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Item 2. Management’s Discussion and Analysis

2023-08-09 compared with 2023-05-10 · 236 added, 109 removed, 719 unchanged (32% 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, 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 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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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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At or for the Three Months Ended

At or for the Six Months Ended

(In thousands, except per share data)

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At or for the Three Months Ended

At or for the Six Months Ended

(In thousands, except per share data)

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RESULTS OF OPERATIONS

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.

Results of Operations for the Three Months Ended June 30, 2023 and June 30, 2022

Net income increased $2.4 million to $14.1 million for three months ended June 30, 2023, compared to $11.7 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.

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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 $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 and dividend income increased by $10.8 million to $34.3 million for the three months ended June 30, 2023 compared to $23.5 million for three months ended June 30, 2022.

Total average interest-earning assets were $3.68 billion for the three months ended June 30, 2023, up from $2.98 billion for the same period in 2022.

Tax equivalent net interest margin increased 0.56% to 3.77% for the three months ended June 30, 2023, up from 3.21% 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 $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.

Total interest income increased $20.1 million, or 77.9%, to $45.9 million for the three months ended June 30, 2023 compared to $25.8 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 $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.

The average balance of interest-earning assets increased by $707.8 million during the three months ended June 30, 2023 compared to the same period in 2022 and the average interest rate earned on these assets increased by 1.51% in the year-over-year second quarters.

Interest Expense.

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.

Interest expense increased $9.4 million, or 398.0%, to $11.7 million for the three months ended June 30, 2023 compared to $2.3 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.

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.

Interest expense on interest-bearing deposits increased by $8.3 million to $10.1 million for the three months ended June 30, 2023 from $1.7 million for the same period in 2022.

The average balance and average cost of interest-bearing deposits was $2.32 billion and 1.74% for the three months ended June 30, 2023, compared to $1.75 billion and 0.40% for the same period in 2022.

Provision for Credit Losses.

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The determination of the amount is complex and involves a high degree of judgment and subjectivity.

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.

We did not record a provision for credit loss during the three months ended June 30, 2023 compared to a provision of $0.5 million for the same period in 2022.

Economic forecasts, primarily US gross domestic product and unemployment projections, were little changed during the second quarter of 2023 resulting in consistent qualitative factors in the CECL methodology.

We recorded $0.1 million net recoveries during the three months ended June 30, 2023 compared to net recoveries of $0.5 million for the three months ended June 30, 2022.

The ACL - Loans was $43.4 million, or 1.31% of total loans, at June 30, 2023 compared to $22.7 million, or 0.95% of total loans at June 30, 2022.

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

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

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.

Noninterest income decreased $1.5 million to $4.1 million for the three months ended June 30, 2023 compared to $5.6 million for the same period in 2022.

This decrease was primarily the result of negative valuation adjustments totaling $0.5 million on the value of mortgage servicing rights during the second quarter of 2023 compared to positive valuation adjustments $1.5 million on these rights during the second quarter of 2022.

Losses on sales of ORE totaling $0.5 million during the second quarter of 2023 also compared unfavorably to minimal losses during the second quarter of 2022.

Offsetting these negative year-over-year second quarter comparisons were elevated current quarter service charges, loan servicing and other noninterest income from the added operational scale from the acquisitions of Denmark and Hometown and higher income provided by Ansay and UFS.

The major components of our noninterest income are listed below:

Three Months Ended March 31,

Three Months Ended June 30,

(in thousands)

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Net gain on sales of mortgage loans

Net gain on sales and valuation of ORE

Net loss on sales and valuation of ORE

Total noninterest income

Noninterest Expense.

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.

Noninterest expense increased $6.2 million to $19.4 million for the three months ended June 30, 2023 compared to $13.2 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 $1.13 billion, or 38.2% from the end of the second quarter of 2022 to the end of the second quarter of 2023 and added to the Company’s branch footprint and employee count.

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 second quarter of 2022 to the second quarter of 2023.

The major components of our noninterest expense are listed below:

Three Months Ended March 31,

Three Months Ended June 30,

(In thousands)

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Postage, stationary, and supplies

Charitable contributions

Outside service fees

Amortization of intangibles

Total noninterest expenses

Income Tax Expense.

We recorded a provision for income taxes of $4.7 million for the three months ended June 30, 2023 compared to a provision of $3.7 million for the same period during 2022, reflecting effective tax rates of 25.1% and 23.9%, 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 Six months Ended June 30, 2023 and June 30, 2022

Net income increased $3.0 million to $24.8 million for six months ended June 30, 2023, compared to $21.8 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 .

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 $20.7 million to $66.5 million for the six months ended June 30, 2023 compared to $45.8 million for six months ended June 30, 2022.

Total average interest-earning assets were $3.60 billion for the six months ended June 30, 2023, up from $2.99 billion for the same period in 2022.

Tax equivalent net interest margin increased 0.63% to 3.76% for the six months ended June 30, 2023, up from 3.13% 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 $36.8 million, or 73.5%, to $86.8 million for the six months ended June 30, 2023 compared to $50.0 million for the same period in 2022.

The average balance of interest-earning assets increased by $616.1 million during the first six months of 2023 compared to the same period in 2022 and the average interest rate earned on these assets increased by 1.47% from 3.42% for the first half of 2022 to 4.89% during the first half of 2023.

Interest Expense.

Interest expense increased $16.0 million, or 376.0%, to $20.3 million for the six months ended June 30, 2023 compared to $4.3 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 $319.6 million during the first six months of 2023 compared to the same period in 2022 and the average interest rate paid on these balances was 0.42% for the first half of 2022 compared to 1.72% for the first half of 2023.

Interest expense on interest-bearing deposits totaled $17.5 million and $3.3 million for the six months ended June 30, 2023 and 2022, respectively.

The average cost of interest-bearing deposits was 1.55% for the six months ended June 30, 2023, compared to 0.38% 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 recorded a provision for credit losses of $4.2 million for the six months ended June 30, 2023 compared to $1.7 million for the same period in 2022.

The increased provision for the first six 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 half of 2023 resulting in consistent qualitative factors in the CECL methodology.

We recorded net recoveries of $0.1 million for the six months ended June 30, 2023 compared to net recoveries of $0.7 million for the same period in 2022.

The ACL was $43.4 million, or 1.31% of total loans, at June 30, 2023 compared to $22.7 million, or 0.95% of total loans at June 30, 2022.

The increased ACL coverage was the result of CECL implementation.

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 $0.9 million to $9.9 million for the six months ended June 30, 2023 compared to $10.8 million for the same period in 2022.

This decrease was primarily the result of positive valuation adjustments totaling $0.2 million on the value of mortgage servicing rights during the first half of 2023 which compared negatively to positive valuation adjustments $2.0 million on these rights during the first half of 2022.

Losses on sales of ORE totaling $0.5 million during the first half of 2023 also compared unfavorably to gains of $0.1 million during the first half of 2022.

Offsetting these negative period-over-period comparisons were elevated current period service charges, loan servicing and other noninterest income from the added operational scale from the acquisitions of Denmark and Hometown and higher income provided by Ansay and UFS.

Net gains on the sale of mortgage loans also

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 half of 2023 compared to the same period in 2022.

The major components of our noninterest income are listed below:

Six Months Ended June 30,

(In thousands)

Noninterest Income

Service Charges

Income from Ansay

Income from UFS

Loan Servicing income

Valuation adjustment on MSR

Net gain on sales of mortgage loans

Net gain (loss) on sales and valuation of ORE

Total noninterest income

Noninterest Expense.

Noninterest expense increased $13.1 million to $39.1 million for the six months ended June 30, 2023 compared to $26.0 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 $1.13 billion, or 38.2% from the end of the second quarter of 2022 to the end of the second quarter of 2023.

Significant one-time expenses from the Company’s acquisition of Hometown during the first quarter of 2023 also caused large increases in salaries, data processing and outside service fees.

The major components of our noninterest expense are listed below:

Six Months Ended June 30,

(In thousands)

Noninterest Expense

Salaries, commissions, and employee benefits

Data processing

Postage, stationary, and supplies

Net loss on sales of securities

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Income Tax Expense.

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.

We recorded a provision for income taxes of $8.3 million for the six months ended June 30, 2023 compared to a provision of $7.1 million for the same period during 2022, reflecting effective tax rates of 25.1% and 24.5%, respectively.

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Three Months Ended

March 31, 2023

March 31, 2022

June 30, 2023

June 30, 2022

Rate Earned/ Paid

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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 three months ended March 31, 2023 and 2022.

Annualized on a fully taxable equivalent basis calculated using a federal tax rate of 21% for the three months ended June 30, 2023 and 2022.

Nonaccrual loans are included in average amounts outstanding.

