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Item 2. Management’s Discussion and Analysis

2023-05-10 compared with 2022-11-09 · 191 added, 320 removed, 637 unchanged (45% of the section changed)

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, 2021, 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, 2022.

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 March 31, 2023.

FORWARD-LOOKING STATEMENTS

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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 26 banking locations in Manitowoc, Outagamie, Brown, Winnebago, Sheboygan, Shawano, Waupaca, Ozaukee, Monroe, and Jefferson counties in Wisconsin.

Including its headquarters in Manitowoc, Wisconsin, the Bank has 28 banking locations in Manitowoc, Outagamie, Brown, Winnebago, Sheboygan, Shawano, Waupaca, Ozaukee, Monroe, Fond du Lac, Columbia, Wautoma and Jefferson counties in Wisconsin.

The Bank offers loan, deposit and treasury management products at each of its banking locations.

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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 ALL to absorb possible losses on existing loans that may become uncollectible.

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.

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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 July 25, 2022, the Company entered into an Agreement and Plan of Merger with Hometown, a Wisconsin Corporation, pursuant to which Hometown will merge with and into the Company and Hometown's banking subsidiary, Hometown Bank, will merge with and into the Bank.

The transaction is expected to close during the first quarter of 2023 and is subject to, among other items, approval by the shareholders of Hometown and regulatory agencies.

Merger consideration will consist of up to 30% cash and no less than 70% of the common stock of the Company, and will total approximately $124 million, subject to the fair market value of the Company's common stock on the date of closing.

Based on results as of September 30, 2022, the combined company would have total assets of approximately $4.26 billion, loans of approximately $3.25 billion, and deposits of approximately $3.68 billion.

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, 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.

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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.

economy contracted in the first half of 2020, ending the longest expansionary period in U.S.

history, due to the COVID-19 pandemic.

During March 2020, in an effort to lessen the impact of COVID-19 on consumers and businesses, the Federal Reserve reduced the federal funds rate 1.5 percentage points to 0.00 to 0.25 percent and the U.S.

government enacted the CARES Act, the largest economic stimulus package in the nation's history.

The Company responded to the pandemic, beginning in March 2020, by supporting our clients, employees, and communities with such measures as remote work capabilities and branch service enhancements, loan payment deferrals, and accelerated investments in several technology initiatives that provided more convenience and a better digital experience as clients adapted to this highly virtual environment.

The Company participated in the PPP and funded approximately 2,998 loans totaling approximately $377.5 million under the programs available in both 2020 and 2021.

Additional government spending measures and the availability of vaccines improved consumer confidence and demand, and the economy largely reopened in 2021, leading to a reduction in the unemployment rate and accelerated GDP growth.

While 2021 and 2022 have seen a recovery in the U.S.

economy compared to 2020, uncertainty and market disruptions such as additional coronavirus variants, pandemic-related supply chain issues and labor shortages persist.

The economic expansion has been met with inflationary pressures which have resulted in the Federal Open Market Committee aggressively tightening monetary policy during 2022, beginning in March 2022 and likely including more interest rate hikes in the future.

With an asset-sensitive balance sheet and our strong position in our markets, we expect increases in loan demand and interest rates should improve returns going forward.

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

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At or for the Three Months Ended

At or for the Nine Months Ended

(In thousands, except per share data)

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Net interest income

Provision for loan losses

Net interest income after provision for loan losses

Provision for credit losses (1)

Net interest income after provision for credit losses (1)

Noninterest income

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Loan servicing income

Valuation adjustment on mortgage servicing rights

Net gain on sales of mortgage loans

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Period-end balances:

Allowance for loan losses

Cash and cash equivalents

Investment securities available-for-sale, at fair value

Investment securities held-to-maturity, at cost

Allowance for credit losses - loans (1)

Premises and equipment

Goodwill and other intangibles, net

Mortgage Servicing Rights

Securities sold under repurchase agreements

Other liabilities

Total liabilities

Stockholders’ equity

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Nonperforming assets to total assets

Allowance for loan losses to loans

Allowance for credit losses - loans to total loans (1)

(1) Prior to January 1, 2023, the incurred loss methodology was used to estimate credit losses.

Subsequent to that date, credit losses are estimated using the CECL methodology.

(2) These measures are not measures prepared in accordance with GAAP, and are therefore considered to be non-GAAP financial measures.

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At or for the Three Months Ended

At or for the Nine Months Ended

(In thousands, except per share data)

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RESULTS OF OPERATIONS

Results of Operations for the Three Months Ended September 30, 2022 and September 30, 2021

Net income decreased $0.7 million to $10.5 million for three months ended September 30, 2022, compared to $11.2 million for the same period in 2021.

This decrease was primarily due to an increase in noninterest expense from one-time costs related to the acquisition of Denmark in the third quarter of 2022 as well as increased scale of operations from that acquisition impacting approximately half of the quarter.

These increased expenses more than offset a rise in net interest income in the year-over-year third quarters.

Results of Operations for the Three Months Ended March 31, 2023 and March 31, 2022

Net income increased $0.5 million to $10.7 million for three months ended March 31, 2023, compared to $10.2 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.

