Document
 
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 September 30, 2017
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,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨
 
Accelerated filer þ
 
Non-accelerated filer ¨
 
Smaller reporting company ¨
 
Emerging growth company ¨
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
The number of shares outstanding of the registrant’s sole class of common stock, par value $0.01 per share, on October 20, 2017 was 8,759,673 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
 
 
September 30,
2017
 
December 31,
2016
 
 
(unaudited)
 
 
 
(In Thousands, Except Share Data)
Assets
 
 
 
 
Cash and due from banks
 
$
20,685

 
$
14,596

Short-term investments
 
52,511

 
62,921

Cash and cash equivalents
 
73,196

 
77,517

Securities available-for-sale, at fair value
 
131,130

 
145,893

Securities held-to-maturity, at amortized cost
 
38,873

 
38,612

Loans held for sale
 

 
1,111

Loans and leases receivable, net of allowance for loan and lease losses of $19,923 and $20,912, respectively
 
1,446,790

 
1,429,763

Premises and equipment, net
 
3,048

 
3,772

Foreclosed properties
 
2,585

 
1,472

Bank-owned life insurance
 
39,988

 
39,048

Federal Home Loan Bank and Federal Reserve Bank stock, at cost
 
5,083

 
2,131

Goodwill and other intangible assets
 
12,735

 
12,773

Accrued interest receivable and other assets
 
32,228

 
28,607

Total assets
 
$
1,785,656

 
$
1,780,699

Liabilities and Stockholders’ Equity
 
 
 
 
Deposits
 
$
1,423,724

 
$
1,538,855

Federal Home Loan Bank advances and other borrowings
 
167,884

 
59,676

Junior subordinated notes
 
10,015

 
10,004

Accrued interest payable and other liabilities
 
17,252

 
10,514

Total liabilities
 
1,618,875

 
1,619,049

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.01 par value, 2,500,000 shares authorized, none issued or outstanding
 

 

Common stock, $0.01 par value, 25,000,000 shares authorized, 9,016,345 and 8,959,239 shares issued, 8,758,923 and 8,715,856 shares outstanding at September 30, 2017 and December 31, 2016, respectively
 
90

 
90

Additional paid-in capital
 
78,353

 
77,542

Retained earnings
 
95,785

 
91,317

Accumulated other comprehensive loss
 
(370
)
 
(522
)
Treasury stock, 257,422 and 243,383 shares at September 30, 2017 and December 31, 2016, respectively, at cost
 
(7,077
)
 
(6,777
)
Total stockholders’ equity
 
166,781

 
161,650

Total liabilities and stockholders’ equity
 
$
1,785,656

 
$
1,780,699


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 September 30,
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(In Thousands, Except Per Share Data)
Interest income
 
 
 
 
 
 
 
 
Loans and leases
 
$
17,686

 
$
18,016

 
$
53,492

 
$
55,161

Securities
 
771

 
698

 
2,326

 
2,102

Short-term investments
 
177

 
184

 
488

 
533

Total interest income
 
18,634

 
18,898

 
56,306

 
57,796

Interest expense
 
 
 
 
 
 
 
 
Deposits
 
2,708

 
2,870

 
8,039

 
8,961

Federal Home Loan Bank advances and other borrowings
 
763

 
453

 
2,185

 
1,425

Junior subordinated notes
 
280

 
280

 
832

 
835

Total interest expense
 
3,751

 
3,603

 
11,056

 
11,221

Net interest income
 
14,883

 
15,295

 
45,250

 
46,575

Provision for loan and lease losses
 
1,471

 
3,537

 
5,699

 
6,824

Net interest income after provision for loan and lease losses
 
13,412

 
11,758

 
39,551

 
39,751

Non-interest income
 
 
 
 
 
 
 
 
Trust and investment services fee income
 
1,653

 
1,364

 
4,930

 
3,981

Gain on sale of Small Business Administration loans
 
606

 
347

 
1,501

 
3,854

Gain on sale of residential mortgage loans
 

 
198

 
26

 
540

Service charges on deposits
 
756

 
772

 
2,287

 
2,247

Loan fees
 
391

 
506

 
1,525

 
1,791

Increase in cash surrender value of bank-owned life insurance
 
314

 
244

 
940

 
730

Other non-interest income
 
619

 
209

 
1,931

 
914

Total non-interest income
 
4,339

 
3,640

 
13,140

 
14,057

Non-interest expense
 
 
 
 
 
 
 
 
Compensation
 
7,645

 
7,637

 
24,710

 
24,454

Occupancy
 
527

 
530

 
1,521

 
1,538

Professional fees
 
995

 
1,065

 
3,046

 
2,888

Data processing
 
592

 
623

 
1,810

 
1,971

Marketing
 
594

 
528

 
1,546

 
1,710

Equipment
 
285

 
292

 
868

 
913

Computer software
 
715

 
539

 
2,037

 
1,607

FDIC insurance
 
320

 
444

 
1,081

 
989

Collateral liquidation costs
 
371

 
89

 
556

 
204

Net loss on foreclosed properties
 

 

 

 
93

Impairment of tax credit investments
 
112

 
3,314

 
338

 
3,520

Small Business Administration recourse provision
 
1,315

 
375

 
2,095

 
449

Other non-interest expense
 
760

 
317

 
2,404

 
1,574

Total non-interest expense
 
14,231

 
15,753

 
42,012

 
41,910

Income (loss) before income tax expense
 
3,520

 
(355
)
 
10,679

 
11,898

Income tax expense (benefit)
 
936

 
(3,020
)
 
2,812

 
957

Net income
 
$
2,584

 
$
2,665

 
$
7,867

 
$
10,941

Earnings per common share
 
 
 
 
 
 
 
 
Basic
 
$
0.30

 
$
0.31

 
$
0.90

 
$
1.26

Diluted
 
0.30

 
0.31

 
0.90

 
1.26

Dividends declared per share
 
0.13

 
0.12

 
0.39

 
0.36

See accompanying Notes to Unaudited Consolidated Financial Statements.

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

 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(In Thousands)
Net income
 
$
2,584

 
$
2,665

 
$
7,867

 
$
10,941

Other comprehensive income, before tax
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
Net unrealized securities gains arising during the period
 
172

 
81

 
199

 
1,317

Securities held-to-maturity:
 
 
 
 
 
 
 
 
Amortization of net unrealized losses transferred from available-for-sale
 
25

 
41

 
79

 
124

Income tax expense
 
(76
)
 
(47
)
 
(126
)
 
(555
)
     Total other comprehensive income
 
121

 
75

 
152

 
886

Comprehensive income
 
$
2,705

 
$
2,740

 
$
8,019

 
$
11,827


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, 2015
 
8,699,410

 
$
89

 
$
76,549

 
$
80,584

 
$
(80
)
 
$
(6,310
)
 
$
150,832

Net income
 

 

 

 
10,941

 

 

 
10,941

Other comprehensive income
 

 

 

 

 
886

 

 
886

Share-based compensation - restricted shares, net
 
37,708

 
1

 
857

 

 

 

 
858

Cash dividends ($0.36 per share)
 

 

 

 
(3,132
)
 

 

 
(3,132
)
Treasury stock purchased
 
(19,819
)
 

 

 

 

 
(454
)
 
(454
)
Balance at September 30, 2016
 
8,717,299

 
$
90

 
$
77,406

 
$
88,393

 
$
806

 
$
(6,764
)
 
$
159,931


 
 
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, 2016
 
8,715,856

 
$
90

 
$
77,542

 
$
91,317

 
$
(522
)
 
$
(6,777
)
 
$
161,650

Net income
 

 

 

 
7,867

 

 

 
7,867

Other comprehensive income
 

 

 

 

 
152

 

 
152

Share-based compensation - restricted shares, net
 
57,106

 

 
811

 

 

 

 
811

Cash dividends ($0.39 per share)
 

 

 

 
(3,399
)
 

 

 
(3,399
)
Treasury stock purchased
 
(14,039
)
 

 

 

 

 
(300
)
 
(300
)
Balance at September 30, 2017
 
8,758,923

 
$
90

 
$
78,353

 
$
95,785

 
$
(370
)
 
$
(7,077
)
 
$
166,781


See accompanying Notes to Unaudited Consolidated Financial Statements.


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First Business Financial Services, Inc.
Consolidated Statements of Cash Flows (Unaudited)
 
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
 
 
(In Thousands)
Operating activities
 
 
 
 
Net income
 
$
7,867

 
$
10,941

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Deferred income taxes, net
 
(1,603
)
 
(9
)
Impairment of tax credit investments
 
338

 
3,520

Provision for loan and lease losses
 
5,699

 
6,824

Depreciation, amortization and accretion, net
 
1,148

 
1,103

Share-based compensation
 
811

 
858

Increase in value of bank-owned life insurance policies
 
(940
)
 
(730
)
Origination of loans for sale
 
(24,606
)
 
(54,794
)
Sale of loans originated for sale
 
27,244

 
59,263

Gain on sale of loans originated for sale
 
(1,527
)
 
(4,394
)
Net loss on foreclosed properties, including impairment valuation
 

 
93

Excess tax benefit from share-based compensation
 
(59
)
 
(138
)
Returns on investments in limited partnerships
 
92

 
250

Net increase in accrued interest receivable and other assets
 
(1,759
)
 
(2,813
)
Net (decrease) increase in accrued interest payable and other liabilities
 
6,739

 
(2,789
)
Net cash provided by operating activities
 
19,444

 
17,185

Investing activities
 
 
 
 
Proceeds from maturities, redemptions and paydowns of available-for-sale securities
 
29,802

 
32,555

Proceeds from maturities, redemptions and paydowns of held-to-maturity securities
 
2,723

 
2,906

Proceeds from sale of available-for-sale securities
 
11,702

 
2,190

Purchases of available-for-sale securities
 
(27,125
)
 
(48,229
)
Purchases of held-to-maturity securities

 
(3,016
)
 
(714
)
Proceeds from sale of foreclosed properties
 

 
57

Net increase in loans and leases
 
(22,530
)
 
(29,962
)
Investments in limited partnerships
 
(500
)
 
(750
)
Returns of investments in limited partnerships
 

 
541

Investment in historic development entities
 
(417
)
 
(1,488
)
Investment in Federal Home Loan Bank and Federal Reserve Bank Stock
 
(12,223
)
 
(388
)
Proceeds from the sale of Federal Home Loan Bank Stock
 
9,271

 
1,066

Purchases of leasehold improvements and equipment, net
 
(942
)
 
(519
)
Net cash used in investing activities
 
(13,255
)
 
(42,735
)
Financing activities
 
 
 
 
Net decrease in deposits
 
(115,107
)
 
(10,924
)
Repayment of Federal Home Loan Bank advances
 
(470,416
)
 
(63,100
)
Proceeds from Federal Home Loan Bank advances
 
580,415

 
59,600

Proceeds from issuance of subordinated notes payable
 
9,090

 

Repayment of subordinated notes payable
 
(7,889
)
 

Net decrease in other borrowed funds
 
(2,904
)
 
(1,240
)
Cash dividends paid
 
(3,399
)
 
(3,132
)
Purchase of treasury stock
 
(300
)
 
(454
)
Net cash used in financing activities
 
(10,510
)
 
(19,250
)
Net decrease in cash and cash equivalents
 
(4,321
)
 
(44,800
)
Cash and cash equivalents at the beginning of the period
 
77,517

 
113,564

Cash and cash equivalents at the end of the period
 
$
73,196

 
$
68,764

Supplementary cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
Interest paid on deposits and borrowings
 
$
10,504

 
$
11,058

Income taxes paid
 
490

 
5,122

Non-cash investing and financing activities:
 
 
 
 
Transfer of loans from held-to-maturity to held-for-sale
 
8,366

 
11,504

Transfer from premises and equipment to foreclosed properties
 
1,113

 


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Table of Contents


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”), through our wholly-owned subsidiary, First Business Bank (“FBB” or the “Bank”), has been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB operates as a commercial banking institution primarily in the Wisconsin and greater Kansas City markets. FBB also offers trust and investment services through First Business Trust & Investments (“FBTI”), a division of FBB. The Bank provides a full range of financial services to businesses, business owners, executives, professionals and high net worth individuals. The Bank is subject to competition from other financial institutions and service providers and is also subject to state and federal regulations. FBB has the following wholly owned subsidiaries: First Business Capital Corp. (“FBCC”), First Madison Investment Corp. (“FMIC”), First Business Equipment Finance, LLC (“FBEF”), ABKC Real Estate, LLC (“ABKC”), Rimrock Road Investment Fund, LLC (“Rimrock Road”), BOC Investment, LLC (“BOC”), Mitchell Street Apartments Investment, LLC (“Mitchell Street”) and FBB Tax Credit Investment LLC (“FBB Tax Credit”). FMIC is located in and was formed under the laws of the state of Nevada.
Basis of Presentation. The accompanying unaudited Consolidated Financial Statements were prepared in accordance with GAAP and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Corporation’s Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2016. The unaudited Consolidated Financial Statements include the accounts of the Corporation and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. In accordance with the provisions of Accounting Standards Codification (“ASC”) Topic 810, the Corporation’s ownership interest in FBFS Statutory Trust II (“Trust II”) has not been consolidated into the financial statements.
Management of the Corporation is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities, level of the allowance for loan and lease losses, lease residuals, property under operating leases, goodwill, level of the Small Business Administration (“SBA”) recourse reserve and income taxes. The results of operations for the nine month period ended September 30, 2017 are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2017. Certain amounts in prior periods may have been reclassified to conform to the current presentation. Subsequent events have been evaluated through the date of the issuance of the unaudited Consolidated Financial Statements. No significant subsequent events have occurred through this date requiring adjustment to the financial statements or disclosures.
The Corporation has not changed its significant accounting and reporting policies from those disclosed in the Corporation’s Form 10-K for the year ended December 31, 2016.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” with an original effective date for annual reporting periods beginning after December 15, 2016. The ASU is a converged standard between the FASB and the IASB that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and industries. The primary objective of the ASU is revenue recognition that represents the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of ASU 2014-09 to annual and interim reporting periods in fiscal years beginning after December 15, 2017. Earlier application is permitted only as of annual and interim reporting periods in fiscal years beginning after December 15, 2016. In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net.” The ASU intends to improve the operability and understandability of the implementation guidance of ASU 2014-09 on principal versus agent considerations. In April, May and December 2016, the FASB also issued ASU No. 2016-10, No. 2016-12 and No. 2016-20, respectively, related to Topic 606. The amendments do not change the core principles of the previously issued guidance, but instead further clarify and provide implementation guidance for certain aspects of the original ASU. The Corporation intends to adopt the accounting standards during the first quarter of 2018, as required. The Corporation has conducted its initial assessment and evaluated contracts to assess and quantify accounting methodology changes resulting from the adoption of this standard. The adoption of this accounting standard is not expected to have a material impact on the Corporation's consolidated financial statements. The

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FASB continues to release new accounting guidance related to the adoption of this standard, which could impact the Corporation's initial assessment and may change the conclusions reached as to the application of this new guidance.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The ASU intends to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities and disclosing key information about leasing arrangements. The ASU will require lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessees’ obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The new lease guidance simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Corporation intends to adopt the accounting standard during the first quarter of 2019, as required, and is currently evaluating the impact on its results of operations, financial position and liquidity.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments- Credit Losses (Topic 326).” The ASU replaces the incurred loss impairment methodology for recognizing credit losses with a methodology that reflects all expected credit losses. The ASU also requires consideration of a broader range of information to inform credit loss estimates, including such factors as past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, and any other financial asset not excluded from the scope that have the contractual right to receive cash. Entities will apply the amendments in the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The ASU is effective for public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal years beginning after December 15, 2018. The Corporation intends to adopt the accounting standard during the first quarter of 2020, as required, and is currently evaluating the impact on its results of operations, financial position and liquidity.
In May 2017, the FASB issued ASU No. 2017-09, “Compensation- Stock Compensation (Topic 718).” The ASU provides clarity about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The ASU is effective for all entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on its results of operations, financial position and liquidity.

In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815).” The ASU intends to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. It also expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on its results of operations, financial position and liquidity.



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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, or dividend equivalents, at the same rate as holders of the Corporation’s common stock. Diluted earnings per share are computed by dividing net income allocated to common shares, adjusted for reallocation of undistributed earnings of unvested restricted shares, by the weighted average number of shares determined for the basic earnings per common share computation plus the dilutive effect of common stock equivalents using the treasury stock method.
There were no anti-dilutive employee share-based awards for the three and nine month periods ended September 30, 2017 and 2016.
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(Dollars in Thousands, Except Share Data)
Basic earnings per common share
 
 
 
 
 
 
 
 
Net income
 
$
2,584

 
$
2,665

 
$
7,867

 
$
10,941

Less: earnings allocated to participating securities
 
35

 
38

 
105

 
165

Basic earnings allocated to common shareholders
 
$
2,549

 
$
2,627

 
$
7,762

 
$
10,776

Weighted-average common shares outstanding, excluding participating securities
 
8,621,311

 
8,582,836

 
8,606,080

 
8,569,613

Basic earnings per common share
 
$
0.30

 
$
0.31

 
$
0.90

 
$
1.26

 
 
 
 
 
 
 
 
 
Diluted earnings per common share
 
 
 
 
 
 
 
 
Earnings allocated to common shareholders, diluted
 
$
2,549

 
$
2,627

 
$
7,762

 
$
10,776

Weighted-average diluted common shares outstanding, excluding participating securities
 
8,621,311

 
8,582,836

 
8,606,080

 
8,569,613

Diluted earnings per common share
 
$
0.30

 
$
0.31

 
$
0.90

 
$
1.26


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, restricted stock, restricted stock units, dividend equivalent units and any other type of award permitted by the Plan. As of September 30, 2017, 217,475 shares were available for future grants under the Plan. Shares covered by awards that expire, terminate or lapse will again be available for the grant of awards under the Plan. The Corporation may issue new shares and shares from its treasury stock for shares delivered under the Plan.
Restricted Stock
Under the Plan, the Corporation may grant restricted stock to plan participants, subject to forfeiture upon the occurrence of certain events until the dates specified in the participant’s award agreement. While restricted stock is subject to forfeiture, with the exception of restricted stock units, which do not have voting rights and are provided dividend equivalents, restricted stock participants may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares. The restricted stock granted under the Plan is typically subject to a vesting period. Compensation expense is recognized over the requisite service period of generally four years for the entire award on a straight-line basis. Upon vesting of restricted stock, the benefit of tax deductions in excess of recognized compensation expense is reflected as an income tax benefit in the unaudited Consolidated Statements of Income.

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Restricted stock activity for the year ended December 31, 2016 and the nine months ended September 30, 2017 was as follows:
 
 
Number of
Restricted Shares/Units
 
Weighted Average
Grant-Date
Fair Value
Nonvested balance as of December 31, 2015
 
135,471

 
$
20.13

Granted
 
60,415

 
22.74

Vested
 
(56,090
)
 
18.71

Forfeited
 
(23,551
)
 
20.90

Nonvested balance as of December 31, 2016
 
116,245

 
21.13

Granted
 
64,725

 
21.62

Vested
 
(45,695
)
 
21.49

Forfeited
 
(7,619
)
 
21.57

Nonvested balance as of September 30, 2017
 
127,656

 
$
21.39


As of September 30, 2017, the Corporation had $2.6 million of deferred unvested compensation expense, which the Corporation expects to recognize over a weighted-average period of approximately 3.03 years.