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

Six Months Ended

June 30, 2023

June 30, 2022

(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

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 six months ended June 30, 2023 and 2022.

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.

Rate/Volume Analysis

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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 March 31, 2023

Three Months Ended June 30, 2023

Six Months Ended June 30, 2023

Compared with

Three Months Ended March 31, 2022

Compared with

Three Months Ended June 30, 2022

Six Months Ended June 30, 2022

Increase/(Decrease) Due to Change in

(dollars in thousands)

Interest income

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Total Assets.

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.

Total assets increased $431.6 million, or 11.8%, to $4.09 billion at June 30, 2023, from $3.66 billion at December 31, 2022.

Cash and Cash Equivalents.

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.

Cash and cash equivalents decreased by $8.1 million to $111.3 million at June 30, 2023 from $119.4 million at December 31, 2022.

Investment Securities.

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.

The carrying value of total investment securities decreased by $80.7 million to $269.0 million at June 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.

Net loans increased by $408.7 million, totaling $3.28 billion at March 31, 2023 compared to $2.87 billion at December 31, 2022.

Net loans increased by $399.8 million, totaling $3.27 billion at June 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.

Bank-Owned Life Insurance.

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.

At June 30, 2023, our investment in bank-owned life insurance was $60.5 million, an increase of $14.4 million from $46.1 million at December 31, 2022.

Deposits increased $345.5 million, or 11.3%, to $3.41 billion at June 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.

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.

At June 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 June 30, 2023, from $1.9 million at December 31, 2022.

Junior subordinated debentures, all of which resulted from the acquisition of Hometown, totaled $10.9 million at June 30, 2023.

Subordinated debt remained stable with $23.5 million at June 30, 2023 and December 31, 2022.

Stockholders’ Equity.

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.

Total stockholders’ equity increased $117.8 million, or 26.0%, to $570.9 million at June 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.

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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 79.7% and 79.1% of our total assets as of March 31, 2023 and December 31, 2022, respectively.

Our loan portfolio is our most significant earning asset, comprising 81.0% and 79.1% of our total assets as of June 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 $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:

Loans increased $420.5 million, or 14.5%, to $3.31 billion as of June 30, 2023 as compared to $2.89 billion as of December 31, 2022.

This increase during the first six 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 $41.2 million or 8.4% in commercial and industrial loans, an increase of $190.0 million or 26.5% in owner occupied commercial real estate loans, an increase of $77.1 million or 11.3% in non-owner occupied commercial real estate, a decrease of $16.9 million or 8.5% in construction and development loans, an increase of $127.8 million or 17.3% in residential 1-4 family loans and an increase of $1.4 million in consumer and other loans.

The following table presents the balance and associated percentage of each major category in our loan portfolio at June 30, 2023, December 31, 2022, and June 30, 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 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.

At June 30, 2023 and December 31, 2022, total loans outstanding to such directors and officers and their associates were $63.8 million and $70.2 million, respectively.

During the six months ended June 30, 2023, $13.9 million of additions and $20.3 million of repayments were made to these loans.

At June 30, 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 $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 portfolio totaled $533.7 million and $492.5 million at June 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.

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Commercial Real Estate (CRE).

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 loan portfolio totaled $1.67 billion and $1.40 billion at June 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.

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Construction and Development (C&D).

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 loan portfolio totaled $182.8 million and $199.7 million at June 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.

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Residential 1 – 4 Family.

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.

Residential 1 – 4 family loans held in portfolio amounted to $867.3 million and $739.5 million at June 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.

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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 $1.20 billion at March 31, 2023 and $866.9 million at December 31, 2022.

We were servicing mortgage loans sold to others without recourse of approximately $1.19 billion at June 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 included in other assets and are carried at fair value.

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.

The net balance of capitalized servicing rights amounted to $13.5 million and $9.6 million at June 30, 2023 and December 31, 2022, respectively.

Consumer Loans.

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.

Our consumer loan portfolio totaled $49.5 million and $45.0 million at June 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.

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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 $15.9 million and $18.8 million at March 31, 2023 and December 31, 2022, respectively, and are immaterial to the overall loan portfolio.

Our other loans totaled $15.6 million and $18.8 million at June 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.

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 March 31, 2023.

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 June 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.

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The composition of our nonperforming assets is as follows:

As of March 31,

As of June 30,

As of December 31,

As of March 31,

As of June 30,

(dollars in thousands)

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Residential real estate owned

Bank property real estate owned

Acquired bank property real estate owned

Total nonperforming assets ("NPAs")

Accruing troubled debt restructured loans

Accruing modified loans to borrowers experiencing financial difficulty (1)

Nonaccrual loans to total loans

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ACL - Loans to total loans

(1) Amounts prior to January 1, 2023 represent accruing troubled debt restructured loans.

Nonaccrual Loans

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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.

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.

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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).

At June 30, 2023, the ACL - Loans was $43.4 million (representing 1.31 % of period end loans).

The Company adopted CECL as of January 1, 2023, which increased the ACL - Loans by $11.0 million.

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The following table summarizes the changes in our ACL - Loans for the periods indicated:

Three months ended

Six months ended

(dollars in thousands)

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Residential 1-4 family

Total net loans charged-off

Total net loans recovered

Provision charged to operating expense

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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 March 31, 2023, deposit liabilities accounted for approximately 83.1% of our total liabilities and equity.

As of June 30, 2023, deposit liabilities accounted for approximately 83.2% 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 $3.46 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.

Total deposits were $3.41 billion and $3.06 billion as of June 30, 2023 and December 31, 2022, respectively.

Noninterest-bearing deposits at June 30, 2023 and December 31, 2022, were $1.08 billion and $934.1 million, respectively, while interest-bearing deposits were $2.32 billion and $2.13 billion at June 30, 2023 and December 31, 2022, respectively.

At June 30, 2023, we had a total of $506.8 million in certificates of deposit, including $1.3 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:

Three months ended

March 31, 2023

Six months ended

June 30, 2023

December 31, 2022

March 31, 2022

June 30, 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 March 31, 2023:

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

Three months ended

Six months ended

(dollars in thousands)

March 31, 2023

June 30, 2023

December 31, 2022

March 31, 2022

June 30, 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 $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.

There were $35.8 million of advances outstanding from the FHLB at June 30, 2023, and $1.9 million as of December 31, 2022.

The total loans pledged as collateral were $1.44 billion at June 30, 2023 and $1.15 billion at December 31, 2022.

There were no outstanding letters of credit from the FHLB at June 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:

Three months ended

Six months ended

(dollars in thousands)

March 31, 2023

June 30, 2023

December 31, 2022

March 31, 2022

June 30, 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 March 31, 2023.

There were no outstanding balances on this note at June 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.

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

As of March 31, 2023 and December 31, 2022, outstanding balances under these agreements totaled $6.0 million.

As of June 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.

1 unchanged sentence

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

As of March 31, 2023, outstanding balances under these agreements totaled $6.0 million.

As of June 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.

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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.

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.

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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 $197.9 million and included gross unrealized gains of $0.3 million and gross unrealized losses of $18.4 at March 31, 2023.

The fair value of securities available for sale totaled $191.3 million and included gross unrealized gains of $50,000 and gross unrealized losses of $20.5 million at June 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.

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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 $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.

Securities held to maturity totaled $77.7 million at June 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 six months ended June 30, 2023.

There were no sales of securities during the six months ended June 30, 2022.

The following tables set forth the composition and maturities of investment securities as of June 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.

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After Ten Years

At March 31, 2023

At June 30, 2023

(dollars in thousands)

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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 March 31, 2023 and December 31, 2022, no allowance for credit losses on securities AFS was recognized.

As of June 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

1 unchanged sentence

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.

Furthermore, the Company does not believe there are any expected credit losses in its HTM securities portfolio at June 30, 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.

As of June 30, 2023, 228 debt securities had gross unrealized losses, with an aggregate depreciation of 9.7% 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.

25 unchanged sentences

Capital Adequacy.

Total stockholders’ equity was $562.4 million at March 31, 2023 compared to $453.1 million at December 31, 2022.

Total stockholders’ equity was $570.9 million at June 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.

27 unchanged sentences

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 March 31, 2023, and brokered deposits are not restricted.

The Bank was well capitalized at June 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.

23 unchanged sentences

(dollars in thousands)

At March 31, 2023

At June 30, 2023

Bank First Corporation:

19 unchanged sentences

Tier I capital (to average assets)

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.

As previously mentioned, the Company carried $23.5 million of subordinated debt as of June 30, 2023 and December 31, 2022, and $10.9 million in junior subordinated debentures as of June 30, 2023, all of which is included in total capital for the Company in the tables above.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

17 unchanged sentences

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

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

Amounts of Commitments Expiring - By Period as of June 30, 2023

Less Than One

15 unchanged sentences

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