Net Interest Income .

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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).

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.

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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 $4.8 million to $27.7 million for the three months ended September 30, 2022 compared to $22.9 million for three months ended September 30, 2021.

The increase in net interest income was primarily due to growth in interest earning assets over the last twelve months as well as increasing net interest margin in the year-over-year third quarters.

Total average interest-earning assets was $3.06 billion for the three months ended September 30, 2022, up from $2.66 billion for the same period in 2021.

Tax equivalent net interest margin increased 0.16% to 3.63% for the three-months ended September 30, 2022, up from 3.47% for the same period in 2021.

Net interest and dividend income increased by $9.9 million to $32.2 million for the three months ended March 31, 2023 compared to $22.3 million for three months ended March 31, 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 year-over-year first quarters.

Total average interest-earning assets was $3.52 billion for the three months ended March 31, 2023, up from $3.00 billion for the same period in 2022.

Tax equivalent net interest margin increased 0.68% to 3.74% for the three-months ended March 31, 2023, up from 3.06% for the same period in 2022.

Net interest margin and net interest income are influenced by internal and external factors.

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Interest Income.

Total interest income increased $5.8 million, or 23.5%, to $30.7 million for the three months ended September 30, 2022 compared to $24.9 million for the same period in 2021.

Total interest income increased $16.7 million, or 68.9%, to $40.9 million for the three months ended March 31, 2023 compared to $24.2 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 $403.3 million during the three months ended September 30, 2022 compared to the same period in 2021 and the average interest rate earned on these assets increased by 0.27% in the year-over-year third quarters.

The average balance of interest-earning assets increased by $523.5 million during the three months ended March 31, 2023 compared to the same period in 2022 and the average interest rate earned on these assets increased by 1.42% in the year-over-year first quarters.

Interest Expense.

Interest expense increased $1.1 million, or 55.1%, to $3.0 million for the three months ended September 30, 2022 compared to $2.0 million for the same period in 2021.

Interest expense increased $6.7 million, or 349.1%, to $8.7 million for the three months ended March 31, 2023 compared to $1.9 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 $0.8 million to $2.6 million for the three months ended September 30, 2022 from $1.8 million for the same period in 2021.

The average balance and average cost of interest-bearing deposits was $2.0 million and 0.52% for the three months ended September 30, 2022, compared to $1.7 million and 0.42% for the same period in 2021.

Provision for Loan Losses.

Interest expense on interest-bearing deposits increased by $5.9 million to $7.5 million for the three months ended March 31, 2023 from $1.6 million for the same period in 2022.

The average balance and average cost of interest-bearing deposits was $2.24 billion and 1.35% for the three months ended March 31, 2023, compared to $1.74 billion and 0.36% for the same period in 2022.

Provision for Credit Losses.

Credit risk is inherent in the business of making loans.

We establish an ALL through charges to earnings, which are shown in the statements of operations as the provision for loan losses.

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 loan losses is determined by conducting a quarterly evaluation of the adequacy of our ALL and charging the shortfall or excess, if any, to the current quarter’s expense.

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 loan 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 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 loan loss during the three months ended September 30, 2022 compared to a provision of $0.7 million for the same period in 2021.

We recorded net recoveries of $0.3 million for the three months ended September 30, 2022 compared to negligible net recoveries for the same period in 2021.

The ALL was $23.0 million, or 0.81% of total loans, at September 30, 2022 compared to $20.2 million, or 0.92% of total loans at September 30, 2021.

The decreased ALL coverage was the result of a significant increase in total purchased loans, due to the Denmark acquisition during the third quarter of 2022, which carry a fair value mark in lieu of a portion of the ALL until they are paid off or renewed.

We recorded a provision for credit loss of $4.2 million during the three months ended March 31, 2023 compared to a provision of $1.2 million for the same period in 2022.

We recorded minimal net recoveries during the three months ended March 31, 2023 compared to net recoveries of $0.2 million for the three months ended March 31, 2022.

The ACL - Loans was $43.3 million, or 1.30% of total loans, at March 31, 2023 compared to $21.7 million, or 0.94% of total loans at March 31, 2022.

The increased ACL - Loans coverage was the result of adopting the CECL methodology as of January 1, 2023.

Noninterest Income.

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Other sources of noninterest income include loan servicing fees and gains on sales of mortgage loans.

Noninterest income increased $0.1 million to $5.2 million for the three months ended September 30, 2022 compared to $5.0 million for the same period in 2021.

This increase was primarily the result of higher loan servicing income, which includes the impact of valuation updates to the Company’s MSRs, offset by a significant reduction in net gains on sales of mortgage loans quarter-over-quarter as the Company, and the banking industry as a whole, saw a slowdown in residential mortgage lending.

MSR valuation updates added $0.9 million to servicing income during the third quarter of 2022, compared to no change during the prior year third quarter.

Noninterest income increased $0.6 million to $5.8 million for the three months ended March 31, 2023 compared to $5.2 million for the same period in 2022.

This increase was primarily the result of higher service charge and loan servicing income provided by added operational scale from the acquisitions of Denmark and Hometown, higher income provided by Ansay and UFS, and a larger positive valuation adjustment on the value of mortgage servicing rights on the Company’s balance sheet.

