk-weighted assets)
Consolidated $ 206,104  8.96  % $ 137,974  6.00  % $ 195,463  8.50  % N/A N/A
First Business Bank 222,500  9.72  137,290  6.00  194,494  8.50  183,053  8.00 
Common equity tier 1 capital
(to risk-weighted assets)
Consolidated $ 196,042  8.53  % $ 103,480  4.50  % $ 160,970  7.00  % N/A N/A
First Business Bank 222,500  9.72  102,967  4.50  160,171  7.00  148,731  6.50 
Tier 1 leverage capital
(to adjusted assets)
Consolidated $ 206,104  7.99  % $ 103,228  4.00  % $ 103,228  4.00  % N/A N/A
First Business Bank 222,500  8.67  102,635  4.00  102,635  4.00  128,294  5.00 
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
    Unless otherwise indicated or unless the context requires otherwise, all references in this Report to the “Corporation,” “we,” “us,” “our,” or similar references mean First Business Financial Services, Inc. together with our subsidiary. “FBB” or the “Bank” refers to our subsidiary, First Business Bank.
Forward-Looking Statements
    This report may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect our current views with respect to future events and financial performance. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results, or other developments. Forward-looking statements are based on management’s expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Such statements are subject to risks and uncertainties, including among other things:
Adverse changes in the economy or business conditions, either nationally or in our markets, including, without limitation, the adverse effects of the COVID-19 pandemic on the global, national, and local economy, which may affect the Corporation’s credit quality, revenue, and business operations.
Competitive pressures among depository and other financial institutions nationally and in our markets.
Increases in defaults by borrowers and other delinquencies.
Our ability to manage growth effectively, including the successful expansion of our client support, administrative infrastructure, and internal management systems.
Fluctuations in interest rates and market prices.
The consequences of continued bank acquisitions and mergers in our markets, resulting in fewer but much larger and financially stronger competitors.
Changes in legislative or regulatory requirements applicable to us and our subsidiaries.
Changes in tax requirements, including tax rate changes, new tax laws, and revised tax law interpretations.
Fraud, including client and system failure or breaches of our network security, including our internet banking activities.
Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portions of SBA loans.
    These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our stockholders and potential investors. See Part I, Item 1A — Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2020 for discussion relating to risk factors impacting us. Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors described within this Form 10-Q could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods.
    Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that, while our management believes such assumptions or bases are reasonable and are made in good faith, assumed facts or bases can vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, an expectation or belief is expressed as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
    We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements.
    The following discussion and analysis is intended as a review of significant events and factors affecting our financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with the unaudited Consolidated Financial Statements and the Notes thereto presented in this Form 10-Q.

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Overview
    We are a registered bank holding company incorporated under the laws of the State of Wisconsin and are engaged in the commercial banking business through our wholly-owned banking subsidiary, FBB. All of our operations are conducted through FBB and First Business Specialty Finance, LLC (“FBSF”), a wholly-owned subsidiary of FBB. We operate as a business bank focusing on delivering a full line of commercial banking products and services tailored to meet the specific needs of small and medium-sized businesses, business owners, executives, professionals, and high net worth individuals. Our products and services include those for business banking, private wealth, and bank consulting. Within business banking, we offer commercial lending, consumer and other lending, asset-based lending, accounts receivable financing, equipment financing, floorplan financing, vendor financing, SBA lending and servicing, treasury management services, and company retirement plans. Our private wealth services for executives and individuals include trust and estate administration, financial planning, investment management, and private banking. For other financial institutions, our bank consulting experts provide investment portfolio administrative services, asset liability management services, and asset liability management process validation. We do not utilize a branch network to attract retail clients. Our operating philosophy is predicated on deep client relationships within our commercial bank markets and skilled expertise within our nationwide specialty finance business lines, combined with the efficiency of centralized administrative functions, such as information technology, loan and deposit operations, finance and accounting, credit administration, compliance, marketing, and human resources. Our focused model allows experienced staff to provide the level of financial expertise needed to develop and maintain long-term relationships with our clients.
Financial Performance Summary

    Results as of and for the three months ended March 31, 2021 include:

Net income totaled $9.7 million, or diluted earnings per share of $1.12, for the three months ended March 31, 2021, compared to $3.3 million, or diluted earnings per share of $0.38, for the same period in 2020.
Annualized return on average assets and annualized return on average equity for the three months ended March 31, 2021 measured 1.51% and 18.48%, respectively, compared to 0.62% and 7.14% for the same period in 2020.
Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled $10.6 million for the three months ended March 31, 2021, up 40.1% from the same period in 2020. Pre-tax, pre-provision adjusted return on average assets was 1.65% for the three months ended March 31, 2021, compared to 1.44% for the same period in 2020.
Net interest margin was 3.44% for both the three months ended March 31, 2021 and March 31, 2020. Adjusted net interest margin, which excludes certain one-time and discrete items, was 3.20% for the three months ended March 31, 2021 compared to 3.32% for the three months ended March 31, 2020.
Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled $3.1 million for the three months ended March 31, 2021 compared to $798,000 for the three months ended March 31, 2020.
Top line revenue, defined as net interest income plus non-interest income, totaled $28.1 million for the three months ended March 31, 2021, up 19.6% from the same period in 2020.
Provision for loan and lease losses was a benefit of $2.1 million for the three months ended March 31, 2021 compared to an expense of $3.2 million for the same period in 2020.
Non-interest income totaled $7.2 million for the three months ended March 31, 2021, once again exceeding the Corporation’s goal of 25%, compared to $6.4 million for the three months ended March 31, 2020.
Non-interest expense was $17.3 million for the three months ended March 31, 2021 compared to $16.1 million for the three months ended March 31, 2020. Operating expense, which excludes certain one-time and discrete items, totaled $17.4 million for the three months ended March 31, 2021 compared to $15.9 million for the three months ended March 31, 2020.
The efficiency ratio improved to 62.19% for the three months ended March 31, 2021, down from 67.74% for the three months ended March 31, 2020.
Total assets at March 31, 2021 increased $52.9 million, or 8.2% annualized, to $2.621 billion from $2.568 billion at December 31, 2020.
Period-end gross loans and leases receivable at March 31, 2021 increased $89.1 million, or 16.6% annualized, to $2.235 billion from $2.146 billion as of December 31, 2020. Average gross loans and leases of $2.183 billion increased $449.2 million, or 25.9%, for the three months ended March 31, 2021, compared to $1.734 billion for the same period in 2020.
Period-end gross loans and leases receivable, excluding net PPP loans, at March 31, 2021 increased $46.9 million, or 9.8% annualized, to $1.968 billion from $1.921 billion as of December 31, 2020. Average gross loans and leases, excluding net PPP loans, of $1.941 billion increased $207.0 million, or 11.9%, for the three months ended March 31, 2021, compared to $1.734 billion for the same period in 2020.
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PPP loans and PPP deferred processing fees were $272.7 million and $5.1 million, respectively, at March 31, 2021. Average PPP loans, net of deferred processing fees, were $242.2 million for the three months ended March 31, 2021.
Non-performing assets were $19.0 million and 0.73% of total assets as of March 31, 2021, compared to $26.7 million and 1.04% of total assets as of December 31, 2020. Non-performing assets to total assets, excluding net PPP loans, was 0.81% as of March 31, 2021.
The allowance for loan and lease losses increased $461,000, or 1.6%, compared to December 31, 2020. The allowance for loan and lease losses decreased to 1.29% of total loans, compared to 1.33% at December 31, 2020. Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.47% of total loans as of March 31, 2021, compared to 1.48% as of December 31, 2020.
Period-end in-market deposits at March 31, 2021 increased $54.2 million, or 12.9% annualized, to $1.737 billion from $1.683 billion as of December 31, 2020. Average in-market deposits of $1.722 billion increased $356.0 million, or 26.1%, for the three months ended March 31, 2021, compared to $1.366 billion for the same period in 2020.
Private wealth and trust assets under management and administration increased by $137.5 million, or 24.5% annualized, to $2.387 billion at March 31, 2021, compared to $2.249 billion at December 31, 2020.
On January 28, 2021, the Board of Directors of the Corporation adopted a new share repurchase program that authorizes the Corporation to repurchase up to $5 million of the Corporation’s common stock over a period of approximately twelve months, ending on January 31, 2022. As of March 31, 2021, the Corporation had repurchased 5,736 shares of its common stock at a weighted average price of $22.49 per share, for a total value of $129,000.
On January 29, 2021, the Corporation’s Board of Directors declared a regular quarterly dividend of $0.18 per share. The quarterly dividend represents a 9% increase over the quarterly dividend declared in October 2020 and, based on fourth quarter 2020 earnings per share, a dividend payout ratio of 25.5%. This regular cash dividend was payable on February 18, 2021 to shareholders of record at the close of business on February 8, 2021. The Board of Directors routinely considers dividend declarations as part of its normal course of business.

