Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2023
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number: 001-38676
BANK FIRST CORPORATION
(Exact name of registrant as specified in its charter)
WISCONSIN
39-1435359
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
402 North 8th Street, Manitowoc, Wisconsin
54220
(Address of principal executive offices)
(Zip Code)
(920) 652-3100
(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 ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically, if any, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name on each exchange on which registered
Common Stock, par value $0.01 per share
BFC
The Nasdaq Stock Market LLC
The number of shares of the issuer’s common stock, par value $0.01, outstanding as of November 9, 2023 was 10,365,891 shares.
TABLE OF CONTENTS
Page Number
Part I. Financial Information
3
ITEM 1.
Financial Statements
Consolidated Balance Sheets – September 30, 2023 (unaudited) and December 31, 2022
Consolidated Statements of Income – Three and Nine Months Ended September 30, 2023 and 2022 (unaudited)
4
Consolidated Statements of Comprehensive Income – Three and Nine Months Ended September 30, 2023 and 2022 (unaudited)
5
Consolidated Statements of Changes in Stockholders’ Equity – Three and Nine Months Ended September 30, 2023 and 2022 (unaudited)
6
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2023 and 2022 (unaudited)
7
Notes to Unaudited Consolidated Financial Statements
9
ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
32
ITEM 3.
Quantitative and Qualitative Disclosures about Market Risk
59
ITEM 4.
Controls and Procedures
61
Part II. Other Information
Legal Proceedings
ITEM 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
62
Defaults Upon Senior Securities
Mine Safety Disclosures
ITEM 5.
Other Information
ITEM 6.
Exhibits
63
Signatures
64
2
PART I – FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets
(In thousands, except share and per share data)
September 30, 2023
December 31, 2022
(Unaudited)
(Audited)
Assets
Cash and due from banks
$
46,332
51,524
Interest-bearing deposits
29,444
67,827
Cash and cash equivalents
75,776
119,351
Securities held to maturity, at amortized cost ($74,888 and $43,770 fair value at September 30, 2023 and December 31, 2022, respectively)
77,154
45,097
Securities available for sale, at fair value ($205,602 and $325,960 amortized cost at September 30, 2023 and December 31, 2022, respectively)
179,046
304,637
Loans held for sale
1,155
648
Loans
3,355,549
2,893,978
Allowance for credit losses - loans ("ACL-Loans")
(43,404)
(22,680)
Loans, net
3,312,145
2,871,298
Premises and equipment, net
70,994
56,448
Goodwill
175,106
110,206
Other investments
21,542
16,495
Cash value of life insurance
60,889
46,050
Core deposit intangibles, net
28,599
16,829
Mortgage servicing rights ("MSR")
13,733
9,582
Other real estate owned (“OREO”)
1,844
2,520
Investment in minority-owned subsidiaries
46,203
44,180
Other assets
23,333
17,091
TOTAL ASSETS
4,087,519
3,660,432
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
2,333,452
2,126,137
Noninterest-bearing deposits
1,064,841
934,092
Total deposits
3,398,293
3,060,229
Securities sold under repurchase agreements
17,191
97,196
Notes payable
35,847
1,929
Subordinated notes
23,500
Junior subordinated debentures
10,972
—
Other liabilities
24,387
24,475
Total liabilities
3,510,190
3,207,329
Stockholders’ equity:
Serial preferred stock - $0.01 par value
Authorized - 5,000,000 shares
Common stock - $0.01 par value
Authorized - 20,000,000 shares
Issued - 11,515,130 and 10,064,858 shares as of September 30, 2023 and December 31, 2022, respectively
Outstanding - 10,379,071 and 9,021,697 shares as of September 30, 2023 and December 31, 2022, respectively
115
101
Additional paid-in capital
333,254
218,263
Retained earnings
316,212
295,496
Treasury stock, at cost - 1,136,059 and 1,043,161 shares as of September 30, 2023 and December 31, 2022, respectively
(52,497)
(45,191)
Accumulated other comprehensive loss
(19,755)
(15,566)
Total stockholders’ equity
577,329
453,103
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
ITEM 1. Financial Statements Continued:
Consolidated Statements of Income
(In thousands, except per share data) (Unaudited)
Three months ended September 30,
Nine months ended September 30,
2023
2022
Interest income:
Loans, including fees
43,552
28,353
124,308
74,131
Securities:
Taxable
2,384
1,590
6,405
4,266
Tax-exempt
243
453
789
1,339
Other
810
344
2,318
1,044
Total interest income
46,989
30,740
133,820
80,780
Interest expense:
Deposits
11,644
2,637
29,177
5,939
252
100
1,383
104
Borrowed funds
1,035
310
2,696
1,274
Total interest expense
12,931
3,047
33,256
7,317
Net interest income
34,058
27,693
100,564
73,463
Provision for credit losses
4,182
1,700
Net interest income after provision for credit losses
96,382
71,763
Noninterest income:
Service charges
1,821
5,186
4,246
Income from Ansay and Associates, LLC (“Ansay”)
791
671
2,812
2,316
Income from UFS, LLC (“UFS”)
784
852
2,444
2,120
Loan servicing income
734
491
2,119
1,377
Valuation adjustment on MSR
229
885
460
2,846
Net gain on sales of mortgage loans
248
264
624
1,338
647
620
2,012
1,562
Total noninterest income
5,254
5,166
15,657
15,805
Noninterest expense:
Salaries, commissions, and employee benefits
10,216
10,812
29,998
24,993
Occupancy
1,455
1,176
4,363
3,505
Data processing
2,153
1,577
6,111
4,353
Postage, stationery, and supplies
244
215
848
542
Net loss (gain) on sales and valuations of OREO
53
(146)
Net loss on sale of securities
75
Advertising
60
226
205
Charitable contributions
150
680
553
Outside service fees
1,438
2,538
4,987
5,096
Amortization of intangibles
1,626
751
4,720
2,173
1,615
6,707
4,260
Total noninterest expense
19,647
18,895
59,257
44,699
Income before provision for income taxes
19,665
13,964
52,782
42,869
Provision for income taxes
4,861
3,431
13,166
10,499
Net Income
14,804
10,533
39,616
32,370
Earnings per share - basic
1.43
1.26
3.89
4.15
Earnings per share - diluted
See accompanying notes to unaudited consolidated financial statements
Consolidated Statements of Comprehensive Income
(In thousands) (Unaudited)
Three Months Ended
Nine Months Ended
September 30,
Other comprehensive income (loss):
Unrealized losses on available for sale securities:
Unrealized holding losses arising during period
(6,093)
(9,188)
(5,308)
(30,613)
Amortization of unrealized holding gains on securities transferred from available for sale to held to maturity
(1)
Reclassification adjustment for losses included in net income
Income tax benefit
1,276
2,480
8,266
Total other comprehensive loss
(4,817)
(6,708)
(4,189)
(22,348)
Comprehensive income
9,987
3,825
35,427
10,022
See accompanying notes to unaudited consolidated financial statements.
Consolidated Statement of Stockholders’ Equity
(In thousands, except share and per share data) (Unaudited)
Accumulated
Serial
Additional
Total
Preferred
Common
Paid-in
Retained
Treasury
Comprehensive
Stockholders'
Stock
Capital
Earnings
Income (loss)
Equity
Balance at January 1, 2022
85
93,149
258,104
(32,294)
3,609
322,653
Net income
10,183
Other comprehensive loss
(8,199)
Purchase of treasury stock
(5,018)
Sale of treasury stock
37
Cash dividends ($0.22 per share)
(1,673)
Amortization of stock-based compensation
320
Vesting of restricted stock awards
(1,303)
1,303
Balance at March 31, 2022
92,166
266,614
(35,972)
(4,590)
318,303
11,654
(7,441)
(7,186)
23
(1,638)
447
Balance at June 30, 2022
92,613
276,630
(43,135)
(12,031)
314,162
(2,109)
25
Cash dividends ($0.25 per share)
(2,256)
448
Shares issued in the acquisition of Denmark Bancshares, Inc. (1,586,475 shares)
16
125,304
125,320
Balance at September 30, 2022
218,365
284,907
(45,219)
(18,739)
439,415
Balance at January 1, 2023
10,680
Other comprehensive income
2,410
(6,727)
(2,616)
456
(1,585)
1,585
Adoption of new accounting pronouncement (See Note 1)
(10,050)
Shares issued in the acquisition of Hometown Bancorp, Ltd. (1,450,272 shares)
14
115,065
115,079
Balance at March 31, 2023
332,199
293,510
(50,296)
(13,156)
562,372
14,132
(1,782)
(1,341)
44
Cash dividends ($0.30 per share)
(3,117)
564
(45)
45
Balance at June 30, 2023
332,718
304,525
(51,548)
(14,938)
570,872
(1,037)
561
(25)
Balance at September 30, 2023
Consolidated Statements of Cash Flows
Nine Months Ended September 30,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment
1,398
1,209
Net amortization (accretion) of securities
(1,705)
337
1,581
1,215
Accretion of purchase accounting valuations
(6,460)
(962)
Net change in deferred loan fees and costs
(1,159)
(946)
Change in fair value of MSR and other investments
(686)
(3,010)
Loss from sale and disposal of premises and equipment
135
Net loss (gain) on sale of OREO and valuation allowance
Proceeds from sales of mortgage loans
56,942
74,463
Originations of mortgage loans held for sale
(56,825)
(73,593)
Gain on sales of mortgage loans
(624)
(1,338)
Realized loss on sale of securities
Undistributed income of UFS joint venture
(2,444)
(2,120)
Undistributed income of Ansay joint venture
(2,812)
(2,316)
Net earnings on life insurance
(1,131)
(636)
Decrease (increase) in other assets
(1,026)
4,206
Decrease in other liabilities
(1,676)
(11,776)
Net cash provided by operating activities
32,643
19,995
Cash flows from investing activities, net of effects of business combination:
Activity in securities available for sale and held to maturity:
Sales
34,197
Maturities, prepayments, and calls
123,968
11,836
Purchases
(138,303)
Net increase in loans
(51,761)
(162,677)
Dividends received from UFS
1,748
1,861
Dividends received from Ansay
1,485
1,364
Proceeds from sale of OREO
1,827
Net sales (purchases) of Federal Home Loan Bank (“FHLB”) stock
262
(1,171)
Net purchases of Federal Reserve Bank (“FRB”) stock
(3,880)
(1,500)
Purchases of premises and equipment
(11,312)
(5,324)
Net cash received in business combination
89,959
154,364
Net cash provided by (used in) investing activities
186,493
(139,230)
Consolidated Statements of Cash Flows (Continued)
Cash flows from financing activities, net of effects of business combination:
Net increase (decrease) in deposits
(194,088)
5,020
Net decrease in securities sold under repurchase agreements
(80,005)
(19,159)
Proceeds from advances of notes payable
121,700
3,122,700
Repayment of notes payable
(92,507)
(3,128,950)
Proceeds from issuance of subordinated notes
6,000
Dividends paid
(8,850)
(5,567)
Proceeds from sales of common stock
144
Repurchase of common stock
(9,105)
(14,313)
Net cash used in financing activities
(262,711)
(34,184)
Net decrease in cash and cash equivalents
(43,575)
(153,419)
Cash and cash equivalents at beginning of period
296,860
Cash and cash equivalents at end of period
143,441
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
29,487
6,985
Income taxes
12,606
9,835
Supplemental schedule of noncash activities:
MSR resulting from sale of loans
597
658
Amortization of unrealized holding gains on securities transferred from available for sale to held to maturity recognized in other comprehensive income, net of tax
Change in unrealized gains and losses on investment securities available for sale, net of tax
(4,246)
(22,347)
Acquisition:
Fair value of assets acquired
615,105
685,840
Fair value of liabilities assumed
549,564
612,700
Net assets acquired
65,541
73,140
Common stock issued in acquisition
124,771
8
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
NOTE 1 – BASIS OF PRESENTATION
Bank First Corporation (the “Company”) provides a variety of financial services to individual and corporate customers through its wholly-owned subsidiary, Bank First, N.A. (the “Bank”). The Bank operates as a full-service financial institution with a primary market area including, but not limited to, the counties in which the Bank’s branches are located. The Bank has twenty-six locations located in Manitowoc, Outagamie, Brown, Winnebago, Sheboygan, Shawano, Waupaca, Ozaukee, Monroe, Fond du Lac, Waushara, Dane, Columbia and Jefferson counties in Wisconsin. The Company and Bank are subject to the regulations of certain federal agencies and undergo periodic examinations by those regulatory authorities.
These interim unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures required by GAAP have been omitted or abbreviated. These unaudited consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 (“Annual Report”).
The unaudited consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods. The results for interim periods are not necessarily indicative of results for a full year.
Critical Accounting Policies and Estimates
Preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for credit losses on securities and loans, valuation of loans in acquisition transactions, valuation of mortgage servicing rights, useful lives for depreciation and amortization, fair value of financial instruments, valuation of deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for credit losses, the determination of the valuation of mortgage servicing rights, the determination and assessment of deferred tax assets and liabilities, and the valuation of loans acquired in acquisition transactions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking or tax regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.
There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as previously disclosed in the Company’s Annual Report, other than what is disclosed in “Updates to Significant Accounting Policies” noted below.
Updates to Significant Accounting Policies
On January 1, 2023, the Company adopted ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), utilizing the modified retrospective method for financial assets measured at amortized cost. Results for the periods beginning after January 1, 2023 are presented under ASU 2016-13 while prior period amounts are reported in accordance with the previously applicable accounting standards. The Company recorded a reduction to retained earnings of approximately $10.1 million upon adoption of ASU 2016-13. The transition adjustment included an increase to the ACL-Loans of $11.0 million and an increase in the Allowance for Credit Losses – Unfunded Commitments (“ACL – Unfunded Commitments”) of $3.3 million, offset by applicable deferred taxes.
The Company adopted ASU 2016-13 using the prospective transition approach for financial assets considered purchased credit deteriorated (“PCD”) that were previously classified as purchase credit impaired (“PCI”). The amortized cost of the PCD assets were adjusted to reflect the addition of $0.3 million to the allowance for credit losses. The remaining noncredit discount (based on the adjusted amortized cost) will be accreted into interest income at the effective interest rate over the remaining life of the assets.
The following table presents the changes in the allowance for credit losses required as a result of this adoption:
January 1, 2023 As
Reported After ASU
Pre-ASU 2016-13
Impact of
Allowance for Credit Losses
2016-13 Adoption
Adoption
Loans held for investments
Commercial/industrial
5,930
4,071
1,859
Commercial real estate - owner occupied
7,186
5,204
1,982
Commercial real estate - non-owner occupied
7,319
5,405
1,914
Construction and development
3,655
1,592
2,063
Residential 1-4 family
8,511
5,944
2,567
Consumer
934
314
117
(33)
Loans held for investments, total
33,652
22,680
Liabilities
Unfunded commitments
3,264
-
36,916
14,236
As a result of adopting ASU 2016-13, certain of the Company’s accounting policies were updated as follows:
Securities: Securities are classified as held to maturity or available for sale at the time of purchase. Investment securities classified as held to maturity, which management has the intent and ability to hold to maturity, are reported at amortized cost. Investment securities classified as available for sale, which management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in stockholders’ equity as a separate component of other comprehensive income.
The net carrying value of debt securities classified as held to maturity or available for sale is adjusted for amortization of premiums and accretion of discounts utilizing the effective interest method over the expected estimated maturity. Such amortization and accretion is included as an adjustment to interest income from securities. Interest and dividends are included in interest income from securities.
Transfers of debt securities into the held to maturity classification from the available for sale classification are made at fair value as of the date of transfer. The unrealized holding gain or loss as of the date of transfer is retained in other comprehensive income and in the carrying value of the held to maturity securities, establishing the amortized cost of the security. These unrealized holding gains and losses as of the date of transfer are amortized or accreted over the remaining life of the security.
Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
Prior to January 1, 2023, unrealized gains or losses considered temporary and the noncredit portion of unrealized losses deemed other-than-temporary were reported as an increase or decrease in accumulated other comprehensive income. The credit related portion of unrealized losses deemed other-than-temporary were recorded in current period earnings.