These positive variances were partially offset by a significant reduction in net gains on sales of mortgage loans as the Company, and the banking industry as a whole, saw a slowdown in residential mortgage lending.

The major components of our noninterest income are listed below:

Three Months Ended September 30,

(In thousands)

Noninterest Income

Service charges

Income from Ansay

Income from UFS

Loan servicing income

Net gain on sales of mortgage loans

Total noninterest income

Noninterest Expense.

Noninterest expense increased $6.4 million to $18.9 million for the three months ended September 30, 2022 compared to $12.5 million for the same period in 2021.

Significant one-time expenses from the Company’s acquisition of Denmark during the third quarter of 2022 caused large increases in salaries, data processing and outside service fees.

The added scale resulting from this transaction, which impacted approximately one-half of the third quarter of 2022, further increased salaries, occupancy and data processing.

Finally, the acquisition of Denmark resulted in the recording of a core deposit intangible totaling $15.1 million.

Amortization of this core deposit intangible began during the third quarter of 2022 and was the cause of the increase in amortization of intangibles in the year-over-year third quarters.

The major components of our noninterest expense are listed below:

Three Months Ended September 30,

Three Months Ended March 31,

(in thousands)

Noninterest Expense

Salaries, commissions, and employee benefits

Data processing

Postage, stationary, and supplies

Net loss on sales of securities

Charitable contributions

Outside service fees

Amortization of intangibles

Total noninterest expenses

Income Tax Expense.

We recorded a provision for income taxes of $3.4 million for the three months ended September 30, 2022 compared to a provision of $3.6 million for the same period during 2021, reflecting effective tax rates of 24.6% and 24.4%, 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.

Results of Operations for the Nine months Ended September 30, 2022 and September 30, 2021

Net income decreased $1.9 million to $32.4 million for nine months ended September 30, 2022, compared to $34.3 million for the same period in 2021.

This decrease was primarily due to a slowdown in residential mortgage production during the first three quarters of 2022 compared to the same period during the prior year and significant one-time expenses related to the Company’s acquisition of Denmark, partially offset by higher net interest income and lower provisions for loan losses during 2022 compared to the prior year period.

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.

Net interest and dividend income increased by $6.6 million to $73.5 million for the nine months ended September 30, 2022 compared to $66.9 million for nine months ended September 30, 2021.

The increase in net interest income was primarily due to growth in interest earning assets over the last twelvemonths.

Total average interest-earning assets was $3.01 billion for the nine months ended September 30, 2022, up from $2.61 billion for the same period in 2021.

Tax equivalent net interest margin decreased 0.17% to 3.30% for the nine months ended September 30, 2022, down from 3.47% for the same period in 2021.

The decrease in net interest margin was primarily caused by a short-term net interest income enhancement strategy which was in place for much of the first two quarters of 2022.

This strategy utilized $300.0 million in short-term borrowings which were invested in short-term, risk-free investments.

Investments and borrowings utilized in this strategy had a net interest margin less than 0.20%.

While this strategy increased net interest income, it had a detrimental impact on net interest margin.

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 $7.4 million, or 10.1%, to $80.8 million for the nine months ended September 30, 2022 compared to $73.3 million for the same period in 2021.

The increase in total interest income was primarily due to growth in interest earnings assets over the last twelve months.

The average balance of interest-earning assets increased by $399.2 million during the first nine months of 2022 compared to the same period in 2021.

Interest Expense.

Interest expense increased $0.8 million, or 12.7%, to $7.3 million for the nine months ended September 30, 2022 compared to $6.5 million for the same period in 2021.

The increase in interest expense was primarily due growth in interest-bearing liabilities over the last twelve months.

The average balance of interest-bearing liabilities increased by $336.6 million during the first nine months of 2022 compared to the same period in 2021.

Interest expense on interest-bearing deposits totaled $5.9 million for the nine months ended September 30, 2022 and 2021.

The average cost of interest-bearing deposits was 0.43% for the nine months ended September 30, 2022, compared to 0.48% for the same period in 2021.

Provision for Loan Losses.

Credit risk is inherent in the business of making loans.

We establish an ALL through charges to earnings, which are shown in the statements of operations as the provision for loan losses.

Specifically identifiable and quantifiable known losses are promptly charged off against the allowance.

The provision for loan losses is determined by conducting a quarterly evaluation of the adequacy of our ALL 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 determination of the amount is complex and involves a high degree of judgment and subjectivity.

We recorded a provision for loan losses of $1.7 million for the nine months ended September 30, 2022 compared to $2.5 million for the same period in 2021.

We recorded net recoveries of $1.0 million for the nine months ended September 30, 2022 compared to net recoveries of $0.1 million for the same period in 2021.

The ALL was $23.0 million, or 0.81% of total loans, at September 30, 2022 compared to $20.2 million, or 0.92% of total loans at September 30, 2021.

The decreased ALL coverage was the result of a significant

increase in total purchased loans, due to the Denmark acquisition during the third quarter of 2022, which carry a fair value mark in lieu of a portion of the ALL until they are paid off or renewed.

