What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-07-30 compared with 2021-04-30 · 362 added, 248 removed, 500 unchanged (55% of the section changed)

39 unchanged sentences

Financial Performance Summary

Results as of and for the three months ended March 31, 2021 include:

• Net income totaled $9.7 million, or diluted earnings per share of $1.12, for the three months ended March 31, 2021, compared to $3.3 million, or diluted earnings per share of $0.38, for the same period in 2020.

• Annualized return on average assets and annualized return on average equity for the three months ended March 31, 2021 measured 1.51% and 18.48%, respectively, compared to 0.62% and 7.14% for the same period in 2020.

• Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled $10.6 million for the three months ended March 31, 2021, up 40.1% from the same period in 2020.

Pre-tax, pre-provision adjusted return on average assets was 1.65% for the three months ended March 31, 2021, compared to 1.44% for the same period in 2020.

• Net interest margin was 3.44% for both the three months ended March 31, 2021 and March 31, 2020.

Adjusted net interest margin, which excludes certain one-time and discrete items, was 3.20% for the three months ended March 31, 2021 compared to 3.32% for the three months ended March 31, 2020.

• Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled $3.1 million for the three months ended March 31, 2021 compared to $798,000 for the three months ended March 31, 2020.

• Top line revenue, defined as net interest income plus non-interest income, totaled $28.1 million for the three months ended March 31, 2021, up 19.6% from the same period in 2020.

• Provision for loan and lease losses was a benefit of $2.1 million for the three months ended March 31, 2021 compared to an expense of $3.2 million for the same period in 2020.

• Non-interest income totaled $7.2 million for the three months ended March 31, 2021, once again exceeding the Corporation’s goal of 25%, compared to $6.4 million for the three months ended March 31, 2020.

• Non-interest expense was $17.3 million for the three months ended March 31, 2021 compared to $16.1 million for the three months ended March 31, 2020.

Operating expense, which excludes certain one-time and discrete items, totaled $17.4 million for the three months ended March 31, 2021 compared to $15.9 million for the three months ended March 31, 2020.

• The efficiency ratio improved to 62.19% for the three months ended March 31, 2021, down from 67.74% for the three months ended March 31, 2020.

• Total assets at March 31, 2021 increased $52.9 million, or 8.2% annualized, to $2.621 billion from $2.568 billion at December 31, 2020.

• Period-end gross loans and leases receivable at March 31, 2021 increased $89.1 million, or 16.6% annualized, to $2.235 billion from $2.146 billion as of December 31, 2020.

Average gross loans and leases of $2.183 billion increased $449.2 million, or 25.9%, for the three months ended March 31, 2021, compared to $1.734 billion for the same period in 2020.

• Period-end gross loans and leases receivable, excluding net PPP loans, at March 31, 2021 increased $46.9 million, or 9.8% annualized, to $1.968 billion from $1.921 billion as of December 31, 2020.

Average gross loans and leases, excluding net PPP loans, of $1.941 billion increased $207.0 million, or 11.9%, for the three months ended March 31, 2021, compared to $1.734 billion for the same period in 2020.

• PPP loans and PPP deferred processing fees were $272.7 million and $5.1 million, respectively, at March 31, 2021.

Average PPP loans, net of deferred processing fees, were $242.2 million for the three months ended March 31, 2021.

• Non-performing assets were $19.0 million and 0.73% of total assets as of March 31, 2021, compared to $26.7 million and 1.04% of total assets as of December 31, 2020.

Non-performing assets to total assets, excluding net PPP loans, was 0.81% as of March 31, 2021.

• The allowance for loan and lease losses increased $461,000, or 1.6%, compared to December 31, 2020.

Results as of and for the three and six months ended June 30, 2021 include:

• Net income totaled $8.2 million, or diluted earnings per share of $0.95, for the three months ended June 30, 2021, compared to $3.3 million, or diluted earnings per share of $0.38, for the same period in 2020.

Net income totaled $18.0 million, or diluted earnings per share of $2.08, for the six months ended June 30, 2021, compared to $6.6 million, or diluted earnings per share of $0.77, for the same period in 2020.

• Annualized return on average assets and annualized return on average equity for the three months ended June 30, 2021 measured 1.26% and 15.09%, respectively, compared to 0.55% and 6.70% for the same period in 2020.

Annualized return on average assets and annualized return on average equity for the six months ended June 30, 2021 measured 1.38% and 16.75%, respectively, compared to 0.58% and 6.92% for the same period in 2020.

• Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled $10.0 million for the three months ended June 30, 2021, up 2.4% from the same period in 2020.

Pre-tax, pre-provision adjusted return on average assets was 1.53% for the three months ended June 30, 2021, compared to 1.61% for the same period in 2020.

Pre-tax, pre-provision adjusted earnings totaled $20.6 million for the six months ended June 30, 2021, up 18.9% from the same period in 2020.

Pre-tax, pre-provision adjusted return on average assets was 1.59% for the six months ended June 30, 2021, compared to 1.53% for the same period in 2020.

• Net interest margin was 3.49% for the three months ended June 30, 2021, up from 3.34% for the same period in 2020.

Adjusted net interest margin, which excludes certain one-time and volatile items, was 3.20% for the three months ended June 30, 2021 compared to 3.32% for the same period in 2020.

Net interest margin was 3.46% for the six months ended June 30, 2021, up from 3.39% for the same period in 2020.

Adjusted net interest margin was 3.20% for the six months ended June 30, 2021 compared to 3.32% for the same period in 2020.

• Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled $3.5 million for the three months ended June 30, 2021 compared to $2.3 million for the three months ended June 30, 2020.

Fees in lieu of interest totaled $6.6 million for the six months ended June 30, 2021 compared to $3.1 million for the six months ended June 30, 2020.

• Top line revenue, defined as net interest income plus non-interest income, totaled $28.0 million for the three months ended June 30, 2021, up 11.0% from the same period in 2020.

Top line revenue totaled $56.0 million for the six months ended June 30, 2021, up 15.1% from the same period in 2020.

• Provision for loan and lease losses was a benefit of $958,000 for the three months ended June 30, 2021 compared to an expense of $5.5 million for the same period in 2020.

Provision for loan and lease losses was a benefit of $3.0 million for the six months ended June 30, 2021 compared to an expense of $8.7 million for the same period in 2020.

• Non-interest income totaled $6.3 million for both the three months ended June 30, 2021 and 2020.

Non-interest income totaled $13.5 million for the six months ended June 30, 2021, up 6.1% from the same period in 2020.

• Non-interest expense was $18.2 million for the three months ended June 30, 2021 compared to $18.3 million for the three months ended June 30, 2020.

Operating expense, which excludes certain one-time and discrete items, totaled $17.9 million for the three months ended June 30, 2021, up 16.2% compared to $15.4 million for the three months ended June 30, 2020.

Non-interest expense was $35.5 million for the six months ended June 30, 2021 compared to

$34.5 million for the six months ended June 30, 2020.

Operating expense totaled $35.4 million for the six months ended June 30, 2021, up 12.9% compared to $31.3 million for the six months ended June 30, 2020.

• The efficiency ratio was 64.17% for the three months ended June 30, 2021, up from 61.22% for the three months ended June 30, 2020.

The efficiency ratio improved to 63.18% for the six months ended June 30, 2021, down from 64.36% for the six months ended June 30, 2020.

• Total assets at June 30, 2021 increased $297.8 million to $2.866 billion from $2.568 billion at December 31, 2020.

• Period-end gross loans and leases receivable were $2.144 billion and $2.146 billion as of June 30, 2021 and December 31, 2020, respectively.

Average gross loans and leases of $2.223 billion increased $240.2 million, or 12.1%, for the three months ended June 30, 2021, compared to $1.983 billion for the same period in 2020.

• Period-end gross loans and leases receivable, excluding net PPP loans, at June 30, 2021 increased $102.2 million, or 10.6% annualized, to $2.023 billion from $1.921 billion as of December 31, 2020.

Average gross loans and leases, excluding net PPP loans, of $1.994 billion increased $263.9 million, or 15.3%, for the three months ended June 30, 2021, compared to $1.730 billion for the same period in 2020.

• Period-end gross PPP loans and PPP deferred processing fees were $123.8 million and $3.1 million, respectively, at June 30, 2021.

Average PPP loans, net of deferred processing fees, were $229.2 million for the three months ended June 30, 2021.

• Non-performing assets were $11.6 million and 0.40% of total assets as of June 30, 2021, compared to $26.7 million and 1.04% of total assets as of December 31, 2020.

Non-performing assets to total assets, excluding net PPP loans, was 0.42% as of June 30, 2021, compared to 1.14% as of December 31, 2020.

• The allowance for loan and lease losses decreased $2.8 million, or 10.0%, compared to December 31, 2020.

The allowance for loan and lease losses decreased to 1.20% of total loans, compared to 1.33% at December 31, 2020.

Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.47% of total loans as of March 31, 2021, compared to 1.48% as of December 31, 2020.

• Period-end in-market deposits at March 31, 2021 increased $54.2 million, or 12.9% annualized, to $1.737 billion from $1.683 billion as of December 31, 2020.

Average in-market deposits of $1.722 billion increased $356.0 million, or 26.1%, for the three months ended March 31, 2021, compared to $1.366 billion for the same period in 2020.

• Private wealth and trust assets under management and administration increased by $137.5 million, or 24.5% annualized, to $2.387 billion at March 31, 2021, compared to $2.249 billion at December 31, 2020.

• On January 28, 2021, the Board of Directors of the Corporation adopted a new share repurchase program that authorizes the Corporation to repurchase up to $5 million of the Corporation’s common stock over a period of approximately twelve months, ending on January 31, 2022.

As of March 31, 2021, the Corporation had repurchased 5,736 shares of its common stock at a weighted average price of $22.49 per share, for a total value of $129,000.

• On January 29, 2021, the Corporation’s Board of Directors declared a regular quarterly dividend of $0.18 per share.

The quarterly dividend represents a 9% increase over the quarterly dividend declared in October 2020 and, based on fourth quarter 2020 earnings per share, a dividend payout ratio of 25.5%.

This regular cash dividend was payable on February 18, 2021 to shareholders of record at the close of business on February 8, 2021.

The Board of Directors routinely considers dividend declarations as part of its normal course of business.

Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.27% of total loans as of June 30, 2021, compared to 1.48% as of December 31, 2020.

• Period-end in-market deposits at June 30, 2021 increased $333.2 million to $2.016 billion from $1.683 billion as of December 31, 2020.

