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Item 2. Management’s Discussion and Analysis

2023-11-09 compared with 2023-08-09 · 178 added, 157 removed, 798 unchanged (30% 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 June 30, 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, Waushara, Dane and Jefferson counties in Wisconsin.

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

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

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In order to maintain its operations and bank locations, the Bank incurs various operating expenses which are further described within the “Results of Operations” later in this section.

The Bank is a 49.8% member of a data processing subsidiary, UFS, which provides core data processing, endpoint management, private cloud services, cyber security and digital banking solutions for over 60 Midwest banks.

As of September 30, 2023, the Bank was a 49.8% member of a data processing subsidiary, UFS, which provides core data processing, endpoint management, private cloud services, cyber security and digital banking solutions for over 60 Midwest banks.

The Bank sold 100% of its member interest in UFS on October 1, 2023.

The Bank, through its 100% owned subsidiary TVG Holdings, Inc., also holds a 40% ownership interest in Ansay, an insurance agency providing clients throughout Wisconsin with insurance and risk management solutions.

These unconsolidated subsidiary interests contribute noninterest income to the Bank through their underlying annual earnings.

These unconsolidated subsidiary interests have historically contributed noninterest income to the Bank through their underlying annual earnings.

On August 12, 2022, the Company consummated its merger with Denmark pursuant to the Agreement and Plan of Bank Merger, dated as of January 18, 2022, by and among the Company and Denmark, whereby Denmark was merged with and into the Company, and Denmark State Bank, Denmark’s wholly owned banking subsidiary, was merged with and into the Bank.

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At or for the Three Months Ended

At or for the Six Months Ended

At or for the Nine Months Ended

(In thousands, except per share data)

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Net gain on sales of mortgage loans

Net gain (loss) on sales and valuations of other real estate owned

Other noninterest income

4 unchanged sentences

Postage, stationery and supplies

Net gain (loss) on sales and valuations of other real estate owned

Net loss on sales of securities

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At or for the Three Months Ended

At or for the Six 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 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.

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

Net income increased $4.3 million to $14.8 million for three months ended September 30, 2023, compared to $10.5 million for the same period in 2022.

This increase was primarily due to the added scale of operations resulting from the Hometown acquisition during the first quarter of 2023.

The third quarter of 2022 was also negatively impacted by $4.6 million in acquisition related expenses, compared to $0.3 million during the third quarter of 2023.

Net Interest Income .

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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 $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.

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 second quarters.

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 and dividend income increased by $6.4 million to $34.1 million for the three months ended September 30, 2023 compared to $27.7 million for three months ended September 30, 2022.

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

Total average interest-earning assets were $3.67 billion for the three months ended September 30, 2023, up from $3.06 billion for the same period in 2022.

Tax equivalent net interest margin increased 0.08% to 3.71% for the three months ended September 30, 2023, up from 3.63% for the same period in 2022.

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

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Interest Income.

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.

Total interest income increased $16.2 million, or 52.9%, to $47.0 million for the three months ended September 30, 2023 compared to $30.7 million for the same period in 2022.

The increase in total interest income was primarily due to the aforementioned growth in interest earnings assets over the last twelve months along with an increase in the average interest rate earned on these assets.

The average balance of interest-earning assets increased by $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.

The average balance of interest-earning assets increased by $608.7 million during the three months ended September

30, 2023 compared to the same period in 2022 and the average interest rate earned on these assets increased by 1.08% in the year-over-year third quarters.

Interest Expense.

Interest expense increased $9.4 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.

Interest expense increased $9.9 million, or 324.4%, to $12.9 million for the three months ended September 30, 2023 compared to $3.0 million for the same period in 2022.

The increase in interest expense was primarily due to elevated interest bearing liabilities and higher crediting interest rates on those liabilities.

Interest expense on interest-bearing deposits increased by $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.

Interest expense on interest-bearing deposits increased by $9.0 million to $11.6 million for the three months ended September 30, 2023 compared to $2.6 million for the same period in 2022.

The average balance and cost of interest-bearing deposits was $2.32 billion and 1.99% for the three months ended September 30, 2023, compared to $2.0 million and 0.52% for the same period in 2022.

Provision for Credit Losses.

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

We did not record a provision for credit loss during the three months ended 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.

We did not record a provision for credit loss during the three months ended September 30, 2023 or 2022.

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

We recorded negligible net recoveries during the three months ended September 30, 2023 compared to net recoveries of $0.3 million for the three months ended September 30, 2022.

Metrics regarding the credit quality of the Bank’s loan portfolio continue to show very little in terms of stress.

The ACL - Loans was $43.4 million, or 1.29% of total loans, at September 30, 2023 compared to $23.0 million, or 0.81% of total loans at September 30, 2022.

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

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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.

A significant portion of our noninterest income has historically been associated with service charges and income from the Bank’s unconsolidated subsidiaries, Ansay and UFS.

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

Noninterest income 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.

Noninterest income increased $0.1 million to $5.3 million for the three months ended September 30, 2023 compared to $5.2 million for the same period in 2022.

While total noninterest income was little changed in the year-over-year third quarters, components of noninterest income did show variability.

Service charges and loan servicing income increased $0.4 million and $0.2 million, respectively, in the third quarter of 2023 compared to the third quarter of 2022 primarily due to the added scale from the acquisitions of Denmark and Hometown.

These increases were offset by a $0.7 million reduction in positive valuation adjustments of MSRs, from $0.9 million during the third quarter of 2022 to $0.2 million during the third quarter of 2023.

The major components of our noninterest income are listed below:

Three Months Ended June 30,

The major components of our noninterest income are listed below:The major components of our noninterest income are listed below:

Three Months Ended September 30,

(in thousands)

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Net gain on sales of mortgage loans

Net loss on sales and valuation of ORE

Total noninterest income

Noninterest Expense.

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.

Noninterest expense increased $0.7 million to $19.6 million for the three months ended September 30, 2023 compared to $18.9 million for the same period in 2022.

Most areas of noninterest expense increased over the past four quarters as a result of added operational scale from the acquisition of Hometown, which increased the total assets, branch footprint and employee count of the Company.

In addition to this trend, core deposit intangible assets of $15.1 million and $16.5 million created by the Denmark and Hometown acquisitions, respectively, created a significant increase in amortization of intangible assets expense from the third quarter of 2022 to the third quarter of 2023.

Counteracting these increases were one-time acquisition costs related to the acquisition of Denmark during the third quarter of 2022, primarily in the areas of salaries and outside service fees, which existed in the third quarter of 2022 but were not repeated during the third quarter of 2023.

The major components of our noninterest expense are listed below:

Three Months Ended June 30,

Three Months Ended September 30,

(In thousands)

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Postage, stationary, and supplies

Net loss on sales and valuations of other real estate owned

Charitable contributions

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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.

We recorded a provision for income taxes of $4.9 million for the three months ended September 30, 2023 compared to a provision of $3.4 million for the same period during 2022, reflecting effective tax rates of 24.7% and 24.6%, respectively.

The effective tax rates were reduced from the statutory federal and state income tax rates during both periods as a result of tax-exempt interest income produced by certain qualifying loans and investments in the Bank’s portfolios.

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.

On July 5, 2023, Wisconsin passed its 2023 state budget which included a provision exempting income earned from commercial loans of $5.0 million or less from state taxability.

As a result of this provision, which was retroactive to the beginning of 2023, the Company was able to reverse $2.4 million state related income tax expense which had been recorded during the first two quarters of 2023.

Also as a result of this provision, the Company’s lower anticipated future effective tax rate required an allowance to be made against the Bank’s deferred tax asset, which increased income tax expense by $2.9 million.

The net impact of these entries was a one-time increase to income tax expense of $0.5 million during the third quarter of 2023.

Results of Operations for the Nine months Ended September 30, 2023 and September 30, 2022

Net income increased $7.2 million to $39.6 million for nine months ended September 30, 2023, compared to $32.4 million for the same period in 2022.

This increase was primarily due to the added scale of operations resulting from the Denmark and Hometown acquisitions during the third quarter of 2022 and first quarter of 2023, respectively.

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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 and dividend income increased by $27.1 million to $100.6 million for the nine months ended September 30, 2023 compared to $73.5 million for nine months ended September 30, 2022.

Total average interest-earning assets were $3.63 billion for the nine months ended September 30, 2023, up from $3.01 billion for the same period in 2022.

Tax equivalent net interest margin increased 0.44% to 3.74% for the nine months ended September 30, 2023, up from 3.30% for the same period in 2022.

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

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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.

Total interest income increased $53.0 million, or 65.7%, to $133.8 million for the nine months ended September 30, 2023 compared to $80.8 million for the same period in 2022.

The 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.

The average balance of interest-earning assets increased by $613.6 million during the first nine months of 2023 compared to the same period in 2022 and the average interest rate earned on these assets increased by 1.34% from 3.63% for the first three quarters of 2022 to 4.97% during the first three quarters of 2023.

Interest Expense.

Interest expense increased $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.

Interest expense increased $26.0 million, or 354.5%, to $33.3 million for the nine months ended September 30, 2023 compared to $7.3 million for the same period in 2022.

The increase in interest expense was primarily due to elevated interest bearing liabilities and higher crediting interest rates on those liabilities.

The average balance of interest-bearing liabilities increased by $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.

The average balance of interest-bearing liabilities increased by $338.9 million during the first nine months of 2023 compared to the same period in 2022 and the average interest rate paid on these balances was 0.48% for the first three quarters of 2022 compared to 1.86% for the first three quarters of 2023.

Interest expense on interest-bearing deposits totaled $29.2 million and $5.9 million for the nine months ended September 30, 2023 and 2022, respectively.

The average cost of interest-bearing deposits was 1.70% for the nine months ended September 30, 2023, compared to 0.43% for the same period in 2022.

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 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.

We recorded a provision for credit losses of $4.2 million for the nine months ended September 30, 2023 compared to $1.7 million for the same period in 2022.

The increased provision for the first nine months of 2023 was primarily related to loans acquired from Hometown.

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

We recorded net recoveries of $0.1 million for the nine months ended September 30, 2023 compared to net recoveries of $1.0 million for the same period in 2022.

The ACL was $43.4 million, or 1.29% of total loans, at September 30, 2023 compared to $23.0 million, or 0.81% of total loans at September 30, 2022.

The increased ACL coverage was the result of CECL implementation.

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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.

A significant portion of our noninterest income has historically been associated with service charges and income from the Bank’s unconsolidated subsidiaries, Ansay and UFS.

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

Noninterest income 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.

Noninterest income decreased $0.1 million to $15.7 million for the nine months ended September 30, 2023 compared to $15.8 million for the same period in 2022.

While total noninterest income was little changed in the year-over-year first nine months, components of noninterest income did show variability.

Service charges and loan servicing income increased $1.0 million and $0.7 million, respectively, for the first nine months of 2023 compared to the same period in 2022 primarily due to the added scale from the acquisitions of Denmark and Hometown.

These increases were offset by a $2.3 million reduction in positive valuation adjustments of MSRs, from $2.8 million during the first nine months of 2022 to $0.5 million during the first nine months of 2023.

Finally, net gains

on the sale of mortgage loans saw a significant decline period-over-period due to an industry wide slowdown in residential mortgage lending due in part to a higher interest rate environment during the first nine months of 2023 compared to the same period in 2022.

The major components of our noninterest income are listed below:

Six Months Ended June 30,

Nine Months Ended September 30,

(In thousands)

6 unchanged sentences

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.

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.

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 half of 2022 to the first half of 2023.

Noninterest expense increased $14.6 million to $59.3 million for the nine months ended September 30, 2023 compared to $44.7 million for the same period in 2022.

Most areas of noninterest expense increased over the past four quarters as a result of added operational scale from the acquisitions of Denmark and Hometown.

Expenses related to these acquisitions totaled $5.7 million during the first nine months of 2022 compared to $1.8 million during the first nine months of 2023 which muted the increase year-over-year in salaries and led to a slight decrease year-over-year in outside service fees.