Subsequent to January 1, 2023, the Bank evaluates securities for potential credit losses at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuers are assessed. If, based on information available such as the decline in the credit worthiness of the issuer, external market ratings or the anticipated or realized elimination of associated dividends, potential credit losses are identified on securities an allowance for credit losses would be established.
10
Loans and Related Interest Income – Originated: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are carried at their amortized cost basis, which is the unpaid principal balance outstanding, net of deferred loan fees and costs and any direct principal charge-offs. The Company made an accounting policy election to exclude accrued interest from the amortized cost basis of loans and report such accrued interest as part of other assets on the consolidated balance sheets.
Interest income is accrued on the unpaid principal balance using the simple interest method. The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower’s ability to meet payment of interest or principal when due. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal, though may be placed in such status earlier. Loans past due 90 days or more may continue on accrual only when they are well secured and/or in process of collection or renewal. When interest accrual is discontinued, all previously accrued but uncollected interest is reversed against current period interest income. Except in very limited circumstances, cash collections on nonaccrual loans are credited to the loan receivable balance and no interest income is recognized on those loans until the principal balance is paid in full. Accrual of interest may be resumed when the customer is current on all principal and interest payments and has been paying on a timely basis for a sustained period of time. See Note 5 for additional information and disclosures on loans.
Loans and Related Interest Income – Acquired: Loans purchased in acquisition transactions are acquired loans, and are recorded at their estimated fair value at the acquisition date.
Prior to January 1, 2023, as described in further detail in the Company’s Annual Report, the Company initially classified acquired loans as either PCI loans (i.e., loans that reflect credit deterioration since origination and it is probable at acquisition that the Company will be unable to collect all contractually required payments) or purchased non-impaired loans (i.e., “performing acquired loans”). The Company estimated the fair value of PCI loans based on the amount and timing of expected principal, interest and other cash flows for each loan. The excess of the loan’s contractual principal and interest payments over all cash flows expected to be collected at acquisition was considered an amount that should not be accreted. These credit discounts (“nonaccretable marks”) were included in the determination of the initial fair value for acquired loans; therefore, no allowance for credit losses was recorded at the acquisition date. Differences between the estimated fair values and expected cash flows of acquired loans at the acquisition date that were not credit-based (“accretable marks”) were subsequently accreted to interest income over the estimated life of the loans. Subsequent to the acquisition date for PCI loans, increases in cash flows over those expected at the acquisition date resulted in a move of the discount from nonaccretable to accretable, while decreases in expected cash flows after the acquisition date were recognized through the provision for credit losses.
Subsequent to January 1, 2023, acquired loans that have evidence of more-than-insignificant deterioration in credit quality since origination are considered PCD loans. At acquisition, an estimate of expected credit losses is made for PCD loans. This initial allowance for credit losses is allocated to individual PCD loans and added to the purchase price or acquisition date fair value to establish the initial amortized cost basis of the PCD loans. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to noncredit factors, resulting in a discount or premium that is amortized to interest income. For acquired loans not deemed PCD loans at acquisition, the difference between the initial fair value mark and the unpaid principal balance are recognized in interest income over the estimated life of the loans. In addition, an initial allowance for expected credit losses is estimated and recorded as provision expense at the acquisition date. The subsequent measurement of expected credit losses for all acquired loans is the same as the subsequent measurement of expected credit losses for originated loans. See Note 5 for additional information and disclosures on loans.
Allowance for Credit Losses - Loans: The ACL-Loans represents management’s estimate of expected credit losses in the Company’s loan portfolio at the balance sheet date. The Company estimates the ACL-Loans based on the amortized costs basis of the underlying loan and has made an accounting policy election to exclude accrued interest from the loan’s amortized cost basis and the related measurement of the ACL-Loans. Estimating the amount of the ACL-Loans is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and nonaccrual loans, and the level of potential problem loans, all of which may be susceptible to significant change.
Prior to January 1, 2023, as described in further detail in the Company’s Annual Report, the Company used an incurred loss impairment model. This methodology assessed the overall appropriateness of the allowance for credit losses and included allocations for specifically identified impaired loans and loss factors for all remaining loans, with a component primarily based on historical loss rates and another component primarily based on other qualitative factors. Impaired loans were individually assessed and measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market
11
price or the fair value of the collateral if the loan was collateral dependent. Loans that were determined not to be impaired were collectively evaluated for impairment, stratified by type and allocated loss ranges based on the Company’s actual historical loss ratios for each strata, and adjustments were also provided for certain environmental and other qualitative factors.
Subsequent to January 1, 2023, the Company uses a current expected loss model (“CECL”). This methodology also considers historical loss rates and other qualitative adjustments, as well as a new forward-looking component that considers reasonable and supportable forecasts over the expected life of each loan. To develop the ACL-Loans estimate under the current expected loss model, the Company segments the loan portfolio into loan pools based on loan type and similar credit risk elements; performs an individual evaluation of PCD loans; calculates the historical loss rates for the segmented loan pools; applies the loss rates over the calculated life of the pooled loans; adjusts for forecasted macro-level economic conditions; and determines qualitative adjustments based on factors and conditions unique to the Bank's portfolio. The Company further individually evaluates certain impaired loans based on the amount and timing of estimated future cash flows and collateral values and establishes specific reserves when these estimated future cash flows or collateral values do not justify the carrying value of the loan.
Allowance for Credit Losses - Unfunded Commitments: In addition to the ACL-Loans, the Company has established an allowance for unfunded commitments, included in other liabilities on the consolidated balance sheets, representing expected credit losses over the contractual period for which the Company is exposed to credit risk resulting from a contractual obligation to extend credit. The ACL-Unfunded Commitments is maintained at a level that management believes is sufficient to absorb losses arising from unfunded loan commitments, and is determined quarterly based on methodology similar to the methodology for determining the ACL-Loans.
Other Recently Implemented Accounting Standards
In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings (“TDRs”) and Vintage Disclosures. This ASU eliminated the accounting guidance for TDRs by creditors and enhanced the disclosure requirements for loan modifications to borrowers experiencing financial difficulty. The ASU also requires public business entities to expand the vintage disclosures to include gross charge-offs by year of origination. The updated guidance was effective for fiscal years beginning after December 15, 2022. Adoption of this ASU did not have a material impact on the Company’s consolidated financial statements; however, it resulted in new disclosures. See Note 5 for the new disclosures.
Recently Issued Not Yet Effective Accounting Standards
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying GAAP to contracts hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. In December 2022, the FASB issued ASU 2022-06, Reference rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848, which defers the sunset date of the original guidance from December 31, 2022 to December 31, 2024. The Company has been diligent in responding to reference rate reform and does not anticipate a significant impact to its financial statements as a result.
In October 2023, the FASB issued ASU 2023-06, Disclosure Improvements. This ASU modifies the disclosure or presentation requirements of a variety of Topics in the Codification. Certain of the amendments represent clarifications to or technical corrections of the current requirements. The effective date for each amendment will be the date on which the Security and Exchange Commission’s removal of that related disclosure from Regulation S-X or Regulation S-K becomes effective, with early adoption prohibited. If, by June 30, 2027, the Securities and Exchange Commission has not removed the applicable requirement from Regulation S-X or Regulation S-K, the pending content of the related amendment will be removed from the Codification and will not become effective for any entity. The Company does not anticipate a significant impact to its financial statement disclosures as a result of this ASU.
NOTE 2 – ACQUISITIONS
On February 10, 2023, the Company completed a merger with Hometown Bancorp, Ltd. (“Hometown”), a bank holding company headquartered in Fond du Lac, Wisconsin, pursuant to the Agreement and Plan of Bank Merger (“Merger Agreement”), dated as of July 25, 2022 by and among the Company and Hometown, whereby Hometown merged with and into the Company, and Hometown Bank, Hometown’s wholly-owned banking subsidiary, merged with and into the Bank. Hometown’s principal activity was the
12
ownership and operation of Hometown Bank, a state-chartered banking institution that operated ten (10) branches in Wisconsin at the time of closing. The merger consideration totaled approximately $130.5 million.
Pursuant to the terms of the Merger Agreement, Hometown shareholders could elect to receive either 0.3962 shares of the Company’s common stock or $29.16 in cash for each outstanding share of Hometown common stock, subject to a maximum of 30% cash consideration in total, with cash paid in lieu of any remaining fractional share. Company stock issued totaled 1,450,272 shares valued at approximately $115.1 million, with cash of $15.4 million comprising the remainder of merger consideration.
The fair value of the assets acquired and liabilities assumed on February 10, 2023 was as follows:
As Recorded by
Fair Value
Hometown
Adjustments
the Company
Cash, cash equivalents and securities
174,582
(1,010)
173,572
1,195
406,168
(10,367)
395,801
7,577
(1,109)
6,468
Core deposit intangible
405
16,085
16,490
28,011
(6,432)
21,579
Total assets acquired
617,938
(2,833)
532,165
209
532,374
Other borrowings
5,000
(331)
4,669
12,372
(1,464)
10,908
469
1,144
1,613
Total liabilities assumed
550,006
(442)
Excess of assets acquired over liabilities assumed
67,932
(2,391)
Less: purchase price
130,452
64,911
Refinement to fair value estimates (1)
(30)
Goodwill (after refinement)
64,881
The Company purchased loans through the acquisition of Hometown for which there was, at the date of acquisition, more than insignificant deterioration of credit quality since origination (PCD Loans). The carrying amount of these loans at acquisition was as follows:
February 10, 2023
Purchase price of PCD loans at acquisition
30,276
Allowance for credit losses on PCD loans at acquisition
5,534
Par value of PCD acquired loans at acquisition
35,810
The Company accounted for this transaction under the acquisition method of accounting, and thus, the financial position and results of operations of Hometown prior to the consummation date was not included in the accompanying consolidated financial statements. The accounting required assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition. The Company determined the fair value of core deposit intangibles, securities, premises and equipment, loans, other assets and liabilities and deposits with the assistance of third-party valuations, appraisals and third-party advisors. The estimated fair values will be subject to refinement for up to one year after deal consummation as additional information becomes available relative to the closing date fair values.
For more information concerning the Company’s acquisitions, see “Note 2 – Acquisition” in the Company’s audited consolidated financial statements included in the Company’s Annual Report.
13
NOTE 3 – EARNINGS PER SHARE
The two-class method is used in the calculation of basic and diluted earnings per share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. There were no anti-dilutive stock options for the nine months ended September 30, 2023 or 2022.
The following table presents the factors used in the earnings per share computations for the period indicated:
Three Months Ended September 30,
(in thousands, except per share data)
Basic
Net income available to common shareholders
Less: Earnings allocated to participating securities
(83)
(76)
(228)
(247)
Net income allocated to common shareholders
14,721
10,457
39,388
32,123
Weighted average common shares outstanding including participating securities
10,388,909
8,265,186
10,186,107
7,796,259
Less: Participating securities (1)
(58,130)
(59,272)
(58,399)
(59,170)
Average shares
10,330,779
8,205,914
10,127,708
7,737,089
Basic earnings per common shares
Diluted
Weighted average common shares outstanding for basic earnings per common share
Add: Dilutive effects of stock based compensation awards
22,842
22,283
23,282
20,637
Average shares and dilutive potential common shares
10,353,621
8,228,197
10,150,990
7,757,726
Diluted earnings per common share
NOTE 4 – SECURITIES
The following is a summary of available for sale securities:
Gross
Amortized
Unrealized
Estimated
Cost
Gains
Losses
U.S. Treasury securities
49,659
(7,824)
41,835
Obligations of U.S. Government sponsored agencies
31,888
(4,108)
27,780
Obligations of states and political subdivisions
63,941
(9,820)
54,121
Mortgage-backed securities
38,692
(2,852)
35,840
Corporate notes
20,682
(1,944)
18,738
Certificates of deposit
740
(8)
732
Total available for sale securities
205,602
(26,556)
149,614
(7,517)
142,097
24,935
(3,186)
21,749
90,701
88
(7,603)
83,186
38,701
(2,064)
36,637
21,005
381
(1,392)
19,994
1,004
974
325,960
(21,792)
The following is a summary of held to maturity securities:
73,002
(2,264)
70,738
4,152
(2)
4,150
Total held to maturity securities
(2,266)
74,888
39,902
(1,440)
38,577
5,195
5,193
(1,442)
43,770
15
The following table shows the fair value and gross unrealized losses of securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
Less Than 12 Months
Greater Than 12 Months
Number
Fair
of
Value
Securities
September 30, 2023 - Available for Sale
8,622
(355)
19,158
(3,753)
27
16,359
(894)
37,762
(8,926)
83
7,149
(310)
28,691
(2,542)
114
4,850
(142)
12,268
(1,802)
17,118
Certificate of Deposits
Totals
36,980
(1,701)
140,446
(24,855)
177,426
245
September 30, 2023 - Held to Maturity
36,117
(694)
34,621
(1,570)
51
218
1
34,839
(1,572)
70,956
52
December 31, 2022 - Available for Sale
99,433
(559)
42,664
(6,958)
6,735
(652)
15,014
(2,534)
50,839
(2,650)
15,933
(4,953)
66,772
103
35,731
(1,993)
879
(71)
36,610
107
9,701
(920)
3,080
(472)
12,781
203,413
(6,804)
77,570
(14,988)
280,983
250
December 31, 2022 - Held to Maturity
29,464
(1,306)
4,868
(134)
34,332
417
29,881
(1,308)
34,749
17
As of September 30, 2023, no allowance for credit losses has been recognized on available for sale securities in an unrealized loss position as the Company does not believe any of the debt securities are credit impaired. This is based on the Company’s analysis of the risk characteristics, including credit ratings, and other qualitative factors related to these securities. The issuers of these securities continue to make timely principal and interest payments under the contractual terms of the securities. As of September 30, 2023, the Company did not intend to sell these securities and it was more likely than not that the Company would not be required to sell the debt securities before recovery of their amortized cost, which may be at maturity. The unrealized losses have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase, not credit deterioration.
Furthermore, based on its analysis the Company has determined that held to maturity securities have zero expected credit losses. U.S. Treasury securities have the full faith and credit backing of the United States Government and the amount of Obligations of states and political subdivisions in an unrealized loss position at September 30, 2023 are not material to the financial statements.
The following is a summary of amortized cost and estimated fair value of securities by contractual maturity as of September 30, 2023. Contractual maturities will differ from expected maturities for mortgage-backed securities because borrowers may have the right to call or prepay obligations without penalties.
Available for Sale
Held to Maturity
Due in one year or less
6,704
6,548
15,819
15,594
Due after one year through 5 years
31,059
28,060
56,263
54,356
Due after 5 years through ten years
74,846
64,319
5,072
4,938
Due after 10 years
54,301
44,279
Subtotal
166,910
143,206
As of September 30, 2023 and December 31, 2022, the carrying values of securities pledged to secure public deposits, securities sold under repurchase agreements, and for other purposes required or permitted by law were approximately $148.4 million and $226.9 million, respectively.
Sales of securities available for sale produced $34.2 million in proceeds, $0.1 million in gross gains and $0.2 million in gross losses for the nine months ended September 30, 2023. There were no sales of securities during the nine months ended September 30, 2022.