For the three and nine months ended September 30, 2017 and 2016, share-based compensation expense related to restricted stock included in the unaudited Consolidated Statements of Income was as follows:
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(In Thousands)
Share-based compensation expense
$
268

 
$
292

 
$
811

 
$
858

 
  
Note 4 — Securities
The amortized cost and fair value of securities available-for-sale and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

 
 
As of September 30, 2017
 
 
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
 
 
(In Thousands)
Available-for-sale:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
3,799

 
$
11

 
$
(3
)
 
$
3,807

Municipal obligations
 
9,342

 
13

 
(23
)
 
9,332

Collateralized mortgage obligations - government issued
 
22,750

 
301

 
(149
)
 
22,902

Collateralized mortgage obligations - government-sponsored enterprises
 
95,608

 
165

 
(684
)
 
95,089

 
 
$
131,499

 
$
490

 
$
(859
)
 
$
131,130



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As of December 31, 2016
 
 
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
 
 
(In Thousands)
Available-for-sale:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
6,298

 
$
7

 
$
(10
)
 
$
6,295

Municipal obligations
 
8,246

 
2

 
(92
)
 
8,156

Asset-backed securities
 
1,116

 

 
(35
)
 
1,081

Collateralized mortgage obligations - government issued
 
30,936

 
423

 
(146
)
 
31,213

Collateralized mortgage obligations - government-sponsored enterprises
 
99,865

 
252

 
(969
)
 
99,148

 
 
$
146,461

 
$
684

 
$
(1,252
)
 
$
145,893


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

 
 
As of September 30, 2017
 
 
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
1,498

 
$

 
$
(5
)
 
$
1,493

Municipal obligations
 
21,928

 
443

 
(14
)
 
22,357

Collateralized mortgage obligations - government issued
 
9,601

 
16

 
(33
)
 
9,584

Collateralized mortgage obligations - government-sponsored enterprises
 
5,846

 
12

 
(18
)
 
5,840

 
 
$
38,873

 
$
471

 
$
(70
)
 
$
39,274


 
 
As of December 31, 2016
 
 
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
1,497

 
$
2

 
$
(5
)
 
$
1,494

Municipal obligations
 
21,173

 
62

 
(78
)
 
21,157

Collateralized mortgage obligations - government issued
 
9,148

 
17

 
(38
)
 
9,127

Collateralized mortgage obligations - government-sponsored enterprises
 
6,794

 
6

 
(58
)
 
6,742

 
 
$
38,612

 
$
87

 
$
(179
)
 
$
38,520


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”). 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. Asset-backed securities represent securities issued by the Student Loan Marketing Association (“SLMA”) which are 97% guaranteed by the U.S. Government. Collateralized mortgage obligations - government issued represent securities guaranteed by the Government National Mortgage Association. Collateralized mortgage obligations

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Table of Contents

- government-sponsored enterprises include securities guaranteed by the FHLMC and the FNMA. There were 14 sales of available-for-sale securities that occurred during the nine months ended September 30, 2017 and three sales of available-for-sale securities that occurred during the nine months ended September 30, 2016.

At September 30, 2017 and December 31, 2016, securities with a fair value of $1.9 million and $22.4 million, respectively, were pledged to secure interest rate swap contracts, outstanding Federal Home Loan Bank (“FHLB”) advances and additional FHLB availability.
The amortized cost and fair value of securities by contractual maturity at September 30, 2017 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay certain obligations with or without call or prepayment penalties.
 
 
Available-for-Sale
 
Held-to-Maturity
 
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
 
(In Thousands)
Due in one year or less
 
$
6,785

 
$
6,783

 
$

 
$

Due in one year through five years
 
13,156

 
13,194

 
11,177

 
11,326

Due in five through ten years
 
48,051

 
48,168

 
13,258

 
13,495

Due in over ten years
 
63,507

 
62,985

 
14,438

 
14,453

 
 
$
131,499

 
$
131,130

 
$
38,873

 
$
39,274


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 September 30, 2017 and December 31, 2016. At September 30, 2017, the Corporation held 106 available-for-sale securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. At September 30, 2017, the Corporation held 56 available-for-sale securities that had been in a continuous unrealized loss position for twelve months or greater.

The Corporation has not specifically identified available-for-sale securities in a loss position that it intends to sell in the near term and does not believe that it will be required to sell any such securities. The Corporation reviews its securities on a quarterly basis to monitor its exposure to other-than-temporary impairment. Consideration is given to such factors as the length of time and extent to which the security has been in an unrealized loss position, changes in security ratings and an evaluation of the present value of expected future cash flows, if necessary. Based on the Corporation’s evaluation, it is expected that the Corporation will recover the entire amortized cost basis of each security. Accordingly, no other-than-temporary impairment was recorded in the unaudited Consolidated Statements of Income for the nine months ended September 30, 2017 and 2016.

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Table of Contents


A summary of unrealized loss information for securities available-for-sale, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows:

 
 
As of September 30, 2017
 
 
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
 
$
800

 
$

 
$
1,997

 
$
3

 
$
2,797

 
$
3

Municipal obligations
 
1,916

 
9

 
3,011

 
14

 
4,927

 
23

Collateralized mortgage obligations - government issued
 
3,679

 
14

 
6,185

 
135

 
9,864

 
149

Collateralized mortgage obligations - government-sponsored enterprises
 
32,752

 
121

 
31,883

 
563

 
64,635

 
684

 
 
$
39,147

 
$
144

 
$
43,076

 
$
715

 
$
82,223

 
$
859


 
 
As of December 31, 2016
 
 
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
 
$
1,991

 
$
10

 
$

 
$

 
$
1,991

 
$
10

Municipal obligations
 
7,207

 
89

 
406

 
3

 
7,613

 
92

Asset-backed securities
 

 
$

 
1,081

 
35

 
1,081

 
35

Collateralized mortgage obligations - government issued
 
10,552

 
130

 
493

 
16

 
11,045

 
146

Collateralized mortgage obligations - government-sponsored enterprises
 
54,843

 
931

 
1,819

 
38

 
56,662

 
969

 
 
$
74,593

 
$
1,160

 
$
3,799

 
$
92

 
$
78,392

 
$
1,252


The tables below show the Corporation’s gross unrealized losses and fair value of held-to-maturity investments, aggregated by investment category and length of time that individual investments were in a continuous loss position at September 30, 2017 and December 31, 2016. At September 30, 2017, the Corporation held 14 held-to-maturity securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. There were seven held-to-maturity securities that had been in a continuous loss position for twelve months or greater as of September 30, 2017. It is expected that the Corporation will recover the entire amortized cost basis of each held-to-maturity security based upon an evaluation of aforementioned factors. Accordingly, no other-than-temporary impairment was recorded in the unaudited Consolidated Statements of Income for the nine months ended September 30, 2017 and 2016.

A summary of unrealized loss information for securities held-to-maturity, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows:


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Table of Contents

 
 
As of September 30, 2017
 
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
1,000

 
$
5

 
$

 
$

 
$
1,000

 
$
5

Municipal obligations
 
853

 
11

 
260

 
3

 
1,113

 
14

Collateralized mortgage obligations - government issued
 
2,806

 
8

 
3,804

 
25

 
6,610

 
33

Collateralized mortgage obligations - government-sponsored enterprises
 

 

 
1,927

 
18

 
1,927

 
18

 
 
$
4,659

 
$
24

 
$
5,991

 
$
46

 
$
10,650

 
$
70


 
 
As of December 31, 2016
 
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
 
(In Thousands)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$
1,000

 
$
5

 
$

 
$

 
$
1,000

 
$
5

Municipal obligations
 
9,472

 
78

 

 

 
9,472

 
78

Collateralized mortgage obligations - government issued
 
6,980

 
38

 

 

 
6,980

 
38

Collateralized mortgage obligations - government-sponsored enterprises
 
4,682

 
58

 

 

 
4,682

 
58

 
 
$
22,134

 
$
179

 
$

 
$

 
$
22,134

 
$
179



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:
 
 
September 30,
2017
 
December 31,
2016
 
 
(In Thousands)
Commercial real estate:
 
 
 
 
Commercial real estate — owner occupied
 
$
182,755

 
$
176,459

Commercial real estate — non-owner occupied
 
461,586

 
473,158

Land development
 
41,499

 
56,638

Construction
 
115,660

 
101,206

Multi-family
 
125,080

 
92,762

1-4 family
 
40,173

 
45,651

Total commercial real estate
 
966,753

 
945,874

Commercial and industrial
 
447,223

 
450,298

Direct financing leases, net
 
28,868

 
30,951

Consumer and other:
 
 
 
 
Home equity and second mortgages
 
7,776

 
8,412

Other
 
17,447

 
16,329

Total consumer and other
 
25,223

 
24,741

Total gross loans and leases receivable
 
1,468,067

 
1,451,864

Less:
 
 
 
 
   Allowance for loan and lease losses
 
19,923

 
20,912

   Deferred loan fees
 
1,354

 
1,189

Loans and leases receivable, net
 
$
1,446,790

 
$
1,429,763

As of September 30, 2017 and December 31, 2016, the total amount of the Corporation’s ownership of SBA loans on the unaudited Consolidated Balance Sheets comprised of the following:
 
 
September 30,
2017
 
December 31,
2016
 
 
(In Thousands)
Retained, unguaranteed portion of sold SBA loans
 
$
30,632

 
$
30,418

Other SBA loans(1)
 
25,684

 
31,728

Total SBA loans
 
$
56,316

 
$
62,146

(1)
Primarily consisted of SBA Express loans, partially funded 7(a) program loans, and impaired SBA loans that were repurchased from the secondary market, all of which were not saleable as of September 30, 2017 and December 31, 2016, respectively.
As of September 30, 2017 and December 31, 2016, $11.9 million and $5.5 million of loans in this portfolio were considered impaired, respectively.
Loans transferred to third parties consist of the guaranteed portion of SBA loans which the Corporation sold in the secondary market, participation interests in other originated loans and residential real estate loans. The total principal amount of the guaranteed portion of SBA loans sold during the three months ended September 30, 2017 and 2016 was $6.3 million and $3.3 million, respectively. The total principal amount of the guaranteed portion of SBA loans sold during the nine months ended September 30, 2017 and 2016 was $15.5 million and $36.4 million, respectively. Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred during the three and nine months ended September 30, 2017 and 2016 have been derecognized in the unaudited Consolidated Financial Statements. 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. The total outstanding balance of sold SBA loans at September 30, 2017 and December 31, 2016 was $103.3 million and $105.1 million, respectively.

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Table of Contents


The total principal amount of transferred participation interests in other originated commercial loans during the three months ended September 30, 2017 and 2016 was $9.0 million and $7.9 million, respectively. The total principal amount of transferred participation interests in other originated commercial loans during the nine months ended September 30, 2017 and 2016 was $17.0 million and $17.7 million, respectively, all of which were treated as sales and derecognized under the applicable accounting guidance at the time of transfer. No gain or loss was recognized on participation interests in other originated loans as they were transferred at or near the date of loan origination and the payments received for servicing the portion of the loans participated represents adequate compensation. The total outstanding balance of these transferred loans at September 30, 2017 and December 31, 2016 was $91.7 million and $102.7 million, respectively. As of September 30, 2017 and December 31, 2016, the total amount of the Corporation’s partial ownership of these transferred loans on the unaudited Consolidated Balance Sheets was $146.2 million and $106.1 million, respectively. No loans in this participation portfolio were considered impaired as of September 30, 2017 and December 31, 2016. The Corporation does not share in the participant’s portion of any potential charge-offs. The total amount of loan participations purchased on the unaudited Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016 was $669,000 and $1.2 million, respectively.

The Corporation also previously sold residential real estate loans, servicing released, in the secondary market. No residential real estate loans were sold during the three months ended September 30, 2017 and $8.0 million were sold during the three months ended September 30, 2016. The total principal amount of residential real estate loans sold during the nine months ended September 30, 2017 and 2016 was $1.6 million and $15.2 million, respectively. Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred have been derecognized in the unaudited Consolidated Financial Statements. The loans were transferred at their fair value and the related gain was recognized as non-interest income upon the transfer in the unaudited Consolidated Financial Statements.

The following tables illustrate ending balances of the Corporation’s loan and lease portfolio, including impaired loans by class of receivable, and considering certain credit quality indicators as of September 30, 2017 and December 31, 2016:
 
 
September 30, 2017
 
 
Category
 
 
 
 
I
 
II
 
III
 
IV
 
Total
 
 
(Dollars in Thousands)
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 
$
147,603

 
$
19,324

 
$
8,690

 
$
7,138

 
$
182,755

Commercial real estate — non-owner occupied
 
438,874

 
19,769

 
1,117

 
1,826

 
461,586

Land development
 
37,659

 
795

 
275

 
2,770

 
41,499

Construction
 
109,102

 
773

 
431

 
5,354

 
115,660

Multi-family
 
125,080

 

 

 

 
125,080

1-4 family
 
29,051

 
7,824

 
1,233

 
2,065

 
40,173

      Total commercial real estate
 
887,369

 
48,485

 
11,746

 
19,153

 
966,753

Commercial and industrial
 
348,179

 
26,605

 
58,470

 
13,969

 
447,223

Direct financing leases, net
 
26,854

 
305

 
1,709

 

 
28,868

Consumer and other:
 
 
 
 
 
 
 
 
 

Home equity and second mortgages
 
7,764

 

 
8

 
4

 
7,776

Other
 
17,066

 

 

 
381

 
17,447

      Total consumer and other
 
24,830

 

 
8

 
385

 
25,223

Total gross loans and leases receivable
 
$
1,287,232

 
$
75,395

 
$
71,933

 
$
33,507

 
$
1,468,067

Category as a % of total portfolio
 
87.68
%
 
5.14
%
 
4.90
%
 
2.28
%
 
100.00
%

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Table of Contents

 
 
December 31, 2016
 
 
Category
 
 
 
 
I
 
II
 
III
 
IV
 
Total
 
 
(Dollars in Thousands)
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 
$
142,704

 
$
20,294

 
$
11,174

 
$
2,287

 
$
176,459

Commercial real estate — non-owner occupied
 
447,895

 
20,933

 
2,721

 
1,609

 
473,158

Land development
 
52,082

 
823

 
293

 
3,440

 
56,638

Construction
 
93,510

 
3,154

 
1,624

 
2,918

 
101,206

Multi-family
 
87,418

 
1,937

 
3,407

 

 
92,762

1-4 family
 
38,504

 
3,144

 
1,431

 
2,572

 
45,651

      Total commercial real estate
 
862,113

 
50,285

 
20,650

 
12,826

 
945,874

Commercial and industrial
 
348,201

 
42,949

 
46,675

 
12,473

 
450,298

Direct financing leases, net
 
29,351

 
1,600

 

 

 
30,951

Consumer and other:
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
8,271

 
121

 
12

 
8

 
8,412

Other
 
15,714

 

 
11

 
604

 
16,329

      Total consumer and other
 
23,985

 
121

 
23

 
612

 
24,741

Total gross loans and leases receivable
 
$
1,263,650

 
$
94,955

 
$
67,348

 
$
25,911

 
$
1,451,864

Category as a % of total portfolio
 
87.04
%
 
6.54
%
 
4.64
%
 
1.78
%
 
100.00
%

Credit underwriting through a committee process is a key component of the Corporation’s operating philosophy. Commercial lenders 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.
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 borrowers’ management team or the industry in which the borrower operates. The Corporation monitors Category I loans and leases through payment performance, continued maintenance of its personal relationships with such borrowers and continued review of such borrowers’ compliance with the terms of their respective agreements.
Category II — Loans and leases in this category are beginning to show signs of deterioration in one or more of the Corporation’s core underwriting criteria such as financial stability, management strength, industry trends or collateral values. Management will place credits in this category to allow for proactive monitoring and resolution with the borrower to possibly mitigate the area of concern and prevent further deterioration or risk of loss to the Corporation. Category II loans are considered performing but are monitored frequently by the assigned business development officer and by subcommittees of the Bank’s Loan Committee.
Category III — Loans and leases in this category are identified by management as warranting special attention. However, the balance in this category is not intended to represent the amount of adversely classified assets held by the Bank. Category III loans and leases generally exhibit undesirable characteristics, such as evidence of adverse financial trends and conditions, managerial problems, deteriorating economic conditions within the related industry or evidence of adverse public filings and may exhibit collateral shortfall positions. Management continues to believe that it will collect all contractual principal and interest in accordance with the original terms of the contracts relating to the loans and leases in this category, and therefore

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Table of Contents

Category III loans are considered performing with no specific reserves established for this category. Category III loans are monitored by management and the Bank’s Loan Committee on a monthly basis and the Bank’s Board 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 Bank will receive the contractual principal and interest in accordance with the original terms of the agreement. Impaired loans are individually evaluated to assess the need for the establishment of specific reserves or charge-offs. When analyzing the adequacy of collateral, the Corporation obtains external appraisals at least annually for impaired loans and leases. External appraisals are obtained from the Corporation’s approved appraiser listing and are independently reviewed to monitor the quality of such appraisals. To the extent a collateral shortfall position is present, a specific reserve or charge-off will be recorded to reflect the magnitude of the impairment. Loans and leases in this category are monitored by management and the Bank’s Loan Committee on a monthly basis and the Bank’s Board of Directors at each of their regularly scheduled meetings.
Utilizing regulatory classification terminology, the Corporation identified $36.7 million and $34.3 million of loans and leases as Substandard as of September 30, 2017 and December 31, 2016, respectively. The Corporation identified $5.1 million of loans and leases as Doubtful as of September 30, 2017. No loans and leases were considered Doubtful as of December 31, 2016. Additionally, no loans were considered Special Mention, or Loss as of either September 30, 2017 or December 31, 2016. The population of Substandard loans is a subset of Category III and Category IV loans.
The delinquency aging of the loan and lease portfolio by class of receivable as of September 30, 2017 and December 31, 2016 was as follows:

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Table of Contents

 
 
September 30, 2017
 
 
30-59
Days Past Due
 
60-89
Days Past Due
 
Greater
Than 90 Days Past Due
 
Total Past Due
 
Current
 
Total Loans and Leases
 
 
(Dollars in Thousands)
Accruing loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$

 
$

 
$

 
$
175,675

 
$
175,675

Non-owner occupied
 

 

 

 

 
459,760

 
459,760

Land development
 

 

 

 

 
38,729

 
38,729

Construction
 
392

 

 

 
392

 
109,914

 
110,306

Multi-family
 

 

 

 

 
125,080

 
125,080

1-4 family
 

 

 

 

 
38,309

 
38,309

Commercial and industrial
 
2,257

 
470

 

 
2,727

 
430,539

 
433,266

Direct financing leases, net
 

 

 

 

 
28,868

 
28,868

Consumer and other:
 