COVID-19 Update
Paycheck Protection Program
On December 27, 2020, the Consolidated Appropriations Act, 2021 (“CAA”) was signed into law. The CAA is a $2.3 trillion spending bill that combines $900 billion in stimulus relief for the COVID-19 pandemic in the United States with a $1.4 trillion omnibus spending bill for the 2021 federal fiscal year and prevents a government shutdown. The CAA allows for a second draw for certain businesses under the PPP. Like the original program, loan proceeds are available to help fund payroll and group health benefit costs, as well as certain mortgage interest, rent and utilities. In addition, authorized costs now also include COVID-19 related worker protection costs, uninsured property damage costs due to looting or vandalism during 2020 and certain supplier costs and expenses for operations. The CAA also expands benefit costs to include group dental, vision, life and disability benefits. All of these changes are generally retroactive to the original CARES Act, meaning that the changes may be taken into account in processing loan forgiveness with respect to an original PPP loan. The Corporation began accepting and processing applications for second draw PPP loans on January 13, 2021.
As of March 31, 2021, the Corporation had $272.7 million in gross PPP loans outstanding and deferred processing fees outstanding of $5.1 million. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. During the three months ended March 31, 2021, the Corporation recognized $2.2 million of processing fees in loans and leases interest income in the unaudited Consolidated Statements of Income. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any at all, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.
Deferral Requests
The Corporation provided loan modifications deferring payments for certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation’s loan modification program. As of March 31, 2021, the Corporation had deferred loans outstanding of $13.0 million, or 0.7% of gross loans and leases, excluding gross PPP loans, compared to $323.2 million, or 18.6% of gross loans and leases, excluding gross PPP loans, as of June 30, 2020.
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The following tables represent a breakdown of the deferred loan balances by industry segment and collateral type:
As of
March 31, 2021
Collateral Type
Industries Description Balance Real Estate Non Real Estate
(In Thousands)
Real Estate and Rental and Leasing $ 9,425  $ 9,425  $ — 
Manufacturing 3,000  —  3,000 
Professional, Scientific, and Technical Services 39  —  39 
Other Services (except Public Administration) 328  212  116 
Educational Services 195  195  — 
Administrative and Support and Waste Management and Remediation Services 11  —  11 
Total deferred loan balances $ 12,998  $ 9,832  $ 3,166 
The following table is a further breakdown of the deferred loan balances by certain credit quality indicators. Please refer to Note 6 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses for the risk category definitions.
As of
March 31, 2021
Category
I II III IV Total
(Dollars in Thousands)
Total deferred loan balances $ 407  $ 11  $ 12,425  $ 155  $ 12,998 
% of Total 3.1  % 0.1  % 95.6  % 1.2  % 100.0  %
As of
December 31, 2020
Category
I II III IV Total
(Dollars in Thousands)
Total deferred loan balances $ 13,466  $ 13,448  $ 58  $ 38  $ 27,010 
% of Total 49.9  % 49.8  % 0.2  % 0.1  % 100.0  %
Exposure to Stressed Industries
    Certain industries have been and are expected to be particularly impacted by social distancing, quarantines, and the economic impact of the COVID-19 pandemic, such as the following:
As of
March 31, 2021 December 31, 2020
Industries: Balance
% Gross Loans and Leases (1)
Balance
% Gross Loans and Leases (1)
(Dollars in Thousands)
Retail (2) (3)
$ 74,534  3.8  % $ 62,719  3.3  %
Hospitality
82,604  4.2  % 80,832  4.2  %
Entertainment
13,943  0.7  % 14,208  0.7  %
Restaurants & food service
23,385  1.2  % 24,854  1.3  %
Total outstanding exposure
$ 194,466  9.9  % $ 182,613  9.5  %
(1)Excluding net PPP loans.
(2)Includes $40.2 million and $48.9 million in loans secured by commercial real estate as of March 31, 2021 and December 31, 2020, respectively.
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(3)Includes $21.3 million and $7.7 million in fully collateralized asset-based loans as of March 31, 2021 and December 31, 2020, respectively.

    As of March 31, 2021, the Corporation had no meaningful direct exposure to the energy sector, airline industry or retail consumer, and does not participate in Shared National Credits.
    Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation’s loan portfolio.

Results of Operations
Top Line Revenue
    Top line revenue, comprised of net interest income and non-interest income, increased 19.6% for the three months ended March 31, 2021 compared to the same period in the prior year primarily due to a $3.8 million, or 22.4%, increase in net interest income and a $781,000, or 12.2%, increase in non-interest income. The increase in net interest income was driven by an increase in average loans and leases outstanding, and loan fees in lieu of interest, while the increase in non-interest income was primarily a result of an increase in gains on the sale of SBA loans and increase in private wealth fee income.
    The components of top line revenue were as follows:
  For the Three Months Ended March 31,
  2021 2020 $ Change % Change
  (Dollars in Thousands)
Net interest income $ 20,863  $ 17,050  $ 3,813  22.4  %
Non-interest income 7,195  6,414  781  12.2 
Top line revenue $ 28,058  $ 23,464  $ 4,594  19.6 
Annualized Return on Average Assets and Annualized Return on Average Equity
    ROAA for the three months ended March 31, 2021 increased significantly to 1.51% compared to 0.62% for the three months ended March 31, 2020. The increase in ROAA was primarily due to a decrease in the provision for loan and lease losses related to a large loan recovery received in January 2021, increase in fees in lieu of interest, and increase in gains on the sale of SBA loans. This increase in profitability was partially offset by a decrease in commercial loan interest rate swap fee income and increase in non-interest expense. We consider ROAA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures.
    ROAE for the three months ended March 31, 2021 was 18.48% compared to 7.14% for the three months ended March 31, 2020. The reasons for the increase in ROAE are consistent with the explanations discussed above with respect to ROAA. We view ROAE as an important measurement for monitoring profitability and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses, and minimizing our costs of credit.
Efficiency Ratio and Pre-Tax, Pre-Provision Adjusted Earnings
    Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse benefit or provision, impairment of tax credit investments, net gains or losses on foreclosed properties, amortization of other intangible assets, losses on early extinguishment of debt, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized net gains or losses on securities, if any. Pre-tax, pre-provision adjusted earnings is defined as operating revenue less operating expense. In the judgment of the Corporation’s management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation’s operating expenses in relation to its core operating revenue by removing the volatility that is associated with certain one-time items and other discrete items.
    The efficiency ratio was 62.19% for the three months ended March 31, 2021 compared to 67.74% for the three months ended March 31, 2020. Operating revenue growth outpaced the change in operating expense for the three months ended March 31, 2021, resulting in positive operating leverage. This improvement was attributable to an increase in net interest income driven by a 25.9% increase in average loans and leases receivable, an $813,000 increase in gains on the sale of SBA
43

