FBIZ 2015.6.30- 10Q Q2 2015
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
 
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2015
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, Madison, WI
 
53719
 
 
 
(Address of Principal Executive Offices)
 
(Zip Code)
(608) 238-8008
Registrant’s telephone number, including area code
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 and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨
 
Accelerated filer þ
 
Non-accelerated filer ¨
 
Smaller reporting company ¨
 
 
 
 
(Do not check if a smaller reporting company)
 
 
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 August 5, 2015 was 4,334,918 shares.


Table of Contents

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






Table of Contents

PART I. Financial Information
Item 1. Financial Statements
First Business Financial Services, Inc.
Consolidated Balance Sheets
 
 
June 30,
2015
 
December 31,
2014
 
 
(unaudited)
 
 
 
(In Thousands, Except Share Data)
Assets
 
 
 
 
Cash and due from banks
 
$
12,829

 
$
14,881

Short-term investments
 
76,019

 
88,356

Cash and cash equivalents
 
88,848

 
103,237

Securities available-for-sale, at fair value
 
146,342

 
144,698

Securities held-to-maturity, at amortized cost
 
39,428

 
41,563

Loans held for sale
 
1,274

 
1,340

Loans and leases receivable, net of allowance for loan and lease losses of $15,199 and $14,329, respectively
 
1,334,091

 
1,265,098

Premises and equipment, net
 
3,998

 
3,943

Foreclosed properties
 
1,854

 
1,693

Cash surrender value of bank-owned life insurance
 
27,785

 
27,314

Investment in Federal Home Loan Bank and Federal Reserve Bank stock, at cost
 
2,891

 
2,340

Accrued interest receivable and other assets
 
24,920

 
26,217

Goodwill and other intangible assets
 
12,133

 
11,944

Total assets
 
$
1,683,564

 
$
1,629,387

Liabilities and Stockholders’ Equity
 
 
 
 
Deposits
 
$
1,471,068

 
$
1,438,268

Federal Home Loan Bank and other borrowings
 
47,401

 
33,994

Junior subordinated notes
 
10,315

 
10,315

Accrued interest payable and other liabilities
 
10,493

 
9,062

Total liabilities
 
1,539,277

 
1,491,639

Commitments and contingencies
 

 

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, 4,545,457 and 4,537,426 shares issued, 4,334,918 and 4,335,927 shares outstanding at June 30, 2015 and December 31, 2014, respectively
 
45

 
45

Additional paid-in capital
 
75,792

 
74,963

Retained earnings
 
74,028

 
67,886

Accumulated other comprehensive income
 
207

 
218

Treasury stock (210,539 and 201,499 shares at June 30, 2015 and December 31, 2014, respectively), at cost
 
(5,785
)
 
(5,364
)
Total stockholders’ equity
 
144,287

 
137,748

Total liabilities and stockholders’ equity
 
$
1,683,564

 
$
1,629,387


See accompanying Notes to Unaudited Consolidated Financial Statements.


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Table of Contents

First Business Financial Services, Inc.
Consolidated Statements of Income (Unaudited)
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(In Thousands, Except Per Share Data)
Interest income:
 
 
 
 
 
 
 
 
Loans and leases
 
$
16,680

 
$
12,651

 
$
34,005

 
$
25,126

Securities income
 
748

 
855

 
1,524

 
1,721

Short-term investments
 
92

 
59

 
207

 
119

Total interest income
 
17,520

 
13,565

 
35,736

 
26,966

Interest expense:
 
 
 
 
 
 
 
 
Deposits
 
2,593

 
2,337

 
5,162

 
4,506

Notes payable and other borrowings
 
461

 
152

 
904

 
310

Junior subordinated notes
 
278

 
277

 
552

 
551

Total interest expense
 
3,332

 
2,766

 
6,618

 
5,367

Net interest income
 
14,188

 
10,799

 
29,118

 
21,599

Provision for loan and lease losses
 
520

 
(91
)
 
1,204

 
89

Net interest income after provision for loan and lease losses
 
13,668

 
10,890

 
27,914

 
21,510

Non-interest income:
 
 
 
 
 
 
 
 
Trust and investment services fee income
 
1,279

 
1,110

 
2,486

 
2,178

Service charges on deposits
 
693

 
600

 
1,389

 
1,167

Loan fees
 
499

 
380

 
1,001

 
769

Increase in cash surrender value of bank-owned life insurance
 
238

 
209

 
472

 
416

Gain on sale of loans
 
1,064

 

 
1,717

 

Other
 
353

 
59

 
909

 
149

Total non-interest income
 
4,126

 
2,358

 
7,974

 
4,679

Non-interest expense:
 
 
 
 
 
 
 
 
Compensation
 
6,924

 
4,741

 
14,278

 
9,798

Occupancy
 
486

 
315

 
986

 
638

Professional fees
 
1,515

 
895

 
2,504

 
1,527

Data processing
 
655

 
423

 
1,185

 
839

Marketing
 
701

 
364

 
1,343

 
711

Equipment
 
298

 
125

 
606

 
255

FDIC insurance
 
220

 
173

 
433

 
363

Collateral liquidation costs
 
78

 
85

 
380

 
243

Net loss (gain) on foreclosed properties
 
1

 
4

 
(15
)
 
4

Other
 
1,096

 
624

 
2,006

 
1,222

Total non-interest expense
 
11,974

 
7,749

 
23,706

 
15,600

Income before income tax expense
 
5,820

 
5,499

 
12,182

 
10,589

Income tax expense
 
1,962

 
1,994

 
4,132

 
3,747

Net income
 
$
3,858

 
$
3,505

 
$
8,050

 
$
6,842

Earnings per common share:
 
 
 
 
 
 
 
 
Basic
 
$
0.89

 
$
0.89

 
$
1.86

 
$
1.73

Diluted
 
$
0.89

 
$
0.88

 
$
1.86

 
$
1.72

Dividends declared per share
 
$
0.22

 
$
0.21

 
$
0.44

 
$
0.42

See accompanying Notes to Unaudited Consolidated Financial Statements.

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Table of Contents

First Business Financial Services, Inc.
Consolidated Statements of Comprehensive Income (Unaudited)

 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(In Thousands)
 
 
 
 
 
 
 
 
 
Net income
 
$
3,858

 
$
3,505

 
$
8,050

 
$
6,842

Other comprehensive (loss) income, before tax
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
Unrealized securities (losses) gains arising during the period
 
(910
)
 
1,793

 
(145
)
 
2,142

Securities held-to-maturity:
 
 
 
 
 
 
 
 
Unrealized losses transferred to held-to-maturity
 

 
(874
)
 

 
(874
)
Amortization of net unrealized losses transferred from available-for-sale
 
64

 
25

 
127

 
25

Income tax benefit (expense)
 
327

 
(364
)
 
7

 
(499
)
Comprehensive income
 
$
3,339

 
$
4,085

 
$
8,039

 
$
7,636


See accompanying Notes to Unaudited Consolidated Financial Statements.

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Table of Contents

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) income
 
Treasury
stock
 
Total
 
 
(In Thousands, Except Share Data)
Balance at December 31, 2013
 
3,943,997

 
$
41

 
$
56,002

 
$
57,143

 
$
(342
)
 
$
(3,569
)
 
$
109,275

Net income
 

 

 

 
6,842

 

 

 
6,842

Other comprehensive income
 

 

 

 

 
794

 

 
794

Exercise of stock options
 
2,000

 

 
48

 

 

 

 
48

Share-based compensation - restricted shares
 
996

 

 
389

 

 

 

 
389

Share-based compensation - tax benefits
 

 

 
38

 

 

 

 
38

Cash dividends ($0.42 per share)
 

 

 

 
(1,657
)
 

 

 
(1,657
)
Treasury stock purchased
 
(1,773
)
 

 

 

 

 
(81
)
 
(81
)
Balance at June 30, 2014
 
3,945,220

 
$
41

 
$
56,477

 
$
62,328

 
$
452

 
$
(3,650
)
 
$
115,648


 
 
Common shares outstanding
 
Common
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Accumulated
other
comprehensive
income
 
Treasury
stock
 
Total
 
 
(In Thousands, Except Share Data)
Balance at December 31, 2014
 
4,335,927

 
$
45

 
$
74,963

 
$
67,886

 
$
218

 
$
(5,364
)
 
$
137,748

Net income
 

 

 

 
8,050

 

 

 
8,050

Other comprehensive loss
 

 

 

 

 
(11
)
 

 
(11
)
Exercise of stock options
 
12,000

 

 
300

 

 

 

 
300

Share-based compensation - restricted shares
 
(3,969
)
 

 
449

 

 

 

 
449

Share-based compensation - tax benefits
 

 

 
80

 

 

 

 
80

Cash dividends ($0.44 per share)
 

 

 

 
(1,908
)
 

 

 
(1,908
)
Treasury stock purchased
 
(9,040
)
 

 

 

 

 
(421
)
 
(421
)
Balance at June 30, 2015
 
4,334,918

 
$
45

 
$
75,792

 
$
74,028

 
$
207

 
$
(5,785
)
 
$
144,287


See accompanying Notes to Unaudited Consolidated Financial Statements.


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Table of Contents

First Business Financial Services, Inc.
Consolidated Statements of Cash Flows (Unaudited)
 
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
 
(In Thousands)
Operating activities
 
 
 
 
Net income
 
$
8,050

 
$
6,842

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Deferred income taxes, net
 
490

 
443

Provision for loan and lease losses
 
1,204

 
89

Depreciation, amortization and accretion, net
 
(604
)
 
870

Share-based compensation
 
449

 
389

Increase in cash surrender value of bank-owned life insurance
 
(472
)
 
(416
)
Origination of loans for sale
 
(32,473
)
 

Sale of loans originated for sale
 
34,256

 

Gain on sale of loans originated for sale
 
(1,717
)
 

Net (gain) loss on foreclosed properties, including impairment valuation
 
(15
)
 
4

Excess tax benefit from share-based compensation
 
(80
)
 
(38
)
Decrease (increase) in accrued interest receivable and other assets
 
192

 
(224
)
Increase (decrease) in accrued interest payable and other liabilities
 
1,514

 
(1,328
)
Net cash provided by operating activities
 
10,794

 
6,631

Investing activities
 
 
 
 
Proceeds from maturities, redemptions and paydowns of available-for-sale securities
 
21,777

 
25,038

Proceeds from maturities, redemptions and paydowns of held-to-maturity securities
 
2,175

 
290

Purchases of available-for-sale securities
 
(24,189
)
 
(31,648
)
Proceeds from sale of foreclosed properties
 
143

 

Net increase in loans and leases
 
(69,107
)
 
(26,760
)
Distributions from limited partnerships
 
332

 
203

Investment in FHLB and FRB Stock
 
(928
)
 
(467
)
Proceeds from sale of FHLB Stock
 
377

 
373

Purchases of leasehold improvements and equipment, net
 
(420
)
 
(159
)
Net cash used in investing activities
 
(69,840
)
 
(33,130
)
Financing activities
 
 
 
 
Net increase in deposits
 
33,106

 
36,842

Proceeds from FHLB advances
 
13,000

 

Net increase in short-term borrowed funds
 
500

 

Repayment of subordinated notes payable
 

 
(4,000
)
Excess tax benefit from share-based compensation
 
80

 
38

Cash dividends paid
 
(1,908
)
 
(1,657
)
Exercise of stock options
 
300

 
48

Purchase of treasury stock
 
(421
)
 
(81
)
Net cash provided by financing activities
 
44,657

 
31,190

Net (decrease) increase in cash and cash equivalents
 
(14,389
)
 
4,691

Cash and cash equivalents at the beginning of the period
 
103,237

 
81,286

Cash and cash equivalents at the end of the period
 
$
88,848

 
$
85,977

Supplementary cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
Interest paid on deposits and borrowings
 
$
6,574

 
$
5,160

Income taxes paid
 
1,469

 
2,867

Non-cash investing and financing activities:
 
 
 
 
Transfer of securities from available-for-sale to held-to-maturity
 

 
44,587

Unrealized loss on transfer from available-for-sale to held-to-maturity
 

 
(874
)
Transfer to foreclosed properties
 
289

 

See accompanying Notes to Unaudited Consolidated Financial Statements.

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Table of Contents

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. (the “Corporation”), its wholly-owned subsidiaries, First Business Bank (“FBB”), First Business Bank – Milwaukee (“FBB – Milwaukee”) and Alterra Bank (“Alterra”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB, FBB – Milwaukee and Alterra are sometimes referred to together as the “Banks.” FBB operates as a commercial banking institution in the Madison, Wisconsin market, consisting primarily of Dane County and the surrounding areas, with loan production offices in Northeast Wisconsin. FBB also offers trust and investment services through First Business Trust & Investments (“FBTI”), a division of FBB. FBB – Milwaukee operates as a commercial banking institution in the Milwaukee, Wisconsin market, consisting primarily of Waukesha County and the surrounding areas, with a loan production office in Kenosha, Wisconsin. Alterra operates as a commercial banking institution in the Kansas City market and the surrounding areas. The Banks provide a full range of financial services to businesses, business owners, executives, professionals and high net worth individuals. The Banks are subject to competition from other financial institutions and service providers and are also subject to state and federal regulations. FBB has the following wholly-owned subsidiaries: First Business Capital Corp. (“FBCC”), First Madison Investment Corp. (“FMIC”), First Business Equipment Finance, LLC (“FBEF”), Rimrock Road Investment Fund, LLC (“Rimrock Road”) and BOC Investment, LLC (“BOC”). FMIC is located in and was formed under the laws of the state of Nevada. FBB-Milwaukee has one subsidiary, FBB – Milwaukee Real Estate, LLC (“FBBMRE”).
Basis of Presentation. The accompanying unaudited Consolidated Financial Statements were prepared in accordance with GAAP and with 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, 2014. The unaudited Consolidated Financial Statements include the accounts of the Corporation and its wholly-owned subsidiaries. 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. All significant intercompany balances and transactions have been eliminated in consolidation.
Management of the Corporation is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of foreclosed property, lease residuals, property under operating leases, securities, income taxes and the level of the allowance for loan and lease losses. The results of operations for the six-month period ended June 30, 2015 are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2015. Certain amounts in prior periods may have been reclassified to conform to the current presentation. Subsequent events have been evaluated through the date of the issuance of the Consolidated Financial Statements. No significant subsequent events have occurred through this date requiring adjustment to the financial statements or disclosures.
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, 2014 except as described further below in this Note 1.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 666).” The ASU is a converged standard between the FASB and the IASB that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and industries. The primary objective of the ASU is revenue recognition that represents the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU is effective for interim and annual reporting periods beginning after December 15, 2016. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Corporation’s consolidated financial position or results of operations.
In June 2014, the FASB issued ASU No. 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” This ASU requires a reporting entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition. A reporting entity should apply FASB ASC Topic 718, Compensation-Stock Compensation, to awards with performance conditions that affect vesting. For all entities, ASU 2014-12 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. ASU 2014-12 may be

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adopted either prospectively for share-based payment awards granted or modified on or after the effective date, or retrospectively, using a modified retrospective approach. The modified retrospective approach would apply to share-based payment awards outstanding as of the beginning of the earliest annual period presented in the financial statements on adoption, and to all new or modified awards thereafter. While the Corporation does not have any performance-based awards outstanding as of the reporting date, the Corporation’s equity incentive plan does allow for such awards. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Corporation’s consolidated financial position or results of operations.
In August 2014, the FASB issued ASU 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This ASU describes how an entity should assess its ability to meet obligations and sets rules for how this information should be disclosed in the financial statements. The standard provides accounting guidance that will be used along with existing auditing standards. The ASU is effective for interim and annual periods beginning after December 15, 2016. Early application is permitted. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Corporation’s consolidated financial position or results of operations.
In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” This ASU changes the way reporting enterprises evaluate whether (a) they should consolidate limited partnerships and similar entities, (b) fees paid to a decision maker or service provider are variable interests in a variable interest entity (VIE), and (c) variable interests in a VIE held by related parties of the reporting enterprise require the reporting enterprise to consolidate the VIE. It also eliminates the VIE consolidation model based on majority exposure to variability that applied to certain investment companies and similar entities. The new guidance excludes money market funds that are required to comply with Rule 2a-7 of the Investment Company Act of 1940 and similar entities from the U.S. GAAP consolidation requirements. The new consolidation guidance is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2015. At the effective date, all previous consolidation analysis that the guidance affects must be reconsidered. This includes the consolidation analysis for all VIEs and for all limited partnerships and similar entities that previously were consolidated by the general partner even though the entities were not VIEs. Early adoption is permitted, including early adoption in an interim period. If a reporting enterprise chooses to early adopt in an interim period, adjustments resulting from the revised consolidation analysis must be reflected as of the beginning of the fiscal year that includes that interim period. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Corporation’s consolidated financial position or results of operations.
In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This ASU intends to simplify the presentation of debt issuance costs. This ASU is effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Corporation’s consolidated financial position or results of operations.

In April 2015, the FASB issued ASU 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement.” This ASU provides explicit guidance to help companies evaluate the accounting for fees paid by a customer in a cloud computing arrangement. The new guidance clarifies that if a cloud computing arrangement includes a software license, the customer should account for the license consistent with its accounting for other software licenses. If the arrangement does not include a software license, the customer should account for the arrangement as a service contract. This ASU is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. An entity can elect to adopt the amendments either prospectively for all arrangements entered into or materially modified after the effective date, or retrospectively. Early adoption is permitted for all entities. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Corporation’s consolidated financial position or results of operations.

In May 2015, the FASB issued ASU 2015-07, “Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” This ASU will eliminate the requirement to categorize investments in the fair value hierarchy if their fair value is measured at net asset value (NAV) per share (or its equivalent) using the practical expedient in the FASB’s fair value measurement guidance. Reporting entities are required to adopt the ASU retrospectively. The effective date for public business entities is fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for all entities. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Corporation’s consolidated financial position or results of operations.