Average in-market deposits of $1.735 billion increased $164.8 million, or 10.5%, for the six months ended June 30, 2021, compared to $1.571 billion for the same period in 2020.

• Private wealth and trust assets under management and administration increased by $315.4 million, or 28.0% annualized, to $2.564 billion at June 30, 2021, compared to $2.249 billion at December 31, 2020.

COVID-19 Update

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The Corporation began accepting and processing applications for second draw PPP loans on January 13, 2021.

As of March 31, 2021, the Corporation had $272.7 million in gross PPP loans outstanding and deferred processing fees outstanding of $5.1 million.

As of June 30, 2021, the Corporation had $123.8 million in gross PPP loans outstanding and deferred processing fees outstanding of $3.1 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 months ended March 31, 2021, the Corporation recognized $2.2 million of processing fees in loans and leases interest income in the unaudited Consolidated Statements of Income.

During the three and six months ended June 30, 2021, $2.5 million and $4.8 million, respectively, was recognized in loans and leases interest income in the unaudited Consolidated Statements of Income.

The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement.

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The Corporation provided loan modifications deferring payments for certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation’s loan modification program.

As of March 31, 2021, the Corporation had deferred loans outstanding of $13.0 million, or 0.7% 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.

Excluding gross PPP loans, as of June 30, 2021, the Corporation had deferred loans outstanding of $20.5 million, or 1.0% of gross loans and leases, compared to $27.0 million, or 1.4% of gross loans and leases as of December 31, 2020.

Of the $20.5 million of deferred loans outstanding, which relate to five credits in total, $19.8 million relates to two hospitality credits that went on deferral during the

second quarter of 2021 and are both accruing and current on payments.

Management believes there will be no losses associated with these two credits.

The following tables represent a breakdown of the deferred loan balances by industry segment and collateral type:

March 31, 2021

June 30, 2021

Collateral Type

1 unchanged sentence

(In Thousands)

Real Estate and Rental and Leasing $ 9,425 $ 9,425 $ —

Accommodation and Food Services $ 19,811 $ 19,811 $ —

Manufacturing 310 310 —

Professional, Scientific, and Technical Services 39 — 39

Other Services (except Public Administration) 328 212 116

Agriculture, Forestry, Fishing, and Hunting 210 — 210

Educational Services 195 195 —

Administrative and Support and Waste Management and Remediation Services 11 — 11

Total deferred loan balances $ 20,526 $ 20,316 $ 210

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Please refer to Note 6 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses for the risk category definitions.

March 31, 2021

June 30, 2021

I II III IV Total

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Certain industries have been and are expected to be particularly impacted by social distancing, quarantines, and the economic impact of the COVID-19 pandemic, such as the following:

March 31, 2021 December 31, 2020

June 30, 2021 December 31, 2020

Balance % Gross Loans and Leases (1)

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(1) Excluding net PPP loans.

(2) Includes $40.2 million and $48.9 million in loans secured by commercial real estate as of March 31, 2021 and December 31, 2020, respectively.

(3) Includes $21.3 million and $7.7 million in fully collateralized asset-based loans as of March 31, 2021 and December 31, 2020, respectively.

As of March 31, 2021, the Corporation had no meaningful direct exposure to the energy sector, airline industry or retail consumer, and does not participate in Shared National Credits.

Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our 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.

(2) Includes $38.6 million and $48.9 million in loans secured by commercial real estate as of June 30, 2021 and December 31, 2020, respectively.

(3) Includes $24.1 million and $7.7 million in fully collateralized asset-based loans as of June 30, 2021 and December 31, 2020, respectively.

As of June 30, 2021, the Corporation had no meaningful direct exposure to the energy sector, airline industry or retail consumer, and does not participate in Shared National Credits.

Because of the uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our 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.

Results of Operations

Top Line Revenue

Top line revenue, comprised of net interest income and non-interest income, increased 19.6% for the three months ended March 31, 2021 compared to the same period in the prior year primarily due to a $3.8 million, or 22.4%, increase in net interest income and a $781,000, or 12.2%, increase in non-interest income.

The increase in net interest income was driven by an increase in average loans and leases outstanding, and loan fees in lieu of interest, while the increase in non-interest income was primarily a result of an increase in gains on the sale of SBA loans and increase in private wealth fee income.

Top line revenue, comprised of net interest income and non-interest income, increased 11.0% for the three months ended June 30, 2021 compared to the same period in 2020 primarily due to a $2.8 million, or 14.6%, increase in net interest income.

The increase in net interest income was driven by an increase in average loans and leases receivable and loan fees in lieu of interest.

Top line revenue increased 15.1% for the six months ended June 30, 2021 compared to the same period in 2020 primarily due to higher net interest income driven by an increase average loans and leases receivable and fees in lieu of interest.

Non-interest income increased due to stronger gains on the sale of SBA loans and private wealth fee income, which was partially offset by a decrease in swap fees from our commercial loan interest rate swap program.

The components of top line revenue were as follows:

For the Three Months Ended March 31,

2021 2020 $ Change % Change

For the Three Months Ended June 30, For the Six Months Ended June 30,

2021 2020 $ Change % Change 2021 2020 $ Change % Change

(Dollars in Thousands)

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Annualized Return on Average Assets and Annualized Return on Average Equity

ROAA for the three months ended March 31, 2021 increased significantly to 1.51% compared to 0.62% for the three months ended March 31, 2020.

The increase in ROAA was primarily due to a decrease in the provision for loan and lease losses related to a large loan recovery received in January 2021, increase in fees in lieu of interest, and increase in gains on the sale of SBA loans.

This increase in profitability was partially offset by a decrease in commercial loan interest rate swap fee income and increase in non-interest expense.

ROAA for the three and six months ended June 30, 2021 increased significantly to 1.26% and 1.38%, compared to 0.55% and 0.58% for the three and six months ended June 30, 2020.

The increase in ROAA was primarily due to a decrease in the provision for loan and lease losses related to a large loan recovery received in January 2021 and continued credit quality improvement following significant reserve build during the COVID-19 pandemic.

ROAA also benefited from an increase in fees in lieu of interest, strong gains on sale of SBA loans, and consistently strong and growing private wealth fee income.

The increase in profitability was partially offset by a decrease in commercial loan interest rate swap fee income and increase in non-interest expense.

We consider ROAA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed.

ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures.

ROAE for the three months ended March 31, 2021 was 18.48% compared to 7.14% for the three months ended March 31, 2020.

ROAE for the three and six months ended June 30, 2021 was 15.09% and 16.75%, compared to 6.70% and 6.92% for the three and six months ended June 30, 2020.

The reasons for the increase in ROAE are consistent with the explanations discussed above with respect to ROAA.

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Pre-tax, pre-provision adjusted earnings is defined as operating revenue less operating expense.

In the judgment of the Corporation’s management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation’s operating expenses in relation to its core operating revenue by removing the volatility that is associated with certain one-time items and other discrete items.

The efficiency ratio was 62.19% for the three months ended March 31, 2021 compared to 67.74% for the three months ended March 31, 2020.

Operating revenue growth outpaced the change in operating expense for the three months ended March 31, 2021, resulting in positive operating leverage.

This improvement was attributable to an increase in net interest income driven by a 25.9% increase in average loans and leases receivable, an $813,000 increase in gains on the sale of SBA

loans, and $2.3 million increase in fees in lieu of interest.

In the judgment of the Corporation’s management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation’s operating expenses in relation to its core operating revenue by removing the volatility associated with certain one-time items and other discrete items.

The efficiency ratio was 64.17% and 63.18% for the three and six months ended June 30, 2021, compared to 61.22% and 64.36% for the three and six months ended June 30, 2020.

Operating expense growth exceeded operating revenue growth for the three months ended June 30, 2021 compared to the same period in 2020 primarily due to a $2.5 million, or 22.8%, increase in compensation principally driven by increased headcount and incentive compensation as compared to the same periods in 2020, reflecting in part the Corporation’s continued execution of its growth strategy and vastly improved performance for the six months ended June 30, 2021 compared to the same period in 2020.

Operating revenue growth outpaced the change in operating expense for the six months ended June 30, 2021 compared to the same period in 2020, resulting in positive operating leverage for the first half of the year.

This improvement was attributable to an increase in net interest income driven by a 12.1% increase in average loans and leases receivable, a $1.3 million increase in fees in lieu of interest.

In addition, non-interest income increased $783,000, or 6.1%, as the increase in gains on the sale of SBA loans and private wealth fee income offset the decline in commercial loan swap fees.

The increase in fees in lieu of interest included $2.5 million in PPP processing fees.

The increase in operating revenue was partially offset by a $1.6 million, or 14.5%, increase in compensation expense reflecting in part the Corporation’s continued execution of its growth strategy.

Full-time equivalent employees (“FTE”) were 306 as of March 31, 2021, increasing by 25, or 8.9%, from 281 as of March 31, 2020.

We believe we will continue to generate modest positive operating leverage and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth.

These initiatives include efforts to expand our specialty finance lines of business, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets.

The increase in operating revenue was partially offset by a $4.1 million, or 18.6%, increase in compensation expense .

We believe we will continue to generate modest positive operating leverage annually and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth.

These initiatives include efforts to expand our specialized lending commercial banking business lines, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets.

We believe the efficiency ratio and pre-tax, pre-provision adjusted earnings allow investors and analysts to better assess the Corporation’s operating expenses in relation to its top line revenue by removing the volatility that is associated with certain non-recurring and other discrete items.

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Please refer to the Non-Interest Income and Non-Interest Expense sections below for discussion on additional drivers of the year-over-year change in the efficiency ratio.

For the Three Months Ended March 31,

2021 2020 $ Change % Change

For the Three Months Ended June 30, For the Six Months Ended June 30,

2021 2020 $ Change % Change 2021 2020 $ Change % Change

(Dollars in Thousands)

Total non-interest expense $ 18,184 $ 18,343 $ (159) (0.9) % $ 35,514 $ 34,488 $ 1,026 3.0 %

Net loss on foreclosed properties 3 102 (99) (97.1)

Net loss on foreclosed properties (1) 348 (349) NM 1 450 (449) (99.8)

Amortization of other intangible assets

8 9 (1) (11.1) 15 18 (3) (16.7)

SBA recourse (benefit) provision (130) 25 (155) N/A

Tax credit investment impairment — 113 (113) N/A

SBA recourse (benefit) provision 245 (30) 275 NM 115 (5) 120 NM

Tax credit investment impairment — 1,841 (1,841) NM — 1,954 (1,954) NM

Loss on early extinguishment of debt

— 744 (744) NM — 744 (744) NM

Total operating expense $ 17,932 $ 15,431 $ 2,501 16.2 $ 35,383 $ 31,327 $ 4,056 12.9

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Net loss on sale of securities

29 — 29 NM 29 (4) 33 NM

Adjusted non-interest income 6,292 6,319 (27) (0.4) $ 13,487 $ 12,737 $ 750 5.9

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Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes.