loans, and $2.3 million increase in fees in lieu of interest. The increase in fees in lieu of interest included $2.2 million in PPP processing fees. The increase in operating revenue was partially offset by a $1.6 million, or 14.5%, increase in compensation expense reflecting in part the Corporation’s continued execution of its growth strategy. Full-time equivalent employees (“FTE”) were 306 as of March 31, 2021, increasing by 25, or 8.9%, from 281 as of March 31, 2020. We believe we will continue to generate modest positive operating leverage and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth. These initiatives include efforts to expand our specialty finance lines of business, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets.
    We believe the efficiency ratio and pre-tax, pre-provision adjusted earnings allow investors and analysts to better assess the Corporation’s operating expenses in relation to its top line revenue by removing the volatility that is associated with certain non-recurring and other discrete items. The efficiency ratio and pre-tax, pre-provision adjusted earnings also allow management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.
    Please refer to the Non-Interest Income and Non-Interest Expense sections below for discussion on additional drivers of the year-over-year change in the efficiency ratio.
For the Three Months Ended March 31,
2021 2020 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 17,330  $ 16,146  $ 1,184  7.3  %
Less:
Net loss on foreclosed properties 102  (99) (97.1)
Amortization of other intangible assets
(1) (11.1)
SBA recourse (benefit) provision (130) 25  (155) N/A
Tax credit investment impairment —  113  (113) N/A
Total operating expense $ 17,449  $ 15,897  $ 1,552  9.8 
Net interest income 20,863  17,050  3,813  22.4 
Total non-interest income 7,195  6,414  781  12.2 
Less:
Net loss on sale of securities
—  (4) N/A
Adjusted non-interest income 7,195  6,418  777  12.1 
Total operating revenue $ 28,058  $ 23,468  $ 4,590  19.6 
Efficiency ratio 62.19  % 67.74  %
Pre-tax, pre-provision adjusted earnings $ 10,609  $ 7,571  $ 3,038  40.1 
Average total assets 2,577,164  2,104,862  472,302  22.4 
Pre-tax, pre-provision adjusted return on average assets 1.65  % 1.44  %
NM = Not Meaningful

Net Interest Income

    Net interest income levels depend on the amount of and yield on interest-earning assets as compared to the amount of and rate paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes.

    The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three months ended March 31, 2021 compared to the same period in 2020. 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.
44

Increase (Decrease) for the Three Months Ended March 31,
  2021 Compared to 2020
Rate Volume Net
  (In Thousands)
Interest-earning assets      
Commercial real estate and other mortgage loans(1)
$ (3,147) $ 2,152  $ (995)
Commercial and industrial loans(1)
(1,465) 3,233  1,768 
Direct financing leases(1)
162  (26) 136 
Consumer and other loans(1)
(52) 89  37 
Total loans and leases receivable (4,502) 5,448  946 
Mortgage-related securities (301) (94) (395)
Other investment securities (28) 88  60 
FHLB and FRB Stock (419) 366  (53)
Short-term investments (93) (31) (124)
Total net change in income on interest-earning assets
(5,343) 5,777  434 
Interest-bearing liabilities
Transaction accounts (738) 341  (397)
Money market accounts (1,563) (32) (1,595)
Certificates of deposit (252) (321) (573)
Wholesale deposits (710) 178  (532)
Total deposits (3,263) 166  (3,097)
FHLB advances (1,301) 991  (310)
Other borrowings (12) 43  31 
Junior subordinated notes (3) —  (3)
Total net change in expense on interest-bearing liabilities
(4,579) 1,200  (3,379)
Net change in net interest income $ (764) $ 4,577  $ 3,813 
(1)The average balances of loans and leases include non-accrual loans and leases and loans held for sale.


45

    The table below shows our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three months ended March 31, 2021 and 2020. The average balances are derived from average daily balances.
  For the Three Months Ended March 31,
  2021 2020
Average
Balance
Interest
Average
Yield/Rate
(4)
Average
Balance
Interest
Average
Yield/Rate
(4)
  (Dollars in Thousands)
Interest-earning assets            
Commercial real estate and other mortgage loans(1)
$ 1,357,141  $ 12,528  3.69  % $ 1,153,972  $ 13,523  4.69  %
Commercial and industrial loans(1)
757,898  9,625  5.08  515,935  7,857  6.09 
Direct financing leases(1)
22,271  244  4.38  27,961  108  1.55 
Consumer and other loans(1)
45,648  398  3.49  35,874  361  4.03 
Total loans and leases receivable(1)
2,182,958  22,795  4.18  1,733,742  21,849  5.04 
Mortgage-related securities(2)
163,324  666  1.63  180,590  1,061  2.35 
Other investment securities(3)
42,177  187  1.77  23,280  127  2.18 
FHLB and FRB stock 12,465  152  4.88  8,512  205  9.63 
Short-term investments 24,575  0.10  35,763  130  1.45 
Total interest-earning assets 2,425,499  23,806  3.93  1,981,887  23,372  4.72 
Non-interest-earning assets 151,665      122,975     
Total assets $ 2,577,164      $ 2,104,862     
Interest-bearing liabilities            
Transaction accounts $ 521,130  250  0.19  $ 271,531  647  0.95 
Money market accounts 657,690  274  0.17  669,482  1,869  1.12 
Certificates of deposit 57,424  177  1.23  134,000  750  2.24 
Wholesale deposits 166,752  318  0.76  132,468  850  2.57 
Total interest-bearing deposits 1,402,996  1,019  0.29  1,207,481  4,116  1.36 
FHLB advances 366,670  1,249  1.36  325,929  1,559  1.91 
Other borrowings 27,296  401  5.88  24,385  370  6.07 
Junior subordinated notes 10,063  274  10.89  10,048  277  11.03 
Total interest-bearing liabilities 1,807,025  2,943  0.65  1,567,843  6,322  1.61 
Non-interest-bearing demand deposit accounts
485,863      291,129     
Other non-interest-bearing liabilities 73,695      62,367     
Total liabilities 2,366,583      1,921,339     
Stockholders’ equity 210,581      183,523     
Total liabilities and stockholders’ equity
$ 2,577,164      $ 2,104,862     
Net interest income   $ 20,863      $ 17,050   
Interest rate spread     3.27  %     3.10  %
Net interest-earning assets $ 618,474      $ 414,044     
Net interest margin     3.44  %     3.44  %
Average interest-earning assets to average interest-bearing liabilities
134.23  %     126.41  %    
Return on average assets(4)
1.51      0.62     
Return on average equity(4)
18.48      7.14     
Average equity to average assets 8.17      8.72     
Non-interest expense to average assets(4)
2.69      3.07     
(1)The average balances of loans and leases include non-accrual loans and leases and loans held for sale. Interest income related to non-accrual loans and leases is recognized when collected. Interest income includes net loan fees in lieu of interest.
(2)Includes amortized cost basis of assets available-for-sale and held-to-maturity.
(3)Yields on tax-exempt municipal securities are not presented on a tax-equivalent basis in this table.
(4)Represents annualized yields/rates.

46

Comparison of Net Interest Income for the Three Months Ended March 31, 2021 and 2020

    Net interest income increased $3.8 million, or 22.4%, during the three months ended March 31, 2021 compared to the three months ended March 31, 2020. The increase in net interest income reflected an increase in average gross loans and leases, an increase in fees in lieu of interest, and a decrease in interest expense, partially offset by adjusted net interest margin compression. Fees in lieu of interest, which can vary from quarter to quarter, totaled $3.1 million for the three months ended March 31, 2021, compared to $798,000 for the same period in 2020. Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $923,000, or 5.7%. Average gross loans and leases for the three months ended March 31, 2021 increased $449.2 million, or 25.9%, compared to the three months ended March 31, 2020. Excluding net PPP loans, average gross loans and leases for the three months ended March 31, 2021 increased $207.0 million, or 11.9%, compared to the three months ended March 31, 2020.
    The yield on average loans and leases for the three months ended March 31, 2021 declined to 4.18%, compared to 5.04% for the three months ended March 31, 2020. Excluding the impact of fees in lieu of interest and PPP loan interest income, the yield on average loans and leases excluding net PPP loans for the three months ended March 31, 2021 was 3.94%, compared to 4.86% for the three months ended, March 31, 2020. Similarly, the yield on average interest-earning assets for the three months ended March 31, 2021 measured 3.93% compared to 4.72% three months ended March 31, 2020. Excluding fees in lieu of interest and PPP loan interest income, the yield on average interest-earning assets excluding net PPP loans for the three months ended March 31, 2021 was 3.69%, compared to 4.56% for the three months ended March 31, 2020. The decline in yields for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 was primarily due to the decrease in LIBOR and Prime rates and related impact on variable-rate loans, in addition to the renewal of fixed-rate loans and reinvestment of security cash flows at historically low interest rates.
    The average rate paid on total interest-bearing liabilities for the three months ended March 31, 2021 decreased to 0.65% compared to 1.61% for the three months ended March 31, 2020. Total interest-bearing liabilities include interest-bearing deposits, federal funds purchased, FHLB advances, subordinated and junior subordinated notes payable, and other borrowings. The average rate paid declined as the Corporation decreased deposit rates in response to the Federal Open Market Committee’s (“FOMC”) decision to lower the target federal funds rate 150 basis points from January 2020 to March 2020. For the three months ended March 31, 2021 compared to the three months ended March 31, 2020, the average target federal funds rate decreased 115 basis points.    
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 three months ended March 31, 2021 increased $40.7 million to $366.7 million at an average rate paid of 1.36%, compared to $325.9 million at an average rate paid of 1.91% for the three months ended March 31, 2020. As of March 31, 2021, the weighted average original maturity of our FHLB term advances was 5.7 years, compared to 5.9 years as of March 31, 2020. Average wholesale deposits, consisting of brokered certificates of deposit, deposits gathered from internet listing services, and non-reciprocal interest bearing transaction accounts, for the three months ended March 31, 2021 increased $34.3 million to $166.8 million at an average rate paid of 0.76%, compared to $132.5 million at an average rate paid of 2.57%. The increase in wholesale deposits was primarily due to receiving non-reciprocal interest bearing transaction accounts, which was partially offset by a decrease in brokered certificates of deposits. As of March 31, 2021, the weighted average original maturity of our termed wholesale deposits was 3.9 years, compared to 4.8 years as of March 31, 2020. The rate paid on average wholesale funding is greater than the cost of in-market deposits and changes more gradually because the portfolio includes longer original maturities as the Corporation match-funds its longer-term fixed rate loans to mitigate interest rates risk.
                Net interest margin was 3.44% for both the three months ended March 31, 2021 and March 31, 2020. Excluding fees in lieu of interest, PPP loan interest income, Federal Reserve interest income, and FHLB dividends, net interest margin measured 3.20% for the three months ended March 31, 2021, compared to 3.32% for the three months ended March 31, 2020. The decrease was primarily due to the decrease in average yield on loans and leases receivable and investment securities, partially offset by a decrease in the average rate paid on in-market deposits and wholesale funding.
    Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in existing higher-yielding specialty finance lines of business will allow the Corporation to achieve a net interest margin of at least 3.50%, on average, over the long-term. However, the collection of loan fees in lieu of interest is an expected source of volatility to quarterly net interest income and net interest margin, particularly given the nature of the Corporation’s asset-based lending business and the Corporation’s participation in the PPP. Net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status or the accumulation of significant short-term deposit inflows.
47

Despite an uncertain rate environment, management expects to effectively manage the Corporation’s liability structure in both term and rate. Further, we expect to attract new in-market deposit relationships which we believe will contribute to our ability to maintain an appropriate cost of funds. In-market deposits, comprised of all transaction accounts, money market accounts, and non-wholesale deposits, increased $54.2 million, or 12.9% annualized, to $1.737 billion at March 31, 2021, compared to $1.683 billion at December 31, 2020. Average in-market deposits increased $356.0 million, or 26.1%, to $1.722 billion for the three months ended March 31, 2021, compared to $1.366 billion for the three months ended March 31, 2020. This significant increase in deposits was due to successful business development efforts combined with excess liquidity resulting from our clients’ participation in the PPP.
Provision for Loan and Lease Losses
    We determine our provision for loan and lease losses pursuant to our allowance for loan and lease loss methodology, which is based on the magnitude of current and historical net charge-offs recorded throughout the established look-back period, the evaluation of several qualitative factors for each portfolio category, and the amount of specific reserves established for impaired loans that present collateral shortfall positions. Refer to Allowance for Loan and Lease Losses, below, for further information regarding our allowance for loan and lease loss methodology.    
    The full impact of COVID-19 is still unknown. It has caused substantial disruption in international and U.S. economies, markets, and employment. The outbreak has had a significant adverse impact on certain industries the Corporation serves, including retail, hospitality, entertainment, and restaurants and food services. Due to COVID-19 and the economic impact it could have on the Corporation’s loan portfolio, additional detail about certain exposure to stressed industries is included in the section titled COVID-19 Update, above.
    The Corporation recognized a $2.1 million provision benefit for the three months ended March 31, 2021, compared to provision expense of $3.2 million for the three months ended March 31, 2020. The quarterly provision benefit was primarily due to a $2.5 million net recovery and $984,000 reduction in the general reserve related to a decrease in historical loss factors. This reserve release was partially offset by a $1.4 million increase in the commercial real estate general reserve associated with an increase in qualitative factors due to the recent rate of growth in the segment.
The following table shows the components of the provision for loan and lease losses for the three months ended March 31, 2021 compared to the three months ended March 31, 2020.
For the Three Months Ended March 31,
2021 2020
(In Thousands)
Change in general reserve due to subjective factor changes $ 1,082  $ 2,831 
Change in general reserve due to historical loss factor changes (984) (255)
Charge-offs 144  131 
Recoveries (2,673) (177)
Change in specific reserves on impaired loans, net (194) 436 
Change due to loan growth, net 557  216 
Total provision for loan and lease losses $ (2,068) $ 3,182 
48

    The legacy on-balance sheet SBA portfolio, defined as SBA 7(a) and Express loans originated in 2016 and prior, has been a source of elevated non-performing assets. Additional information on our legacy SBA portfolio is as follows:
As of
March 31,
2021
December 31,
2020
March 31,
2020
(In Thousands)
Performing loans:
Off-balance sheet loans
$ 17,523  $ 23,354  $ 31,212 
On-balance sheet loans
7,340  11,117  17,935 
Gross loans
24,863  34,471  49,147 
Non-performing loans:
Off-balance sheet loans
1,835  1,931  4,887 
On-balance sheet loans
6,832  7,435  13,833 
Gross loans
8,667  9,366  18,720 
Total loans:
Off-balance sheet loans
19,358  25,285  36,099 
On-balance sheet loans
14,172  18,552  31,768 
Gross loans
$ 33,530  $ 43,837  $ 67,867 
    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.
Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its potential effects on clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation’s loan portfolio.
Comparison of Non-Interest Income for the Three Months Ended March 31, 2021 and 2020
Non-Interest Income
    For the three months ended March 31, 2021 non-interest income increased by $781,000, or 12.2%, to $7.2 million from $6.4 million for the same period in 2020. Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream through greater contribution from fee-based revenues. Total non-interest income accounted for 25.6% of total revenues for the three months ended March 31, 2021, compared to 27.3% for the three months ended March 31, 2020, exceeding our long-term goal of 25% in both periods of comparison. Management believes the expected gradual expansion of its SBA lending program, fees from commercial loan interest rate swap activity with commercial borrowers, and the geographic expansion of its private wealth management division in our bank markets outside of Greater Dane County will allow the Corporation to sustain a strategic target of 25% over the long-term.
The increase in total non-interest income for the three months ended March 31, 2021 primarily reflected a significant increase in gains on the sale of SBA loans, increase in returns on mezzanine fund investments, and strong private wealth management services fee income, partially offset by a decrease in swap fees.
49

    The components of non-interest income were as follows:
For the Three Months Ended March 31,
2021 2020 $ Change % Change
(Dollars in Thousands)
Private wealth management services fee income
$ 2,407  $ 2,112  $ 295  14.0  %
Gain on sale of SBA loans 1,078  265  813  NM
Service charges on deposits 917  818  99  12.1 
Loan fees 545  485  60  12.4 
Increase in cash surrender value of bank-owned life insurance
350  295  55  18.6 
Net loss on sale of securities —  (4) NM
Swap fees 684  1,681  (997) (59.3)
Other non-interest income 1,214  762  452  59.3 
Total non-interest income $ 7,195  $ 6,414  $ 781  12.2 
Fee income ratio(1)
25.6  % 27.3  %
(1)     Fee income ratio is fee income, per the above table, divided by top line revenue (defined as net interest income plus non-interest income).
    Private wealth management service fees increased $295,000, or 14.0%, for the three months ended March 31, 2021, compared to the three months ended March 31, 2020. Private wealth management services fee income is primarily driven by the amount of assets under management and administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets. This increase was driven by growth in assets under management and administration attributable to both new client relationships and increased equity market values. As of March 31, 2021, private wealth and trust assets under management and administration totaled a record $2.387 billion, increasing $137.5 million, or 6.1%, compared to $2.249 billion as of December 31, 2020 and $722.1 million, or 43.4%, compared to $1.664 billion as of March 31, 2020.
    Commercial loan interest rate swap fee income was $684,000 for the three months ended March 31, 2021, compared to $1.7 million for the three months ended March 31, 2020. We originate commercial real estate loans in which we offer clients a floating rate and an interest rate swap. The client’s swap is then offset with a counter-party dealer. The execution of these transactions generates swap fee income. The aggregate amortizing notional value of interest rate swaps with various borrowers was $645.1 million as of March 31, 2021, compared to $397.7 million as of March 31, 2020. Interest rate swaps continue to be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter.
    Gains on sale of SBA loans increased $813,000 for the three months ended March 31, 2021, compared to the three months ended March 31, 2020. Gross SBA loan commitments closed for the three months ended March 31, 2021 totaled $9.7 million, compared to $6.2 million for the same period in 2020. Based on this recent activity, an enhanced business development team, and a consistent pipeline of new business, management believes the annual gain on sale of SBA loans will continue to increase at a measured pace moving forward.
    Other non-interest income for the three months ended March 31, 2021 totaled $1.2 million, compared to $762,000 for three months ended March 31, 2020. The increase was primarily due to above average returns from the Corporation’s investments in mezzanine funds.
50

Comparison of Non-Interest Expense for the Three Months Ended March, 2021 and 2020
Non-Interest Expense    
Non-interest expense for the three months ended March 31, 2021 increased by $1.2 million, or 7.3%, to $17.3 million compared to $16.1 million for the same period in 2020. Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased $1.6 million, or 9.8%, to $17.4 million for the three months ended March 31, 2021 compared to $15.9 million for the same period in 2020. The increase in operating expense was primarily due to an increase in compensation, computer software, and FDIC insurance expense, partially offset by a decrease in other non-interest expense.    
The components of non-interest expense were as follows:
For the Three Months Ended March 31,
2021 2020 $ Change % Change
(Dollars in Thousands)
Compensation
$ 12,657  $ 11,052  $ 1,605  14.5  %
Occupancy 552  572  (20) (3.5)
Professional fees
866  819  47  5.7 
Data processing 770  677  93  13.7 
Marketing 391  461  (70) (15.2)
Equipment
246  291  (45) (15.5)
Computer software 1,115  889  226  25.4 
FDIC insurance 362  208  154  74.0 
Collateral liquidation costs 94  121  (27) (22.3)
Net loss on foreclosed properties 102  (99) (97.1)
Impairment on tax credit investments —  113  (113) NM
SBA recourse (benefit) provision (130) 25  (155) NM
Other non-interest expense
404  816  (412) (50.5)
Total non-interest expense $ 17,330  $ 16,146  $ 1,184  7.3 
Total operating expense(1)
$ 17,449  $ 15,897  $ 1,552  9.8 
Full-time equivalent employees
306  281 

(1)Total operating expense represents total non-interest expense, adjusted to exclude the impact of discrete items as previously defined in the non-GAAP efficiency ratio calculation, above.    
    Compensation expense for the three months ended March 31, 2021 was $12.7 million, an increase of $1.6 million, or 14.5%, compared to the three months ended March 31, 2020. The increase reflects new hires, annual merit increases, growth in employee benefit costs, and an increase in individual incentive compensation. Average full-time equivalent employees increased to 305, up 6.6% for the quarter ended March 31, 2021, compared to 286 for the quarter ended March 31, 2020. The increase reflects new hires, annual merit increases, and an increase in the annual corporate incentive plan accrual compared to a reduction to the same accrual during the first quarter of 2020 due to uncertainty amid the COVID-19 pandemic. We believe we will continue to generate modest positive operating leverage and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth. These initiatives include efforts to expand our specialty finance lines of business, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets. We expect to continue investing in talent, both in the form of additional business development and operational staff, to support our long-term strategic plan.
    Computer software expense increased $226,000 to $1.1 million for the three months ended March 31, 2021 compared to $889,000 for the three months ended March 31, 2020. The increase was principally due to investments in technology platforms to improve the client experience and continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy.
FDIC insurance expense for the three months ended March 31, 2021 was $362,000, an increase of $154,000 compared to the three months ended March 31, 2020. Management expects FDIC insurance expense to increase commensurate with asset growth going forward.
51

    No historic tax credits or related impairment were recognized for the three months ended March 31, 2021. The impairment on tax credit investments for the three months ended March 31, 2020 is related to a new market tax credit which is more than offset by a reduction to income tax expense, which results in a net benefit to earnings. Management intends to continue actively pursuing in-market tax credit opportunities throughout 2021 and beyond.
    SBA recourse provision was a benefit of $130,000 for the three months ended March 31, 2021, compared to recourse expense of $25,000 for the three months ended March 31, 2020. The total recourse reserve balance was $593,000, or 0.7% of total sold SBA loans outstanding, at March 31, 2021, compared to $723,000, or 0.9%, at December 31, 2020, and $1.1 million, or 1.6%, at March 31, 2020. Changes to SBA recourse reserves may be a source of non-interest expense volatility in future quarters, though the magnitude of this volatility should continue to diminish over time as the outstanding balance of sold legacy SBA loans continues to decline.
Other non-interest expense for the three months ended March 31, 2021 was $404,000, a decrease of $412,000 compared to the three months ended March 31, 2020. The decrease was principally due to a decrease in business-related travel expenses due to the Corporation’s adherence to COVID-19 restrictions and a reduction in the credit valuation adjustment (“CVA”) related to the commercial loan interest rate swap program. The CVA represents a change in the market value of the Company’s commercial loan interest rate swaps to estimate potential borrower credit risk within the portfolio. The CVA can vary from period to period based on the size of the portfolio, credit metrics, and the interest rate environment in any given quarter. There was no CVA as of March 31, 2020.
Income Taxes
    Income tax expense totaled $3.1 million for the three months ended March 31, 2021 compared to an income tax expense of $858,000 for the three months ended March 31, 2020. The effective tax rate, excluding tax credits and other discrete items, for the three months ended March 31, 2021 was 23.4% compared to 20.7% for the three months ended March 31, 2020.

Financial Condition
General
    Total assets increased by $52.9 million, or 2.1%, to $2.621 billion as of March 31, 2021 compared to $2.568 billion at December 31, 2020. The increase in total assets was primarily driven by loan growth, partially offset by a decrease in securities.
Short-Term Investments
    Short-term investments increased by $11.4 million, or 41.6%, to $38.7 million at March 31, 2021 from $27.4 million at December 31, 2020. Our short-term investments primarily consist of interest-bearing deposits held at the FRB and commercial paper. We value the safety and soundness provided by the FRB and therefore incorporate short-term investments in our on-balance sheet liquidity program. As of March 31, 2021 and December 31, 2020, we did not hold any commercial paper. Due to current economic conditions, we decided to temporarily exit this short-term investment. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio. The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to be in a position to benefit from an anticipated change in the yield curve level and shape. In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio. Please refer to the section entitled Liquidity and Capital Resources for further discussion.
Securities
    Total securities, including available-for-sale and held-to-maturity, decreased by $12.3 million, or 5.8%, to $198.0 million at March 31, 2021 compared to $210.3 million at December 31, 2020. During the three months ended March 31, 2021, due to a steepening yield curve, we recognized unrealized losses of $2.2 million before income taxes through other comprehensive income, compared to gains of $4.5 million for the same period in 2020. As of March 31, 2021 and December 31, 2020, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 5.1 years and 5.0 years, respectively. Our investment philosophy remains as stated in our most recent Annual Report on Form 10-K.
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    We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, data integrity validation primarily through comparison of current price to an expectation-based analysis of movement in prices based upon the changes in the related yield curves, and other market factors. No securities within our portfolio were deemed to be other-than-temporarily impaired as of March 31, 2021.
Loans and Leases Receivable    
    Loans and leases receivable, net of allowance for loan and lease losses, increased by $88.7 million to $2.206 billion at March 31, 2021 from $2.117 billion at December 31, 2020 which was driven by second draw PPP loans and commercial loan growth, partially offset by PPP loan forgiveness. Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by $46.4 million, or 9.8% annualized, to $1.939 billion at March 31, 2021 from December 31, 2020.

Total commercial real estate (“CRE”) increased $33.4 million to $1.392 billion, up from $1.359 billion at December 31, 2020. Non-owner occupied CRE, multi-family, and construction loans were the largest contributors to CRE loan growth as of March 31, 2021, increasing $27.6 million, $10.8 million, and $10.3 million, respectively, from December 31, 2020.
There continues to be a concentration in CRE loans which represented 70.5% and 63.2% of our total loans, excluding net PPP loans, as of March 31, 2021 and December 31, 2020, respectively. As of March 31, 2021, 18.4% of the CRE loans were owner-occupied CRE, compared to 18.7% as of December 31, 2020. We consider owner-occupied CRE more characteristic of the Corporation’s C&I portfolio as, in general, the client’s primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property. Management has elevated its underwriting standards during the COVID-19 pandemic to ensure business owners and guarantors have robust liquidity, operating performance, and collateral positions. Even with these higher standards, the Corporation has been able to grow loans and deepen banking relationships.
Our C&I portfolio increased $52.0 million, or 28.4% annualized, to $784.3 million from $732.3 million at December 31, 2020. Excluding net PPP loans, C&I loans increased $9.7 million, or 7.7% annualized, to $516.7 million from $507.0 million at December 31, 2020 primarily due to a $15.6 million increase in asset-based loans. Some of our specialty finance products have historically experienced counter cyclical growth, growing during times of economic stress and uncertainty. As such, management expects asset-based loans and accounts receivable financing volume to increase in 2021. We will continue to actively pursue C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management, and private wealth management relationships which generate additional fee revenue.
Underwriting of new credit is primarily through approval from a serial sign-off or committee process and is a key component of our operating philosophy. Business development officers have no individual lending authority limits, and thus, a significant portion of our new credit extensions require approval from a loan approval committee regardless of the type of loan or lease, amount of the credit, or the related complexities of each proposal. In addition, we make every reasonable effort to ensure that there is appropriate collateral or a government guarantee at the time of origination to protect our interest in the related loan or lease. To monitor the ongoing credit quality of our loans and leases, each credit is evaluated for proper risk rating using a nine grade risk rating system at the time of origination, subsequent renewal, evaluation of updated financial information from our borrowers, or as other circumstances dictate.
    While we continue to experience significant competition from banks operating in our primary geographic areas, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to expect our new loan and lease activity to be adequate to replace normal amortization, allowing us to continue growing in future years. The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K.
Deposits
    As of March 31, 2021, deposits increased by $47.2 million, or 10.2% annualized, to $1.903 billion from $1.856 billion at December 31, 2020 primarily due to a $81.5 million increase in transaction accounts, partially offset by a decrease in certificate of deposits and money market accounts of $17.9 million and $9.4 million, respectively.
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Transaction account balances increased primarily due to the influx of PPP loan proceeds. Management attributes the transition from money market accounts to reciprocal transaction accounts with full FDIC insurance to our clients’ preferences for safety and soundness amid the economic uncertainty created by the COVID-19 pandemic. Period-end deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to maintain existing and new client relationships.
    Our strategic efforts remain focused on adding in-market deposit relationships. We measure the success of in-market deposit gathering efforts based on the number and average balances of our deposit accounts as compared to ending balances due to the volatility of some of our larger relationships. The Bank’s average in-market deposits, consisting of all transaction accounts, money market accounts, and certificates of deposit, were approximately $1.722 billion for the three months ended March 31, 2021, compared to $1.569 billion for the year ended December 31, 2020.
FHLB Advances and Other Borrowings
    As of March 31, 2021, FHLB advances and other borrowings increased by $29.3 million, or 7.0%, to $448.4 million from $419.2 million at December 31, 2020. While total wholesale funding as a percentage of total bank funding has decreased meaningfully overall due to significant in-market deposit growth, we continue to replace the majority of our maturing brokered certificates of deposit with FHLB advances at lower rates, as needed, to match-fund fixed rate loans and mitigate interest rate risk. Total bank funding is defined as total deposits plus FHLB advances, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances.
As of March 31, 2021 and December 31, 2020, the Corporation had other borrowings of $8.9 million and $920,000 respectively, which consisted of sold loans which were accounted for as a secured borrowing, because they did not qualify for true sale accounting and borrowings associated with our investment in a community development entity.
    During the second quarter of 2020, the Corporation tested its ability to borrow from the Federal Reserve Paycheck Protection Program Liquidity Facility (“PPPLF”) in the event funding was required to support the Banks PPP lending efforts. On April 28, 2020, the Corporation borrowed $29.6 million from the PPPLF at a rate of 0.35%. The borrowing was fully collateralized by a tranche of PPP loans originated by the Bank on April 15, 2020 and matures on April 15, 2022, or when the tranche of PPP loans utilized to collateralize the PPPLF borrowing are forgiven, whichever comes first. As of November 2, 2020, the borrowing was paid in full.
    Consistent with our funding philosophy to manage interest rate risk, we will use the most efficient and cost effective source of wholesale funds. We will utilize FHLB advances to the extent we maintain an adequate level of excess borrowing capacity for liquidity and contingency funding purposes and pricing remains favorable in comparison to the wholesale deposit alternative. We will use FHLB advances and/or brokered certificates of deposit in specific maturity periods needed, typically three to five years, to match-fund fixed rate loans and effectively mitigate the interest rate risk measured through our asset/liability management process and to support asset growth initiatives while taking into consideration our operating goals and desired level of usage of wholesale funds. Please refer to the section titled Liquidity and Capital Resources, below, for further information regarding our use and monitoring of wholesale funds.
Derivatives
The Corporation’s derivative financial instruments, under which the Corporation is required to either receive cash from or pay cash to counterparties depending on changes in interest rates applied to notional amounts, are carried at fair value on the consolidated balance sheets. We offer interest rate swap products directly to qualified commercial borrowers, originating a floating rate loan and an interest rate swap providing a fixed rate to the borrower. The client’s swap is then offset with a counter-party dealer. The execution of these transactions generates swap fee income. The aggregate amortizing notional value of interest rate swaps with various borrowers increased $247.4 million, or 62.2%, to $645.1 million as of March 31, 2021, compared to $397.7 million as of March 31, 2020. The fair value of these interest rate swaps decreased $23.3 million, or 47.1%, to $26.1 million as of March 31, 2021, compared to $49.4 million as of March 31, 2020. The significant decline in fair value of the derivative contracts is directly related to the level of interest rates as of March 31, 2021, compared to the maturity term and amortization rates when the derivative contracts were originally executed.
For further information and discussion of our derivatives, see Note 13 — Derivative Financial Instruments of the Consolidated Financial Statements.