 
 
 
 
 
 


 
 
 
 
Home equity and second mortgages
 
229

 

 

 
229

 
7,547

 
7,776

Other
 

 

 

 

 
17,066

 
17,066

Total
 
2,878

 
470

 

 
3,348

 
1,431,487

 
1,434,835

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

 

 
4,825

 
4,825

 
2,255

 
7,080

Non-owner occupied
 

 

 
1,791

 
1,791

 
35

 
1,826

Land development
 

 

 

 

 
2,770

 
2,770

Construction
 

 

 
5,353

 
5,353

 
1

 
5,354

Multi-family
 

 

 

 

 

 

1-4 family
 
529

 
10

 
1,041

 
1,580

 
284

 
1,864

Commercial and industrial
 
207

 
497

 
11,005

 
11,709

 
2,248

 
13,957

Direct financing leases, net
 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 

 

Other
 

 

 
358

 
358

 
23

 
381

Total
 
736

 
507

 
24,373

 
25,616

 
7,616


33,232

Total loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 

 

 
4,825

 
4,825

 
177,930

 
182,755

Non-owner occupied
 

 

 
1,791

 
1,791

 
459,795

 
461,586

Land development
 

 

 

 

 
41,499

 
41,499

Construction
 
392

 

 
5,353

 
5,745

 
109,915

 
115,660

Multi-family
 

 

 

 

 
125,080

 
125,080

1-4 family
 
529

 
10

 
1,041

 
1,580

 
38,593

 
40,173

Commercial and industrial
 
2,464

 
967

 
11,005

 
14,436

 
432,787

 
447,223

Direct financing leases, net
 

 

 

 

 
28,868

 
28,868

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 

Home equity and second mortgages
 
229

 

 

 
229

 
7,547

 
7,776

Other
 

 

 
358

 
358

 
17,089

 
17,447

Total
 
$
3,614

 
$
977

 
$
24,373

 
$
28,964

 
$
1,439,103

 
$
1,468,067

Percent of portfolio
 
0.24
%
 
0.07
%
 
1.66
%
 
1.97
%
 
98.03
%
 
100.00
%

19

Table of Contents

 
 
December 31, 2016
 
 
30-59
Days Past Due
 
60-89
Days Past Due
 
Greater
Than 90 Days Past Due
 
Total Past Due
 
Current
 
Total Loans and Leases
 
 
(Dollars in Thousands)
Accruing loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
$

 
$

 
$

 
$

 
$
174,236

 
$
174,236

Non-owner occupied
 

 

 

 

 
471,549

 
471,549

Land development
 

 

 

 

 
53,198

 
53,198

Construction
 

 

 

 

 
98,288

 
98,288

Multi-family
 

 

 

 

 
92,762

 
92,762

1-4 family
 
75

 

 

 
75

 
43,639

 
43,714

Commercial and industrial
 
55

 
468

 

 
523

 
437,312

 
437,835

Direct financing leases, net
 

 

 

 

 
30,951

 
30,951

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 
8,412

 
8,412

Other
 

 

 

 

 
15,725

 
15,725

Total
 
130

 
468

 

 
598

 
1,426,072

 
1,426,670

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

 

 
1,183

 
1,183

 
1,040

 
2,223

Non-owner occupied
 

 

 

 

 
1,609

 
1,609

Land development
 

 

 

 

 
3,440

 
3,440

Construction
 
2,482

 

 
436

 
2,918

 

 
2,918

Multi-family
 

 

 

 

 

 

1-4 family
 

 

 
1,240

 
1,240

 
697

 
1,937

Commercial and industrial
 
3,345

 
168

 
6,740

 
10,253

 
2,210

 
12,463

Direct financing leases, net
 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 

 

Other
 
186

 

 
378

 
564

 
40

 
604

Total
 
6,013

 
168

 
9,977

 
16,158

 
9,036

 
25,194

Total loans and leases
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 

 

 
1,183

 
1,183

 
175,276

 
176,459

Non-owner occupied
 

 

 

 

 
473,158

 
473,158

Land development
 

 

 

 

 
56,638

 
56,638

Construction
 
2,482

 

 
436

 
2,918

 
98,288

 
101,206

Multi-family
 

 

 

 

 
92,762

 
92,762

1-4 family
 
75

 

 
1,240

 
1,315

 
44,336

 
45,651

Commercial and industrial
 
3,400

 
636

 
6,740

 
10,776

 
439,522

 
450,298

Direct financing leases, net
 

 

 

 

 
30,951

 
30,951

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 
8,412

 
8,412

Other
 
186

 

 
378

 
564

 
15,765

 
16,329

Total
 
$
6,143

 
$
636

 
$
9,977

 
$
16,756

 
$
1,435,108

 
$
1,451,864

Percent of portfolio
 
0.42
%
 
0.04
%
 
0.69
%
 
1.15
%
 
98.85
%
 
100.00
%

20

Table of Contents

The Corporation’s total impaired assets consisted of the following at September 30, 2017 and December 31, 2016, respectively.
 
 
September 30,
2017
 
December 31,
2016
 
 
(Dollars in Thousands)
Non-accrual loans and leases
 
 
 
 
Commercial real estate:
 
 
 
 
Commercial real estate — owner occupied
 
$
7,080

 
$
2,223

Commercial real estate — non-owner occupied
 
1,826

 
1,609

Land development
 
2,770

 
3,440

Construction
 
5,354

 
2,918

Multi-family
 

 

1-4 family
 
1,864

 
1,937

Total non-accrual commercial real estate
 
18,894

 
12,127

Commercial and industrial
 
13,957

 
12,463

Direct financing leases, net
 

 

Consumer and other:
 
 
 
 
Home equity and second mortgages
 

 

Other
 
381

 
604

Total non-accrual consumer and other loans
 
381

 
604

Total non-accrual loans and leases
 
33,232

 
25,194

Foreclosed properties, net
 
2,585

 
1,472

Total non-performing assets
 
35,817

 
26,666

Performing troubled debt restructurings
 
275

 
717

Total impaired assets

$
36,092

 
$
27,383

 
 
September 30,
2017
 
December 31,
2016
Total non-accrual loans and leases to gross loans and leases
 
2.26
%
 
1.74
%
Total non-performing assets to total gross loans and leases plus foreclosed properties, net
 
2.44

 
1.83

Total non-performing assets to total assets
 
2.01

 
1.50

Allowance for loan and lease losses to gross loans and leases
 
1.36

 
1.44

Allowance for loan and lease losses to non-accrual loans and leases
 
59.95

 
83.00

As of September 30, 2017 and December 31, 2016, $10.9 million and $12.8 million of the non-accrual loans and leases were considered troubled debt restructurings, respectively. There were no unfunded commitments associated with troubled debt restructured loans and leases as of September 30, 2017.


21

Table of Contents

The following table provides the number of loans modified in a troubled debt restructuring and the pre- and post-modification recorded investment by class of receivable as of September 30, 2017 and December 31, 2016.
 
 
As of September 30, 2017
 
As of December 31, 2016
 
 
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)
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 
3
 
$
1,065

 
$
888

 
3
 
$
1,065

 
$
930

Commercial real estate — non-owner occupied
 
1
 
158

 
35

 
1
 
158

 
39

Land development
 
1
 
5,745

 
2,770

 
1
 
5,745

 
3,440

Construction
 
 

 

 
2
 
331

 
314

Multi-family
 
 

 

 
 

 

1-4 family
 
10
 
1,287

 
1,353

 
11
 
1,391

 
1,393

Commercial and industrial
 
11
 
8,944

 
5,759

 
10
 
8,094

 
7,058

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
 
1
 
37

 
4

 
1
 
37

 
8

Other
 
2
 
2,094

 
359

 
1
 
2,076

 
378

Total
 
29
 
$
19,330

 
$
11,168

 
30
 
$
18,897

 
$
13,560


All loans and leases modified as a troubled debt restructuring are measured for impairment. The nature and extent of the impairment of restructured loans, including those which have experienced a default, is considered in the determination of an appropriate level of the allowance for loan and lease losses.

As of September 30, 2017 and December 31, 2016, the Corporation’s troubled debt restructurings grouped by type of concession were as follows:
 
 
As of September 30, 2017
 
As of December 31, 2016
 
 
Number of
Loans
 
Recorded Investment
 
Number of
Loans
 
Recorded Investment
 
 
(Dollars in Thousands)
Commercial real estate:
 
 
 
 
 
 
 
 
   Extension of term
 

 
$

 
1

 
$
8

   Interest rate concession
 
1

 
49

 
1

 
52

   Combination of extension of term and interest rate concession
 
14

 
4,997

 
16

 
6,056

Commercial and industrial:
 
 
 
 
 
 
 
 
   Combination of extension of term and interest rate concession
 
11

 
5,759

 
10

 
7,058

Consumer and other:
 
 
 
 
 
 
 
 
   Extension of term
 
1

 
342

 
1

 
378

   Combination of extension of term and interest rate concession
 
2

 
21

 
1

 
8

Total
 
29

 
$
11,168

 
30

 
$
13,560


During the three months ended September 30, 2017, two commercial and industrial loans totaling $800,000 were modified to a troubled debt restructuring. During the nine months ended September 30, 2017, four commercial and industrial loans and one consumer loan totaling $4.4 million and $17,000, respectively, were modified to a troubled debt restructuring. No loans were modified to a troubled debt restructuring during the three and nine months ended September 30, 2016.

22

Table of Contents


There were five loans and leases modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the three and nine months ended September 30, 2017.
The following represents additional information regarding the Corporation’s impaired loans and leases, including performing troubled debt restructurings, by class:
 
 
As of and for the Nine Months Ended September 30, 2017
 
 
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
 
$
6,727

 
$
6,727

 
$

 
$
4,898

 
$
394

 
$

 
$
394

Non-owner occupied
 
1,826

 
1,866

 

 
1,932

 
99

 

 
99

Land development
 
2,770

 
5,441

 

 
3,218

 
65

 

 
65

Construction
 
2,482

 
2,482

 

 
611

 
208

 

 
208

Multi-family
 

 

 

 
1

 

 

 

1-4 family
 
2,065

 
2,319

 

 
2,387

 
69

 

 
69

Commercial and industrial
 
1,740

 
2,103

 

 
6,782

 
509

 

 
509

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
4

 
4

 

 
6

 

 

 

Other
 
358

 
1,025

 

 
397

 
45

 

 
45

Total
 
17,972

 
21,967

 

 
20,232

 
1,389

 

 
1,389

With impairment reserve recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
411

 
411

 
15

 
424

 
19

 

 
19

Non-owner occupied
 

 

 

 

 

 

 

Land development
 

 



 





 

Construction
 
2,872

 
2,872


94

 
4,091


108



 
108

Multi-family
 

 

 

 

 

 

 

1-4 family
 

 

 

 

 

 

 

Commercial and industrial
 
12,229

 
12,702

 
5,658

 
10,114

 
453

 

 
453

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

 

 

 

Other
 
23

 
23

 
23

 
10

 

 

 

Total
 
15,535

 
16,008

 
5,790

 
14,639

 
580

 

 
580

Total:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
7,138

 
7,138

 
15

 
5,322

 
413

 

 
413

Non-owner occupied
 
1,826

 
1,866

 

 
1,932

 
99

 

 
99

Land development
 
2,770

 
5,441

 

 
3,218

 
65

 

 
65

Construction
 
5,354

 
5,354

 
94

 
4,702

 
316

 

 
316

Multi-family
 

 

 

 
1

 

 

 

1-4 family
 
2,065

 
2,319

 

 
2,387

 
69

 

 
69

Commercial and industrial
 
13,969

 
14,805

 
5,658

 
16,896

 
962

 

 
962

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
4

 
4

 

 
6

 

 

 

Other
 
381

 
1,048

 
23

 
407

 
45

 

 
45

Grand total
 
$
33,507

 
$
37,975

 
$
5,790

 
$
34,871

 
$
1,969

 
$

 
$
1,969


23

Table of Contents

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


 
 
As of and for the Year Ended December 31, 2016
 
 
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
 
$
1,788

 
$
1,788

 
$

 
$
3,577

 
$
328

 
$
118

 
$
210

   Non-owner occupied
 
1,609

 
1,647

 

 
1,318

 
91

 
79

 
12

   Land development
 
3,440

 
6,111

 

 
3,898

 
107

 

 
107

   Construction
 
436

 
438




291


20



 
20

   Multi-family
 

 

 

 

 
1

 
134

 
(133
)
   1-4 family
 
2,379

 
2,379

 

 
2,755

 
125

 
94

 
31

Commercial and industrial
 
1,307

 
1,307

 

 
709

 
79

 
62

 
17

Direct financing leases, net
 

 

 

 
6

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Home equity and second mortgages
 
8

 
8

 

 
307

 
16

 
127

 
(111
)
   Other
 
378

 
1,044

 

 
510

 
71

 

 
71

      Total
 
11,345

 
14,722

 

 
13,371

 
838

 
614

 
224

With impairment reserve recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Owner occupied
 
499

 
499

 
70

 
111

 
28

 

 
28

   Non-owner occupied
 

 

 

 

 

 

 

   Land development
 

 









 

   Construction
 
2,482

 
2,482


1,790


834


45



 
45

   Multi-family
 

 

 

 

 

 

 

   1-4 family
 
193

 
199

 
39

 
203

 
5

 

 
5

Commercial and industrial
 
11,166

 
11,166

 
3,700

 
8,448

 
701

 

 
701

Direct financing leases, net
 

 

 

 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Home equity and second mortgages
 

 

 

 

 

 

 

   Other
 
226

 
226

 

 
19

 

 

 

      Total
 
14,566

 
14,572

 
5,599

 
9,615

 
779

 

 
779

Total:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Owner occupied
 
2,287

 
2,287

 
70

 
3,688

 
356

 
118

 
238

   Non-owner occupied
 
1,609

 
1,647

 

 
1,318

 
91

 
79

 
12

   Land development
 
3,440

 
6,111

 

 
3,898

 
107

 

 
107

   Construction
 
2,918

 
2,920

 
1,790

 
1,125

 
65

 

 
65

   Multi-family
 

 

 

 

 
1

 
134

 
(133
)
   1-4 family
 
2,572

 
2,578

 
39

 
2,958

 
130

 
94

 
36

Commercial and industrial
 
12,473

 
12,473

 
3,700

 
9,157

 
780

 
62

 
718

Direct financing leases, net
 

 

 

 
6

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
8

 
8

 

 
307

 
16

 
127

 
(111
)
Other
 
604

 
1,270

 

 
529

 
71

 

 
71

      Grand total
 
$
25,911

 
$
29,294

 
$
5,599

 
$
22,986

 
$
1,617

 
$
614

 
$
1,003

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

24

Table of Contents

The difference between the recorded investment of loans and leases and the unpaid principal balance of $4.5 million and $3.4 million as of September 30, 2017 and December 31, 2016, respectively, represents partial charge-offs of loans and leases resulting from losses due to the appraised value of the collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $275,000 and $717,000 of loans as of September 30, 2017 and December 31, 2016, respectively, that were performing troubled debt restructurings, and although not on non-accrual, were reported as impaired due to the concession in terms. When a loan is placed on non-accrual, interest accrual is discontinued and previously accrued but uncollected interest is deducted from interest income. Cash payments collected on non-accrual loans are first applied to such loan’s principal. Foregone interest represents the interest that was contractually due on the loan but not received or recorded. To the extent the amount of principal on a non-accrual loan is fully collected and additional cash is received, the Corporation will recognize interest income.
To determine the level and composition of the allowance for loan and lease losses, the Corporation categorizes the portfolio into segments with similar risk characteristics. First, the Corporation evaluates loans and leases for potential impairment classification. The Corporation analyzes each loan and lease determined to be impaired on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of expected cash flows. The Corporation applies historical trends from established risk factors to each category of loans and leases that has not been individually evaluated for the purpose of establishing the general portion of the allowance.
A summary of the activity in the allowance for loan and lease losses by portfolio segment is as follows:

 
 
As of and for the Three Months Ended September 30, 2017
 
 
Commercial
Real Estate
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
 
 
(Dollars in Thousands)
Beginning balance
 
$
12,003

 
$
9,090

 
$
584

 
$
21,677

Charge-offs
 
(8
)
 
(3,217
)
 
(5
)
 
(3,230
)
Recoveries
 
2

 
2

 
1

 
5

Net charge-offs
 
(6
)
 
(3,215
)
 
(4
)
 
(3,225
)
Provision for credit losses
 
(2,462
)
 
3,968

 
(35
)
 
1,471

Ending balance
 
$
9,535

 
$
9,843

 
$
545

 
$
19,923

 
 
As of and for the Three Months Ended September 30, 2016
 
 
Commercial
Real Estate
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
 
 
(Dollars in Thousands)
Beginning balance
 
$
11,436

 
$
6,017

 
$
701

 
$
18,154

Charge-offs
 
(259
)
 
(1,396
)
 
(1
)
 
(1,656
)
Recoveries
 
31

 

 
1

 
32

Net charge-offs
 
(228
)
 
(1,396
)
 

 
(1,624
)
Provision for credit losses
 
1,607

 
2,051

 
(121
)
 
3,537

Ending balance
 
$
12,815

 
$
6,672

 
$
580

 
$
20,067



25

Table of Contents

 
 
As of and for the Nine Months Ended September 30, 2017
 
 
Commercial
Real Estate
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
 
 
(Dollars in Thousands)
Beginning balance
 
$
12,384

 
$
7,970

 
$
558

 
$
20,912

Charge-offs
 
(126
)
 
(6,978
)
 
(92
)
 
(7,196
)
Recoveries
 
152

 
314

 
42

 
508

Net recoveries (charge-offs)
 
26

 
(6,664
)
 
(50
)
 
(6,688
)
Provision for credit loss
 
(2,875
)
 
8,537

 
37

 
5,699

Ending balance
 
$
9,535

 
$
9,843

 
$
545

 
$
19,923


 
 
As of and for the Nine Months Ended September 30, 2016
 
 
Commercial
Real Estate
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
 
 
(Dollars in Thousands)
Beginning balance
 
$
11,220

 
$
4,387

 
$
709

 
$
16,316

Charge-offs
 
(1,194
)
 
(2,048
)
 
(8
)
 
(3,250
)
Recoveries
 
170

 
2

 
5

 
177

Net charge-offs
 
(1,024
)
 
(2,046
)
 
(3
)
 
(3,073
)
Provision for credit loss
 
2,619

 
4,331

 
(126
)
 
6,824

Ending balance
 
$
12,815

 
$
6,672

 
$
580

 
$
20,067


The following tables provide information regarding the allowance for loan and lease losses and balances by type of allowance methodology.
 
 
As of September 30, 2017
 
 
Commercial
Real Estate
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
 
 
(Dollars in Thousands)
Allowance for loan and lease losses:
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
 
$
9,426

 
$
4,185

 
$
522

 
$
14,133

Individually evaluated for impairment
 
109

 
5,658

 
23

 
5,790

Loans acquired with deteriorated credit quality
 

 

 

 

Total
 
$
9,535

 
$
9,843

 
$
545

 
$
19,923

Loans and lease receivables:
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
 
$
947,600

 
$
462,122

 
$
24,838

 
$
1,434,560

Individually evaluated for impairment
 
18,535

 
13,962

 
385

 
32,882

Loans acquired with deteriorated credit quality
 
618

 
7

 

 
625

Total
 
$
966,753

 
$
476,091

 
$
25,223

 
$
1,468,067


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As of December 31, 2016
 
 
Commercial
Real Estate
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
 
 
(Dollars in Thousands)
Allowance for loan and lease losses:
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
 
$
10,485

 
$
4,270

 
$
558

 
$
15,313

Individually evaluated for impairment
 
1,899

 
3,700

 

 
5,599

Loans acquired with deteriorated credit quality
 

 

 

 

Total
 
$
12,384

 
$
7,970

 
$
558

 
$
20,912

Loans and lease receivables:
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
 
$
933,048

 
$
468,776

 
$
24,129

 
$
1,425,953

Individually evaluated for impairment
 
11,222

 
12,452

 
612

 
24,286

Loans acquired with deteriorated credit quality
 
1,604

 
21

 

 
1,625

Total
 
$
945,874

 
$
481,249

 
$
24,741

 
$
1,451,864



Note 6 — Other Assets
The Corporation is a limited partner in several limited partnership investments. The Corporation is not the general partner, does not have controlling ownership and is not the primary beneficiary in any of these limited partnerships and the limited partnerships have not been consolidated. These investments are accounted for using the equity method of accounting and are evaluated for impairment at the end of each reporting period. For historic rehabilitation tax credits, the Corporation begins to evaluate its investments for impairment at the time the credit is earned, which is typically in the year the project is placed in service, through the end of its five-year compliance period. New market tax credits are also evaluated for impairment beginning at the time the tax credits are earned on the project through the seven-year compliance period.
Historic Rehabilitation Tax Credits
In 2015, the Corporation invested in a development entity through BOC, a wholly-owned subsidiary of FBB, to acquire, rehabilitate and operate a historic building in Madison, Wisconsin. At September 30, 2017 and December 31, 2016, the net carrying value of the investment was $174,000.
In 2016, the Corporation also invested in a development entity through Mitchell Street, a wholly-owned subsidiary of FBB, to rehabilitate a historic building in Milwaukee, Wisconsin. At September 30, 2017 and December 31, 2016, the net carrying value of the investment was $563,000. The aggregate capital contributions to the project will depend upon the final amount of the certified project costs, but are expected to approximate $5.5 million. The Corporation is also anticipating the sale of the state credits associated with the investment to a third party. No historic tax credits were received at September 30, 2017. The credits will be taken when the project is placed in service and are subject to a five-year recapture period.
In 2017, the Corporation also invested in a development entity through FBB Tax Credit, a wholly-owned subsidiary of FBB, to rehabilitate a historic building in Kenosha, Wisconsin. At September 30, 2017, the net carrying value of the investment was $417,000. The aggregate capital contributions to the project will depend upon the final amount of the certified project costs, but are expected to approximate $2.1 million. The credits will be taken when the project is placed in service and are subject to a five-year recapture period.
New Market Tax Credits
The Corporation invested in a community development entity (“CDE”) through Rimrock Road, a wholly-owned subsidiary of FBB, to develop and operate a real estate project located in a low-income community. At September 30, 2017 and December 31, 2016, Rimrock had one CDE investment with a net carrying value of $6.7 million and $7.1 million, respectively. The investment provides federal new market tax credits over a seven-year credit allowance period through 2020. The remaining federal new market tax credit to be utilized over a maximum of seven years was $1.5 million as of September 30, 2017. The Corporation’s use of the federal new market tax credit during the nine months ended September 30, 2017 and 2016 was $338,000 and $281,000, respectively.
Other Investments

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Table of Contents

The Corporation has an equity investment in Aldine Capital Fund, LP, a mezzanine fund, of $948,000 and $883,000 recorded as of September 30, 2017 and December 31, 2016, respectively. The Corporation’s equity investment in Aldine Capital Fund II, LP, also a mezzanine fund, totaled $3.7 million and $3.1 million as of September 30, 2017 and December 31, 2016, respectively. The Corporation’s share of these partnerships’ income included in the unaudited Consolidated Statements of Income for the nine months ended September 30, 2017 and 2016 was $236,000 and $708,000, respectively.
The Corporation is the sole owner of $315,000 of common securities issued by Trust II, a Delaware business trust. The purpose of Trust II was to complete the sale of $10.0 million of 10.50% fixed rate preferred securities. Trust II, a wholly owned subsidiary of the Corporation, is not consolidated into the financial statements of the Corporation. The investment in Trust II of $315,000 as of September 30, 2017 and December 31, 2016 is included in accrued interest receivable and other assets.
A summary of accrued interest receivable and other assets is as follows:
 
 
September 30, 2017
 
December 31, 2016
 
 
(In Thousands)
Accrued interest receivable
 
$
4,722

 
$
4,677

Net deferred tax asset
 
5,543

 
4,052

Investment in historic development entities
 
1,154

 
737

Investment in a CDE
 
6,719

 
7,106

Investment in limited partnerships
 
4,607

 
3,963

Investment in Trust II
 
315

 
315

Fair value of interest rate swaps
 
1,380

 
352

Prepaid expenses
 
3,338

 
3,074

Other assets
 
4,450

 
4,331

Total accrued interest receivable and other assets
 
$
32,228

 
$
28,607


Note 7 — Deposits
The composition of deposits at September 30, 2017 and December 31, 2016 is shown below. Average balances represent year-to-date averages.
 
 
September 30, 2017
 
December 31, 2016
 
 
Balance
 
Average
Balance
 
Average Rate
 
Balance
 
Average
Balance
 
Average Rate
 
 
(Dollars in Thousands)
Non-interest-bearing transaction accounts
 
$
253,320

 
$
228,231

 
%
 
$
252,638

 
$
246,182

 
%
Interest-bearing transaction accounts
 
251,355

 
221,526

 
0.53

 
183,992

 
169,571

 
0.27

Money market accounts
 
527,705

 
601,455

 
0.45

 
627,090

 
642,784

 
0.48

Certificates of deposit
 
58,144

 
55,888

 
0.98

 
58,454

 
65,608

 
0.90

Wholesale deposits
 
333,200

 
374,083

 
1.68

 
416,681

 
467,826

 
1.62

Total deposits
 
$
1,423,724

 
$
1,481,183

 
0.72

 
$
1,538,855

 
$
1,591,971

 
0.74




Note 8 — FHLB Advances, Other Borrowings and Junior Subordinated Notes
The composition of borrowed funds at September 30, 2017 and December 31, 2016 is shown below. Average balances represent year-to-date averages.
 
 
September 30, 2017
 
December 31, 2016
 
 
Balance
 
Weighted Average
Balance
 
Weighted
Average Rate
 
Balance
 
Weighted Average
Balance
 
Weighted
Average Rate
 
 
(Dollars in Thousands)
Federal funds purchased
 
$

 
$
88

 
1.21
%
 
$

 
$
178

 
0.92
%
FHLB advances
 
143,500

 
83,987

 
1.24

 
33,578

 
14,485

 
0.97

Line of credit
 
10

 
435

 
3.63

 
1,010

 
2,079

 
3.26

Other borrowings(1)
 
675

 
1,432

 
15.37

 
2,590

 
1,739

 
7.64

Subordinated notes payable
 
23,699

 
22,978

 
7.04

 
22,498

 
22,467

 
7.13

Junior subordinated notes
 
10,015

 
10,009

 
11.08

 
10,004

 
9,997

 
11.07

 
 
$
177,899

 
$
118,929

 
3.38

 
$
69,680

 
$
50,945

 
6.03

 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
$
54,510

 
 
 
 
 
$
20,588

 
 
 
 
Long-term borrowings
 
123,389

 
 
 
 
 
49,092

 
 
 
 
 
 
$
177,899

 
 
 
 
 
$
69,680

 
 
 
 
(1)
Weighted average rate of other borrowings reflects the cost of prepaying a secured borrowing during the second quarter of 2017.

As of September 30, 2017 and December 31, 2016, 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, 2017, the Corporation pays a commitment fee on this line of credit. During both the nine months ended September 30, 2017 and 2016, the Corporation incurred interest expense due to this fee of $10,000.

Note 9 — Commitments and Contingencies
In the ordinary course of business, the Corporation sells the guaranteed portion of SBA loans, as well as participation interests in other originated loans, to third parties. The Corporation has a continuing involvement in each of the transferred lending arrangements by way of relationship management and servicing the loans, as well as being subject to normal and customary requirements of the SBA loan program and standard representations and warranties related to sold amounts. In the event of a loss resulting from default and a determination by the SBA that there is a deficiency in the manner in which the loan was originated, funded or serviced by the Corporation, the SBA may require the Corporation to repurchase the loan, deny its

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Table of Contents

liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from the Corporation. The Corporation must comply with applicable SBA regulations in order to maintain the guaranty. In addition, the Corporation retains the option to repurchase the sold guaranteed portion of an SBA loan if the loan defaults.

Management has assessed estimated losses inherent in the outstanding guaranteed portion of SBA loans sold in accordance with ASC 450, Contingencies, and determined a recourse reserve based on the probability of future losses for these loans to be $2.7 million at September 30, 2017, which is reported in accrued interest payable and other liabilities on the unaudited Consolidated Balance Sheets. During the nine months ended September 30, 2017, a $2.1 million recourse provision was recorded.

The summary of the activity in the SBA recourse reserve is as follows:
 
 
As of and for the Nine Months Ended September 30, 2017
 
As of and for the Year Ended December 31, 2016
 
 
(In Thousands)
Balance at the beginning of the period
 
$
1,750

 
$

SBA recourse provision
 
2,095

 
2,068

Charge-offs, net
 
(1,141
)
 
(318
)
Balance at the end of the period
 
$
2,704

 
$
1,750

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

Note 10 — 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:
 
 
September 30, 2017
 
 
Fair Value Measurements Using
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In Thousands)
Assets:
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$

 
$
3,807

 
$

 
$
3,807

Municipal obligations
 

 
9,332

 

 
9,332

Collateralized mortgage obligations - government issued
 

 
22,902

 

 
22,902

Collateralized mortgage obligations - government-sponsored enterprises
 

 
95,089

 

 
95,089

Interest rate swaps
 

 
1,380

 

 
1,380

Liabilities:
 
 
 
 
 
 
 

Interest rate swaps
 

 
1,380

 

 
1,380

 
 
December 31, 2016
 
 
Fair Value Measurements Using
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In Thousands)
Assets:
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
U.S. Government agency obligations - government-sponsored enterprises
 
$

 
$
6,295

 
$

 
$
6,295

Municipal obligations
 

 
8,156

 

 
8,156

Asset backed securities
 

 
1,081

 

 
1,081

Collateralized mortgage obligations - government issued
 

 
31,213

 

 
31,213

Collateralized mortgage obligations - government-sponsored enterprises
 

 
99,148

 

 
99,148

Interest rate swaps
 

 
352

 

 
352

Liabilities:
 
 
 
 
 
 
 
 
Interest rate swaps
 

 
352

 

 
352


For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the nine months ended September 30, 2017 or the year ended December 31, 2016 related to the above measurements.

30

Table of Contents

Assets and liabilities measured at fair value on a non-recurring basis, segregated by fair value hierarchy are summarized below:
 
 
September 30, 2017
 
 
Fair Value Measurements Using
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In Thousands)
Impaired loans
 
$

 
$
7,637

 
$
8,661

 
$
16,298

Foreclosed properties
 

 
1,472

 

 
1,472


 
 
December 31, 2016
 
 
Fair Value Measurements Using
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In Thousands)
Impaired loans
 
$

 
$
12,268

 
$
1,097

 
$
13,365

Foreclosed properties
 

 
1,472

 

 
1,472


Impaired loans were written down to the fair value of their underlying collateral less costs to sell of $16.3 million and $13.4 million at September 30, 2017 and December 31, 2016, respectively, through the establishment of specific reserves or by recording charge-offs when the carrying value exceeded the fair value of the underlying collateral of impaired loans. Valuation techniques consistent with the market approach, income approach or cost approach were used to measure fair value and primarily included observable inputs for the individual impaired loans being evaluated such as current appraisals, recent sales of similar assets or other observable market data, and are reflected within Level 2 of the hierarchy. In cases where an input is unobservable, specifically when discounts are applied to appraisal values to adjust such values to current market conditions or to reflect net realizable value, the impaired loan balance is reflected within Level 3 of the hierarchy. The quantification of unobservable inputs for Level 3 impaired loan values range from 13% - 90% as of the measurement date of September 30, 2017. The weighted average of those unobservable inputs was 20%. The majority of the impaired loans in the Level 3 category are considered collateral dependent loans or are supported by a SBA guaranty.
Foreclosed properties, upon initial recognition, are remeasured and reported at fair value through a charge-off to the allowance for loan and lease losses, if deemed necessary, based upon the fair value of the foreclosed property. The fair value of a foreclosed property, upon initial recognition, is estimated using a market approach or Level 2 inputs based on observable market data, typically a current appraisal, or Level 3 inputs based upon assumptions specific to the individual property or equipment. Level 3 inputs typically include unobservable inputs such as management applied discounts used to further reduce values to a net realizable value and may be used in situations when observable inputs become stale. Foreclosed property fair value inputs may transition to Level 1 upon receipt of an accepted offer for the sale of the related foreclosed property.

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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:
 
 
September 30, 2017
 
 
Carrying
Amount
 
Fair Value
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
 
 
(In Thousands)
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
73,196

 
$
73,218

 
$
56,487

 
$
16,731

 
$

Securities available-for-sale
 
131,130

 
131,130

 

 
131,130

 

Securities held-to-maturity
 
38,873

 
39,274

 

 
39,274

 

Loans held for sale
 

 

 

 

 

Loans and lease receivables, net
 
1,446,790

 
1,427,071

 

 
7,637

 
1,419,434

Bank-owned life insurance
 
39,988

 
39,988

 
39,988

 

 

Federal Home Loan Bank and Federal Reserve Bank stock
 
5,083

 
5,083

 

 

 
5,083

Accrued interest receivable
 
4,722

 
4,722

 
4,722

 

 

Interest rate swaps
 
1,380

 
1,380

 

 
1,380

 

Financial liabilities:
 
 
 

 
 
 
 
 
 
Deposits
 
1,423,724

 
1,424,275

 
1,032,379

 
391,896

 

Federal Home Loan Bank advances and other borrowings
 
167,884

 
152,391

 

 
152,391

 

Junior subordinated notes
 
10,015

 
8,829

 

 

 
8,829

Accrued interest payable
 
2,317

 
2,317

 
2,317

 

 

Interest rate swaps
 
1,380

 
1,380

 

 
1,380

 

Off-balance-sheet items:
 
 
 

 
 
 
 
 
 
Standby letters of credit
 
86

 
86

 

 

 
86




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Table of Contents

 
 
December 31, 2016
 
 
Carrying
Amount
 
Fair Value
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
 
 
(In Thousands)
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
77,517

 
$
77,517

 
$
55,622

 
$
21,895

 
$

Securities available-for-sale
 
145,893

 
145,893

 

 
145,893

 

Securities held-to-maturity
 
38,612

 
38,520

 

 
38,520

 

Loans held for sale
 
1,111

 
1,222

 

 
1,222

 

Loans and lease receivables, net
 
1,429,763

 
1,447,044

 

 
12,268

 
1,434,776

Bank-owned life insurance
 
39,048

 
39,048

 

 
39,048

 

Federal Home Loan Bank and Federal Reserve Bank stock
 
2,131

 
2,131

 

 
2,131

 

Accrued interest receivable
 
4,677

 
4,677

 
4,677

 

 

Interest rate swaps
 
352

 
352

 

 
352

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits
 
1,538,855

 
1,539,413

 
1,063,720

 
475,693

 

Federal Home Loan Bank advances and other borrowings
 
59,676

 
60,893

 

 
60,893

 

Junior subordinated notes
 
10,004

 
9,072

 

 

 
9,072

Accrued interest payable
 
1,765

 
1,765

 
1,765

 

 

Interest rate swaps
 
352

 
352

 

 
352

 

Off-balance-sheet items:
 
 
 
 
 
 
 
 
 
 
Standby letters of credit
 
58

 
58

 

 

 
58

Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the unaudited Consolidated Balance Sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Corporation.
Cash and Cash Equivalents: The carrying amount reported for cash and due from banks and interest-bearing deposits held by the Corporation approximates fair value because of its immediate availability and because it does not present unanticipated credit concerns. As of September 30, 2017 and December 31, 2016, the Corporation held $13.4 million and $20.3 million, respectively, of commercial paper. The fair value of commercial paper is classified as a Level 2 input due to the lack of available independent pricing sources. The carrying value of brokered certificates of deposit purchased approximates the fair value 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 both September 30, 2017 and December 31, 2016, the Corporation held $3.3 million and $1.6 million of brokered certificates of deposits, respectively.

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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 by another pricing source on a quarterly basis to review for reasonableness. Any significant differences in pricing are reviewed with appropriate members of management who have the relevant technical expertise to assess the results. The Corporation has determined that these valuations are classified in Level 2 of the fair value hierarchy. When the independent pricing service does not provide a fair value measurement for a particular security, the Corporation will estimate the fair value based on specific information about each security. Fair values derived in this manner are classified in Level 3 of the fair value hierarchy.

Loans Held for Sale: Loans held for sale, which consist of the guaranteed portion of SBA loans, are carried at the lower of cost or estimated fair value. The estimated fair value is based on what secondary markets are currently offering for portfolios with similar characteristics.
Loans and Lease Receivables, net: 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 Bank’s 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 Federal Reserve Bank (“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.
Bank-Owned 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.
Accrued Interest Receivable and Accrued Interest Payable: The carrying amounts reported for accrued interest receivable and accrued interest payable approximate fair value because of their immediate availability and because they do not present unanticipated credit concerns.
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 Bank for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
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.
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.

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

Note 11 — 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 considered the impact of netting and any applicable credit enhancements such as collateral postings, thresholds and guarantees.
At September 30, 2017, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $52.3 million. The Corporation receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These interest rate swaps mature between September 2018 and March 2034. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported on the unaudited Consolidated Balance Sheets as a derivative asset of $1.4 million, included in accrued interest receivable and other assets as of September 30, 2017. In the event of default on a commercial borrower interest rate swap by the counterparty, a right of offset exists to allow for the commercial borrower to set off amounts due against the related commercial loan. As of September 30, 2017, no interest rate swaps were in default and therefore all values for the commercial borrower swaps are recorded on a gross basis on the unaudited Consolidated Balance Sheets.
At September 30, 2017, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $52.3 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 September 2018 through March 2034. Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and were reported on the unaudited Consolidated Balance Sheets as a net derivative liability of $1.4 million. The value of these swaps was included in accrued interest payable and other liabilities as of September 30, 2017. The gross amount of dealer counterparty swaps was also $1.4 million as no right of offset existed with the dealer counterparty swaps as of September 30, 2017.
The table below provides information about the balance sheet location and fair value of the Corporation’s derivative instruments as of September 30, 2017 and December 31, 2016.

 
 
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
 
 
 
 
 
 
 
 
September 30, 2017
 
Accrued interest receivable and other assets
 
$
1,380

 
Accrued interest payable and other liabilities
 
$
1,380

December 31, 2016
 
Accrued interest receivable and other assets

 
$
352

 
Accrued interest payable and other liabilities

 
$
352


No derivative instruments held by the Corporation for the nine months ended September 30, 2017 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 nine months ended September 30, 2017 and 2016 had an insignificant impact on the unaudited Consolidated Statements of Income.

Note 12 — Regulatory Capital

The Corporation and the Bank are subject to various regulatory capital requirements administered by Federal and the State of Wisconsin banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions on the part of regulators, that if undertaken, could have a direct material effect on the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory practices. The Corporation’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. The Corporation regularly reviews and updates when appropriate its Capital and Liquidity Action Plan, which is designed to help ensure appropriate capital adequacy, to plan for future capital needs and to ensure that the Corporation serves as a source of financial strength to the Bank. The Corporation’s and the Bank’s Boards of Directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their respective capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.
As a bank holding company, the Corporation’s ability to pay dividends is affected by the policies and enforcement powers of the Board of Governors of the Federal Reserve system (the “Federal Reserve”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring or significantly reducing dividends if: (i) net income available to common shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividend; (ii) the prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current prospective financial condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios. Management intends, when appropriate under regulatory guidelines, to consult with the Federal Reserve Bank of Chicago and provide it with information on the Corporation’s then-current and prospective earnings and capital position in advance of declaring any cash dividends. As a Wisconsin corporation, the Corporation is subject to the limitations of the Wisconsin Business Corporation Law, which prohibit the Corporation from paying dividends if such payment would: (i) render the Corporation unable to pay its debts as they become due in the usual course of business, or (ii) result in the Corporation’s assets being less than the sum of its total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of any stockholders with preferential rights superior to those stockholders receiving the dividend.
The Bank is also subject to certain legal, regulatory and other restrictions on their ability to pay dividends to the Corporation. As a bank holding company, the payment of dividends by the Bank to the Corporation is one of the sources of funds the Corporation could use to pay dividends, if any, in the future and to make other payments. Future dividend decisions by the Bank and the Corporation will continue to be subject to compliance with various legal, regulatory and other restrictions as defined from time to time.
Qualitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of Total, Common Equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to adjusted total assets. These risk-based capital requirements presently address credit risk related to both recorded and off-balance-sheet commitments and obligations.


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In July 2013, the FRB and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks. These rules are applicable to all financial institutions that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as bank and savings and loan holding companies other than “small bank holding companies” (generally non-publicly traded bank holding companies with consolidated assets of less than $1 billion). Under the final rules, minimum requirements increased for both the quantity and quality of capital held by the Corporation. The rules include a new Common Equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. The rules also permit banking organizations with less than $15 billion in assets to retain, through a one-time election, the past treatment for accumulated other comprehensive income, which did not affect regulatory capital. The Corporation elected to retain this treatment, which reduces the volatility of regulatory capital ratios. A new capital conservation buffer, comprised of Common Equity Tier 1 capital, was also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and will increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. As of September 30, 2017, both the Corporation’s and the Bank’s capital levels remained characterized as well capitalized under the new rules.
The following table summarizes both the Corporation’s and Bank’s capital ratios and the ratios required by their federal regulators at September 30, 2017:

 
 
Actual
 
Minimum Required for Capital Adequacy Purposes
 
For Capital Adequacy Purposes Plus Capital Conservation Buffer
 
Minimum Required to Be Well
Capitalized Under Prompt Corrective Action Requirements
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
(Dollars in Thousands)
As of September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
209,495

 
11.91
%
 
$
140,737

 
8.00
%
 
$
162,727

 
9.25
%
 
N/A

 
N/A

First Business Bank
 
205,877

 
11.75

 
140,132

 
8.00

 
162,027

 
9.25

 
$
175,164

 
10.00
%
Tier 1 capital
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
165,873

 
9.43
%
 
$
105,553

 
6.00
%
 
$
127,543

 
7.25
%
 
N/A

 
N/A

First Business Bank
 
185,954

 
10.62

 
105,099

 
6.00

 
126,994

 
7.25

 
$
140,132

 
8.00
%
Common equity tier 1 capital
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
155,858

 
8.86
%
 
$
79,164

 
4.50
%
 
$
101,155

 
5.75
%
 
N/A

 
N/A

First Business Bank
 
185,954

 
10.62

 
78,824

 
4.50

 
100,720

 
5.75

 
$
113,857

 
6.50
%
Tier 1 leverage capital
(to adjusted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
165,873

 
9.39
%
 
$
70,654

 
4.00
%
 
$
70,654

 
4.00
%
 
N/A

 
N/A

First Business Bank
 
185,954

 
10.56

 
70,409

 
4.00

 
70,409

 
4.00

 
$
88,011

 
5.00
%


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The following table summarizes both the Corporation’s and the Corporation’s legacy bank charters’ ratios and the ratios required by their federal regulators at December 31, 2016:
 
 
Actual
 
Minimum Required for Capital Adequacy Purposes
 
For Capital Adequacy Purposes Plus Capital Conservation Buffer
 
Minimum Required to Be Well
Capitalized Under Prompt Corrective Action Requirements
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
(Dollars in Thousands)
As of December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
204,117

 
11.74
%
 
$
139,101

 
8.00
%
 
$
149,968

 
8.625
%
 
N/A

 
N/A

First Business Bank
 
147,811

 
11.55

 
102,362

 
8.00

 
110,360

 
8.625

 
$
127,953

 
10.00
%
First Business Bank — Milwaukee
 
24,347

 
11.02

 
17,680

 
8.00

 
19,062

 
8.625

 
22,101

 
10.00

Alterra Bank
 
31,699

 
13.27

 
19,106

 
8.00

 
20,599

 
8.625

 
23,882

 
10.00

Tier 1 capital
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
160,964

 
9.26
%
 
$
104,326

 
6.00
%
 
$
115,193

 
6.625
%
 
N/A

 
N/A

First Business Bank
 
134,208

 
10.49

 
76,772

 
6.00

 
84,769

 
6.625

 
$
102,362

 
8.00
%
First Business Bank — Milwaukee
 
22,323

 
10.10

 
13,260

 
6.00

 
14,642

 
6.625

 
17,680

 
8.00

Alterra Bank
 
28,685

 
12.01

 
14,329

 
6.00

 
15,822

 
6.625

 
19,106

 
8.00

Common equity tier 1 capital
(to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
150,960

 
8.68
%
 
$
78,244

 
4.50
%
 
$
89,111

 
5.125
%
 
N/A

 
N/A

First Business Bank
 
134,208

 
10.49

 
57,579

 
4.50

 
65,576

 
5.125

 
$
83,170

 
6.50
%
First Business Bank — Milwaukee
 
22,323

 
10.10

 
9,945

 
4.50

 
11,327

 
5.125

 
14,365

 
6.50

Alterra Bank
 
28,685

 
12.01

 
10,747

 
4.50

 
12,240

 
5.125

 
15,524

 
6.50

Tier 1 leverage capital
(to adjusted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
160,964

 
9.07
%
 
$
70,985

 
4.00
%
 
$
70,985

 
4.00
%
 
N/A

 
N/A

First Business Bank
 
134,208

 
10.40

 
51,600

 
4.00

 
51,600

 
4.00

 
$
64,500

 
5.00
%
First Business Bank — Milwaukee
 
22,323

 
9.15

 
9,758

 
4.00

 
9,758

 
4.00

 
12,198

 
5.00

Alterra Bank
 
28,685

 
10.58

 
10,842

 
4.00

 
10,842

 
4.00

 
13,552

 
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” or the “Bank” refers to our subsidiary, First Business Bank.
Forward-Looking Statements
This report may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect First Business’s current views with respect to future events and financial performance. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results or other developments. Forward-looking statements are based on management’s expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Such statements are subject to risks and uncertainties, including among other things:

Competitive pressures among depository and other financial institutions nationally and in our markets.
Adverse changes in the economy or business conditions, either nationally or in our markets.
Increases in defaults by borrowers and other delinquencies.
Our ability to manage growth effectively, including the successful expansion of our client support, administrative infrastructure and internal management systems.
Fluctuations in interest rates and market prices.
The consequences of continued bank acquisitions and mergers in our markets, resulting in fewer but much larger and financially stronger competitors.
Changes in legislative or regulatory requirements applicable to us and our subsidiaries.
Changes in tax requirements, including tax rate changes, new tax laws and revised tax law interpretations.
Fraud, including client and system failure or breaches of our network security, including our internet banking activities.
Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portion of SBA loans.
These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our shareholders and potential investors. See Part I, Item 1A — Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016 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 is believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements.
The following discussion and analysis is intended as a review of significant events and factors affecting our financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with the unaudited Consolidated Financial Statements and the Notes thereto presented in this Form 10-Q.


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Overview
We are a registered bank holding company incorporated under the laws of the State of Wisconsin and are engaged in the commercial banking business through our wholly-owned banking subsidiary, FBB. All of our operations are conducted through the Bank and certain of its subsidiaries. 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- to medium-sized businesses, business owners, executives, professionals and high net worth individuals. Our products and services include commercial lending, SBA lending and servicing, asset-based lending, equipment financing, factoring, trust and investment services, treasury management services and a broad range of deposit products. We do not utilize a branch network to attract retail clients. Our operating philosophy is predicated on deep client relationships fostered by local expertise combined with the efficiency of centralized administrative functions such as information technology, loan and deposit operations, finance and accounting, credit administration, compliance and human resources. We believe we have a niche business banking model and we consistently operate within our model. This allows our experienced staff to provide the level of financial expertise needed to develop and maintain long-term relationships with our clients.
Operational Summary
Effective June 1, 2017, we completed the consolidation of our three former bank charters into a single charter and rebranded Alterra Bank to First Business Bank. We believe the charter consolidation and brand consistency will be meaningful contributors to improved operating efficiency and profitability as we move forward into 2018.
Results for the three and nine months ended September 30, 2017 include:
Total assets increased to $1.786 billion as of September 30, 2017 compared to $1.781 billion as of December 31, 2016.
Net income for the three months ended September 30, 2017 was $2.6 million compared to net income of $2.7 million for the three months ended September 30, 2016. Net income for the nine months ended September 30, 2017 was $7.9 million compared to net income of $10.9 million for the nine months ended September 30, 2016.
Diluted earnings per common share for the three months ended September 30, 2017 were $0.30 compared to diluted earnings per common share of $0.31 for the three months ended September 30, 2016. Diluted earnings per common share for the nine months ended September 30, 2017 were $0.90 compared to diluted earnings per common share of $1.26 for the nine months ended September 30, 2016.
Annualized return on average assets (“ROAA”) and annualized return on average equity (“ROAE”) were 0.58% and 6.22%, respectively, for the three month period ended September 30, 2017, compared to 0.59% and 6.69%, respectively, for the same time period in 2016. ROAA and ROAE were 0.59% and 6.36%, respectively, for the nine month period ended September 30, 2017 compared to 0.80% and 9.26%, respectively, for the same time period in 2016.
Trust and investment services fee income increased 21.2% to $1.7 million for the three months ended September 30, 2017 compared to $1.4 million for the three months ended September 30, 2016. For the nine months ended September 30, 2017, trust and investment services fee income increased 23.8% to $4.9 million compared to $4.0 million for the nine months ended September 30, 2016.
Top line revenue, the sum of net interest income and non-interest income, increased 1.5% to $19.2 million for the three months ended September 30, 2017 compared to $18.9 million for the three months ended September 30, 2016. For the nine months ended September 30, 2017, top line revenue decreased 3.7% to $58.4 million compared to $60.6 million for the nine months ended September 30, 2016.
Net interest margin increased two basis points to 3.52% for the three months ended September 30, 2017 compared to 3.50% for the three months ended September 30, 2016. Net interest margin was 3.56% for both the nine months ended September 30, 2017 and nine months ended September 30, 2016.
Efficiency ratio was 66.56% for the three months ended September 30, 2017, compared to 63.63% for the three months ended September 30, 2016. For the nine months ended September 30, 2017 our efficiency ratio was 67.55% compared to 62.35% for the same time period in 2016.
Provision for loan and lease losses was $1.5 million for the three months ended September 30, 2017 compared to $3.5 million for the same period in the prior year. Provision for loan and lease losses was $5.7 million for the nine months ended September 30, 2017 compared to $6.8 million for the same time period in 2016.

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SBA recourse provision was $1.3 million for the three months ended September 30, 2017, compared to $375,000 for the three months ended September 30, 2016. For the nine months ended September 30, 2017, SBA recourse provision was $2.1 million compared to $449,000 for the nine months ended September 30, 2016.
Net charge-offs of $3.2 million represented an annualized 0.88% of average loans and leases for the three months ended September 30, 2017 compared to annualized net charge-offs of 0.44% for the three months ended September 30, 2016. Net charge-offs of $6.7 million represented an annualized 0.61% of average loans and leases for the nine months ended September 30, 2017 compared to annualized net charge-offs of 0.28% for the nine months ended September 30, 2016.
Gross loans and leases receivable increased $16.0 million to $1.467 billion at September 30, 2017 from $1.451 billion at December 31, 2016.
Allowance for loan and lease losses as a percentage of gross loans and leases was 1.36% at September 30, 2017 compared to 1.44% at December 31, 2016.
Non-performing assets as a percentage of total assets was 2.01% at September 30, 2017 compared to 1.50% at December 31, 2016.
Non-accrual loans increased by $8.0 million, or 31.9%, to $33.2 million at September 30, 2017 from $25.2 million at December 31, 2016.

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.
For the three months ended September 30, 2017, top line revenue increased 1.5% compared to the same period in the prior year primarily due to an increase in trust and investment fee income, swap fee income and gains from the sale of SBA loans. This increase was partially offset by a shift in the mix of loan originations toward lower-yielding conventional commercial loans, alongside runoff in the Company’s higher-yielding specialty lending portfolios.
For the nine months ended September 30, 2017, top line revenue decreased 3.7% compared to the same period in the prior year primarily due to the anticipated decline in the gain on sale of SBA loans based on management’s third quarter 2016 decision to rebuild the SBA platform, as well as from a shift in the mix of loan originations toward lower-yielding conventional commercial loans in recent quarters. These 2017 revenue headwinds were partially offset by increased trust and investment services fee income, an increase in swap fee income and a decrease in interest expense guided by successful efforts to manage various in-market deposit rates and utilize an efficient mix of wholesale funding sources.
Top line revenue has also benefited moderately in 2017 from increased rates on certain variable-rate loans following the Federal Open Market Committee’s (“FOMC”) decision to raise the targeted federal funds rate in December 2016, March 2017 and June 2017.
The components of top line revenue were as follows:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
 
Change
 
2017
 
2016
 
Change
 
 
(Dollars in Thousands)
Net interest income
 
$
14,883

 
$
15,295

 
(2.7
)%
 
$
45,250

 
$
46,575

 
(2.8
)%
Non-interest income
 
4,339

 
3,640

 
19.2

 
13,140

 
14,057

 
(6.5
)
Total top line revenue
 
$
19,222

 
$
18,935

 
1.5

 
$
58,390

 
$
60,632

 
(3.7
)

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Annualized Return on Average Assets and Annualized Return on Average Equity
ROAA for the three months ended September 30, 2017 decreased to 0.58% compared to 0.59% for the three months ended September 30, 2016. During the third quarter of 2016, in accordance with the applicable accounting guidance, the Corporation recognized $3.2 million in nonrecurring tax credit investment impairment expense, which corresponded with the $3.6 million in historic tax credits recognized during the quarter, providing a net benefit to after-tax earnings of $430,000. Excluding the impairment impact of tax credit investments, third quarter 2016 ROAA was 0.49%. The increase in ROAA for the three months ended September 30, 2017 was primarily due to a decrease in provision for loan and lease losses combined with an increase in trust and investment fee income, swap fee income and gains from the sale of SBA loans. This improvement in profitability was partially offset by an increase in SBA recourse provision. ROAA for the nine months ended September 30, 2017 decreased to 0.59% compared to 0.80% for the nine months ended September 30, 2016. Excluding the impairment impact of tax credit investments, ROAA for the nine months ended September 30, 2016 was 0.77%. The decline in ROAA for the nine months ended September 30, 2017 was primarily due to management’s strategic decision during the third quarter of 2016 to temporarily slow SBA production in order to accommodate significant investment in both SBA personnel and infrastructure, combined with an increase in SBA recourse provision, partially offset by a decrease in provision for loan and lease losses. 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 that can ultimately influence return on equity measures.
ROAE for the three months ended September 30, 2017 was 6.22% compared to 6.69% for the three months ended September 30, 2016. Excluding the aforementioned impairment impact of tax credit investments, third quarter 2016 ROAE was 5.61%. The reasons for the increase in ROAE are consistent with the explanations discussed above with respect to ROAA for the three months ended September 30, 2017. ROAE for the nine months ended September 30, 2017 was 6.36% compared to 9.26% for the nine months ended September 30, 2016. Excluding the impairment impact of tax credit investments, ROAE for the nine months ended September 30, 2016 was 8.90%. The reasons for the decline in ROAE are consistent with the explanations discussed above with respect to ROAA for the nine months ended September 30, 2017. We view ROAE to be an important measure of profitability and we continue to focus on improving the return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses and seeking to minimize our credit costs.
Efficiency Ratio
Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse provision, impairment of tax credit investments, losses or gains on foreclosed properties, amortization of other intangible assets and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized gains or losses on securities, if any.
The efficiency ratio was 66.56% and 67.55% for the three and nine months ended September 30, 2017, respectively, compared to 63.63% and 62.35% for the three and nine months ended September 30, 2016, respectively. Despite this reported reduction in operating efficiency in both periods of comparison, we believe we continue to progress towards enhancing the Corporation’s long-term efficiency ratio, building on the strategic changes we have made to date and laying the foundation to generate sustainable and high-quality revenue growth. After significant investment in 2016 and 2017, we believe we now have a high-quality SBA infrastructure, with the people and processes in place to resume production in the quarters and years ahead as we begin to enhance our SBA sales presence. At the same time, we expect our recently completed charter consolidation and impending core system conversion to create capacity within our existing workforce to accommodate future growth in a highly efficient manner. We believe these strategic initiatives will act as a catalyst for earnings growth in 2018 and beyond. Management will continue to take proactive measures to drive positive operating leverage with the objective of moving the efficiency ratio back within the Corporation’s long-term operating goal of 58-62%.
We believe the efficiency ratio allows investors and analysts to better assess the Corporation’s operating expenses in relation to its operating revenue by removing the volatility that is associated with certain non-recurring or discrete items. The efficiency ratio also allows management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.