The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three months ended March 31, 2021 compared to the same period in 2020.

The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three and six months ended June 30, 2021 compared to the same period in 2020.

The change in net interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) has been allocated to the rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Increase (Decrease) for the Three Months Ended March 31,

2021 Compared to 2020

Rate Volume Net

Increase (Decrease) for the Three Months Ended June 30, Increase (Decrease) for the Six Months Ended June 30,

2021 Compared to 2020 2021 Compared to 2020

Rate Volume Net Rate Volume Net

(In Thousands)

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Direct financing leases (1)

(81) (92) (173) 94 (131) (37)

Consumer and other loans (1)

(26) 77 51 (78) 166 88

Total loans and leases receivable (384) 2,427 2,043 (4,754) 7,743 2,989

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FHLB advances 57 (56) 1 (448) 139 (309)

Federal reserve PPP lending facility — (18) (18) — (18) (18)

Other borrowings (36) 108 72 (49) 153 104

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(1) The average balances of loans and leases include non-accrual loans and leases and loans held for sale.

The table below shows our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three months ended March 31, 2021 and 2020.

The tables below shows our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three and six months ended June 30, 2021 and 2020.

The average balances are derived from average daily balances.

For the Three Months Ended March 31,

For the Three Months Ended June 30,

Balance Interest Average

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FHLB advances 405,855 1,284 1.27 409,281 1,283 1.25

Federal reserve PPPLF — — — 20,821 18 0.35

Other borrowings 32,447 443 5.46 24,681 371 6.01

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(4) Represents annualized yields/rates.

Comparison of Net Interest Income for the Three Months Ended March 31, 2021 and 2020

Net interest income increased $3.8 million, or 22.4%, during the three months ended March 31, 2021 compared to the three months ended March 31, 2020.

The increase in net interest income reflected an increase in average gross loans and leases, an increase in fees in lieu of interest, and a decrease in interest expense, partially offset by adjusted net interest margin compression.

Fees in lieu of interest, which can vary from quarter to quarter, totaled $3.1 million for the three months ended March 31, 2021, compared to $798,000 for the same period in 2020.

Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $923,000, or 5.7%.

Average gross loans and leases for the three months ended March 31, 2021 increased $449.2 million, or 25.9%, compared to the three months ended March 31, 2020.

Excluding net PPP loans, average gross loans and leases for the three months ended March 31, 2021 increased $207.0 million, or 11.9%, compared to the three months ended March 31, 2020.

The yield on average loans and leases for the three months ended March 31, 2021 declined to 4.18%, compared to 5.04% for the three months ended March 31, 2020.

Excluding the impact of fees in lieu of interest and PPP loan interest income, the yield on average loans and leases excluding net PPP loans for the three months ended March 31, 2021 was 3.94%, compared to 4.86% for the three months ended, March 31, 2020.

Similarly, the yield on average interest-earning assets for the three months ended March 31, 2021 measured 3.93% compared to 4.72% three months ended March 31, 2020.

Excluding fees in lieu of interest and PPP loan interest income, the yield on average interest-earning assets excluding net PPP loans for the three months ended March 31, 2021 was 3.69%, compared to 4.56% for the three months ended March 31, 2020.

The decline in yields for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 was primarily due to the decrease in LIBOR and Prime rates and related impact on variable-rate loans, in addition to the renewal of fixed-rate loans and reinvestment of security cash flows at historically low interest rates.

The average rate paid on total interest-bearing liabilities for the three months ended March 31, 2021 decreased to 0.65% compared to 1.61% for the three months ended March 31, 2020.

For the Six Months Ended June 30,

Balance Interest Average

Yield/Rate (4)

Balance Interest Average

Yield/Rate (4)

(Dollars in Thousands)

Interest-earning assets

Commercial real estate and other mortgage loans (1)

$ 1,371,744 $ 25,615 3.73 % $ 1,173,251 $ 25,973 4.43 %

Commercial and industrial loans (1)

765,117 19,500 5.10 621,399 16,204 5.22

Direct financing leases (1)

21,071 466 4.42 27,538 503 3.65

Consumer and other loans (1)

45,335 805 3.55 36,244 717 3.96

Total loans and leases receivable (1)

2,203,267 46,386 4.21 1,858,432 43,397 4.67

Mortgage-related securities (2)

156,249 1,297 1.66 177,352 1,973 2.22

Other investment securities (3)

41,871 372 1.78 26,737 285 2.13

FHLB and FRB stock 13,323 329 4.94 9,407 331 7.04

Short-term investments 39,922 22 0.11 48,396 146 0.60

Total interest-earning assets 2,454,632 48,406 3.94 2,120,324 46,132 4.35

Non-interest-earning assets 144,741 144,991

Total assets $ 2,599,373 $ 2,265,315

Interest-bearing liabilities

Transaction accounts $ 510,024 498 0.20 $ 320,188 938 0.59

Money market accounts 660,319 557 0.17 653,598 2,237 0.68

Certificates of deposit 51,677 288 1.11 128,791 1,377 2.14

Wholesale deposits 164,654 619 0.75 119,032 1,488 2.50

Total interest-bearing deposits 1,386,674 1,962 0.28 1,221,609 6,040 0.99

FHLB advances 386,371 2,533 1.31 367,604 2,842 1.55

Federal reserve PPPLF — — — 10,410 18 0.35

Other borrowings 29,886 844 5.65 24,533 740 6.03

Junior subordinated notes 10,064 552 10.97 10,050 555 11.04

Total interest-bearing liabilities 1,812,995 5,891 0.65 1,634,206 10,195 1.25

Non-interest-bearing demand deposit accounts

506,767 365,771

Other non-interest-bearing liabilities 65,146 74,436

Total liabilities 2,384,908 2,074,413

Stockholders’ equity 214,465 190,902

Total liabilities and stockholders’ equity

$ 2,599,373 $ 2,265,315

Net interest income $ 42,515 $ 35,937

Interest rate spread 3.29 % 3.10 %

Net interest-earning assets $ 641,637 $ 486,118

Net interest margin 3.46 % 3.39 %

Average interest-earning assets to average interest-bearing liabilities

135.39 % 129.75 %

Return on average assets (4)

Return on average equity (4)

Average equity to average assets 8.25 8.43

Non-interest expense to average assets (4)

(1) The average balances of loans and leases include non-accrual loans and leases and loans held for sale.

Interest income related to non-accrual loans and leases is recognized when collected.

Interest income includes net loan fees in lieu of interest.

(2) Includes amortized cost basis of assets available-for-sale and held-to-maturity.

(3) Yields on tax-exempt municipal securities are not presented on a tax-equivalent basis in this table.

(4) Represents annualized yields/rates.

Comparison of Net Interest Income for the Three and Six Months Ended June 30, 2021 and 2020

Net interest income increased $2.8 million, or 14.6%, during the three months ended June 30, 2021 compared to the three months ended June 30, 2020.

Fees in lieu of interest, which can vary from quarter to quarter, totaled $3.5 million for the three months ended June 30, 2021, compared to $2.3 million for the same period in 2020.

Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $1.5 million, or 9.7%.

Average gross loans and leases for the three months ended June 30, 2021 increased $240.2 million, or 12.1%, compared to the three months ended June 30, 2020.

Excluding net PPP loans, average gross loans and leases for the three months ended June 30, 2021 increased $263.9 million, or 15.3%, compared to the three months ended June 30, 2020.

Net interest income increased $6.6 million, or 18.3%, during the six months ended June 30, 2021 compared to the six months ended June 30, 2020.

The reasons for the increase in net income for the six months ended June 30, 2021 are consistent with the explanations discussed above with respect to the three months ended June 30, 2021.

Fees in lieu of interest totaled $6.6 million for the six months ended June 30, 2021, compared to $3.1 million for the same period in 2020.

Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $2.5 million, or 7.7%.

Average gross loans and leases for the six months ended June 30, 2021 increased $344.8 million, or 18.6%, compared to the six months ended June 30, 2020.

Excluding net PPP loans, average gross loans and leases for the six months ended June 30, 2021 increased $235.6 million, or 13.6%, compared to the six months ended June 30, 2020.

The yield on average loans and leases for the three and six months ended June 30, 2021 declined to 4.24% and 4.21%, respectively, compared to 4.35% and 4.67% for the three and six months ended June 30, 2020, respectively.

Excluding the impact of fees in lieu of interest and PPP loan interest income, the yield on average loans and leases excluding net PPP loans for the three and six months ended June 30, 2021 was 3.91% and 3.92%, respectively, compared to 4.31% and 4.58% for the three and six months ended June 30, 2020, respectively.

Similarly, the yield on average interest-earning assets for the three and six months ended June 30, 2021 measured 3.96% and 3.94%, respectively, compared to 4.03% and 4.35% three and six months ended June 30, 2020, respectively.

Excluding fees in lieu of interest and PPP loan interest income, the yield on average interest-earning assets excluding net PPP loans for the three and six months ended June 30, 2021 was 3.64% and 3.66%, respectively, compared to 3.96% and 4.26% for the three and six months ended June 30, 2020, respectively.

The decline in yields for both periods of comparison was primarily due to the decrease in LIBOR and Prime rates and related impact on variable-rate loans, in addition to the renewal of fixed-rate loans and reinvestment of security cash flows at historically low interest rates.

The average rate paid on total interest-bearing liabilities for the both three and six months ended June 30, 2021 decreased to 0.65% compared to 0.91% and 1.25% for the three and six months ended June 30, 2020, respectively.

Total interest-bearing liabilities include interest-bearing deposits, federal funds purchased, FHLB advances, subordinated and junior subordinated notes payable, and other borrowings.

The average rate paid declined as the Corporation decreased deposit rates in response to the Federal Open Market Committee’s (“FOMC”) decision to lower the target federal funds rate 150 basis points from January 2020 to March 2020.

For the three months ended March 31, 2021 compared to the three months ended March 31, 2020, the average target federal funds rate decreased 115 basis points.

For the six months ended June 30, 2021 compared to the six months ended June 30, 2020, the average target federal funds rate decreased 58 basis points.

Consistent with the Corporation’s longstanding funding strategy to manage interest rate risk and use the most efficient and cost effective source of wholesale funds, a combination of fixed rate wholesale deposits and fixed rate FHLB advances are used at various maturity terms to meet the Corporation’s funding needs.

Average FHLB advances for the three months ended March 31, 2021 increased $40.7 million to $366.7 million at an average rate paid of 1.36%, compared to $325.9 million at an average rate paid of 1.91% for the three months ended March 31, 2020.

As of March 31, 2021, the weighted average original maturity of our FHLB term advances was 5.7 years, compared to 5.9 years as of March 31, 2020.

Average wholesale deposits, consisting of brokered certificates of deposit, deposits gathered from internet listing services, and non-reciprocal interest bearing transaction accounts, for the three months ended March 31, 2021 increased $34.3 million to $166.8 million at an average rate paid of 0.76%, compared to $132.5 million at an average rate paid of 2.57%.

The increase in wholesale deposits was primarily due to receiving non-reciprocal interest bearing transaction accounts, which was partially offset by a decrease in brokered certificates of deposits.

As of March 31, 2021, the weighted average original maturity of our termed wholesale deposits was 3.9 years, compared to 4.8 years as of March 31, 2020.

Average FHLB advances for the three months ended June 30, 2021 decreased $3.4 million to $405.9 million at an average rate paid of 1.27%, compared to $409.3 million at an average rate paid of 1.25% for the three months ended June 30, 2020.

Average FHLB advances for the six months ended June 30, 2021 increased $18.8 million to $386.4 million at an average rate paid of 1.31%, compared to $367.6 million at an average rate paid of 1.55% for the six months ended June 30, 2020.

As of June 30, 2021, the weighted average original maturity of our FHLB term advances was 6.1 years, compared to 5.3 years as of June 30, 2020.

Average wholesale deposits, consisting of brokered certificates of deposit, deposits gathered from internet listing services, and non-reciprocal interest bearing transaction accounts, for the three months ended June 30, 2021 increased $57.0 million to $162.6 million at an average rate paid of 0.74%, compared to $105.6 million at an average rate paid of 2.42%.

The increase in wholesale deposits was primarily due to adding non-maturity brokered deposits at a favorable rate compared to alternative funding sources.

Average wholesale deposits for the six months ended June 30, 2021 increased $45.6 million to $164.7 million at an average rate paid of 0.75%, compared to $119.0 million at an average rate paid of 2.50%.

As of June 30, 2021, the weighted average original maturity of our termed wholesale deposits was 3.5 years, compared to 4.6 years as of June 30, 2020.

The rate paid on average wholesale funding is greater than the cost of in-market deposits and changes more gradually because the portfolio includes longer original maturities as the Corporation match-funds its longer-term fixed rate loans to mitigate interest rates risk.

Net interest margin was 3.44% for both the three months ended March 31, 2021 and March 31, 2020.

Excluding fees in lieu of interest, PPP loan interest income, Federal Reserve interest income, and FHLB dividends, net interest margin measured 3.20% for the three months ended March 31, 2021, compared to 3.32% for the three months ended March 31, 2020.

The decrease was primarily due to the decrease in average yield on loans and leases receivable and investment securities, partially offset by a decrease in the average rate paid on in-market deposits and wholesale funding.

Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in existing higher-yielding specialty finance lines of business will allow the Corporation to achieve a net interest margin of at least 3.50%, on average, over the long-term.

Net interest margin was 3.49% and 3.46% for the three and six months ended June 30, 2021, respectively, compared to 3.34% and 3.39% for the three and six months ended June 30, 2020, respectively.

Excluding fees in lieu of interest, PPP loan interest income, Federal Reserve interest income, and FHLB dividends, adjusted net interest margin measured 3.20% for both

the three and six months ended June 30, 2021, compared to 3.32% and 3.32% for the three and six months ended June 30, 2020, respectively.

The decrease in adjusted net interest margin for both periods of comparison was primarily due to the decrease in average yield on loans and leases receivable and investment securities, partially offset by a decrease in the average rate paid on in-market deposits and wholesale funding.

Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in existing higher-yielding specialized lending commercial banking products will allow the Corporation to achieve a net interest margin of at least 3.50%, on average, over the long-term.

However, the collection of loan fees in lieu of interest is an expected source of volatility to quarterly net interest income and net interest margin, particularly given the nature of the Corporation’s asset-based lending business and the Corporation’s participation in the PPP.

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Further, we expect to attract new in-market deposit relationships which we believe will contribute to our ability to maintain an appropriate cost of funds.

In-market deposits, comprised of all transaction accounts, money market accounts, and non-wholesale deposits, increased $54.2 million, or 12.9% annualized, to $1.737 billion at March 31, 2021, compared to $1.683 billion at December 31, 2020.

Average in-market deposits increased $356.0 million, or 26.1%, to $1.722 billion for the three months ended March 31, 2021, compared to $1.366 billion for the three months ended March 31, 2020.

In-market deposits, comprised of all transaction accounts, money market accounts, and non-wholesale deposits, increased $333.2 million, or 39.6% annualized, to $2.016 billion at June 30, 2021, compared to $1.683 billion at December 31, 2020.

The large increase in deposits was partially due to the proceeds of a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in third quarter.

Excluding this temporary deposit, total period-end in-market deposits increased $108.2 million to $1.791 billion, or 12.9% annualized.

Average in-market deposits increased $164.8 million, or 10.5%, to $1.735 billion for the three months ended June 30, 2021, compared to $1.571 billion for the three months ended June 30, 2020.

This significant increase in deposits was due to successful business development efforts combined with excess liquidity resulting from our clients’ participation in the PPP.

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Refer to Allowance for Loan and Lease Losses , below, for further information regarding our allowance for loan and lease loss methodology.

The full impact of COVID-19 is still unknown.

It has caused substantial disruption in international and U.S.

economies, markets, and employment.

The outbreak has had a significant adverse impact on certain industries the Corporation serves, including retail, hospitality, entertainment, and restaurants and food services.

Due to COVID-19 and the economic impact it could have on the Corporation’s loan portfolio, additional detail about certain exposure to stressed industries is included in the section titled COVID-19 Update , above.

The Corporation recognized a $2.1 million provision benefit for the three months ended March 31, 2021, compared to provision expense of $3.2 million for the three months ended March 31, 2020.

The quarterly provision benefit was primarily due to a $2.5 million net recovery and $984,000 reduction in the general reserve related to a decrease in historical loss factors.

This reserve release was partially offset by a $1.4 million increase in the commercial real estate general reserve associated with an increase in qualitative factors due to the recent rate of growth in the segment.

The following table shows the components of the provision for loan and lease losses for the three months ended March 31, 2021 compared to the three months ended March 31, 2020.

For the Three Months Ended March 31,

The long-term impact of COVID-19 on the economy is unknown, however, economic conditions have improved steadily in 2021 following the vaccine rollout and the termination of various pandemic safety protocols by states and businesses.

While the outbreak did have a temporary adverse impact on certain industries the Corporation serves, including retail, hospitality, entertainment, and restaurants and food services, management believes the long-term impact it may have on the Corporation’s loan portfolio will be limited.

Additional detail about certain exposure to stressed industries is included in the section titled COVID-19 Update , above.

The Corporation recognized a $1.0 million and $3.0 million provision benefit for the three and six months ended June 30, 2021, respectively, compared to provision expense of $5.5 million and $8.7 million for the three and six months ended June 30, 2020, respectively.

The provision benefit for the three months ended June 30, 2021 was primarily due to a $1.7 million reduction in the general reserve from improving historical loss rates and a $1.5 million decrease in specific reserves.

These decreases were partially offset by $2.3 million in net charge-offs and a $498,000 increase in the general reserve due to loan growth.

Net charge-offs for the quarter principally consisted of a $2.2 million charge-off of one previously identified and partially reserved for legacy SBA loan.

The provision benefit for the six months ended June 30, 2021 was primarily due to a $2.7 million reduction in the general reserve from improving historical loss rates and a $1.7 million decrease in specific reserves.

These decreases were partially offset by a $1.1 million increase in the general reserve due to loan growth.

The following table shows the components of the provision for loan and lease losses for the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020.

For the Three Months Ended June 30, For the Six Months Ended June 30,

2021 2020 2021 2020

(In Thousands)

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Additional information on our legacy SBA portfolio is as follows:

2021 December 31,

2021 March 31,

2021 June 30,

(In Thousands)

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Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its potential 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.

Comparison of Non-Interest Income for the Three Months Ended March 31, 2021 and 2020

Comparison of Non-Interest Income for the Three and Six Months Ended June 30, 2021 and 2020

Non-Interest Income

For the three months ended March 31, 2021 non-interest income increased by $781,000, or 12.2%, to $7.2 million from $6.4 million for the same period in 2020.

Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream through greater contribution from fee-based revenues.

Total non-interest income accounted for 25.6% of total revenues for the three months ended March 31, 2021, compared to 27.3% for the three months ended March 31, 2020, exceeding our long-term goal of 25% in both periods of comparison.

Management believes the expected gradual expansion of its SBA lending program, fees from commercial loan interest rate swap activity with commercial borrowers, and the geographic expansion of its private wealth management division in our bank markets outside of Greater Dane County will allow the Corporation to sustain a strategic target of 25% over the long-term.

The increase in total non-interest income for the three months ended March 31, 2021 primarily reflected a significant increase in gains on the sale of SBA loans, increase in returns on mezzanine fund investments, and strong private wealth management services fee income, partially offset by a decrease in swap fees.

Non-interest income was $6.3 million for both the three months ended June 30, 2021 and June 30, 2020.

Non-interest income increased $783,000, or 6.1%, to $13.5 million for the six months ended June 30, 2021 compared to $12.7 million for the same period in 2020.

Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream.

Total non-interest income accounted for 22.6% and 24.1% of total revenues for the three and six months ended June 30, 2021, compared to 25.1% and 26.2% for the three and six months ended June 30, 2020.

The decline in fee revenue compared to total revenue is primarily due to an increase in net interest income and a reduction in commercial loan swap fees.

Management believes the continued gradual expansion of its SBA lending program and the geographic expansion of its private wealth management division in bank markets outside of South Central Wisconsin will allow the Corporation to sustain a strategic target of 25% over the long-term.

The components of non-interest income were as follows:

For the Three Months Ended March 31,

2021 2020 $ Change % Change

For the Three Months Ended June 30, For the Six Months Ended June 30,

2021 2020 $ Change % Change 2021 2020 $ Change % Change

(Dollars in Thousands)

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$ 2,744 $ 2,124 $ 620 29.2 % $ 5,151 $ 4,235 $ 916 21.6 %

Gain on sale of SBA loans 1,078 265 813 NM

Gain on sale of SBA loans 1,203 574 629 109.6 2,281 839 1,442 171.9

Service charges on deposits 941 829 112 13.5 1,859 1,647 212 12.9

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350 377 (27) (7.2) 699 672 27 4.0

Net loss on sale of securities — (4) 4 NM

Net loss on sale of securities 29 — 29 NM 29 (4) 33 NM

Swap fees — 1,655 (1,655) (100.0) 684 3,336 (2,652) (79.5)

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(1) Fee income ratio is fee income, per the above table, divided by top line revenue (defined as net interest income plus non-interest income).

Private wealth management service fees increased $295,000, or 14.0%, for the three months ended March 31, 2021, compared to the three months ended March 31, 2020.

Private wealth management service fees increased $620,000, or 29.2%, and $916,000, or 21.6%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020.

Private wealth management services fee income is primarily driven by the amount of assets under management and administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets.

This increase was driven by growth in assets under management and administration attributable to both new client relationships and increased equity market values.

As of March 31, 2021, private wealth and trust assets under management and administration totaled a record $2.387 billion, increasing $137.5 million, or 6.1%, compared to $2.249 billion as of December 31, 2020 and $722.1 million, or 43.4%, compared to $1.664 billion as of March 31, 2020.

Commercial loan interest rate swap fee income was $684,000 for the three months ended March 31, 2021, compared to $1.7 million for the three months ended March 31, 2020.

As of June 30, 2021, private wealth and trust assets under management and administration totaled a record $2.564 billion, increasing $315.4 million, or 14.0%, compared to $2.249 billion as of December 31, 2020 and $691.0 million, or 36.9%, compared to $1.873 billion as of June 30, 2020.

No commercial loan interest rate swap fee income was recognized for the three months ended June 30, 2021, compared to $1.7 million for the same period in 2020.

Commercial loan interest rate swap fee income was $684,000 for the six months ended June 30, 2021, compared to $3.3 million for the six months ended June 30, 2020.

We originate commercial real estate loans in which we offer clients a floating rate and an interest rate swap.

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The execution of these transactions generates swap fee income.

The aggregate amortizing notional value of interest rate swaps with various borrowers was $645.1 million as of March 31, 2021, compared to $397.7 million as of March 31, 2020.

Interest rate swaps continue to be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter.

Gains on sale of SBA loans increased $813,000 for the three months ended March 31, 2021, compared to the three months ended March 31, 2020.

Gross SBA loan commitments closed for the three months ended March 31, 2021 totaled $9.7 million, compared to $6.2 million for the same period in 2020.

Based on this recent activity, an enhanced business development team, and a consistent pipeline of new business, management believes the annual gain on sale of SBA loans will continue to increase at a measured pace moving forward.

Other non-interest income for the three months ended March 31, 2021 totaled $1.2 million, compared to $762,000 for three months ended March 31, 2020.

The increase was primarily due to above average returns from the Corporation’s investments in mezzanine funds.

Comparison of Non-Interest Expense for the Three Months Ended March, 2021 and 2020

The aggregate amortizing notional value of interest rate swaps with various borrowers was $637.0 million as of June 30, 2021, compared to $467.1 million as of June 30, 2020.

Interest rate swaps can be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter.

Gains on sale of SBA loans increased $629,000, or 109.6%, and $1.4 million, or 171.9%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020.

Gross SBA loan commitments closed for the three and six months ended June 30, 2021 totaled $9.7 million and $19.4 million, respectively, compared to $18.1 million and $24.2 million for the same period in 2020.

Management believes the gain on sale of traditional SBA loans, while variable based on timing of closings, will continue to increase annually at a measured pace.

Other non-interest income increased $176,000, or 57.0%, and $627,000, or 58.5%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020.

The increase in both periods of comparison was primarily due to an increase in returns from the Corporation’s investments in mezzanine funds and an increase in bank consulting services fee income.

Comparison of Non-Interest Expense for the Three and Six Months Ended June 30, 2021 and 2020

Non-Interest Expense

Non-interest expense for the three months ended March 31, 2021 increased by $1.2 million, or 7.3%, to $17.3 million compared to $16.1 million for the same period in 2020.

Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased $1.6 million, or 9.8%, to $17.4 million for the three months ended March 31, 2021 compared to $15.9 million for the same period in 2020.

The increase in operating expense was primarily due to an increase in compensation, computer software, and FDIC insurance expense, partially offset by a decrease in other non-interest expense.

Non-interest expense for the three months ended June 30, 2021 decreased by $159,000, or 0.9%, to $18.2 million compared to $18.3 million for the same period in 2020.

Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased $2.5 million, or 16.2%, to $17.9 million for the three months ended June 30, 2021 compared to $15.4 million for the same period in 2020.

Non-interest expense for the six months ended June 30, 2021 increased by $1.0 million, or 3.0%, to $35.5 million compared to $34.5 million for the same period in 2020.

Operating expense increased $4.1 million, or 12.9%, to $35.4 million for the six months ended June 30, 2021 compared to $31.3 million for the same period in 2020.

The increase in operating expense in both periods of comparison was primarily due to an increase in compensation, marketing, computer software, and FDIC insurance expense, partially offset by a decrease in other non-interest expense.

The components of non-interest expense were as follows :

For the Three Months Ended March 31,

2021 2020 $ Change % Change

For the Three Months Ended June 30, For the Six Months Ended June 30,

2021 2020 $ Change % Change 2021 2020 $ Change % Change

(Dollars in Thousands)

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Collateral liquidation costs 84 115 (31) (27.0) 178 236 (58) (24.6)

Net loss on foreclosed properties 3 102 (99) (97.1)

Net (gain) loss on foreclosed properties (1) 348 (349) NM 1 450 (449) (99.8)

Impairment on tax credit investments — 1,841 (1,841) NM — 1,954 (1,954) (100.0)

SBA recourse (benefit) provision (130) 25 (155) NM

SBA recourse (benefit) provision 245 (30) 275 NM 115 (5) 120 NM

Loss on early extinguishment of debt

— 744 (744) NM — 744 (744) NM

Other non-interest expense

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Full-time equivalent employees

319 283 319 283

(1) Total operating expense represents total non-interest expense, adjusted to exclude the impact of discrete items as previously defined in the non-GAAP efficiency ratio calculation, above.

Compensation expense for the three months ended March 31, 2021 was $12.7 million, an increase of $1.6 million, or 14.5%, compared to the three months ended March 31, 2020.

The increase reflects new hires, annual merit increases, growth in employee benefit costs, and an increase in individual incentive compensation.

Average full-time equivalent employees increased to 305, up 6.6% for the quarter ended March 31, 2021, compared to 286 for the quarter ended March 31, 2020.

The increase reflects new hires, annual merit increases, and an increase in the annual corporate incentive plan accrual compared to a reduction to the same accrual during the first quarter of 2020 due to uncertainty amid the COVID-19 pandemic.

Compensation expense for the three and six months ended June 30, 2021 was $13.3 million, an increase of $2.5 million, or 22.8%, and $25.9 million, an increase of $4.1 million, or 18.6%, respectively, compared to the three and six months ended June 30, 2020.

The increase in both periods of comparison reflects new hires, annual merit increases, growth in employee benefit costs, and an increase in the expected payout on annual corporate and individual incentive compensation plans.

The annual corporate bonus and individual incentive compensation plans for the three and six months ended June 30, 2021 totaled $2.5 million and $4.1 million, respectively, due to strong Bank performance driven by effective business development efforts and continued improvement in credit, compared to $1.2 million and $2.2 million for three and six months ended June 30, 2020,

respectively.

Average full-time equivalent employees increased to 312, up 11.0% for the quarter ended June 30, 2021, compared to 281 for the quarter ended June 30, 2020.

We expect to continue investing in talent, both in the form of additional business development and operational staff, to support our long-term strategic plan.

Computer software expense increased $226,000 to $1.1 million for the three months ended March 31, 2021 compared to $889,000 for the three months ended March 31, 2020.

The increase was principally due to investments in technology platforms to improve the client experience and continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy.

FDIC insurance expense for the three months ended March 31, 2021 was $362,000, an increase of $154,000 compared to the three months ended March 31, 2020.

Computer software expense increased $163,000, or 16.9%, and $388,000, or 20.9%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020.

The increase was principally due to investments in and maintenance of technology platforms to improve the client experience and continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy.

Marketing expense increased $159,000, or 45.2%, and $89,000, or 10.9%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020.

Management expects marketing expense to continue to increase modestly and return to pre-pandemic levels over the next several quarters primarily driven by sponsorships and business development activities.

FDIC insurance expense increased $41,000, or 17.2%, and $194,000, or 43.3%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020.

Management expects FDIC insurance expense to increase commensurate with asset growth going forward.

No historic tax credits or related impairment were recognized for the three months ended March 31, 2021.

The impairment on tax credit investments for the three months ended March 31, 2020 is related to a new market tax credit which is more than offset by a reduction to income tax expense, which results in a net benefit to earnings.

No historic tax credits or related impairment were recognized for the three and six months ended June 30, 2021.

The impairment on tax credit investments for the three and six months ended June 30, 2020 are related to a new market and historic tax credits.

The impairment on tax credits are more than offset by a reduction to income tax expense resulting in a net benefit to earnings in the year the credits are earned.

Management intends to continue actively pursuing in-market tax credit opportunities throughout 2021 and beyond.

SBA recourse provision was a benefit of $130,000 for the three months ended March 31, 2021, compared to recourse expense of $25,000 for the three months ended March 31, 2020.

The total recourse reserve balance was $593,000, or 0.7% of total sold SBA loans outstanding, at March 31, 2021, compared to $723,000, or 0.9%, at December 31, 2020, and $1.1 million, or 1.6%, at March 31, 2020.

SBA recourse provision expense totaled $245,000 and $115,000 for the three and six months ended June 30, 2021, respectively, compared to recourse benefit of $30,000 and $5,000 for the three and six months ended June 30, 2020, respectively.

The total recourse reserve balance was $830,000, or 0.9% of total sold SBA loans outstanding, at June 30, 2021, compared to $723,000, or 0.9%, at December 31, 2020, and $1.0 million, or 1.4%, at June 30, 2020.

Changes to SBA recourse reserves may be a source of non-interest expense volatility in future quarters, though the magnitude of this volatility should continue to diminish over time as the outstanding balance of sold legacy SBA loans continues to decline.

Other non-interest expense for the three months ended March 31, 2021 was $404,000, a decrease of $412,000 compared to the three months ended March 31, 2020.

The decrease was principally due to a decrease in business-related travel expenses due to the Corporation’s adherence to COVID-19 restrictions and a reduction in the credit valuation adjustment (“CVA”) related to the commercial loan interest rate swap program.

The Corporation incurred a $744,000 loss, recognized through non-interest expense, on the early extinguishment of $59.5 million in FHLB term advances late in the second quarter of 2020, as the Corporation lowered wholesale funding costs and improved the Corporation’s funding position.

Other non-interest expense decreased $369,000, or 67.7%, and $777,000, or 57.2%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020.

The decrease was principally due to a reduction in the credit valuation adjustment (“CVA”) related to the commercial loan interest rate swap program and a reduction in the loan servicing valuation adjustment related to the Bank’s SBA portfolio.

The CVA represents a change in the market value of the Company’s commercial loan interest rate swaps to estimate potential borrower credit risk within the portfolio.

The CVA can vary from period to period based on the size of the portfolio, credit metrics, and the interest rate environment in any given quarter.

There was no CVA as of March 31, 2020.

Income tax expense totaled $3.1 million for the three months ended March 31, 2021 compared to an income tax expense of $858,000 for the three months ended March 31, 2020.

The effective tax rate, excluding tax credits and other discrete items, for the three months ended March 31, 2021 was 23.4% compared to 20.7% for the three months ended March 31, 2020.

There was no CVA as of June 30, 2020.

Income tax expense totaled $5.6 million for the six months ended June 30, 2021 compared to an income tax benefit of $1.1 million for the six months ended June 30, 2020.

The effective tax rate, excluding tax credits and other discrete items, for the six months ended June 30, 2021 was 23.6% compared to 18.6% for the six months ended June 30, 2020.

Financial Condition

Total assets increased by $52.9 million, or 2.1%, to $2.621 billion as of March 31, 2021 compared to $2.568 billion at December 31, 2020.

The increase in total assets was primarily driven by loan growth, partially offset by a decrease in securities.

Total assets increased by $297.8 million, or 11.6%, to $2.866 billion as of June 30, 2021 compared to $2.568 billion at December 31, 2020.

The increase in total assets was primarily driven by short-term investments, partially offset by a decrease in securities and loans and leases receivable.

Short-Term Investments

Short-term investments increased by $11.4 million, or 41.6%, to $38.7 million at March 31, 2021 from $27.4 million at December 31, 2020.

Our short-term investments primarily consist of interest-bearing deposits held at the FRB and commercial paper.

Short-term investments increased by $338.0 million to $365.4 million at June 30, 2021 from $27.4 million at December 31, 2020.

The large increase in short-term investments was primarily due to the proceeds of a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in July, and PPP loan forgiveness proceeds.

Excluding the temporary business sale proceeds, total short-term investments increased $113.1 million to $140.4 million.

Our short-term investments primarily consist of interest-bearing deposits held at the FRB.

We value the safety and soundness provided by the FRB and therefore incorporate short-term investments in our on-balance sheet liquidity program.

As of March 31, 2021 and December 31, 2020, we did not hold any commercial paper.

Due to current economic conditions, we decided to temporarily exit this short-term investment.

We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio.

The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives.

These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to be in a position to benefit from an anticipated change in the yield curve level and shape.

In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio.

Please refer to the section entitled Liquidity and Capital Resources for further discussion.

Total securities, including available-for-sale and held-to-maturity, decreased by $12.3 million, or 5.8%, to $198.0 million at March 31, 2021 compared to $210.3 million at December 31, 2020.

During the three months ended March 31, 2021, due to a steepening yield curve, we recognized unrealized losses of $2.2 million before income taxes through other comprehensive income, compared to gains of $4.5 million for the same period in 2020.

As of March 31, 2021 and December 31, 2020, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 5.1 years and 5.0 years, respectively.

Total securities, including available-for-sale and held-to-maturity, decreased by $16.7 million, or 7.9%, to $193.6 million at June 30, 2021 compared to $210.3 million at December 31, 2020.

During the six months ended June 30, 2021 we recognized unrealized losses of $1.6 million before income taxes through other comprehensive income, compared to gains of $4.2 million for the same period in 2020.

As of June 30, 2021 and December 31, 2020, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 5.6 years and 5.0 years, respectively.

Our investment philosophy remains as stated in our most recent Annual Report on Form 10-K.

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On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, data integrity validation primarily through comparison of current price to an expectation-based analysis of movement in prices based upon the changes in the related yield curves, and other market factors.

No securities within our portfolio were deemed to be other-than-temporarily impaired as of March 31, 2021.

No securities within our portfolio were deemed to be other-than-temporarily impaired as of June 30, 2021.

Loans and Leases Receivable

Loans and leases receivable, net of allowance for loan and lease losses, increased by $88.7 million to $2.206 billion at March 31, 2021 from $2.117 billion at December 31, 2020 which was driven by second draw PPP loans and commercial loan growth, partially offset by PPP loan forgiveness.

Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by $46.4 million, or 9.8% annualized, to $1.939 billion at March 31, 2021 from December 31, 2020.

Loans and leases receivable, net of allowance for loan and lease losses, increased by $437,000 to $2.118 billion at June 30, 2021 from $2.117 billion at December 31, 2020 which was driven by commercial loan growth, partially offset by PPP loan forgiveness.

Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by $105.0 million, or 11.1% annualized, to $1.997 billion at June 30, 2021 from December 31, 2020.

Excluding net PPP loans, C&I loans increased $67.7 million, or 26.7% annualized, to $574.7 million from $507.0 million at December 31, 2020 primarily due to a $59.9 million increase in loans from our specialized lending business lines.

The majority of our specialized lending commercial banking business lines are early stage and faster growing while the more mature business lines, like asset-based lending, have historically experienced counter cyclical growth, growing during and following times of economic stress.

Management expects specialized lending volume to continue to increase in 2021 and 2022 following the proactive investments made prior to and during the COVID-19 pandemic.

Including net PPP loans, our C&I portfolio decreased $36.9 million to $695.4 million from $732.3 million at December 31, 2020.

Total commercial real estate (“CRE”) increased $32.9 million to $1.392 billion, up from $1.359 billion at December 31, 2020.

Non-owner occupied CRE, multi-family, and construction loans were the largest contributors to CRE loan growth as of March 31, 2021, increasing $27.6 million, $10.8 million, and $10.3 million, respectively, from December 31, 2020.

There continues to be a concentration in CRE loans which represented 70.5% and 63.2% of our total loans, excluding net PPP loans, as of March 31, 2021 and December 31, 2020, respectively.

As of March 31, 2021, 18.4% of the CRE loans were owner-occupied CRE, compared to 18.7% as of December 31, 2020.

Non-owner occupied CRE and multi-family loans were the largest contributors to CRE loan growth as of June 30, 2021, increasing $49.8 million, and $7.8 million, respectively, from December 31, 2020.

There continues to be a concentration in CRE loans which represented 68.7% and 70.6% of our total loans, excluding net PPP loans, as of June 30, 2021 and December 31, 2020, respectively.

As of June 30, 2021, 18.2% of the CRE loans were owner-occupied CRE, compared to 18.7% as of December 31, 2020.

We consider owner-occupied CRE more characteristic of the Corporation’s C&I portfolio as, in general, the client’s primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property.

Management has elevated its underwriting standards during the COVID-19 pandemic to ensure business owners and guarantors have robust liquidity, operating performance, and collateral positions.

Management has elevated its underwriting standards during the

COVID-19 pandemic to ensure business owners and guarantors have robust liquidity, operating performance, and collateral positions.

Even with these higher standards, the Corporation has been able to grow loans and deepen banking relationships.

Our C&I portfolio increased $52.0 million, or 28.4% annualized, to $784.3 million from $732.3 million at December 31, 2020.

Excluding net PPP loans, C&I loans increased $9.7 million, or 7.7% annualized, to $516.7 million from $507.0 million at December 31, 2020 primarily due to a $15.6 million increase in asset-based loans.

Some of our specialty finance products have historically experienced counter cyclical growth, growing during times of economic stress and uncertainty.

As such, management expects asset-based loans and accounts receivable financing volume to increase in 2021.

We will continue to actively pursue C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management, and private wealth management relationships which generate additional fee revenue.

Underwriting of new credit is primarily through approval from a serial sign-off or committee process and is a key component of our operating philosophy.

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The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K.

As of March 31, 2021, deposits increased by $47.2 million, or 10.2% annualized, to $1.903 billion from $1.856 billion at December 31, 2020 primarily due to a $81.5 million increase in transaction accounts, partially offset by a decrease in certificate of deposits and money market accounts of $17.9 million and $9.4 million, respectively.

Transaction account balances increased primarily due to the influx of PPP loan proceeds.

Management attributes the transition from money market accounts to reciprocal transaction accounts with full FDIC insurance to our clients’ preferences for safety and soundness amid the economic uncertainty created by the COVID-19 pandemic.

As of June 30, 2021, deposits increased by $305.2 million, or 32.9% annualized, to $2.161 billion from $1.856 billion at December 31, 2020 primarily due to a $309.1 million and $43.6 million increase in transaction accounts and money market accounts, respectively, partially offset by a decrease in wholesale deposits and certificates of deposit of $28.0 million and $19.6 million, respectively.

The large increase in deposits was primarily due to the proceeds of a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in July, and PPP forgiveness proceeds.

Excluding the temporary deposits described above, total deposits increased $80.2 million to $1.936 billion, or 8.6% annualized.

Excluding the temporary deposits, transaction and money market accounts increased $84.2 million.

Period-end deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to maintain existing and new client relationships.

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We measure the success of in-market deposit gathering efforts based on the number and average balances of our deposit accounts as compared to ending balances due to the volatility of some of our larger relationships.

The Bank’s average in-market deposits, consisting of all transaction accounts, money market accounts, and certificates of deposit, were approximately $1.722 billion for the three months ended March 31, 2021, compared to $1.569 billion for the year ended December 31, 2020.

The Bank’s average in-market deposits, consisting of all transaction accounts, money market accounts, and certificates of deposit, were approximately $1.729 billion for the six months ended June 30, 2021, compared to $1.569 billion for the year ended December 31, 2020.

FHLB Advances and Other Borrowings

As of March 31, 2021, FHLB advances and other borrowings increased by $29.3 million, or 7.0%, to $448.4 million from $419.2 million at December 31, 2020.

As of June 30, 2021, FHLB advances and other borrowings increased by $946,000, or 0.5% annualized, to $420.1 million from $419.2 million at December 31, 2020.

While total wholesale funding as a percentage of total bank funding has decreased meaningfully overall due to significant in-market deposit growth, we continue to replace the majority of our maturing brokered certificates of deposit with FHLB advances at lower rates, as needed, to match-fund fixed rate loans and mitigate interest rate risk.

Total bank funding is defined as total deposits plus FHLB advances, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances.

As of March 31, 2021 and December 31, 2020, the Corporation had other borrowings of $8.9 million and $920,000 respectively, which consisted of sold loans which were accounted for as a secured borrowing, because they did not qualify for true sale accounting and borrowings associated with our investment in a community development entity.

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.

Total bank funding is defined as total deposits plus FHLB advances, and Federal Reserve Discount Window advances.

As of June 30, 2021 and December 31, 2020, the Corporation had other borrowings of $8.5 million and $920,000 respectively, which consisted of sold loans which were accounted for as a secured borrowing, because they did not qualify for true sale accounting and borrowings associated with our investment in a community development entity.

During the second quarter of 2020, the Corporation tested its ability to borrow from the Federal Reserve 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 was 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.

As of November 2, 2020, the borrowing was paid in full.

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The execution of these transactions generates swap fee income.

The aggregate amortizing notional value of interest rate swaps with various borrowers increased $247.4 million, or 62.2%, to $645.1 million as of March 31, 2021, compared to $397.7 million as of March 31, 2020.

The fair value of these interest rate swaps decreased $23.3 million, or 47.1%, to $26.1 million as of March 31, 2021, compared to $49.4 million as of March 31, 2020.

The significant decline in fair value of the derivative contracts is directly related to the level of interest rates as of March 31, 2021, compared to the maturity term and amortization rates when the derivative contracts were originally executed.

The aggregate amortizing notional value of interest rate swaps with various borrowers increased $7.9 million, or 1.3%, to $637.0 million as of June 30, 2021, compared to $629.1 million as of December 31, 2020.

The fair value of these interest rate swaps decreased $17.0 million, or 34.4%, to $32.4 million as of June 30, 2021, compared to $49.4 million as of December 31, 2020.

The decline in fair value of the derivative contracts is directly related to the level of interest rates as of June 30, 2021, compared to the maturity term and amortization rates when the derivative contracts were originally executed.

For further information and discussion of our derivatives, see Note 13 — Derivative Financial Instruments of the Consolidated Financial Statements.

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Impaired Assets

Total impaired assets consisted of the following at March 31, 2021 and December 31, 2020, respectively:

Total impaired assets consisted of the following at June 30, 2021 and December 31, 2020, respectively:

2021 December 31,

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Allowance for loan and lease losses to non-accrual loans and leases 224.79 107.15

Net PPP loans outstanding as of March 31, 2021 and December 31, 2020, were $267.6 million and $225.3 million, respectively.

Net PPP loans outstanding as of June 30, 2021 and December 31, 2020, were $120.7 million and $225.3 million, respectively.

The following asset quality ratios exclude net PPP loans as they are fully guaranteed by the SBA:

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Allowance for loan and lease losses to gross loans and leases 1.27 1.48

Non-accrual loans decreased $7.6 million, or 28.6%, to $19.0 million at March 31, 2021, compared to $26.6 million at December 31, 2020.

The decrease in non-accrual loans was principally due to loan payoffs and loans returning to accrual status.

The Corporation’s non-accrual loans as a percentage of total gross loans and leases measured 0.85% and 1.24% at March 31, 2021 and December 31, 2020, respectively.

Non-accrual loans as a percentage of total gross loans and leases, excluding net PPP loans, was 0.96% and 1.38% at March 31, 2021 and December 31, 2020, respectively.

As of March 31, 2021 and December 31,

2020, $4.8 million and $6.5 million of non-accrual loans and leases were considered troubled debt restructurings, respectively.

Non-accrual loans decreased $15.2 million, or 57.1%, to $11.4 million at June 30, 2021, compared to $26.6 million at December 31, 2020.

The decrease in non-accrual loans was principally due to loan payoffs, loans returning to accrual status, and $3.0 million of charge-offs, of which $2.2 million was from the legacy SBA portfolio and $471,000 from the small ticket vendor finance program.

All charge-offs for the six months ended June 30, 2021 were previously identified impaired loans, unrelated to the economic slowdown from the COVID-19 pandemic.

Management does not view these charge-offs as being indicative of any systemic issues across the Corporation’s loan and lease portfolio.

The Corporation’s non-accrual loans as a percentage of total gross loans and leases measured 0.53% and 1.24% at June 30, 2021 and December 31, 2020, respectively.

Non-accrual loans as a percentage of total gross loans and leases, excluding net PPP loans, was 0.56% and 1.38% at June 30, 2021 and December 31, 2020, respectively.

As of June 30, 2021 and December 31, 2020, $523,000 and $6.5 million of non-accrual loans and leases were considered troubled debt restructurings, respectively.

Please refer to the section titled COVID-19 Update for additional information on credit quality.

We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio.

Non-performing assets as a percentage of total assets decreased to 0.73% at March 31, 2021 from 1.04% at December 31, 2020.

As of March 31, 2021, the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.4% of the total portfolio was in a current payment status, compared to 99.0% as of December 31, 2020.

Non-performing assets as a percentage of total assets decreased to 0.40% at June 30, 2021 from 1.04% at December 31, 2020.

As of June 30, 2021, the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.9% of the total portfolio was in a current payment status, compared to 99.0% as of December 31, 2020.

We also monitor asset quality through our established categories as defined in Note 6 – Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses of the Consolidated Financial Statements.

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We are proactively working with our impaired loan borrowers to find meaningful solutions to difficult situations that are in the best interests of the Bank.

As of March 31, 2021, as well as in all previous reporting periods, there were no loans over 90 days past due and still accruing interest.

As of June 30, 2021, as well as in all previous reporting periods, there were no loans over 90 days past due and still accruing interest.

Loans and leases greater than 90 days past due are considered impaired and are placed on non-accrual status.

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The following represents additional information regarding our impaired loans and leases:

As of and for the Three Months Ended March 31, As of and for the

As of and for the Six Months Ended June 30, As of and for the

Year Ended December 31,

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A summary of foreclosed properties activity is as follows:

As of and for the Three Months Ended March 31, As of and for the

As of and for the Six Months Ended June 30, As of and for the

Year Ended December 31,

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Proceeds from sale of foreclosed properties — (1,160) (2,582)

Net gain (loss) on sale of foreclosed properties — 16 (20)

Net loss on sale of foreclosed properties — (54) (20)

Impairment adjustments (4) (396) (363)

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Allowance for Loan and Lease Losses

The allowance for loan and lease losses increased $461,000, or 1.6%, from $28.5 million as of December 31, 2020 to $29.0 million as of March 31, 2021.

The allowance for loan and lease losses as a percentage of gross loans and leases decreased from 1.33% as of December 31, 2020 to 1.29% as of March 31, 2021.

The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.47% as of March 31, 2021 compared to 1.48% as of December 31, 2020.

The decreased in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by a significant loan recovery and the related impact it had on our historical loss factors.

This general reserve release was offset by an increase in the commercial real estate general reserve associated with an increase in qualitative factors due to the recent rate of growth in the segment and an increase in general reserve commensurate with loan growth.

The allowance for loan and lease losses decreased $2.8 million, or 10.0%, from $28.5 million as of December 31, 2020 to $25.7 million as of June 30, 2021.

The allowance for loan and lease losses as a percentage of gross loans and leases decreased from 1.33% as of December 31, 2020 to 1.20% as of June 30, 2021.

The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.27% as of June 30, 2021 compared to 1.47% as of December 31, 2020.

The decrease in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by a significant commercial real estate loan recovery during the first quarter of 2021, and the related impact it had on our commercial real estate historical loss factors, and the release of specific reserves following loan payoffs and charge-offs.

These general and specific reserve releases were partially offset primarily by an increase in general reserve commensurate with loan growth.

There have been no substantive changes to our methodology for estimating the appropriate level of allowance for loan and lease loss reserves from what was previously outlined in our most recent Annual Report on Form 10-K.

Please refer to the section titled COVID-19 Update for additional information.

During the three months ended March 31, 2021, we recorded net recoveries on impaired loans and leases of $2.5 million, comprised of $144,000 of charge-offs and $2.7 million of recoveries.

We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed, in particular as it relates to our commercial clients impacted by the COVID-19 pandemic.

Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios.

As of March 31, 2021 and December 31, 2020, our allowance for loan and lease losses to total non-accrual loans and leases was 152.60% and 107.15%, respectively.

This ratio increased as our remaining non-accrual loan and lease portfolio has a larger proportion of SBA loans when compared to December 31, 2020, which historically carry larger collateral shortfalls when compared to our conventional commercial loans.

During the six months ended June 30, 2021, we recorded net recoveries on impaired loans and leases of $180,000, comprised of $3.0 million of charge-offs and $3.2 million of recoveries.

While we likely will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed, management believes charge-offs in the foreseeable future will be at lower levels based on our total non-accrual loans and leases as a percentage of gross loans and leases of 0.53% at June 30, 2021, is the Corporation’s lowest level of non-accrual loans since the fourth quarter of 2006.

Loans and leases with previously established specific reserves, however, may ultimately result in a charge-off under a variety of scenarios.

As of June 30, 2021 and December 31, 2020, our ratio of allowance for loan and lease losses to total non-accrual loans and leases was 224.79% and 107.15%, respectively.

This ratio continues to increase due to the significant decline in non-accrual loans and as our remaining non-accrual loan and lease portfolio has a larger proportion of SBA loans when compared to December 31, 2020, which historically carry larger collateral shortfalls when compared to our conventional commercial loans.

Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease.

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Conversely, if we identify further impaired loans, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve.

Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as of March 31, 2021.

To determine the level and composition of the allowance for loan and lease losses, we break out the portfolio by segments with similar risk characteristics.

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The methodology also focuses on evaluation of several qualitative factors for each portfolio category, including but not limited to:

management’s ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, existing economic conditions, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations of loans to specific industries, and other qualitative factors that could affect credit losses.

As of June 30, 2021, the allowance for loan and lease losses included $726,000 in general reserve related to economic uncertainty, compared to $947,000 as of December 31, 2020.

Management removed qualitative factors due to COVID-19 uncertainty from the majority of our specialized lending and commercial and industrial portfolios reflecting continued strong performance while maintaining a general reserve on industries previously identified as stressed, specifically hospitality and retail.

When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for loan and lease loss reserve to bring the loan or lease to its net realizable value.

Many of the impaired loans as of March 31, 2021 are collateral dependent.

Many of the impaired loans as of June 30, 2021 are collateral dependent.

It is typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment at least annually, or more frequently as circumstances warrant.

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Foreclosure actions may have been initiated on certain of these commercial real estate and other mortgage loans.

As a result of our review process, we have concluded an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was $29.0 million, or 1.29% of gross loans and leases, at March 31, 2021.

As a result of our review process, we have concluded an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was $25.7 million, or 1.20% of gross loans and leases, at June 30, 2021.

However, given ongoing complexities with current workout situations and the uncertainty surrounding future economic conditions, further charge-offs, and increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion.

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A summary of the activity in the allowance for loan and lease losses follows:

As of and for the Three Months Ended March 31,

As of and for the Three Months Ended June 30, As of and for the Six Months Ended June 30,

2021 2020 2021 2020

(Dollars in Thousands)

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Home equity and second mortgages — — — —

Other (24) (6) (24) (12)

Total charge-offs (2,894) (817) (3,038) (948)

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Home equity and second mortgages — — 1 —

Other 1 — 1 —

Total recoveries 545 64 3,218 241

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Allowance at end of period $ 25,675 $ 27,464 $ 25,675 $ 27,464

Annualized net recoveries as a percent of average gross loans and leases (0.46) % (0.01) %

Annualized net recoveries as a percent of average gross loans and leases, excluding average net PPP loans (0.52) % (0.01) %

Annualized net charge-offs (recoveries) as a percent of average gross loans and leases 0.42 % 0.15 % (0.02) % 0.08 %

Annualized net charge-offs (recoveries) as a percent of average gross loans and leases, excluding average net PPP loans 0.47 % 0.17 % (0.02) % 0.08 %

Liquidity and Capital Resources

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While the Bank is subject to certain generally applicable regulatory limitations regarding its ability to pay dividends to the Corporation, we do not believe that the Corporation will be adversely affected by these dividend limitations.

The Corporation’s principal liquidity requirements at March 31, 2021 were the interest payments due on subordinated and junior subordinated notes.

On January 29, 2021, the Bank’s Board of Directors declared a dividend in the aggregate amount of $2.0 million bringing year-to-date dividend declarations to $2.0 million.

The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect on March 31, 2021, and continue to meet the heightened requirements imposed by Basel III, including the capital conservation buffer that was fully phased-in as of January 1, 2019.

The Corporation’s principal liquidity requirements at June 30, 2021 were the interest payments due on subordinated and junior subordinated notes.

On April 30, 2021, the Bank’s Board of Directors declared a dividend in the aggregate amount of $2.5 million bringing year-to-date dividend declarations to $4.5 million.

The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect on June 30, 2021, and continue to meet the heightened requirements imposed by Basel III, including the capital conservation buffer that was fully phased-in as of January 1, 2019.

The Corporation’s Board and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.

The Bank maintains liquidity by obtaining funds from several sources.

The Bank’s primary source of funds are principal and interest payments on loans receivable and mortgage-related securities, deposits, and other borrowings, such as federal funds, FHLB advances, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances.

The scheduled payments of loans and mortgage-related securities are generally a predictable source of funds.

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We define our on-balance sheet liquidity as the total of our short-term investments, our unencumbered securities available-for-sale, and our unencumbered pledged loans.

As of March 31, 2021 and December 31, 2020, our immediate on-balance sheet liquidity was $724.2 million and $640.2 million, respectively.

The increase as of March 31, 2021 compared to December 31, 2020 is principally due to the Banks ability to pledge PPP loans and borrow from the Federal Reserve PPPLF.

Excluding Federal Reserve PPPLF availability, immediate on-balance sheet liquidity was $456.6 million and $414.9 million as of March 31, 2021 and December 31, 2020, respectively.

This increase in on-balance sheet liquidity compared to December 31, 2020 is primarily due to a decrease in securities pledged.

At March 31, 2021 and December 31, 2020, the Bank had $37.7 million and $44.4 million on deposit with the FRB recorded in short-term investments, respectively.

As of June 30, 2021 and December 31, 2020, our immediate on-balance sheet liquidity was $829.0 million and $640.2 million, respectively.

The increase as of June 30, 2021 compared to December 31, 2020 was principally due to the proceeds from a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in July, and PPP forgiveness proceeds.

Immediate on-balance sheet liquidity as of December 31, 2020 included $225.3 million of availability from the Federal Reserve’s PPPLF advance program.

Excluding the temporary proceeds from the commercial client’s business sale and the PPPLF advance program, immediate on-balance sheet liquidity was $604.0 million and $414.9 million as of June 30, 2021 and December 31, 2020, respectively.

This increase in on-balance sheet liquidity compared to December 31, 2020 is primarily due to excess cash held at the FRB due to PPP loan forgiveness proceeds.

At June 30, 2021 and December 31, 2020, the Bank had $364.5 million and $26.7 million on deposit with the FRB recorded in short-term investments, respectively.

Any excess funds not used for loan funding or satisfying other cash obligations were maintained as part of our on-balance sheet liquidity in our interest-bearing accounts with the FRB, as we value the safety and soundness provided by the FRB.

We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow run off of maturing wholesale certificates of deposit or invest in securities to maintain adequate liquidity at an improved margin.

We had $581.3 million of outstanding wholesale funds at March 31, 2021, compared to $567.0 million of wholesale funds as of December 31, 2020, which represented 25.1% and 25.2%, respectively, of ending balance total bank funding.

Wholesale funds include FHLB advances, Federal Reserve PPPLF advances, brokered certificates of deposit, and deposits gathered from internet listing services.

Total bank funding is defined as total deposits plus FHLB advances and Federal Reserve PPPLF advances.

We had $532.3 million of outstanding wholesale funds at June 30, 2021, compared to $567.0 million of wholesale funds as of December 31, 2020, which represented 20.9% and 25.2%, respectively, of ending balance total bank funding.

Wholesale funds include FHLB advances, brokered certificates of deposit, deposits gathered from reciprocal deposit programs above the general cap if, applicable, and receive only deposits from reciprocal deposit programs.

Total bank funding is defined as total deposits plus FHLB advances.

We are committed to raising in-market deposits while utilizing wholesale funds to mitigate interest rate risk.

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The short-term FHLB advances will typically have terms of one week to one month to cover the overall expected funding demands.

Period-end in-market deposits increased $54.2 million, or 12.9% annualized, to $1.737 billion at March 31, 2021 from $1.683 billion at December 31, 2020 as in-market deposit balances increased due to our client’s PPP loan proceeds and successful business development efforts.

Excluding temporary deposits from the sale of a commercial client’s business, period-end in-market deposits increased $108.2 million, or 12.9% annualized, to $1.791 billion at June 30, 2021 from $1.683 billion at December 31, 2020 as in-market deposit balances increased due to our client’s PPP loan proceeds and successful business development efforts.

Our in-market relationships remain stable;

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Nonetheless, we will continue to use wholesale funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management process or in shorter time periods if in-market deposit balances decline.

In order to provide for ongoing liquidity and funding, all of our wholesale funds are certificates of deposit which do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual

maturity terms and no call provisions.

In order to provide for ongoing liquidity and funding, all of our wholesale

certificates of deposit do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual maturity terms.

The Bank limits the percentage of wholesale funds to total bank funds in accordance with liquidity policies approved by its Board.

The Bank was in compliance with its policy limits as of March 31, 2021.

The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the year ended March 31, 2021.

The Bank was in compliance with its policy limits as of June 30, 2021.

The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the year ended June 30, 2021.

In the event that there is a disruption in the availability of wholesale funds at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through on-balance sheet liquidity.

These potential funding sources include deposits maintained at the FRB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral.

As of March 31, 2021, the available liquidity was in excess of the stated policy minimum.

As of June 30, 2021, the available liquidity was in excess of the stated policy minimum.

We believe the Bank will also have access to the unused federal funds lines, cash flows from borrower repayments, and cash flows from security maturities.

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We believe that the Bank has sufficient liquidity to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows.

During the three months ended March 31, 2021, operating activities resulted in a net cash inflow of $6.8 million, which included net income of $9.7 million, partially offset by a $2.1 million provision for loan and lease loss benefit.

Net cash used in investing activities for the three months ended March 31, 2021 was approximately $79.5 million which consisted of cash outflows to fund net loan growth, partially offset by a net reduction in securities.

Net cash provided by financing activities resulted in a net cash inflow of $74.6 million for the three months ended March 31, 2021 primarily due to a net increase in FHLB advances and a net increase in deposits.

The Corporation's capital ratios continued to exceed the highest required regulatory benchmark levels.

As of June 30, 2021, total capital to risk-weighted assets was 11.22%, tier 1 capital to risk-weighted assets was 9.14%, tier 1 leverage capital to adjusted average assets was 8.48% and common equity tier 1 capital to risk-weighted assets was 8.72%.

In addition, as of June 30, 2021, tangible common equity to tangible assets was 7.33%.

As of July 29, 2021, the Corporation had purchased 46,513 shares of its common stock, since the adoption of its previously disclosed stock repurchase program, at a weighted average price of $26.53 per share, for a total value of $1.2 million.

The Corporation had $3.8 million of buyback authority remaining under the program as of July 29, 2021.

As previously announced, during the second quarter of 2021, the Corporation’s Board of Directors declared a regular quarterly dividend of $0.18 per share.

The dividend was paid on May 24, 2021 to stockholders of record at the close of business on May 10, 2021.

Measured against second quarter 2021 diluted earnings per share of $0.95, the dividend represents a 18.9% payout ratio.

The Board of Directors routinely considers dividend declarations as part of its normal course of business.

During the six months ended June 30, 2021, operating activities resulted in a net cash inflow of $15.0 million, which included net income of $18.0 million, partially offset by a $3.0 million provision for loan and lease loss benefit.

Net cash provided by investing activities for the six months ended June 30, 2021 was $15.9 million primarily due to proceeds received from the sale of securities available for sale.

Net cash provided by financing activities was $302.2 million for the six months ended June 30, 2021 primarily due to a net increase in deposits, partially offset by a net reduction in FHLB advances and cash dividends paid.

Please refer to the Consolidated Statements of Cash Flows included in PART I., Item 1 for further details regarding significant sources of cash flow for the Corporation.

Contractual Obligations and Off-Balance Sheet Arrangements

As of March 31, 2021, there were no material changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.

As of June 30, 2021, there were no material changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.

We continue to believe that we have adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis