FIRST BUSINESS FINANCIAL SERVICES, INC. 10-Q

Item 1. Financial Statements First Business Financial Services, Inc. Consolidated Balance Sheets September 30, 2020 December 31, 2019 (Unaudited) (In Thousands, Except Share Data) Assets Cash and due from banks $ 28,228 $ 16,107 Short-term investments 23,500 50,995 Cash and cash equivalents 51,728 67,102 Securities available-for-sale, at fair value 179,274 173,133 Securities held-to-maturity, at amortized cost 28,897 32,700 Loans held for sale 15,049 5,205 Loans and leases receivable, net of allowance for loan and lease losses of $ 30,817 and $ 19,520 , respectively 2,139,482 1,695,115 Premises and equipment, net 2,130 2,557 Foreclosed properties 613 2,919 Right-of-use assets 6,141 6,906 Bank-owned life insurance 51,798 42,761 Federal Home Loan Bank stock, at cost 15,153 7,953 Goodwill and other intangible assets 12,024 11,922 Accrued interest receivable and other assets 99,558 48,506 Total assets $ 2,601,847 $ 2,096,779 Liabilities and Stockholders’ Equity Deposits $ 1,821,375 $ 1,530,379 Federal Home Loan Bank advances and other borrowings 483,517 319,382 Junior subordinated notes 10,058 10,047 Lease liabilities 6,728 7,541 Accrued interest payable and other liabilities 79,384 35,274 Total liabilities 2,401,062 1,902,623 Stockholders’ equity: Preferred stock, $ 0.01 par value, 2,500,000 shares authorized, no ne issued or outstanding — — Common stock, $ 0.01 par value, 25,000,000 shares authorized, 9,227,351 and 9,162,720 shares issued, 8,561,714 and 8,566,044 shares outstanding at September 30, 2020 and December 31, 2019, respectively 92 92 Additional paid-in capital 82,620 81,188 Retained earnings 135,760 129,105 Accumulated other comprehensive loss ( 1,170 ) ( 1,348 ) Treasury stock, 665,637 and 596,676 shares at September 30, 2020 and December 31, 2019, respectively, at cost ( 16,517 ) ( 14,881 ) Total stockholders’ equity 200,785 194,156 Total liabilities and stockholders’ equity $ 2,601,847 $ 2,096,779 See accompanying Notes to Unaudited Consolidated Financial Statements. 1 Table of Contents First Business Financial Services, Inc. Consolidated Statements of Income (Unaudited) For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (In Thousands, Except Per Share Data) Interest income Loans and leases $ 21,105 $ 23,922 $ 64,502 $ 72,033 Securities 1,004 1,194 3,262 3,464 Short-term investments 167 322 644 930 Total interest income 22,276 25,438 68,408 76,427 Interest expense Deposits 1,623 6,006 7,663 18,060 Federal Home Loan Bank advances and other borrowings 1,752 2,376 5,352 6,153 Junior subordinated notes 280 280 835 832 Total interest expense 3,655 8,662 13,850 25,045 Net interest income 18,621 16,776 54,558 51,382 Provision for loan and lease losses 3,835 1,349 12,487 613 Net interest income after provision for loan and lease losses 14,786 15,427 42,071 50,769 Non-interest income Private wealth management service fees 2,167 2,060 6,402 6,125 Gain on sale of Small Business Administration loans 760 454 1,598 993 Service charges on deposits 881 795 2,527 2,314 Loan fees 478 439 1,414 1,316 Increase in cash surrender value of bank-owned life insurance 365 305 1,037 894 Net loss on sale of securities — ( 4 ) ( 4 ) ( 5 ) Commercial loan swap fees 2,446 374 5,782 1,898 Other non-interest income 311 1,369 1,385 2,699 Total non-interest income 7,408 5,792 20,141 16,234 Non-interest expense Compensation 11,857 10,324 33,705 30,991 Occupancy 570 580 1,696 1,730 Professional fees 943 751 2,621 2,745 Data processing 679 654 2,066 1,923 Marketing 356 548 1,169 1,611 Equipment 310 277 905 938 Computer software 1,017 859 2,873 2,485 FDIC insurance 312 1 760 595 Collateral liquidation costs 45 110 281 108 Net (gain) loss on foreclosed properties ( 121 ) 262 329 241 Tax credit investment impairment (recovery) 113 ( 120 ) 2,066 3,982 SBA recourse provision (benefit) 57 ( 427 ) 53 167 Loss on early extinguishment of debt — — 744 — Other non-interest expense 620 897 1,977 2,406 Total non-interest expense 16,758 14,716 51,245 49,922 Income before income tax benefit 5,436 6,503 10,967 17,081 Income tax expense (benefit) 1,143 1,418 73 ( 475 ) Net income $ 4,293 $ 5,085 $ 10,894 $ 17,556 Earnings per common share 2 Table of Contents Basic $ 0.50 $ 0.59 $ 1.27 $ 2.01 Diluted 0.50 0.59 1.27 2.01 Dividends declared per share 0.165 0.15 0.495 0.45 See accompanying Notes to Unaudited Consolidated Financial Statements. 3 Table of Contents First Business Financial Services, Inc. Consolidated Statements of Comprehensive Income (Unaudited) For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (In Thousands) Net income $ 4,293 $ 5,085 $ 10,894 $ 17,556 Other comprehensive income (loss), before tax Securities available-for-sale: Unrealized securities (losses) gains arising during the period ( 377 ) 64 3,860 3,302 Reclassification adjustment for net loss realized in net income — 4 4 5 Securities held-to-maturity: Amortization of net unrealized losses transferred from available-for-sale 10 14 30 42 Interest rate swaps: Unrealized gain (losses) on interest rate swaps arising during the period 389 ( 846 ) ( 3,654 ) ( 3,310 ) Income tax (expense) benefit ( 6 ) 195 ( 62 ) ( 10 ) Total other comprehensive income (loss) 16 ( 569 ) 178 29 Comprehensive income $ 4,309 $ 4,516 $ 11,072 $ 17,585 See accompanying Notes to Unaudited Consolidated Financial Statements. 4 Table of Contents First Business Financial Services, Inc. Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) Common Shares Outstanding Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Total (In Thousands, Except Share Data) Balance at January 1, 2019 8,785,480 $ 91 $ 79,623 $ 110,310 $ ( 1,684 ) $ ( 7,633 ) $ 180,707 Cumulative effect of adoption of ASC Topic 842 — — — 687 — — 687 Net income — — — 5,899 — — 5,899 Other comprehensive income — — — — 279 — 279 Share-based compensation - restricted shares, net 49,730 — 318 — — — 318 Cash dividends ($ 0.15 per share) — — — ( 1,312 ) — — ( 1,312 ) Treasury stock purchased ( 70,074 ) — — — — ( 1,478 ) ( 1,478 ) Balance at March 31, 2019 8,765,136 91 79,941 115,584 ( 1,405 ) ( 9,111 ) 185,100 Net income — — — 6,572 — — 6,572 Other comprehensive income — — — — 319 — 319 Share-based compensation - restricted shares, net 31,151 — 410 — — — 410 Cash dividends ( $ 0.15 per share) — — — ( 1,315 ) — — ( 1,315 ) Treasury stock purchased ( 96,831 ) — — — — ( 2,231 ) ( 2,231 ) Balance at June 30, 2019 8,699,456 $ 91 $ 80,351 $ 120,841 $ ( 1,086 ) $ ( 11,342 ) $ 188,855 Net income — — — 5,085 — — 5,085 Other comprehensive loss — — — — ( 569 ) — ( 569 ) Share-based compensation - restricted shares, net 6,930 1 389 — — — 390 Cash dividends ($ 0.15 per share) — — — ( 1,298 ) — — ( 1,298 ) Treasury stock purchased ( 70,301 ) — — — — ( 1,671 ) ( 1,671 ) Balance at September 30, 2019 8,636,085 $ 92 $ 80,740 $ 124,628 $ ( 1,655 ) $ ( 13,013 ) $ 190,792 5 Table of Contents Common Shares Outstanding Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Total (In Thousands, Except Share Data) Balance at January 1, 2020 8,566,044 $ 92 $ 81,188 $ 129,105 $ ( 1,348 ) $ ( 14,881 ) $ 194,156 Net income — — — 3,278 — — 3,278 Other comprehensive income — — — — 663 — 663 Share-based compensation - restricted shares, net 63,684 — 417 — — — 417 Cash dividends ($ 0.165 per share) — — — ( 1,410 ) — — ( 1,410 ) Treasury stock purchased ( 58,594 ) — — — — ( 1,447 ) ( 1,447 ) Balance at March 31, 2020 8,571,134 92 81,605 130,973 ( 685 ) ( 16,328 ) 195,657 Net income — — — 3,323 — — 3,323 Other comprehensive loss — — — — ( 501 ) — ( 501 ) Share-based compensation - restricted shares, net 5,357 — 516 — — — 516 Cash dividends ($ 0.165 per share) — — — ( 1,414 ) — — ( 1,414 ) Treasury stock purchased ( 1,357 ) — — — — ( 19 ) ( 19 ) Balance at June 30, 2020 8,575,134 $ 92 $ 82,121 $ 132,882 $ ( 1,186 ) $ ( 16,347 ) $ 197,562 Net income — — — 4,293 — — 4,293 Other comprehensive income — — — — 16 — 16 Share-based compensation - restricted shares, net ( 4,410 ) — 499 — — — 499 Cash dividends ($ 0.165 per share) — — — ( 1,415 ) — — ( 1,415 ) Treasury stock purchased ( 9,010 ) — — — — ( 170 ) ( 170 ) Balance at September 30, 2020 8,561,714 $ 92 $ 82,620 $ 135,760 $ ( 1,170 ) $ ( 16,517 ) $ 200,785 See accompanying Notes to Unaudited Consolidated Financial Statements. 6 Table of Contents First Business Financial Services, Inc. Consolidated Statements of Cash Flows (Unaudited) For the Nine Months Ended September 30, 2020 2019 (In Thousands) Operating activities Net income $ 10,894 $ 17,556 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income taxes, net ( 2,291 ) 105 Impairment of tax credit investments 2,066 3,982 Provision for loan and lease losses 12,487 613 SBA recourse provision 53 167 Depreciation, amortization and accretion, net 2,509 2,252 Share-based compensation 1,432 1,118 Net loss on sale of securities 4 5 Gain on sale of a state tax credit — ( 206 ) Increase in bank-owned life insurance policies ( 1,037 ) ( 894 ) Origination of loans for sale ( 56,923 ) ( 39,799 ) Sale of loans originated for sale 48,676 43,009 Gain on sale of SBA loans ( 1,598 ) ( 993 ) Net loss on foreclosed properties, including impairment valuation 329 241 Loan servicing right impairment valuation ( 3 ) 25 Excess tax benefit from share-based compensation ( 35 ) ( 74 ) Payments on operating leases ( 1,166 ) ( 1,143 ) Payments received on operating leases 84 — Net increase in accrued interest receivable and other assets ( 52,492 ) ( 24,918 ) Net increase in accrued interest payable and other liabilities 42,429 19,710 Net cash provided by operating activities 5,418 20,756 Investing activities Proceeds from maturities, redemptions, and paydowns of available-for-sale securities 40,353 21,225 Proceeds from maturities, redemptions, and paydowns of held-to-maturity securities 3,759 4,282 Proceeds from sale of available-for-sale securities 839 15,249 Purchases of available-for-sale securities ( 43,751 ) ( 55,608 ) Proceeds from sale of foreclosed properties 2,057 — Net increase in loans and leases ( 456,933 ) ( 104,229 ) Investments in limited partnerships ( 750 ) ( 1,250 ) Returns of investments in limited partnerships — 1,499 Investment in historic development entities ( 259 ) ( 4,505 ) Distributions from historic development entities 30 — Investment in Federal Home Loan Bank stock ( 13,422 ) ( 4,700 ) Proceeds from the sale of Federal Home Loan Bank stock 6,222 3,625 Purchases of leasehold improvements and equipment, net ( 204 ) ( 108 ) Purchases of bank-owned life insurance policies ( 8,000 ) — Net cash used in investing activities ( 470,059 ) ( 124,520 ) Financing activities Net increase in deposits 290,996 53,517 Proceeds from Federal Home Loan Bank advances 979,200 435,000 Repayment of Federal Home Loan Bank advances ( 845,444 ) ( 401,000 ) Loss on early extinguishment of debt 744 — Repayment of subordinated notes payable — ( 15,000 ) Proceeds from issuance of subordinated notes payable — 15,000 Proceeds from the Federal Reserve Paycheck Protection Program Lending Facility 29,605 — Net increase (decrease) in long-term borrowed funds 41 ( 36 ) Cash dividends paid ( 4,239 ) ( 3,925 ) Purchase of treasury stock ( 1,636 ) ( 5,380 ) Net cash provided by financing activities 449,267 78,176 Net decrease in cash and cash equivalents ( 15,374 ) ( 25,588 ) Cash and cash equivalents at the beginning of the period 67,102 86,546 Cash and cash equivalents at the end of the period $ 51,728 $ 60,958 Supplementary cash flow information Cash paid during the period for: Interest paid on deposits and borrowings $ 15,223 $ 25,828 7 Table of Contents Income taxes paid 3,436 1,303 Non-cash