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Please refer to both the Non-Interest Income and Non-Interest Expense sections below for discussion on the primary drivers of the year-over-year increase in the efficiency ratio.
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
$ Change
 
% Change
 
 
(Dollars in Thousands)
Total non-interest expense
 
$
14,231

 
$
15,753

 
$
(1,522
)
 
(9.7
)%
 
$
42,012

 
$
41,910

 
$
102

 
0.2
 %
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss on foreclosed properties

 

 

 

 
NM

 

 
93

 
(93
)
 
(100.0
)
Amortization of other intangible assets
 
14

 
16

 
(2
)
 
(12.5
)
 
41

 
48

 
(7
)
 
(14.6
)
SBA recourse provision
 
1,315

 
375

 
940

 
250.7

 
2,095

 
449

 
1,646

 
366.6

Impairment of tax credit investments
 
112

 
3,314

 
(3,202
)
 
(96.6
)
 
338

 
3,520


(3,182
)
 
(90.4
)
Deconversion fees
 

 

 

 
NM

 
101

 

 
101

 
NM

Total adjusted operating expense
 
$
12,790

 
$
12,048

 
$
742

 
6.2

 
$
39,437

 
$
37,800

 
$
1,637

 
4.3

Net interest income
 
$
14,883

 
$
15,295

 
$
(412
)
 
(2.7
)
 
$
45,250

 
$
46,575

 
(1,325
)
 
(2.8
)
Total non-interest income
 
4,339

 
3,640

 
699

 
19.2

 
13,140

 
14,057

 
(917
)
 
(6.5
)
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain on sale of securities
 
5

 

 
5

 
NM

 
6

 
7

 
(1
)
 
(14.3
)
Total operating revenue
 
$
19,217

 
$
18,935

 
$
282

 
1.5

 
$
58,384

 
$
60,625

 
$
(2,241
)
 
(3.7
)
Efficiency ratio
 
66.56
%
 
63.63
%
 


 


 
67.55
%
 
62.35
%
 


 

NM = Not meaningful


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Table of Contents

Net Interest Income
Net interest income levels depend on the amount of and yield on interest-earning assets as compared to the amount of and rate paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes.
The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three and nine months ended September 30, 2017 compared to the same periods in 2016. The change in net interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) has been allocated to the rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
 
Increase (Decrease) for the Three Months Ended September 30,
 
Increase (Decrease) for the Nine Months Ended September 30,
 
 
2017 Compared to 2016
 
2017 Compared to 2016
 
 
Rate
 
Volume
 
Net
 
Rate
 
Volume
 
Net
 
 
(In Thousands)
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate and other mortgage loans(1)
 
$
45

 
$
221

 
$
266

 
$
(1,283
)
 
$
777

 
$
(506
)
Commercial and industrial loans(1)
 
(309
)
 
(155
)
 
(464
)
 
(290
)
 
(679
)
 
(969
)
Direct financing leases
 
(20
)
 
(18
)
 
(38
)
 
(56
)
 
(51
)
 
(107
)
Consumer and other loans
 
(135
)
 
41

 
(94
)
 
(161
)
 
75

 
(86
)
Total loans and leases receivable
 
(419
)
 
89

 
(330
)
 
(1,790
)
 
122

 
(1,668
)
Mortgage-related securities
 
99

 
(53
)
 
46

 
183

 
(59
)
 
124

Other investment securities
 
19

 
8

 
27

 
38

 
61

 
99

FHLB and FRB Stock
 
(40
)
 
44

 
4

 
(15
)
 
27

 
12

Short-term investments
 
118

 
(129
)
 
(11
)
 
292

 
(349
)
 
(57
)
Total net change in income on interest-earning assets
 
(223
)
 
(41
)
 
(264
)
 
(1,292
)
 
(198
)
 
(1,490
)
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Transaction accounts
 
207

 
44

 
251

 
490

 
122

 
612

Money market accounts
 
(6
)
 
(52
)
 
(58
)
 
(256
)
 
(178
)
 
(434
)
Certificates of deposit
 
13

 
(15
)
 
(2
)
 
51

 
(81
)
 
(30
)
Wholesale deposits
 
148

 
(501
)
 
(353
)
 
234

 
(1,303
)
 
(1,069
)
Total deposits
 
362

 
(524
)
 
(162
)
 
519

 
(1,440
)
 
(921
)
FHLB advances
 
(7
)
 
340

 
333

 
18

 
698

 
716

Other borrowings
 
(14
)
 
(10
)
 
(24
)
 
152

 
(108
)
 
44

Junior subordinated notes
 
1

 

 
1

 
5

 
(8
)
 
(3
)
Total net change in expense on interest-bearing liabilities
 
342

 
(194
)
 
148

 
694

 
(858
)
 
(164
)
Net change in net interest income
 
$
(565
)
 
$
153

 
$
(412
)
 
$
(1,986
)
 
$
660

 
$
(1,326
)
(1)
Includes loans held for sale.



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Table of Contents

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 and nine months ended September 30, 2017 and 2016. The average balances are derived from average daily balances.
 
 
For the Three Months Ended September 30,
 
 
2017
 
2016
 
 
Average
Balance
 
Interest
 
Average
Yield/Rate
(5)
 
Average
Balance
 
Interest
 
Average
Yield/Rate
(5)
 
 
(Dollars in Thousands)
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate and other mortgage loans(1)
 
$
966,711

 
$
10,922

 
4.52
%
 
$
947,167

 
$
10,656

 
4.50
%
Commercial and industrial loans(1)
 
448,955

 
6,187

 
5.51

 
459,871

 
6,651

 
5.79

Direct financing leases(1)
 
28,648

 
303

 
4.23

 
30,231

 
341

 
4.51

Consumer and other loans(1)
 
26,577

 
274

 
4.12

 
23,662

 
368

 
6.22

Total loans and leases receivable(1)
 
1,470,891

 
17,686

 
4.81

 
1,460,931

 
18,016

 
4.93

Mortgage-related securities(2)
 
136,330

 
613

 
1.80

 
149,414

 
567

 
1.52

Other investment securities(3)
 
36,106

 
158

 
1.75

 
34,042

 
131

 
1.54

FHLB and FRB stock
 
3,949

 
25

 
2.53

 
2,163

 
21

 
3.88

Short-term investments
 
44,478

 
152

 
1.37

 
103,549

 
163

 
0.63

Total interest-earning assets
 
1,691,754

 
18,634

 
4.41

 
1,750,099

 
18,898

 
4.32

Non-interest-earning assets
 
85,768

 
 
 
 
 
67,884

 
 
 
 
Total assets
 
$
1,777,522

 
 
 
 
 
$
1,817,983

 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Transaction accounts
 
$
240,035

 
364

 
0.61

 
$
182,743

 
113

 
0.25

Money market accounts
 
588,811

 
700

 
0.48

 
632,415

 
758

 
0.48

Certificates of deposit
 
57,716

 
150

 
1.04

 
63,581

 
152

 
0.96

Wholesale deposits
 
346,641

 
1,494

 
1.72

 
465,273

 
1,847

 
1.59

Total interest-bearing deposits
 
1,233,203

 
2,708

 
0.88

 
1,344,012

 
2,870

 
0.85

FHLB advances
 
103,401

 
351

 
1.36

 
4,991

 
18

 
1.44

Other borrowings(4)
 
24,400

 
411

 
6.74

 
24,976

 
435

 
6.97

Junior subordinated notes
 
10,013

 
281

 
11.23

 
9,998

 
280

 
11.20

Total interest-bearing liabilities
 
1,371,017

 
3,751

 
1.09

 
1,383,977

 
3,603

 
1.04

Non-interest-bearing demand deposit accounts
 
224,961

 
 
 
 
 
263,627

 
 
 
 
Other non-interest-bearing liabilities
 
15,376

 
 
 
 
 
11,098

 
 
 
 
Total liabilities
 
1,611,354

 
 
 
 
 
1,658,702

 
 
 
 
Stockholders’ equity
 
166,168

 
 
 
 
 
159,281

 
 
 
 
Total liabilities and stockholders’ equity
 
$
1,777,522

 
 
 
 
 
$
1,817,983

 
 
 
 
Net interest income
 
 
 
$
14,883

 
 
 
 
 
$
15,295

 
 
Interest rate spread
 
 
 
 
 
3.32
%
 
 
 
 
 
3.28
%
Net interest-earning assets
 
$
320,737

 
 
 
 
 
$
366,122

 
 
 
 
Net interest margin
 
 
 
 
 
3.52
%
 
 
 
 
 
3.50
%
Average interest-earning assets to average interest-bearing liabilities
 
123.39
%
 
 
 
 
 
126.45
%
 
 
 
 
Return on average assets(5)
 
0.58

 
 
 
 
 
0.59

 
 
 
 
Return on average equity(5)
 
6.22

 
 
 
 
 
6.69

 
 
 
 
Average equity to average assets
 
9.35

 
 
 
 
 
8.76

 
 
 
 
Non-interest expense to average assets(5)
 
3.20

 
 
 
 
 
3.47

 
 
 
 
(1)
The average balances of loans and leases include non-performing loans and leases and loans held for sale. Interest income related to non-performing loans and leases is recognized when collected. Interest income includes net loan fees collected in lieu of interest.
(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.
(4)
Average rate of other borrowings reflects the cost of prepaying a secured borrowing during the second quarter of 2017.
(5)
Represents annualized yields/rates.

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Table of Contents


 
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
 
 
Average
Balance
 
Interest
 
Average
Yield/Rate(5)
 
Average
Balance
 
Interest
 
Average
Yield/Rate(5)
 
 
(Dollars in Thousands)
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate and other mortgage loans(1)
 
$
957,408

 
$
31,861

 
4.44
%
 
$
934,615

 
$
32,366

 
4.62
%
Commercial and industrial loans(1)
 
451,352

 
19,863

 
5.87

 
466,729

 
20,833

 
5.95

Direct financing leases(1)
 
29,161

 
932

 
4.26

 
30,683

 
1,039

 
4.51

Consumer and other loans(1)
 
27,780

 
837

 
4.02

 
25,581

 
923

 
4.81

Total loans and leases receivable(1)
 
1,465,701

 
53,493

 
4.87

 
1,457,608

 
55,161

 
5.04

Mortgage-related securities(2)
 
140,705

 
1,845

 
1.75

 
145,599

 
1,721

 
1.58

Other investment securities(3)
 
37,466

 
480

 
1.71

 
32,518

 
381

 
1.56

FHLB and FRB stock
 
3,779

 
73

 
2.58

 
2,482

 
61

 
3.28

Short-term investments
 
48,375

 
415

 
1.14

 
107,369

 
472

 
0.59

Total interest-earning assets
 
1,696,026

 
56,306

 
4.43

 
1,745,576

 
57,796

 
4.41

Non-interest-earning assets
 
82,628

 
 
 
 
 
75,969

 
 
 
 
Total assets
 
$
1,778,654

 
 
 
 
 
$
1,821,545

 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Transaction accounts
 
$
221,526

 
885

 
0.53

 
$
164,278

 
273

 
0.22

Money market accounts
 
601,455

 
2,019

 
0.45

 
650,864

 
2,453

 
0.50

Certificates of deposit
 
55,888

 
415

 
0.99

 
67,440

 
446

 
0.88

Wholesale deposits
 
374,083

 
4,720

 
1.68

 
478,038

 
5,789

 
1.61

Total interest-bearing deposits
 
1,252,952

 
8,039

 
0.86

 
1,360,620

 
8,961

 
0.88

FHLB advances
 
83,987

 
784

 
1.24

 
8,941

 
68

 
1.01

Other borrowings(4)
 
24,933

 
1,401

 
7.49

 
26,982

 
1,357

 
6.71

Junior subordinated notes
 
10,009

 
832

 
11.08

 
10,101

 
835

 
11.02

Total interest-bearing liabilities
 
1,371,881

 
11,056

 
1.07

 
1,406,644

 
11,221

 
1.06

Non-interest-bearing demand deposit accounts
 
228,231

 
 
 
 
 
246,238

 
 
 
 
Other non-interest-bearing liabilities
 
13,726

 
 
 
 
 
11,126

 
 
 
 
Total liabilities
 
1,613,838

 
 
 
 
 
1,664,008

 
 
 
 
Stockholders’ equity
 
164,816

 
 
 
 
 
157,537

 
 
 
 
Total liabilities and stockholders’ equity
 
$
1,778,654

 
 
 
 
 
$
1,821,545

 
 
 
 
Net interest income
 
 
 
$
45,250

 
 
 
 
 
$
46,575

 
 
Interest rate spread
 
 
 
 
 
3.36
%
 
 
 
 
 
3.35
%
Net interest-earning assets
 
$
324,145

 
 
 
 
 
$
338,932

 
 
 
 
Net interest margin
 
 
 
 
 
3.56
%
 
 
 
 
 
3.56
%
Average interest-earning assets to average interest-bearing liabilities
 
123.63
%
 
 
 
 
 
124.10
%
 
 
 
 
Return on average assets(5)
 
0.59

 
 
 
 
 
0.80

 
 
 
 
Return on average equity(5)
 
6.36

 
 
 
 
 
9.26

 
 
 
 
Average equity to average assets
 
9.27

 
 
 
 
 
8.65

 
 
 
 
Non-interest expense to average assets(5)
 
3.15

 
 
 
 
 
3.07

 
 
 
 

(1)
The average balances of loans and leases include non-performing loans and leases and loans held for sale. Interest income related to non-performing loans and leases is recognized when collected. Interest income includes net loan fees collected in lieu of interest.
(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.
(4)
Average rate of other borrowings reflects the cost of prepaying a secured borrowing during the second quarter of 2017.
(5)
Represents annualized yields/rates.

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Table of Contents

Comparison of Net Interest Income for the Three and Nine Months Ended September 30, 2017 and 2016

Net interest income decreased $412,000, or 2.7%, and $1.3 million, or 2.8%, during the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. In both periods of comparison, the decrease in net interest income was primarily attributable to a decrease in the yield on average total loans and leases receivable resulting from a decrease in loan prepayment fees and interest income collected on loans previously in non-accrual status, combined with a shift in the mix of loan originations toward lower-yielding conventional commercial loans. The decrease was partially offset by increased rates on certain variable-rate loans following the FOMC’s decision to raise the targeted federal funds rate in December 2016, March 2017 and June 2017 and successful efforts to manage various in-market deposit rates and utilize an efficient mix of wholesale funding sources.
The yield on average earning assets for the three months ended September 30, 2017 increased nine basis points to 4.41%, compared to 4.32% for the three months ended September 30, 2016. The increase was principally due to a $68.6 million year-over-year decrease in average cash held at the Federal Reserve, a higher yielding securities portfolio and increased rates on certain variable-rate loans following the FOMC’s decision to raise the targeted federal funds rate in December 2016, March 2017 and June 2017. The decrease in average cash held at the Federal Reserve was primarily due to growth in our loan and lease portfolio combined with a purposeful net reduction in wholesale funding sources. The increase in the yield on average earning assets was partially offset by a decrease in loan prepayment fees and interest income collected on loans previously in non-accrual status, combined with a shift in the mix of loan originations toward lower-yielding conventional commercial loans and a year-over-year increase in average non-accrual loans.
The yield on average earning assets for the nine months ended September 30, 2017 increased two basis points to 4.43%, compared to 4.41% for the nine months ended September 30, 2016. The reasons for the increase are consistent with the explanations discussed above with respect to yield on average earning assets for the three months ended September 30, 2017.
The weighted average rate paid on our interest-bearing deposits for the three months ended September 30, 2017 increased three basis points to 0.88%, compared to 0.85% for the three months ended September 30, 2016. The moderate rate increase is primarily attributable to a shift in our in-market deposit funding base as average transaction account balances increased $57.3 million to $240.0 million with a weighted average rate paid of 0.61%, while average money market account balances decreased $43.6 million to $588.8 million with a weighted average rate paid of 0.48%. The increase in transaction account balances is related to successful efforts in attracting stable in-market deposits from municipality relationships throughout our markets, more than offsetting the decrease in money market account balances which was driven by pricing discipline. Despite the resulting increase in weighted average rate paid due to the change in in-market deposit mix, the increase in transaction account balances at markets rates has reduced our need to fully replenish the Bank’s wholesale funding sources as wholesale deposits are purposefully runoff in favor of the currently more cost effective Federal Home Loan Bank (“FHLB”) advances.
The weighted average rate paid on our interest-bearing deposits for the nine months ended September 30, 2017 decreased two basis points to 0.86%, compared to 0.88% for the nine months ended September 30, 2016. The decrease was primarily attributable to a positive interest-bearing deposit mix change, as average in-market deposit accounts decreased only $3.7 million for the nine months ended September 30, 2017, while average higher-rate wholesale deposits decreased $104.0 million during the same period.
The rising rate environment has resulted in modest increases in deposit pricing as necessary to serve the Company’s client relationships. Management believes a modest increase in average total interest-bearing deposit costs may continue as the Company looks to effectively manage deposit relationships amid intense competition and continued expectation of a rising rate environment.
The overall weighted average rate paid on interest-bearing liabilities was 1.09% and 1.07% for the three and nine months ended September 30, 2017, compared to 1.04% and 1.06% for the three and nine months ended September 30, 2016. The primary reason for only a moderate increase in rate paid, despite a rising rate environment, was a favorable change in the Corporation’s wholesale funding mix as fixed rate maturing wholesale deposits with longer original maturity terms were replaced with fixed rate FHLB advances at lower rates. In addition, the weighted average rate paid on interest-bearing liabilities continued to benefit from a relatively stable level of in-market interest-bearing deposits, on average. Consistent with the Corporation’s longstanding funding strategy to use the most efficient and cost effective source of wholesale funds, management will continue to replace maturing wholesale deposits with fixed rate FHLB advances at various maturity terms commensurate with the Bank’s funding needs. Average FHLB advances for the three and nine months ended September 30, 2017 increased $98.4 million and $75.0 million to $103.4 million and $84.0 million at a weighted average rate paid of 1.36% and 1.24%, respectively. As of September 30, 2017, the weighted average original maturity of our FHLB term advances was 2.3 years.

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Table of Contents

We expect to continue to effectively manage the Corporation’s liability structure in both term and rate to deliver a stable net interest margin within our target range. Further, we expect continued success in attracting in-market deposit relationships in our Wisconsin and Kansas markets which we believe will contribute to our ability to maintain an appropriate cost of funds. Average in-market client deposits - comprised of all transaction accounts, money market accounts and non-wholesale deposits - were $1.112 billion and $1.107 billion for the three and nine months ended September 30, 2017, compared to $1.142 billion and $1.129 billion for the three and nine months ended September 30, 2016.
Net interest margin increased two basis points to 3.52% for the three months ended September 30, 2017, compared to 3.50% for the three months ended September 30, 2016 primarily due to a positive change in earning asset mix. Average total loans and leases receivable represented 83% of total average assets for the three months ended September 30, 2017, compared to 80% for the same period in 2016 which benefited net interest margin by eight basis points. This was offset by an eight basis point decrease attributable to the increase in FHLB term advances during the period of comparison. In addition, the Corporation’s ability to manage in-market deposit rates during a rising rate environment while also allowing higher-rate wholesale deposits to runoff, positively affected net interest margin by approximately two basis points. Replacing wholesale deposits with FHLB advances is consistent with our funding philosophy to utilize the most efficient and cost effective sources of wholesale funds and is expected to lower our FDIC assessment rate in future periods. Net interest margin for the nine months ended September 30, 2017 and 2016 was 3.56%.
Management believes the successful efforts to optimize funding costs and profitably expand loan balances will allow the Company to continue to maintain a net interest margin of 3.50% or better. However, the collection of loan fees in lieu of interest is an expected source of volatility to quarterly net interest income and net interest margin, given the nature of the Company’s asset-based lending business. Net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status or the accumulation of significant short-term deposit inflows.
Provision for Loan and Lease Losses
We 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 in the period and the amount of reserves established for impaired loans that present collateral shortfall positions. Refer to the section in this MD&A entitled Allowance for Loan and Lease Losses, below, for further information regarding our allowance for loan and lease loss methodology.    
We recorded provision expense of $1.5 million and $5.7 million for the three and nine months ended September 30, 2017, respectively, compared to $3.5 million and $6.8 million for the same time periods in 2016. Provision for the nine months ended September 30, 2017 reflected $4.6 million of estimated losses related to the previously disclosed $6.7 million Wisconsin-based commercial and industrial impaired loan. Management continues to pursue all potential repayment sources related to this credit. The provision for the nine months ended September 30, 2017 also reflected $5.0 million in charge-offs related to the Corporation’s remaining energy sector exposure, which was partially offset by a $2.3 million specific reserve related to this credit as of December 31, 2016. These increases were also partially offset by the reversal of a $1.8 million specific reserve based on the full repayment of a previously disclosed impaired construction loan originated in our Kansas City market. The payoff proceeds were received in October 2017, which will reduce non-performing loans by $2.5 million in the fourth quarter of 2017.
The addition of specific reserves on impaired loans represents new specific reserves established when collateral shortfalls are present, while conversely the release of specific reserves represents the reduction of previously established reserves that are no longer required. Changes in the allowance for loan and lease losses due to subjective factor changes reflect management’s evaluation of the level of risk within the portfolio based upon several factors for each portfolio segment. Charge-offs in excess of previously established specific reserves require an additional provision for loan and lease losses to maintain the allowance for loan and lease losses at a level deemed appropriate by management. Change in the inherent risk of the portfolio is primarily influenced by the overall growth in gross loans and leases and an analysis of loans previously charged off, as well as, movement of existing loans and leases in and out of an impaired loan classification where a specific evaluation of a particular credit may be required rather than the application of a general reserve ratio. Refer to the section in this MD&A entitled Asset Quality, below, for further information regarding the overall credit quality of our loan and lease portfolio.


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Comparison of Non-Interest Income for the Three and Nine Months Ended September 30, 2017 and 2016
Non-Interest Income
Non-interest income consists primarily of fees earned for trust and investment services, gains on sale of SBA loans, service charges on deposits and loan fee income. For the three months ended September 30, 2017 non-interest income increased by $699,000, or 19.2%, to $4.3 million from $3.6 million for the same period in 2016. For the nine months ended September 30, 2017 non-interest income decreased by $917,000, or 6.5%, to $13.1 million from $14.1 million for the same period in 2016.
Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream through greater contribution from fee-based revenues. Total non-interest income accounted for 22.6% and 22.5% of our total revenues for the three and nine months ended September 30, 2017, compared to 19.2% and 23.2% for the three and nine months ended September 30, 2016. Management believes the expected steady and gradual expansion of our rebuilt SBA lending program will drive our fee income ratio towards our current strategic target of 25.0%.
The components of non-interest income were as follows for the three and nine months ended September 30, 2017 and 2016: 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
$ Change
 
% Change
 
(In Thousands)
Trust and investment services fee income
$
1,653

 
$
1,364

 
$
289

 
21.2
 %
 
4,930

 
3,981

 
$
949

 
23.8
 %
Gain on sale of SBA loans
606

 
347

 
259

 
74.6

 
1,501

 
3,854

 
(2,353
)
 
(61.1
)
Gain on sale of residential mortgage loans

 
198

 
(198
)
 
(100.0
)
 
26

 
540

 
(514
)
 
(95.2
)
Service charges on deposits
756

 
772

 
(16
)
 
(2.1
)
 
2,287

 
2,247

 
40

 
1.8

Loan fees
391

 
506

 
(115
)
 
(22.7
)
 
1,525

 
1,791

 
(266
)
 
(14.9
)
Increase in cash surrender value of bank-owned life insurance
314

 
244

 
70

 
28.7

 
940

 
730

 
210

 
28.8

Other non-interest income
619

 
209

 
410

 
196.2

 
1,931

 
914

 
1,017

 
111.3

Total non-interest income
$
4,339

 
$
3,640

 
$
699

 
19.2

 
$
13,140

 
$
14,057

 
$
(917
)
 
(6.5
)
Fee income ratio(1)
22.6
%
 
19.2
%
 
 
 
 
 
22.5
%
 
23.2
%
 
 
 
 
(1) Fee income ratio is fee income, per the above table, divided by top line revenue (defined as net interest income plus non-interest income).
The decrease in total non-interest income for the nine months ended September 30, 2017 primarily reflected lower gains from SBA and residential mortgage loans sales stemming from the Corporation’s decision to rebuild its SBA platform and to exit the residential mortgage loan origination business. The decrease was partially offset by record trust and investment services fee income, an increase in loan swap fee income and an increase in bank-owned life insurance (“BOLI”) fee income driven by a $9.8 million purchase of additional BOLI in December 2016.
Trust and investment services fee income increased by $289,000, or 21.2%, and $949,000, or 23.8%, to a record $1.7 million and $4.9 million for the three and nine months ended September 30, 2017, respectively, compared to $1.4 million and $4.0 million for the three and nine months ended September 30, 2016. This increase was driven by growth in assets under management and administration attributable to both increased equity market values and new client relationships. At September 30, 2017, there were a record $1.240 billion of trust assets under management compared to $977.0 million at December 31, 2016 and $935.6 million at September 30, 2016. Assets under administration were $176.5 million at September 30, 2017 compared to $227.4 million at December 31, 2016 and $231.8 million at September 30, 2016. The decrease in assets under administration reflected the transfer of client assets from assets under administration to assets under management. The retirement plan services industry is undergoing a migration from advised services to fiduciary services. Consequently, during the first quarter of 2017, one large and several smaller retirement plans changed their service model, which resulted in assets moving to full fiduciary status. We anticipate there will be similar migration of additional assets because of this trend in the future.

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Gains on sale of SBA loans for the three and nine months ended September 30, 2017 totaled $606,000 and $1.5 million, respectively, an increase of $259,000, or 74.6%, compared to the three months ended September 30, 2016 and a decrease of $2.4 million, or 61.1%, compared to the nine months ended September 30, 2016. In order to meet market demand and drive high-quality growth, we continue to ensure current and future SBA loan production is achieved in a sustainable manner. In 2018, we anticipate production to continue to grow at a moderate pace in tandem with the steady and gradual expansion of our rebuilt SBA lending program.
Loan fees for the three and nine months ended September 30, 2017 totaled $391,000 and $1.5 million, respectively, a decrease of $115,000, or 22.7%, and $266,000, or 14.9%, from the same periods in 2016. The decrease in loan fees was primarily attributable to a decrease in fees commensurate with a decrease in both SBA and asset-based lending production, specifically the fee income generated from packaging SBA loans and asset-based lending audit fee income.
Other non-interest income for the three and nine months ended September 30, 2017 totaled $619,000 and $1.9 million, respectively, an increase of $410,000, or 196.2%, and $1.0 million, or 111.3%, from the same periods in 2016. During the three and nine months ended September 30, 2017, the Corporation originated commercial real estate loans in which the Corporation offered the client a floating rate and interest rate swap and then offset the client swap with a counter-party dealer. The execution of these transactions generated $418,000 and $866,000 in swap fee income for the three and nine months ended September 30, 2017, respectively, compared to no swap fee income for the three months ended September 30, 2016 and $21,000 for the nine months ended September 30, 2016. We believe due to the market’s assumption of a rising interest rate environment throughout 2017 and into 2018, we could see additional loan demand for these types of relationship-based opportunities.
Comparison of Non-Interest Expense for the Three and Nine Months Ended September 30, 2017 and 2016
Non-Interest Expense    
The components of non-interest expense were as follows for the three and nine months ended September 30, 2017 and 2016: 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
$ Change
 
% Change
 
(Dollars in Thousands)
Compensation
$
7,645

 
$
7,637

 
$
8

 
0.1
 %
 
$
24,710

 
$
24,454

 
$
256

 
1.0
 %
Occupancy
527

 
530

 
(3
)
 
(0.6
)
 
1,521

 
1,538

 
(17
)
 
(1.1
)
Professional fees
995

 
1,065

 
(70
)
 
(6.6
)
 
3,046

 
2,888

 
158

 
5.5

Data processing
592

 
623

 
(31
)
 
(5.0
)
 
1,810

 
1,971

 
(161
)
 
(8.2
)
Marketing
594

 
528

 
66

 
12.5

 
1,546

 
1,710

 
(164
)
 
(9.6
)
Equipment
285

 
292

 
(7
)
 
(2.4
)
 
868

 
913

 
(45
)
 
(4.9
)
Computer software
715

 
539

 
176

 
32.7

 
2,037

 
1,607

 
430

 
26.8

FDIC insurance
320

 
444

 
(124
)
 
(27.9
)
 
1,081

 
989

 
92

 
9.3

Collateral liquidation costs
371

 
89

 
282

 
316.9

 
556

 
204

 
352

 
172.5

Net loss on foreclosed properties

 

 

 
NM

 

 
93

 
(93
)
 
(100.0
)
Impairment on tax credit investments
112

 
3,314

 
(3,202
)
 
(96.6
)
 
338

 
3,520

 
(3,182
)
 
(90.4
)
SBA recourse provision
1,315

 
375

 
940

 
250.7

 
2,095

 
449

 
1,646

 
366.6

Other non-interest expense
760

 
317

 
443

 
139.7

 
2,404

 
1,574

 
830

 
52.7

Total non-interest expense
$
14,231

 
$
15,753

 
$
(1,522
)
 
(9.7
)
 
$
42,012

 
$
41,910

 
$
102

 
0.2

Total adjusted operating expense (1)
$
12,790

 
$
12,048

 
 
 
 
 
$
39,437

 
$
37,800

 
 
 
 
Compensation expense to total adjusted operating expense
59.77
%
 
63.39
%
 
 
 
 
 
62.66
%
 
64.69
%
 
 
 
 
Full-time equivalent employees
251

 
263

 
 
 
 
 
 
 
 
 
 
 
 

(1)
Total adjusted operating expense excludes the impact of discrete items as previously defined in the non-GAAP efficiency ratio calculation.
Non-interest expense for the three months ended September 30, 2017 decreased by $1.5 million, or 9.7%, to $14.2 million compared to $15.8 million for the same period in 2016. During the third quarter of 2016, in accordance with the

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applicable accounting guidance, the Corporation recognized $3.2 million in nonrecurring tax credit investment impairment expense, which corresponded with the $3.6 million in historic tax credits recognized during the quarter, providing a net benefit to after-tax earnings of $430,000. Excluding the impairment impact of tax credit investments, third quarter 2016 non-interest expense totaled $12.6 million. The increase in non-interest expense was primarily due to an increase in collateral liquidation costs and SBA recourse provision, partially offset by a decrease in FDIC insurance as the Corporation continues to reduce its reliance on wholesale deposits in favor of FHLB advances.    
Collateral liquidation costs for the three months ended September 30, 2017 were $371,000 compared to $89,000 for the same period in 2016. The increase primarily reflected the Corporation’s workout process related to two non-performing loans.    
SBA recourse provision for the three months ended September 30, 2017 was $1.3 million compared to $375,000 for the same period in 2016. The increase reflected refinements to the recourse reserve estimate due to the migration of certain credits with potential guaranty eligibility issues during the third quarter.
Management has extensively overhauled the previously acquired SBA lending platform and implemented best practices in the critical areas of credit, operations and compliance. These essential functions are overseen by a team of experienced SBA professionals, including a Director of SBA Credit, Director of SBA Operations and SBA Compliance Manager, who all joined the team within the past 12 months. With these major pieces of the rebuild in place in 2017, we are now actively recruiting more producers in order to achieve the appropriate mix of producers and internal support staff to drive an optimal level of efficiency in our SBA business model.
Despite these enhancements to the SBA platform, changes to SBA recourse provision may be a source of non-interest expense volatility in future quarters; however, we believe the frequency and volatility in SBA recourse provision should diminish over time as we continue to originate new SBA loans with our rebuilt platform, the existing portfolio amortizes down and ongoing remediation efforts mitigate potential losses. As of September 30, 2017, the total outstanding balance of sold SBA loans originated prior to 2017 was $97.3 million, of which $8.4 million were impaired. The total outstanding balance of sold SBA loans originated in 2017 was $6.0 million. Based on management’s estimate of losses in the guaranteed portion of sold SBA loans, a recourse reserve of $2.7 million was outstanding as of September 30, 2017.
Other non-interest expense increased by $443,000, or 139.7%, to $760,000 for the three months ended September 30, 2017 from $317,000 for the three months ended September 30, 2016. The increase was primarily due to the Corporation historically reflecting its quarterly allocation of net income/loss from its equity investments in two mezzanine funds in other non-interest expense. Due to the underlying funds being in an earnings position for a sustained period of time, the Corporation recognized its share of earnings in other non-interest income for the three months ended September 30, 2017.
Non-interest expense for the nine months ended September 30, 2017 increased by $102,000, or 0.2%, to $42.0 million compared to $41.9 million for the same period in 2016. Excluding the impairment impact of tax credit investments, non-interest expense for the nine months ended September 30, 2016 totaled $38.4 million. The increase in non-interest expense was primarily due to an increase in computer software expense, collateral liquidation costs, SBA recourse provision and other non-interest expense, partially offset by a decrease in marketing costs, data processing and net losses on foreclosed properties.
Computer software expense increased by $430,000, or 26.8%, to $2.0 million for the nine months ended September 30, 2017 from $1.6 million for the nine months ended September 30, 2016. The increase was principally due to investments in technology platforms, continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy.
SBA recourse provision for the nine months ended September 30, 2017 was $2.1 million compared to $449,000 for the same period in 2016. The reasons for the increase in SBA recourse provision are consistent with the explanations discussed above with respect to SBA recourse provision for the three months ended September 30, 2017.    
Other non-interest expense increased by $830,000, or 52.7%, to $2.4 million for the nine months ended September 30, 2017 from $1.6 million for the nine months ended September 30, 2016. The increase was primarily due to the Corporation historically reflecting its quarterly allocation of net income/loss from its equity investments in two mezzanine funds in other non-interest expense. Due to the underlying funds being in an earnings position for a sustained period of time, the Corporation recognized its share of earnings in other non-interest income for the nine months ended September 30, 2017.
Marketing costs decreased $164,000, or 9.6%, to $1.5 million for the nine months ended September 30, 2017 from $1.7 million for the nine months ended September 30, 2016. The favorable variance is primarily due to a purposeful reduction

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or delay of certain advertising initiatives during the current year as management works to align expense growth with expected revenue production.
Expense management and strategic investments are critical components of our growth strategy and our culture, from our limited branch network and unique funding model, to our investments in talent and technology. We are diligently managing our operating costs to align with revenue expectations while continuing to make investments that enhance our business and our ability to serve current and prospective clients.
Income Taxes
Income tax expense was $2.8 million for the nine months ended September 30, 2017, with an effective tax rate of 26.3%, compared to income tax expense of $1.0 million for the nine months ended September 30, 2016, with an effective tax rate of 8.0%. During the third quarter of 2016, the Corporation recognized $3.6 million in historic tax credits. No significant discrete items were recognized during 2017.
Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. The rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change.

Financial Condition
General
Total assets increased by $5.0 million, or 0.3%, to $1.786 billion as of September 30, 2017 compared to $1.781 billion at December 31, 2016. The increase in total assets was primarily driven by an increase in loans and leases receivable and other assets, partially offset by a decline in our short-term investments and available-for-sale securities portfolio.
Short-Term Investments
Short-term investments decreased by $10.4 million, or 16.5%, to $52.5 million at September 30, 2017 from $62.9 million at December 31, 2016. 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 incorporate short-term investments in our on-balance-sheet liquidity program. The decrease in short-term investments primarily reflected a reduction in cash held at the FRB driven by a decrease in both in-market and wholesale deposits and modest loan growth. As of September 30, 2017, our total investment in commercial paper, which is also considered a short-term investment, was $13.4 million as compared to $20.3 million at December 31, 2016. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio. The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to 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 the section entitled Liquidity and Capital Resources, below, for further discussion.
Securities
Total securities, including available-for-sale and held-to-maturity, decreased by $14.5 million to $170.0 million at September 30, 2017 compared to $184.5 million at December 31, 2016. During the nine months ended September 30, 2017, we recognized unrealized gains of $199,000 before income taxes through other comprehensive income. As of September 30, 2017 and December 31, 2016, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted average expected maturity of 3.47 and 3.30 years, respectively. Generally, our investment philosophy remains as stated in our most recent Annual Report on Form 10-K.
We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, data integrity validation through comparison of current price to prior period prices and an expectation-based analysis of movement in prices

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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 September 30, 2017.
We sold approximately $11.7 million of securities issued by government-sponsored enterprises during the nine months ended September 30, 2017 to proactively manage our securities portfolio to meet our long-term investment objectives.
Loans and Leases Receivable    
Loans and leases receivable, net of allowance for loan and lease losses, increased by $17.0 million, or 1.2%, to $1.447 billion at September 30, 2017 from $1.430 billion at December 31, 2016. As of September 30, 2017, multi-family loans were the largest contributor to loan growth increasing $32.3 million, or 34.8%, to $125.1 million from $92.8 million at December 31, 2016. There continues to be a concentration in commercial real estate (“CRE”), however, in general our composition of total loans and leases has remained relatively consistent due to balanced growth across our product offerings. CRE loans represented 66% and 65% of our total loans as of September 30, 2017 and December 31, 2016, respectively. As of September 30, 2017, approximately 19% of the CRE loans were owner-occupied CRE. We consider owner-occupied CRE more characteristic of the Corporation’s commercial and industrial (“C&I”) portfolio as, in general, the client’s primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property.
Our C&I portfolio decreased $3.1 million, or 0.7%, to $447.2 million at September 30, 2017 from $450.3 million at December 31, 2016 reflecting specialty finance prepayments and continued competitive pressure amid soft commercial loan demand overall. The countercyclical nature of the asset-based lending business may result in increased payoffs and fees collected in lieu of interest in periods of economic stability, with increased loan fundings and interest income during weaker economic markets. We will continue to emphasize actively pursuing C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management and trust and investment relationships which generate additional fee revenue.
While we continue to experience significant competition as banks operating in our primary geographic areas attempt to deploy liquidity, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to expect our new loan and lease activity to be adequate to replace normal amortization and to continue to grow at a modest pace in future quarters. 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.
Non-performing loans increased $8.0 million, or 31.9%, to $33.2 million at September 30, 2017, compared to $25.2 million at December 31, 2016. The Corporation’s non-performing loans as a percentage of total gross loans and leases measured 2.26% and 1.74% at September 30, 2017 and December 31, 2016, respectively. Likewise, the ratio of non-performing assets to total assets increased to 2.01% at September 30, 2017, compared to 1.50% at December 31, 2016. Please refer to the section entitled Asset Quality, below, for additional information.
Deposits
As of September 30, 2017, deposits decreased by $115.1 million, or 7.5% to $1.424 billion from $1.539 billion at December 31, 2016. The decrease in deposits was primarily driven by pricing discipline, in addition to a purposeful reduction in the level of wholesale deposits, which decreased by $83.5 million, or 20.0%, to $333.2 million at September 30, 2017 from $416.7 million at December 31, 2016. The decrease in wholesale deposits was partially offset by an increase in the level of interest-bearing transaction accounts, which increased by $67.4 million, or 36.6%, to $251.4 million at September 30, 2017 from $184.0 million at December 31, 2016 related to successful efforts in attracting stable in-market deposits from municipality relationships throughout our markets. 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.
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. The Bank’s 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 average bank funding sources, approximately $1.107 billion, or 70.7%, were considered in-market deposits for the nine months ended September 30, 2017. This compares to in-market deposits of $1.129 billion, or 69.9%, for the same period in 2016.     

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FHLB Advances and Other Borrowings
As of September 30, 2017, FHLB advances and other borrowings increased by $108.2 million, or 181.3%, to $167.9 million from $59.7 million at December 31, 2016.
The Corporation’s targeted operating range of bank wholesale funds to total deposits is 30%-40%. As of September 30, 2017, the ratio of end of period bank wholesale funds to end of period total bank funds was 30.4%. Consistent with our funding philosophy to match-fund long-term fixed rate loans with the most efficient and cost effective source of wholesale funds, and given current market conditions, we expect to allow our brokered certificate of deposit portfolio to mature and/or amortize down to within 10%-15% of total assets and replace with the now more cost effective FHLB advances in order to lower our FDIC assessment rate in future periods. Refer to the section entitled Liquidity and Capital Resources, below, for further information regarding our use and monitoring of wholesale deposits.

Asset Quality
Non-performing Assets
Total impaired assets consisted of the following at September 30, 2017 and December 31, 2016, respectively:
 
 
September 30,
2017
 
December 31,
2016
 
 
(Dollars in Thousands)
Non-accrual loans and leases
 
 
 
 
Commercial real estate:
 
 
 
 
Commercial real estate - owner occupied
 
$
7,080

 
$
2,223

Commercial real estate - non-owner occupied
 
1,826

 
1,609

Land development
 
2,770

 
3,440

Construction
 
5,354

 
2,918

Multi-family
 

 

1-4 family
 
1,864

 
1,937

Total non-accrual commercial real estate
 
18,894

 
12,127

Commercial and industrial
 
13,957

 
12,463

Direct financing leases, net
 

 

Consumer and other:
 
 
 
 
Home equity and second mortgages
 

 

Other
 
381

 
604

Total non-accrual consumer and other loans
 
381

 
604

Total non-accrual loans and leases
 
33,232

 
25,194

Foreclosed properties, net
 
2,585

 
1,472

Total non-performing assets
 
35,817

 
26,666

Performing troubled debt restructurings
 
275

 
717

Total impaired assets
 
$
36,092

 
$
27,383

 
 
 
 
 
Total non-accrual loans and leases to gross loans and leases
 
2.26
%
 
1.74
%
Total non-performing assets to gross loans and leases plus foreclosed properties, net
 
2.44

 
1.83

Total non-performing assets to total assets
 
2.01

 
1.50

Allowance for loan and lease losses to gross loans and leases
 
1.36

 
1.44

Allowance for loan and lease losses to non-accrual loans and leases
 
59.95

 
83.00

As of September 30, 2017 and December 31, 2016, $10.9 million and $12.8 million of non-accrual loans were considered troubled debt restructurings, respectively.

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We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio. Non-performing assets increased $9.2 million, or 34.3%, to $35.8 million at September 30, 2017 from $26.7 million at December 31, 2016. The increase reflected $12.3 million of additional non-performing assets primarily related to three loan relationships that were moved to impaired status during the first quarter of 2017. During the third quarter of 2017, non–performing assets decreased $3.9 million primarily due to $3.2 million of net charge-offs associated with the aforementioned Wisconsin-based commercial and industrial and energy sector impaired loans. In addition, full payoff proceeds were received in October 2017 for a previously disclosed construction loan originated in our Kansas City market, which will reduce non-performing loans by $2.5 million in the fourth quarter of 2017.
We also monitor early stage delinquencies to assist in the identification of potential future problems. As of September 30, 2017, 98.0% of the loan and lease portfolio was in a current payment status, compared to 98.8% as of December 31, 2016. We also monitor our asset quality through our established credit quality indicator categories. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to sell the underlying collateral, inadequate cash flow from the operations of the underlying businesses, liquidation events or bankruptcy filings. We work proactively with our impaired loan borrowers to find solutions to difficult situations that are in the best interests of the Bank.
The following represents additional information regarding our impaired loans and leases:
 
 
As of and for the Nine Months Ended September 30,
 
As of and for the
Year Ended December 31,
 
 
2017
 
2016
 
2016
 
 
(In Thousands)
Impaired loans and leases with no impairment reserves required
 
$
17,972

 
$
15,829

 
$
11,345

Impaired loans and leases with impairment reserves required
 
15,535

 
10,615

 
14,566

Total impaired loans and leases
 
33,507

 
26,444

 
25,911

Less:
 
 
 
 
 
 
Impairment reserve (included in allowance for loan and lease losses)
 
5,790

 
4,636

 
5,599

Net impaired loans and leases
 
$
27,717

 
$
21,808

 
$
20,312

Average impaired loans and leases
 
$
34,871

 
$
21,103

 
$
22,986

Foregone interest income attributable to impaired loans and leases
 
$
1,969

 
$
1,059

 
$
1,617

Less: Interest income recognized on impaired loans and leases
 

 
373

 
614

Net foregone interest income on impaired loans and leases
 
$
1,969

 
$
686

 
$
1,003

Non-performing assets also include foreclosed properties. Following the planned discontinuation of all banking activities at the Corporation’s Overland Park branch in the second quarter of 2017, the building and land were reclassified to other real estate owned at that time. Management is in the process of selling the property, which is expected to be completed by the end of the year.
A summary of our current-period foreclosed properties activity is as follows:
(In Thousands)
 
Foreclosed properties as of December 31, 2016
$
1,472

Premises and equipment transferred to foreclosed properties
1,113

Foreclosed properties as of September 30, 2017
$
2,585


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Allowance for Loan and Lease Losses
The allowance for loan and lease losses decreased $989,000 from $20.9 million as of December 31, 2016 to $19.9 million as of September 30, 2017. The allowance for loan and lease losses as a percentage of gross loans and leases also decreased from 1.44% as of December 31, 2016 to 1.36% as of September 30, 2017. 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.
During the three months ended September 30, 2017, we recorded net charge-offs on impaired loans and leases of approximately $3.2 million, or 0.88% of average loans and leases annualized, comprised of $3.2 million of charge-offs and $5,000 of recoveries. During the three months ended September 30, 2016, we recorded net charge-offs on impaired loans and leases of approximately $1.6 million, or 0.44% of average loans and leases annualized, comprised of $1.7 million of charge-offs and $32,000 of recoveries.
During the nine months ended September 30, 2017, we recorded net charge-offs on impaired loans and leases of approximately $6.7 million, or 0.61% of average loans and leases annualized, comprised of $7.2 million of charge-offs and $508,000 of recoveries. During the nine months ended September 30, 2016, we recorded net charge-offs on impaired loans and leases of approximately $3.1 million, or 0.28% of average loans and leases annualized, comprised of $3.3 million of charge-offs and $177,000 of recoveries.
We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed. Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios. Based upon the application of our methodology for estimating the appropriate level of allowance for loan and lease loss reserves, 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 $19.9 million, or 1.36% of total loans and leases, was appropriate as of September 30, 2017. Given ongoing complexities with current workout situations, further charge-offs and increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion. In addition, various federal and state regulatory agencies review the 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.
As of September 30, 2017 and December 31, 2016, our allowance for loan and lease losses to total non-accrual loans and leases was 59.95% and 83.00%, respectively. This ratio decreased primarily due to the collateral positions related to the additional non-accrual loans during 2017. During the third quarter of 2017, the allowance for loan and lease losses to total non-accrual loans increased 1.62% from the linked quarter. 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 that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease losses to non-accrual loans and leases ratio as compared to our peers or industry expectations. Our allowance for loan and lease losses is measured more through general characteristics, including historical loss experience of our portfolio rather than through specific identification and we therefore expect to see this ratio rise as we continue to grow our loan and lease portfolio. Conversely, if we identify additional impaired loans or leases 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 was appropriate for the probable losses inherent in our loan and lease portfolio as of September 30, 2017.


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Table of Contents

A tabular summary of the activity in the allowance for loan and lease losses follows:
 
 
As of and for the Three Months Ended September 30,
 
As of and for the Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(Dollars in Thousands)
Allowance at beginning of period
 
$
21,677

 
$
18,154

 
$
20,912

 
$
16,316

Charge-offs:
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 

 

 
(9
)
 
(41
)
Commercial real estate — non-owner occupied
 

 

 
(80
)
 

Construction and land development
 

 
(250
)
 

 
(948
)
Multi-family
 

 

 

 

1-4 family
 
(8
)
 
(9
)
 
(37
)
 
(205
)
Commercial and industrial
 
(3,217
)
 
(1,396
)
 
(6,978
)
 
(2,048
)
Direct financing leases
 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
Home equity and second mortgages
 

 

 

 

Other
 
(5
)
 
(1
)
 
(92
)
 
(8
)
Total charge-offs
 
(3,230
)
 
(1,656
)
 
(7,196
)
 
(3,250
)
Recoveries:
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
Commercial real estate — owner occupied
 

 

 
42

 

Commercial real estate — non-owner occupied
 
1

 
1

 
2

 
74

Construction and land development
 

 
28

 
101

 
28

Multi-family
 

 

 

 

1-4 family
 
1

 
2

 
7

 
68

Commercial and industrial
 
2

 

 
314

 
2

Direct financing leases
 

 

 

 

Consumer and other:
 
 
 
 
 
 
 
 
Home equity and second mortgages
 
1

 
1

 
2

 
3

Other
 

 

 
40

 
2

Total recoveries
 
5

 
32

 
508

 
177

Net charge-offs
 
(3,225
)
 
(1,624
)
 
(6,688
)
 
(3,073
)
Provision for loan and lease losses
 
1,471

 
3,537

 
5,699

 
6,824

Allowance at end of period
 
$
19,923

 
$
20,067

 
$
19,923

 
$
20,067

Annualized net charge-offs as a % of average gross loans and leases
 
0.88
%
 
0.44
%
 
0.61
%
 
0.28
%



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Liquidity and Capital Resources
The Corporation expects to meet its liquidity needs through existing cash on hand, established cash flow sources, its third party senior line of credit and dividends received from the Bank. While the Bank is subject to certain generally applicable regulatory limitations regarding its ability to pay dividends to the Corporation, we do not believe that the Corporation will be adversely affected by these dividend limitations. The Corporation’s principal liquidity requirements at September 30, 2017 were the interest payments due on subordinated and junior subordinated notes. On October 25, 2017, the Bank’s Board of Directors declared a dividend in the amount of $4.5 million bringing year-to-date dividend declarations to $14.5 million. The capital ratios of the Corporation and its subsidiaries continue to meet all applicable regulatory capital adequacy requirements. The Corporation’s and the Bank’s respective Boards of Directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.
The Bank maintains liquidity by obtaining funds from several sources. The Bank’s primary 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.
On-balance-sheet liquidity is 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 September 30, 2017 and December 31, 2016, our immediate on-balance-sheet liquidity was $450.2 million and $543.1 million, respectively. At September 30, 2017 and December 31, 2016, the Bank had $35.4 million and $40.9 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 bank wholesale funding or invest in securities to maintain adequate liquidity at an improved margin.
We had $476.7 million of outstanding wholesale funds at September 30, 2017, compared to $450.3 million of wholesale funds as of December 31, 2016, which represented 30.4% and 28.6%, respectively, of ending balance total Bank funding. Wholesale funds include brokered certificates of deposit, deposits gathered from internet listing services and FHLB advances. Total Bank funding is defined as total deposits plus FHLB advances. We are committed to raising in-market deposits while maintaining our overall target mix of wholesale funds and in-market deposits. Wholesale funds continue to be an efficient and cost effective source of funding for the Bank and allows it to gather funds across a larger geographic base at price levels and maturities that are more attractive than local time deposits when required to raise a similar level of in-market deposits within a short time period. Access to such deposits and borrowings allows us the flexibility to refrain from pursuing single service deposit relationships in markets that have experienced unfavorable pricing levels. In addition, the administrative costs associated with wholesale funds are considerably lower than those that would be incurred to administer a similar level of local deposits with a similar maturity structure. During the time frames necessary to accumulate wholesale funds in an orderly manner, we will use short-term FHLB advances to meet our temporary funding needs. The short-term FHLB advances will typically have terms of one week to one month to cover the overall expected funding demands.
Our in-market relationships remain stable; however, deposit balances associated with those relationships will fluctuate. We expect to establish new client relationships and continue marketing efforts aimed at increasing the balances in existing clients’ deposit accounts. Nonetheless, we will continue to use wholesale funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management process or in shorter time periods if in-market deposit balances decline. In order to provide for ongoing liquidity and funding, all of our wholesale funds are certificates of deposit which do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual maturity terms and no call provisions. The Bank limits the percentage of wholesale funds to total Bank funds in accordance with liquidity policies approved by its Board of Directors. The Corporation’s overall operating range of wholesale funds to total Bank funds is 30%-40%. The Bank was in compliance with policy limits as of September 30, 2017 and December 31, 2016.
The Bank was able to access the wholesale deposit market as needed at rates and terms comparable to market standards during the nine month period ended September 30, 2017. In the event there is a disruption in the availability of wholesale deposits at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through on-balance-sheet liquidity. These potential funding sources include deposits with the FRB and borrowings from the FHLB or Federal Reserve Discount Window utilizing currently unencumbered

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securities and acceptable loans as collateral. As of September 30, 2017, the available liquidity was in excess of the stated policy minimum. We believe the Bank will also have access to the unused federal funds lines, cash flows from borrower repayments and cash flows from security maturities. The Bank also has the ability to raise local market deposits by offering attractive rates to generate the level required to fulfill their liquidity needs.
The Bank is required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. We believe the Bank has sufficient liquidity to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows.
During the nine months ended September 30, 2017, operating activities resulted in a net cash inflow of $19.4 million, which included net income of $7.9 million. Net cash used in investing activities for the nine months ended September 30, 2017 was approximately $13.3 million which consisted of cash outflows to fund net loan growth and reinvestment of cash flows within purchases of additional securities, partially offset by cash inflows from maturities, redemptions and paydowns of available-for-sale and held-to-maturity securities. Net cash used in financing activities for the nine months ended September 30, 2017 was $10.5 million primarily from net decreases in deposits and cash dividends paid to shareholders, partially offset by net increases in FHLB advances. Please refer to the Consolidated Statements of Cash Flows included in PART I. Item 1. for further details regarding significant sources of cash flow for the Corporation.

Contractual Obligations and Off-Balance-Sheet Arrangements
As of September 30, 2017, there were no material changes to our contractual obligations and off-balance-sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016. 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
Our primary market risk is interest rate risk, which arises from exposure of our financial position to changes in interest rates. It is our strategy to reduce the impact of interest rate risk on net interest margin by maintaining a favorable match between the maturities and repricing dates of interest-earning assets and interest-bearing liabilities. This strategy is monitored by the Bank’s Asset/Liability Management Committee, in accordance with policies approved by the Bank’s Board. This committee meets regularly to review the sensitivity of the Bank’s assets and liabilities to changes in interest rates, liquidity needs and sources, and pricing and funding strategies.
We use two techniques to measure interest rate risk. The first is simulation of earnings. In this measurement technique the balance sheet is modeled as an ongoing entity whereby future growth, pricing and funding assumptions are implemented. These assumptions are modeled under different rate scenarios that include a parallel, instantaneous and sustained change in interest rates. Key assumptions include:
the behavior of interest rates and pricing spreads;
the changes in product balances; and
the behavior of loan and deposit clients in different rate environments.
This analysis incorporates several assumptions, the most material of which relate to the re-pricing characteristics and balance fluctuations of deposits with indeterminate or non-contractual maturities, and is measured as a percentage change in net interest income for the next 12 months due to instantaneous movements in benchmark interest rates from a baseline scenario. Estimated changes are dependent upon material assumptions such as those previously discussed.
The earnings simulation analysis does not incorporate any management actions that may be used to mitigate negative consequences of actual interest rate movement. For that reason and others, they do not reflect the likely actual results but serve as conservative estimates of interest rate risk. The simulation analysis is not comparable to actual results or directly predictive of future values of other measures provided.
The second measurement technique used is static gap analysis. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. In general, a positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature in a time frame and a negative gap indicates the opposite. In addition to the gap position, other determinants of net interest income are the shape of the yield curve, general rate levels and

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the corresponding effect of contractual interest rate floors, reinvestment spreads, balance sheet growth and mix, and interest rate spreads. Our success in attracting in-market deposits adds to the interest rate liability sensitivity of the organization.
We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity and/or repricing characteristics based on market conditions. Wholesale certificates of deposit and FHLB advances are a significant source of our funding and we use a variety of maturities to augment our management of interest rate exposure. 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 these assumptions to be reasonable, although the actual amortization and repayment of assets and liabilities may vary substantially. Our economic sensitivity to changes in interest rates at September 30, 2017 has not changed materially since December 31, 2016.

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 September 30, 2017.
Changes in Internal Control over Financial Reporting
There was no change in the Corporation’s internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) that occurred during the quarter ended September 30, 2017 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 Annual Report on Form 10-K for the year ended December 31, 2016.
    
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a)
None.
(b)
Not applicable.
(c)
None.
 
 
 
 
 
 
 
 
 
Item 3. Defaults Upon Senior Securities
Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.


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Table of Contents

Item 5. Other Information
None.


Item 6. Exhibits
31.1

 
 
 
 
31.2

 
 
 
 
32

 
 
 
 
101

 
The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016, (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2017 and 2016, (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2017 and 2016, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2017 and 2016, (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016, and (vi) the Notes to Unaudited Consolidated Financial Statements
 
 
 
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
FIRST BUSINESS FINANCIAL SERVICES, INC.
 
October 27, 2017
/s/ Corey A. Chambas
 
Corey A. Chambas 
 
Chief Executive Officer
 
 
October 27, 2017
/s/ Edward G. Sloane, Jr.
 
Edward G. Sloane, Jr.
 
Chief Financial Officer
 
(principal financial officer)


60