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Asset Quality
Impaired Assets
    Total impaired assets consisted of the following at March 31, 2021 and December 31, 2020, respectively:
March 31,
2021
December 31,
2020
  (Dollars in Thousands)
Non-accrual loans and leases    
Commercial real estate:    
Commercial real estate - owner occupied $ 2,169  $ 5,429 
Commercial real estate - non-owner occupied 3,016  3,783 
Land development —  890 
Construction —  — 
Multi-family —  — 
1-4 family 493  250 
Total non-accrual commercial real estate 5,678  10,352 
Commercial and industrial 12,716  16,155 
Direct financing leases, net 49  49 
Consumer and other:    
Home equity and second mortgages 534  40 
Other 15  21 
Total non-accrual consumer and other loans 549  61 
Total non-accrual loans and leases 18,992  26,617 
Foreclosed properties, net 31  34 
Total non-performing assets 19,023  26,651 
Performing troubled debt restructurings 59  46 
Total impaired assets $ 19,082  $ 26,697 
Total non-accrual loans and leases to gross loans and leases 0.85  % 1.24  %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
0.85  1.24 
Total non-performing assets to total assets 0.73  1.04 
Allowance for loan and lease losses to gross loans and leases 1.29  1.33 
Allowance for loan and lease losses to non-accrual loans and leases 152.60  107.15 
    Net PPP loans outstanding as of March 31, 2021 and December 31, 2020, were $267.6 million and $225.3 million, respectively. The following asset quality ratios exclude net PPP loans as they are fully guaranteed by the SBA:
March 31,
2021
December 31,
2020
Total non-accrual loans and leases to gross loans and leases 0.96  % 1.38  %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
0.96  1.38 
Total non-performing assets to total assets 0.81  1.14 
Allowance for loan and lease losses to gross loans and leases 1.47  1.48 
Non-accrual loans decreased $7.6 million, or 28.6%, to $19.0 million at March 31, 2021, compared to $26.6 million at December 31, 2020. The decrease in non-accrual loans was principally due to loan payoffs and loans returning to accrual status. The Corporation’s non-accrual loans as a percentage of total gross loans and leases measured 0.85% and 1.24% at March 31, 2021 and December 31, 2020, respectively. Non-accrual loans as a percentage of total gross loans and leases, excluding net PPP loans, was 0.96% and 1.38% at March 31, 2021 and December 31, 2020, respectively. As of March 31, 2021 and December 31,
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2020, $4.8 million and $6.5 million of non-accrual loans and leases were considered troubled debt restructurings, respectively. Please refer to the section titled COVID-19 Update for additional information on credit quality.    
    We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio. Non-performing assets as a percentage of total assets decreased to 0.73% at March 31, 2021 from 1.04% at December 31, 2020. As of March 31, 2021, the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.4% of the total portfolio was in a current payment status, compared to 99.0% as of December 31, 2020. We also monitor asset quality through our established categories as defined in Note 6 – Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses of the Consolidated Financial Statements. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to sell the underlying collateral, inadequate cash flow from the operations of the underlying businesses, liquidation events, or bankruptcy filings. We are proactively working with our impaired loan borrowers to find meaningful solutions to difficult situations that are in the best interests of the Bank.
    As of March 31, 2021, 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.
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    The following represents additional information regarding our impaired loans and leases:
As of and for the Three Months Ended March 31, As of and for the
Year Ended December 31,
  2021 2020 2020
  (In Thousands)
Impaired loans and leases with no impairment reserves required
$ 10,391  $ 13,006  $ 18,966 
Impaired loans and leases with impairment reserves required
8,660  15,025  7,697 
Total impaired loans and leases 19,051  28,031  26,663 
Less: Impairment reserve (included in allowance for loan and lease losses)
3,487  3,802  3,681 
Net impaired loans and leases $ 15,564  $ 24,229  $ 22,982 
Average impaired loans and leases $ 22,091  $ 22,144  $ 27,703 
Foregone interest income attributable to impaired loans and leases
$ 603  $ 601  $ 2,794 
Less: Interest income recognized on impaired loans and leases
68  636 
Net foregone interest income on impaired loans and leases $ 535  $ 592  $ 2,158 
    Non-performing assets also include foreclosed properties. A summary of foreclosed properties activity is as follows:
As of and for the Three Months Ended March 31, As of and for the
Year Ended December 31,
2021 2020 2020
(In Thousands)
Balance at the beginning of the period $ 34  $ 2,919  $ 2,919 
Transfer of loans and leases to foreclosed properties —  —  80 
Proceeds from sale of foreclosed properties —  (1,148) (2,582)
Net gain (loss) on sale of foreclosed properties —  16  (20)
Impairment adjustments (3) (118) (363)
Balance at the end of the period $ 31  $ 1,669  $ 34 
Allowance for Loan and Lease Losses
    The allowance for loan and lease losses increased $461,000, or 1.6%, from $28.5 million as of December 31, 2020 to $29.0 million as of March 31, 2021. The allowance for loan and lease losses as a percentage of gross loans and leases decreased from 1.33% as of December 31, 2020 to 1.29% as of March 31, 2021. The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.47% as of March 31, 2021 compared to 1.48% as of December 31, 2020. The decreased in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by a significant loan recovery and the related impact it had on our historical loss factors. This general reserve release was offset by an increase in the commercial real estate general reserve associated with an increase in qualitative factors due to the recent rate of growth in the segment and an increase in general reserve commensurate with loan growth.
    There have been no substantive changes to our methodology for estimating the appropriate level of allowance for loan and lease loss reserves from what was previously outlined in our most recent Annual Report on Form 10-K. Please refer to the section titled COVID-19 Update for additional information.
    During the three months ended March 31, 2021, we recorded net recoveries on impaired loans and leases of $2.5 million, comprised of $144,000 of charge-offs and $2.7 million of recoveries. We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed, in particular as it relates to our commercial clients impacted by the COVID-19 pandemic. Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios.
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    As of March 31, 2021 and December 31, 2020, our allowance for loan and lease losses to total non-accrual loans and leases was 152.60% and 107.15%, respectively. This ratio increased as our remaining non-accrual loan and lease portfolio has a larger proportion of SBA loans when compared to December 31, 2020, which historically carry larger collateral shortfalls when compared to our conventional commercial loans. Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we try to ensure that we have sufficient collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases either does not require additional 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 March 31, 2021.
    To determine the level and composition of the allowance for loan and lease losses, we break out the portfolio by segments with similar risk characteristics. First, we evaluate loans and leases for potential impairment classification. We analyze each loan and lease identified as impaired on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of expected cash flows. For each segment of loans and leases that has not been individually evaluated, management segregates the Bank’s loss factors into a quantitative general reserve component based on historical loss rates throughout the defined look back period. The quantitative general reserve component also considers an estimate of the historical loss emergence period, which is the period of time between the event that triggers the loss to the charge-off of that loss. The methodology also focuses on evaluation of several qualitative factors for each portfolio category, including but not limited to: management’s ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, existing economic conditions, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations of loans to specific industries, and other qualitative factors that could affect credit losses.
    When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for loan and lease loss reserve to bring the loan or lease to its net realizable value. Many of the impaired loans as of March 31, 2021 are collateral dependent. It is typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment at least annually, or more frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, we have found that in general real estate values have been stable or improved; however, in specific situations current fair values collateralizing certain impaired loans were inadequate to support the entire amount of the outstanding debt. Foreclosure actions may have been initiated on certain of these commercial real estate and other mortgage loans.
    As a result of our review process, we have concluded an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was $29.0 million, or 1.29% of gross loans and leases, at March 31, 2021. 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:
As of and for the Three Months Ended March 31,
  2021 2020
  (Dollars in Thousands)
Allowance at beginning of period $ 28,521  $ 19,520 
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 (144) (125)
Direct financing leases —  — 
Consumer and other:  
Home equity and second mortgages —  — 
Other —  (6)
Total charge-offs (144) (131)
Recoveries:    
Commercial real estate:    
Commercial real estate — owner occupied 140 
Commercial real estate — non-owner occupied
—  — 
Construction and land development 2,078  — 
Multi-family —  — 
1-4 family — 
Commercial and industrial 453  176 
Direct financing leases —  — 
Consumer and other:    
Home equity and second mortgages — 
Other —  — 
Total recoveries 2,673  177 
Net recoveries 2,529  46 
Provision for loan and lease losses (2,068) 3,182 
Allowance at end of period $ 28,982  $ 22,748 
Annualized net recoveries as a percent of average gross loans and leases (0.46) % (0.01) %
Annualized net recoveries as a percent of average gross loans and leases, excluding average net PPP loans (0.52) % (0.01) %