investing and financing activities: Increase in right-of-use exchange for operating lease liability 190 — Transfer from loans and leases to foreclosed properties 80 596 See accompany Notes to Unaudited Consolidated Financial Statements 8 Table of Contents Notes to Unaudited Consolidated Financial Statements Note 1 — Nature of Operations and Summary of Significant Accounting Policies Nature of Operations The accounting and reporting practices of First Business Financial Services, Inc. (“FBFS” or the “Corporation”), through our wholly-owned subsidiary, First Business Bank (“FBB” or the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB operates as a commercial banking institution primarily in Wisconsin and the greater Kansas City Metro. FBB also offers private wealth management services through First Business Trust & Investments (“FBTI”) and bank consulting services through First Business Consulting Services (“FBCS”), both divisions of FBB. The Bank provides a full range of financial services to businesses, business owners, executives, professionals, and high net worth individuals. The Bank is subject to competition from other financial institutions and service providers and is also subject to state and federal regulations. FBB has the following wholly-owned subsidiaries: First Business Capital Corp. (“FBCC”), First Madison Investment Corp. (“FMIC”), First Business Equipment Finance, LLC (“FBEF”), ABKC Real Estate, LLC (“ABKC”), FBB Real Estate 2, LLC (“FBB RE 2”), Rimrock Road Investment Fund, LLC (“Rimrock Road”), BOC Investment, LLC (“BOC”), Mitchell Street Apartments Investment, LLC (“Mitchell Street”), and FBB Tax Credit Investment LLC (“FBB Tax Credit”). FMIC is located in and was formed under the laws of the state of Nevada. Basis of Presentation The accompanying unaudited Consolidated Financial Statements were prepared in accordance with GAAP and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Corporation’s Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019. The unaudited Consolidated Financial Statements include the accounts of the Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. In accordance with the provisions of Accounting Standards Codification (“ASC”) Topic 810, the Corporation’s ownership interest in FBFS Statutory Trust II (“Trust II”) has not been consolidated into the financial statements. Management of the Corporation is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities and interest rate swaps, level of the allowance for loan and lease losses, lease residuals, property under operating leases, goodwill, level of the Small Business Administration (“SBA”) recourse reserve, and income taxes. The results of operations for the three and nine months ended September 30, 2020, are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2020. Certain amounts in prior periods may have been reclassified to conform to the current presentation. Subsequent events have been evaluated through the date of the issuance of the unaudited Consolidated Financial Statements. No significant subsequent events have occurred through this date requiring adjustment to the financial statements or disclosures. The Corporation has not changed its significant accounting and reporting policies from those disclosed in the Corporation’s Form 10-K for the year ended December 31, 2019. Recent Accounting Pronouncements In June 2016, the FASB issued ASU No. 2016-13, “ Financial Instruments- Credit Losses (Topic 326), ” which is often referred to as CECL. The ASU replaces the incurred loss impairment methodology for recognizing credit losses with a methodology that reflects all expected credit losses. The ASU also requires consideration of a broader range of information to inform credit loss estimates, including such factors as past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, and any other financial asset not excluded from the scope under which the Corporation has the contractual right to receive cash. Entities will apply the amendments in the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. In November 2019, the FASB issued ASU No. 2019-10, “ Financial Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). ” The ASU delays the effective date for the credit losses standard from January 2020 to January 2023 for certain entities, including certain Securities and Exchange Commission filers, public business entities, and private companies. As a smaller reporting company, the Corporation is eligible for the delay and will be deferring adoption. The Corporation has established a cross-functional committee and has implemented a third-party software solution to assist with the adoption of the 9 Table of Contents standard. Management has gathered all necessary data and reviewed potential methods to calculate the expected credit losses. Management is currently calculating sample expected loss computations and developing the allowance methodology and assumptions that will be used under the new standard. Management will continue to progress on its implementation project plan and improve the Corporation’s approach throughout the deferral period. Note 2 — Significant Events On March 11, 2020, the World Health Organization declared COVID-19, the disease caused by the novel coronavirus, a pandemic as a result of the global spread of the coronavirus illness. In response to the outbreak, federal and state authorities in the U.S. introduced various measures to try to limit or slow the spread of the virus, including travel restrictions, nonessential business closures, stay-at-home orders, and strict social distancing. The Corporation activated its Pandemic Preparedness Plan to protect the health of employees and clients, which includes temporarily limiting lobby hours and transitioning the vast majority of the Corporation’s workforce to remote work. The Corporation has not incurred any significant disruptions to its business activities. The full impact of COVID-19 is unknown and rapidly evolving. It has caused substantial disruption in international and U.S. economies, markets, and employment. The outbreak is having a significant adverse impact on certain industries the Corporation serves, including retail, restaurants and food services, hospitality, and entertainment. As of September 30, 2020, the Corporation’s aggregate outstanding exposure in these segments was $ 188.5 million, or 10.2 % of the Corporation’s gross loans and leases. Based on management’s current assessment of the increased inherent risk in the loan portfolio, the allowance for loan and leases losses increased $ 11.3 million, or 57.9 %, compared to December 31, 2019. The increase in the allowance for loan and lease losses was in large part due to an increase in specific reserves on impaired loans, in addition to several qualitative factors after careful evaluation by management. Most notably, an increase in specific reserves of $ 5.5 million was driven by deterioration of two existing legacy SBA impaired relationships and one relationship in the hospitality industry. Additionally, a $ 4.7 million increase was due to the economic conditions caused by the pandemic, including the increase in the unemployment rate, management’s ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, and the level of loans and leases subject to more frequent review by management. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation’s loan portfolio. The Corporation provided loan payment deferrals of up to six months to certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation’s loan modification program. As of September 30, 2020, the Corporation had 60 deferral requests outstanding, representing $ 131.5 million in total loans, or 7.1 % of gross loans and leases, excluding gross PPP loans, compared to $ 323.2 million, or 18.6 % of gross loans and leases, excluding gross PPP loans as of June 30, 2020. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payment at the end of the modification period and the deferred amounts will be moved to the end of the loan term. The loan will not be reported as past due during the deferral period. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law. The CARES Act is a $2 trillion stimulus package to provide relief to U.S. businesses and consumers struggling as a result of the pandemic. A provision in the CARES Act includes a $349 billion fund for the creation of the Paycheck Protection Program (“PPP”) through the Small Business Administration (“SBA”) and Treasury Department. On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was signed into law, adding an additional $320 billion of funding to the PPP. The PPP is intended to provide loans to small businesses to pay their employees, rent, mortgage interest, and utilities. The loans may be forgiven conditioned upon the client providing payroll documentation evidencing their compliant use of funds and otherwise complying with the terms of the program. The Corporation began accepting and processing applications for loans under the PPP on April 3, 2020. As of September 30, 2020, the Corporation had $ 332.3 million in gross PPP loans outstanding and deferred processing fees outstanding of $ 6.9 million. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. During the three and nine months ended September 30, 2020, $ 1.1 million and $ 2.0 million was recognized in loans and leases interest income in the unaudited Consolidated Statements of Income, respectively. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any at all, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits. Goodwill Impairment Analysis The Company completed an impairment analysis of goodwill as of August 1, 2020 and determined there was no impairment. 10 Table of Contents Goodwill impairment exists when a reporting unit’s carrying value exceeds its fair value. A qualitative assessment is performed to determine whether it is more likely than not that the fair value of equity of the reporting unit exceeds the carrying value. As part of the Corporation’s qualitative assessment of goodwill impairment, management considered the triggering event of the COVID-19 pandemic and determined that the significant change in the general economic environment and financial markets, including the Corporation’s market capitalization, represents an interim impairment indicator requiring continued evaluation. The Corporation performed Step 1, quantitative goodwill impairment testing, as of August 1, 2020. The initial basis for the valuation was a forecast prepared by management for the years ended 2020 through 2024. The income approach as well as the market approach were utilized by an independent third party to determine the fair value of the Corporation’s goodwill . The fair value of the Corporation’s equity based on the analysis performed was $ 289.0 million, which exceeded its book value by $ 89.4 million, or 44.8 %, as of August 1, 2020. Based on the analysis performed, management concluded the Corporation’s goodwill is not impaired as of August 1, 2020. Note 3 — Earnings per Common Share Earnings per common share are computed using the two-class method. Basic earnings per common share are computed by dividing net income allocated to common shares by the weighted-average number of shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends, or dividend equivalents, at the same rate as holders of the Corporation’s common stock. Diluted earnings per share are computed by dividing net income allocated to common shares adjusted for reallocation of undistributed earnings of unvested restricted shares by the weighted average number of shares determined for the basic earnings per common share computation plus the dilutive effect of common stock equivalents using the treasury stock method. For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (Dollars in Thousands, Except Share Data) Basic earnings per common share Net income $ 4,293 $ 5,085 $ 10,894 $ 17,556 Less: earnings allocated to participating securities 110 111 284 340 Basic earnings allocated to common stockholders $ 4,183 $ 4,974 $ 10,610 $ 17,216 Weighted-average common shares outstanding, excluding participating securities 8,404,084 8,492,445 8,380,676 8,546,192 Basic earnings per common share $ 0.50 $ 0.59 $ 1.27 $ 2.01 Diluted earnings per common share Earnings allocated to common stockholders, diluted $ 4,183 $ 4,974 $ 10,610 $ 17,216 Weighted-average diluted common shares outstanding, excluding participating securities 8,404,084 8,492,445 8,380,676 8,546,192 Diluted earnings per common share $ 0.50 $ 0.59 $ 1.27 $ 2.01 Note 4 — Share-Based Compensation The Corporation adopted the 2019 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2019. The Plan is administered by the Compensation Committee of the Board of Directors of the Corporation and provides for the grant of equity ownership opportunities through incentive stock options and nonqualified stock options, restricted stock, restricted stock units, dividend equivalent units, and any other type of award permitted by the Plan. As of September 30, 2020, 151,899 shares were available for future grants under the Plan. Shares covered by awards that expire, terminate, or lapse will again be available for the grant of awards under the Plan. The Corporation may issue new shares and shares from its treasury stock for shares delivered under the Plan. 11 Table of Contents Restricted Stock Under the Plan, the Corporation may grant restricted stock awards, restricted stock units, and other stock-based awards to plan participants, subject to forfeiture upon the occurrence of certain events until the dates specified in the participant’s award agreement. While restricted stock is subject to forfeiture, restricted stock award participants may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares. Restricted stock units do not have voting rights and are provided dividend equivalents. The restricted stock granted under the Plan is typically subject to a vesting period. Compensation expense for restricted stock is recognized over the requisite service period of generally four years for the entire award on a straight-line basis. Upon vesting of restricted stock, the benefit of tax deductions in excess of recognized compensation expense is reflected as an income tax benefit in the unaudited Consolidated Statements of Income. The Corporation also issues a combination of performance based restricted stock units and restricted stock awards to its executive officers. Vesting of the performance based restricted stock units will be measured on Total Shareholder Return (“TSR”) and Return on Average Equity (“ROAE”) and will cliff-vest after a three-year measurement period based on the Corporation’s performance relative to a custom peer group. At the end of the performance period, the number of actual shares to be awarded varies between 0% and 200% of target amounts. The restricted stock awards issued to executive officers will vest ratably over a three-year period. Compensation expense is recognized for performance based restricted stock units over the requisite service and performance period of generally three years for the entire expected award on a straight-line basis. The compensation expense for the awards expected to vest for the percentage of performance based restricted stock units subject to the ROAE metric will be adjusted if there is a change in the expectation of ROAE. The compensation expense for the awards expected to vest for the percentage of performance based restricted stock units subject to the TSR metric are never adjusted, and are amortized utilizing the accounting fair value provided using a Monte Carlo pricing model. Restricted stock activity for the year ended December 31, 2019 and the nine months ended September 30, 2020 was as follows: Number of Restricted Shares/Units Weighted Average Grant-Date Fair Value Nonvested balance as of January 1, 2019 131,621 $ 21.02 Granted 95,265 23.64 Vested ( 48,207 ) 20.62 Forfeited ( 1,744 ) 23.67 Nonvested balance as of December 31, 2019 176,935 22.51 Granted (1) 75,345 26.10 Vested ( 49,978 ) 22.27 Forfeited ( 10,714 ) 22.89 Nonvested balance as of September 30, 2020 191,588 $ 24.30 (1) The number of restricted shares/units shown includes the shares that would be granted if the target level of performance is achieved related to the performance based restricted stock units. The number of shares actually issued may vary. As of September 30, 2020, the Corporation had $ 3.7 million of unvested compensation expense, which the Corporation expects to recognize over a weighted-average period of approximately 2.30 years. Share-based compensation expense related to restricted stock included in the unaudited Consolidated Statements of Income was as follows: For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (In Thousands) Share-based compensation expense $ 499 $ 390 $ 1,432 $ 1,118 12 Table of Contents Note 5 — Securities The amortized cost and fair value of securities available-for-sale and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows: As of September 30, 2020 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (In Thousands) Available-for-sale: U.S. government agency securities - government-sponsored enterprises $ 21,601 $ 10 $ ( 74 ) $ 21,537 Municipal securities 13,520 462 ( 19 ) 13,963 Residential mortgage-backed securities - government issued 11,018 527 — 11,545 Residential mortgage-backed securities - government-sponsored enterprises 107,765 2,691 ( 9 ) 110,447 Commercial mortgage-backed securities - government issued 5,848 194 — 6,042 Commercial mortgage-backed securities - government-sponsored enterprises 12,639 811 — 13,450 Other securities 2,205 85 — 2,290 $ 174,596 $ 4,780 $ ( 102 ) $ 179,274 As of December 31, 2019 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (In Thousands) Available-for-sale: U.S. government agency securities - government-sponsored enterprises $ 23,616 $ 152 $ ( 10 ) $ 23,758 Municipal securities 160 — — 160 Residential mortgage-backed securities - government issued 16,119 234 ( 5 ) 16,348 Residential mortgage-backed securities - government-sponsored enterprises 111,561 847 ( 406 ) 112,002 Commercial mortgage-backed securities - government issued 6,705 45 ( 87 ) 6,663 Commercial mortgage-backed securities - government-sponsored enterprises 11,953 23 ( 9 ) 11,967 Other securities 2,205 30 — 2,235 $ 172,319 $ 1,331 $ ( 517 ) $ 173,133 The amortized cost and fair value of securities held-to-maturity and the corresponding amounts of gross unrealized gains and losses were as follows: 13 Table of Contents As of September 30, 2020 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (In Thousands) Held-to-maturity: Municipal securities $ 18,591 $ 470 $ ( 21 ) $ 19,040 Residential mortgage-backed securities - government issued 4,121 131 — 4,252 Residential mortgage-backed securities - government-sponsored enterprises 4,173 180 — 4,353 Commercial mortgage-backed securities - government-sponsored enterprises 2,012 307 — 2,319 $ 28,897 $ 1,088 $ ( 21 ) $ 29,964 As of December 31, 2019 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (In Thousands) Held-to-maturity: Municipal securities $ 19,727 $ 335 $ ( 8 ) $ 20,054 Residential mortgage-backed securities - government issued 5,776 19 ( 9 ) 5,786 Residential mortgage-backed securities - government-sponsored enterprises 5,183 51 ( 23 ) 5,211 Commercial mortgage-backed securities - government-sponsored enterprises 2,014 123 — 2,137 $ 32,700 $ 528 $ ( 40 ) $ 33,188 U.S. government agency securities - government-sponsored enterprises represent securities issued by the Federal National Mortgage Association (“FNMA”) and the SBA. Municipal securities include securities issued by various municipalities located primarily within Wisconsin and are primarily general obligation bonds that are tax-exempt in nature. Residential and commercial mortgage-backed securities - government issued represent securities guaranteed by the Government National Mortgage Association. Residential and commercial mortgage-backed securities - government-sponsored enterprises include securities guaranteed by the Federal Home Loan Mortgage Corporation, FNMA, and the FHLB. Other securities represent certificates of deposit of insured banks and savings institutions with an original maturity greater than three months. There were no sales of available-for-sale securities that occurred during the three months ended September 30, 2020 and one sale that occurred during the nine months ended September 30, 2020. There were 37 and 46 sales of available-for-sale securities that occurred during the three and nine months ended September 30, 2019, respectively. At September 30, 2020 and December 31, 2019, securities with a fair value of $ 79.8 million and $ 30.3 million, respectively, were pledged to secure various obligations, including interest rate swap contracts, outstanding FHLB advances, additional FHLB availability, the Federal Reserve Discount Window, and municipal deposits. At September 30, 2020, pledged securities with a fair value of $ 129.3 million were available to secure various obligations. No pledged securities were available to secure various obligations as of December 31, 2019. The amortized cost and fair value of securities by contractual maturity at September 30, 2020 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay certain obligations with or without call or prepayment penalties. 14 Table of Contents Available-for-Sale Held-to-Maturity Amortized Cost Fair Value Amortized Cost Fair Value (In Thousands) Due in one year or less $ — $ — $ 2,804 $ 2,823 Due in one year through five years 8,148 8,439 12,085 12,344 Due in five through ten years 33,651 35,229 10,872 11,513 Due in over ten years 132,797 135,606 3,136 3,284 $ 174,596 $ 179,274 $ 28,897 $ 29,964 The tables below show the Corporation’s gross unrealized losses and fair value of available-for-sale investments aggregated by investment category and length of time that individual investments were in a continuous loss position at September 30, 2020 and December 31, 2019. At September 30, 2020, the Corporation held 12 available-for-sale securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have generally declined in value due to the current interest rate environment. At September 30, 2020, the Corporation held one available-for-sale security that had been in a continuous unrealized loss position for twelve months or greater. The Corporation also has not specifically identified available-for-sale securities in a loss position that it intends to sell in the near term and does not believe that it will be required to sell any such securities. The Corporation reviews its securities on a quarterly basis to monitor its exposure to other-than-temporary impairment. Consideration is given to such factors as the length of time and extent to which the security has been in an unrealized loss position, changes in security ratings, and an evaluation of the present value of expected future cash flows, if necessary. Based on the Corporation’s evaluation, it is expected that the Corporation will recover the entire amortized cost basis of each security. Accordingly, no other-than-temporary impairment was recorded in the unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2020 and 2019. A summary of unrealized loss information for securities available-for-sale, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows: As of September 30, 2020 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (In Thousands) Available-for-sale: U.S. government agency securities - government-sponsored enterprises $ 12,933 $ 41 $ 4,086 $ 33 $ 17,019 $ 74 Municipal securities $ 2,460 $ 19 $ — $ — $ 2,460 $ 19 Residential mortgage-backed securities - government-sponsored enterprises 15,115 9 — — 15,115 9 $ 30,508 $ 69 $ 4,086 $ 33 $ 34,594 $ 102 15 Table of Contents As of December 31, 2019 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (In Thousands) Available-for-sale: U.S. government agency securities - government-sponsored enterprises $ 4,363 $ 10 $ — $ — $ 4,363 $ 10 Residential mortgage-backed securities - government issued 4,619 5 — — 4,619 5 Residential mortgage-backed securities - government-sponsored enterprises 36,972 253 11,304 153 48,276 406 Commercial mortgage-backed securities - government issued — — 4,727 87 4,727 87 Commercial mortgage-backed securities - government-sponsored enterprises 2,245 4 1,047 5 3,292 9 $ 48,199 $ 272 $ 17,078 $ 245 $ 65,277 $ 517 The tables below show the Corporation’s gross unrealized losses and fair value of held-to-maturity investments, aggregated by investment category and length of time that individual investments were in a continuous loss position at September 30, 2020 and December 31, 2019. At September 30, 2020, the Corporation held two held-to-maturity securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have generally declined in value due to the current interest rate environment. There was one held-to-maturity security that had been in a continuous loss position for twelve months or greater as of September 30, 2020. It is expected that the Corporation will recover the entire amortized cost basis of each held-to-maturity security based upon an evaluation of aforementioned factors. Accordingly, no other-than-temporary impairment was recorded in the unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2020 and 2019. A summary of unrealized loss information for securities held-to-maturity, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows: As of September 30, 2020 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (In Thousands) Held-to-maturity: Municipal securities $ 271 $ 18 $ 213 $ 3 $ 484 $ 21 As of December 31, 2019 Less than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (In Thousands) Held-to-maturity: Municipal securities $ 499 $ 8 $ — $ — $ 499 $ 8 Residential mortgage-backed securities - government issued — — 1,887 9 1,887 9 Residential mortgage-backed securities - government-sponsored enterprises 1,364 5 2,144 18 3,508 23 $ 1,863 $ 13 $ 4,031 $ 27 $ 5,894 $ 40 16 Table of Contents Note 6 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses Loan and lease receivables consist of the following: September 30, 2020 December 31, 2019 (In Thousands) Commercial real estate: Commercial real estate — owner occupied $ 240,706 $ 226,614 Commercial real estate — non-owner occupied 565,781 516,652 Land development 50,864 51,097 Construction 142,726 109,057 Multi-family 287,583 217,322 1-4 family 38,857 33,359 Total commercial real estate 1,326,517 1,154,101 Commercial and industrial 790,349 503,402 Direct financing leases, net 24,743 28,203 Consumer and other: Home equity and second mortgages 7,106 7,006 Other 29,341 22,664 Total consumer and other 36,447 29,670 Total gross loans and leases receivable 2,178,056 1,715,376 Less: Allowance for loan and lease losses 30,817 19,520 Deferred loan fees 7,757 741 Loans and leases receivable, net $ 2,139,482 $ 1,695,115 The total amount of the Corporation’s ownership of SBA loans comprised of the following: September 30, 2020 December 31, 2019 (In Thousands) SBA 7(a) loans $ 41,380 $ 40,402 SBA 504 loans 24,833 20,592 SBA Express loans and lines of credit 1,591 1,781 SBA PPP loans 332,342 — Total SBA loans $ 400,146 $ 62,775 As of September 30, 2020 and December 31, 2019, $ 9.6 million and $ 12.1 million of SBA loans were considered impaired, respectively. Loans transferred to third parties consist of the guaranteed portions of SBA 7(a) loans which the Corporation sold in the secondary market and participation interests in other, non-SBA originated loans. The total principal amount of the guaranteed portions of SBA 7(a) loans sold during the three months ended September 30, 2020, and 2019, was $ 7.9 million and $ 4.9 million, respectively. The total principal amount of the guaranteed portions of SBA 7(a) loans sold during the nine months ended September 30, 2020, and 2019, was $ 17.2 million and $ 10.5 million, respectively. Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred during the three and nine months ended September 30, 2020, and 2019, have been derecognized in the unaudited Consolidated Financial Statements. The guaranteed portions of SBA loans were transferred at their fair value and the related gain was recognized upon the transfer as 17 Table of Contents non-interest income in the unaudited Consolidated Financial Statements. The total outstanding balance of sold SBA loans at September 30, 2020, and December 31, 2019, was $ 75.1 million and $ 73.8 million, respectively. The total principal amount of transferred participation interests in other, non-SBA originated loans during the three months ended September 30, 2020, and 2019, was $ 7.7 million and $ 7.5 million, respectively. The total principal amount of transferred participation interests in other, non-SBA originated loans during the nine months ended September 30, 2020, and 2019, was $ 29.9 million and $ 31.5 million, respectively, all of which were treated as sales and derecognized under the applicable accounting guidance at the time of transfer. No gain or loss was recognized on participation interests in other, non-SBA originated loans as they were transferred at or near the date of loan origination and the payments received for servicing the portion of the loans participated represents adequate compensation. The total outstanding balance of these transferred loans at September 30, 2020, and December 31, 2019, was $ 144.1 million and $ 142.8 million, respectively. As of September 30, 2020, and December 31, 2019, the total amount of the Corporation’s partial ownership of these transferred loans on the unaudited Consolidated Balance Sheets was $ 266.7 million and $ 244.6 million, respectively. As of September 30, 2020, the non-SBA originated participation portfolio contained an impaired loan totaling $ 5.8 million with a sold portion of $ 4.2 million. There were no loans impaired as of December 31, 2019. The Corporation does not share in the participant’s portion of any potential charge-offs. The total amount of loan participations purchased on the unaudited Consolidated Balance Sheets as of September 30, 2020, and December 31, 2019, was $ 424,000 and $ 492,000 , respectively. The following tables illustrate ending balances of the Corporation’s loan and lease portfolio, including impaired loans by class of receivable, and considering certain credit quality indicators: September 30, 2020 Category I II III IV Total (Dollars in Thousands) Commercial real estate: Commercial real estate — owner occupied $ 173,645 $ 34,561 $ 24,559 $ 7,941 $ 240,706 Commercial real estate — non-owner occupied 459,399 79,260 21,309 5,813 565,781 Land development 48,660 1,314 — 890 50,864 Construction 113,476 19,928 9,322 — 142,726 Multi-family 253,849 33,734 — — 287,583 1-4 family 35,446 1,681 1,350 380 38,857 Total commercial real estate 1,084,475 170,478 56,540 15,024 1,326,517 Commercial and industrial 658,865 51,665 59,126 20,693 790,349 Direct financing leases, net 17,962 289 6,141 351 24,743 Consumer and other: Home equity and second mortgages 6,389 598 119 — 7,106 Other 29,127 185 — 29 29,341 Total consumer and other 35,516 783 119 29 36,447 Total gross loans and leases receivable $ 1,796,818 $ 223,215 $ 121,926 $ 36,097 $ 2,178,056 Category as a % of total portfolio 82.49 % 10.25 % 5.60 % 1.66 % 100.00 % 18 Table of Contents December 31, 2019 Category I II III IV Total (Dollars in Thousands) Commercial real estate: Commercial real estate — owner occupied $ 187,728 $ 18,455 $ 16,399 $ 4,032 $ 226,614 Commercial real estate — non-owner occupied 459,821 55,524 1,307 — 516,652 Land development 49,132 439 — 1,526 51,097 Construction 108,959 — 98 — 109,057 Multi-family 205,750 11,572 — — 217,322 1-4 family 29,284 1,843 1,759 473 33,359 Total commercial real estate 1,040,674 87,833 19,563 6,031 1,154,101 Commercial and industrial 398,445 34,478 55,904 14,575 503,402 Direct financing leases, net 21,282 579 6,342 — 28,203 Consumer and other: Home equity and second mortgages 6,307 610 89 — 7,006 Other 22,517 — — 147 22,664 Total consumer and other 28,824 610 89 147 29,670 Total gross loans and leases receivable $ 1,489,225 $ 123,500 $ 81,898 $ 20,753 $ 1,715,376 Category as a % of total portfolio 86.82 % 7.20 % 4.77 % 1.21 % 100.00 % Each credit is evaluated for proper risk rating upon origination, at the time of each subsequent renewal, upon receipt and evaluation of updated financial information from the Corporation’s borrowers, or as other circumstances dictate. The Corporation primarily uses a nine grade risk rating system to monitor the ongoing credit quality of its loans and leases. The risk rating grades follow a consistent definition and are then applied to specific loan types based on the nature of the loan. Each risk rating is subjective and, depending on the size and nature of the credit, subject to various levels of review and concurrence on the stated risk rating. In addition to its nine grade risk rating system, the Corporation groups loans into four loan and related risk categories which determine the level and nature of review by management. Category I — Loans and leases in this category are performing in accordance with the terms of the contract and generally exhibit no immediate concerns regarding the security and viability of the underlying collateral, financial stability of the borrower, integrity or strength of the borrowers’ management team, or the industry in which the borrower operates. The Corporation monitors Category I loans and leases through payment performance, continued maintenance of its personal relationships with such borrowers, and continued review of such borrowers’ compliance with the terms of their respective agreements. Category II — Loans and leases in this category are beginning to show signs of deterioration in one or more of the Corporation’s core underwriting criteria such as financial stability, management strength, industry trends, or collateral values. Management will place credits in this category to allow for proactive monitoring and resolution with the borrower to possibly mitigate the area of concern and prevent further deterioration or risk of loss to the Corporation. Category II loans are considered performing but are monitored frequently by the assigned business development officer and by asset quality review committees. Category III — Loans and leases in this category are identified by management as warranting special attention. However, the balance in this category is not intended to represent the amount of adversely classified assets held by the Bank. Category III loans and leases generally exhibit undesirable characteristics, such as evidence of adverse financial trends and conditions, managerial problems, deteriorating economic conditions within