Noninterest Income.

Noninterest income is an important component of our total revenues.

A significant portion of our noninterest income is 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 decreased $2.1 million to $16.0 million for the nine months ended September 30, 2022 compared to $18.0 million for the same period in 2021.

This decrease was caused by a significant reduction in net gains on sales of mortgage loans as the Company, and the banking industry as a whole, saw an extreme slowdown in residential mortgage lending due in part to a higher interest rate environment during 2022 compared to 2021.

This decrease was partially offset by higher loan servicing income, which includes the impact of valuation updates to the Company’s MSRs.

These valuation updates added $2.8 million to servicing income during the first three quarters of 2022, compared to $0.6 million during the first three quarters of 2021.

The major components of our noninterest income are listed below:

Nine Months Ended September 30,

(In thousands)

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Loan servicing income

Valuation adjustment on MSR

Net gain on sales of mortgage loans

Net gain on sales and valuations of other real estate owned

Net gain on sales and valuation of ORE

Total noninterest income

Noninterest Expense.

Noninterest expense increased $7.7 million to $44.8 million for the nine months ended September 30, 2022 compared to $37.1 million for the same period in 2021.

Significant one-time expenses from the Company’s acquisition of Denmark during the third quarter of 2022 caused large increases in salaries, data processing and outside service fees.

The added scale resulting from this transaction, which impacted approximately one-half of the third quarter of 2022, as well as inflationary pressures further increased salaries, occupancy and data processing.

Finally, the acquisition of Denmark resulted in the recording of a core deposit intangible totaling $15.1 million.

Amortization of this core deposit intangible began during the third quarter of 2022 and was the cause of the increase in amortization of intangibles in the year-over-year periods.

Noninterest expense increased $6.9 million to $19.7 million for the three months ended March 31, 2023 compared to $12.7 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, which increased the total assets by $1.24 billion, or 42.5% from the end of the first quarter of 2022 to the end of the first quarter of 2023.

In addition to this trend, one-time expenses directly attributable to these acquisitions totaling $1.3 million during the first quarter of 2023 caused increases in several expense areas, most notably personnel, occupancy and outside service fees.

Finally, 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 quarter of 2022 to the first quarter of 2023.

The major components of our noninterest expense are listed below:

Nine Months Ended September 30,

Three Months Ended March 31,

(In thousands)

9 unchanged sentences

Income Tax Expense.

We recorded a provision for income taxes of $10.5 million for the nine months ended September 30, 2022 compared to a provision of $11.0 million for the same period during 2021, reflecting effective tax rates of 24.5% and 24.2%, respectively.

We recorded a provision for income taxes of $3.6 million for the three months ended March 31, 2023 compared to a provision of $3.4 million for the same period during 2022, reflecting effective tax rates of 25.0% and 25.1%, respectively.

7 unchanged sentences

Three Months Ended

September 30, 2022

September 30, 2021

March 31, 2023

March 31, 2022

Rate Earned/ Paid

9 unchanged sentences

Non interest-earning assets

Allowance for loan losses

LIABILITIES AND SHAREHOLDERS’ EQUITY

Interest-bearing deposits

Checking accounts

Savings accounts

Money market accounts

Certificates of deposit

Brokered deposits

Total interest-bearing deposits

Other borrowed funds

Total interest-bearing liabilities

Non-interest bearing liabilities

Demand deposits

Other liabilities

Total liabilities

Shareholders’ equity

Total liabilities & shareholders’ equity

Net interest income on a fully taxable equivalent basis

Less taxable equivalent adjustment

Net interest income

Net interest spread (3)

Net interest margin (4)

Annualized on a fully taxable equivalent basis calculated using a federal tax rate of 21% for the three months ended September 30, 2022 and 2021.

Nonaccrual loans are included in average amounts outstanding.

Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.

Net interest margin represents net interest income on a fully tax equivalent basis as a percentage of average interest-earning assets.

Nine Months Ended

September 30, 2022

September 30, 2021

(dollars in thousands)

Interest-earning assets

Taxable (available for sale)

Tax-exempt (available for sale)

Taxable (held to maturity)

Tax-exempt (held to maturity)

Cash and due from banks

Total interest-earning assets

Non interest-earning assets

Allowance for loan losses

Allowance for credit losses - loans

LIABILITIES AND SHAREHOLDERS’ EQUITY

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Net interest margin (4)

Annualized on a fully taxable equivalent basis calculated using a federal tax rate of 21% for the nine months ended September 30, 2022 and 2021.

Annualized on a fully taxable equivalent basis calculated using a federal tax rate of 21% for the three months ended March 31, 2023 and 2022.

Nonaccrual loans are included in average amounts outstanding.

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(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, 2022

Nine Months Ended September 30, 2022

Compared with

Three Months Ended March 31, 2023

Compared with

Three Months Ended September 30, 2021

Nine Months Ended September 30, 2021

Increase/(Decrease) Due to Change in

Three Months Ended March 31, 2022

Increase/(Decrease) Due to Change in

(dollars in thousands)

Interest income

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Total Assets.