Core deposit intangible assets of $15.1 million and $16.5 million created by the Denmark and Hometown acquisitions, respectively, created a significant increase in amortization of intangible assets expense from the first three quarters of 2022 to the first three quarters of 2023.

Finally, losses on sales of ORE totaling $0.5 million during the first three quarters of 2023 compared unfavorably to gains of $0.1 million during the first three quarters of 2022.

The major components of our noninterest expense are listed below:

Six Months Ended June 30,

Nine Months Ended September 30,

(In thousands)

3 unchanged sentences

Postage, stationary, and supplies

Net loss (gain) on sales and valuations of other real estate owned

Net loss on sales of securities

4 unchanged sentences

Income Tax Expense.

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.

We recorded a provision for income taxes of $13.2 million for the nine months ended September 30, 2023 compared to a provision of $10.5 million for the same period during 2022, reflecting effective tax rates of 24.9% and 24.6%, respectively.

The 2023 Wisconsin state budget included a provision exempting income earned from commercial loans of $5.0 million or less from state taxability.

As a result of this provision, the Company’s lower anticipated future effective tax rate required an allowance to be made against the Bank’s deferred tax asset, which increased income tax expense by $2.9 million.

This required allowance offset the lower effective tax rate on current earnings, leading to comparable effective tax rates through the first nine months of 2023 and 2022.

NET INTEREST MARGIN

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Three Months Ended

June 30, 2023

June 30, 2022

September 30, 2023

September 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 June 30, 2023 and 2022.

Annualized on a fully taxable equivalent basis calculated using a federal tax rate of 21% for the three months ended September 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

Nine Months Ended

September 30, 2023

September 30, 2022

(dollars in thousands)

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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 six months ended June 30, 2023 and 2022.

Annualized on a fully taxable equivalent basis calculated using a federal tax rate of 21% for the nine months ended September 30, 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 June 30, 2023

Six Months Ended June 30, 2023

Three Months Ended September 30, 2023

Nine Months Ended September 30, 2023

Compared with

Three Months Ended June 30, 2022

Six Months Ended June 30, 2022

Three Months Ended September 30, 2022

Nine Months Ended September 30, 2022

Increase/(Decrease) Due to Change in

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Total Assets.

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.

Total assets increased $427.1 million, or 11.7%, to $4.09 billion at September 30, 2023, from $3.66 billion at December 31, 2022.

Cash and Cash Equivalents.

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

Cash and cash equivalents decreased by $43.6 million to $75.8 million at September 30, 2023 from $119.4 million at December 31, 2022.

Investment Securities.

The carrying value of total investment securities decreased by $80.7 million to $269.0 million at June 30, 2023, from $349.7 million at December 31, 2022.

The carrying value of total investment securities decreased by $93.5 million to $256.2 million at September 30, 2023, from $349.7 million at December 31, 2022.

This decline was primarily the result of significant maturities of securities in the Bank’s portfolio, as well as sales of approximately $34.2 million of securities, during the first quarter of 2023.

Net loans increased by $399.8 million, totaling $3.27 billion at June 30, 2023 compared to $2.87 billion at December 31, 2022.

Proceeds of these maturities and sales were utilized to fund loan growth and compensate for declining deposit balances through the first three quarters of 2023.

Net loans increased by $440.8 million, totaling $3.31 billion at September 30, 2023 compared to $2.87 billion at December 31, 2022.

The fair value of loans acquired as part of the acquisition of Hometown during the first quarter of 2023 totaled $395.8 million.

Bank-Owned Life Insurance.

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.

At September 30, 2023, our investment in bank-owned life insurance was $60.9 million, an increase of $14.8 million from $46.1 million at December 31, 2022.

Deposits increased $338.1 million, or 11.0%, to $3.40 billion at September 30, 2023 from $3.06 billion at December 31, 2022.

The fair value of deposits acquired as part of the acquisition of Hometown during the first quarter of 2023 totaled $532.4 million.

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.

At September 30, 2023, borrowings consisted of advances from the FHLB of Chicago, junior subordinated debentures, and subordinated debt to other banks and an individual.

FHLB borrowings increased to $35.8 million at September 30, 2023, from $1.9 million at December 31, 2022.

Junior subordinated debentures, all of which resulted from the acquisition of Hometown, totaled $11.0 million at September 30, 2023.

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

Stockholders’ Equity.

Total stockholders’ equity increased $117.8 million, or 26.0%, to $570.9 million at June 30, 2023, from $453.1 million at December 31, 2022.

Total stockholders’ equity increased $124.2 million, or 27.4%, to $577.3 million at September 30, 2023, from $453.1 million at December 31, 2022.

The primary driver of this increase was the Hometown acquisition, which added $115.1 million to stockholders’ equity.

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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 81.0% and 79.1% of our total assets as of June 30, 2023 and December 31, 2022, respectively.

Our loan portfolio is our most significant earning asset, comprising 82.1% and 79.1% of our total assets as of September 30, 2023 and December 31, 2022, respectively.

Our strategy is to grow our loan portfolio by originating quality commercial and consumer loans that comply with our credit policies and that produce revenues consistent with our financial objectives.

We believe our loan portfolio is well-balanced, which provides us with the opportunity to grow while monitoring our loan concentrations.

Loans increased $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:

Loans increased $461.6 million, or 15.9%, to $3.36 billion as of September 30, 2023 as compared to $2.89 billion as of December 31, 2022.

This increase during the first nine months of 2023 was primarily driven by the acquisition of Hometown, which included approximately $395.8 million in loan balances, and has been comprised of an increase of $38.9 million or 7.9% in commercial and industrial loans, an increase of $180.5 million or 25.2% in owner occupied commercial real estate loans, an increase of $103.6 million or 15.2% in non-owner occupied commercial real estate, a decrease of $2.6 million or 1.3% in construction and development loans, an increase of $139.5 million or 18.9% in residential 1-4 family loans and an increase of $1.7 million in consumer and other loans.

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

September 30,

(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 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.

At September 30, 2023 and December 31, 2022, total loans outstanding to such directors and officers and their associates were $64.3 million and $70.2 million, respectively.

During the nine months ended September 30, 2023, $21.0 million of additions and $26.9 million of repayments were made to these loans.

At September 30, 2023 and December 31, 2022, all of the loans to directors and officers were performing according to their original terms.

Loan categories

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Commercial and Industrial (C&I).

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 portfolio totaled $531.4 million and $492.5 million at September 30, 2023 and December 31, 2022, respectively, and represented 16% and 17% of our total loans at those dates.

Our C&I loan customers represent various small and middle-market established businesses involved in professional services, accommodation and food services, health care, financial services, wholesale trade, manufacturing, distribution, retailing and non-profits.

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Commercial Real Estate (CRE).

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 loan portfolio totaled $1.68 billion and $1.40 billion at September 30, 2023 and December 31, 2022, respectively, and represented 50% and 48% of our total loans at those dates.

Our CRE loans are secured by a variety of property types including multifamily dwellings, retail facilities, office buildings, commercial mixed use, lodging and industrial and warehouse properties.

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Construction and Development (C&D).

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 loan portfolio totaled $197.1 million and $199.7 million at September 30, 2023 and December 31, 2022, respectively, and represented 6% and 7% of our total loans at those dates.

Our C&D loans are generally for the purpose of creating value out of real estate through construction and development work, and also include loans used to purchase recreational use land.

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Residential 1 – 4 Family.

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.

Residential 1 – 4 family loans held in portfolio amounted to $879.0 million and $739.5 million at September 30, 2023 and December 31, 2022, respectively, and represented 26% and 25% of our total loans at those dates.

We offer fixed and adjustable-rate residential mortgage loans with maturities up to 30 years.

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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 $1.19 billion at June 30, 2023 and $866.9 million at December 31, 2022.

We were servicing mortgage loans sold to others without recourse of approximately $1.2 billion at September 30, 2023 and $866.9 million at December 31, 2022.

Loans sold with the retention of servicing assets result in the capitalization of servicing rights.

Loan servicing rights are included in other assets and are carried at fair value.

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.

Loan servicing rights are carried at fair value.

The net balance of capitalized servicing rights amounted to $13.7 million and $9.6 million at September 30, 2023 and December 31, 2022, respectively.

Consumer Loans.

Our consumer loan portfolio totaled $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.

Our consumer loan portfolio totaled $50.7 million and $45.0 million at September 30, 2023 and December 31, 2022, respectively, and represented 2% of our total loans at those dates.

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

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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 $15.6 million and $18.8 million at June 30, 2023 and December 31, 2022, respectively, and are immaterial to the overall loan portfolio.

Our other loans totaled $14.7 million and $18.8 million at September 30, 2023 and December 31, 2022, respectively, and are immaterial to the overall loan portfolio.

The other loans category consists primarily of over-drafted depository accounts, loans utilized to purchase or carry securities and loans to nonprofit organizations.

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 June 30, 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 September 30, 2023.

The tables do not include any estimate of prepayments, which can significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below.

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The composition of our nonperforming assets is as follows:

As of June 30,

As of September 30,

As of December 31,

As of June 30,

As of September 30,

(dollars in thousands)

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

At September 30, 2023, the ACL - Loans was $43.4 million (representing 1.29% of period end loans).

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

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

Six months ended

Nine months ended

September 30,

(dollars in thousands)

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

September 30,

(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 June 30, 2023, deposit liabilities accounted for approximately 83.2% of our total liabilities and equity.

As of September 30, 2023, deposit liabilities accounted for approximately 83.1% of our total liabilities and equity.

We accept deposits primarily from customers in the communities in which our branches and offices are located, as well as from small businesses and other customers throughout our lending area.

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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 $3.41 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.

Total deposits were $3.40 billion and $3.06 billion as of September 30, 2023 and December 31, 2022, respectively.

Noninterest-bearing deposits at September 30, 2023 and December 31, 2022, were $1.06 billion and $934.1 million, respectively, while interest-bearing deposits were $2.33 billion and $2.13 billion at September 30, 2023 and December 31, 2022, respectively.

At September 30, 2023, we had a total of $548.1 million in certificates of deposit, including $0.7 million of brokered deposits.

Based on historical experience and our current pricing strategy, we believe we will retain a majority of these accounts upon maturity, although our long-term strategy is to minimize reliance on certificates of deposits by increasing relationship deposits in lower earning savings and demand deposit accounts.

The following tables set forth the average balances of our deposits for the periods indicated:

Six months ended

June 30, 2023

Nine months ended

September 30, 2023

December 31, 2022

June 30, 2022

September 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 June 30, 2023:

The following table provides information on maturities of certificates of deposits which exceed FDIC insurance limits of $250,000 as of September 30, 2023:

Time Deposits over FDIC

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

Six months ended

Nine months ended

(dollars in thousands)

June 30, 2023

September 30, 2023

December 31, 2022

June 30, 2022

September 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 $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.

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

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

There were no outstanding letters of credit from the FHLB at September 30, 2023 or December 31, 2022.

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

Six months ended

Nine months ended

(dollars in thousands)

June 30, 2023

September 30, 2023

December 31, 2022

June 30, 2022

September 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 June 30, 2023.

There were no outstanding balances on this note at September 30, 2023.

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

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These notes were all issued with 10-year maturities, carry interest at a variable rate payable quarterly, are callable on or after the sixth anniversary of their issuance dates, and qualify for Tier 2 capital for regulatory purposes.

These note agreements were repaid in full on October 2, 2023.

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

As of June 30, 2023 and December 31, 2022, outstanding balances under these agreements totaled $6.0 million.

As of September 30, 2023 and December 31, 2022, outstanding balances under these agreements totaled $6.0 million.

These notes were issued with 10-year maturities, will carry interest at a fixed rate of 5.0% through June 30, 2025, and at a variable rate thereafter, payable quarterly.

1 unchanged sentence

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

As of June 30, 2023, outstanding balances under these agreements totaled $6.0 million.

As of September 30, 2023, outstanding balances under these agreements totaled $6.0 million.

These notes were issued with 10-year maturities, will carry interest at a fixed rate of 5.25% through August 6, 2027, and at a variable rate thereafter, payable quarterly.

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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 June 30, 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 $191.3 million and included gross unrealized gains of $50,000 and gross unrealized losses of $20.5 million at June 30, 2023.

The fair value of securities available for sale totaled $179.0 million and included no gross unrealized gains and gross unrealized losses of $26.6 million at September 30, 2023.

At December 31, 2022, the fair value of securities available for sale totaled $304.6 million and included gross unrealized gains of $0.5 million and gross unrealized losses of $21.8 million.

2 unchanged sentences

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

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.

Securities held to maturity totaled $77.2 million at September 30, 2023 and $45.1 million at December 31, 2022.

The Company had recognized net losses on sales of securities of $75,000 during the nine months ended September 30, 2023.

There were no sales of securities during the nine months ended September 30, 2022.

The following tables set forth the composition and maturities of investment securities as of September 30, 2023 and December 31, 2022.

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

5 unchanged sentences

After Ten Years

At June 30, 2023

At September 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 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

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 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 June 30, 2023, 228 debt securities had gross unrealized losses, with an aggregate depreciation of 9.7% from our amortized cost basis.

As of September 30, 2023 and December 31, 2022, no allowance for credit losses on securities AFS was recognized.

The Company does not consider its securities AFS with unrealized losses to be attributable to credit-related factors, as the unrealized losses

in each category have occurred as a result of changes in noncredit-related factors such as changes in interest rates, market spreads and market conditions subsequent to purchase, not credit deterioration.

Furthermore, as of September 30, 2023, the Company did not have the intent to sell any of these securities AFS and believes that it is more likely than not that we will not have to sell any such securities before a recovery of cost.

Furthermore, the Company does not believe there are any expected credit losses in its HTM securities portfolio at September 30, 2023 or December 31, 2022.

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

As of September 30, 2023, 297 debt securities had gross unrealized losses, with an aggregate depreciation of 10.2% from our amortized cost basis.

The largest unrealized loss percentage of any single security was 32.7% (or $0.7 million) of its amortized cost.

25 unchanged sentences

Capital Adequacy.

Total stockholders’ equity was $570.9 million at June 30, 2023 compared to $453.1 million at December 31, 2022.

Total stockholders’ equity was $577.3 million at September 30, 2023 compared to $453.1 million at December 31, 2022.

Our capital management consists of providing adequate equity to support our current and future operations.

The Bank is subject to various regulatory capital requirements administered by state and federal banking agencies, including the Federal Reserve and the 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.

The Bank is subject to various regulatory capital requirements administered by state and federal banking agencies, including the Federal Reserve and the

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.

23 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 June 30, 2023, and brokered deposits are not restricted.

The Bank was well capitalized at September 30, 2023, and brokered deposits are not restricted.

To be well-capitalized, the Bank must maintain at least a 6.5% CET1 to risk-weighted assets ratio, an 8.0% Tier 1 capital to risk-weighted assets ratio, a 10.0% Total capital to risk-weighted assets ratio, and a 5.0% leverage ratio.

3 unchanged sentences

A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under prompt corrective action statutes.

The federal banking agencies may consider a financial institutions risk profile when evaluation whether it qualifies as a community bank for purposes of the capital ratio requirement.

The federal banking agencies may consider a financial institution’s risk profile when evaluation whether it qualifies as a community bank for purposes of the capital ratio requirement.

The federal banking agencies set the minimum capital for the new Community Bank Leverage Ratio at 9%.

17 unchanged sentences

(dollars in thousands)

At June 30, 2023

At September 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 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.

As previously mentioned, the Company carried $23.5 million of subordinated debt as of September 30, 2023 and December 31, 2022, and $11.0 million in junior subordinated debentures as of September 30, 2023, all of which is included in total capital for the Company in the tables above.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

17 unchanged sentences

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

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

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