the related industry, or evidence of adverse public filings and may exhibit collateral shortfall positions. Management continues to believe that it will collect all contractual principal and interest in accordance with the original terms of the contracts relating to the loans and leases in this category, and therefore Category III loans are considered performing with no specific reserves established for this category. Category III loans are monitored by management and asset quality review committees on a monthly basis. Category IV — Loans and leases in this category are considered to be impaired. Impaired loans and leases, with the exception of performing troubled debt restructurings, have been placed on non-accrual as management has determined that it is unlikely that the Bank will receive the contractual principal and interest in accordance with the original terms of the agreement. Impaired 19 Table of Contents loans are individually evaluated to assess the need for the establishment of specific reserves or charge-offs. When analyzing the adequacy of collateral, the Corporation obtains external appraisals at least annually for impaired loans and leases. External appraisals are obtained from the Corporation’s approved appraiser listing and are independently reviewed to monitor the quality of such appraisals. To the extent a collateral shortfall position is present, a specific reserve or charge-off will be recorded to reflect the magnitude of the impairment. Loans and leases in this category are monitored by management and asset quality review committees on a monthly basis. The delinquency aging of the loan and lease portfolio by class of receivable was as follows: 20 Table of Contents September 30, 2020 30-59 Days Past Due 60-89 Days Past Due Greater Than 90 Days Past Due Total Past Due Current Total Loans and Leases (Dollars in Thousands) Accruing loans and leases Commercial real estate: Owner occupied $ — $ — $ — $ — $ 232,765 $ 232,765 Non-owner occupied — — — — 559,968 559,968 Land development — — — — 49,974 49,974 Construction — — — — 142,726 142,726 Multi-family — — — — 287,583 287,583 1-4 family 47 — — 47 38,477 38,524 Commercial and industrial 1,491 530 — 2,021 767,635 769,656 Direct financing leases, net — — — — 24,392 24,392 Consumer and other: Home equity and second mortgages — — — — 7,106 7,106 Other — — — — 29,312 29,312 Total 1,538 530 — 2,068 2,139,938 2,142,006 Non-accruing loans and leases Commercial real estate: Owner occupied — 272 — 272 7,669 7,941 Non-owner occupied — — — — 5,813 5,813 Land development — — — — 890 890 Construction — — — — — — Multi-family — — — — — — 1-4 family — — 333 333 — 333 Commercial and industrial 86 545 7,039 7,670 13,023 20,693 Direct financing leases, net — — — — 351 351 Consumer and other: Home equity and second mortgages — — — — — — Other — — 29 29 — 29 Total 86 817 7,401 8,304 27,746 36,050 Total loans and leases Commercial real estate: Owner occupied — 272 — 272 240,434 240,706 Non-owner occupied — — — — 565,781 565,781 Land development — — — — 50,864 50,864 Construction — — — — 142,726 142,726 Multi-family — — — — 287,583 287,583 1-4 family 47 — 333 380 38,477 38,857 Commercial and industrial 1,577 1,075 7,039 9,691 780,658 790,349 Direct financing leases, net — — — — 24,743 24,743 Consumer and other: Home equity and second mortgages — — — — 7,106 7,106 Other — — 29 29 29,312 29,341 Total $ 1,624 $ 1,347 $ 7,401 $ 10,372 $ 2,167,684 $ 2,178,056 Percent of portfolio 0.07 % 0.06 % 0.35 % 0.48 % 99.52 % 100.00 % 21 Table of Contents December 31, 2019 30-59 Days Past Due 60-89 Days Past Due Greater Than 90 Days Past Due Total Past Due Current Total Loans and Leases (Dollars in Thousands) Accruing loans and leases Commercial real estate: Owner occupied $ — $ — $ — $ — $ 222,582 $ 222,582 Non-owner occupied — — — — 516,652 516,652 Land development — 990 — 990 48,581 49,571 Construction 309 — — 309 108,748 109,057 Multi-family — — — — 217,322 217,322 1-4 family — — — — 33,026 33,026 Commercial and industrial 2,707 52 — 2,759 486,068 488,827 Direct financing leases, net — — — — 28,203 28,203 Consumer and other: Home equity and second mortgages — — — — 7,006 7,006 Other — — — — 22,517 22,517 Total 3,016 1,042 — 4,058 1,690,705 1,694,763 Non-accruing loans and leases Commercial real estate: Owner occupied — — 342 342 3,690 4,032 Non-owner occupied — — — — — — Land development — — — — 1,526 1,526 Construction — — — — — — Multi-family — — — — — — 1-4 family — 333 — 333 — 333 Commercial and industrial 4,368 2,717 3,123 10,208 4,367 14,575 Direct financing leases, net — — — — — — Consumer and other: Home equity and second mortgages — — — — — — Other — — 147 147 — 147 Total 4,368 3,050 3,612 11,030 9,583 20,613 Total loans and leases Commercial real estate: Owner occupied — — 342 342 226,272 226,614 Non-owner occupied — — — — 516,652 516,652 Land development — 990 — 990 50,107 51,097 Construction 309 — — 309 108,748 109,057 Multi-family — — — — 217,322 217,322 1-4 family — 333 — 333 33,026 33,359 Commercial and industrial 7,075 2,769 3,123 12,967 490,435 503,402 Direct financing leases, net — — — — 28,203 28,203 Consumer and other: Home equity and second mortgages — — — — 7,006 7,006 Other — — 147 147 22,517 22,664 Total $ 7,384 $ 4,092 $ 3,612 $ 15,088 $ 1,700,288 $ 1,715,376 Percent of portfolio 0.43 % 0.24 % 0.21 % 0.88 % 99.12 % 100.00 % 22 Table of Contents The Corporation’s total impaired assets consisted of the following: September 30, 2020 December 31, 2019 (In Thousands) Non-accrual loans and leases Commercial real estate: Commercial real estate — owner occupied $ 7,941 $ 4,032 Commercial real estate — non-owner occupied 5,813 — Land development 890 1,526 Construction — — Multi-family — — 1-4 family 333 333 Total non-accrual commercial real estate 14,977 5,891 Commercial and industrial 20,693 14,575 Direct financing leases, net 351 — Consumer and other: Home equity and second mortgages — — Other 29 147 Total non-accrual consumer and other loans 29 147 Total non-accrual loans and leases 36,050 20,613 Foreclosed properties, net 613 2,919 Total non-performing assets 36,663 23,532 Performing troubled debt restructurings 47 140 Total impaired assets $ 36,710 $ 23,672 September 30, 2020 December 31, 2019 Total non-accrual loans and leases to gross loans and leases 1.66 % 1.20 % Total non-performing assets to total gross loans and leases plus foreclosed properties, net 1.68 1.37 Total non-performing assets to total assets 1.41 1.12 Allowance for loan and lease losses to gross loans and leases 1.41 1.14 Allowance for loan and lease losses to non-accrual loans and leases 85.48 94.70 As of September 30, 2020, and December 31, 2019, $ 15.4 million and $ 15.6 million of the non-accrual loans and leases were considered troubled debt restructurings, respectively. The Corporation has allocated $ 4.4 million and $ 2.7 million of specific reserves to troubled debt restructurings as of September 30, 2020 and December 31, 2019, respectively. There were no unfunded commitments associated with troubled debt restructured loans and leases as of September 30, 2020. All loans and leases modified as a troubled debt restructuring are measured for impairment. The nature and extent of the impairment of restructured loans, including those which have experienced a default, is considered in the determination of an appropriate level of the allowance for loan and lease losses. The following table provides the number of loans modified in a troubled debt restructuring and the pre- and post-modification recorded investment by class of receivable: 23 Table of Contents For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment (Dollars in Thousands) Commercial real estate: Commercial real estate — owner occupied — $ — $ — 2 $ 299 $ 272 Commercial and industrial — — — 3 6,007 5,589 Total — $ — $ — 5 $ 6,306 $ 5,861 For the Three Months Ended September 30, For the Nine Months Ended September 30, 2019 Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment (Dollars in Thousands) Commercial real estate: Commercial real estate — owner occupied 2 $ 3,774 $ 3,741 2 $ 3,774 $ 3,741 Commercial and industrial 2 2,804 2,804 16 13,412 13,023 Total 4 $ 6,578 $ 6,545 18 $ 17,186 $ 16,764 Restructured loan modifications may include payment schedule modifications, interest rate concessions, maturity date extensions, principal reduction, or some combination of these concessions. During the three and nine months ended September 30, 2020, and 2019, the modification of terms primarily consisted of payment schedule modifications or principal reductions. There were two commercial and industrial loans for a total of $ 703,000 and two owner-occupied commercial real estate loans for a total of $ 272,000 modified in troubled debt restructurings during the previous 12 months which subsequently defaulted during the three and nine months ended September 30, 2020. There were no loans modified in a troubled debt restructuring during the 12 months previous to September 30, 2019 which subsequently defaulted during the three and nine months ended September 30, 2019. 24 Table of Contents The following represents additional information regarding the Corporation’s impaired loans and leases, including performing troubled debt restructurings, by class: As of and for the Nine Months Ended September 30, 2020 Recorded Investment (1) Unpaid Principal Balance Impairment Reserve Average Recorded Investment (2) Foregone Interest Income Interest Income Recognized Net Foregone Interest Income (In Thousands) With no impairment reserve recorded: Commercial real estate: Owner occupied $ 4,471 $ 4,498 $ — $ 3,092 $ 149 $ 72 $ 77 Non-owner occupied — — — 35 — — — Land development 890 5,187 — 1,295 19 — 19 Construction — — — — — — — Multi-family — — — — — — — 1-4 family 380 385 — 416 30 79 ( 49 ) Commercial and industrial 9,787 12,300 — 10,620 813 316 497 Direct financing leases, net — — — — — — — Consumer and other: Home equity and second mortgages — — — — — — — Other 29 695 — 106 32 — 32 Total 15,557 23,065 — 15,564 1,043 467 576 With impairment reserve recorded: Commercial real estate: Owner occupied 3,470 4,829 2,974 3,534 297 — 297 Non-owner occupied 5,813 5,813 2,768 21 399 — 399 Land development — — — — — — — — — — Construction — — — — — — — — — — Multi-family — — — — — — — 1-4 family — — — — — — — Commercial and industrial 10,906 12,228 2,981 5,724 308 — 308 Direct financing leases, net 351 351 175 56 2 — 2 Consumer and other: Home equity and second mortgages — — — — — — — Other — — — — — — — Total 20,540 23,221 8,898 9,335 1,006 — 1,006 Total: Commercial real estate: Owner occupied 7,941 9,327 2,974 6,626 446 72 374 Non-owner occupied 5,813 5,813 2,768 56 399 — 399 Land development 890 5,187 — 1,295 19 — 19 Construction — — — — — — — Multi-family — — — — — — — 1-4 family 380 385 — 416 30 79 ( 49 ) Commercial and industrial 20,693 24,528 2,981 16,344 1,121 316 805 Direct financing leases, net 351 351 175 56 2 — 2 Consumer and other: Home equity and second mortgages — — — — — — — Other 29 695 — 106 32 — 32 Grand total $ 36,097 $ 46,286 $ 8,898 $ 24,899 $ 2,049 $ 467 $ 1,582 (1) The recorded investment represents the unpaid principal balance net of any partial charge-offs. (2) Average recorded investment is calculated primarily using daily average balances. 25 Table of Contents As of and for the Year Ended December 31, 2019 Recorded Investment (1) Unpaid Principal Balance Impairment Reserve Average Recorded Investment (2) Foregone Interest Income Interest Income Recognized Net Foregone Interest Income (In Thousands) With no impairment reserve recorded: Commercial real estate: Owner occupied $ 387 $ 387 $ — $ 3,285 $ 64 $ 355 $ ( 291 ) Non-owner occupied — — — 58 1 — 1 Land development 1,526 5,823 — 1,843 52 6 46 Construction — — — — — — — Multi-family — — — — — — — 1-4 family 473 478 — 356 19 46 ( 27 ) Commercial and industrial 4,779 6,549 — 14,479 1,073 379 694 Direct financing leases, net — — — — — — — Consumer and other: Home equity and second mortgages — — — — — 7 ( 7 ) Other 147 813 — 191 48 — 48 Total 7,312 14,050 — 20,212 1,257 793 464 With impairment reserve recorded: Commercial real estate: Owner occupied 3,645 5,004 1,082 1,511 414 — 414 Non-owner occupied — — — — — — — Land development — — — — — — — Construction — — — — — — — Multi-family — — — — — — — 1-4 family — — — — — — — Commercial and industrial 9,796 11,179 2,283 2,367 1,022 — 1,022 Direct financing leases, net — — — — — — — Consumer and other: Home equity and second mortgages — — — — — — — Other — — — — — — — Total 13,441 16,183 3,365 3,878 1,436 — 1,436 Total: Commercial real estate: Owner occupied 4,032 5,391 1,082 4,796 478 355 123 Non-owner occupied — — — 58 1 — 1 Land development 1,526 5,823 — 1,843 52 6 46 Construction — — — — — — — Multi-family — — — — — — — 1-4 family 473 478 — 356 19 46 ( 27 ) Commercial and industrial 14,575 17,728 2,283 16,846 2,095 379 1,716 Direct financing leases, net — — — — — — — Consumer and other: Home equity and second mortgages — — — — — 7 ( 7 ) Other 147 813 — 191 48 — 48 Grand total $ 20,753 $ 30,233 $ 3,365 $ 24,090 $ 2,693 $ 793 $ 1,900 (1) The recorded investment represents the unpaid principal balance net of any partial charge-offs. (2) Average recorded investment is calculated primarily using daily average balances. 26 Table of Contents The difference between the recorded investment of loans and leases and the unpaid principal balance of $ 10.2 million and $ 9.5 million as of September 30, 2020, and December 31, 2019, respectively, represents partial charge-offs of loans and leases resulting from losses due to the appraised value of the collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $ 47,000 and $ 140,000 of loans as of September 30, 2020, and December 31, 2019, respectively, that were performing troubled debt restructurings, and although not on non-accrual, were reported as impaired due to the concession in terms. When a loan is placed on non-accrual, interest accrual is discontinued and previously accrued but uncollected interest is deducted from interest income. Cash payments collected on non-accrual loans are first applied to such loan’s principal. Foregone interest represents the interest that was contractually due on the loan but not received or recorded. To the extent the amount of principal on a non-accrual loan is fully collected and additional cash is received, the Corporation will recognize interest income. To determine the level and composition of the allowance for loan and lease losses, the Corporation categorizes the portfolio into segments with similar risk characteristics. First, the Corporation evaluates loans and leases for potential impairment classification. The Corporation analyzes each loan and lease determined to be impaired on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of expected cash flows. The Corporation applies historical trends from established risk factors to each category of loans and leases that has not been individually evaluated for the purpose of establishing the general portion of the allowance. A summary of the activity in the allowance for loan and lease losses by portfolio segment is as follows: As of and for the Three Months Ended September 30, 2020 Commercial Real Estate Commercial and Industrial Consumer and Other Total (In Thousands) Beginning balance $ 16,438 $ 10,179 $ 847 $ 27,464 Charge-offs — ( 505 ) — ( 505 ) Recoveries — 21 2 23 Net charge-offs — ( 484 ) 2 ( 482 ) Provision for loan and lease losses 3,742 127 ( 34 ) 3,835 Ending balance $ 20,180 $ 9,822 $ 815 $ 30,817 As of and for the Three Months Ended September 30, 2019 Commercial Real Estate Commercial and Industrial Consumer and Other Total (In Thousands) Beginning balance $ 11,269 $ 7,892 $ 658 $ 19,819 Charge-offs — ( 1,097 ) ( 2 ) ( 1,099 ) Recoveries 1 99 1 101 Net recoveries 1 ( 998 ) ( 1 ) ( 998 ) Provision for loan and lease losses ( 132 ) 1,517 ( 36 ) 1,349 Ending balance $ 11,138 $ 8,411 $ 621 $ 20,170 As of and for the Nine Months Ended September 30, 2020 Commercial Real Estate Commercial and Industrial Consumer and Other Total (In Thousands) Beginning balance $ 10,852 $ 8,078 $ 590 $ 19,520 Charge-offs ( 27 ) ( 1,414 ) ( 13 ) ( 1,454 ) Recoveries 3 259 2 264 Net charge-offs ( 24 ) ( 1,155 ) ( 11 ) ( 1,190 ) Provision for loan and lease losses 9,352 2,899 236 12,487 Ending balance $ 20,180 $ 9,822 $ 815 $ 30,817 27 Table of Contents As of and for the Nine Months Ended September 30, 2019 Commercial Real Estate Commercial and Industrial Consumer and Other Total (In Thousands) Beginning balance $ 11,662 $ 8,079 $ 684 $ 20,425 Charge-offs — ( 1,158 ) ( 4 ) ( 1,162 ) Recoveries 74 191 29 294 Net recoveries 74 ( 967 ) 25 ( 868 ) Provision for loan and lease losses ( 598 ) 1,299 ( 88 ) 613 Ending balance $ 11,138 $ 8,411 $ 621 $ 20,170 The following tables provide information regarding the allowance for loan and lease losses and balances by type of allowance methodology. As of September 30, 2020 Commercial Real Estate Commercial and Industrial Consumer and Other Total (In Thousands) Allowance for loan and lease losses: Collectively evaluated for impairment $ 14,438 $ 6,666 $ 815 $ 21,919 Individually evaluated for impairment 5,742 3,156 — 8,898 Total $ 20,180 $ 9,822 $ 815 $ 30,817 Loans and lease receivables: Collectively evaluated for impairment $ 1,311,493 $ 794,048 $ 36,418 $ 2,141,959 Individually evaluated for impairment 15,024 21,044 29 36,097 Total $ 1,326,517 $ 815,092 $ 36,447 $ 2,178,056 As of December 31, 2019 Commercial Real Estate Commercial and Industrial Consumer and Other Total (In Thousands) Allowance for loan and lease losses: Collectively evaluated for impairment $ 9,770 $ 5,795 $ 590 $ 16,155 Individually evaluated for impairment 1,082 2,283 — 3,365 Total $ 10,852 $ 8,078 $ 590 $ 19,520 Loans and lease receivables: Collectively evaluated for impairment $ 1,148,070 $ 517,030 $ 29,523 $ 1,694,623 Individually evaluated for impairment 6,031 14,575 147 20,753 Total $ 1,154,101 $ 531,605 $ 29,670 $ 1,715,376 Note 7 — Leases The Corporation leases various office spaces and specialty financing production offices under non-cancellable operating leases which expire on various dates through 2028. The Corporation also leases office equipment. The Corporation recognizes a right-of-use asset and an operating lease liability for all leases, with the exception of short-term leases. Right-of-use assets represent the right to use an underlying asset for the lease term and lease liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. Lease expense for operating leases and short-term leases 28 Table of Contents is recognized on a straight-line basis over the lease term. During 2020, the Corporation extended the term of one of its office spaces by one year, resulting in a $ 190,000 increase in the right-of-use assets in exchange for a lease liability. The Corporation entered into a sublease for vacated office space which expires in 2023. The components of total lease expense were as follows: For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (In Thousands) Operating lease cost $ 373 $ 391 $ 1,116 $ 1,172 Short-term lease cost 52 56 174 197 Variable lease cost 141 129 394 366 Less: sublease income ( 28 ) — ( 84 ) — Total lease cost, net $ 538 $ 576 $ 1,600 $ 1,735 Quantitative information regarding the Corporation’s operating leases was as follows: September 30, 2020 December 31, 2019 Weighted-average remaining lease term (in years) 5.95 6.56 Weighted-average discount rate 3.00 % 3.09 % The following maturity analysis shows the undiscounted cash flows due on the Corporation’s operating leases liabilities: (In Thousands) 2020 $ 391 2021 1,557 2022 1,373 2023 1,015 2024 756 Thereafter 2,307 Total undiscounted cash flows 7,399 Discount on cash flows ( 671 ) Total lease liability $ 6,728 Note 8 — Other Assets A summary of accrued interest receivable and other assets was as follows: September 30, 2020 December 31, 2019 (In Thousands) Accrued interest receivable $ 9,938 $ 5,760 Net deferred tax asset 7,588 5,353 Investment in historic development entities 2,345 2,216 Investment in a community development entity 5,189 5,571 Investment in limited partnerships 5,641 4,476 Investment in Trust II 315 315 Fair value of interest rate swaps 58,210 18,346 Prepaid expenses 2,402 2,285 Other assets 7,930 4,184 Total accrued interest receivable and other assets $ 99,558 $ 48,506 29 Table of Contents Note 9 — Deposits The composition of deposits is shown below. Average balances represent year to date averages. September 30, 2020 December 31, 2019 Balance Average Balance Average Rate Balance Average Balance Average Rate (Dollars in Thousands) Non-interest-bearing transaction accounts $ 452,268 $ 392,455 — % $ 293,573 $ 275,495 — % Interest-bearing transaction accounts 484,761 362,326 0.44 273,909 222,244 1.53 Money market accounts 636,872 649,999 0.52 674,409 617,341 1.71 Certificates of deposit 93,344 122,781 2.05 137,012 156,048 2.47 Wholesale deposits 154,130 132,811 2.03 151,476 225,302 2.27 Total deposits $ 1,821,375 $ 1,660,372 0.62 $ 1,530,379 $ 1,496,430 1.53 Note 10 — FHLB Advances, Other Borrowings and Junior Subordinated Notes The composition of borrowed funds is shown below. Average balances represent year to date averages. September 30, 2020 December 31, 2019 Balance Weighted Average Balance Weighted Average Rate Balance Weighted Average Balance Weighted Average Rate (Dollars in Thousands) Federal funds purchased $ — $ 95 0.69 % $ — $ 59 2.45 % Federal Reserve PPPLF 29,605 16,855 0.35 — — — FHLB advances 429,500 371,738 1.51 295,000 286,464 2.17 Other borrowings 675 675 8.12 675 675 8.11 Subordinated notes payable (1) 23,737 23,720 5.95 23,707 24,502 7.45 Junior subordinated notes 10,058 10,052 11.08 10,047 10,040 11.08 $ 493,575 $ 423,135 1.95 $ 329,429 $ 321,740 2.87 Short-term borrowings $ 231,000 $ 118,500 Long-term borrowings 262,575 210,929 $ 493,575 $ 329,429 (1) Weighted average rate of subordinated notes payable reflects the accelerated amortization of subordinated debt issuance costs as a result of the early redemption of a subordinated note during the third quarter of 2019. During the nine months ended September 30, 2020, the Corporation prepaid $ 59.5 million of short-term FHLB advances that had a weighted average interest rate of 2.34 %. The transaction was accounted for as an early debt extinguishment resulting in a pre-tax loss of $ 744,000 during the nine months ended September 30, 2020. During the second quarter of 2020, the Corporation tested its ability to borrow from the Federal Reserve Paycheck Protection Program Liquidity Facility (“PPPLF”) in the event funding was required to support the Banks PPP lending efforts. On April 28, 2020, the Corporation borrowed $ 29.6 million from the PPPLF at a rate of 0.35 %. The borrowing is fully collateralized by a tranche of PPP loans originated by the Bank on April 15, 2020 and matures on April 15, 2022, or when the tranche of PPP loans utilized to collateralize the PPPLF borrowing are forgiven, whichever comes first. 