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Note 2 — Earnings Per Common Share
Earnings per common share are computed using the two-class method. Basic earnings per common share are computed by dividing net income allocated to common shares by the weighted average number of shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends 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 both the three and six month periods ending June 30, 2015 and 2014, there were no average anti-dilutive employee share-based awards.
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(Dollars in Thousands, Except Per Share Data)
Basic earnings per common share
 
 
 
 
 
 
 
 
Net income
 
$
3,858

 
$
3,505

 
$
8,050

 
$
6,842

Less: earnings allocated to participating securities
 
65

 
75

 
138

 
147

Basic earnings allocated to common shareholders
 
$
3,793

 
$
3,430

 
$
7,912

 
$
6,695

 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding, excluding participating securities
 
4,261,127

 
3,860,087

 
4,261,218

 
3,859,795

 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.89

 
$
0.89

 
$
1.86

 
$
1.73

 
 
 
 
 
 
 
 
 
Diluted earnings per common share
 
 
 
 
 
 
 
 
Earnings allocated to common shareholders
 
$
3,793

 
$
3,430

 
$
7,912

 
$
6,695

Reallocation of undistributed earnings
 

 

 

 

Diluted earnings allocated to common shareholders
 
$
3,793

 
$
3,430

 
$
7,912

 
$
6,695

 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding, excluding participating securities
 
4,261,127

 
3,860,087

 
4,261,218

 
3,859,795

Dilutive effect of share-based awards
 

 
23,268

 
1,121

 
22,203

Weighted-average diluted common shares outstanding, excluding participating securities
 
4,261,127

 
3,883,355

 
4,262,339

 
3,881,998

 
 
 
 
 
 
 
 
 
Diluted earnings per common share
 
$
0.89

 
$
0.88

 
$
1.86

 
$
1.72


Note 3 — Share-Based Compensation
The Corporation adopted the 2012 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2012. The Plan is administered by the Compensation Committee of the Board of Directors of the Corporation and provides for the grant of equity ownership opportunities through incentive stock options and nonqualified stock options (together, “Stock Options”), restricted stock, restricted stock units, dividend equivalent units, and any other type of award permitted by the Plan. As of June 30, 2015, 178,738 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 treasury for shares delivered under the Plan.

8

Table of Contents

Stock Options
The Corporation may grant Stock Options to senior executives and other employees under the Plan. Stock Options generally have an exercise price that is equal to the fair value of the common shares on the date the option is awarded. Stock Options granted under the Plan are subject to graded vesting, generally ranging from 4 years to 8 years, and have a contractual term of 10 years. For any new awards issued, compensation expense is recognized over the requisite service period for the entire award on a straight-line basis. No Stock Options have been granted since the Corporation became a reporting company under the Securities Exchange Act of 1934, as amended, and no Stock Options have been modified, repurchased or canceled since such time. For that reason, no stock-based compensation related to Stock Options was recognized in the Consolidated Financial Statements for the three and six months ended June 30, 2015 and 2014. As of June 30, 2015, all Stock Options granted and not previously forfeited have vested. The benefits of tax deductions as a result of disqualifying dispositions upon exercise of stock options are recognized as a financing cash flow.
Stock Option activity for the year ended December 31, 2014 and six months ended June 30, 2015 was as follows:
 
 
Options
 
Weighted
Average
Exercise Price
 
Weighted
Average
Remaining
Contractual
Life (Years)
Outstanding at December 31, 2013
 
51,000

 
$
24.24

 
0.88
Granted
 

 

 
 
Exercised
 
(39,000
)
 
24.00

 
 
Expired
 

 

 
 
Forfeited
 

 

 
 
Outstanding at December 31, 2014
 
12,000

 
$
25.00

 
0.13
Exercisable at December 31, 2014
 
12,000

 
$
25.00

 
0.13
 
 
 
 
 
 
 
Outstanding as of December 31, 2014
 
12,000

 
$
25.00

 
0.13
Granted
 

 

 
 
Exercised
 
(12,000
)
 
25.00

 
 
Expired
 

 

 
 
Forfeited
 

 

 
 
Outstanding as of June 30, 2015
 

 
$

 

Exercisable at June 30, 2015
 

 
$

 

Restricted Stock
Under the Plan, the Corporation may grant restricted shares to plan participants, subject to forfeiture upon the occurrence of certain events until the dates specified in the participant’s award agreement. While the restricted shares are subject to forfeiture, the participant may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares. The restricted shares granted under the Plan are subject to graded vesting. Compensation expense is recognized over the requisite service period of generally four years for the entire award on a straight-line basis. Upon vesting of restricted share awards, the benefit of tax deductions in excess of recognized compensation expense is recognized as a financing cash flow activity.

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Table of Contents

Restricted share activity for the year ended December 31, 2014 and the six months ended June 30, 2015 was as follows:
 
 
Number of
Restricted Shares
 
Weighted Average
Grant-Date
Fair Value
Nonvested balance as of December 31, 2013
 
84,709

 
$
23.10

Granted
 
32,261

 
44.98

Vested
 
(39,471
)
 
19.71

Forfeited
 

 

Nonvested balance as of December 31, 2014
 
77,499

 
33.94

Granted
 
500

 
46.60

Vested
 
(913
)
 
44.23

Forfeited
 
(4,469
)
 
31.37

Nonvested balance as of June 30, 2015
 
72,617

 
$
34.05


As of June 30, 2015, $1.7 million of deferred compensation expense was included in additional paid-in capital in the Consolidated Balance Sheets related to unvested restricted shares which the Corporation expects to recognize over a weighted-average period of approximately 2.5 years. As of June 30, 2015, all restricted shares that vested were delivered.

For the three and six months ended June 30, 2015 and 2014, share-based compensation expense related to restricted stock included in the Consolidated Statements of Income was as follows:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In Thousands)
Share-based compensation expense
$
215

 
$
196

 
$
449

 
$
389

 
  
Note 4 — Securities
The amortized cost and estimated 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 June 30, 2015
 
 
Amortized cost
 
Gross
unrealized
holding gains
 
Gross
unrealized
holding losses
 
Estimated
fair value
 
 
(In Thousands)
Available-for-sale:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
8,047

 
$
13

 
$
(37
)
 
$
8,023

Municipal obligations
 
3,254

 
4

 
(11
)
 
3,247

Asset-backed securities
 
1,441

 
4

 

 
1,445

Collateralized mortgage obligations - government issued
 
54,918

 
1,178

 
(114
)
 
55,982

Collateralized mortgage obligations - government-sponsored enterprises
 
77,765

 
233

 
(353
)
 
77,645

 
 
$
145,425

 
$
1,432

 
$
(515
)
 
$
146,342



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Table of Contents

 
 
As of December 31, 2014
 
 
Amortized cost
 
Gross
unrealized
holding gains
 
Gross
unrealized
holding losses
 
Estimated
fair value
 
 
(In Thousands)
Available-for-sale:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
9,046

 
$

 
$
(81
)
 
$
8,965

Municipal obligations
 
573

 
5

 

 
578

Asset-backed securities
 
1,514

 
$

 
(4
)
 
1,510

Collateralized mortgage obligations - government issued
 
67,740

 
1,390

 
(256
)
 
68,874

Collateralized mortgage obligations - government-sponsored enterprises
 
64,763

 
234

 
(226
)
 
64,771

 
 
$
143,636

 
$
1,629

 
$
(567
)
 
$
144,698


The amortized cost and estimated fair value of securities held-to-maturity and the corresponding amounts of gross unrecognized gains and losses were as follows:

 
 
As of June 30, 2015
 
 
Amortized cost
 
Gross
unrecognized
holding gains
 
Gross
unrecognized
holding losses
 
Estimated
fair value
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
1,494

 
$
4

 
$
(9
)
 
$
1,489

Municipal obligations
 
16,063

 
48

 
(40
)
 
16,071

Collateralized mortgage obligations - government issued
 
13,106

 
73

 
(39
)
 
13,140

Collateralized mortgage obligations - government-sponsored enterprises
 
8,765

 

 
(46
)
 
8,719

 
 
$
39,428

 
$
125

 
$
(134
)
 
$
39,419


 
 
As of December 31, 2014
 
 
Amortized cost
 
Gross
unrecognized
holding gains
 
Gross
unrecognized
holding losses
 
Estimated
fair value
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
1,490

 
$

 
$
(17
)
 
$
1,473

Municipal obligations
 
16,088

 
85

 
(18
)
 
16,155

Collateralized mortgage obligations - government issued
 
14,505

 
57

 
(31
)
 
14,531

Collateralized mortgage obligations - government-sponsored enterprises
 
9,480

 
74

 
(19
)
 
9,535

 
 
$
41,563

 
$
216

 
$
(85
)
 
$
41,694


U.S. Government agency obligations - government-sponsored enterprises represent securities issued by the Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”). Collateralized mortgage obligations - government issued represent securities guaranteed by the Government National Mortgage Association

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Table of Contents

(“GNMA”). Collateralized mortgage obligations - government-sponsored enterprises include securities guaranteed by the FHLMC and the FNMA. Asset-backed securities represent securities issued by the Student Loan Marketing Association (“SLMA”) which are 97% guaranteed by the U.S. government. Municipal obligations include securities issued by various municipalities located primarily within the State of Wisconsin and are primarily general obligation bonds that are tax-exempt in nature. There were no sales of securities available-for-sale for the three and six months ended June 30, 2015 and 2014.

At June 30, 2015 and December 31, 2014, securities with a fair value of $28.0 million and $32.7 million, respectively, were pledged to secure interest rate swap contracts, outstanding Federal Home Loan Bank (“FHLB”) advances, if any, and additional FHLB availability.
The amortized cost and estimated fair value of securities by contractual maturity at June 30, 2015 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay certain obligations without call or prepayment penalties.
 
 
Available-for-Sale
 
Held-to-Maturity
 
 
Amortized cost
 
Estimated
fair value
 
Amortized cost
 
Estimated
fair value
 
 
(In Thousands)
Due in one year or less
 
$

 
$

 
$

 
$

Due in one year through five years
 
10,384

 
10,360

 
3,389

 
3,383

Due in five through ten years
 
84,949

 
85,407

 
13,668

 
13,681

Due in over ten years
 
50,092

 
50,575

 
22,371

 
22,355

 
 
$
145,425

 
$
146,342

 
$
39,428

 
$
39,419


The tables below show the Corporation’s gross unrealized losses and fair value of available-for-sale investments with unrealized losses, aggregated by investment category and length of time that individual investments were in a continuous loss position at June 30, 2015 and December 31, 2014. At June 30, 2015 and December 31, 2014, the Corporation held 66 and 59 available-for-sale securities that were in an unrealized loss position, respectively. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. At June 30, 2015, the Corporation held 17 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. It is expected that the Corporation will recover the entire amortized cost basis of each security based upon an evaluation of the present value of the expected future cash flows. Accordingly, no other than temporary impairment was recorded in the Consolidated Statements of Income for the six months ended June 30, 2015 and 2014.

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Table of Contents


A summary of unrealized loss information for securities available-for-sale, categorized by security type follows:

 
 
As of June 30, 2015
 
 
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 obligations - government-sponsored enterprises
 
$
999

 
$
1

 
$
3,714

 
$
36

 
$
4,713

 
$
37

Municipal obligations
 
2,423

 
11

 

 

 
2,423

 
11

Collateralized mortgage obligations - government issued
 
2,970

 
14

 
6,878

 
100

 
9,848

 
114

Collateralized mortgage obligations - government-sponsored enterprises
 
40,081

 
292

 
4,604

 
61

 
44,685

 
353

 
 
$
46,473

 
$
318

 
$
15,196

 
$
197

 
$
61,669

 
$
515


 
 
As of December 31, 2014
 
 
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 obligations - government-sponsored enterprises
 
$
3,486

 
$
12

 
$
5,479

 
$
69

 
$
8,965

 
$
81

Asset-backed securities
 

 
$

 
1,510

 
4

 
1,510

 
4

Collateralized mortgage obligations - government issued
 
9,201

 
50

 
9,536

 
206

 
18,737

 
256

Collateralized mortgage obligations - government-sponsored enterprises
 
29,498

 
97

 
4,993

 
129

 
34,491

 
226

 
 
$
42,185

 
$
159

 
$
21,518

 
$
408

 
$
63,703

 
$
567


The tables below show the Corporation’s gross unrecognized 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 June 30, 2015 and December 31, 2014. At June 30, 2015 and December 31, 2014, the Corporation held 37 and 57 held-to-maturity securities that were in an unrecognized loss position, respectively. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. There were four held-to-maturity securities that were in a continuous unrecognized loss position for twelve months or greater as of June 30, 2015. It is expected that the Corporation will recover the entire amortized cost basis of each held-to-maturity security based upon an evaluation of the present value of the expected future cash flows. Accordingly, no other than temporary impairment was recorded in the Consolidated Statements of Income for the six months ended June 30, 2015.

A summary of unrecognized loss information for securities held-to-maturity, categorized by security type follows:


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Table of Contents

 
 
As of June 30, 2015
 
 
Less than 12 months
 
12 months or longer
 
Total
 
 
Fair value
 
Unrecognized
losses
 
Fair value
 
Unrecognized
losses
 
Fair value
 
Unrecognized
losses
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$

 
$

 
$
1,000

 
$
9

 
$
1,000

 
$
9

Municipal obligations
 
4,217

 
28

 
398

 
12

 
4,615

 
40

Collateralized mortgage obligations - government issued
 
6,426

 
39

 

 

 
6,426

 
39

Collateralized mortgage obligations - government-sponsored enterprises
 
8,765

 
46

 

 

 
8,765

 
46

 
 
$
19,408

 
$
113

 
$
1,398

 
$
21

 
$
20,806

 
$
134


 
 
As of December 31, 2014
 
 
Less than 12 months
 
12 months or longer
 
Total
 
 
Fair value
 
Unrecognized
losses
 
Fair value
 
Unrecognized
losses
 
Fair value
 
Unrecognized
losses
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
1,490

 
$
17

 
$

 
$

 
$
1,490

 
$
17

Municipal obligations
 
2,222

 
18

 

 

 
2,222

 
18

Collateralized mortgage obligations - government issued
 
3,247

 
31

 

 

 
3,247

 
31

Collateralized mortgage obligations - government-sponsored enterprises
 
3,076

 
19

 

 

 
3,076

 
19

 
 
$
10,035

 
$
85

 
$

 
$

 
$
10,035

 
$
85






14

Table of Contents

Note 5 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses

Loan and lease receivables consist of the following:
 
 
June 30,
2015
 
December 31,
2014
 
 
(In Thousands)
Commercial real estate
 
 
 
 
Commercial real estate — owner occupied
 
$
169,768

 
$
163,884

Commercial real estate — non-owner occupied
 
400,018

 
417,962

Construction and land development
 
140,318

 
121,160

Multi-family
 
86,912

 
72,578

1-4 family (1)
 
47,091

 
36,182

Total commercial real estate
 
844,107

 
811,766

Commercial and industrial (2)
 
454,868

 
416,654

Direct financing leases, net
 
28,723

 
34,165

Consumer and other
 
 
 
 
Home equity and second mortgages (3)
 
9,466

 
7,866

Other
 
14,547

 
11,341

Total consumer and other
 
24,013

 
19,207

Total gross loans and leases receivable
 
1,351,711

 
1,281,792

Less:
 
 
 
 
   Allowance for loan and lease losses
 
15,199

 
14,329

   Deferred loan fees
 
1,147

 
1,025

Loans and leases receivable, net
 
$
1,335,365

 
$
1,266,438

(1)
Includes residential real estate loans held for sale totaling $331,000 as of June 30, 2015 and $1.3 million as of December 31, 2014.
(2)
Includes guaranteed portion of SBA loans held for sale totaling $638,000 as of June 30, 2015.
(3)
Includes guaranteed portion of SBA loans held for sale totaling $305,000 as of June 30, 2015.

Loans transferred to third parties consist of the guaranteed portion of SBA loans as well as participation interests in other originated loans. The total principal amount of loans transferred during the three months ended June 30, 2015 and 2014 was $32.0 million and $6.6 million, respectively. For the six months ended June 30, 2015 and 2014, $46.6 million and $11.7 million of loans were transferred to third parties, respectively. Each of the transfers of these financial assets met the qualifications for sale accounting, including the requirements specific to loan participations, and therefore all of the loans transferred during the three and six months ended June 30, 2015 and June 30, 2014 have been derecognized in the unaudited Consolidated Financial Statements. The Corporation has a continuing involvement in each of the agreements by way of relationship management and servicing the loans; however, there are no further obligations to the third-party participant required of the Corporation in the event of a borrower’s default, other than standard representations and warranties related to sold amounts. The guaranteed portion 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. No gain or loss was recognized on participation interests in other originated loans as they were transferred at or near the date of loan origination and the payments received for servicing the portion of the loans participated represents adequate compensation. The total amount of loan participations purchased on the Corporation’s Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014 was $475,000 and $482,000, respectively.

The total amount of outstanding loans transferred to third parties as loan participations sold at June 30, 2015 and December 31, 2014 was $140.0 million and $116.6 million, respectively, all of which was treated as a sale and derecognized under the applicable accounting guidance in effect at the time of the transfers of the financial assets. The Corporation’s continuing involvement with these loans is by way of partial ownership, relationship management and all servicing responsibilities. As of June 30, 2015 and December 31, 2014, the total amount of the Corporation’s partial ownership of loans on the Corporation’s Consolidated Balance Sheets was $98.4 million and $96.4 million, respectively. As of June 30, 2015, $1.0 million loans in this participation sold portfolio were considered impaired as compared to $1.2 million as of December 31, 2014. The Corporation does not share in the participant’s portion of the charge-offs.


15

Table of Contents

The Corporation sells residential real estate loans, servicing released, in the secondary market. The total principal amount of residential real estate loans sold during the three and six months ended June 30, 2015 was $10.3 million and $19.5 million, respectively. No residential real estate loans were originated or sold during the three months ended June 30, 2014. Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred during the three and six months ended June 30, 2015 have been derecognized in the unaudited Consolidated Financial Statements. The Corporation has a continuing involvement in each of the transactions by way of relationship management; however, there are no further obligations of the Corporation in the event of a borrower’s default, other than standard representations and warranties related to the sold amount. The loans were transferred at their fair value and the related gain was recognized as non-interest income upon the transfer in the unaudited Consolidated Financial Statements.