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Liquidity and Capital Resources
    The Corporation expects to meet its liquidity needs through existing cash on hand, established cash flow sources, its third party senior line of credit, and dividends received from the Bank. While the Bank is subject to certain generally applicable regulatory limitations regarding its ability to pay dividends to the Corporation, we do not believe that the Corporation will be adversely affected by these dividend limitations. The Corporation’s principal liquidity requirements at March 31, 2021 were the interest payments due on subordinated and junior subordinated notes. On January 29, 2021, the Bank’s Board of Directors declared a dividend in the aggregate amount of $2.0 million bringing year-to-date dividend declarations to $2.0 million. The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect on March 31, 2021, and continue to meet the heightened requirements imposed by Basel III, including the capital conservation buffer that was fully phased-in as of January 1, 2019. The Corporation’s Board and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.
    The Bank maintains liquidity by obtaining funds from several sources. The Bank’s primary source of funds are principal and interest payments on loans receivable and mortgage-related securities, deposits, and other borrowings, such as federal funds, FHLB advances, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances. The scheduled payments of loans and mortgage-related securities are generally a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest rates, economic conditions, and competition.
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 March 31, 2021 and December 31, 2020, our immediate on-balance sheet liquidity was $724.2 million and $640.2 million, respectively. The increase as of March 31, 2021 compared to December 31, 2020 is principally due to the Banks ability to pledge PPP loans and borrow from the Federal Reserve PPPLF. Excluding Federal Reserve PPPLF availability, immediate on-balance sheet liquidity was $456.6 million and $414.9 million as of March 31, 2021 and December 31, 2020, respectively. This increase in on-balance sheet liquidity compared to December 31, 2020 is primarily due to a decrease in securities pledged. At March 31, 2021 and December 31, 2020, the Bank had $37.7 million and $44.4 million on deposit with the FRB recorded in short-term investments, respectively. Any excess funds not used for loan funding or satisfying other cash obligations were maintained as part of our on-balance sheet liquidity in our interest-bearing accounts with the FRB, as we value the safety and soundness provided by the FRB. We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow run off of maturing wholesale certificates of deposit or invest in securities to maintain adequate liquidity at an improved margin.
    We had $581.3 million of outstanding wholesale funds at March 31, 2021, compared to $567.0 million of wholesale funds as of December 31, 2020, which represented 25.1% and 25.2%, respectively, of ending balance total bank funding. Wholesale funds include FHLB advances, Federal Reserve PPPLF advances, brokered certificates of deposit, and deposits gathered from internet listing services. Total bank funding is defined as total deposits plus FHLB advances and Federal Reserve PPPLF advances. We are committed to raising in-market deposits while utilizing wholesale funds to mitigate interest rate risk. Wholesale funds continue to be an efficient and cost effective source of funding for the Bank and allows it to gather funds across a larger geographic base at price levels and maturities that are more attractive than local time deposits when required to raise a similar level of in-market deposits within a short time period. Access to such deposits and borrowings allows us the flexibility to refrain from pursuing single service deposit relationships in markets that have experienced unfavorable pricing levels. In addition, the administrative costs associated with wholesale funds are considerably lower than those that would be incurred to administer a similar level of local deposits with a similar maturity structure. During the time frames necessary to accumulate wholesale funds in an orderly manner, we will use short-term FHLB advances to meet our temporary funding needs. The short-term FHLB advances will typically have terms of one week to one month to cover the overall expected funding demands.
     Period-end in-market deposits increased $54.2 million, or 12.9% annualized, to $1.737 billion at March 31, 2021 from $1.683 billion at December 31, 2020 as in-market deposit balances increased due to our client’s PPP loan proceeds and successful business development efforts. Our in-market relationships remain stable; however, deposit balances associated with those relationships will fluctuate. We expect to establish new client relationships and continue marketing efforts aimed at increasing the balances in existing clients’ deposit accounts. Nonetheless, we will continue to use wholesale funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management process or in shorter time periods if in-market deposit balances decline. In order to provide for ongoing liquidity and funding, all of our wholesale funds are certificates of deposit which do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual
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maturity terms and no call provisions. The Bank limits the percentage of wholesale funds to total bank funds in accordance with liquidity policies approved by its Board. The Bank was in compliance with its policy limits as of March 31, 2021.
    The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the year ended March 31, 2021. 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 March 31, 2021, 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 three months ended March 31, 2021, operating activities resulted in a net cash inflow of $6.8 million, which included net income of $9.7 million, partially offset by a $2.1 million provision for loan and lease loss benefit. Net cash used in investing activities for the three months ended March 31, 2021 was approximately $79.5 million which consisted of cash outflows to fund net loan growth, partially offset by a net reduction in securities. Net cash provided by financing activities resulted in a net cash inflow of $74.6 million for the three months ended March 31, 2021 primarily due to a net increase in FHLB advances and a net increase in deposits. Please refer to the Consolidated Statements of Cash Flows included in PART I., Item 1 for further details regarding significant sources of cash flow for the Corporation.

Contractual Obligations and Off-Balance Sheet Arrangements
    As of March 31, 2021, there were no material changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020. We continue to believe that we have adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.

Item 3. Quantitative and Qualitative Disclosures about Market Risk
    Not applicable.

Item 4. 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 March 31, 2021.
Changes in Internal Control over Financial Reporting
    There was no change in the Corporation’s internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) that occurred during the quarter ended March 31, 2021 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

PART II. Other Information
Item 1. Legal Proceedings
    From time to time, the Corporation and its subsidiaries are engaged in legal proceedings in the ordinary course of their respective businesses. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations, or cash flows.
61


Item 1A. Risk Factors

    There were no material changes to the risk factors previously disclosed in Item 1A. to Part I of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a)None.
(b)Not applicable.
(c)None.
Item 3. Defaults Upon Senior Securities
Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information
None.


Item 6. Exhibits
31.1 
31.2 
32 
101  The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of March 31, 2021 and December 31, 2020, (ii) Consolidated Statements of Income for the three months ended March 31, 2021 and 2020, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2021 and 2020, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2021 and 2020, (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020, and (vi) the Notes to Unaudited Consolidated Financial Statements
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
FIRST BUSINESS FINANCIAL SERVICES, INC.
 
April 30, 2021 /s/ Corey A. Chambas
  Corey A. Chambas 
  Chief Executive Officer
   
April 30, 2021 /s/ Edward G. Sloane, Jr.
  Edward G. Sloane, Jr.
  Chief Financial Officer
(principal financial officer)

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