NOTE 5 – LOANS, ALLOWANCE FOR CREDIT LOSSES, AND CREDIT QUALITY
The following table presents total loans by portfolio segment and class of loan as of September 30, 2023 and December 31, 2022:
531,906
492,563
898,141
717,401
785,400
681,783
197,927
200,022
Residential 1‑4 family
878,860
739,339
50,527
44,796
14,821
18,905
Subtotals
3,357,582
2,894,809
ACL - Loans
Loans, net of ACL - Loans
3,314,178
2,872,129
Deferred loan fees, net
(2,033)
(831)
The ACL - Loans is based on the Company’s evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay a loan, the estimated value of any underlying collateral, composition of the loan portfolio and other relevant factors. Loans with similar risk characteristics are evaluated in pools and, depending on the nature of each identified pool, the Company utilizes a discounted cash flow (“DCF”), probability of default / loss given default (“PD/LGD”) or remaining life method. The historical loss experience estimate by pool is then adjusted by forecast factors that are quantitatively related to the Company’s historical credit loss experience, such as national unemployment rates, gross domestic product and indexes which are indicative of the value of underlying collateral. Losses are forecasted over the expected life of the loan, first by predicting over a period of time determined to be reasonable and supportable (currently four calendar quarters), and at the end of the reasonable and supportable period reverting to long term historical averages. The reasonable and supportable period and reversion period are re-evaluated each quarter by the Company and are dependent on the current economic environment among other factors. The expected credit losses for each loan pool are then adjusted for changes in qualitative factors not inherently considered in the quantitative analyses. The qualitative adjustments either increase or decrease the quantitative model estimation. The Company considers factors that are relevant within the qualitative framework which include the following: lending policy, changes in nature and volume of loans, staff experience, changes in volume and trends of problem loans, concentration risk, trends in underlying collateral values, external factors, quality of loan review system and other economic conditions. Expected credit losses for loans that no longer share similar risk characteristics with the collectively evaluated pools are excluded from the collective evaluation and estimated on an individual basis. Individual evaluations are performed for nonaccrual loans, loans rated substandard, and modified loans (previously classified as TDRs). Specific allocations of the ACL for credit losses on individually evaluated loans are estimated on one of several methods, including the estimated fair value of the underlying collateral, observable market value of similar debt or the present value of expected cash flows.
A summary of the activity in the ACL - Loans by loan type for the nine-months ended September 30, 2023 is summarized as follows:
Commercial
Real Estate -
Construction
Commercial /
Owner
Non - Owner
and
Residential
Industrial
Occupied
Development
1-4 Family
ACL - Loans - January 1, 2023
Adoption of CECL
ACL - Loans on PCD loans acquired
1,082
4,424
28
Charge-offs
(69)
(70)
Recoveries
70
196
Provision
538
(220)
1,245
(87)
2,509
4,092
ACL - Loans - September 30, 2023
7,555
11,460
8,564
3,568
11,152
1,007
98
43,404
A summary of the activity in the allowance for loan losses (“ALL”) by loan type for the nine-months ended September 30, 2022 is as follows:
ALL - January 1, 2022
3,699
5,633
5,151
984
4,445
224
179
20,315
(39)
(17)
(27)
455
74
360
152
1,113
134
(643)
365
507
1,312
90
(65)
ALL September 30, 2022
4,288
5,064
5,876
1,643
5,724
299
151
23,045
ALL ending balance individually evaluated for impairment
775
925
ALL ending balance collectively evaluated for impairment
4,138
5,101
22,120
Loans outstanding - September 30, 2022
486,839
723,964
668,505
209,619
706,794
43,953
19,178
2,858,852
Loans ending balance individually evaluated for impairment
487
2,541
1,396
211
4,635
Loans ending balance collectively evaluated for impairment
486,352
721,423
667,109
706,583
2,854,217
In addition to the ACL-Loans, the Company has established an ACL-Unfunded Commitments, classified in other liabilities on the consolidated balance sheets. This allowance is maintained to absorb losses arising from unfunded loan commitments, and is determined quarterly based on methodology similar to the methodology for determining the ACL-Loans. The ACL - Unfunded Commitments was $3.5 million at September 30, 2023. See Note 10 for further information on commitments.
18
The provision for credit losses is determined by the Company as the amount to be added to the ACL loss accounts for various types of financial instruments including loans, investment securities, and off-balance sheet credit exposures after net charge-offs have been deducted to bring the ACL to a level that, in management’s judgment, is necessary to absorb expected credit losses over the lives of the respective financial instruments. The following table presents the components of the provision for credit losses.
Year Ended
September 30, 2022
Provision for credit losses on:
2,200
Unfunded Commitments
Total provision for credit losses
The Company’s past due and non-accrual loans as of September 30, 2023 is summarized as follows:
90 Days
Non-Accrual
30-89 Days
or more
with no
Past Due
Non-
specifically
Accruing
and Accruing
Accrual
allocated ACL
78
531
627
47
180
1,958
2,388
843
444
445
76
116
1,177
446
2,946
4,569
2,463
The Company’s past due and non-accrual loans as of December 31, 2022 is summarized as follows:
192
418
610
1,301
2,688
3,989
237
254
774
268
505
1,547
19
24
2,523
273
3,628
6,424
Interest recognized on non-accrual loans is considered immaterial to the consolidated financial statements for the nine months ended September 30, 2023 and 2022.
A loan is considered to be collateral dependent when, based upon management’s assessment, the borrower is experiencing financial
difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. For collateral dependent loans, expected credit losses are based on the estimated fair value of the collateral at the balance sheet date, with consideration for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. The following table presents collateral dependent loans by portfolio segment and collateral type, including those loans with and without a related allowance allocation. A significant portion of the loan balances in this table and essentially all of the allowance allocations relate to PCD loans which were acquired from Hometown. Real estate collateral primarily consists of operating facilities of the underlying borrowers. Other business assets collateral primarily consists of receivables and inventory of the underlying borrowers.
Collateral Type
As of September 30, 2023
Without an
With an
Allowance
Real Estate
Business Assets
Allocation
5,719
5,672
1,919
9,699
8,109
2,854
35
Total Loans
9,734
15,453
1,672
13,781
4,773
Prior to the adoption of ASU 2016-13, the allowance included specific reserves for certain individually evaluated impaired loans. Specific reserves reflected estimated losses on impaired loans from management’s analysis developed through specific credit allocations. The following table shows a summary of impaired loans individually evaluated as of December 31, 2022:
Commercial/
1‑4 Family
With an allowance recorded:
Recorded investment
Unpaid principal balance
Related allowance
With no related allowance recorded:
284
2,487
497
200
3,468
Total:
515
3,486
Average recorded investment
361
3,726
1,017
5,341
The Company utilizes a numerical risk rating system for commercial relationships. All other types of relationships (ex: residential, consumer, other) are assigned a “Pass” rating, unless they have fallen 90 days past due or more, at which time they receive a rating of 7. The Company uses split ratings for government guaranties on loans. The portion of a loan that is supported by a government guaranty is included with other Pass credits.
The determination of a commercial loan risk rating begins with completion of a matrix, which assigns scores based on the strength of the borrower’s debt service coverage, collateral coverage, balance sheet leverage, industry outlook, and customer concentration. A weighted average is taken of these individual scores to arrive at the overall rating. This rating is subject to adjustment by the loan officer based on facts and circumstances pertaining to the borrower. Risk ratings are subject to independent review.
Commercial borrowers with ratings between 1 and 5 are considered Pass credits, with 1 being most acceptable and 5 being just above the minimum level of acceptance. Commercial borrowers rated 6 have potential weaknesses which may jeopardize repayment ability. Borrowers rated 7 have a well-defined weakness or weaknesses such as the inability to demonstrate significant cash flow for debt service based on analysis of the company’s financial information. These loans remain on accrual status provided full collection of principal and interest is reasonably expected. Otherwise they are deemed impaired and placed on nonaccrual status. Borrowers rated 8 are the same as 7 rated credits with one exception: collection or liquidation in full is not probable.
20
The following table presents total loans by risk ratings and year of origination. Loans acquired from other previously acquired institutions have been included in the table based upon the actual origination date.
Amortized Cost Basis by Origination Year
Revolving
2021
2020
2019
Prior
to Term
Grades 1-4
61,115
139,591
67,111
60,218
11,767
23,074
101,456
464,332
Grade 5
5,069
4,649
13,299
4,484
2,652
3,441
21,456
55,050
Grade 6
203
725
921
1,849
Grade 7
39
163
5,887
804
1,133
2,598
10,675
Grade 8
66,223
144,606
87,022
65,506
14,470
27,648
126,431
Current-period gross charge-offs
45,784
105,640
177,796
125,287
55,462
204,060
52,566
766,595
4,881
18,569
13,968
8,694
7,043
23,604
7,619
84,378
137
1,098
965
427
489
3,233
1,589
8,142
3,906
4,127
10,524
13,370
2,277
43,935
52,254
132,488
196,768
138,225
73,994
241,461
62,951
48,018
102,690
233,310
127,811
73,184
153,717
11,382
750,112
1,042
3,878
13,610
3,720
6,125
28,482
65
369
5,818
554
6,806
49,060
106,568
246,985
131,900
79,109
160,396
37,716
71,328
43,618
5,250
1,872
4,203
1,207
165,194
10,313
16,548
3,434
772
26
194
464
31,751
175
797
982
48,039
87,876
47,052
6,197
1,898
5,194
1,671
88,804
205,155
204,165
163,959
44,299
82,398
77,274
866,054
1,535
2,918
767
378
2,060
332
8,068
160
181
394
102
2,481
172
4,251
90,531
208,467
205,050
165,072
44,779
87,120
77,841
20,383
13,897
7,264
5,157
1,434
1,360
50,512
1,375
347
800
581
1,199
40
9,873
1,891
14,731
1,981
69
326,837
694,702
790,722
513,256
215,724
533,067
283,274
21
The breakdown of loans by risk rating as of December 31, 2022 is as follows:
Pass (1-5)
474,586
3,708
14,156
492,450
665,986
8,031
42,946
716,963
677,303
4,317
681,620
198,581
1,127
199,708
736,146
3,217
739,514
44,961
44,963
18,760
2,816,323
11,890
65,765
On January 1, 2023, the Company adopted ASU 2022-02, which eliminated the accounting guidance for TDRs by creditors and enhanced the disclosure requirements for certain loan modifications to borrowers experiencing financial difficulty. Loans that were both experiencing financial difficulty and were modified during the nine months ended September 30, 2023, were insignificant to these consolidated financial statements. The Company also had no new TDRs during the nine months ended September 30, 2022.
The following tables present loans acquired with deteriorated credit quality and the change in the accretable and non-accretable components of the related discounts prior to the adoption of ASU 2016-13.
Unpaid
Recorded
Principal
Investment
Balance
Commercial & Industrial
712
1,091
2,539
2,843
824
1,045
4,075
4,979
Accretable
Non-accretable
discount
Balance at beginning of period
813
149
Acquired balance, net
292
Reclassifications between accretable and non-accretable
(61)
(135)
Accretion to loan interest income
(476)
(561)
Balance at end of period
690
679
225
22
NOTE 6 – MORTGAGE SERVICING RIGHTS
Loans serviced for others are not included in the accompanying consolidated balance sheets. MSRs are recognized as separate assets when loans sold in the secondary market are sold with servicing retained. The Company utilizes a third-party consulting firm to determine an accurate assessment of the MSRs fair value. The third-party firm collects relevant data points from numerous sources. Some of these data points relate directly to the pricing level or relative value of the mortgage servicing while other data points relate to the assumptions used to derive fair value. In addition, the valuation evaluates specific collateral types, and current and historical performance of the collateral in question. The valuation process focuses on the non-distressed secondary servicing market, common industry practices and current regulatory standards. The primary determinants of the fair value of MSRs are servicing fee percentage, ancillary income, expected loan life or prepayment speeds, discount rates, costs to service, delinquency rates, foreclosure losses and recourse obligations. The valuation data also contains interest rate shock analyses for monitoring fair value changes in differing interest rate environments.
Following is an analysis of activity in the MSR asset:
Fair value at beginning of period
5,016
Servicing asset additions
654
771
Loan payments and payoffs
(1,225)
(918)
Changes in valuation inputs and assumptions used in the valuation model
1,031
3,012
Amount recognized through earnings
2,865
MSR asset acquired
3,691
1,701
Fair value at end of period
Unpaid principal balance of loans serviced for others
1,183,257
866,941
Mortgage servicing rights as a percent of loans serviced for others
1.16
1.11
The primary economic assumptions utilized by the Company in measuring the value of MSRs were constant prepayment speeds of 7.7 and 7.9 months as of September 30, 2023 and December 31, 2022 and discount rates of 10.19% and 10.21% as of each of those periods, respectively.
NOTE 7 – NOTES PAYABLE
From time to time the Company utilizes FHLB advances to fund liquidity. At September 30, 2023 and December 31, 2022, the Company had outstanding balances borrowed from the FHLB of $36.1 million and $1.9 million, respectively. The advances, rate, and maturities of FHLB advances were as follows:
December 31,
Maturity
Rate
Fixed rate, fixed term
06/01/2023
1.79%
807
11/21/2023
3.06%
600
03/23/2026
4.02%
10,000
05/26/2026
1.95%
03/23/2027
3.91%
03/23/2028
3.85%
04/22/2030
0.00%
508
36,108
1,915
Adjustment due to purchase accounting
(261)
Future maturities of borrowings were as follows:
1 year or less
1,407
1 to 2 years
2 to 3 years
15,000
3 to 4 years
4 to 5 years
Over 5 years
As of September 30, 2023, the Company had borrowing availability at the FHLB totaling $773.6 million in addition to the existing borrowings noted in the tables above.
The Company maintains a $7.5 million line of credit with a commercial bank, which was entered into on May 15, 2022. There were no outstanding balances on this note at September 30, 2023 or December 31, 2022. Any future borrowings will require monthly payments of interest at a variable rate, and will be due in full on May 15, 2024.
NOTE 8 – SUBORDINATED NOTES AND JUNIOR SUBORDINATED DEBENTURES
During September 2017, the Company entered into subordinated note agreements with three separate commercial banks. The Company had outstanding balances of $11.5 million under these agreements as of September 30, 2023 and December 31, 2022. These notes were all issued with 10-year maturities, carry interest at a variable rate payable quarterly, are callable on or after the sixth anniversary of the issuance dates, and qualify for Tier 2 capital for regulatory purposes. See Note 14 for information regarding activity related to these notes subsequent to September 30, 2023.
During July 2020, the Company entered into subordinated note agreements with two separate commercial banks. The Company had outstanding balances of $6.0 million under these agreements as of September 30, 2023 and December 31, 2022. These notes were issued with 10-year maturities, carry interest at a fixed rate of 5.0% through June 30, 2025, and at a variable rate thereafter, payable quarterly. These notes are callable on or after January 1, 2026 and qualify for Tier 2 capital for regulatory purposes.
During August 2022, the Company entered into subordinated note agreements with an individual. The Company had outstanding balances of $6.0 million under these agreements as of September 30, 2023. These notes were issued with 10-year maturities, carry interest at a fixed rate of 5.25% through August 6, 2027, and at a variable rate thereafter, payable quarterly. These notes are callable on or after August 6, 2027 and qualify for Tier 2 capital for regulatory purposes.
As a result of the acquisition of Hometown during February 2023, the Company acquired all of the common securities of Hometown’s wholly-owned subsidiaries, Hometown Bancorp, Ltd. Capital Trust I (“Trust I”) and Hometown Bancorp, Ltd. Capital Trust II (“Trust II”). The Company also assumed adjustable rate junior subordinated debentures issued to these trusts. The junior subordinated debentures issued to Trust I and Trust II total $4.1 and $8.2 million, respectively, carry interest at floating rates resetting on each quarterly payment date, and are due on January 7, 2034 and December 15, 2036, respectively. Both junior subordinated debentures are redeemable by the Company, subject to prior approval by the Federal Reserve Bank, on any quarterly payment date. The junior subordinated debentures represent the sole asset of Trust I and Trust II. The trusts are not included in the consolidated financial statements. The net effect of all agreements assumed with respect to Trust I and Trust II is that the Company, through payments on its debentures, is liable for the distributions and other payments required on the trusts’ preferred securities. Trust I and Trust II also provide the Company with $12.0 million in Tier 1 capital for regulatory capital purposes. Interest on all debentures is current. Applicable discounts (initially recorded to carry the acquired debentures at their then estimated fair value) are being accreted to interest expense over the remaining life of the debentures, and total $1.4 million at September 30, 2023.
NOTE 9 – REGULATORY MATTERS
Banks and certain bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.
The Economic Growth, Regulatory Relief, and Consumer Protection Act, signed into law in May 2018 raised the threshold for those bank holding companies subject to the Federal Reserve’s Small Bank Holding Company Policy Statement to $3 billion. As a result, as of the effective date of that change in 2018, the Company was no longer required to comply with the risk-based capital rules applicable to the Bank. The Federal Reserve may, however, require smaller bank holding companies to maintain certain minimum capital levels, depending upon general economic conditions and a bank holding company’s particular condition, risk profile and growth plans. Due to the acquisition of Denmark Bancshares, Inc. (“Denmark”) the Company is subject to compliance with risk-based capital rules beginning with the third quarter of 2022, and will remain so as long as it remains above the $3 billion threshold.
Under regulatory guidance for non-advanced approaches institutions, the Bank is required to maintain minimum amounts and ratios of common equity Tier I capital to risk-weighted assets, including an additional conservation buffer determined by banking regulators. As of September 30, 2023 and December 31, 2022, this buffer was 2.5%. The Bank met all capital adequacy requirements to which they are subject as of September 30, 2023 and December 31, 2022.
Actual and required capital amounts and ratios are presented below at period-end:
To Be Well
Minimum Capital
Capitalized Under
For Capital
Adequacy with
Prompt Corrective
Actual
Adequacy Purposes
Capital Buffer
Action Provisions
Amount
Ratio
Total capital (to risk-weighted assets):
Company
469,931
12.97
%
289,759
8.00
380,309
10.50
362,199
10.00
Bank
432,259
11.94
289,528
380,005
361,909
Tier 1 capital (to risk-weighted assets):
412,915
11.40
217,319
6.00
307,869
8.50
398,743
11.02
217,146
307,623
Common Equity Tier 1 capital (to risk-weighted assets):
400,915
11.07
162,989
4.50
253,539
7.00
235,429
6.50
162,859
253,337
235,241
Tier 1 capital (to average assets):
10.56
156,440
4.00
195,550
5.00
10.20
156,313
195,391
387,814
12.23
253,689
332,967
317,112
372,312
11.75
253,504
332,724
316,880
341,634
10.77
190,267
269,545
349,632
11.03
190,128
269,348
142,700
221,978
206,123
142,596
221,816
205,972
9.69
140,992
176,240
9.93
140,887
176,108
NOTE 10 – COMMITMENTS AND CONTINGENCIES
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate-lock commitments). Rate-lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements and for fixed rate commitments also considers the difference between current levels of interest rates and committed rates. The notional amount of rate-lock commitments at September 30, 2023 and December 31, 2022 was approximately $10.4 million and $3.7 million, respectively.
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual or notional amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments. Since some of the commitments are expected to expire without being drawn upon and some of the commitments may not be drawn upon to the total extent of the commitment, the notional amount of these commitments does not necessarily represent future cash requirements.
The following commitments were outstanding:
Notional Amount
Commitments to extend credit:
Fixed
104,580
120,906
Variable
689,877
539,658
Credit card arrangements
20,213
17,364
Letters of credit
10,537
10,343
NOTE 11 – FAIR VALUE MEASUREMENTS
Accounting guidance establishes a fair value hierarchy to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.
Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices 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.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Information regarding the fair value of assets measured at fair value on a recurring basis is as follows:
Instruments
Markets
Significant
Measured
for Identical
Observable
Unobservable
At Fair
Inputs
(Level 1)
(Level 2)
(Level 3)
Securities available for sale
Mortgage servicing rights
There were no assets measured on a recurring basis using significant unobservable inputs (Level 3) during these periods.
Information regarding the fair value of assets measured at fair value on a non-recurring basis is as follows:
Quoted Prices
In Active
OREO
Loans individually evaluated, net of reserve
12,524
Impaired Loans, net of impairment reserve
3,478
5,998
The following is a description of the valuation methodologies used by the Company for the items noted in the table above, including the general classification of such instruments in the fair value hierarchy. For loans individually evaluated (referred to as impaired loans prior to January 1, 2023), the amount of reserve is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell. The following table shows significant unobservable inputs used in the fair value measurement of Level 3 assets:
Weighted
Range of
Average
Valuation Technique
Discounts
Discount
Other real estate owned
Third party appraisals, sales contracts or brokered price options
Collateral discounts and estimated costs to sell
0
Loans individually evaluated
Third party appraisals and discounted cash flows
Collateral discounts and discount rates
0% - 53
30.9
As of December 31, 2022
Impaired loans
0% - 71
25.5
The carrying value and estimated fair value of financial instruments at September 30, 2023 and December 31, 2022 follows:
Carrying
amount
Level 1
Level 2
Level 3
Financial assets:
Securities held to maturity
3,184,002
Other investments, at cost
Financial liabilities:
3,072,252
2,832,454
2,732,007
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. 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. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Consequently, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
Fair value estimates are made at a specific 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 Company’s entire holdings of a particular instrument. Because no market exists for a significant portion of the Company’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 that could affect the estimates. Fair value estimates are based on existing on- and off-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.
Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the consolidated balance sheet. Significant assets and liabilities that are not considered financial assets and liabilities include premises and equipment. 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 have not been considered in the estimates.
NOTE 12 – STOCK BASED COMPENSATION
The Company has made restricted share grants pursuant to the Bank First Corporation 2011 Equity Plan and the Bank First Corporation 2020 Equity Plan, which replaced the 2011 Plan. The purpose of the Plan is to provide financial incentives for selected employees and for the non-employee Directors of the Company, thereby promoting the long-term growth and financial success of the Company. The number of shares of Company stock that may be issued pursuant to awards under the 2020 Plan shall not exceed, in the aggregate, 700,000. As of September 30, 2023, 76,373 shares of Company stock have been awarded under the 2020 Plan. Compensation expense for restricted stock is based on the fair value of the awards of Bank First Corporation common stock at the time of grant. The value of restricted stock grants that are expected to vest is amortized into expense over the vesting periods. For the nine months ended September 30, 2023 and 2022, compensation expense of $1.6 million and $1.2 million, respectively, was recognized related to restricted stock awards.
29
As of September 30, 2023, there was $2.6 million of unrecognized compensation cost related to non-vested restricted stock awards granted under the plan. That cost is expected to be recognized over a weighted average period of 1.58 years. The aggregate grant date fair value of restricted stock awards that vested during the nine months ended September 30, 2023, was approximately $1.6 million.
For the period ended
Weighted-
Average Grant-
Shares
Date Fair Value
Restricted Stock
Outstanding at beginning of year
59,272
65.85
58,611
61.44
Granted
25,506
80.15
25,451
69.73
Vested
(25,762)
62.05
(20,785)
60.52
Forfeited or cancelled
(820)
65.09
(4,005)
60.50
Outstanding at end of year
58,196
71.42
NOTE 13 – LEASES
Accounting standards require lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements, establishing a right-of-use (“ROU”) model that requires a lessee to recognize a ROU lease asset and liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.
Lessee Leases
The Company’s lessee leases are operating leases, and consist of leased real estate for branches. Options to extend and renew leases are generally exercised under normal circumstances. Advance notification is required prior to termination, and any noticing period is often limited to the months prior to renewal. Rent escalations are generally specified by a payment schedule, or are subject to a defined formula. The Company also elected the practical expedient to not separate lease and non-lease components for all leases, the majority of which consist of real estate common area maintenance expenses. Generally, leases do not include guaranteed residual values, but instead typically specify that the leased premises are to be returned in satisfactory condition with the Company liable for damages.
For operating leases, the lease liability and ROU asset (before adjustments) are recorded at the present value of future lease payments. Accounting standards require the use of the lease interest rate; however, this rate is typically not known. As an alternative, the use of an entity’s fully secured incremental borrowing rate is permitted. The Company is electing to utilize the Wall Street Journal Prime Rate on the date of lease commencement.
(dollars in thousands)
Amortization of ROU Assets - Operating Leases
Interest on Lease Liabilities - Operating Leases
Operating Lease Cost (Cost resulting from lease payments)
73
Weighted Average Lease Term (Years) - Operating Leases
30.25
24.68
Weighted Average Discount Rate - Operating Leases
5.50
30
A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liabilities as of September 30, 2023 is as follows:
Operating lease payments due:
Within one year
After one but within two years
86
After two but within three years
92
After three but within four years
94
After four years but within five years
After five years
3,067
Total undiscounted cash flows
3,518
Discount on cash flows
(1,935)
Total operating lease liabilities
1,583
NOTE 14 – SUBSEQUENT EVENTS
The Bank sold 100% of its member interest in UFS, LLC in a transaction which closed on October 1, 2023. The transaction resulted in proceeds of $52.2 million and a pre-tax gain of $39.3 million which will be realized during the fourth quarter of 2023.
The Bank repaid $11.5 million in subordinated notes on October 2, 2023. These notes were originated during September 2017 and qualified for Tier 2 capital for regulatory purposes.
31
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2022, included in our Annual Report and with our unaudited condensed accompanying notes set forth in this Quarterly Report on Form 10-Q for the quarterly period September 30, 2023.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report are forward-looking statements within the meaning of and subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements relating to the Company’s assets, business, cash flows, condition (financial or otherwise), credit quality, financial performance, liquidity, short and long-term performance goals, prospects, results of operations, strategic initiatives, potential future acquisitions, disposition and other growth opportunities. These statements, which are based upon certain assumptions and estimates and describe the Company’s future plans, results, strategies and expectations, can generally be identified by the use of the words and phrases “may,” “will,” “should,” “could,” “would,” “goal,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target,” “aim,” “predict,” “continue,” “seek,” “projection” and other variations of such words and phrases and similar expressions. These forward-looking statements are not historical facts, and are based upon current expectations, estimates and projections about the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control. The inclusion of these forward-looking statements should not be regarded as a representation by the Company or any other person that such expectations, estimates and projections will be achieved. Accordingly, the Company cautions investors that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict and that are beyond the Company’s control. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable as of the date of this report, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements. A number of factors could cause actual results to differ materially from those contemplated by the forward-looking statement in this report including, without limitation, the risks and other factors set forth in the Company’s Registration Statements under the captions “Cautionary Note Regarding Forward-Looking Statements” and “Risk factors.” Many of these factors are beyond the Company’s ability to control or predict. If one or more events related to these or other risks or uncertainties materialize, or if the Company’s underlying assumptions prove to be incorrect, actual results may differ materially from the forward-looking statements. Accordingly, investors should not place undue reliance on any such forward-looking statements. Any forward-looking statements speaks only as of the date of this report, and the Company does not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by law. New risks and uncertainties may emerge from time to time, and it is not possible for the Company to predict their occurrence or how they will affect the Company.
We qualify all of our forward-looking statements by these cautionary statements.
OVERVIEW
Bank First Corporation is a Wisconsin corporation that was organized primarily to serve as the holding company for Bank First, N.A. Bank First, N.A., which was incorporated in 1894, is a nationally-chartered bank headquartered in Manitowoc, Wisconsin. It is a member of the Board of Governors of the Federal Reserve System (“Federal Reserve”), and is regulated by the Office of the Comptroller of the Currency (“OCC”). Including its headquarters in Manitowoc, Wisconsin, the Bank has twenty-six banking locations in Manitowoc, Outagamie, Brown, Winnebago, Sheboygan, Shawano, Waupaca, Ozaukee, Monroe, Fond du Lac, Waushara, Dane, Columbia and Jefferson counties in Wisconsin. The Bank offers loan, deposit and treasury management products at each of its banking locations.
As with most community banks, the Bank derives a significant portion of its income from interest received on loans and investments. The Bank’s primary source of funding is deposits, both interest-bearing and noninterest-bearing. In order to maximize the Bank’s net interest income, or the difference between the income on interest-earning assets and the expense of interest-bearing liabilities, the Bank must not only manage the volume of these balance sheet items, but also the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities. To account for credit risk inherent in all loans, the Bank maintains an ACL - Loans to absorb possible losses on existing loans that may become uncollectible. The Bank establishes and maintains this allowance by charging a provision for loan losses against operating earnings. Beyond its net interest income, the Bank further receives income through the net gain on sale of loans held for sale as well as servicing income which is retained on those sold loans. In order to maintain its operations and bank locations, the Bank incurs various operating expenses which are further described within the “Results of Operations” later in this section.
As of September 30, 2023, the Bank was a 49.8% member of a data processing subsidiary, UFS, which provides core data processing, endpoint management, private cloud services, cyber security and digital banking solutions for over 60 Midwest banks. The Bank sold 100% of its member interest in UFS on October 1, 2023. The Bank, through its 100% owned subsidiary TVG Holdings, Inc., also holds a 40% ownership interest in Ansay, an insurance agency providing clients throughout Wisconsin with insurance and risk management solutions. These unconsolidated subsidiary interests have historically contributed noninterest income to the Bank through their underlying annual earnings.
On August 12, 2022, the Company consummated its merger with Denmark pursuant to the Agreement and Plan of Bank Merger, dated as of January 18, 2022, by and among the Company and Denmark, whereby Denmark was merged with and into the Company, and Denmark State Bank, Denmark’s wholly owned banking subsidiary, was merged with and into the Bank. The system integration was completed, and five branches of Denmark State Bank opened on August 15, 2022 as a branch of the Bank, expanding the Bank’s presence in Manitowoc, Brown, Outagamie and Shawano County.
On February 10, 2023, the Company consummated its merger with Hometown pursuant to the Agreement and Plan of Bank Merger, dated as of July 25, 2022, by and among the Company and Hometown, whereby Hometown was merged with and into the Company, and Hometown Bank, Hometown’s wholly owned banking subsidiary, was merged with and into the Bank. The system integration was completed, and six branches of Hometown Bank opened on February 13, 2023 as branches of the Bank, expanding the Bank’s presence in Fond du Lac, Columbia, Dane and Waushara County.
The Company accounts for these transactions under the acquisition method of accounting, and thus, the financial position and results of operations of acquired institutions prior to the consummation date are not included in the accompanying consolidated financial statements. The acquisition method of accounting required assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition. The Company determines the fair value of core deposit intangibles, securities, premises and equipment, loans, other assets and liabilities, deposits and borrowings with the assistance of third party valuations, appraisals, and third party advisors. The estimated fair values are subject to refinement for up to one year after the consummation as additional information becomes available relative to the closing date fair values.
33
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following tables present certain selected historical consolidated financial data as of the dates or for the period indicated:
At or for the Three Months Ended
At or for the Nine Months Ended
(In thousands, except per share data)
9/30/2023
6/30/2023
3/31/2023
12/31/2022
9/30/2022
Results of Operations:
Interest income
45,929
40,902
35,754
Interest expense
11,657
8,668
5,132
34,272
32,234
30,622
Provision for credit losses (1)
500
Net interest income after provision for credit losses (1)
28,052
30,122
Noninterest income
4,554
5,849
3,896
Noninterest expense
19,946
19,664
17,254
Income before income tax expense
18,880
14,237
16,764
Income tax expense
4,748
3,557
3,920
12,844
Earnings per common share - basic
1.37
1.09
Earnings per common share - diluted
Common Shares:
Basic weighted average
10,331,725
9,714,184
8,962,400
Diluted weighted average
10,346,575
9,737,879
8,993,685
Outstanding
10,379,071
10,389,240
10,407,114
9,021,697
9,028,629
Noninterest income / noninterest expense:
1,766
1,599
1,564
Income from Ansay
950
1,071
242
Income from UFS
770
890
935
749
636
545
Valuation adjustment on mortgage servicing rights
(548)
779
236
140
222
Other noninterest income
631
Personnel expense
9,870
9,912
8,162
Occupancy, equipment and office
1,317
1,591
1,962
2,094
1,864
1,971
Postage, stationery and supplies
380
Net gain (loss) on sales and valuations of other real estate owned
Net loss on sales of securities
81
66
228
223
165
1,347
2,202
1,631
1,422
980
Other noninterest expense
2,620
2,088
Period-end balances:
111,326
169,691
119,350
Investment securities available-for-sale, at fair value
191,303
197,895
303,280
Investment securities held-to-maturity, at cost
77,708
78,032
40,826
3,314,481
3,323,296
2,859,293
Allowance for credit losses - loans (1)
(43,409)
(43,316)
(23,045)
Premises and equipment
66,958
63,736
57,019
Goodwill and other intangibles, net
203,705
205,329
207,022
127,036
129,361
Mortgage Servicing Rights
13,504
14,052
9,563
Other Assets
154,966
154,871
156,820
126,984
121,016
Total assets
4,092,071
4,167,228
3,640,754
3,405,736
3,463,235
3,138,201
23,802
46,636
21,963
Borrowings
70,319
70,269
25,429
26,069
21,392
23,991
15,106
3,521,199
3,604,856
3,201,339
Stockholders’ equity
Book value per common share
55.62
54.95
54.04
50.22
48.67
Tangible book value per common share (2)
36.00
35.18
34.14
36.14
34.34
34
Average balances:
3,324,729
3,312,353
3,135,438
2,860,967
2,640,397
3,258,199
2,419,451
Interest-earning assets
3,671,620
3,683,143
3,524,672
3,316,406
3,062,921
3,627,015
3,013,382
4,092,565
4,100,549
3,901,713
3,633,251
3,349,615
4,032,308
3,249,469
3,423,760
3,407,650
3,269,838
3,111,328
2,911,561
3,367,647
2,675,199
Interest-bearing liabilities
2,411,062
2,437,034
2,334,956
2,198,549
2,034,158
2,394,630
2,055,732
204,556
206,209
160,156
111,440
90,962
190,470
69,861
576,315
567,531
520,212
446,579
401,130
554,892
347,442
Financial ratios (3):
Return on average assets
1.44
1.38
1.40
1.25
1.31
1.33
Return on average common equity
10.19
9.99
8.33
11.41
10.42
9.55
12.46
Average equity to average assets
14.08
13.84
13.33
12.29
11.98
13.76
10.69
Stockholders’ equity to assets
14.12
13.95
13.50
12.38
12.07
Tangible equity to tangible assets (2)
9.62
9.40
8.97
9.23
8.83
Loan yield
5.23
5.20
4.96
4.58
4.29
5.13
4.13
Earning asset yield
5.11
5.04
4.74
4.32
4.03
4.97
3.63
Cost of funds
2.13
1.92
1.51
0.93
0.59
1.86
0.48
Net interest margin, taxable equivalent
3.71
3.77
3.74
3.30
Net loan charge-offs to average loans
(0.01)
0.00
0.12
(0.05)
(0.04)
Nonperforming loans to total loans
0.10
0.15
0.14
0.17
Nonperforming assets to total assets
0.13
0.18
0.22
Allowance for credit losses - loans to total loans (1)
1.29
1.30
0.78
0.81
GAAP RECONCILIATION AND MANAGEMENT EXPLANATION OF NON-GAAP FINANCIAL MEASURES
We identify certain financial measures discussed in the Report as being “non-GAAP financial measures.” The non-GAAP financial measures presented in this Report are tangible book value per common share and tangible equity to tangible assets.
In accordance with the SEC’s rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows.
The non-GAAP financial measures that we discuss in this Report should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in our selected historical consolidated financial data may differ from that of other companies reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have presented in our selected historical consolidated financial data when comparing such non-GAAP financial measures. The following discussion and reconciliations provide a more detailed analysis of these non-GAAP financial measures.
Tangible book value per common share and tangible equity to tangible assets are non-GAAP measures that exclude the impact of goodwill and other intangibles used by the Company’s management to evaluate capital adequacy. Because intangible assets such as goodwill and other intangibles vary extensively from company to company, we believe that the presentation of this information allows investors to more easily compare the Company’s capital position to other companies. The most directly comparable financial measures calculated in accordance with GAAP are book value per common share, return on average common equity and stockholders’ equity to total assets.
Tangible Assets
Adjustments:
(175,106)
(175,104)
(175,125)
(110,206)
(111,551)
Core deposit intangible, net of amortization
(28,599)
(30,225)
(31,897)
(16,829)
(17,810)
Tangible assets
3,883,814
3,886,742
3,960,206
3,533,397
3,511,393
Tangible Common Equity
Tangible common equity
373,624
365,543
355,350
326,068
310,054
Tangible book value per common share
Total stockholders’ equity to total assets
Tangible common equity to tangible assets
RESULTS OF OPERATIONS
Results of Operations for the Three Months Ended September 30, 2023 and September 30, 2022
General. Net income increased $4.3 million to $14.8 million for three months ended September 30, 2023, compared to $10.5 million for the same period in 2022. This increase was primarily due to the added scale of operations resulting from the Hometown acquisition during the first quarter of 2023. The third quarter of 2022 was also negatively impacted by $4.6 million in acquisition related expenses, compared to $0.3 million during the third quarter of 2023.
Net Interest Income. The management of interest income and expense is fundamental to our financial performance. Net interest income, the difference between interest income and interest expense, is the largest component of the Company’s total revenue. Management closely monitors both total net interest income and the net interest margin (net interest income divided by average earning assets). We seek to maximize net interest income without exposing the Company to an excessive level of interest rate risk through our asset and liability policies. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. Our net interest margin can also be adversely impacted by the reversal of interest on nonaccrual loans and the reinvestment of loan payoffs into lower yielding investment securities and other short-term investments.
Net interest and dividend income increased by $6.4 million to $34.1 million for the three months ended September 30, 2023 compared to $27.7 million for three months ended September 30, 2022. The increase in net interest income was primarily due to growth in interest earning assets over the last twelve months, resulting from the acquisition of Hometown, as well as increasing net interest margin in the year-over-year third quarters. Total average interest-earning assets were $3.67 billion for the three months ended September 30, 2023, up from $3.06 billion for the same period in 2022. Tax equivalent net interest margin increased 0.08% to 3.71% for the three months ended September 30, 2023, up from 3.63% for the same period in 2022. Net interest margin and net interest income are influenced by internal and external factors. Internal factors include balance sheet changes on both volume and mix and pricing decisions, and external factors include changes in market interest rates, competition and the shape of the interest rate yield curve.
Interest Income. Total interest income increased $16.2 million, or 52.9%, to $47.0 million for the three months ended September 30, 2023 compared to $30.7 million for the same period in 2022. The increase in total interest income was primarily due to the aforementioned growth in interest earnings assets over the last twelve months along with an increase in the average interest rate earned on these assets. The average balance of interest-earning assets increased by $608.7 million during the three months ended September
36
30, 2023 compared to the same period in 2022 and the average interest rate earned on these assets increased by 1.08% in the year-over-year third quarters.
Interest Expense. Interest expense increased $9.9 million, or 324.4%, to $12.9 million for the three months ended September 30, 2023 compared to $3.0 million for the same period in 2022. The increase in interest expense was primarily due to elevated interest bearing liabilities and higher crediting interest rates on those liabilities.
Interest expense on interest-bearing deposits increased by $9.0 million to $11.6 million for the three months ended September 30, 2023 compared to $2.6 million for the same period in 2022. The average balance and cost of interest-bearing deposits was $2.32 billion and 1.99% for the three months ended September 30, 2023, compared to $2.0 million and 0.52% for the same period in 2022.
Provision for Credit Losses. Credit risk is inherent in the business of making loans. We establish an allowance for credit losses through charges to earnings, which are shown in the statements of operations as the provision for credit losses. Specifically identifiable and quantifiable known losses are promptly charged off against the allowance. The provision for credit losses is determined by conducting a quarterly evaluation of the adequacy of our allowance for credit losses and charging the shortfall or excess, if any, to the current quarter’s expense. This has the effect of creating variability in the amount and frequency of charges to earnings. The provision for credit losses and level of allowance for each period are dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in our market area. The determination of the amount is complex and involves a high degree of judgment and subjectivity.
We did not record a provision for credit loss during the three months ended September 30, 2023 or 2022. Economic forecasts, primarily US gross domestic product and unemployment projections, were little changed during the third quarter of 2023 resulting in consistent qualitative factors in the CECL methodology. We recorded negligible net recoveries during the three months ended September 30, 2023 compared to net recoveries of $0.3 million for the three months ended September 30, 2022. Metrics regarding the credit quality of the Bank’s loan portfolio continue to show very little in terms of stress. The ACL - Loans was $43.4 million, or 1.29% of total loans, at September 30, 2023 compared to $23.0 million, or 0.81% of total loans at September 30, 2022. The increased ACL - Loans coverage was the result of adopting the CECL methodology as of January 1, 2023.
Noninterest Income. Noninterest income is an important component of our total revenues. A significant portion of our noninterest income has historically been associated with service charges and income from the Bank’s unconsolidated subsidiaries, Ansay and UFS. Other sources of noninterest income include loan servicing fees and gains on sales of mortgage loans.
Noninterest income increased $0.1 million to $5.3 million for the three months ended September 30, 2023 compared to $5.2 million for the same period in 2022. While total noninterest income was little changed in the year-over-year third quarters, components of noninterest income did show variability. Service charges and loan servicing income increased $0.4 million and $0.2 million, respectively, in the third quarter of 2023 compared to the third quarter of 2022 primarily due to the added scale from the acquisitions of Denmark and Hometown. These increases were offset by a $0.7 million reduction in positive valuation adjustments of MSRs, from $0.9 million during the third quarter of 2022 to $0.2 million during the third quarter of 2023.
The major components of our noninterest income are listed below:
The major components of our noninterest income are listed below:The major components of our noninterest income are listed below:
$ Change
% Change
(in thousands)
(In thousands)
Noninterest Income
438
120
(68)
49
(656)
(74)
(16)
(6)
Noninterest Expense. Noninterest expense increased $0.7 million to $19.6 million for the three months ended September 30, 2023 compared to $18.9 million for the same period in 2022. Most areas of noninterest expense increased over the past four quarters as a result of added operational scale from the acquisition of Hometown, which increased the total assets, branch footprint and employee count of the Company. In addition to this trend, core deposit intangible assets of $15.1 million and $16.5 million created by the Denmark and Hometown acquisitions, respectively, created a significant increase in amortization of intangible assets expense from the third quarter of 2022 to the third quarter of 2023. Counteracting these increases were one-time acquisition costs related to the acquisition of Denmark during the third quarter of 2022, primarily in the areas of salaries and outside service fees, which existed in the third quarter of 2022 but were not repeated during the third quarter of 2023.
The major components of our noninterest expense are listed below:
Noninterest Expense
(596)
279
576
Postage, stationary, and supplies
Net loss on sales and valuations of other real estate owned
NM
79
(1,100)
(43)
875
558
Total noninterest expenses
752
Income Tax Expense. We recorded a provision for income taxes of $4.9 million for the three months ended September 30, 2023 compared to a provision of $3.4 million for the same period during 2022, reflecting effective tax rates of 24.7% and 24.6%, respectively. The effective tax rates were reduced from the statutory federal and state income tax rates during both periods as a result of tax-exempt interest income produced by certain qualifying loans and investments in the Bank’s portfolios. On July 5, 2023, Wisconsin passed its 2023 state budget which included a provision exempting income earned from commercial loans of $5.0 million or less from state taxability. As a result of this provision, which was retroactive to the beginning of 2023, the Company was able to reverse $2.4 million state related income tax expense which had been recorded during the first two quarters of 2023. Also as a result of this provision, the Company’s lower anticipated future effective tax rate required an allowance to be made against the Bank’s deferred tax asset, which increased income tax expense by $2.9 million. The net impact of these entries was a one-time increase to income tax expense of $0.5 million during the third quarter of 2023.
Results of Operations for the Nine months Ended September 30, 2023 and September 30, 2022
General. Net income increased $7.2 million to $39.6 million for nine months ended September 30, 2023, compared to $32.4 million for the same period in 2022. This increase was primarily due to the added scale of operations resulting from the Denmark and Hometown acquisitions during the third quarter of 2022 and first quarter of 2023, respectively.
38
Net interest and dividend income increased by $27.1 million to $100.6 million for the nine months ended September 30, 2023 compared to $73.5 million for nine months ended September 30, 2022. The increase in net interest income was primarily due to growth in interest earning assets over the last twelve months, resulting from the acquisitions of Denmark and Hometown, as well as increasing net interest margin in the first nine months of 2023 compared to the same period in 2022. Total average interest-earning assets were $3.63 billion for the nine months ended September 30, 2023, up from $3.01 billion for the same period in 2022. Tax equivalent net interest margin increased 0.44% to 3.74% for the nine months ended September 30, 2023, up from 3.30% for the same period in 2022. Net interest margin and net interest income are influenced by internal and external factors. Internal factors include balance sheet changes on both volume and mix and pricing decisions, and external factors include changes in market interest rates, competition and the shape of the interest rate yield curve.
Interest Income. Total interest income increased $53.0 million, or 65.7%, to $133.8 million for the nine months ended September 30, 2023 compared to $80.8 million for the same period in 2022. The increase in total interest income was primarily due to the aforementioned growth in interest earnings assets over the last twelve months along with an increase in the average interest rate earned on these assets. The average balance of interest-earning assets increased by $613.6 million during the first nine months of 2023 compared to the same period in 2022 and the average interest rate earned on these assets increased by 1.34% from 3.63% for the first three quarters of 2022 to 4.97% during the first three quarters of 2023.
Interest Expense. Interest expense increased $26.0 million, or 354.5%, to $33.3 million for the nine months ended September 30, 2023 compared to $7.3 million for the same period in 2022. The increase in interest expense was primarily due to elevated interest bearing liabilities and higher crediting interest rates on those liabilities. The average balance of interest-bearing liabilities increased by $338.9 million during the first nine months of 2023 compared to the same period in 2022 and the average interest rate paid on these balances was 0.48% for the first three quarters of 2022 compared to 1.86% for the first three quarters of 2023.
Interest expense on interest-bearing deposits totaled $29.2 million and $5.9 million for the nine months ended September 30, 2023 and 2022, respectively. The average cost of interest-bearing deposits was 1.70% for the nine months ended September 30, 2023, compared to 0.43% for the same period in 2022.
We recorded a provision for credit losses of $4.2 million for the nine months ended September 30, 2023 compared to $1.7 million for the same period in 2022. The increased provision for the first nine months of 2023 was primarily related to loans acquired from Hometown. Economic forecasts, primarily US gross domestic product and unemployment projections, were little changed during the first three quarters of 2023 resulting in consistent qualitative factors in the CECL methodology. We recorded net recoveries of $0.1 million for the nine months ended September 30, 2023 compared to net recoveries of $1.0 million for the same period in 2022. The ACL was $43.4 million, or 1.29% of total loans, at September 30, 2023 compared to $23.0 million, or 0.81% of total loans at September 30, 2022. The increased ACL coverage was the result of CECL implementation.
Noninterest income decreased $0.1 million to $15.7 million for the nine months ended September 30, 2023 compared to $15.8 million for the same period in 2022. While total noninterest income was little changed in the year-over-year first nine months, components of noninterest income did show variability. Service charges and loan servicing income increased $1.0 million and $0.7 million, respectively, for the first nine months of 2023 compared to the same period in 2022 primarily due to the added scale from the acquisitions of Denmark and Hometown. These increases were offset by a $2.3 million reduction in positive valuation adjustments of MSRs, from $2.8 million during the first nine months of 2022 to $0.5 million during the first nine months of 2023. Finally, net gains
on the sale of mortgage loans saw a significant decline period-over-period due to an industry wide slowdown in residential mortgage lending due in part to a higher interest rate environment during the first nine months of 2023 compared to the same period in 2022.
Service Charges
940
496
324
Loan Servicing income
742
54
(2,386)
(84)
(714)
(53)
450
(148)
Noninterest Expense. Noninterest expense increased $14.6 million to $59.3 million for the nine months ended September 30, 2023 compared to $44.7 million for the same period in 2022. Most areas of noninterest expense increased over the past four quarters as a result of added operational scale from the acquisitions of Denmark and Hometown. Expenses related to these acquisitions totaled $5.7 million during the first nine months of 2022 compared to $1.8 million during the first nine months of 2023 which muted the increase year-over-year in salaries and led to a slight decrease year-over-year in outside service fees. Core deposit intangible assets of $15.1 million and $16.5 million created by the Denmark and Hometown acquisitions, respectively, created a significant increase in amortization of intangible assets expense from the first three quarters of 2022 to the first three quarters of 2023. Finally, losses on sales of ORE totaling $0.5 million during the first three quarters of 2023 compared unfavorably to gains of $0.1 million during the first three quarters of 2022.
5,005
858
1,758
306
56
Net loss (gain) on sales and valuations of other real estate owned
688
(471)
127
(109)
3,382
253
2,447
57
14,558
Income Tax Expense. We recorded a provision for income taxes of $13.2 million for the nine months ended September 30, 2023 compared to a provision of $10.5 million for the same period during 2022, reflecting effective tax rates of 24.9% and 24.6%, respectively. The effective tax rates were reduced from the statutory federal and state income tax rates during both periods as a result of tax-exempt interest income produced by certain qualifying loans and investments in the Bank’s portfolios. The 2023 Wisconsin state budget included a provision exempting income earned from commercial loans of $5.0 million or less from state taxability. As a result of this provision, the Company’s lower anticipated future effective tax rate required an allowance to be made against the Bank’s deferred tax asset, which increased income tax expense by $2.9 million. This required allowance offset the lower effective tax rate on current earnings, leading to comparable effective tax rates through the first nine months of 2023 and 2022.
NET INTEREST MARGIN
Net interest income represents the difference between interest earned, primarily on loans and investments, and interest paid on funding sources, primarily deposits and borrowings. Interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate paid on total interest-bearing liabilities. Net interest margin is the amount of net interest income, on a fully taxable-equivalent basis, expressed as a percentage of average interest-earning assets. The average rate earned on earning assets is the amount of annualized taxable-equivalent interest income expressed as a percentage of average earning assets. The average rate paid on interest-bearing liabilities is equal to annualized interest expense as a percentage of average interest-bearing liabilities.
The following tables set forth the distribution of our average assets, liabilities and stockholders’ equity, and average rates earned or paid on a fully taxable equivalent basis for each of the periods indicated:
Income/
Rate Earned/ Paid
Expenses (1)
ASSETS
Loans (2)
3,219,654
169,083
5.25
2,545,855
109,147
105,075
4,691
4.46
94,542
4,227
4.47
Taxable (available for sale)
176,363
6,933
3.93
240,261
5,453
2.27
Tax-exempt (available for sale)
33,629
1,111
81,355
2,143
2.63
Taxable (held to maturity)
73,007
2,595
3.55
31,014
853
2.75
Tax-exempt (held to maturity)
109
5,196
2.58
59,740
3,140
5.26
64,698
1,366
2.11
Total interest-earning assets
187,662
123,323
Non interest-earning assets
464,357
309,925
Allowance for credit losses - loans
(43,412)
(23,231)
LIABILITIES AND SHAREHOLDERS’ EQUITY
Checking accounts
294,961
5,762
1.95
262,003
1,359
0.52
Savings accounts
838,980
10,753
1.28
750,027
3,224
0.43
Money market accounts
661,274
13,582
2.05
682,260
2,957
525,609
16,075
3.06
297,622
2,725
0.92
Brokered deposits
874
2.29
6,781
199
2.93
Total interest-bearing deposits
2,321,698
46,192
1.99
1,998,693
10,464
Other borrowed funds
89,364
5,108
5.72
35,465
1,625
Total interest-bearing liabilities
51,300
12,089
Non-interest bearing liabilities
Demand deposits
1,102,062
912,868
3,126
1,459
3,516,250
2,948,485
Shareholders’ equity
Total liabilities & shareholders’ equity
Net interest income on a fully taxable equivalent basis
136,362
111,234
Less taxable equivalent adjustment
(1,241)
(1,366)
135,121
109,868
Net interest spread (3)
2.98
3.43
Net interest margin (4)
41
Earned/
Paid (1)
3,155,397
162,543
5.15
2,323,410
95,783
4.12
102,802
4,629
96,041
4,215
4.39
199,164
6,234
3.13
223,506
5,180
2.32
38,310
1,218
3.18
81,067
2,126
2.62
66,895
2,407
3.60
19,685
524
2.66
4,518
2.59
5,464
141
59,929
3,021
264,209
1,395
0.53
180,169
109,364
446,437
258,122
Allowance for loan losses
(41,144)
(22,035)
294,753
5,145
1.75
244,615
0.28
839,459
9,372
1.12
643,841
2,494
0.39
664,758
11,883
1.79
679,091
2,343
0.35
491,544
12,495
2.54
255,197
2,147
0.84
4,005
2.87
9,217
269
2.92
2,294,519
39,010
1.70
1,831,961
7,941
100,111
5.45
223,771
1,842
0.82
44,463
9,783
1,073,128
843,238
9,658
3,057
3,477,416
2,902,027
Total liabilities & shareholders' equity
135,706
99,581
(1,252)
(1,361)
134,454
98,220
3.11
3.15
42
Rate/Volume Analysis
The following tables describe the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volumes (changes in average balance multiplied by prior year average rate) and (ii) changes attributable to changes in rate (change in average interest rate multiplied by prior year average balance), while (iii) changes attributable to the combined impact of volumes and rates have been allocated proportionately to separate volume and rate categories.
Three Months Ended September 30, 2023
Nine Months Ended September 30, 2023
Compared with
Three Months Ended September 30, 2022
Nine Months Ended September 30, 2022
Increase/(Decrease) Due to Change in
Volume
32,400
27,536
59,936
39,343
27,417
66,760
470
302
112
414
Taxable (AFS)
(1,733)
3,213
1,480
(611)
1,665
1,054
Tax-exempt (AFS)
(1,480)
(1,032)
(1,291)
383
(908)
Taxable (HTM)
1,433
309
1,742
1,642
241
1,883
Tax-exempt (HTM)
(24)
(112)
1,886
1,774
(1,843)
3,469
30,951
33,388
64,339
37,518
33,287
70,805
4,211
4,403
169
4,457
425
7,104
7,529
956
5,922
6,878
(94)
10,719
10,625
(50)
9,590
9,540
3,292
10,058
13,350
3,251
7,097
10,348
Brokered Deposits
(143)
(36)
(179)
(150)
(4)
(154)
Total interest bearing deposits
3,672
32,056
35,728
4,176
26,893
31,069
2,995
488
3,483
(1,530)
5,141
3,611
6,667
32,544
39,211
2,646
32,034
34,680
Change in net interest income
24,284
844
25,128
34,872
1,253
36,125
CHANGES IN FINANCIAL CONDITION
Total Assets. Total assets increased $427.1 million, or 11.7%, to $4.09 billion at September 30, 2023, from $3.66 billion at December 31, 2022.
Cash and Cash Equivalents. Cash and cash equivalents decreased by $43.6 million to $75.8 million at September 30, 2023 from $119.4 million at December 31, 2022.
Investment Securities. The carrying value of total investment securities decreased by $93.5 million to $256.2 million at September 30, 2023, from $349.7 million at December 31, 2022. This decline was primarily the result of significant maturities of securities in the Bank’s portfolio, as well as sales of approximately $34.2 million of securities, during the first quarter of 2023. Proceeds of these maturities and sales were utilized to fund loan growth and compensate for declining deposit balances through the first three quarters of 2023.
Loans. Net loans increased by $440.8 million, totaling $3.31 billion at September 30, 2023 compared to $2.87 billion at December 31, 2022. The fair value of loans acquired as part of the acquisition of Hometown during the first quarter of 2023 totaled $395.8 million.
43
Bank-Owned Life Insurance. At September 30, 2023, our investment in bank-owned life insurance was $60.9 million, an increase of $14.8 million from $46.1 million at December 31, 2022.
Deposits. Deposits increased $338.1 million, or 11.0%, to $3.40 billion at September 30, 2023 from $3.06 billion at December 31, 2022. The fair value of deposits acquired as part of the acquisition of Hometown during the first quarter of 2023 totaled $532.4 million.
Borrowings. At September 30, 2023, borrowings consisted of advances from the FHLB of Chicago, junior subordinated debentures, and subordinated debt to other banks and an individual. FHLB borrowings increased to $35.8 million at September 30, 2023, from $1.9 million at December 31, 2022. Junior subordinated debentures, all of which resulted from the acquisition of Hometown, totaled $11.0 million at September 30, 2023. Subordinated debt remained stable with $23.5 million at September 30, 2023 and December 31, 2022.
Stockholders’ Equity. Total stockholders’ equity increased $124.2 million, or 27.4%, to $577.3 million at September 30, 2023, from $453.1 million at December 31, 2022. The primary driver of this increase was the Hometown acquisition, which added $115.1 million to stockholders’ equity.
LOANS
Our lending activities are conducted principally in Wisconsin. The Bank makes commercial and industrial loans, commercial real estate loans, construction and development loans, residential real estate loans, and a variety of consumer loans and other loans. Much of the loans made by the Bank are secured by real estate collateral. The Bank’s commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower, with liquidation of the underlying real estate collateral typically being viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are also often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment. Repayment of the Bank’s residential loans are generally dependent on the health of the employment market in the borrowers’ geographic areas and that of the general economy with liquidation of the underlying real estate collateral being typically viewed as the primary source of repayment in the event of borrower default.
Our loan portfolio is our most significant earning asset, comprising 82.1% and 79.1% of our total assets as of September 30, 2023 and December 31, 2022, respectively. Our strategy is to grow our loan portfolio by originating quality commercial and consumer loans that comply with our credit policies and that produce revenues consistent with our financial objectives. We believe our loan portfolio is well-balanced, which provides us with the opportunity to grow while monitoring our loan concentrations.
Loans increased $461.6 million, or 15.9%, to $3.36 billion as of September 30, 2023 as compared to $2.89 billion as of December 31, 2022. This increase during the first nine months of 2023 was primarily driven by the acquisition of Hometown, which included approximately $395.8 million in loan balances, and has been comprised of an increase of $38.9 million or 7.9% in commercial and industrial loans, an increase of $180.5 million or 25.2% in owner occupied commercial real estate loans, an increase of $103.6 million or 15.2% in non-owner occupied commercial real estate, a decrease of $2.6 million or 1.3% in construction and development loans, an increase of $139.5 million or 18.9% in residential 1-4 family loans and an increase of $1.7 million in consumer and other loans.
The following table presents the balance and associated percentage of each major category in our loan portfolio at September 30, 2023, December 31, 2022, and September 30, 2022:
% of Total
Commercial & industrial
531,368
486,696
Commercial real estate
Owner occupied
897,439
723,524
Non-owner occupied
785,183
668,337
Construction & development
197,095
209,270
879,033
706,956
50,729
44,113
Other loans
14,702
19,171
2,858,067
Our directors and officers and their associates are customers of, and have other transactions with, the Bank in the normal course of business. All loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than normal risk of collection or present other unfavorable features. At September 30, 2023 and December 31, 2022, total loans outstanding to such directors and officers and their associates were $64.3 million and $70.2 million, respectively. During the nine months ended September 30, 2023, $21.0 million of additions and $26.9 million of repayments were made to these loans. At September 30, 2023 and December 31, 2022, all of the loans to directors and officers were performing according to their original terms.
Loan categories
The principal categories of our loan portfolio are discussed below:
Commercial and Industrial (C&I). Our C&I portfolio totaled $531.4 million and $492.5 million at September 30, 2023 and December 31, 2022, respectively, and represented 16% and 17% of our total loans at those dates.
Our C&I loan customers represent various small and middle-market established businesses involved in professional services, accommodation and food services, health care, financial services, wholesale trade, manufacturing, distribution, retailing and non-profits. Most clients are privately owned with markets that range from local to national in scope. Many of the loans to this segment are secured by liens on corporate assets and the personal guarantees of the principals. The regional economic strength or weakness impacts the relative risks in this loan category. There is little concentration in any one business sector, and loan risks are generally diversified among many borrowers.
Commercial Real Estate (CRE). Our CRE loan portfolio totaled $1.68 billion and $1.40 billion at September 30, 2023 and December 31, 2022, respectively, and represented 50% and 48% of our total loans at those dates.
Our CRE loans are secured by a variety of property types including multifamily dwellings, retail facilities, office buildings, commercial mixed use, lodging and industrial and warehouse properties. We do not have any specific industry or customer concentrations in our CRE portfolio. Our commercial real estate loans are generally for terms up to ten years, with loan-to-values that generally do not exceed 80%. Amortization schedules are long term and thus a balloon payment is generally due at maturity. Under most circumstances, the Bank will offer to rewrite or otherwise extend the loan at prevailing interest rates.
Construction and Development (C&D). Our C&D loan portfolio totaled $197.1 million and $199.7 million at September 30, 2023 and December 31, 2022, respectively, and represented 6% and 7% of our total loans at those dates.
Our C&D loans are generally for the purpose of creating value out of real estate through construction and development work, and also include loans used to purchase recreational use land. Borrowers typically provide a copy of a construction or development contract which is subject to bank acceptance prior to loan approval. Disbursements are handled by a title company. Borrowers are required to inject their own equity into the project prior to any note proceeds being disbursed. These loans are, by their nature, intended to be short term and are refinanced into other loan types at the end of the construction and development period.
Residential 1 – 4 Family. Residential 1 – 4 family loans held in portfolio amounted to $879.0 million and $739.5 million at September 30, 2023 and December 31, 2022, respectively, and represented 26% and 25% of our total loans at those dates.
We offer fixed and adjustable-rate residential mortgage loans with maturities up to 30 years. One-to-four family residential mortgage loans are generally underwritten according to Fannie Mae guidelines, and we refer to loans that conform to such guidelines as “conforming loans.” We generally originate both fixed and adjustable-rate mortgage loans in amounts up to the maximum conforming loan limits as established by the Federal Housing Finance Agency, which is generally $726,200 for one-unit properties. In addition, we also offer loans above conforming lending limits typically referred to as “jumbo” loans. These loans are typically underwritten to the same guidelines as conforming loans; however, we may choose to hold a jumbo loan within its portfolio with underwriting criteria that does not exactly match conforming guidelines.
We do not offer reverse mortgages nor do we offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on his loan, resulting in an increased principal balance during the life of the loan. We also do not offer “subprime loans” (loans that are made with low down payments to borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (defined as loans having less than full documentation).
Residential real estate loans are originated both for sale to the secondary market as well as for retention in the Bank’s loan portfolio. The decision to sell a loan to the secondary market or retain within the portfolio is determined based on a variety of factors including but not limited to our asset/liability position, the current interest rate environment, and customer preference. Servicing rights are retained on all loans sold to the secondary market.
We were servicing mortgage loans sold to others without recourse of approximately $1.2 billion at September 30, 2023 and $866.9 million at December 31, 2022.
Loans sold with the retention of servicing assets result in the capitalization of servicing rights. Loan servicing rights are carried at fair value. The net balance of capitalized servicing rights amounted to $13.7 million and $9.6 million at September 30, 2023 and December 31, 2022, respectively.
Consumer Loans. Our consumer loan portfolio totaled $50.7 million and $45.0 million at September 30, 2023 and December 31, 2022, respectively, and represented 2% of our total loans at those dates. Consumer loans include secured and unsecured loans, lines of credit and personal installment loans.
Consumer loans generally have greater risk compared to longer-term loans secured by improved, owner-occupied real estate, particularly consumer loans that are secured by rapidly depreciable assets. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan repayments are dependent on the borrower’s continuing financial stability and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Other Loans. Our other loans totaled $14.7 million and $18.8 million at September 30, 2023 and December 31, 2022, respectively, and are immaterial to the overall loan portfolio. The other loans category consists primarily of over-drafted depository accounts, loans utilized to purchase or carry securities and loans to nonprofit organizations.
46
Loan Portfolio Maturities.
The following tables summarize the dollar amount of loans maturing in our portfolio based on their loan type, fixed or variable rate of interest, and contractual terms to maturity at September 30, 2023. The tables do not include any estimate of prepayments, which can significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.
One Year or
One to Five
Five to Fifteen
Over Fifteen
Less
Years
136,464
261,652
130,037
3,215
Owner Occupied
114,150
372,428
333,553
77,308
Non-owner Occupied
46,564
372,559
357,360
8,700
Construction & Development
36,402
52,355
60,179
48,159
14,614
109,752
237,663
517,004
Consumer and other
5,752
39,352
16,572
3,755
65,431
353,946
1,208,098
1,135,364
658,141
Fixed Rate Loans:
22,850
226,923
91,893
3,186
344,852
59,246
331,816
138,907
21,390
551,359
40,320
359,538
205,656
605,514
14,458
47,600
42,292
34,854
139,204
6,726
87,159
193,351
277,182
564,418
5,324
38,497
16,102
63,678
148,924
1,091,533
688,201
340,367
2,269,025
Floating Rate Loans:
113,614
34,729
38,144
186,516
54,904
40,612
194,646
55,918
346,080
6,244
13,021
151,704
179,669
21,944
4,755
17,887
13,305
57,891
7,888
22,593
44,312
239,822
314,615
428
855
1,753
205,022
116,565
447,163
317,774
1,086,524
NONPERFORMING ASSETS
In order to operate with a sound risk profile, we focus on originating loans that we believe to be of high quality. We have established loan approval policies and procedures to assist us in maintaining the overall quality of our loan portfolio. When delinquencies in our loans exist, we rigorously monitor the levels of such delinquencies for any negative or adverse trends. From time to time, we may modify loans to extend the term or make other concessions to help a borrower with a deteriorating financial condition stay current on their loan and to avoid foreclosure. We generally do not forgive principal or interest on loans or modify the interest rates on loans to rates that are below market rates. Furthermore, we are committed to collecting on all of our loans and, as a result, at times have lower net charge-offs compared to many of our peer banks. We believe that our commitment to collecting on all of our loans results in higher loan recoveries.
Our nonperforming assets consist of nonperforming loans and foreclosed real estate. Nonperforming loans are those on which the accrual of interest has stopped, as well as loans that are contractually 90 days past due on which interest continues to accrue. The composition of our nonperforming assets is as follows:
As of September 30,
As of December 31,
Nonperforming loans
Nonaccrual loans
516
Total nonaccrual loans
4,370
Loans past due > 90 days, but still accruing
162
Total loans past due > 90 days, but still accruing
403
Total nonperforming loans
3,392
3,901
Commercial real estate owned
Residential real estate owned
Acquired bank property real estate owned
1,405
Total OREO
Total nonperforming assets ("NPAs")
5,236
6,421
6,178
Accruing modified loans to borrowers experiencing financial difficulty (1)
Ratios
Nonaccrual loans to total loans
0.09
NPAs to total loans plus OREO
0.16
0.21
NPAs to total assets
ACL - Loans to nonaccrual loans
1,473
625
527
ACL - Loans to total loans
Nonaccrual Loans
Loans are typically placed on nonaccrual status when any payment of principal and/or interest is 90 days or more past due, unless the collateral is sufficient to cover both principal and interest and the loan is in the process of collection. Loans are also placed on nonaccrual status when management believes, after considering economic and business conditions, that the principal or interest will not be collectible in the normal course of business. We monitor closely the performance of our loan portfolio. In addition to the monitoring and review of loan performance internally, we have also contracted with an independent organization to review our commercial and retail loan portfolios. The status of delinquent loans, as well as situations identified as potential problems, is reviewed on a regular basis by senior management.
48
ALLOWANCE FOR CREDIT LOSSES - LOANS
The Company assesses the adequacy of its ACL - Loans at the end of each calendar quarter. The level of ACL - Loans is based on the Company’s evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay a loan, the estimated value of any underlying collateral, composition of the loan portfolio and other relevant factors. The ACL - Loans is increased by a provision for credit losses, which is charged to expense, when the analysis shows that an increase is warranted. The ACL – Loans is reduced by charge-offs, net of recoveries, when they occur. The ACL is believed adequate to absorb all expected future losses to be recognized over the contractual life of the loans in the portfolio.
Loans with similar risk characteristics are evaluated in pools and, depending on the nature of each identified pool, the Company utilizes a discounted cash flow (“DCF”), probability of default / loss given default (“PD/LGD”) or remaining life method. The historical loss experience estimate by pool is then adjusted by forecast factors that are quantitatively related to the Company’s historical credit loss experience, such as national unemployment rates, gross domestic product and indexes which are indicative of the value of underlying collateral. Losses are forecasted over the expected life of the loan, first by predicting over a period of time determined to be reasonable and supportable (currently four calendar quarters), and at the end of the reasonable and supportable period reverting to long term historical averages. The reasonable and supportable period and reversion period are re-evaluated each quarter by the Company and are dependent on the current economic environment among other factors. See Note 1 and Note 5 in the Notes to Unaudited Consolidated Financial Statements included in Item 1. Financial Statements elsewhere in this report.
The expected credit losses for each loan pool are then adjusted for changes in qualitative factors not inherently considered in the quantitative analyses. The qualitative adjustments either increase or decrease the quantitative model estimation. The Company considers factors that are relevant within the qualitative framework which include the following: lending policy, changes in nature and volume of loans, staff experience, changes in volume and trends of problem loans, concentration risk, trends in underlying collateral values, external factors, quality of loan review system and other economic conditions.
Expected credit losses for loans that no longer share similar risk characteristics with the collectively evaluated pools are excluded from the collective evaluation and estimated on an individual basis. Individual evaluations are performed for nonaccrual loans, loans rated substandard, and modified loans (previously classified as TDRs). Specific allocations of the ACL for credit losses are estimated on one of several methods, including the estimated fair value of the underlying collateral, observable market value of similar debt or the present value of expected cash flows.
At September 30, 2023, the ACL - Loans was $43.4 million (representing 1.29% of period end loans). The Company adopted CECL as of January 1, 2023, which increased the ACL - Loans by $11.0 million. In addition, the ACL - Loans increased due to the acquisition of Hometown, which required a $3.6 million provision for credit losses on non-PCD loans and a $5.5 million reserve related to PCD loans. Net charge-offs remain negligible.
The following table summarizes the changes in our ACL - Loans for the periods indicated:
Nine months ended
Year ended
Balance of ACL - Loans at the beginning of period
Net loans charged-off (recovered):
(5)
(499)
(455)
816
(360)
(152)
(104)
(3)
Other Loans
(37)
Total net loans recovered
(126)
(165)
(1,030)
Provision charged to operating expense
Balance of ACL - Loans at end of period
Ratio of net charge-offs (recoveries) to average loans by loan composition
(0.12)
(0.11)
(0.06)
(0.09)
0.01
0.05
0.04
0.36
(0.19)
Total net charge-offs to average loans
The following table summarizes an allocation of the ACL - Loans and the related percentage of loans outstanding in each category for the periods below.
% of
(in thousands, except %)
Loan Type:
Total allowance
50
SOURCES OF FUNDS
General. Deposits traditionally have been our primary source of funds for our investment and lending activities. We also borrow from the FHLB of Chicago to supplement cash needs, to lengthen the maturities of liabilities for interest rate risk management purposes and to manage our cost of funds. Our additional sources of funds are scheduled payments and prepayments of principal and interest on loans and investment securities and fee income and proceeds from the sales of loans and securities.
Deposits. Our current deposit products include non-interest bearing and interest-bearing checking accounts, savings accounts, money market accounts, and certificate of deposits. As of September 30, 2023, deposit liabilities accounted for approximately 83.1% of our total liabilities and equity. We accept deposits primarily from customers in the communities in which our branches and offices are located, as well as from small businesses and other customers throughout our lending area. We rely on our competitive pricing and products, quality customer service, and convenient locations and hours to attract and retain deposits. Deposit rates and terms are based primarily on current business strategies, market interest rates, liquidity requirements and our deposit growth goals.
Total deposits were $3.40 billion and $3.06 billion as of September 30, 2023 and December 31, 2022, respectively. Noninterest-bearing deposits at September 30, 2023 and December 31, 2022, were $1.06 billion and $934.1 million, respectively, while interest-bearing deposits were $2.33 billion and $2.13 billion at September 30, 2023 and December 31, 2022, respectively.
At September 30, 2023, we had a total of $548.1 million in certificates of deposit, including $0.7 million of brokered deposits. Based on historical experience and our current pricing strategy, we believe we will retain a majority of these accounts upon maturity, although our long-term strategy is to minimize reliance on certificates of deposits by increasing relationship deposits in lower earning savings and demand deposit accounts.
The following tables set forth the average balances of our deposits for the periods indicated:
Percent
Noninterest-bearing demand deposits
31.9
878,727
31.6
31.5
Interest-bearing checking deposits
8.8
253,443
9.1
Savings deposits
24.9
691,599
24.8
24.1
19.7
666,717
23.9
25.4
14.6
286,054
10.3
9.6
0.1
8,587
0.3
2,785,127
The following table provides information on maturities of certificates of deposits which exceed FDIC insurance limits of $250,000 as of September 30, 2023:
Time Deposits over FDIC
Portion of Time Deposits in
Insurance Limits
Excess of FDIC Insurance Limits
3 months or less remaining
28,956
12,706
Over 3 to 6 months remaining
66,329
35,579
Over 6 to 12 months remaining
24,428
9,428
Over 12 months or more remaining
4,839
131,802
62,552
The Company has securities sold under repurchase agreements which have contractual maturities up to one year from the transaction date with variable and fixed rate terms. The agreements to repurchase require that the Company (seller) repurchase identical securities as those that are sold. The securities underlying the agreements are under the Company’s control.
The following table summarizes securities sold under repurchase agreements, and the weighted average interest rates paid:
Average daily amount of securities sold under repurchase agreements during the period
38,462
25,749
19,109
Weighted average interest rate on average daily securities sold under repurchase agreements
4.81
0.73
Maximum outstanding securities sold under repurchase agreements at any month-end
60,306
38,803
Securities sold under repurchase agreements at period end
Weighted average interest rate on securities sold under repurchase agreements at period end
5.36
4.31
3.10
The Company’s borrowings have historically consisted primarily of FHLB of Chicago advances collateralized by a blanket pledge agreement on the Company’s FHLB capital stock and retail and commercial loans held in the Company’s portfolio. There were $35.8 million of advances outstanding from the FHLB at September 30, 2023, and $1.9 million as of December 31, 2022.
The total loans pledged as collateral were $1.44 billion at September 30, 2023 and $1.15 billion at December 31, 2022. There were no outstanding letters of credit from the FHLB at September 30, 2023 or December 31, 2022.
The following table summarizes borrowings, which consist of borrowings from the FHLB, and the weighted average interest rates paid:
Average daily amount of borrowings outstanding during the period
29,048
139,498
185,740
Weighted average interest rate on average daily borrowing
3.91
0.42
Maximum outstanding borrowings at any month-end
36,577
308,756
Borrowing outstanding at period end
2,550
Weighted average interest rate on borrowing at period end
3.58
1.71
2.02
Lines of credit and other borrowings.
We maintain a $7.5 million line of credit with another commercial bank, which was entered into on May 15, 2022. There were no outstanding balances on this note at September 30, 2023. Any future borrowings will required monthly payments of interest at a variable rate, and will be due in full on May 15, 2024.
During September 2017, the Company entered into subordinated note agreements with three separate commercial banks. As of September 30, 2021 and December 31, 2020, outstanding balances under these agreements totaled $11.5 million. These notes were all issued with 10-year maturities, carry interest at a variable rate payable quarterly, are callable on or after the sixth anniversary of their issuance dates, and qualify for Tier 2 capital for regulatory purposes. These note agreements were repaid in full on October 2, 2023.
During July 2020, the Company entered into subordinated note agreements with two separate commercial banks. As of September 30, 2023 and December 31, 2022, outstanding balances under these agreements totaled $6.0 million. These notes were issued with 10-year maturities, will carry interest at a fixed rate of 5.0% through June 30, 2025, and at a variable rate thereafter, payable quarterly. These notes are callable on or after January 1, 2026 and qualify for Tier 2 capital for regulatory purposes.
During August 2022, the Company entered into subordinated note agreements with an individual. As of September 30, 2023, outstanding balances under these agreements totaled $6.0 million. These notes were issued with 10-year maturities, will carry interest at a fixed rate of 5.25% through August 6, 2027, and at a variable rate thereafter, payable quarterly. These notes are callable on or after August 6, 2027 and qualify for Tier 2 capital for regulatory purposes.
INVESTMENT SECURITIES
Our securities portfolio consists of securities available for sale and securities held to maturity. Securities are classified as held to maturity or available for sale at the time of purchase. Obligations of states and political subdivisions and mortgage-backed securities, all of which are issued by U.S. government agencies or U.S. government-sponsored enterprises, make up the largest components of the securities portfolio. We manage our investment portfolio to provide an adequate level of liquidity as well as to maintain neutral interest rate-sensitive positions, while earning an adequate level of investment income without taking undue or excessive risk.
Securities available for sale consist of U.S. treasury securities, obligations of states and political subdivision, mortgage-backed securities, and corporate notes. Securities classified as available for sale, which management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in stockholders’ equity as a separate component of other comprehensive income. The fair value of securities available for sale totaled $179.0 million and included no gross unrealized gains and gross unrealized losses of $26.6 million at September 30, 2023. At December 31, 2022, the fair value of securities available for sale totaled $304.6 million and included gross unrealized gains of $0.5 million and gross unrealized losses of $21.8 million.
Securities classified as held to maturity consist of U.S. treasury securities and obligations of states and political subdivisions. These securities, which management has the intent and ability to hold to maturity, are reported at amortized cost. Securities held to maturity totaled $77.2 million at September 30, 2023 and $45.1 million at December 31, 2022.
The Company had recognized net losses on sales of securities of $75,000 during the nine months ended September 30, 2023. There were no sales of securities during the nine months ended September 30, 2022.
The following tables set forth the composition and maturities of investment securities as of September 30, 2023 and December 31, 2022. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
After One, But
After Five, But
Within One Year
Within Five Years
Within Ten Years
After Ten Years
At September 30, 2023
Yield (1)
Available for sale securities
19,812
1.3
29,847
1.5
1.4
972
5.2
1,456
5.1
16,393
2.3
13,067
2.4
2.5
9,791
4.1
14,536
3.5
39,614
2.8
3.1
4.4
12,114
3.0
12,449
14,125
3.7
3.6
4,992
3.3
14,070
1,620
6.6
3.8
1.2
6,708
43,173
87,295
2.7
68,426
Held to maturity securities
14,863
3.4
53,938
4,201
2,325
2.6
871
4.2
22,527
99,436
92,367
282,756
At December 31, 2022
99,991
9,857
39,766
12,846
1.9
1.7
3,927
5,541
24,338
56,895
3.2
3,358
9,829
2.9
12,608
12,906
4,983
14,674
1,348
8.6
503
1.1
501
107,779
30,711
104,232
83,238
2.2
35,772
4,130
389
3,935
39,707
5,001
108,168
70,418
109,233
371,057
Weighted Average Yield is shown on a fully taxable equivalent basis using a federal tax rate of 21%.
The Company evaluates securities for potential credit losses on at least a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) credit quality of individual securities and their issuers are assessed; (2) the length of time and the extent to which the fair value has been less than cost; (3) the financial condition and near-term prospects of the issuer; and (4) that the Company does not have the intent to sell the security and it is more likely than not that it will not have to sell the security before recovery of its cost basis.
As of September 30, 2023 and December 31, 2022, no allowance for credit losses on securities AFS was recognized. The Company does not consider its securities AFS with unrealized losses to be attributable to credit-related factors, as the unrealized losses
in each category have occurred as a result of changes in noncredit-related factors such as changes in interest rates, market spreads and market conditions subsequent to purchase, not credit deterioration. Furthermore, as of September 30, 2023, the Company did not have the intent to sell any of these securities AFS and believes that it is more likely than not that we will not have to sell any such securities before a recovery of cost.
Furthermore, the Company does not believe there are any expected credit losses in its HTM securities portfolio at September 30, 2023 or December 31, 2022. All U.S. Treasury securities have the full faith and credit backing of the United States government and the amount of obligations of states and political subdivisions in an unrealized loss position is immaterial to the financial statements.
As of September 30, 2023, 297 debt securities had gross unrealized losses, with an aggregate depreciation of 10.2% from our amortized cost basis. The largest unrealized loss percentage of any single security was 32.7% (or $0.7 million) of its amortized cost. The largest unrealized dollar loss of any security was $1.8 million (or 18.5%).
As of December 31, 2022, 267 debt securities had gross unrealized losses, with an aggregate depreciation of 6.9% from our amortized cost basis. The largest unrealized loss percentage of any single security was 30.4% (or $0.6 million) of its amortized cost. The largest unrealized dollar loss of any single security was $1.5 million (or 15.4%).
The unrealized losses on these debt securities arose primarily due to changing interest rates and are considered to be temporary.
LIQUIDITY AND CAPITAL RESOURCES
Impact of Inflation and Changing Prices. Our consolidated financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on our performance than they would on industrial companies.
Liquidity. Liquidity is defined as the Company’s ability to generate adequate cash to meet its needs for day-to-day operations and material long and short-term commitments. Liquidity is the risk of potential loss if we were unable to meet our funding requirements at a reasonable cost. We are expected to maintain adequate liquidity at the Bank to meet the cash flow requirements of customers who may be either depositors wishing to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Our asset and liability management policy is intended to cause the Bank to maintain adequate liquidity and, therefore, enhance our ability to raise funds to support asset growth, meet deposit withdrawals and lending needs, maintain reserve requirements and otherwise sustain our operations.
We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all of our short-term and long-term cash requirements. We manage our liquidity based on demand and specific events and uncertainties to meet current and future financial obligations of a short-term nature. We also monitor our liquidity requirements in light of interest rate trends, changes in the economy and the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits. Our objective in managing liquidity is to respond to the needs of depositors and borrowers as well as to increase earnings enhancement opportunities in a changing marketplace.
Our liquidity is maintained through our investment portfolio, deposits, borrowings from the FHLB, and lines available from correspondent banks. Our highest priority is placed on growing noninterest bearing deposits through strong community involvement in the markets that we serve. Borrowings and brokered deposits are considered short-term supplements to our overall liquidity but are not intended to be relied upon for long-term needs. The Company currently has $1.76 billion in availability between borrowings and brokered deposits for future funding if liquidity needs were to develop. We believe that our present position is adequate to meet our current and future liquidity needs, and management knows of no trend or event that will have a material impact on the Company’s ability to maintain liquidity at satisfactory levels.
Capital Adequacy. Total stockholders’ equity was $577.3 million at September 30, 2023 compared to $453.1 million at December 31, 2022.
Our capital management consists of providing adequate equity to support our current and future operations. The Bank is subject to various regulatory capital requirements administered by state and federal banking agencies, including the Federal Reserve and the
55
OCC. Failure to meet minimum capital requirements may prompt certain actions by regulators that, if undertaken, could have a direct material adverse effect on our financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measure of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the classifications are also subject to qualitative judgment by the regulator in regard to components, risk weighting and other factors.
The Bank is subject to the following risk-based capital ratios: a common equity Tier 1 (“CET1”) risk-based capital ratio, a Tier 1 risk-based capital ratio, which includes CET1 and additional Tier 1 capital, and a total capital ratio, which includes Tier 1 and Tier 2 capital. CET1 is primarily comprised of the sum of common stock instruments and related surplus net of treasury stock, retained earnings, and certain qualifying minority interests, less certain adjustments and deductions, including with respect to goodwill, intangible assets, mortgage servicing assets and deferred tax assets subject to temporary timing differences. Additional Tier 1 capital is primarily comprised of noncumulative perpetual preferred stock, tier 1 minority interests and grandfathered trust preferred securities. Tier 2 capital consists of instruments disqualified from Tier 1 capital, including qualifying subordinated debt, other preferred stock and certain hybrid capital instruments, and a limited amount of loan loss reserves up to a maximum of 1.25% of risk-weighted assets, subject to certain eligibility criteria. The capital rules also define the risk-weights assigned to assets and off-balance sheet items to determine the risk-weighted asset components of the risk-based capital rules, including, for example, certain “high volatility” commercial real estate, past due assets, structured securities and equity holdings.
The leverage capital ratio, which serves as a minimum capital standard, is the ratio of Tier 1 capital to quarterly average assets net of goodwill, certain other intangible assets, and certain required deduction items. The required minimum leverage ratio for all banks is 4%.
Failure to be well-capitalized or to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our operations or financial condition. For example, only a well-capitalized depository institution may accept brokered deposits without prior regulatory approval. Failure to be well-capitalized or to meet minimum capital requirements could also result in restrictions on the Bank’s ability to pay dividends or otherwise distribute capital or to receive regulatory approval of applications or other restrictions on its growth.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, requires the federal bank regulatory agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements. FDICIA establishes five regulatory capital tiers: “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, and “critically undercapitalized”. A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. The FDICIA imposes progressively more restrictive restraints on operations, management and capital distributions, depending on the category in which an institution is classified. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions may not accept brokered deposits absent a waiver from the FDIC, are subject to growth limitations and are required to submit capital restoration plans for regulatory approval. A depository institution’s holding company must guarantee any required capital restoration plan, up to an amount equal to the lesser of 5 percent of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. Federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. All of the federal bank regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels for federally insured depository institutions. The Bank was well capitalized at September 30, 2023, and brokered deposits are not restricted.
To be well-capitalized, the Bank must maintain at least a 6.5% CET1 to risk-weighted assets ratio, an 8.0% Tier 1 capital to risk-weighted assets ratio, a 10.0% Total capital to risk-weighted assets ratio, and a 5.0% leverage ratio.
The Bank’s regulatory capital ratios were above the applicable well-capitalized standards and met the then-applicable capital conservation buffer. Based on current estimates, we believe that the Bank will continue to exceed all applicable well-capitalized regulatory capital requirements and the capital conservation buffer in 2023.
As a result of the Economic Growth Act, the federal banking agencies were required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s Tier 1 capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under prompt corrective action statutes. The federal banking agencies may consider a financial institution’s risk profile when evaluation whether it qualifies as a community bank for purposes of the capital ratio requirement. The federal banking agencies set the minimum capital for the new Community Bank Leverage Ratio at 9%. The Bank does not intend to opt into the Community Bank Leverage Ratio Framework.
On December 21, 2018, federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the upcoming implementation of CECL accounting standard under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking organizations are expected to experience upon adopting CECL; and (iii) require the use of CECL in stress tests beginning with the 2020 capital planning and stress testing cycle for certain banking organizations. for more information regarding Accounting Standards Update No. 2016-13, which introduced CECL as the methodology to replace the current “incurred loss” methodology for financial assets measured at amortized cost, and changed the approaches for recognizing and recording credit losses on available-for-sale debt securities and purchased credit impaired financial assets, including the required implementation date for the Company, see the Company’s Annual Report.
Federal banking regulators have issued risk-based capital guidelines, which assign risk factors to asset categories and off-balance-sheet items. The following table reflects capital ratios computed utilizing the implemented Basel III regulatory capital framework discussed above:
Minimum Capital Required
Minimum To Be Well-
for Capital Adequacy Plus
Capitalized Under prompt
Required for Capital
Capital Conservation Buffer
corrective Action
Adequacy
Basel III Phase-In Schedule
Provisions
Bank First Corporation:
Total capital (to risk-weighted assets)
13.0
8.0
10.5
N/A
Tier I capital (to risk-weighted assets)
11.4
6.0
8.5
Common equity tier I capital (to risk-weighted assets)
11.1
4.5
7.0
Tier I capital (to average assets)
10.6
4.0
Bank First, N.A:
11.9
10.0
11.0
6.5
10.2
5.0
12.2
10.8
190,627
9.7
11.8
9.9
As previously mentioned, the Company carried $23.5 million of subordinated debt as of September 30, 2023 and December 31, 2022, and $11.0 million in junior subordinated debentures as of September 30, 2023, all of which is included in total capital for the Company in the tables above.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
We are party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to originate and sell loans, standby and direct pay letters of credit, unused lines of credit and unadvanced portions of construction and development loans. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in these particular classes of financial instruments.
Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments, standby and direct pay letters of credit and unadvanced portions of construction and development loans is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Off-Balance Sheet Arrangements. Our significant off-balance-sheet arrangements consist of the following:
Off-balance sheet arrangement means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with the registrant is a party, under which the registrant has (1) any obligation under a guarantee contract, (2) retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement, (3) any obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument, or (4) any obligation, including a contingent obligation, arising out of a variable interest.
Loan commitments are made to accommodate the financial needs of our customers. Standby and direct pay letters of credit commit us to make payments on behalf of customers when certain specified future events occur. Both arrangements have credit risk essentially the same as that involved in extending loans to clients and are subject to our normal credit policies. Collateral (e.g., securities, receivables, inventory, equipment, etc.) is obtained based on management’s credit assessment of the customer.
Loan commitments and standby and direct pay letters of credit do not necessarily represent our future cash requirements because while the borrower has the ability to draw upon these commitments at any time, these commitments often expire without being drawn upon. Our off-balance sheet arrangements at the dates indicated were as follows:
Amounts of Commitments Expiring - By Period as of September 30, 2023
Less Than One
One to Three
Three to Five
Other Commitments
Year
After Five Years
Unused lines of credit
794,457
361,398
131,459
81,687
219,913
Standby and direct pay letters of credit
8,368
1,391
595
183
Total commitments
825,207
369,766
132,850
82,282
240,309
Amounts of Commitments Expiring - By Period as of December 31, 2022
Less Than
One to
Three to
After Five
One Year
Three Years
Five Years
660,564
299,202
91,567
52,037
217,758
8,023
1,415
722
688,271
307,225
92,982
52,759
235,305
58
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest rate risk inherent in its lending, investment and deposit-taking activities. To that end, management actively monitors and manages its interest rate risk exposure.
Our profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact our earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. We monitor the impact of changes in interest rates on its net interest income using several tools.
Our primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on our net interest income and capital, while configuring our asset-liability structure to obtain the maximum yield-cost spread on that structure. We rely primarily on our asset-liability structure to control interest rate risk.
Interest Rate Sensitivity. Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (repricing risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay home mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries (basis risk).
An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.
The Company actively manages its interest rate sensitivity position. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve sustainable growth in net interest income. The Company’s ALCO, using policies and procedures approved by the Company’s board of directors, is responsible for the management of the Company’s interest rate sensitivity position. The Company manages interest rate sensitivity by changing the mix, pricing and re-pricing characteristics of its assets and liabilities, through the management of its investment portfolio, its offerings of loan and selected deposit terms and through wholesale funding. Wholesale funding consists of, but is not limited to, multiple sources including borrowings with the FHLB of Chicago, the Federal Reserve Bank of Chicago’s discount window and certificates of deposit from institutional brokers.
The Company uses several tools to manage its interest rate risk including interest rate sensitivity analysis, or gap analysis, market value of portfolio equity analysis, interest rate simulations under various rate scenarios and net interest margin reports. The results of these reports are compared to limits established by the Company’s ALCO policies and appropriate adjustments are made if the results are outside the established limits.
There are an infinite number of potential interest rate scenarios, each of which can be accompanied by differing economic/political/regulatory climates; can generate multiple differing behavior patterns by markets, borrowers, depositors, etc.; and, can last for varying degrees of time. Therefore, by definition, interest rate risk sensitivity cannot be predicted with certainty. Accordingly, the Company’s interest rate risk measurement philosophy focuses on maintaining an appropriate balance between theoretical and practical scenarios; especially given the primary objective of the Company’s overall asset/liability management process is to facilitate meaningful strategy development and implementation.
Therefore, we model a set of interest rate scenarios capturing the financial effects of a range of plausible rate scenarios; the collective impact of which will enable the Company to clearly understand the nature and extent of its sensitivity to interest rate changes. Doing so necessitates an assessment of rate changes over varying time horizons and of varying/sufficient degrees such that the impact of embedded options within the balance sheet are sufficiently examined.
The following tables demonstrate the annualized result of an interest rate simulation and the estimated effect that a parallel interest rate shift, or “shock,” in the yield curve and subjective adjustments in deposit pricing might have on the Company’s projected net interest income over the next 12 months.
This simulation assumes that there is no growth in interest-earning assets or interest-bearing liabilities over the next 12 months. The changes to net interest income shown below are in compliance with the Company’s policy guidelines.
As of September 30, 2023:
Change in Interest Rates
Percentage Change in
(in Basis Points)
Net Interest Income
+400
(5.0)%
+300
(3.7)%
+200
(2.5)%
+100
(1.3)%
-100
1.2%
As of December 31, 2022:
3.6%
2.7%
2.1%
1.5%
(4.4)%
Economic Value of Equity Analysis. We also analyze the sensitivity of the Company’s financial condition to changes in interest rates through our economic value of equity model. This analysis measures the difference between estimated changes in the present value of the Company’s assets and estimated changes in the present value of the Company’s liabilities assuming various changes in current interest rates. The Company’s economic value of equity analysis as of September 30, 2023 estimated that, in the event of an instantaneous 200 basis point increase in interest rates, the Company would experience a 2.94% increase in the economic value of equity. At the same date, our analysis estimated that, in the event of an instantaneous 100 basis point decrease in interest rates, the Company would experience a 1.50% decrease in the economic value of equity. The estimates of changes in the economic value of our equity require us to make certain assumptions including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturities and decay rates. These assumptions are inherently uncertain and, as a result, we cannot precisely predict the impact of changes in interest rates on the economic value of our equity. Although our economic value of equity analysis provides an indication of our interest rate risk exposure at a particular point in time, such estimates are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on the economic value of our equity and will differ from actual results.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), undertook an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report, and, based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, in recording, processing, summarizing and reporting in a timely manner the information that the Company is required to disclose in its reports under the Exchange Act and in accumulating and communicating to the Company’s management, including the Company’s CEO and CFO, such information as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
No changes were made to our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are a party to various litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.
ITEM 1A. RISK FACTORS
Additional information regarding risk factors appears in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Statements” of this Form 10-Q and in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022. There have been no material changes during the quarterly period ended September 30, 2023 to the risk factors previously disclosed in the Company’s Annual Report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On April 18, 2023, the Company reactivated its share repurchase program, pursuant to which the Company may repurchase up to $26 million of its common stock, par value $0.01 per share, for a period of one (1) year, ending on April 17, 2024. The program was announced in a Current Report on Form 8-K on April 19, 2023. The table below sets forth information regarding repurchases of our common stock during the third quarter of 2023 under that program as well as pursuant to the 2020 Equity Plan and other repurchases.
Total Number
Maximum Number
of Shares Repurchased as
of Shares
Part of
that May Yet Be
Total Number of Shares
Average Price Paid per
Publicly Announced
Purchased Under the
Repurchased
Share(1)
Plans or Programs
Plans or Programs(2)
July 2023
294,014
August 2023
September 2023
11,057
77.15
282,957
The average price paid per share is calculated on a trade date basis for all open market transactions and excludes commissions and other transaction expenses.
Based on the closing per share price as of September 30, 2023 ($77.15).
The Inflation Reduction Act of 2022 (“IRA”) created a new nondeductible 1% excise tax on repurchases of corporate stock by certain publicly traded corporations or their specified affiliates after December 31, 2022. The tax is imposed on the fair value of the stock of a covered corporation that is repurchased in a given year, less the fair market value of any stock issued in that year. The Company falls under the definition of a “covered corporation”. The excise tax applies to all of the stock of a covered corporation regardless of whether the corporation has profits or losses. The impact of the IRA on our consolidated financial statements will be dependent on the extent of stock repurchases made in current and future periods.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
Exhibit Index
Exhibit Number
Description
31.1
Rule 13a-14(a) Certification of Chief Executive Officer*
31.2
Rules 13a-14(a) Certification of Chief Financial Officer*
32.1
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer**
101 INS
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
Cover Page Interactive Data File (the cover page XBRL tags are embedded in the Inline XBRL document)
*Filed herewith.
**Furnished herewith.
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.
DATE:
November 9, 2023
BY:
/s/Kevin M. LeMahieu
Kevin M. LeMahieu
Chief Financial Officer
(Principal Financial and Accounting Officer)