ASC 310-30, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, applies to purchased loans with evidence of deterioration in credit quality since origination for which it is probable at acquisition that the Corporation will be unable to collect all contractually required payments are considered to be credit impaired. Purchased credit-impaired loans are initially recorded at fair value, which is estimated by discounting the cash flows expected to be collected at the acquisition date. Because the estimate of expected cash flows reflects an estimate of future credit losses expected to be incurred over the life of the loans, an allowance for credit losses is not recorded at the acquisition date. The excess of cash flows expected at acquisition over the estimated fair value, referred to as the accretable yield, is recognized in interest income over the remaining life of the loan on a level-yield basis, contingent on the subsequent evaluation of future expected cash flows. The difference between the contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. A subsequent decrease in the estimate of cash flows expected to be received on purchased credit-impaired loans generally results in the recognition of an allowance for credit losses. Subsequent increases in cash flows result in reversal of any nonaccretable difference (or allowance for loan and lease losses to the extent any has been recorded) with a positive impact on interest income subsequently recognized. The measurement of cash flows involves assumptions and judgments for interest rates, prepayments, default rates, loss severity, and collateral values. All of these factors are inherently subjective and significant changes in the cash flow estimates over the life of the loan can result.

The following table reflects the contractually required payments receivable and fair value of the Corporation’s purchased credit impaired loans as of June 30, 2015 and December 31, 2014:
 
June 30,
2015
 
December 31,
2014
 
(In Thousands)
Contractually required payments
$
6,382

 
$
6,874

Fair value of purchased credit impaired loans
$
3,701

 
$
4,025

The following table presents a rollforward of the Corporation’s accretable yield as of June 30, 2015 and December 31, 2014:
 
As of and for the Six Months Ended June 30, 2015
 
As of and for the Year Ended December 31, 2014
 
(In Thousands)
Accretable yield, beginning of period
$
676

 
$
683

Accretion recognized in earnings
(22
)
 
(7
)
Reclassification to nonaccretable difference for loans with changing cash flows(1)
(21
)
 

Changes in accretable yield for non-credit related changes in expected cash flows(2)
(155
)
 

Accretable yield, end of period
$
478

 
$
676

(1)
Represents changes in accretable yield for those loans that are driven primarily by credit performance.
(2)
Represents changes in accretable yield for those loans that are driven primarily by changes in actual and estimated payments.




16

Table of Contents

The following information illustrates ending balances of the Corporation’s loan and lease portfolio, including impaired loans by class of receivable, and considering certain credit quality indicators as of June 30, 2015 and December 31, 2014:
 
 
Category
 
 
As of June 30, 2015
 
I
 
II
 
III
 
IV
 
Total
 
 
(Dollars in Thousands)
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 
$
137,582

 
$
18,053

 
$
13,480

 
$
653

 
$
169,768

Commercial real estate — non-owner occupied
 
372,874

 
24,903

 
1,334

 
907

 
400,018

Construction and land development
 
121,404

 
8,370

 
5,927

 
4,617

 
140,318

Multi-family
 
85,641

 
367

 
894

 
10

 
86,912

1-4 family
 
37,919

 
4,755

 
2,057

 
2,360

 
47,091

      Total commercial real estate
 
755,420

 
56,448

 
23,692

 
8,547

 
844,107

 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial(1) 
 
407,737

 
10,501

 
29,224

 
7,406

 
454,868

 
 
 
 
 
 
 
 
 
 
 
Direct financing leases, net
 
26,633

 
1,382

 
708

 

 
28,723

 
 
 
 
 
 
 
 
 
 
 
Consumer and other:
 
 
 
 
 
 
 
 
 

Home equity and second mortgages
 
8,359

 
447

 
162

 
498

 
9,466

Other
 
13,856

 

 

 
691

 
14,547

      Total consumer and other
 
22,215

 
447

 
162

 
1,189

 
24,013

 
 
 
 
 
 
 
 
 
 
 
Total gross loans and leases receivable
 
$
1,212,005

 
$
68,778

 
$
53,786

 
$
17,142

 
$
1,351,711

Category as a % of total portfolio
 
89.66
%
 
5.09
%
 
3.98
%
 
1.27
%
 
100.00
%
(1)
Category IV includes $6.2 million considered performing impaired loans with interest income recognized on a cash basis as of June 30, 2015. Subsequent to June 30, 2015, the Corporation granted a concession to the client and considered the loans to be troubled debt restructurings.



17

Table of Contents

 
 
Category
 
 
As of December 31, 2014
 
I
 
II
 
III
 
IV
 
Total
 
 
(Dollars in Thousands)
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 
$
131,094

 
$
15,592

 
$
16,621

 
$
577

 
$
163,884

Commercial real estate — non-owner occupied
 
378,671

 
20,823

 
17,498

 
970

 
417,962

Construction and land development
 
100,934

 
8,193

 
6,876

 
5,157

 
121,160

Multi-family
 
70,897

 
751

 
913

 
17

 
72,578

1-4 family
 
25,997

 
5,278

 
3,336

 
1,571

 
36,182

      Total commercial real estate
 
707,593

 
50,637

 
45,244

 
8,292

 
811,766

 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
 
383,755

 
18,524

 
12,026

 
2,349

 
416,654

 
 
 
 
 
 
 
 
 
 
 
Direct financing leases, net
 
32,756

 
1,120

 
289

 

 
34,165

 
 
 
 
 
 
 
 
 
 
 
Consumer and other:
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
7,039

 
205

 
189

 
433

 
7,866

Other
 
10,570

 
50

 

 
721

 
11,341

      Total consumer and other
 
17,609

 
255

 
189

 
1,154

 
19,207

 
 
 
 
 
 
 
 
 
 
 
Total gross loans and leases receivable
 
$
1,141,713

 
$
70,536

 
$
57,748

 
$
11,795

 
$
1,281,792

Category as a % of total portfolio
 
89.07
%
 
5.50
%
 
4.51
%
 
0.92
%
 
100.00
%

Credit underwriting through a committee process is a key component of the Corporation’s operating philosophy. Business development officers have relatively low individual lending authority limits, and thus a significant portion of the Corporation’s new credit extensions require approval from a loan approval committee regardless of the type of loan or lease, asset quality grade of the credit, amount of the credit, or the related complexities of each proposal. In addition, the Corporation makes every effort to ensure that there is appropriate collateral at the time of origination to protect the Corporation’s interest in the related loan or lease.
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 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 borrower’s management team or the industry in which the borrower operates. Loans and leases in this category are not subject to additional monitoring procedures above and beyond what is required at the origination or renewal of the loan or lease. 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 and collateral values. Management will place credits in this category to allow for proactive monitoring and resolution with the borrower to possibly mitigate the area of concern and prevent further deterioration or risk of loss to the Corporation. Category II loans are considered performing but are monitored frequently by the assigned business development officer and by subcommittees of the Banks’ loan committees.

18

Table of Contents

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 Banks. 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 required 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 loan committees of the Banks on a monthly basis and the Banks’ Boards of Directors at each of their regularly scheduled meetings.
Category IV — Loans and leases in this category are considered to be impaired. Impaired loans and leases have been placed on non-accrual as management has determined that it is unlikely that the Banks will receive the required principal and interest in accordance with the contractual terms of the agreement. Impaired loans are individually evaluated to assess the need for the establishment of specific reserves or charge-offs. When analyzing the adequacy of collateral, the Corporation obtains external appraisals at least annually for impaired loans and leases. External appraisals are obtained from the Corporation’s approved appraiser listing and are independently reviewed to monitor the quality of such appraisals. To the extent a collateral shortfall position is present, a specific reserve or charge-off will be recorded to reflect the magnitude of the impairment. Loans and leases in this category are monitored by management and loan committees of the Banks on a monthly basis and the Banks’ Boards of Directors at each of their regularly scheduled meetings.
Utilizing regulatory classification terminology, the Corporation identified $10.6 million and $27.1 million of loans and leases as Substandard as of June 30, 2015 and December 31, 2014, respectively. No loans were considered Special Mention, Doubtful or Loss as of either June 30, 2015 or December 31, 2014. The population of Substandard loans are a subset of Category III and Category IV loans.

19

Table of Contents

The delinquency aging of the loan and lease portfolio by class of receivable as of June 30, 2015 and December 31, 2014 is as follows:
As of June 30, 2015
 
30-59
days past due
 
60-89
days past due
 
Greater
than 90
days past due
 
Total past due
 
Current
 
Total loans
 
 
(Dollars in Thousands)
Accruing loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$

 
$

 
$

 
$
169,189

 
$
169,189

Non-owner occupied
 

 

 

 

 
399,736

 
399,736

Construction and land development
 

 

 

 

 
135,779

 
135,779

Multi-family
 

 

 

 

 
86,902

 
86,902

1-4 family
 

 

 

 

 
45,775

 
45,775

Commercial and industrial
 
399

 

 

 
399

 
447,091

 
447,490

Direct financing leases, net
 

 

 

 

 
28,723

 
28,723

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 
9,063

 
9,063

Other
 

 

 

 

 
13,856

 
13,856

Total
 
399

 

 

 
399

 
1,336,114

 
1,336,513

Non-accruing loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$
490

 
$

 
$
490

 
$
89

 
$
579

Non-owner occupied
 

 

 
235

 
235

 
47

 
282

Construction and land development
 

 

 

 

 
4,539

 
4,539

Multi-family
 

 

 

 

 
10

 
10

1-4 family
 
658

 
96

 
175

 
929

 
387

 
1,316

Commercial and industrial(1)
 
219

 
194

 
582

 
995

 
6,383

 
7,378

Direct financing leases, net
 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 
50

 
50

 
353

 
403

Other
 

 

 
691

 
691

 

 
691

Total
 
877

 
780

 
1,733

 
3,390

 
11,808

 
15,198

Total loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$
490

 
$

 
$
490

 
$
169,278

 
$
169,768

Non-owner occupied
 

 

 
235

 
235

 
399,783

 
400,018

Construction and land development
 

 

 

 

 
140,318

 
140,318

Multi-family
 

 

 

 

 
86,912

 
86,912

1-4 family
 
658

 
96

 
175

 
929

 
46,162

 
47,091

Commercial and industrial
 
618

 
194

 
582

 
1,394

 
453,474

 
454,868

Direct financing leases, net
 

 

 

 

 
28,723

 
28,723

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 

Home equity and second mortgages
 

 

 
50

 
50

 
9,416

 
9,466

Other
 

 

 
691

 
691

 
13,856

 
14,547

Total
 
$
1,276

 
$
780

 
$
1,733

 
$
3,789

 
$
1,347,922

 
$
1,351,711

Percent of portfolio
 
0.09
%
 
0.06
%
 
0.13
%
 
0.28
%
 
99.72
%
 
100.00
%

20

Table of Contents

(1)
Current balance includes $6.2 million considered performing impaired loans with interest income recognized on a cash basis as of June 30, 2015. Subsequent to June 30, 2015, the Corporation granted a concession to the client and considered the loans to be troubled debt restructurings.
As of December 31, 2014
 
30-59
days past due
 
60-89
days past due
 
Greater
than 90
days past due
 
Total past due
 
Current
 
Total loans
 
 
(Dollars in Thousands)
Accruing loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$

 
$

 
$

 
$
163,384

 
$
163,384

Non-owner occupied
 

 

 

 

 
417,676

 
417,676

Construction and land development
 

 

 

 

 
116,228

 
116,228

Multi-family
 

 

 

 

 
72,561

 
72,561

1-4 family
 

 

 

 

 
35,492

 
35,492

Commercial and industrial
 

 

 

 

 
414,336

 
414,336

Direct financing leases, net
 

 

 

 

 
34,165

 
34,165

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 
7,537

 
7,537

Other
 

 

 

 

 
10,621

 
10,621

Total
 

 

 

 

 
1,272,000

 
1,272,000

Non-accruing loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$

 
$

 
$

 
$
500

 
$
500

Non-owner occupied
 

 
215

 

 
215

 
71

 
286

Construction and land development
 

 
193

 

 
193

 
4,739

 
4,932

Multi-family
 

 

 

 

 
17

 
17

1-4 family
 

 
106

 
306

 
412

 
278

 
690

Commercial and industrial
 
364

 
146

 
736

 
1,246

 
1,072

 
2,318

Direct financing leases, net
 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 
329

 
329

Other
 

 

 
720

 
720

 

 
720

Total
 
364

 
660

 
1,762

 
2,786

 
7,006

 
9,792

Total loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$

 
$

 
$

 
$
163,884

 
$
163,884

Non-owner occupied
 

 
215

 

 
215

 
417,747

 
417,962

Construction and land development
 

 
193

 

 
193

 
120,967

 
121,160

Multi-family
 

 

 

 

 
72,578

 
72,578

1-4 family
 

 
106

 
306

 
412

 
35,770

 
36,182

Commercial and industrial
 
364

 
146

 
736

 
1,246

 
415,408

 
416,654

Direct financing leases, net
 

 

 

 

 
34,165

 
34,165

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 
7,866

 
7,866

Other
 

 

 
720

 
720

 
10,621

 
11,341

Total
 
$
364

 
$
660

 
$
1,762

 
$
2,786

 
$
1,279,006

 
$
1,281,792

Percent of portfolio
 
0.03
%
 
0.05
%
 
0.14
%
 
0.22
%
 
99.78
%
 
100.00
%

21

Table of Contents

The Corporation’s total impaired assets consisted of the following at June 30, 2015 and December 31, 2014, respectively.
 
 
June 30,
2015
 
December 31,
2014
 
 
(Dollars in Thousands)
Non-accrual loans and leases
 
 
 
 
Commercial real estate:
 
 
 
 
Commercial real estate — owner occupied
 
$
579

 
$
500

Commercial real estate — non-owner occupied
 
282

 
286

Construction and land development
 
4,539

 
4,932

Multi-family
 
10

 
17

1-4 family
 
1,316

 
690

Total non-accrual commercial real estate
 
6,726

 
6,425

Commercial and industrial(1)
 
7,378

 
2,318

Direct financing leases, net
 

 

Consumer and other:
 
 
 
 
Home equity and second mortgages
 
403

 
329

Other
 
691

 
720

Total non-accrual consumer and other loans
 
1,094

 
1,049

Total non-accrual loans and leases
 
15,198

 
9,792

Performing troubled debt restructurings
 
1,944

 
2,003

Total impaired loans and leases
 
17,142

 
11,795

Foreclosed properties, net
 
1,854

 
1,693

Total impaired assets

$
18,996

 
$
13,488

 
 
June 30,
2015
 
December 31,
2014
Total non-accrual loans and leases to gross loans and leases
 
1.12
%
 
0.76
%
Total non-performing assets to total gross loans and leases plus foreclosed properties, net
 
1.26

 
0.89

Total non-performing assets to total assets
 
1.01

 
0.70

Allowance for loan and lease losses to gross loans and leases
 
1.12

 
1.12

Allowance for loan and lease losses to non-accrual loans and leases
 
100.01

 
146.33

(1)
Balance includes $6.2 million considered performing impaired loans with interest income recognized on a cash basis as of June 30, 2015. Subsequent to June 30, 2015, the Corporation granted a concession to the client and considered the loans to be troubled debt restructurings.
As of June 30, 2015 and December 31, 2014, $6.9 million and $7.4 million of the non-accrual loans were considered troubled debt restructurings, respectively. As of June 30, 2015, there were no unfunded commitments associated with troubled debt restructured loans and leases.

22

Table of Contents

 
 
As of June 30, 2015
 
As of December 31, 2014
 
 
Number
of
Loans
 
Pre-Modification
Recorded
Investment
 
Post-Modification
Recorded
Investment
 
Number
of
Loans
 
Pre-Modification
Recorded
Investment
 
Post-Modification
Recorded
Investment
 
 
(Dollars in Thousands)
Troubled debt restructurings:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 
2
 
$
625

 
$
564

 
2
 
$
624

 
$
577

Commercial real estate — non-owner occupied
 
5
 
1,151

 
907

 
5
 
1,095

 
970

Construction and land development
 
3
 
6,034

 
4,678

 
4
 
6,260

 
5,157

Multi-family
 
1
 
184

 
10

 
1
 
184

 
17

1-4 family
 
16
 
2,119

 
1,435

 
16
 
2,119

 
1,368

Commercial and industrial
 
3
 
201

 
144

 
4
 
361

 
155

Direct financing leases, net
 
 

 

 
 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
6
 
681

 
375

 
6
 
772

 
431

Other
 
1
 
2,076

 
690

 
2
 
2,080

 
721

Total
 
37
 
$
13,071

 
$
8,803

 
40
 
$
13,495

 
$
9,396


All loans and leases modified as a troubled debt restructuring are evaluated 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.

As of June 30, 2015 and December 31, 2014, the Corporation’s troubled debt restructurings grouped by type of concession were as follows:
 
 
As of June 30, 2015
 
As of December 31, 2014
 
 
Number
of
Loans
 
Recorded Investment
 
Number
of
Loans
 
Recorded Investment
 
 
(Dollars in Thousands)
Commercial real estate
 
 
 
 
 
 
 
 
   Extension of term
 
1

 
$
31

 
1

 
$
39

   Interest rate concession
 
1

 
56

 
1

 
65

   Combination of extension and interest rate concession
 
25

 
7,506

 
26

 
7,984

Commercial and industrial
 
 
 
 
 
 
 
 
   Combination of extension and interest rate concession
 
3

 
144

 
4

 
155

Consumer and other
 
 
 
 
 
 
 
 
   Extension of term
 
2

 
723

 
3

 
753

   Combination of extension and interest rate concession
 
5

 
343

 
5

 
400

Total
 
37

 
$
8,803

 
40

 
$
9,396


There were no loans and leases modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the six months ended June 30, 2015.
 
 
 
 
 

23

Table of Contents

The following represents additional information regarding the Corporation’s impaired loans and leases by class:
 
 
Impaired Loans and Leases
 
 
As of and for the Six Months Ended June 30, 2015
 
 
Recorded
investment
 
Unpaid
principal
balance
 
Impairment
reserve
 
Average
recorded
investment(1)
 
Foregone
interest
income
 
Interest
income
recognized
 
Net
foregone
interest
income
 
 
(In Thousands)
With no impairment reserve recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$
564

 
$
564

 
$

 
$
575

 
$
13

 
$

 
$
13

Non-owner occupied
 
860

 
860

 

 
918

 
6

 

 
6

Construction and land development
 
4,617

 
7,287

 

 
5,039

 
71

 

 
71

Multi-family
 
10

 
377

 

 
13

 
24

 

 
24

1-4 family
 
1,442

 
1,514

 

 
1,578

 
33

 

 
33

Commercial and industrial(2)
 
6,375

 
6,384

 

 
231

 
63

 
1

 
62

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
317

 
317

 

 
292

 
8

 

 
8

Other
 
691

 
1,357

 

 
704

 
41

 

 
41

Total
 
14,876

 
18,660

 

 
9,350

 
259

 
1

 
258

With impairment reserve recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$
89

 
$
89

 
$
4

 
$
17

 
$

 
$

 
$

Non-owner occupied
 
47

 
87

 
47

 
48

 
2

 

 
2

Construction and land development
 

 

 

 

 

 

 

Multi-family
 

 

 

 

 

 

 

1-4 family
 
918

 
924

 
177

 
375

 
11

 

 
11

Commercial and industrial
 
1,031

 
1,031

 
253

 
1,241

 
38

 

 
38

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
181

 
181

 
94

 
127

 
7

 

 
7

Other
 

 

 

 

 

 

 

Total
 
2,266

 
2,312

 
575

 
1,808

 
58

 

 
58

Total:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$
653

 
$
653

 
$
4

 
$
592

 
$
13

 
$

 
$
13

Non-owner occupied
 
907

 
947

 
47

 
966

 
8

 

 
8

Construction and land development
 
4,617

 
7,287

 

 
5,039

 
71

 

 
71

Multi-family
 
10

 
377

 

 
13

 
24

 

 
24

1-4 family
 
2,360

 
2,438

 
177

 
1,953

 
44

 

 
44

Commercial and industrial
 
7,406

 
7,415

 
253

 
1,472

 
101

 
1

 
100

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
498

 
498

 
94

 
419

 
15

 

 
15

Other
 
691

 
1,357

 

 
704

 
41

 

 
41

Grand total
 
$
17,142

 
$
20,972

 
$
575

 
$
11,158

 
$
317

 
$
1

 
$
316

(1)
Average recorded investment is calculated primarily using daily average balances.
(2)
Recorded investment and unpaid principal balances include $6.2 million considered performing impaired loans with interest income recognized on a cash basis as of June 30, 2015. Subsequent to June 30, 2015, the Corporation granted a concession to the client and considered the loans to be troubled debt restructurings.


24

Table of Contents

 
 
Impaired Loans and Leases
 
 
As of and for the Year Ended December 31, 2014
 
 
Recorded
investment
 
Unpaid
principal
balance
 
Impairment
reserve
 
Average
recorded
investment
(1)
 
Foregone
interest
income
 
Interest
income
recognized
 
Net
Foregone
Interest
Income
 
 
(In Thousands)
With no impairment reserve recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Owner occupied
 
$
577

 
$
577

 
$

 
$
484

 
$
30

 
$
79

 
$
(49
)
   Non-owner occupied
 
921

 
921

 

 
349

 
22

 

 
22

   Construction and land development
 
5,157

 
7,828

 

 
5,285

 
155

 

 
155

   Multi-family
 
17

 
384

 

 
24

 
53

 

 
53

   1-4 family
 
1,181

 
1,218

 

 
380

 
15

 
12

 
3

Commercial and industrial
 
2,316

 
2,926

 

 
6,141

 
463

 
649

 
(186
)
Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Home equity and second mortgages
 
380

 
380

 

 
495

 
18

 

 
18

   Other
 
721

 
1,389

 

 
768

 
87

 

 
87

      Total
 
11,270

 
15,623

 

 
13,926

 
843

 
740

 
103

With impairment reserve recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Owner occupied
 
$

 
$

 
$

 
$

 
$

 
$

 
$

   Non-owner occupied
 
49

 
89

 
49

 
52

 
4

 

 
4

   Construction and land development
 

 

 

 

 

 

 

   Multi-family
 

 

 

 

 

 

 

   1-4 family
 
390

 
390

 
155

 
405

 
18

 

 
18

Commercial and industrial
 
33

 
33

 
33

 
34

 

 

 

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Home equity and second mortgages
 
53

 
53

 
53

 
57

 
5

 

 
5

   Other
 

 

 

 

 

 

 

      Total
 
525

 
565

 
290

 
548

 
27

 

 
27

Total:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Owner occupied
 
$
577

 
$
577

 
$

 
$
484

 
$
30

 
$
79

 
$
(49
)
   Non-owner occupied
 
970

 
1,010

 
49

 
401

 
26

 

 
26

   Construction and land development
 
5,157

 
7,828

 

 
5,285

 
155

 

 
155

   Multi-family
 
17

 
384

 

 
24

 
53

 

 
53

   1-4 family
 
1,571

 
1,608

 
155

 
785

 
33

 
12

 
21

Commercial and industrial
 
2,349

 
2,959

 
33

 
6,175

 
463

 
649

 
(186
)
Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
433

 
433

 
53

 
552

 
23

 

 
23

Other
 
721

 
1,389

 

 
768

 
87

 

 
87

      Grand total
 
$
11,795

 
$
16,188

 
$
290

 
$
14,474

 
$
870

 
$
740

 
$
130

(1)
Average recorded investment is calculated primarily using daily average balances.

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Table of Contents

The difference between the loans and leases recorded investment and the unpaid principal balance of $3.8 million and $4.4 million as of June 30, 2015 and December 31, 2014 represents partial charge-offs resulting from confirmed losses due to the value of the collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $1.9 million and $2.0 million of loans as of June 30, 2015 and December 31, 2014 that were performing troubled debt restructurings, and thus, while 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 principal. Foregone interest represents the interest that was contractually due on the note but not received or recorded. To the extent the amount of principal on a non-accrual note 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 breaks out the portfolio by segments and risk ratings. 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 Six Months Ended June 30, 2015
 
 
Commercial
real estate
 
Commercial
and
industrial loans and leases
 
Consumer
and other
 
Total
 
 
(Dollars in Thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
Beginning balance
 
$
8,619

 
$
5,492

 
$
218

 
$
14,329

Charge-offs
 
(91
)
 
(313
)
 
(4
)
 
(408
)
Recoveries
 
66

 
5

 
3

 
74

Provision
 
123

 
1,024

 
57

 
1,204

Ending balance
 
$
8,717

 
$
6,208

 
$
274

 
$
15,199

Ending balance: individually evaluated for impairment
 
$
228

 
$
124

 
$
94

 
$
446

Ending balance: collectively evaluated for impairment
 
$
8,489

 
$
5,955

 
$
180

 
$
14,624

Ending balance: loans acquired with deteriorated credit quality
 
$

 
$
129

 
$

 
$
129

Loans and lease receivables:
 
 
 
 
 
 
 
 
Ending balance, gross
 
$
844,107

 
$
483,591

 
$
24,013

 
$
1,351,711

Ending balance: individually evaluated for impairment(1)
 
$
5,589

 
$
6,751

 
$
959

 
$
13,299

Ending balance: collectively evaluated for impairment
 
$
835,559

 
$
476,186

 
$
22,824

 
$
1,334,569

Ending balance: loans acquired with deteriorated credit quality
 
$
2,959

 
$
654

 
$
230

 
$
3,843

Allowance as % of gross loans
 
1.03
%
 
1.28
%
 
1.14
%
 
1.12
%
(1)
Commercial and industrial loans and leases balance includes $6.2 million considered performing impaired loans with interest income recognized on a cash basis as of June 30, 2015. Subsequent to June 30, 2015, the Corporation granted a concession to the client and considered the loans to be troubled debt restructurings.



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Table of Contents

 
 
As of and for the Six Months Ended June 30, 2014
 
 
Commercial
real estate
 
Commercial
and
industrial loans and leases
 
Consumer
and other
 
Total
 
 
(Dollars in Thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
Beginning balance
 
$
9,055

 
$
4,573

 
$
273

 
$
13,901

Charge-offs
 

 

 

 

Recoveries
 
17

 
1

 
7

 
25

Provision
 
(304
)
 
432

 
(39
)
 
89

Ending balance
 
$
8,768

 
$
5,006

 
$
241

 
$
14,015

Ending balance: individually evaluated for impairment
 
$
342

 
$
208

 
$
56

 
$
606

Ending balance: collectively evaluated for impairment
 
$
8,426

 
$
4,798

 
$
185

 
$
13,409

Ending balance: loans acquired with deteriorated credit quality
 
$

 
$

 
$

 
$

Loans and lease receivables:
 
 
 
 
 
 
 
 
Ending balance, gross
 
$
637,403

 
$
355,549

 
$
15,663

 
$
1,008,615

Ending balance: individually evaluated for impairment
 
$
5,416

 
$
6,664

 
$
1,331

 
$
13,411

Ending balance: collectively evaluated for impairment
 
$
630,616

 
$
348,885

 
$
14,332

 
$
993,833

Ending balance: loans acquired with deteriorated credit quality
 
$
1,371

 
$

 
$

 
$
1,371

Allowance as % of gross loans
 
1.38
%
 
1.41
%
 
1.54
%
 
1.39
%

Note 6 — Deposits
The composition of deposits at June 30, 2015 and December 31, 2014 was as follows. Average balances represent year-to-date averages.
 
 
June 30, 2015
 
December 31, 2014
 
 
Balance
 
Average
balance
 
Weighted
average rate
 
Balance
 
Average
balance
 
Weighted
average rate
 
 
(Dollars in Thousands)
Non-interest-bearing transaction accounts
 
$
221,064

 
$
202,905

 
%
 
$
204,328

 
$
154,687

 
%
Interest-bearing transaction accounts
 
107,318

 
106,442

 
0.23

 
104,199

 
83,508

 
0.22

Money market accounts
 
588,240

 
615,485

 
0.55

 
575,766

 
493,322

 
0.52

Certificates of deposit
 
109,966

 
117,748

 
0.75

 
126,635

 
60,284

 
0.89

Wholesale deposits
 
444,480

 
426,136

 
1.36

 
427,340

 
416,202

 
1.49

Total deposits
 
$
1,471,068

 
$
1,468,716

 
0.70

 
$
1,438,268

 
$
1,208,003

 
0.78





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Table of Contents

Note 7 — FHLB Advances, Other Borrowings and Junior Subordinated Notes Payable
The composition of borrowed funds at June 30, 2015 and December 31, 2014 was as follows. Average balances represent year-to-date averages.
 
 
June 30, 2015
 
December 31, 2014
 
 
Balance
 
Average
balance
 
Weighted
average
rate
 
Balance
 
Average
balance
 
Weighted
average
rate
 
 
(Dollars in Thousands)
Federal funds purchased
 
$

 
$
224

 
0.81
%
 
$

 
$
237

 
0.82
%
FHLB advances and other borrowings
 
22,965

 
16,770

 
0.99

 
10,058

 
5,093

 
0.56

Senior line of credit
 
1,510

 
1,018

 
3.17

 
1,010

 
13

 
3.30

Subordinated notes payable
 
22,926

 
22,926

 
6.96

 
22,926

 
13,362

 
7.07

Junior subordinated notes
 
10,315

 
10,315

 
10.70

 
10,315

 
10,315

 
10.78

 
 
$
57,716

 
$
51,253

 
5.68

 
$
44,309

 
$
29,020

 
7.24

 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
$
18,010

 
 
 
 
 
$
2,010

 
 
 
 
Long-term borrowings
 
39,706

 
 
 
 
 
42,299

 
 
 
 
 
 
$
57,716

 
 
 
 
 
$
44,309

 
 
 
 

As of June 30, 2015, 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, 2015, the Corporation pays a commitment fee on this senior line of credit. During the six months ended June 30, 2015 the Corporation incurred $6,000 additional interest expense due to this fee. Prior to February 19, 2015, the Corporation paid an unused line fee on this senior line of credit. During the six months ended June 30, 2014, the Corporation incurred $7,000 additional interest expense due to this fee.

Note 8 — 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.

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Table of Contents

Assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy level, are summarized below:
 
 
Fair Value Measurements Using
 
 
June 30, 2015
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In Thousands)
Assets:
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
Municipal obligations
 
$

 
$
3,247

 
$

 
$
3,247

Asset backed securities
 

 
1,445

 

 
1,445

U.S. Government agency obligations - government-sponsored enterprises
 

 
8,023

 

 
8,023

Collateralized mortgage obligations - government issued
 

 
55,982

 

 
55,982

Collateralized mortgage obligations - government-sponsored enterprises
 

 
77,645

 

 
77,645

Interest rate swaps
 

 
519

 

 
519

Liabilities:
 
 
 
 
 
 
 

Interest rate swaps
 
$

 
$
519

 
$

 
$
519

 
 
Fair Value Measurements Using
 
 
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In Thousands)
Assets:
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
Municipal obligations
 
$

 
$
578

 
$

 
$
578

Asset backed securities
 

 
1,510

 

 
1,510

U.S. Government agency obligations - government-sponsored enterprises
 

 
8,965

 

 
8,965

Collateralized mortgage obligations - government issued
 

 
68,874

 

 
68,874

Collateralized mortgage obligations - government-sponsored enterprises
 

 
64,771

 

 
64,771

Interest rate swaps
 

 
575

 

 
575

Liabilities:
 
 
 
 
 
 
 
 
Interest rate swaps
 
$

 
$
575

 
$

 
$
575


For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the six months ended June 30, 2015 or the year ended December 31, 2014 related to the above measurements.

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Table of Contents

Assets and liabilities measured at fair value on a non-recurring basis, segregated by fair value hierarchy are summarized below:
 
 
 
 
As of and for the Six Months Ended June 30, 2015
 
 
Balance at
 
Fair Value Measurements Using
 
Total
Gains
(Losses)
 
 
June 30,
2015
 
Level 1
 
Level 2
 
Level 3
 
 
 
(In Thousands)
Impaired loans
 
$
8,795

 
$

 
$
7,573

 
$
1,222

 
$

Foreclosed properties
 
1,854

 

 
1,854

 

 
(1
)
Loan servicing rights
 
1,168

 

 

 
1,168

 


 
 
 
 
As of and for the Year Ended December 31, 2014
 
 
Balance at
 
Fair Value Measurements Using
 
Total
Gains
(Losses)
 
 
December 31,
2014
 
Level 1
 
Level 2
 
Level 3
 
 
 
(In Thousands)
Impaired loans
 
$
8,565

 
$

 
$
7,025

 
$
1,540

 
$

Foreclosed properties
 
1,693

 

 
1,693

 

 
(4
)
Loan servicing rights
 
943

 

 

 
943

 


Impaired loans which are collateral dependent were written down to their net realizable value of $8.8 million and $8.6 million at June 30, 2015 and December 31, 2014, respectively, through the establishment of specific reserves or by recording charge-offs when the carrying value exceeded the fair value. Valuation techniques consistent with the market approach, income approach, or cost approach were used to measure fair value and primarily included observable inputs for the individual impaired loans being evaluated such as current appraisals, recent sales of similar assets or other observable market data, and are reflected within Level 2 of the hierarchy. In cases where an input is unobservable, specifically discounts applied to appraisal values to adjust such values to current market conditions or to reflect net realizable value, the impaired loan balance is reflected within Level 3 of the hierarchy. The quantification of unobservable inputs for Level 3 impaired loan values range from 10% - 100%. The weighted average of those unobservable inputs as of the measurement date of June 30, 2015 was 44%. The majority of the impaired loans in the Level 3 category are considered collateral dependent loans.
Loan servicing rights represent the asset retained upon sale of the guaranteed portion of certain SBA loans. When SBA loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The servicing rights are subsequently measured using the amortization method, which requires amortization into interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.
The Corporation periodically reviews this portfolio for impairment and engages a third-party valuation firm to assess the fair value of the overall servicing rights portfolio. Loan servicing rights do not trade in an active, open market with readily observable prices. While sales of loan servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Corporation utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its loan servicing rights. The valuation model incorporates prepayment assumptions to project loan servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the loan servicing rights. The valuation model considers portfolio characteristics of the underlying serviced portion of the SBA loans and uses the following significant unobservable inputs: (1) constant prepayment rate (“CPR”) assumptions based on the SBA sold pools historical CPR as quoted in Bloomberg and (2) a discount rate of 10%. Due to the nature of the valuation inputs, loan servicing rights are classified in Level 3 of the fair value hierarchy.
As of June 30, 2015 and December 31, 2014, the estimated fair value of the Corporation’s loan servicing asset was $1.2 million and $943,000, respectively.

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Table of Contents

Foreclosed properties, upon initial recognition, are re-measured and reported at fair value through a charge-off to the allowance for loan and lease losses, if deemed necessary, based upon the fair value of the foreclosed property. The fair value of a foreclosed property, upon initial recognition, is estimated using a market approach or Level 2 inputs based on observable market data, typically a current appraisal, or Level 3 inputs based upon assumptions specific to the individual property or equipment. Level 3 inputs typically include unobservable inputs such as management-applied discounts used to further reduce values to a net realizable value and may be used in situations when observable inputs become stale. Foreclosed property fair value inputs may transition to Level 1 upon receipt of an accepted offer for the sale of the related foreclosed property.
As of June 30, 2015, there were no foreclosed properties supported by a Level 3 valuation. Subsequent impairments of foreclosed properties are recorded as a loss on foreclosed properties. Based upon an evaluation of value of certain of the Corporation’s foreclosed properties, impairment losses of $1,000 were recognized for the six months ended June 30, 2015. The activity of the Corporation’s foreclosed properties is summarized as follows:
 
As of and for the Six Months Ended June 30, 2015
 
As of and for the Year Ended December 31, 2014
 
(In Thousands)
Foreclosed properties at the beginning of the period
$
1,693

 
$
333

Foreclosed properties acquired in acquisition, at fair value

 
1,605

Loans transferred to foreclosed properties, at lower of cost or fair value
289

 

Proceeds from sale of foreclosed properties
(143
)
 
(255
)
Net gain on sale of foreclosed properties
16

 
14

Impairment valuation
(1
)
 
(4
)
Foreclosed properties at the end of the period
$
1,854

 
$
1,693


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Table of Contents

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:
 
 
June 30, 2015
 
 
Carrying
Amount
 
Fair Value
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
 
 
(In Thousands)
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
88,848

 
$
88,856

 
$
73,693

 
$
6,663

 
$
8,500

Securities available-for-sale
 
146,342

 
146,342

 

 
146,342

 

Securities held-to-maturity
 
39,428

 
39,419

 

 
39,419

 

Loans held for sale
 
1,274

 
1,274

 

 
1,274

 

Loans and lease receivables, net
 
1,334,091

 
1,365,475

 

 
7,573

 
1,357,902

Federal Home Loan Bank and Federal Reserve Bank stock
 
2,891

 
2,891

 

 

 
2,891

Cash surrender value of life insurance
 
27,785

 
27,785

 
27,785

 

 

Accrued interest receivable
 
4,159

 
4,159

 
4,159

 

 

Interest rate swaps
 
519

 
519

 

 
519

 

Financial liabilities:
 
 
 

 
 
 
 
 
 
Deposits
 
$
1,471,068

 
$
1,473,706

 
$
916,622

 
$
557,084

 
$

Federal Home Loan Bank and other borrowings
 
47,401

 
45,477

 

 
45,477

 

Junior subordinated notes
 
10,315

 
7,084

 

 

 
7,084

Interest rate swaps
 
519

 
519

 

 
519

 

Accrued interest payable
 
1,618

 
1,618

 
1,618

 

 

Off-balance-sheet items:
 
 
 

 
 
 
 
 
 
Standby letters of credit
 
124

 
124

 

 

 
124

Commitments to extend credit
 

 
*

 
*

 
*

 
*


*Not meaningful

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Table of Contents

 
 
December 31, 2014
 
 
Carrying
Amount
 
Fair Value
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
 
 
(In Thousands)
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
103,237

 
$
103,227

 
$
85,937

 
$
6,890

 
$
10,400

Securities available-for-sale
 
144,698

 
144,698

 

 
144,698

 

Securities held-to-maturity
 
41,563

 
41,694

 

 
41,694

 

Loans held for sale
 
1,340

 
1,340

 

 
1,340

 

Loans and lease receivables, net
 
1,265,098

 
1,285,162

 

 
7,025

 
1,278,137

Federal Home Loan Bank and Federal Reserve Bank stock
 
2,340

 
2,340

 

 

 
2,340

Cash surrender value of life insurance
 
27,314

 
27,314

 
27,314

 

 

Accrued interest receivable
 
3,932

 
3,932

 
3,932

 

 

Interest rate swaps
 
575

 
575

 

 
575

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits
 
$
1,438,268

 
$
1,440,248

 
$
884,292

 
$
555,956

 
$

Federal Home Loan Bank and other borrowings
 
33,994

 
34,590

 

 
34,590

 

Junior subordinated notes
 
10,315

 
7,101

 

 

 
7,101

Interest rate swaps
 
575

 
575

 

 
575

 

Accrued interest payable
 
1,574

 
1,574

 
1,574

 

 

Off-balance-sheet items:
 
 
 
 
 
 
 
 
 
 
Standby letters of credit
 
192

 
192

 

 

 
192

Commitments to extend credit
 

 
*

 
*

 
*

 
*


*Not meaningful
Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the Consolidated Balance Sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Corporation.
Cash and cash equivalents: The carrying amounts reported for cash and due from banks, interest-bearing deposits held by the Corporation, accrued interest receivable and accrued interest payable approximate fair value because of their immediate availability and because they do not present unanticipated credit concerns. The carrying value of commercial paper, included in the cash and cash equivalents category, approximates fair value due to the short-term maturity structure of the instrument. As of June 30, 2015 and December 31, 2014, the Corporation held $8.5 million and $10.4 million, respectively, of commercial paper. The fair value of commercial paper is considered a Level 3 input due to the lack of available independent pricing sources. The carrying value of brokered certificates of deposit purchased is equivalent to the purchase price of the instruments as the Corporation has not elected a fair value option for these instruments. The fair value of brokered certificates of deposits purchased is based on the discounted value of contractual cash flows using a discount rate reflective of rates currently offered for deposits of similar remaining maturities. As of June 30, 2015 and December 31, 2014, the Corporation held $6.7 million and $6.9 million, respectively, of brokered certificates of deposits.

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Table of Contents

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 to 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 residential real estate mortgage loans and the guaranteed portion of SBA loans, are carried at the lower of cost or estimated fair value. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics.
Loans and Leases: The fair value estimation process for the loan portfolio uses an exit price concept and reflects discounts that the Corporation believes are consistent with liquidity discounts in the market place. Fair values are estimated for portfolios of loans with similar financial characteristics. The fair value of performing and nonperforming loans is calculated by discounting scheduled and expected cash flows through the estimated maturity using estimated market rates that reflect the credit and interest rate risk inherent in the portfolio of loans and then applying a discount factor based upon the embedded credit risk of the loan and the fair value of collateral securing nonperforming loans when the loan is collateral dependent. The estimate of maturity is based on the Banks’ historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. Significant unobservable inputs include, but are not limited to, discounts (investor yield premiums) applied to fair value calculations to further determine the exit price value of a portfolio of loans.
Federal Home Loan Bank and Federal Reserve Bank Stock: The carrying amount of FHLB and FRB stock equals its fair value because the shares may be redeemed by the FHLB and the FRB at their carrying amount of $100 per share.
Cash Surrender Value of Life Insurance: The carrying amount of the cash surrender value of life insurance approximates its fair value as the carrying value represents the current settlement amount.
Deposits: The fair value of deposits with no stated maturity, such as demand deposits and money market accounts, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates do not include the intangible value that results from the funding provided by deposit liabilities compared to borrowing funds in the market.
Borrowed Funds: Market rates currently available to the Corporation and Banks for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
Financial Instruments with Off-Balance-Sheet Risks: The fair value of the Corporation’s off-balance-sheet instruments is based on quoted market prices and fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the credit standing of the related counterparty. Commitments to extend credit and standby letters of credit are generally not marketable. Furthermore, interest rates on any amounts drawn under such commitments would generally be established at market rates at the time of the draw. Fair value would principally derive from the present value of fees received for those products.
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 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

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Table of Contents

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 9 — 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 designated as accounting hedge relationships 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 primarily 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 considers the impact of netting and any applicable credit enhancements such as collateral postings, thresholds and guarantees.
At June 30, 2015, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was 27.3 million. The Corporation receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These interest rate swaps mature in March, 2016 through February, 2023. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported on the Consolidated Balance Sheets as a derivative asset of $519,000 and are included in accrued interest receivable and other assets. In the event of default on a commercial borrower interest rate swap by the counterparty, a right of offset exists to allow the commercial borrower to set off amounts due against the related commercial loan. As of June 30, 2015, no interest rate swaps were in default and therefore all values for the commercial borrower swaps are recorded on a gross basis within the Corporation’s financial position.
At June 30, 2015, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also 27.3 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 March, 2016 through February, 2023. Dealer counterparty swaps are subject to master netting agreements among the contracts within each of the Banks and are reported on the Consolidated Balance Sheets as a net derivative liability of $519,000, included in accrued interest payable and other liabilities as of June 30, 2015. The gross amount of dealer counterparty swaps, without regard to the enforceable master netting agreement, was a derivative liability of $519,000, included in accrued interest payable and other liabilities as of June 30, 2015. No right of offset exists with the dealer counterparty swaps.
The table below provides information about the location and fair value of the Corporation’s derivative instruments as of June 30, 2015 and December 31, 2014.

 
 
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
 
 
 
 
 
 
 
 
June 30, 2015
 
Other assets
 
$
519

 
Other liabilities
 
$
519

December 31, 2014
 
Other assets
 
$
575

 
Other liabilities
 
$
575



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No derivative instruments held by the Corporation for the six months ended June 30, 2015 were considered hedging instruments. 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 six months ended June 30, 2015 and 2014 had an insignificant impact on the unaudited Consolidated Statements of Income.

Note 10 — Regulatory Capital

The Corporation and the Banks are subject to various regulatory capital requirements administered by Federal, State of Wisconsin and State of Kansas 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 Banks’ assets, liabilities and certain off-balance-sheet items as calculated under regulatory practices. The Corporation’s and the Banks’ 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 (the “Capital 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 Banks. The Corporation’s and the Banks’ 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 companies 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 prospective financial condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios. Management intends, when appropriate under regulatory guidelines, to consult with the Federal Reserve Bank of Chicago and provide it with information on the Corporation’s then-current and prospective earnings and capital position in advance of declaring any cash dividends. As a Wisconsin corporation, the Corporation is subject to the limitations of the Wisconsin Business Corporation Law, which prohibit the Corporation from paying dividends if such payment would: (i) render the Corporation unable to pay its debts as they become due in the usual course of business, or (ii) result in the Corporation’s assets being less than the sum of its total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of any stockholders with preferential rights superior to those stockholders receiving the dividend.
The Banks are 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 Banks to the Corporation is one of the sources of funds the Corporation could use to pay dividends, if any, in the future and to make other payments. Future dividend decisions by the Banks 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 Banks 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 average assets. These risk-based capital requirements presently address credit risk related to both recorded and off-balance-sheet commitments and obligations. Management believes, as of June 30, 2015, that the Corporation and the Banks met all applicable capital adequacy requirements.

In July 2013, the FRB and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for U.S. banks. These rules are applicable to all financial institutions that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as bank and savings and loan holding companies other than “small bank holding companies” (generally non-publicly traded bank holding companies with consolidated assets of less than $1 billion). Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Corporation. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. The rules also permit banking organizations with less than $15 billion to retain, through one-time election, the existing treatment for accumulated other comprehensive income, which would not affect regulatory capital. The Corporation elected to retain this treatment, which reduces the volatility of regulatory capital ratios. A new capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer

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will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019.

The phase-in period for the final rules became effective for the Corporation on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of June 30, 2015, the Corporation’s and the Bank’s capital levels remained characterized as well capitalized under the new rules.
The following table summarizes the Corporation’s and Banks’ capital ratios and the ratios required by their federal regulators at June 30, 2015 and December 31, 2014, respectively:

 
 
Actual
 
Minimum Required for Capital Adequacy Purposes
 
Minimum Required to Be Well
Capitalized Under Prompt Corrective Action Requirements
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
(Dollars in Thousands)
As of June 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Total capital
 
 
 
 
 
 
 
 
 
 
 
 
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
181,281

 
11.11
%
 
$
130,502

 
8.00
%
 
N/A

 
N/A

First Business Bank
 
135,519

 
11.23

 
96,523

 
8.00

 
$
120,654

 
10.00
%
First Business Bank — Milwaukee
 
19,404

 
11.27

 
13,779

 
8.00

 
17,223

 
10.00

Alterra Bank
 
27,979

 
10.79

 
20,748

 
8.00

 
25,935

 
10.00

Tier 1 capital
 
 
 
 
 
 
 
 
 
 
 
 
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
143,156

 
8.78
%
 
$
97,877

 
6.00
%
 
N/A

 
N/A

First Business Bank
 
123,424

 
10.23

 
72,393

 
6.00

 
$
96,523

 
8.00
%
First Business Bank — Milwaukee
 
17,746

 
10.30

 
10,334

 
6.00

 
13,779

 
8.00

Alterra Bank
 
26,533

 
10.23

 
15,561

 
6.00

 
20,748

 
8.00

Common equity tier 1 capital
 
 
 
 
 
 
 
 
 
 
 
 
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
133,156

 
8.16
%
 
$
73,407

 
4.50
%
 
N/A

 
N/A

First Business Bank
 
123,424

 
10.23

 
54,294

 
4.50

 
$
106,033

 
6.50
%
First Business Bank — Milwaukee
 
17,746

 
10.30

 
7,751

 
4.50

 
78,425

 
6.50

Alterra Bank
 
26,533

 
10.23

 
11,671

 
4.50

 
11,195

 
6.50

Tier 1 capital
 
 
 
 
 
 
 
 
 
 
 
 
(to average assets)
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
143,156

 
8.66
%
 
$
5,326

 
4.00
%
 
N/A

 
N/A

First Business Bank
 
123,424

 
10.55

 
4,937

 
4.00

 
$
6,171

 
5.00
%
First Business Bank — Milwaukee
 
17,746

 
7.46

 
710

 
4.00

 
887

 
5.00

Alterra Bank
 
26,533

 
10.00

 
1,061

 
4.00

 
1,327

 
5.00


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Actual
 
Minimum Required for Capital Adequacy Purposes
 
Minimum Required to Be Well
Capitalized Under Prompt Corrective Action Requirements
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
(Dollars in Thousands)
As of December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Total capital
 
 
 
 
 
 
 
 
 
 
 
 
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
173,263

 
12.13
%
 
$
114,253

 
8.00
%
 
N/A

 
N/A

First Business Bank
 
131,411

 
12.19

 
86,272

 
8.00

 
$
107,841

 
10.00
%
First Business Bank — Milwaukee
 
19,128

 
12.47

 
12,274

 
8.00

 
15,343

 
10.00

Alterra Bank
 
22,657

 
10.90

 
16,628

 
8.00

 
20,785

 
10.00

Tier 1 capital
 
 
 
 
 
 
 
 
 
 
 
 
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
136,008

 
9.52

 
$
57,127

 
4.00
%
 
N/A

 
N/A

First Business Bank
 
118,907

 
11.03

 
43,136

 
4.00

 
$
64,704

 
6.00
%
First Business Bank — Milwaukee
 
17,641

 
11.50

 
6,137

 
4.00

 
9,206

 
6.00

Alterra Bank
 
22,320

 
10.74

 
8,314

 
4.00

 
12,471

 
6.00

Tier 1 capital
 
 
 
 
 
 
 
 
 
 
 
 
(to average assets)
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
136,008

 
8.71

 
$
62,490

 
4.00
%
 
N/A

 
N/A

First Business Bank
 
118,907

 
10.13

 
46,960

 
4.00

 
$
58,700

 
5.00
%
First Business Bank — Milwaukee
 
17,641

 
7.90

 
8,935

 
4.00

 
11,169

 
5.00

Alterra Bank
 
22,320

 
9.01

 
9,910

 
4.00

 
12,388

 
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 subsidiaries. “FBB”, “FBB - Milwaukee” and “Alterra” are used to refer to our subsidiaries, First Business Bank, First Business Bank - Milwaukee, and Alterra Bank, respectively, and the “Banks” is used to refer to FBB, FBB - Milwaukee, and Alterra together.
Forward-Looking Statements
When used in this report the words or phrases “may,” “could,” “should,” “hope,” “might,” “believe,” “expect,” “plan,” “assume,” “intend,” “estimate,” “anticipate,” “project,” “likely,” or similar expressions are intended to identify “forward-looking statements.” Such statements are subject to risks and uncertainties, including, without limitation, changes in economic conditions in the market areas of FBB, FBB - Milwaukee, or Alterra, changes in policies by regulatory agencies, fluctuation in interest rates, demand for loans in the market areas of FBB, FBB - Milwaukee, or Alterra, borrowers defaulting in the repayment of loans and competition. These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our shareholders and potential investors. See Item 1A — Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2014 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.

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 subsidiaries, FBB, FBB-Milwaukee and Alterra. All of our operations are conducted through the Banks and certain subsidiaries of FBB. We operate as a business bank focusing on delivering a full line of commercial banking products and services tailored to meet the specific needs of small- and medium-sized businesses, business owners, executives, professionals and high net worth individuals. Business lines include commercial lending, SBA lending, asset-based lending, equipment financing, factoring, residential mortgage lending, trust and investment services, treasury management services and a broad range of deposit products. We do not utilize a branch network to attract retail clients. Our operating philosophy is focused on local decision-making and local client service from each of our primary banking locations in Madison, Brookfield and Appleton, Wisconsin and Leawood, Kansas combined with the efficiency of centralized administrative functions, such as credit, information technology, marketing, finance and accounting and human resources. We have a unique niche business-banking model and we consistently operate within this model to provide value-added financial solutions to our clients through the high touch service of our experienced staff.
For the remainder of 2015, we plan to continue to diligently focus on maintaining asset quality while organically growing our loan and lease portfolio, increasing the number and volume of transaction accounts to support ongoing efforts to increase fee revenue associated with treasury management services, trust and investment services and SBA lending activity and investing in and utilizing technology to support these initiatives. While we grow, we will maintain our efficient operating model and we believe timely investments in technology and people are imperative as we continue to drive operational efficiency to keep pace with our strategic growth trajectory. We believe this strategy will continue to create opportunities to increase market share and capitalize on economic expansion in our core Wisconsin and Kansas City markets.

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Table of Contents

Operational Highlights
Total assets increased to $1.684 billion as of June 30, 2015 compared to $1.629 billion as of December 31, 2014.
Net income for the three months ended June 30, 2015 was $3.9 million compared to net income of $3.5 million for the three months ended June 30, 2014. Net income for the six months ended June 30, 2015 was $8.1 million compared to net income of $6.8 million for the six months ended June 30, 2014.
Diluted earnings per common share for the three months ended June 30, 2015 were $0.89 compared to diluted earnings per common share of $0.88 for the three months ended June 30, 2014. Diluted earnings per common share for the six months ended June 30, 2015 were $1.86 compared to diluted earnings per common share of $1.72 for the six months ended June 30, 2014.
Net interest margin increased by 9 basis points to 3.61% for the three months ended June 30, 2015 compared to 3.52% for the three months ended June 30, 2014. Net interest margin increased by 15 basis points to 3.70% for the six months ended June 30, 2015 compared to 3.55% for the six months ended June 30, 2014.
Top line revenue, the sum of net interest income and non-interest income, increased 39.2% to $18.3 million for the three months ended June 30, 2015 compared to $13.2 million for the three months ended June 30, 2014. For the six months ended June 30, 2015, top line revenue increased 41.2% to $37.1 million as compared to $26.3 million for the six months ended June 30, 2014.
Annualized return on average assets (“ROAA”) and annualized return on average equity (“ROAE”) were 0.93% and 10.73%, respectively, for the three-month period ended June 30, 2015, compared to 1.09% and 12.29%, respectively, for the same time period in 2014. ROAA and ROAE were 0.96% and 11.35%, respectively, for the six-month period ended June 30, 2015, compared to 1.07% and 12.15%, respectively, for the same time period in 2014.
Our efficiency ratio was 65.28% for the three months end June 30, 2015, compared to 58.87% for the three months ended June 30, 2014. For the six months ended June 30, 2015 our efficiency ratio was 63.85%, compared to 59.35% for the same time period in 2014.
Our effective tax rate was 33.9% and 35.4% for the six months ended June 30, 2015 and 2014, respectively.
Our provision for loan and lease losses was $520,000 for the three months ended June 30, 2015 compared to a negative provision of $91,000 for the same period in the prior year. Provision for loan and lease losses was $1.2 million for the six months end June 30, 2015 compared to $89,000 for the comparable period of 2014.
Allowance for loan and lease losses as a percentage of gross loans and leases was 1.12% at both June 30, 2015 and December 31, 2014.
Non-performing assets as a percentage of total assets was 1.01% at June 30, 2015 compared to 0.70% at December 31, 2014.
Non-accrual loans increased by $5.4 million, or 55.2%, to $15.2 million at June 30, 2015 from $9.8 million at December 31, 2014.