Total assets increased $703.2 million, or 23.9%, to $3.64 billion at September 30, 2022, from $2.94 billion at December 31, 2021.

Total assets increased $506.8 million, or 13.9%, to $4.17 billion at March 31, 2023, from $3.66 billion at December 31, 2022.

Cash and Cash Equivalents.

Cash and cash equivalents decreased by $153.4 million to $143.4 million at September 30, 2022 from $296.9 million at December 31, 2021, the result of significant loan growth during the first two quarters of 2022 as well as investing approximately $100.0 million in one-year treasury notes during the first quarter of 2022.

Cash and cash equivalents increased by $50.3 million to $169.7 million at March 31, 2023 from $119.4 million at December 31, 2022.

Investment Securities.

The carrying value of total investment securities increased by $125.5 million to $344.1 million at September 30, 2022, from $218.6 million at December 31, 2021.

Net loans increased by $619.8 million, totaling $2.84 billion at September 30, 2022 compared to $2.22 billion at December 31, 2021.

The carrying value of total investment securities decreased by $73.8 million to $275.9 million at March 31, 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 $32.2 million of securities, during the first quarter of 2023.

Net loans increased by $408.7 million, totaling $3.28 billion at March 31, 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.

Bank-Owned Life Insurance.

At September 30, 2022, our investment in bank-owned life insurance was $45.8 million, an increase of $13.9 million from $31.9 million at December 31, 2021.

Deposits increased $609.8 million, or 24.1%, to $3.14 billion at September 30, 2022 from $2.53 billion at December 31, 2021.

At September 30, 2022, borrowings consisted of advances from the FHLB of Chicago, as well as subordinated debt to other banks and an individual.

FHLB borrowings decreased to $2.6 million at September 30, 2022, from $8.0 million at December 31, 2021.

Subordinated debt increased to $23.5 million at September 30, 2022 compared to $17.5 million at December 31, 2021.

At March 31, 2023, our investment in bank-owned life insurance was $60.1 million, an increase of $14.0 million from $46.1 million at December 31, 2022.

Deposits increased $403.0 million, or 13.2%, to $3.46 billion at March 31, 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.

At March 31, 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 $36.9 million at March 31, 2023, from $1.9 million at December 31, 2022.

Junior subordinated debentures, all of which resulted from the acquisition of Hometown, totaled $10.9 at March 31, 2023.

Subordinated debt remained stable with $23.5 million at March 31, 2023 and December 31, 2022.

Stockholders’ Equity.

Total stockholders’ equity increased $116.8 million, or 36.2%, to $439.4 million at September 30, 2022, from $322.7 million at December 31, 2021.

The primary driver of this increase was the Denmark acquisition, which added $125.3 million to stockholders’ equity.

Strong earnings through the first three quarters of 2022 were offset by valuation adjustments to the Bank’s available for sale investment portfolio, which is accounted for through the comprehensive income component of equity, due to significant movements in the interest rate environment.

Further offsetting the strong earnings was $13.8 million in repurchases of its common stock by the Company.

Total stockholders’ equity increased $109.3 million, or 24.1%, to $562.4 million at March 31, 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.

Our lending activities are conducted principally in Wisconsin.

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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 78.5% and 76.1% of our total assets as of September 30, 2022 and December 31, 2021, respectively.

Our loan portfolio is our most significant earning asset, comprising 79.7% and 79.1% of our total assets as of March 31, 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 $622.6 million, or 27.8%, to $2.86 billion as of September 30, 2022 as compared to $2.24 billion as of December 31, 2021.

This increase during the first nine months of 2022 was primarily driven by the acquisition of Denmark, which included approximately $457.1 million in loan balances, and has been comprised of an increase of $120.5 million or 32.9% in commercial and industrial loans, an increase of $149.0 million or 25.9% in owner occupied commercial real estate loans, an increase of $131.4 million or 24.5% in non-owner occupied commercial real estate, an increase of $76.8 million or 58.0% in construction and development loans, an increase of $135.1 million or 23.6% in residential 1-4 family loans and an increase of $9.7 million or 18.1% 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, 2022, December 31, 2021, and September 30, 2021:

September 30,

Loans increased $429.3 million, or 14.8%, to $3.32 billion as of March 31, 2023 as compared to $2.89 billion as of December 31, 2022.

This increase during the first three 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 $55.4 million or 11.2% in commercial and industrial loans, an increase of $198.8 million or 27.7% in owner occupied commercial real estate loans, an increase of $85.7 million or 12.6% in non-owner occupied commercial real estate, a decrease of $24.5 million or 12.3% in construction and development loans, an increase of $113.7 million or 15.4% in residential 1-4 family loans and an increase of $0.2 million in consumer and other loans.

The following table presents the balance and associated percentage of each major category in our loan portfolio at March 31, 2023, December 31, 2022, and March 31, 2022:

(dollars in thousands)

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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, 2022 and December 31, 2021, total loans outstanding to such directors and officers and their associates were $72.1 million and $73.5 million, respectively.

During the nine months ended September 30, 2022, $36.3 million of additions and $37.7 million of repayments were made to these loans.

At September 30, 2022 and December 31, 2021, all of the loans to directors and officers were performing according to their original terms, other than standard and customary payment deferrals allowed under the CARES act, which were provided under the same terms as all other customers of the Bank.

At March 31, 2023 and December 31, 2022, total loans outstanding to such directors and officers and their associates were $68.5 million and $70.2 million, respectively.

During the three months ended March 31, 2023, $6.6 million of additions and $8.3 million of repayments were made to these loans.

At March 31, 2023 and December 31, 2022, all of the loans to directors and officers were performing according to their original terms.

Loan categories

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Commercial and Industrial (C&I).

Our C&I portfolio totaled $486.7 million and $366.2 million at September 30, 2022 and December 31, 2021, respectively, and represented 17% and 16% of our total loans at those dates.

Our C&I portfolio totaled $547.8 million and $492.5 million at March 31, 2023 and December 31, 2022, respectively, and represented 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.

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Commercial Real Estate (CRE).

Our CRE loan portfolio totaled $1.39 billion and $1.11 billion at September 30, 2022 and December 31, 2021, respectively, and represented 49% and 50% of our total loans at those dates.

Our CRE loan portfolio totaled $1.68 billion and $1.40 billion at March 31, 2023 and December 31, 2022, respectively, and represented 51% 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.

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Construction and Development (C&D).

Our C&D loan portfolio totaled $209.3 million and $132.5 million at September 30, 2022 and December 31, 2021, respectively, and represented 7% and 6% of our total loans at those dates.

Our C&D loan portfolio totaled $175.2 million and $199.7 million at March 31, 2023 and December 31, 2022, respectively, and represented 5% 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.

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Residential 1 – 4 Family.

Residential 1 – 4 family loans held in portfolio amounted to $707.0 million and $571.8 million at September 30, 2022 and December 31, 2021, respectively, and represented 25% and 26% of our total loans at those dates.

Residential 1 – 4 family loans held in portfolio amounted to $853.2 million and $739.5 million at March 31, 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.

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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).

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.

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Servicing rights are retained on all loans sold to the secondary market.

We were servicing mortgage loans sold to others without recourse of approximately $873.4 million at September 30, 2022 and $705.5 million at December 31, 2021.

We were servicing mortgage loans sold to others without recourse of approximately $1.20 billion at March 31, 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 included in other assets and are carried at fair value.

The net balance of capitalized servicing rights amounted to $9.6 million and 5.0 million at September 30, 2022 and December 31, 2021, respectively.

The net balance of capitalized servicing rights amounted to $14.1 million and $9.6 million at March 31, 2023 and December 31, 2022, respectively.

Consumer Loans.

Our consumer loan portfolio totaled $44.1 million and $32.1 million at September 30, 2022 and December 31, 2021, respectively, and represented 2% and 1% of our total loans at those dates.

Our consumer loan portfolio totaled $48.0 million and $45.0 million at March 31, 2023 and December 31, 2022, respectively, and represented 1% and 2% of our total loans at those dates.

Consumer loans include secured and unsecured loans, lines of credit and personal installment loans.

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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.

Our other loans totaled $19.2 million at September 30, 2022 and December 31, 2021, respectively, and are immaterial to the overall loan portfolio.

Our other loans totaled $15.9 million and $18.8 million at March 31, 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.

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, 2022.

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

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 March 31, 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.

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The composition of our nonperforming assets is as follows:

As of September 30,

As of March 31,

As of December 31,

As of September 30,

As of March 31,

(dollars in thousands)

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NPAs to total assets

ALL to nonaccrual loans

ALL to total loans

At September 30, 2022 and December 31, 2021, impaired loans had specific reserves of $0.9 million and $0.8 million, respectively.

ACL - Loans to nonaccrual loans

ACL - Loans to total loans

Nonaccrual Loans

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The status of delinquent loans, as well as situations identified as potential problems, is reviewed on a regular basis by senior management.

Troubled Debt Restructurings

A troubled debt restructuring includes a loan modification where a borrower is experiencing financial difficulty and we grant a concession to that borrower that we would not otherwise consider except for the borrower’s financial difficulties.

These concessions may include modifications of the terms of the debt such as deferral of payments, extension of maturity, reduction of principal balance, reduction of the stated interest rate other than normal market rate adjustments, or a combination of these concessions.

Debt may be bifurcated with separate terms for each tranche of the restructured debt.

Restructuring a loan in lieu of aggressively enforcing the collection of the loan may benefit the Company by increasing the ultimate probability of collection.

A TDR may be either on accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability.

If a TDR is placed on nonaccrual status, which would occur based on the same criteria as non-TDR loans, it remains there until a sufficient period of performance under the restructured terms has occurred at which it returned to accrual status, generally 6 months.

As of September 30, 2022 and December 31, 2021 the Company had specific reserves of $7,000 for TDRs, and none of them have subsequently defaulted.

ALLOWANCE FOR LOAN LOSSES

ALL represents management’s estimate of probable and inherent credit losses in the loan portfolio.

Estimating the amount of the ALL require the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows or impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change.

The loan portfolio also represents the largest asset on the consolidated balance sheets.

Loan losses are charged off against the ALL, while recoveries of amounts previously charged off are credited to the ALL.

A provision for loan losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

The ALL consists of specific reserves for certain individually evaluated impaired loans and general reserves for collectively evaluated non-impaired loans.

Specific reserves reflect estimated losses on impaired loans from management’s analyses developed through specific credit allocations.

The specific reserves are based on regular analyses of impaired, non-homogenous loans greater than $250,000.

These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values.

The general reserve is based in part on the Bank’s historical loss experience which is updated quarterly.

The general reserve portion of the ALL also includes consideration of certain qualitative factors such as (1) changes in lending policies and/or underwriting practices, (2) national and local economic conditions, (3) changes in portfolio volume and nature, (4) experience, ability and depth of lending management and other relevant staff, (5) levels of and trends in past-due and nonaccrual loans and quality, (6) changes in loan review and oversight, (7) impact and effects of concentrations and (8) other issues deemed relevant.

There are many factors affecting ALL;

some are quantitative while others require qualitative judgment.

The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change.

To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect our earnings or financial position in future periods.

Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged off or for which an actual loss is realized.

As an integral part of their examination process, various regulatory agencies review the ALL as well.

Such agencies may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

The following table summarizes the changes in our ALL for the periods indicated:

Nine months ended

September 30,

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 predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted 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 March 31, 2023, the ACL - Loans was $43.3 million (representing 1.30 % 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:

Three months ended

(dollars in thousands)

Balance of ALL at the beginning of period

Balance of ACL - Loans at the beginning of period

Adoption of CECL

ACL - Loans on PCD loans acquired

Net loans charged-off (recovered):

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Provision charged to operating expense

Balance of ALL at end of period

Balance of ACL - Loans at end of period

Ratio of net charge-offs (recoveries) to average loans by loan composition

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Total net charge-offs to average loans

The level of charge-offs depends on many factors, including the national and regional economy.

Cyclical lagging factors may result in charge-offs being higher than historical levels.

Although the allowance is allocated between categories, the entire allowance is available to absorb losses attributable to all loan categories.

Management believes that the current ALL is adequate.

The following table summarizes an allocation of the ALL and the related percentage of loans outstanding in each category for the periods below.

September 30,

The following table summarizes an allocation of the ACL - Loans and the related percentage of loans outstanding in each category for the periods below.

(in thousands, except %)

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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, 2022, deposit liabilities accounted for approximately 86.2% of our total liabilities and equity.

As of March 31, 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.

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Deposit rates and terms are based primarily on current business strategies, market interest rates, liquidity requirements and our deposit growth goals.

Total deposits were $3.14 billion and $2.53 billion as of September 30, 2022 and December 31, 2021, respectively.

Noninterest-bearing deposits at September 30, 2022 and December 31, 2021, were $971.8 million and $799.9 million, respectively, while interest-bearing deposits were $2.17 billion and $1.73 billion at September 30, 2022 and December 31, 2021, respectively.

At September 30, 2022, we had a total of $356.9 million in certificates of deposit, including $6.7 million of brokered deposits.

Total deposits were $3.46 billion and $3.06 billion as of March 31, 2023 and December 31, 2022, respectively.

Noninterest-bearing deposits at March 31, 2023 and December 31, 2022, were $1.10 billion and $934.1 million, respectively, while interest-bearing deposits were $2.36 billion and $2.13 billion at March 31, 2023 and December 31, 2022, respectively.

At March 31, 2023, we had a total of $457.4 million in certificates of deposit, including $6.7 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:

Nine months ended

September 30, 2022

Three months ended

March 31, 2023

December 31, 2022

September 30, 2021

March 31, 2022

(dollars in thousands)

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Brokered deposits

The following table provides information on maturities of certificates of deposits which exceed FDIC insurance limits of $250,000 as of September 30, 2022:

The following table provides information on maturities of certificates of deposits which exceed FDIC insurance limits of $250,000 as of March 31, 2023:

Time Deposits over FDIC

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The following table summarizes securities sold under repurchase agreements, and the weighted average interest rates paid:

Nine months ended

Three months ended

(dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

September 30, 2021

March 31, 2022

Average daily amount of securities sold under repurchase agreements during the period

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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 $2.6 million of advances outstanding from the FHLB at September 30, 2022, and $8.0 million as of December 31, 2021.

The total loans pledged as collateral were $588.8 million at September 30, 2022 and $915.5 million at December 31, 2021.

There were no outstanding letters of credit from the FHLB at September 30, 2022 and December 31, 2021.

There were $36.9 million of advances outstanding from the FHLB at March 31, 2023, and $1.9 million as of December 31, 2022.

The total loans pledged as collateral were $1.18 billion at March 31, 2023 and $1.15 billion at December 31, 2022.

There were no outstanding letters of credit from the FHLB at March 31, 2023 or December 31, 2022.

The following table summarizes borrowings, which consist of borrowings from the FHLB, and the weighted average interest rates paid:

Nine months ended

Three months ended

(dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

September 30, 2021

March 31, 2022

Average daily amount of borrowings outstanding during the period

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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, 2022.

There were no outstanding balances on this note at March 31, 2023.