30 Table of Contents As of September 30, 2020 and December 31, 2019, the Corporation was in compliance with its debt covenants under its third-party secured senior line of credit. Per the promissory note dated February 19, 2020, the Corporation pays a fee on this line of credit. During both the nine months ended September 30, 2020 and 2019, the Corporation incurred interest expense of $ 10,000 due to this fee. Note 11 — Commitments and Contingencies In the normal course of business, various legal proceedings involving the Corporation are pending. Management, based upon advice from legal counsel, does not anticipate any significant losses as a result of these actions. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations, and cash flows. The Corporation sells the guaranteed portions of SBA 7(a) loans, as well as participation interests in other, non-SBA originated, loans to third parties. The Corporation has a continuing involvement in each of the transferred lending arrangements by way of relationship management and servicing the loans, as well as being subject to normal and customary requirements of the SBA loan program and standard representations and warranties related to sold amounts. In the event of a loss resulting from default and a determination by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Corporation, the SBA may require the Corporation to repurchase the loan, deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from the Corporation. The Corporation must comply with applicable SBA regulations in order to maintain the guaranty. In addition, the Corporation retains the option to repurchase the sold guaranteed portion of an SBA loan if the loan defaults. Management has assessed estimated losses inherent in the outstanding guaranteed portions of SBA loans sold in accordance with ASC 450, Contingencies , and determined a recourse reserve based on the probability of future losses for these loans to be $ 1.1 million at September 30, 2020, which is reported in accrued interest payable and other liabilities on the unaudited Consolidated Balance Sheets. The summary of the activity in the SBA recourse reserve is as follows: As of and for the Three Months Ended September 30, As of and for the Nine Months Ended September 30, 2020 2019 2020 2019 (In Thousands) Balance at the beginning of the period $ 1,007 $ 2,068 $ 1,345 $ 2,956 SBA recourse (benefit) provision 57 ( 427 ) 53 167 Charge-offs, net ( 4 ) 2 ( 338 ) ( 1,480 ) Balance at the end of the period $ 1,060 $ 1,643 $ 1,060 $ 1,643 Note 12 — Fair Value Disclosures The Corporation determines the fair values of its financial instruments based on the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is defined as the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date and is based on exit prices. Fair value includes assumptions about risk, such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. The standard describes three levels of inputs that may be used to measure fair value. Level 1 — Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date. Level 2 — Level 2 inputs are inputs, other than quoted prices included with Level 1, that are observable for the asset or liability either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. 31 Table of Contents Level 3 — Level 3 inputs are supported by little or no market activity and are significant to the fair value of the assets or liabilities. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. Assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy level, are summarized below: September 30, 2020 Fair Value Measurements Using Level 1 Level 2 Level 3 Total (In Thousands) Assets: Securities available-for-sale: U.S. government agency securities - government-sponsored enterprises $ — $ 21,537 $ — $ 21,537 Municipal securities — 13,963 — 13,963 Residential mortgage-backed securities - government issued — 11,545 — 11,545 Residential mortgage-backed securities - government-sponsored enterprises — 110,447 — 110,447 Commercial mortgage-backed securities - government issued — 6,042 — 6,042 Commercial mortgage-backed securities - government-sponsored enterprises — 13,450 — 13,450 Other securities — 2,290 — 2,290 Interest rate swaps — 58,210 — 58,210 Liabilities: Interest rate swaps — 64,404 — 64,404 December 31, 2019 Fair Value Measurements Using Level 1 Level 2 Level 3 Total (In Thousands) Assets: Securities available-for-sale: U.S. government agency securities - government-sponsored enterprises $ — $ 23,758 $ — $ 23,758 Municipal securities — 160 — 160 Residential mortgage-backed securities - government issued — 16,348 — 16,348 Residential mortgage-backed securities - government-sponsored enterprises — 112,002 — 112,002 Commercial mortgage-backed securities - government issued — 6,663 — 6,663 Commercial mortgage-backed securities - government-sponsored enterprises — 11,967 — 11,967 Other securities — 2,235 — 2,235 Interest rate swaps — 18,346 — 18,346 Liabilities: Interest rate swaps — 20,885 — 20,885 32 Table of Contents For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the three and nine months ended September 30, 2020 or the year ended December 31, 2019 related to the above measurements. Assets and liabilities measured at fair value on a non-recurring basis, segregated by fair value hierarchy are summarized below: September 30, 2020 Fair Value Measurements Using Level 1 Level 2 Level 3 Total (In Thousands) Impaired loans $ — $ — $ 22,152 $ 22,152 Foreclosed properties — — 613 613 Loan servicing rights — — 1,323 1,323 December 31, 2019 Fair Value Measurements Using Level 1 Level 2 Level 3 Total (In Thousands) Impaired loans $ — $ — $ 15,699 $ 15,699 Foreclosed properties — — 2,919 2,919 Loan servicing rights — — 1,195 1,195 Impaired loans were written down to the fair value of their underlying collateral less costs to sell of $ 22.2 million and $ 15.7 million at September 30, 2020 and December 31, 2019, respectively, through the establishment of specific reserves or by recording charge-offs when the carrying value exceeded the fair value of the underlying collateral of impaired loans. Valuation techniques consistent with the market approach, income approach, or cost approach were used to measure fair value. These techniques included observable inputs for the individual impaired loans being evaluated, such as current appraisals, recent sales of similar assets, or other observable market data, and unobservable inputs, typically when discounts are applied to appraisal values to adjust such values to current market conditions or to reflect net realizable values. The quantification of unobservable inputs for Level 3 impaired loan values range from 5 % - 93 % as of the measurement date of September 30, 2020. The weighted average of those unobservable inputs was 26 %. The majority of the impaired loans are considered collateral dependent loans or are supported by an SBA guaranty. Foreclosed properties, upon initial recognition, are remeasured and reported at fair value through a charge-off to the allowance for loan and lease losses, if deemed necessary, based upon the fair value of the foreclosed property. The fair value of a foreclosed property, upon initial recognition, is estimated using a market approach or based on observable market data, typically a current appraisal, or based upon assumptions specific to the individual property or equipment, such as management applied discounts used to further reduce values to a net realizable value when observable inputs become stale. Loan servicing rights represent the asset retained upon sale of the guaranteed portion of certain SBA loans. When SBA loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The servicing rights are subsequently measured using the amortization method, which requires amortization into interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. The Corporation periodically reviews this portfolio for impairment and engages a third-party valuation firm to assess the fair value of the overall servicing rights portfolio. Loan servicing rights do not trade in an active, open market with readily observable prices. While sales of loan servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Corporation utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its loan servicing rights. The valuation model incorporates prepayment assumptions to project loan servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the loan servicing rights. The valuation model considers portfolio characteristics of the underlying serviced portion of the SBA loans and uses the following significant unobservable inputs: (1) constant prepayment rate (“CPR”) assumptions based on the SBA sold pools historical CPR as quoted in Bloomberg and (2) a discount rate. Due to the nature of the valuation inputs, loan servicing rights are classified in Level 3 of the fair value hierarchy. 33 Table of Contents Fair Value of Financial Instruments The Corporation is required to disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions, consistent with exit price concepts for fair value measurements, are set forth below: September 30, 2020 Carrying Amount Fair Value Total Level 1 Level 2 Level 3 (In Thousands) Financial assets: Cash and cash equivalents $ 51,728 $ 51,728 $ 51,728 $ — $ — Securities available-for-sale 179,274 179,274 — 179,274 — Securities held-to-maturity 28,897 29,964 — 29,964 — Loans held for sale 15,049 16,404 — 16,404 — Loans and lease receivables, net 2,139,482 2,136,174 — — 2,136,174 Federal Home Loan Bank stock 15,153 N/A N/A N/A N/A Accrued interest receivable 9,938 9,938 9,938 — — Interest rate swaps 58,210 58,210 — 58,210 — Financial liabilities: Deposits 1,821,375 1,823,640 1,658,901 164,739 — Federal Home Loan Bank advances and other borrowings 483,517 492,911 — 492,911 — Junior subordinated notes 10,058 9,982 — — 9,982 Accrued interest payable 1,509 1,509 1,509 — — Interest rate swaps 64,404 64,404 — 64,404 — Off-balance sheet items: Standby letters of credit 51 51 — — 51 N/A = The fair value is not applicable due to restrictions placed on transferability 34 Table of Contents December 31, 2019 Carrying Amount Fair Value Total Level 1 Level 2 Level 3 (In Thousands) Financial assets: Cash and cash equivalents $ 67,102 $ 67,102 $ 61,202 $ 5,900 $ — Securities available-for-sale 173,133 173,133 — 173,133 — Securities held-to-maturity 32,700 33,188 — 33,188 — Loans held for sale 5,205 5,673 — 5,673 — Loans and lease receivables, net 1,695,115 1,706,201 — — 1,706,201 Federal Home Loan Bank stock 7,953 N/A N/A N/A N/A Accrued interest receivable 5,760 5,760 5,760 — — Interest rate swaps 18,346 18,346 — 18,346 — Financial liabilities: Deposits 1,530,379 1,532,517 1,241,891 290,626 — Federal Home Loan Bank advances and other borrowings 319,382 319,507 — 319,507 — Junior subordinated notes 10,047 9,970 — — 9,970 Accrued interest payable 2,882 2,282 2,282 — — Interest rate swaps 20,885 20,885 — 20,885 — Off-balance sheet items: Standby letters of credit 63 63 — — 63 N/A = The fair value is not applicable due to restrictions placed on transferability Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the unaudited Consolidated Balance Sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Corporation. Securities: The fair value measurements of investment securities are determined by a third-party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information, and the securities’ terms and conditions, among other things. The fair value measurements are subject to independent verification by another pricing source on a quarterly basis to review for reasonableness. Any significant differences in pricing are reviewed with appropriate members of management who have the relevant technical expertise to assess the results. The Corporation has determined that these valuations are classified in Level 2 of the fair value hierarchy. When the independent pricing service does not provide a fair value measurement for a particular security, the Corporation will estimate the fair value based on specific information about each security. Fair values derived in this manner are classified in Level 3 of the fair value hierarchy. Loans Held for Sale: Loans held for sale, which consist of the guaranteed portions of SBA 7(a) loans, are carried at the lower of cost or estimated fair value. The estimated fair value is based on what secondary markets are currently offering for portfolios with similar characteristics. Interest Rate Swaps: The carrying amount and fair value of existing derivative financial instruments are based upon independent valuation models, which use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative contract. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the 35 Table of Contents respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Corporation considers the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. Limitations: Fair value estimates are made at a discrete point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holding of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and are not considered in the estimates. Note 13 — Derivative Financial Instruments The Corporation offers interest rate swap products directly to qualified commercial borrowers. The Corporation economically hedges client derivative transactions by entering into offsetting interest rate swap contracts executed with a third party. Derivative transactions executed as part of this program are not considered hedging instruments and are marked-to-market through earnings each period. The derivative contracts have mirror-image terms, which results in the positions’ changes in fair value offsetting through earnings each period. The credit risk and risk of non-performance embedded in the fair value calculations is different between the dealer counterparties and the commercial borrowers which may result in a difference in the changes in the fair value of the mirror-image swaps. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the counterparty’s risk in the fair value measurements. When evaluating the fair value of its derivative contracts for the effects of non-performance and credit risk, the Corporation considered the impact of netting and any applicable credit enhancements such as collateral postings, thresholds, and guarantees. At September 30, 2020, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $ 577.9 million. The Corporation receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These interest rate swaps mature between March 2021 and August 2037. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported on the unaudited Consolidated Balance Sheet as a derivative asset of $ 58.2 million, included in accrued interest receivable and other assets. As of September 30, 2020, no interest rate swaps were in default. At September 30, 2020, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $ 577.9 million. The Corporation pays fixed rates and receives floating rates based upon LIBOR on the swaps with dealer counterparties. These interest rate swaps mature in March 2021 through August 2037. Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported on the unaudited Consolidated Balance Sheet as a net derivative liability of $ 58.2 million, included in accrued interest payable and other liabilities. The gross amount of dealer counterparty swaps, without regard to the enforceable master netting agreement, was a gross derivative liability of $ 58.2 million and no gross derivative asset. No right of offset existed with dealer counterparty swaps as of September 30, 2020. All changes in the fair value of these instruments are recorded in other non-interest income. Given the mirror-image terms of the outstanding derivative portfolio, the change in fair value for the three and nine months ended September 30, 2020 and 2019 had an insignificant impact on the unaudited Consolidated Statements of Income. The Corporation also enters into interest rate swaps to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans. These LIBOR-based derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The instruments are designated as cash flow hedges as the receipt of floating rate interest from the counterparty is used to manage interest rate risk associated with forecasted issuances of short-term FHLB advances. The change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings. As of September 30, 2020, the aggregate notional value of interest rate swaps designated as cash flow hedges was $ 114.0 million. These interest rate swaps mature between December 2021 and December 2027. A pre-tax unrealized gain of $ 389,000 36 Table of Contents and a pre-tax unrealized loss of $ 3.7 million were recognized in other comprehensive income for the three and nine months ended September 30, 2020, respectively, and there was no ineffective portion of these hedges. Information about the balance sheet location and fair value of the Corporation’s derivative instruments below: Interest Rate Swap Contracts Asset Derivatives Liability Derivatives Balance Sheet Location Fair Value Balance Sheet Location Fair Value (In Thousands) Derivatives not designated as hedging instruments September 30, 2020 Accrued interest receivable and other assets $ 58,210 Accrued interest payable and other liabilities $ 58,210 December 31, 2019 Accrued interest receivable and other assets $ 18,346 Accrued interest payable and other liabilities $ 18,346 Derivatives designated as hedging instruments September 30, 2020 Accumulated other comprehensive income (1) $ 6,193 Accrued interest payable and other liabilities $ 6,193 December 31, 2019 Accumulated other comprehensive income (1) $ 2,539 Accrued interest payable and other liabilities $ 2,539 (1) The fair value of derivatives designated as hedging instruments included in accumulated other comprehensive income represent pre-tax amounts, which are reported net of tax on the unaudited Consolidated Balance Sheets. Note 14 — Regulatory Capital The Corporation and the Bank are subject to various regulatory capital requirements administered by Federal and Wisconsin banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions on the part of regulators, that if undertaken, could have a direct material effect on the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory practices. The Corporation’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Corporation regularly reviews and updates, when appropriate, its Capital and Liquidity Action Plan, which is designed to help ensure appropriate capital adequacy, to plan for future capital needs, and to ensure that the Corporation serves as a source of financial strength to the Bank. The Corporation’s and the Bank’s Boards of Directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their respective capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness. As a bank holding company, the Corporation’s ability to pay dividends is affected by the policies and enforcement powers of the Board of Governors of the Federal Reserve system (the “Federal Reserve”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring, or significantly reducing dividends if: (i) net income available to common stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividend; (ii) the prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios. Management intends, when appropriate under regulatory guidelines, to consult with the Federal Reserve and provide it with information on the Corporation’s then-current and prospective earnings and capital position in advance of declaring any cash dividends. As a Wisconsin corporation, the Corporation is subject to the limitations of the Wisconsin Business Corporation Law, which prohibit the Corporation from paying dividends if such payment would: (i) render the Corporation unable to pay its debts as they become due in the usual course of business, or (ii) result in the Corporation’s assets being less than the sum of its total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of any stockholders with preferential rights superior to those stockholders receiving the dividend. The Bank is also subject to certain legal, regulatory, and other restrictions on its ability to pay dividends to the Corporation. As a bank holding company, the payment of dividends by the Bank to the Corporation is one of the sources of funds the 37 Table of Contents Corporation could use to pay dividends, if any, in the future and to make other payments. Future dividend decisions by the Bank and the Corporation will continue to be subject to compliance with various legal, regulatory, and other restrictions as defined from time to time. Qualitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of Total Common Equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to adjusted total assets. These risk-based capital requirements presently address credit risk related to both recorded and off-balance sheet commitments and obligations. As of September 30, 2020, the Corporation’s capital levels exceeded the regulatory minimums and the Bank’s capital levels remained characterized as well capitalized under the regulatory framework. The following tables summarize both the Corporation’s and the Bank’s capital ratios and the ratios required by their federal regulators: As of September 30, 2020 Actual Minimum Required for Capital Adequacy Purposes For Capital Adequacy Purposes Plus Capital Conservation Buffer Minimum Required to Be Well Capitalized Under Prompt Corrective Action Requirements Amount Ratio Amount Ratio Amount Ratio Amount Ratio (Dollars in Thousands) Total capital (to risk-weighted assets) Consolidated $ 252,325 11.42 % $ 176,728 8.00 % $ 231,956 10.50 % N/A N/A First Business Bank 243,967 11.11 175,634 8.00 230,519 10.50 219,542 10.00 % Tier 1 capital (to risk-weighted assets) Consolidated $ 200,922 9.09 % $ 132,546 6.00 % $ 187,774 8.50 % N/A N/A First Business Bank 216,469 9.86 131,725 6.00 186,611 8.50 175,634 8.00 Common equity tier 1 capital (to risk-weighted assets) Consolidated $ 190,864 8.64 % $ 99,410 4.50 % $ 154,637 7.00 % N/A N/A First Business Bank 216,469 9.86 98,794 4.50 153,680 7.00 142,702 6.50 Tier 1 leverage capital (to adjusted assets) Consolidated $ 200,922 8.04 % $ 99,940 4.00 % $ 99,940 4.00 % N/A N/A First Business Bank 216,469 8.72 99,347 4.00 99,347 4.00 124,183 5.00 38 Table of Contents As of December 31, 2019 Actual Minimum Required for Capital Adequacy Purposes For Capital Adequacy Purposes Plus Capital Conservation Buffer Minimum Required to Be Well Capitalized Under Prompt Corrective Action Requirements Amount Ratio Amount Ratio Amount Ratio Amount Ratio (Dollars in Thousands) Total capital (to risk-weighted assets) Consolidated $ 239,029 12.01 % $ 159,185 8.00 % $ 208,930 10.50 % N/A N/A First Business Bank 233,181 11.79 158,177 8.00 207,607 10.50 197,721 10.00 % Tier 1 capital (to risk-weighted assets) Consolidated $ 194,456 9.77 % $ 119,388 6.00 % $ 169,134 8.50 % N/A N/A First Business Bank 212,315 10.74 118,633 6.00 168,063 8.50 158,177 8.00 Common equity tier 1 capital (to risk-weighted assets) Consolidated $ 184,409 9.27 % $ 89,541 4.50 % $ 139,286 7.00 % N/A N/A First Business Bank 212,315 10.74 88,974 4.50 138,405 7.00 128,519 6.50 Tier 1 leverage capital (to adjusted assets) Consolidated $ 194,456 9.27 % $ 83,950 4.00 % $ 83,950 4.00 % N/A N/A First Business Bank 212,315 10.18 83,414 4.00 83,414 4.00 104,268 5.00 39 Table of Contents