Results of Operations
Top Line Revenue
Top line revenue is comprised of net interest income and non-interest income. This measurement is also commonly referred to as operating revenue. Top line revenue increased 39.2% and 41.2% for the three and six months ended June 30, 2015, respectively, as compared to the same period in the prior year primarily due to the acquisition of Alterra, which was completed on November 1, 2014. The components of top line revenue were as follows:

 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
Change
 
2015
 
2014
 
Change
 
 
(Dollars in Thousands)
Net interest income
 
$
14,188

 
$
10,799

 
31.4
%
 
$
29,118

 
$
21,599

 
34.8
%
Non-interest income
 
4,126

 
2,358

 
75.0

 
7,974

 
4,679

 
70.4

Total top line revenue
 
$
18,314

 
$
13,157

 
39.2

 
$
37,092

 
$
26,278

 
41.2


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Return on Average Assets and Return on Average Equity
ROAA for the three months ended June 30, 2015 decreased to 0.93% compared to 1.09% for the three months ended June 30, 2014. ROAA for the six months ended June 30, 2015 was 0.96% compared to 1.07% for the six months ended June 30, 2014. The decline in ROAA for both time periods presented was primarily due to the increase in total average assets exceeding the increase in net income primarily due to the acquisition of Alterra. Total average assets for the three months ended 2015 increased 29.9% year over year while net income increased 10.1%. Total average assets for the six months ended 2015 increased 31.1% year over year while net income increased 17.7%. ROAA is a critical metric used by us to measure the profitability of our organization and how efficiently our assets are deployed. It is a measurement that 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 June 30, 2015 was 10.73% compared to 12.29% for the three months ended June 30, 2014. ROAE for the six months ended June 30, 2015 was 11.35% compared to 12.15% for the six months ended June 30, 2014. The decline was primarily due to the growth of our average equity outpacing the improvement in our net income for the comparable periods which can be directly attributable to the acquisition of Alterra and the issuance of 360,081 shares of common stock as a portion of consideration paid in the transaction. We view return on average equity to be an important measure of profitability, and we 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 credit costs.

Efficiency Ratio

Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of losses or gains on foreclosed properties and amortization of other intangible assets, if any, divided by top line revenue. In the judgment of our management, the efficiency ratio allows investors and analysts to better assess the Corporation’s operating expenses in relation to its top line revenue by removing the volatility that is associated with certain one-time and other discrete items. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.

Total non-interest expense, in particular professional fees, increased in line with expectations as we continue to search for a permanent Chief Financial Officer and a new Chief Accounting Officer as well as invest in solutions that will drive operational efficiency. Management expects to continue investing in products and technology to support strategic growth initiatives. Please refer to the Non-Interest Expense section below for further discussion on the primary drivers of the year-over-year increase in the efficiency ratio.
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(Dollars in Thousands)
Total non-interest expense
 
$
11,974

 
$
7,749

 
$
23,706

 
$
15,600

Less:
 
 
 
 
 
 
 
 
Net loss (gain) on foreclosed properties
 
1

 
4

 
(15
)
 
4

Amortization of other intangible assets
 
18

 

 
36

 

Total operating expense
 
$
11,955

 
$
7,745

 
$
23,685

 
$
15,596

Net interest income
 
$
14,188

 
$
10,799

 
$
29,118

 
$
21,599

Total non-interest income
 
4,126

 
2,358

 
7,974

 
4,679

Top line revenue
 
$
18,314

 
$
13,157

 
$
37,092

 
$
26,278

Efficiency ratio
 
65.28
%
 
58.87
%
 
63.85
%
 
59.35
%

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Net Interest Income
Net interest income levels depend on the amounts of and yields on interest-earning assets as compared to the amounts of and rates paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes.
The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three and six months ended June 30, 2015 compared to the same period of 2014. The change in net interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) has been allocated to the rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
 
Increase (Decrease) for the Three Months Ended June 30,
 
Increase (Decrease) for the Six Months Ended June 30,
 
 
2015 Compared to 2014
 
2015 Compared to 2014
 
 
Rate
 
Volume
 
Net
 
Rate
 
Volume
 
Net
 
 
(In Thousands)
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate and other mortgage loans(1)
 
$
(244
)
 
$
2,214

 
$
1,970

 
$
(24
)
 
$
4,366

 
$
4,342

Commercial and industrial loans(1)
 
239

 
1,693

 
1,932

 
518

 
3,714

 
4,232

Direct financing leases(1)
 
1

 
25

 
26

 
8

 
103

 
111

Consumer and other loans(1)
 
22

 
79

 
101

 
44

 
150

 
194

Total loans and leases receivable
 
18

 
4,011

 
4,029

 
546

 
8,333

 
8,879

Mortgage-related securities(2)
 
(114
)
 

 
(114
)
 
(216
)
 
19

 
(197
)
Other investment securities(3)
 
1

 
6

 
7

 
9

 
(9
)
 

FHLB and FRB Stock
 
17

 
2

 
19

 
32

 
4

 
36

Short-term investments
 
(21
)
 
35

 
14

 
(36
)
 
88

 
52

Total net change in income on interest-earning assets
 
(99
)
 
4,054

 
3,955

 
335

 
8,435

 
8,770

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Transaction accounts
 
3

 
15

 
18

 

 
31

 
31

Money market accounts
 
58

 
212

 
270

 
106

 
431

 
537

Certificates of deposit
 
(26
)
 
130

 
104

 
(63
)
 
266

 
203

Wholesale deposits
 
(159
)
 
23

 
(136
)
 
(270
)
 
155

 
(115
)
Total deposits
 
(124
)
 
380

 
256

 
(227
)
 
883

 
656

FHLB advances
 
16

 
11

 
27

 
33

 
17

 
50

Other borrowings
 
(6
)
 
289

 
283

 
(14
)
 
559

 
545

Junior subordinated notes
 

 

 

 

 

 

Total net change in expense on interest-bearing liabilities
 
(114
)
 
680

 
566

 
(208
)
 
1,459

 
1,251

Net change in net interest income
 
$
15

 
$
3,374

 
$
3,389

 
$
543

 
$
6,976

 
$
7,519

(1)
The average balances of loans and leases include non-performing loans and leases. Interest income related to non-performing loans and leases is recognized when collected.
(2)
Includes amortized cost basis of assets available for sale and held to maturity.
(3)
Yields on tax-exempt municipal obligations are not presented on a tax-equivalent basis in this table.


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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 June 30, 2015 and 2014. The average balances are derived from average daily balances.
 
 
For the Three Months Ended June 30,
 
 
2015
 
2014
 
 
Average
balance
 
Interest
 
Average
yield/rate
 
Average
balance
 
Interest
 
Average
yield/rate
 
 
(Dollars in Thousands)
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate and other mortgage loans(1)
 
$
824,250

 
$
9,672

 
4.69
%
 
$
636,174

 
$
7,702

 
4.84
%
Commercial and industrial loans(1)
 
439,986

 
6,408

 
5.83

 
323,045

 
4,476

 
5.54

Direct financing leases(1)
 
29,631

 
342

 
4.62

 
27,457

 
316

 
4.60

Consumer and other loans(1)
 
24,888

 
258

 
4.15

 
17,044

 
157

 
3.68

Total loans and leases receivable(1)
 
1,318,755

 
16,680

 
5.06

 
1,003,720

 
12,651

 
5.04

Mortgage-related securities(2)
 
156,137

 
632

 
1.62

 
156,073

 
746

 
1.91

Other investment securities(3)
 
28,912

 
116

 
1.60

 
27,497

 
109

 
1.59

FHLB and FRB stock
 
2,926

 
20

 
2.73

 
1,427

 
1

 
0.44

Short-term investments
 
66,035

 
72

 
0.44

 
37,451

 
58

 
0.62

Total interest-earning assets
 
1,572,765

 
17,520

 
4.46

 
1,226,168

 
13,565

 
4.43

Non-interest-earning assets
 
93,477

 
 
 
 
 
56,063

 
 
 
 
Total assets
 
$
1,666,242

 
 
 
 
 
$
1,282,231

 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Transaction accounts
 
$
105,582

 
63

 
0.24

 
$
80,027

 
45

 
0.22

Money market accounts
 
605,195

 
841

 
0.56

 
449,907

 
571

 
0.51

Certificates of deposit
 
111,192

 
219

 
0.79

 
47,332

 
115

 
0.97

Wholesale deposits
 
428,080

 
1,470

 
1.37

 
422,024

 
1,606

 
1.52

Total interest-bearing deposits
 
1,250,049

 
2,593

 
0.83

 
999,290

 
2,337

 
0.94

FHLB advances
 
22,749

 
31

 
0.55

 
9,418

 
4

 
0.17

Other borrowings
 
25,556

 
430

 
6.73

 
8,381

 
148

 
7.06

Junior subordinated notes
 
10,315

 
278

 
10.78

 
10,315

 
277

 
10.74

Total interest-bearing liabilities
 
1,308,669

 
3,332

 
1.02

 
1,027,404

 
2,766

 
1.08

Non-interest-bearing demand deposit accounts
 
205,508

 
 
 
 
 
134,892

 
 
 
 
Other non-interest-bearing liabilities
 
8,252

 
 
 
 
 
5,882

 
 
 
 
Total liabilities
 
1,522,429

 
 
 
 
 
1,168,178

 
 
 
 
Stockholders’ equity
 
143,813

 
 
 
 
 
114,053

 
 
 
 
Total liabilities and stockholders’ equity
 
$
1,666,242

 
 
 
 
 
$
1,282,231

 
 
 
 
Net interest income
 
 
 
$
14,188

 
 
 
 
 
$
10,799

 
 
Interest rate spread
 
 
 
 
 
3.44
%
 
 
 
 
 
3.35
%
Net interest-earning assets
 
$
264,096

 
 
 
 
 
$
198,764

 
 
 
 
Net interest margin
 
 
 
 
 
3.61
%
 
 
 
 
 
3.52
%
Average interest-earning assets to average interest-bearing liabilities
 
120.18
%
 
 
 
 
 
119.35
%
 
 
 
 
Return on average assets
 
0.93

 
 
 
 
 
1.09

 
 
 
 
Return on average equity
 
10.73

 
 
 
 
 
12.29

 
 
 
 
Average equity to average assets
 
8.63

 
 
 
 
 
8.89

 
 
 
 
Non-interest expense to average assets
 
2.87

 
 
 
 
 
2.42

 
 
 
 

(1)
The average balances of loans and leases include non-performing loans and leases. Interest income related to non-performing loans and leases is recognized when collected.
(2)
Includes amortized cost basis of assets available for sale and held to maturity.
(3)
Yields on tax-exempt municipal obligations are not presented on a tax-equivalent basis in this table.

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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 six months ended June 30, 2015 and 2014. The average balances are derived from average daily balances.
 
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
 
Average
balance
 
Interest
 
Average
yield/
cost
 
Average
balance
 
Interest
 
Average
yield/
cost
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate and other mortgage loans(1)
 
$
819,617

 
$
19,541

 
4.77
%
 
$
636,491

 
$
15,199

 
4.78
%
Commercial and industrial loans(1)
 
433,379

 
13,232

 
6.11
%
 
310,938

 
9,000

 
5.79
%
Direct financing leases(1)
 
31,183

 
725

 
4.65
%
 
26,760

 
614

 
4.59
%
Consumer and other loans(1)
 
24,501

 
507

 
4.14
%
 
17,064

 
313

 
3.67
%
Total loans and leases receivable(1)
 
1,308,680

 
34,005

 
5.20
%
 
991,253

 
25,126

 
5.07
%
Mortgage-related securities(2)
 
155,735

 
1,294

 
1.66
%
 
153,788

 
1,491

 
1.94
%
Other investment securities(3)
 
28,594

 
230

 
1.61
%
 
29,711

 
230

 
1.55
%
FHLB and FRB stock
 
2,763

 
38

 
2.75
%
 
1,344

 
2

 
0.30
%
Short-term investments
 
79,410

 
169

 
0.43
%
 
40,671

 
117

 
0.58
%
Total interest-earning assets
 
1,575,182

 
35,736

 
4.54
%
 
1,216,767

 
26,966

 
4.43
%
Non-interest-earning assets
 
94,869

 
 
 
 
 
56,878

 
 
 
 
Total assets
 
$
1,670,051

 
 
 
 
 
$
1,273,645

 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Transaction accounts
 
$
106,442

 
121

 
0.23
%
 
$
79,313

 
90

 
0.23
%
Money market
 
615,485

 
1,694

 
0.55
%
 
456,206

 
1,157

 
0.51
%
Certificates of deposit
 
117,748

 
439

 
0.75
%
 
49,119

 
236

 
0.96
%
Wholesale deposits
 
426,136

 
2,908

 
1.36
%
 
404,728

 
3,023

 
1.49
%
Total interest-bearing deposits
 
1,265,811

 
5,162

 
0.82
%
 
989,366

 
4,506

 
0.91
%
FHLB advances
 
16,095

 
55

 
0.68
%
 
6,282

 
5

 
0.16
%
Other borrowings
 
24,843

 
849

 
6.83
%
 
8,513

 
305

 
7.17
%
Junior subordinated notes
 
10,315

 
552

 
10.70
%
 
10,315

 
551

 
10.68
%
Total interest-bearing liabilities
 
1,317,064

 
6,618

 
1.00
%
 
1,014,476

 
5,367

 
1.06
%
Non-interest-bearing demand deposit accounts
 
202,905

 
 
 
 
 
139,397

 
 
 
 
Other non-interest-bearing liabilities
 
8,202

 
 
 
 
 
7,150

 
 
 
 
Total liabilities
 
1,528,171

 
 
 
 
 
1,161,023

 
 
 
 
Stockholders’ equity
 
141,880

 
 
 
 
 
112,622

 
 
 
 
Total liabilities and stockholders’ equity
 
$
1,670,051

 
 
 
 
 
$
1,273,645

 
 
 
 
Net interest income
 
 
 
$
29,118

 
 
 
 
 
$
21,599

 
 
Interest rate spread
 
 
 
 
 
3.54
%
 
 
 
 
 
3.37
%
Net interest-earning assets
 
$
258,118

 
 
 
 
 
$
202,291

 
 
 
 
Net interest margin
 
 
 
 
 
3.70
%
 
 
 
 
 
3.55
%
Average interest-earning assets to average interest-bearing liabilities
 
119.60
%
 
 
 
 
 
119.94
%
 
 
 
 
Return on average assets
 
0.96

 
 
 
 
 
1.07

 
 
 
 
Return on average equity
 
11.35

 
 
 
 
 
12.15

 
 
 
 
Average equity to average assets
 
8.50

 
 
 
 
 
8.84

 
 
 
 
Non-interest expense to average assets
 
2.84

 
 
 
 
 
2.45

 
 
 
 

(1)
The average balances of loans and leases include non-performing loans and leases. Interest income related to non-performing loans and leases is recognized when collected.
(2)
Includes amortized cost basis of assets available for sale and held to maturity.
(3)
Yields on tax-exempt municipal obligations are not presented on a tax-equivalent basis in this table.


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Comparison of Net Interest Income for the Three Months Ended June 30, 2015 and 2014
Net interest income increased $3.4 million, or 31.4%, during the three months ended June 30, 2015 compared to the same period in 2014. The increase in net interest income was primarily attributable to the addition of Alterra and the corresponding favorable volume variance on the loan and the lease portfolio, partially offset by an overall unfavorable variance on interest-bearing liabilities.
The yield on average earning assets for the three months ended June 30, 2015 was 4.46% compared to 4.43% for the three months ended June 30, 2014. The increase in the yield on average earning assets was attributable to several factors. The total loans and leases receivable yield was 5.06% for the three months ended June 30, 2015, compared to 5.04% for the three months ended June 30, 2014 primarily due to the addition of the Alterra loan portfolio at yields greater than that of the Wisconsin-based portfolio. This benefit was partially offset by fixed rate commercial real estate loans renewing at current market rates subject to competitive pricing pressures, an increase in average short-term investments in the form of excess cash held on deposit at the FRB and a 29 basis point decrease in the yield on average mortgage-related securities.
The overall weighted average rate paid on interest-bearing liabilities was 1.02% for the three months ended June 30, 2015, a decrease of 6 basis points from 1.08% for the three months ended June 30, 2014. The decrease in the overall rate on the interest-bearing liabilities was primarily caused by a decrease in rate paid on our wholesale deposits as well as our in-market certificates of deposit. This decrease was partially offset by an unfavorable rate variance on the money market account deposit category and by the addition of other borrowings resulting from the $15.0 million of subordinated debt issued on August 26, 2014 at a rate that is significantly higher than our average cost of funds.
The weighted average rate paid on our interest-bearing deposits was 0.83% for the three months ended June 30, 2015, a decrease of 11 basis points from 0.94% for the three months ended June 30, 2014. The decrease in the weighted average rate paid on our interest-bearing deposits was primarily driven by the replacement of maturing wholesale deposits with in-market deposit relationships at lower current rates. The continued low rate environment combined with the maturity structure of our wholesale deposits continues to provide us the opportunity to manage our liability structure in both term and rate to deliver an enhanced net interest margin. Further, the addition of Alterra in-market deposits combined with our continued success of attracting in-market deposits in our Wisconsin-based markets contributed to the overall decline in our cost of funds. Average in-market client deposits - comprised of all transaction accounts, money market accounts and non-wholesale deposits - increased 44.3% to $1.027 billion for the period ended June 30, 2015 from $712.2 million for the period ended June 30, 2014 primarily attributable to the acquisition of Alterra.
Net interest margin increased nine basis points to 3.61% for the three months ended June 30, 2015 compared to 3.52% for the three months ended June 30, 2014. Net accretion/amortization on the Alterra purchase accounting adjustments of $542,000, partially offset by continued competitive pricing pressure on the loan and lease portfolio, drove a favorable impact of 12 basis points in net interest margin. Management expects the net accretion/amortization to remain volatile in future quarters due to the uncertain nature of loan prepayments. In addition, the changing mix of our deposit base reduced our overall cost of funds and positively affected our net interest margin by approximately ten basis points, offsetting the nine basis point decrease related to the declining yield on our investment portfolio. Other factors, primarily the issuance of $15.0 million of subordinated debt on August 26, 2014, negatively influenced the net interest margin by four basis points in the aggregate.
Comparison of Net Interest Income for the Six Months Ended June 30, 2015 and 2014
Net interest income increased $7.5 million, or 34.8%, during the six months ended June 30, 2015 compared to the same period in 2014. The increase in net interest income was primarily attributable to the addition of Alterra and the corresponding favorable rate and volume variances on the loan and the lease portfolio, partially offset by an overall unfavorable variance on interest-bearing liabilities.
The yield on average earning assets for the six months ended June 30, 2015 was 4.54% compared to 4.43% for the six months ended June 30, 2014. The reasons for the increase in the yield on average earning assets are consistent with explanations provided for the second quarter results discussed above.
The overall weighted average rate paid on interest-bearing liabilities was 1.00% for the six months ended June 30, 2015, a decrease of six basis points from 1.06% for the six months ended June 30, 2014. The reasons for the decrease in the overall weighted average rate paid on interest-bearing liabilities are consistent with explanations provided for the second quarter results discussed above.
Net interest margin increased 15 basis points to 3.70% for the six months ended June 30, 2015 compared to 3.55% for the six months ended June 30, 2014. Net accretion/amortization on the Alterra purchase accounting adjustments of $1.8 million,

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partially offset by continued competitive pricing pressure on the loan and lease portfolio, drove a favorable impact of 19 basis points in net interest margin. In addition, the changing mix of our deposit base reduced our overall cost of funds and positively affected our net interest margin by approximately nine basis points, offsetting the nine basis point decrease related to the declining yield on our investment portfolio. Other factors, primarily the issuance of the subordinated debt, negatively influenced the net interest margin by four basis points in the aggregate.
Provision for Loan and Lease Losses
We determine our provision for loan and lease losses based upon credit risk and other subjective factors pursuant to our allowance for loan and lease loss methodology, the magnitude of current and historical net charge-offs recorded and the amount of reserves established for impaired loans that present collateral shortfall positions.    
We recorded provision expense of $520,000 and negative provision of $91,000 for the three months ended June 30, 2015 and 2014, respectively. Provision for the three months ended June 30, 2015 primarily reflects additions commensurate with growth, partially offset by a reduction of the loss factors applied in calculating the probable losses within the loan and lease portfolio for which a reserve should be established, primarily due to improving macro and microeconomic factors.    
During the three and six months ended June 30, 2015 and 2014, the factors influencing the provision for loan and lease losses were the following:
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(In Thousands)
Components of the provision for loan and lease losses:
 
 
 
 
 
 
 
 
Net additions of specific reserves on impaired loans
 
$
243

 
$
99

 
$
252

 
$
205

Net decrease in allowance for loan and lease loss reserve due to subjective factor changes
 
(693
)
 
(496
)
 
(693
)
 
(502
)
Charge-offs in excess of specific reserves
 
24

 

 
348

 

Recoveries
 
(70
)
 
(6
)
 
(75
)
 
(26
)
Change in inherent risk of the loan and lease portfolio
 
1,016

 
312

 
1,372

 
412

Total provision for loan and lease losses
 
$
520

 
$
(91
)
 
$
1,204

 
$
89


The net additions of specific reserves on impaired loans represents the new specific reserves established on impaired loans for which, although collateral shortfalls are present, we believe we will recover our principal, offset by any release of previously established reserves that are no longer required. A decrease in allowance for loan and lease losses reserves due to subjective factor changes reflects management’s evaluation of the level of risk within the portfolio based upon the level and trend of certain criteria such as delinquencies, volume and average loan size, average risk rating, technical defaults, geographic concentrations, loans and leases on management attention watch lists, unemployment rates in our market areas, experience in credit granting functions, and changes in underwriting standards. As our asset quality metrics improve and the level and trend of the factors improve for a sustained period of time, the level of general reserve due to these factors may be reduced, causing an overall reduction in the level of the required reserve deemed to be appropriate by management. Conversely, increases in the level and trend of these factors may warrant an increase to our overall allowance for loan loss. Charge-offs in excess of specific reserves represent an additional provision for loan and lease losses required to maintain the allowance for loan and leases at a level deemed appropriate by management. This amount is net of the release of any specific reserve that may have already been provided. Charge-offs in excess of specific reserves can occur in situations where: (i) a loan has previously been partially written down to its estimated fair value and continues to decline, (ii) rapid deterioration of a credit requires an immediate partial or full charge-off, or (iii) the specific reserve was not adequate to cover the amount of the required charge-off. Change in the inherent risk of the portfolio can be influenced by portfolio growth or by migration 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 ratio. Refer to Asset Quality for further information regarding the overall credit quality of our loan and lease portfolio.


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Table of Contents

Non-interest Income
Comparison of Non-Interest Income for the Three Months Ended June 30, 2015 and 2014
Non-interest income increased $1.8 million, or 75.0%, to $4.1 million for the three months ended June 30, 2015, from $2.4 million for the three months ended June 30, 2014. The increase was primarily due to increased fees earned for trust and investment services and the additional fee income related to the acquisition of Alterra, specifically gain on the sale of loans.
Trust and investment services fee income increased by $169,000, or 15.2%, to $1.3 million for the three months ended June 30, 2015 from $1.1 million for the three months ended June 30, 2014. This increase was primarily driven by the amount of assets under management and administration as well as the mix of business at different fee structures and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets. At June 30, 2015, we had $800.6 million of trust assets under management compared to $773.2 million at December 31, 2014 and $703.6 million at June 30, 2014. Assets under administration were $197.3 million at June 30, 2015 compared to $186.5 million at December 31, 2014 and $186.0 million at June 30, 2014.
Services charges on deposits increased by $93,000, or 15.5%, to $693,000 for the three months ended June 30, 2015, compared to $600,000 for the three months ended June 30, 2014. The increase in services charges on deposits was primarily due to the acquisition of Alterra, and the related increase in transaction accounts, in addition to the increase in transaction accounts in our Wisconsin markets.
Loan fees increased by $119,000, or 31.3%, to $499,000 for the three months ended June 30, 2015, compared to $380,000 for the three months ended June 30, 2014. The increase in loan fees was primarily due to the acquisition of Alterra and the related increase in fee income on our SBA and residential mortgage business lines.
Gain on sale of loans for the three months ended June 30, 2015 totaled $1.1 million, an increase of $1.1 million from the same period in 2014, attributable to $222,000 from the sale of the residential real estate loans originated in our Kansas City market and $842,000 from the sale of the guaranteed portion of SBA loans originated in our Kansas City and Wisconsin markets.
Other non-interest income increased by $294,000 to $353,000 for the three months ended June 30, 2015, compared to $59,000 for the three months ended June 30, 2014. The increase in other income was primarily due to gains recognized on the termination of leased assets and the unwinding of the reserve for unfunded commitments resulting from the fair value purchase accounting adjustments associated with the Alterra transaction. The remaining reserve for unfunded commitments was $99,000 as of June 30, 2015. Should the commitment be withdrawn for any reason or become fully funded prior to maturity, we will accelerate the remaining liability accordingly.
Comparison of Non-Interest Income for the Six Months Ended June 30, 2015 and 2014
Non-interest income increased $3.3 million, or 70.4%, to $8.0 million for the six months ended June 30, 2015, from $4.7 million for the six months ended June 30, 2014. The increase was primarily due to increased fees earned for trust and investment services and the additional fee income related to the acquisition of Alterra, specifically gain on the sale of loans.
Trust and investment services fee income increased by $308,000, or 14.1%, to $2.5 million for the six months ended June 30, 2015 from $2.2 million for the six months ended June 30, 2014. Consistent with the second quarter results discussed above, trust and investment services fee income was primarily driven by the amount of assets under management as market values continue to increase. Assets under management can be positively or negatively influenced by the timing and magnitude of volatility within the equity markets, which will therefore influence the level of fee income recognized.
Services charges on deposits increased by $222,000, or 19.0%, to $1.4 million for the six months ended June 30, 2015, compared to $1.2 million for the six months ended June 30, 2014. The increase in services charges on deposits was due to the acquisition of Alterra in addition to the increase in transaction accounts in our Wisconsin markets.
Loan fees increased by $232,000, or 30.2%, to $1.0 million for the six months ended June 30, 2015, compared to $769,000 for the six months ended June 30, 2014. The reasons for the increase in loan fees are consistent with explanations provided for the second quarter results discussed above.
Gain on sale of loans and leases for the six months ended June 30, 2015 totaled $1.7 million, an increase of $1.7 million from the same period in 2014. Consistent with the second quarter results discussed above, the increase in gain on sale of loans and leases was attributable to $370,000 from the sale of the residential real estate loans originated in our Kansas City

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Table of Contents

market and $1.3 million from the sale of the guaranteed portion of SBA loans originated in our Kansas City and Wisconsin markets.
Other non-interest income increased by $760,000 to $909,000 for the six months ended June 30, 2015, compared to $149,000 for the six months ended June 30, 2014. The reasons for the increase in other non-interest income are consistent with explanations provided for the second quarter results discussed above.
Non-Interest Expense
Comparison of Non-Interest Expense for the Three Months Ended June 30, 2015 and 2014
Non-interest expense increased by $4.2 million, or 54.5%, to $12.0 million for the three months ended June 30, 2015 from $7.7 million for the comparable period of 2014. The acquisition of Alterra was the primary driver for the increase in all non-interest expense categories. Compensation, professional fees and marketing expenses comprise the majority of the overall increase.
Compensation expense increased by $2.2 million, or 46.0%, to $6.9 million for the three months ended June 30, 2015 from $4.7 million for the three months ended June 30, 2014. In addition to the increase related to Alterra, the overall increase reflects growth in compensation costs related to annual merit increases, employee benefit costs and incentive compensation accruals on a larger base of employees than in the comparative period of the prior year. Full time equivalent employees as of June 30, 2015 were 219, up 45.0% from 151 at June 30, 2014. Most of the increase was the result of the Alterra acquisition. Excluding Alterra, full time equivalent employees as of June 30, 2015 increased by 20 compared to June 30, 2014. As opportunities arise, we expect to continue investing in talent to support our strategic growth efforts, both in the form of additional business development officers and operational staff.
Professional fees expense increased by $620,000, or 69.3%, to $1.5 million for the three months ended June 30, 2015 from $895,000 for the three months ended June 30, 2014. The increase was primarily due to the addition of Alterra and our ongoing strategy to invest in technology-based corporate initiatives as we continue to implement solutions that will drive operational efficiency. For the quarter ended June 30, 2015, professional fees specifically related to information technology (“IT”) projects increased $326,000. In addition, fees paid to other outside service providers increased $253,000 primarily due to temp-to-hire employees required to support our strategic IT initiatives. The largest remaining item in the variance was an increase in recruiting expenses related to our search for a permanent Chief Financial Officer and new Chief Accounting Officer, offset by a decrease in merger-related costs of $287,000.
Marketing expense increased by $337,000, or 92.6%, to $701,000 for the three months ended June 30, 2015 from $364,000 for the three months ended June 30, 2014. The acquisition of Alterra was the primary driver for the increase.
Comparison of Non-Interest Expense for the Six Months Ended June 30, 2015 and 2014
Non-interest expense increased by $8.1 million, or 52.0%, to $23.7 million for the six months ended June 30, 2015 from $15.6 million for the comparable period of 2014. The acquisition of Alterra was the primary driver for the increase in all non-interest expense categories. Compensation, professional fees and marketing expenses comprise the majority of the overall increase.
Compensation expense increased by $4.5 million, or 45.7%, to $14.3 million for the six months ended June 30, 2015 from $9.8 million for the six months ended June 30, 2014. The reasons for the increase in compensation expense are consistent with explanations provided for the second quarter results discussed above.
Professional fees expense increased by $1.0 million, or 64.0%, to $2.5 million for the six months ended June 30, 2015 from $1.5 million for the six months ended June 30, 2014. Consistent with the second quarter results discussed above, professional fees specifically related to IT projects increased $437,000. In addition, fees paid to other outside service providers increased $287,000 primarily due to temp-to-hire employees required to support our strategic IT initiatives while fees paid to our external auditors increased by $147,000 primarily due to the additional services required to complete the acquisition of Alterra. The largest item in the remaining variance is an increase in recruiting expenses related to our search for a new Chief Financial Officer and Chief Accounting Officer, partially offset by a decrease in merger-related costs of $209,000.
Marketing expense increased by $632,000, or 88.9%, to $1.3 million for the six months ended June 30, 2015 from $711,000 for the six months ended June 30, 2014. The acquisition of Alterra was the primary driver for the increase.

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Table of Contents

Income Taxes
Income tax expense was $4.1 million for the six months ended June 30, 2015, with an effective tax rate of 33.9%, compared to income tax expense of $3.7 million for the six months ended June 30, 2014, with an effective tax rate of 35.4%. The effective tax rate differs from the federal statutory corporate tax rate as follows:
 
 
For the Six Months Ended June 30,
 
 
2015
 
2014
Statutory federal tax rate
 
34.4
 %
 
34.4
 %
State taxes, net of federal benefit
 
4.6

 
4.7

Bank owned life insurance
 
(1.3
)
 
(1.4
)
Tax-exempt security and loan income, net of TEFRA adjustments
 
(3.4
)
 
(3.4
)
Federal new market tax credit
 
(1.0
)
 

Non-deductible transaction costs
 

 
0.7

Other
 
0.6

 
0.4

 
 
33.9
 %
 
35.4
 %
Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. Typically, the rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change.

Financial Condition
General
Our total assets increased by $54.2 million, or 3.3%, to $1.684 billion as of June 30, 2015 compared to $1.629 billion at December 31, 2014. The increase in total assets was primarily driven by growth in our loan and lease portfolio.
Short-term investments
Short-term investments decreased by $12.3 million, or 14.0%, to $76.0 million at June 30, 2015 from $88.4 million at December 31, 2014. Our short-term investments primarily consist of interest-bearing deposits held at the FRB. We value the safety and soundness provided by the FRB and therefore we incorporate short-term investments in our on-balance-sheet liquidity program. As of June 30, 2015, our total investment in commercial paper, which is also considered a short-term investment, was $8.5 million as compared to $10.4 million at December 31, 2014. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards applied to our loan and lease portfolio. The original maturities of the commercial paper are usually sixty 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 take advantage of an anticipated rising-rate environment. 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 growth when opportunities are presented and the level of our available-for-sale securities portfolio. Please refer to Liquidity and Capital Resources for further discussion.
Securities
Total securities, including available-for-sale and held-to-maturity, decreased by $491,000 to $185.8 million at June 30, 2015 compared to $186.3 million at December 31, 2014. During the six months ended June 30, 2015, we recognized unrealized holding losses of $145,000 before income taxes through other comprehensive income. As of June 30, 2015, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted average maturity of 3.09 years. Generally, our investment philosophy remains unchanged from our statements made 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 of a representative sample of the portfolio, data integrity validation through comparison of current price to prior period prices, and an expectation-based analysis of movement in prices based upon the changes in the related yield curves and other market factors. No securities within our portfolio were deemed to be other-than-temporarily impaired as of June 30, 2015. There were no sales of securities during the three and six months ended June 30, 2015.
Loans and Leases Receivable
Loans and leases receivable, net of allowance for loan and lease losses, increased by $68.9 million, or 5.4%, to $1.335 billion at June 30, 2015 from $1.266 billion at December 31, 2014 with the majority of the growth distributed relatively evenly between our commercial and industrial and commercial real estate portfolios. We continue to have a concentration in commercial real estate, as commercial real estate loans represent approximately 62% of our total loans as of June 30, 2015. Over the past five years there has been a generally declining trend in this concentration level as we continue to direct our efforts toward growing our commercial and industrial portfolio. 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.
Our commercial and industrial portfolio increased $38.2 million, or 9.2%, to $454.9 million at June 30, 2015 from $416.7 million at December 31, 2014 while our commercial real estate portfolio increased by $32.3 million, or 4.0%, to $844.1 million at June 30, 2015 from $811.8 million at December 31, 2014. We believe loan growth relative to prior years reflects improvement in economic activity within our markets, in addition to the ability of our business development teams to capture market share from the competition. While we continue to experience significant competition as banks operating in our primary geographic area attempt to deploy excess liquidity, we remain committed to our underwriting standards. We expect our new loan and lease activity to be more than adequate to replace normal amortization and to continue to grow in future quarters.
Non-performing loans increased $5.4 million, or 55.2%, to $15.2 million, compared to $9.8 million at December 31, 2014, primarily due to one $6.2 million relationship identified as impaired in the second quarter. Subsequent to June 30, 2015, we granted a concession to the client and considered the loans to be troubled debt restructurings. Management believes this increase is not systemic in nature or indicative of a trend of increasing non-performing loans. Further, management expects the outcome of this relationship to be consistent with results experienced historically due to an aggressive and disciplined credit resolution process. As a result, the Company's non-performing loans as a percentage of total gross loans and leases measured 1.12% and 0.76% at June 30, 2015 and December 31, 2014, respectively. Likewise, the ratio of non-performing assets to total assets increased to 1.01% at June 30, 2015, compared to 0.70% at December 31, 2014. We do not expect any material changes in non-accrual loans as a percentage of gross loans and leases; however, we may experience some volatility from time to time. Please refer to Asset Quality for additional information.
Deposits
As of June 30, 2015, deposits increased by $32.8 million to $1.471 billion from $1.438 billion at December 31, 2014. The increase in deposits was primarily due to an increase in the level of in-market deposits, specifically non-interest-bearing transaction accounts, which increased by $16.7 million to $221.1 million at June 30, 2015 from $204.3 million at December 31, 2014, and partially due to a $12.5 million increase in the level of money market accounts to $588.2 million at June 30, 2015 from $575.8 million at December 31, 2014. Deposit ending balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, our ability to service and maintain client relationships and new client deposit relationships.
Our strategic efforts continue to be focused on adding in-market relationships and related transaction deposit accounts. We measure the success of deposit gathering efforts based on our ability to maintain the average balances of our in-market deposit accounts consistent with our current period mix and recent trends. Our Banks’ in-market deposits, consisting of all transaction accounts, money market accounts and non-wholesale deposits, are obtained primarily from the South Central, Northeastern and Southeastern regions of Wisconsin and the greater Kansas City area. Of our total year-to-date average deposits, approximately $1.043 billion, or 71.0%, were considered in-market deposits for the six months ended June 30, 2015. This compares to in-market deposits of $724.0 million, or 64.1%, for the year-to-date average at June 30, 2014.
The Corporation’s operating range of wholesale deposits to total deposits is 30%-40%. As of June 30, 2015, the ratio of wholesale deposits to total deposits was 30.2%. We will continue to use wholesale deposits in specific maturity periods needed, typically three to five years, to effectively mitigate 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

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wholesale deposits. Refer to Liquidity and Capital Resources for further information regarding our use and monitoring of wholesale deposits.     
FHLB Advances and Other Borrowings
As of June 30, 2015, FHLB advances and other borrowings increased by $13.4 million, or 39.4%, to $47.4 million from $34.0 million at December 31, 2014. The primary reason for the increase in borrowings was due to a two-week advance of $13.0 million from the FHLB with a maturity date of July 13, 2015 at a rate of 0.16%. We routinely utilize short-term advances from the FHLB in order to provide the appropriate time to accumulate wholesale deposits in an orderly manner.

Asset Quality
Non-performing Assets
Our total impaired assets consisted of the following at June 30, 2015 and December 31, 2014, respectively:
 
 
June 30,
2015
 
December 31,
2014
 
 
(Dollars in Thousands)
Non-accrual loans and leases
 
 
 
 
Commercial real estate:
 
 
 
 
Commercial real estate - owner occupied
 
$
579

 
$
500

Commercial real estate - non-owner occupied
 
282

 
286

Construction and land development
 
4,539

 
4,932

Multi-family
 
10

 
17

1-4 family
 
1,316

 
690

Total non-accrual commercial real estate
 
6,726

 
6,425

Commercial and industrial(1)
 
7,378

 
2,318

Direct financing leases, net
 

 

Consumer and other:
 
 
 
 
Home equity and second mortgages
 
403

 
329

Other
 
691

 
720

Total non-accrual consumer and other loans
 
1,094

 
1,049

Total non-accrual loans and leases
 
15,198

 
9,792

Performing troubled debt restructurings
 
1,944

 
2,003

Total impaired loans and leases
 
17,142

 
11,795

Foreclosed properties, net
 
1,854

 
1,693

Total impaired assets
 
$
18,996

 
$
13,488

 
 
 
 
 
Total non-accrual loans and leases to gross loans and leases
 
1.12
%
 
0.76
%
Total non-performing assets to total loans and leases plus other real estate owned
 
1.26

 
0.89

Total non-performing assets to total assets
 
1.01

 
0.70

Allowance for loan and lease losses to gross loans and leases
 
1.12

 
1.12

Allowance for loan and lease losses to non-accrual loans and leases
 
100.01

 
146.33

As of June 30, 2015 and December 31, 2014, $6.9 million and $7.4 million of the non-accrual loans were considered troubled debt restructurings, respectively.

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A summary of our non-accrual loan and lease activity from December 31, 2014 through June 30, 2015 is as follows:
(In Thousands)
 
Non-accrual loans and leases as of the beginning of the period
$
9,792

Loans and leases transferred to non-accrual status(1)
7,648

Accretion of the fair value discount on purchased credit impaired loans
22

Non-accrual loans and leases transferred to foreclosed properties
(289
)
Non-accrual loans and leases partially or fully charged-off
(408
)
Cash received and applied to principal of non-accrual loans and leases
(1,567
)
Non-accrual loans and leases as of the end of the period
$
15,198

(1)
Balance includes $6.2 million considered performing impaired loans with interest income recognized on a cash basis as of June 30, 2015. Subsequent to June 30, 2015, the Corporation granted a concession to the client and considered the loans to be troubled debt restructurings.
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. As of June 30, 2015, non-performing assets as a percentage of total assets increased to 1.01% from 0.70% at December 31, 2014. This is primarily due to one $6.2 million relationship identified as impaired in the second quarter. We believe this increase is not systemic in nature or indicative of a trend of increasing non-performing loans. We expect the outcome of this relationship to be consistent with results experienced historically due to an aggressive and disciplined credit resolution process. This increase was partially offset by cash collections on previously identified impaired loans and a partial charge-off on one commercial loan.

We also monitor early stage delinquencies to assist in the identification of potential future problems. As of June 30, 2015, the payment performance did not point to any new areas of concern, as approximately 99.7% of the loan and lease portfolio was in a current payment status. This metric can change rapidly however, if factors unknown to us change. We also monitor our asset quality through our established credit quality indicator categories. We are generally seeing positive trends with improving percentages of loans and leases in our higher quality loan categories which is indicative of overall credit quality improvement. While overall asset quality has improved, we will continue to actively monitor the credit quality of our loan and lease portfolios. Through this monitoring effort, 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 generally work proactively with our impaired loan borrowers to find meaningful solutions to difficult situations that are in the best interests of the Banks. Given our current low level of non-accrual loans, any meaningful improvement in reducing this balance further will likely be at a slower pace than what has been accomplished over the last several years. We expect to demonstrate an overall declining trend of non-accrual loan balances; however, we may experience some volatility in this trend from time to time.

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The following represents additional information regarding our impaired loans and leases:
 
 
As of and for the Six Months Ended June 30,
 
As of and for the
Year Ended December 31,
 
 
2015
 
2014
 
2014
 
 
(In Thousands)
Impaired loans and leases with no impairment reserves required(1)
 
$
14,876

 
$
7,290

 
$
11,270

Impaired loans and leases with impairment reserves required
 
2,266

 
7,492

 
525

Total impaired loans and leases
 
17,142

 
14,782

 
11,795

Less:
 
 
 
 
 
 
Impairment reserve (included in allowance for loan and lease losses)
 
575

 
606

 
290

Net impaired loans and leases
 
$
16,567

 
$
14,176

 
$
11,505

Average impaired loans and leases
 
$
11,158

 
$
15,285

 
$
14,474

Foregone interest income attributable to impaired loans and leases
 
$
317

 
$
443

 
$
870

Less: Interest income recognized on impaired loans and leases
 
1

 
310

 
740

Net foregone interest income on impaired loans and leases
 
$
316

 
$
133

 
$
130

(1)
Balance includes $6.2 million considered performing impaired loans with interest income recognized on a cash basis as of June 30, 2015. Subsequent to June 30, 2015, the Corporation granted a concession to the client and considered the loans to be troubled debt restructurings.
Non-performing assets also include foreclosed properties. A summary of our current-period foreclosed properties activity is as follows:
(In Thousands)
 
Foreclosed properties as of December 31, 2014
$
1,693

Loans transferred to foreclosed properties
289

Proceeds from sale of foreclosed properties
(143
)
Net gain on sale of foreclosed properties
16

Impairment valuation
(1
)
Foreclosed properties as of June 30, 2015
$
1,854

Allowance for loan and lease losses.
The allowance for loan and lease losses as a percentage of gross loans and leases was 1.12% as of both June 30, 2015 and December 31, 2014. During the six months ended June 30, 2015, we recorded net charge-offs on impaired loans and leases of approximately $334,000, comprised of $408,000 of charge-offs and $74,000 of recoveries. During the six months ended June 30, 2014, we recorded net recoveries on impaired loans and leases of approximately $25,000, comprised of no charge-offs and $25,000 of recoveries.
While charge-offs have been relatively low in recent periods, we will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed. Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios. 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. Based upon this methodology, which includes actively monitoring the asset quality and inherent risks within the loan and lease portfolio, management concluded that an allowance for loan and lease losses of $15.2 million, or 1.12% of total loans and leases, was appropriate as of June 30, 2015. Given ongoing complexities with current workout situations and the measured pace of improvement in 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 appropriateness of the allowance for loan and lease losses. These agencies could require certain loan and lease balances to be classified differently or charged off if 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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As of June 30, 2015 and December 31, 2014, our allowance for loan and lease losses to total non-accrual loans and leases was 100.01% and 146.33%, respectively. 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 endeavor to have appropriate collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases either does not require additional specific reserves or requires only a minimal amount of required specific reserve, as we believe the loans and leases are adequately collateralized as of the measurement period. In addition, management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined with certainty that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease loss to non-accrual loans and leases ratio as compared to our peers or industry expectations. In general, as asset quality remains strong, our allowance for loan and lease loss is measured more through general characteristics, including historical loss experience of our portfolio rather than through specific identification and we therefore expect to see this ratio to rise. As was the case with the $6.2 million relationship identified in the second quarter of 2015, if we identify additional impaired loans which are adequately collateralized and therefore require no specific or general reserve, this ratio could fall. 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 June 30, 2015.




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A tabular summary of the activity in the allowance for loan and lease losses follows:
 
 
As of and for the Three Months Ended June 30,
 
As of and for the Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(Dollars in Thousands)
Allowance at beginning of period
 
$
14,694

 
$
14,101

 
$
14,329

 
$
13,901

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
 
(80
)
 

 
(91
)
 

Commercial and industrial
 

 

 
(313
)
 

Direct financing leases
 

 

 

 

Consumer and other
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

Other
 
(4
)
 

 
(4
)
 

Total charge-offs
 
(84
)
 

 
(408
)
 
 
Recoveries:
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 

 

 

 
8

Commercial real estate — non-owner occupied
 

 

 

 
4

Construction and land development
 
62

 

 
62

 

Multi-family
 

 

 

 

1-4 family
 
2

 
2

 
4

 
5

Commercial and industrial
 
5

 
1

 
5

 
1

Direct financing leases
 

 

 

 

Consumer and other
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 
2

 
2

 
7

Other
 

 

 
1

 

Total recoveries
 
69

 
5

 
74

 
25

Net (charge-offs) recoveries
 
(15
)
 
5

 
(334
)
 
25

Provision for loan and lease losses
 
520

 
(91
)
 
1,204

 
89

Allowance at end of period
 
$
15,199

 
$
14,015

 
$
15,199

 
$
14,015

Annualized net (charge-offs) recoveries as a % of average gross loans and leases
 
 %
 
%
 
(0.05
)%
 
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 Banks. While the Banks are subject to certain regulatory limitations regarding their ability to pay dividends to the Corporation, we do not believe that the Corporation will be adversely affected by these dividend limitations. The Corporation’s principal liquidity requirements at June 30, 2015 were the interest payments due on subordinated and junior subordinated notes. In April 2015, FBB declared a dividend in the amount of $2.0 million bringing year-to-date dividend declarations to $4.0 million through June 30, 2015. During the year ended December 31, 2014, FBB declared and paid dividends totaling $8.0 million. The capital ratios of the Corporation and its subsidiaries continue to meet all applicable regulatory capital adequacy requirements. The Corporation’s and the Banks’ respective Boards of Directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.
The Banks maintain liquidity by obtaining funds from several sources. The Banks’ primary sources of funds are principal and interest repayments on loans receivable and mortgage-related securities, deposits and other borrowings, such as federal funds and FHLB advances. The scheduled payments of loans and mortgage-related securities are generally a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest rates, economic conditions and competition.
We view on-balance-sheet liquidity as a critical element to maintaining adequate liquidity to meet our cash and collateral obligations. We define our on-balance-sheet liquidity as the total of our short-term investments, our unencumbered securities fair value and our unencumbered pledged loans. As of June 30, 2015 and December 31, 2014, our immediate on-balance-sheet liquidity was $299.5 million and $290.8 million, respectively. At June 30, 2015 and December 31, 2014, the Banks had $60.7 million and $70.5 million on deposit with the FRB, 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 brokered certificates of deposit, or invest in securities to maintain adequate liquidity at an improved margin.
We had $444.5 million of outstanding wholesale deposits at June 30, 2015, compared to $427.3 million of wholesale deposits as of December 31, 2014, which represented 30.2% and 29.7%, respectively, of the ending balance of total deposits. While we are committed to our continued efforts to raise in-market deposits and maintain our overall mix of wholesale deposits and in-market deposits, wholesale deposits continue to be an efficient source of funding for the Banks and allow them 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 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 deposits 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 deposits in an orderly manner, we will use FHLB short-term advances to meet our temporary funding needs. The FHLB short-term advances will typically have terms of one week to one month to cover the overall expected funding demands.
Our in-market relationships remain stable; however, deposit balances associated with those relationships will fluctuate. We expect to establish new client relationships and continue marketing efforts aimed at increasing the balances in existing clients’ deposit accounts. Nonetheless, we will continue to use wholesale deposits 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 deposits 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. The Banks limit the percentage of wholesale deposits to total deposits in accordance with liquidity policies approved by their respective Boards of Directors. The Corporation’s overall operating range of wholesale deposits to total deposits is 30%-40%. The Banks were in compliance with their respective policy limits as of June 30, 2015 and December 31, 2014.
The Banks were able to access the wholesale deposit market as needed at rates and terms comparable to market standards during the six-month period ended June 30, 2015. In the event there is a disruption in the availability of wholesale deposits at maturity, the Banks have 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 with the FRB and borrowings from the FHLB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As of June 30, 2015, the available liquidity was in excess of the stated policy

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minimum. As on-balance-sheet liquidity is utilized to fund growth, asset quality remains stable and the ratio of in-market deposits to total deposits remains within an acceptable range, management may consider reducing the number of months of maturity coverage slightly while remaining confident in its ability to manage the maturities of wholesale deposits in the event of a disruption in the wholesale market. We believe the Banks will also have access to the unused federal funds lines, cash flows from borrower repayments and cash flows from security maturities. The Banks also have the ability to raise local market deposits by offering attractive rates to generate the level required to fulfill their liquidity needs.
The Banks are required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. We believe the Banks have 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 six months ended June 30, 2015, operating activities resulted in a net cash inflow of $10.8 million. Operating cash flows included net income of $8.1 million. Net cash used in investing activities for the the six months ended June 30, 2015 was approximately $69.8 million which consisted of cash outflows to fund net loan growth and reinvestment of cash flows within purchases of additional securities available-for-sale offset by cash inflows from maturities, redemptions and paydowns of available-for-sale and held-to-maturity securities. Net cash provided by financing activities for the the six months ended June 30, 2015 was $44.7 million primarily from net increases in deposits and the use of FHLB short-term advances to meet our temporary funding needs. Please refer to the Consolidated Statements of Cash Flows for further details regarding significant sources of cash flow for the Corporation.

Contractual Obligations and Off-Balance-Sheet Arrangements
As of June 30, 2015, there were no significant 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, 2014. 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
Interest rate risk, or market risk, arises from exposure of our financial position to changes in interest rates. It is our strategy to reduce the impact of interest rate risk on net interest margin and net interest income by maintaining a favorable match between the maturities and repricing dates of interest-earning assets and interest-bearing liabilities. This strategy is monitored by the Banks’ respective Asset/Liability Management Committees, in accordance with policies approved by the Banks’ respective Boards of Directors. These committees meet regularly to review the sensitivity of each Bank’s assets and liabilities to changes in interest rates, liquidity needs and sources, and pricing and funding strategies.
We use two techniques to measure interest rate risk. The first is simulation of earnings. In this measurement technique the balance sheet is modeled as an ongoing entity whereby future growth, pricing, and funding assumptions are implemented. These assumptions are modeled under different rate scenarios that include a simultaneous, instant and sustained change in interest rates. The second measurement technique used is static gap analysis. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. In general, a positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature in a time frame and a negative gap indicates the opposite. In addition to the gap position, other determinants of net interest income are the shape of the yield curve, general rate levels and the corresponding effect of contractual interest rate floors, reinvestment spreads, balance sheet growth and mix and interest rate spreads. We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity and/or repricing characteristics based on market conditions. Currently, we do not employ any derivatives to assist in managing our interest rate risk exposure; however, management has the authorization, as permitted within applicable approved policies, and ability to utilize such instruments should they be appropriate to manage interest rate exposure.
The process of asset and liability management requires management to make a number of assumptions as to when an asset or liability will reprice or mature. Management believes that its assumptions approximate actual experience and considers them reasonable, although the actual amortization and repayment of assets and liabilities may vary substantially. Our economic sensitivity to changes in interest rates at June 30, 2015 has not changed materially since December 31, 2014.



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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 June 30, 2015.
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 June 30, 2015 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.

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 Form 10-K for the year ended December 31, 2014.
    
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a)
None.
(b)
Not applicable.
(c)
Issuer Purchases of Equity Securities
Period
 
Total Number of Shares Purchased(1)
 
Average
Price Paid Per Share
 
Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans or Programs
 
Approximate
Dollar Value of
Shares that May
Yet Be
Purchased Under
the Plans or Programs
April 1, 2015 - April 30, 2015
 

 
$

 

 
$

May 1, 2015 - May 31, 2015
 
168

 
$
45.62

 

 
$

June 1, 2015 - June 30, 2015
 

 
$

 

 
$

Total
 
168

 
$
45.62

 

 
$


(1)
The shares in this column represent: the 168 shares that were surrendered to us to satisfy income tax withholding obligations in connection with the vesting of restricted shares.

Item 3. Defaults Upon Senior Securities
Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

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Table of Contents


Item 5. Other Information
None.


Item 6. Exhibits
31.1

 
Certification of the Chief Executive Officer +
 
 
 
31.2

 
Certification of the Chief Financial Officer +
 
 
 
32

 
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 +
 
 
 
101

 
The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014, (ii) Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014, (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three and six months ended June 30, 2015 and 2014, (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014, and (vi) the Notes to Unaudited Consolidated Financial Statements +
+
 
Submitted electronically with this Quarterly Report.
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.
 
August 7, 2015
/s/ Corey A. Chambas
 
Corey A. Chambas 
 
Chief Executive Officer
 
 
August 7, 2015
/s/ James F. Ropella
 
James F. Ropella
 
Chief Financial Officer (Principal Financial and Accounting Officer)


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Table of Contents

FIRST BUSINESS FINANCIAL SERVICES, INC.
Exhibit Index to Quarterly Report on Form 10-Q

Exhibit Number
31.1

Certification of the Chief Executive Officer +
 

 
31.2

Certification of the Chief Financial Officer +
 

 
32

Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 +
 

 
101

The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014, (ii) Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014, (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three and six months ended June 30, 2015 and 2014, (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014, and (vi) the Notes to Unaudited Consolidated Financial Statements +
+
 
Submitted electronically with this Quarterly Report.

60