Any future borrowings will required monthly payments of interest at a variable rate, and will be due in full on May 15, 2024.

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During July 2020, the Company entered into subordinated note agreements with two separate commercial banks.

As of September 30, 2022 and December 31, 2021, outstanding balances under these agreements totaled $6.0 million.

As of March 31, 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.

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During August 2022, the Company entered into subordinated note agreements with an individual.

As of September 30, 2022, outstanding balances under these agreements totaled $6.0 million.

As of March 31, 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.

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 debenture issued to Trust I totals $4.1 million, carries interest at a floating rate of the three-month LIBOR plus 3.30% (resetting on each quarterly payment date), and is due on January 7, 2034.

The junior subordinated debenture issued to Trust II totals $8.2 million, carries interest at a floating rate of the three-month LIBOR plus 1.80% (resetting on each quarterly payment date), and is due on December 15, 2036.

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 March 31, 2023.

INVESTMENT SECURITIES

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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 $303.3 million and included gross unrealized gains of $0.4 million and gross unrealized losses of $26.1 at September 30, 2022.

The fair value of securities available for sale totaled $197.9 million and included gross unrealized gains of $0.3 million and gross unrealized losses of $18.4 at March 31, 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.

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These securities, which management has the intent and ability to hold to maturity, are reported at amortized cost.

Securities held to maturity totaled $40.8 million at September 30, 2022 and $5.9 million at December 31, 2021.

The Company had recognized gains or losses on sales of securities of $0 and $3,000 during the nine months ended September 30, 2022 and 2021, respectively.

The following tables set forth the composition and maturities of investment securities as of September 30, 2022 and December 31, 2021.

Securities held to maturity totaled $78.0 million at March 31, 2023 and $45.1 million at December 31, 2022.

The Company had recognized net losses on sales of securities of $75,000 during the three months ended March 31, 2023.

There were no sales of securities during the three months ended March 31, 2022.

The following tables set forth the composition and maturities of investment securities as of March 31, 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.

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After Ten Years

At September 30, 2022

At March 31, 2023

(dollars in thousands)

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Held to maturity securities

Treasury securities

Obligations of states and political subdivisions

Weighted Average Yield is shown on a fully taxable equivalent basis using a federal tax rate of 21% at September 30, 2022 and December 31, 2021, respectively.

The Company evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant such evaluation.

Total held to maturity securities

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;

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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, 2022, 270 debt securities had gross unrealized losses, with an aggregate depreciation of 7.8% from our amortized cost basis.

As of March 31, 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, the Company does 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 March 31, 2023 or December 31, 2022.

Treasury securities have the full faith and credit backing of the United States government and the amount of obligations of states and political subdivisions is immaterial to the financial statements.

As of March 31, 2023, 224 debt securities had gross unrealized losses, with an aggregate depreciation of 8.7% from our amortized cost basis.

The largest unrealized loss percentage of any single security was 27.2% (or $0.5 million) of its amortized cost.

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The largest unrealized loss percentage of any single security was 30.4% (or $0.6 million) of its amortized cost.

This was also the largest unrealized dollar loss of any single security.

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.

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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 investment portfolio, deposits, borrowings from the FHLB, and lines available from correspondent banks.

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 $1.12 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 $439.4 million at September 30, 2022 compared to $322.7 million at December 31, 2021.

Total stockholders’ equity was $562.4 million at March 31, 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 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.

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.

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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, 2022, and brokered deposits are not restricted.

To be well-capitalized, the Bank must maintain at least the following capital ratios:

● 6.5% CET1 to risk-weighted assets;

● 8.0% Tier 1 capital to risk-weighted assets;

● 10.0% Total capital to risk-weighted assets;

● 5.0% leverage ratio.

The Bank was well capitalized at March 31, 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.

The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”) signed into law in May 2018 scaled back certain requirements of the Dodd-Frank Act and provided other regulatory relief.

Among the provisions of the Economic Growth Act was a requirement that the Federal Reserve raise the asset threshold for those bank holding companies subject to the Federal Reserve’s Small Bank Holding Company Policy Statement (“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 as described above.

The Federal Reserve may however, require smaller bank holding companies subject to the Policy Statement 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 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.

As a result of the Economic Growth Act, the federal banking agencies were also 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.

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.

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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 the “current expected credit losses” (“CECL”) accounting standard under GAAP;

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;

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(dollars in thousands)

At September 30, 2022

At March 31, 2023

Bank First Corporation:

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Tier I capital (to average assets)

As previously mentioned, the Company carried $23.5 million and $17.5 million of subordinated debt as of September 30, 2022 and December 31, 2021, respectively, which is included in total capital for the Company in the tables above.

As previously mentioned, the Company carried $23.5 million of subordinated debt as of March 31, 2023 and December 31, 2022, and $12.0 million in junior subordinated debentures as of March 31, 2023, all of which is included in total capital for the Company in the tables above.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

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Our off-balance sheet arrangements at the dates indicated were as follows:

Amounts of Commitments Expiring - By Period as of September 30, 2022

Amounts of Commitments Expiring - By Period as of March 31, 2023

Less Than One

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis