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Item 2. Management’s Discussion and Analysis

2021-10-29 compared with 2021-07-30 · 258 added, 264 removed, 598 unchanged (47% of the section changed)

39 unchanged sentences

Financial Performance Summary

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.

Results as of and for the three and nine months ended September 30, 2021 include:

• Net income totaled $9.2 million, or diluted earnings per share of $1.07, for the three months ended September 30, 2021, compared to $4.3 million, or diluted earnings per share of $0.50, for the same period in 2020.

Net income totaled $27.2 million, or diluted earnings per share of $3.15, for the nine months ended September 30, 2021, compared to $10.9 million, or diluted earnings per share of $1.27, for the same period in 2020.

• Annualized return on average assets and annualized return on average equity for the three months ended September 30, 2021 measured 1.41% and 16.39%, respectively, compared to 0.68% and 8.58% for the same period in 2020.

Annualized return on average assets and annualized return on average equity for the nine months ended September 30, 2021 measured 1.39% and 16.63%, respectively, compared to 0.62% and 7.49% for the same period in 2020.

• Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled $9.7 million for the three months ended September 30, 2021, up 3.9% from the same period in 2020.

Pre-tax, pre-provision adjusted return on average assets was 1.49% for the three months ended September 30, 2021, compared to 1.47% for the same period in 2020.

Pre-tax, pre-provision adjusted earnings totaled $30.3 million for the nine months ended September 30, 2021, up 13.6% from the same period in 2020.

Pre-tax, pre-provision adjusted return on average assets was 1.55% for the nine months ended September 30, 2021, compared to 1.51% for the same period in 2020.

• Net interest margin was 3.45% for the three months ended September 30, 2021, up from 3.14% for the same period in 2020.

Adjusted net interest margin, which excludes certain one-time and volatile items, was 3.22% for the three months ended September 30, 2021 compared to 3.24% for the same period in 2020.

Net interest margin was 3.46% for the nine months ended September 30, 2021, up from 3.30% for the same period in 2020.

Adjusted net interest margin was 3.21% for the nine months ended September 30, 2021 compared to 3.29% 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 $2.8 million for the three months ended September 30, 2021 compared to $1.5 million for the three months ended September 30, 2020.

Fees in lieu of interest totaled $9.5 million for the nine months ended September 30, 2021 compared to $4.6 million for the nine months ended September 30, 2020.

PPP fee income, included in loan fee amortization, was $1.7 million and $6.4 million for the three and nine months ended September 30, 2021 compared to $1.1 million and $2.0 million for the same periods in 2020.

• Top line revenue, defined as net interest income plus non-interest income, totaled $28.2 million for the three months ended September 30, 2021, up 8.5% from the same period in 2020.

Top line revenue totaled $84.3 million for the nine months ended September 30, 2021, up 12.8% from the same period in 2020.

• Provision for loan and lease losses was a benefit of $2.3 million for the three months ended September 30, 2021 compared to an expense of $3.8 million for the same period in 2020.

Provision for loan and lease losses was a benefit of $5.3 million for the nine months ended September 30, 2021 compared to an expense of $12.5 million for the same period in 2020.

• The efficiency ratio was 65.68% for the three months ended September 30, 2021, up from 64.16% for the three months ended September 30, 2020.

The efficiency ratio improved to 64.02% for the nine months ended September 30, 2021, down from 64.29% for the nine months ended September 30, 2020.

• Total assets at September 30, 2021 increased $16.6 million to $2.584 billion from $2.568 billion at December 31, 2020.

• Period-end gross loans and leases receivable were $2.123 billion and $2.146 billion as of September 30, 2021 and December 31, 2020, respectively.

Average gross loans and leases of $2.179 billion increased $226.2 million, or 11.6%, for the nine months ended September 30, 2021, compared to $1.953 billion for the same period in 2020.

• Period-end gross loans and leases receivable, excluding net PPP loans, at September 30, 2021 increased $138.2 million, or 9.6% annualized, to $2.059 billion from $1.921 billion as of December 31, 2020.

Average gross loans and leases, excluding net PPP loans, of $1.993 billion increased $232.9, or 13.2%, for the nine months ended September 30, 2021, compared to $1.760 billion for the same period in 2020.

• Period-end gross PPP loans and PPP deferred processing fees were $65.9 million and $1.4 million, respectively, at September 30, 2021.

Average PPP loans, net of deferred processing fees, were $185.7 million for the nine months ended September 30, 2021 compared to $192.5 million for the same period in 2020.

• Non-performing assets were $7.6 million and 0.29% of total assets as of September 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 0.30% as of September 30, 2021, compared to 1.14% as of December 31, 2020.

• The allowance for loan and lease losses decreased $3.8 million, or 13.5%, compared to December 31, 2020.

The allowance for loan and lease losses decreased to 1.16% of total loans, compared to 1.33% at December 31, 2020.

Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.27% 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.

Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.20% of total loans as of September 30, 2021, compared to 1.48% as of December 31, 2020.

• Period-end in-market deposits at September 30, 2021 increased $146.6 million to $1.830 billion from $1.683 billion as of December 31, 2020.

Average in-market deposits of $1.756 billion increased $228.9 million, or 15.0%, for the nine months ended September 30, 2021, compared to $1.528 billion for the same period in 2020.

• Private wealth and trust assets under management and administration increased by $445.2 million, or 26.4% annualized, to $2.694 billion at September 30, 2021, compared to $2.249 billion at December 31, 2020.

COVID-19 Update

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On December 27, 2020, the Consolidated Appropriations Act, 2021 (“CAA”) was signed into law.

The CAA is a $2.3 trillion spending bill that combines $900 billion in stimulus relief for the COVID-19 pandemic in the United States with a $1.4 trillion omnibus spending bill for the 2021 federal fiscal year and prevents a government shutdown.

The CAA allows for a second draw for certain businesses under the PPP.

The CAA allowed for a second draw for certain businesses under the PPP.

Like the original program, loan proceeds are available to help fund payroll and group health benefit costs, as well as certain mortgage interest, rent and utilities.

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All of these changes are generally retroactive to the original CARES Act, meaning that the changes may be taken into account in processing loan forgiveness with respect to an original PPP loan.

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

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 Corporation accepted and processed applications for second draw PPP loans from January 13, 2021 through the application deadline of May 31, 2021..

As of September 30, 2021, the Corporation had $65.9 million in gross PPP loans outstanding and deferred processing fees outstanding of $1.4 million.

The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method.

During the three and 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.

During the three and nine months ended September 30, 2021, $1.7 million and $6.4 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.

As loan losses are expected to be immaterial, if any at all, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation.

As loan losses are expected to be immaterial, if any, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation.

Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.

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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.

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.

Excluding gross PPP loans, as of September 30, 2021, the Corporation had five deferred loans outstanding in an aggregate amount of $24.1 million, or 1.2% 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 $24.1 million of deferred loans outstanding, $23.5 million relates to three hospitality credits which received principal payment deferrals and are accruing and current on interest payments.

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

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

June 30, 2021

September 30, 2021

Collateral Type

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Manufacturing 428 — 428

Agriculture, Forestry, Fishing, and Hunting 210 — 210

Educational Services 195 195 —

Retail Trade 115 — 115

Total deferred loan balances $ 24,064 $ 23,521 $ 543

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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.

June 30, 2021

September 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:

June 30, 2021 December 31, 2020

September 30, 2021 December 31, 2020

Balance % Gross Loans and Leases (1)

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(1) Excluding net PPP loans.

(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.

(2) Includes $39.6 million and $48.9 million in loans secured by commercial real estate as of September 30, 2021 and December 31, 2020, respectively.

(3) Includes $23.2 million and $7.7 million in fully collateralized asset-based loans as of September 30, 2021 and December 31, 2020, respectively.

As of September 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 the future effect of the ongoing pandemic on the Corporation’s loan portfolio.

Results of Operations

Top Line Revenue

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.

Top line revenue, comprised of net interest income and non-interest income, increased 8.5% for the three months ended September 30, 2021 compared to the same period in 2020 primarily due to a $2.6 million, or 14.0%, increase in net interest income.

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

Top line revenue increased 12.8% for the nine months ended September 30, 2021 compared to the same period in 2020 primarily due to higher net interest income driven by an increase in average loans and leases receivable and loan fees in lieu of interest.

Non-interest income for the nine months ended 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 June 30, For the Six Months Ended June 30,

For the Three Months Ended September 30, For the Nine Months Ended September 30,

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

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Annualized Return on Average Assets and Annualized Return on Average Equity

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 for the three and nine months ended September 30, 2021 increased to 1.41% and 1.39%, compared to 0.68% and 0.62% for the three and nine months ended September 30, 2020.

The increase in ROAA was primarily due to a decrease in provision for loan and lease losses related to two large loan recoveries received in January and September 2021 combined with 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.

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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 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.

ROAE for the three and nine months ended September 30, 2021 was 16.39% and 16.63%, compared to 8.58% and 7.49% for the three and nine months ended September 30, 2020.

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

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Efficiency Ratio and Pre-Tax, Pre-Provision Adjusted Earnings

Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse benefit or provision, impairment of tax credit investments, net gains or losses on foreclosed properties, amortization of other intangible assets, losses on early extinguishment of debt, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized net gains or losses on securities, if any.

Efficiency ratio is a non-GAAP measure representing operating expense, which is non-interest expense excluding the effects of the SBA recourse benefit or provision, impairment of tax credit investments, net gains or losses on foreclosed properties, amortization of other intangible assets, losses on early extinguishment of debt, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized net gains or losses on securities, if any.

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 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 efficiency ratio was 65.68% and 64.02% for the three and nine months ended September 30, 2021, compared to 64.16% and 64.29% for the three and nine months ended September 30, 2020.

Operating expense growth exceeded operating revenue growth for the three months ended September 30, 2021 compared to the same period in 2020 primarily due to a $1.5 million, or 12.6%, increase in compensation principally driven by increased headcount and incentive compensation.

Operating revenue growth outpaced the growth in operating expense for the nine months ended September 30, 2021 compared to the same period in 2020, resulting in positive operating leverage.

This improvement was attributed to an increase in net interest income driven by a 11.6% increase in average loans and leases receivable and a $4.9 million increase in fees in lieu of interest.

The increase in operating revenue was partially offset by a $5.6 million, or 16.5%, 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.

Excluding the non-recurring impact of PPP loan fee income and interest income, we believe we will generate 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 and operating efficiency through the use of technology.

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.

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The efficiency ratio and pre-tax, pre-provision adjusted earnings also allow management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE.

The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.

The information provided below reconciles the efficiency ratio and pre-tax, pre-provision adjusted earnings to its most comparable GAAP measure.

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 June 30, For the Six Months Ended June 30,

For the Three Months Ended September 30, For the Nine Months Ended September 30,

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

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Total non-interest expense $ 18,490 $ 16,758 $ 1,732 10.3 % $ 54,003 $ 51,245 $ 2,758 5.4 %

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

Net loss (gain) on foreclosed properties 6 (121) 127 NM 7 329 (322) (97.9)

Amortization of other intangible assets

7 9 (2) (22.2) 23 27 (4) (14.8)

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

SBA recourse (benefit) provision (69) 57 (126) NM 45 53 (8) (15.1)

Tax credit investment impairment — 113 (113) NM — 2,066 (2,066) NM

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Total non-interest income 7,015 7,408 (393) (5.3) 20,531 20,141 390 1.9

Net loss on sale of securities

29 — 29 NM 29 (4) 33 NM

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

Adjusted non-interest income 7,015 7,408 (393) (5.3) $ 20,502 $ 20,145 $ 357 1.8

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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 and six months ended June 30, 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 nine months ended September 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 June 30, Increase (Decrease) for the Six Months Ended June 30,

Increase (Decrease) for the Three Months Ended September 30, Increase (Decrease) for the Nine Months Ended September 30,

2021 Compared to 2020 2021 Compared to 2020

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

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 June 30,

For the Three Months Ended September 30,

Balance Interest Average

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(4) Represents annualized yields/rates.

For the Six Months Ended June 30,

For the Nine Months Ended September 30,

Balance Interest Average

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(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.

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 a reduction in the yield on average interest-earning assets.

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.

Comparison of Net Interest Income for the Three and Nine Months Ended September 30, 2021 and 2020

Net interest income increased $2.6 million, or 14.0%, during the three months ended September 30, 2021 compared to the three months ended September 30, 2020.

The increase in net interest income reflected an increase in average gross loans and leases excluding PPP loans, an increase in fees in lieu of interest, and a decrease in interest expense, partially offset by a reduction in the yield on average interest-earning assets excluding PPP loan fees.

Fees in lieu of interest, which can vary from quarter to quarter, totaled $2.8 million for the three months ended September 30, 2021, compared to $1.5 million for the same period in 2020.

Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $1.9 million, or 11.4%.

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.

Average gross loans and leases for the three months ended September 30, 2021 decreased $8.3 million, or 0.4%, compared to the three months ended September 30, 2020.

Excluding net PPP loans, average gross loans and leases for the three months ended September 30, 2021 increased $227.2 million, or 12.5%, compared to the three months ended September 30, 2020.

Net interest income increased $9.2 million, or 16.8%, during the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.

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

Fees in lieu of interest totaled $9.5 million for the nine months ended September 30, 2021, compared to $4.6 million for the same period in 2020.

Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $4.3 million, or 8.9%.

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.

Average gross loans and leases for the nine months ended September 30, 2021 increased $226.2 million, or 11.6%, compared to the nine months ended September 30, 2020.

Excluding net PPP loans, average gross loans and leases for the nine months ended September 30, 2021 increased $232.9 million, or 13.2%, compared to the nine months ended September 30, 2020.

The yield on average loans and leases for the three and nine months ended September 30, 2021 was 4.31% and 4.24%, respectively, compared to 3.95% and 4.40% for the three and nine months ended September 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 nine months ended September 30, 2021 was 3.89% and 3.91%, respectively, compared to 4.13% and 4.43% for the three and nine months ended September 30, 2020, respectively.

Similarly, the yield on average interest-earning assets for the three and nine months ended September 30, 2021 measured 3.90% and 3.93%, respectively, compared to 3.75% and 4.13% three and nine months ended September 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 nine months ended September 30, 2021 was 3.53% and 3.61%, respectively, compared to 3.89% and 4.13% for the three and nine months ended September 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 cash flows from the securities portfolio at historically low interest rates.

The average rate paid on total interest-bearing liabilities for the three and nine months ended September 30, 2021 decreased to 0.63% and 0.64% compared to 0.81% and 1.09% for the three and nine months ended September 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 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.

For the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, the average target federal funds rate decreased 39 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 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 3.49% 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.

Average FHLB advances for the three months ended September 30, 2021 increased $1.1 million to $381.1 million at an average rate paid of 1.29%, compared to $379.9 million at an average rate paid of 1.43% for the three months ended September 30, 2020.

Average FHLB advances for the nine months ended September 30, 2021 increased $12.8 million to $384.6 million at an average rate paid of 1.30%, compared to $371.7 million at an average rate paid of 1.51% for the nine months ended September 30, 2020.

As of September 30, 2021, the weighted average original maturity of our FHLB term advances was 6.2 years, compared to 5.1 years as of September 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 September 30, 2021 decreased $70.9 million to $89.1 million at an average rate paid of 0.92%, compared to $160.1 million at an average rate paid of 1.33% for the same period in 2020.

The decrease in wholesale deposits was primarily due to voluntary reduction of non-maturity brokered deposits given current levels of excess liquidity.

Average wholesale deposits for the nine months ended September 30, 2021 increased $6.4 million to $139.2 million at an average rate paid of 0.79%, compared to $132.8 million at an average rate paid of 2.03% for the same period in 2020.

As of September 30, 2021, the weighted average original maturity of our termed wholesale deposits was 3.7 years, compared to 4.3 years as of September 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 3.45% and 3.46% for the three and nine months ended September 30, 2021, respectively, compared to 3.14% and 3.30% for the three and nine months ended September 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 3.22% and 3.21% for the three and nine months ended September 30, 2021, respectively, compared to 3.24% and 3.29% for the three and nine months ended September 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.

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Net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status or the accumulation of significant short-term deposit inflows.

Given the Corporation’s excess liquidity and the current interest rate environment, in the near-team management believes net interest margin will be slightly less than the long-term target of 3.50%.

Despite an uncertain rate environment, management expects to effectively manage the Corporation’s liability structure in both term and rate.

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 $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.

In-market deposits, comprised of all transaction accounts, money market accounts, and non-wholesale deposits, increased $146.6 million, or 11.6% annualized, to $1.830 billion at September 30, 2021, compared to $1.683 billion at December 31, 2020.

Average in-market deposits increased $228.9 million, or 15.0%, to $1.756 billion for the nine months ended September 30, 2021, compared to $1.528 billion for the nine months ended September 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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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.

The Corporation recognized a $2.3 million and $5.3 million provision benefit for the three and nine months ended September 30, 2021, respectively, compared to provision expense of $3.8 million and $12.5 million for the three and nine months ended September 30, 2020, respectively.

The provision benefit for the three months ended September 30, 2021 was primarily due to a net recovery of $1.3 million, a $923,000 reduction in the general reserve from improving historical loss rates, and a $451,000 decrease in specific reserves.

These decreases were partially offset by a $426,000 increase in the general reserve due to loan growth.

The provision benefit for the nine months ended September 30, 2021 was primarily due to a net recovery of $1.5 million, a $3.6 million reduction in the general reserve from improving historical loss rates and a $2.1 million decrease in specific reserves.

These decreases were partially offset by a $1.5 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,

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

For the Three Months Ended September 30, For the Nine Months Ended September 30,

2021 2020 2021 2020

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Total provision for loan and lease losses $ (2,269) $ 3,835 $ (5,295) $ 12,487

The legacy on-balance sheet SBA portfolio, defined as SBA 7(a) and Express loans originated in 2016 and prior, has been a source of elevated non-performing assets.

The legacy on-balance sheet SBA portfolio, defined as SBA 7(a) and Express loans originated in 2016 and prior, was a source of elevated non-performing assets and charge-offs.

Additional information on our legacy SBA portfolio is as follows:

2021 March 31,

September 30,

2021 June 30,

2021 September 30,

(In Thousands)

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Refer to Asset Quality , below, for further information regarding the overall credit quality of our loan and lease portfolio.

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 and Six Months Ended June 30, 2021 and 2020

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 the future effect of the ongoing pandemic on the Corporation’s loan portfolio.

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

Non-Interest Income

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.

Non-interest income decreased $393,000, or 5.3%, to $7.0 million for the three months ended September 30, 2021 compared to $7.4 million for the same period in 2020.

Non-interest income increased $390,000, or 1.9%, to $20.5 million for the nine months ended September 30, 2021 compared to $20.1 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.

Total non-interest income accounted for 24.8% and 24.4% of total revenues for the three and nine months ended September 30, 2021, compared to 28.5% and 27.0% for the three and nine months ended September 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 interest rate swap fee income.

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

The components of non-interest income were as follows:

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

For the Three Months Ended September 30, For the Nine Months Ended September 30,

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

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357 365 (8) (2.2) 1,056 1,037 19 1.8

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

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

Swap fees — 2,446 (2,446) (100.0) 684 5,782 (5,098) (88.2)

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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 $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.

Private wealth management service fees increased $592,000, or 27.3%, and $1.5 million, or 23.6%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020.

Private wealth management 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 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.

As of September 30, 2021, private wealth and trust assets under management and administration totaled a record $2.694 billion, increasing $445.2 million, or 26.4% annualized, compared to $2.249 billion as of December 31, 2020 and $676.6 million, or 33.5%, compared to $2.018 billion as of September 30, 2020.

No commercial loan interest rate swap fee income was recognized for the three months ended September 30, 2021, compared to $2.4 million for the same period in 2020.

Commercial loan interest rate swap fee income was $684,000 for the nine months ended September 30, 2021, compared to $5.8 million for the nine months ended September 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 $637.0 million as of June 30, 2021, compared to $467.1 million as of June 30, 2020.

The aggregate amortizing notional value of interest rate swaps with various borrowers was $634.0 million as of September 30, 2021, compared to $577.9 million as of September 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.

Subsequent to September 30, 2021,we completed two commercial loan interest rate swap transactions which generated swap fees totaling $684,000.

Gains on sale of SBA loans for the three months ended September 30, 2021 decreased $39,000, or 5.1%, compared to the same period in 2020.

We expect this revenue stream to return to levels consistent with the first half of the year in the coming quarters and continue to believe gains on sale of traditional SBA loans (i.e., SBA loans unrelated to PPP loans), while variable based on timing of closings, will continue to increase annually at a measured pace.

Gain on sale of SBA loans increased $1.4 million, or 87.9%, for the nine months ended September 30, 2021 compared to the same period in 2020.

Loans fees increased $235,000, or 49.2%, and $414,000, or 29.3%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020.

The increase in both periods of comparison is primarily due to a full year of floorplan financing curtailment fees.

Other non-interest income increased $1.2 million, or 385.2%, and $1.8 million, or 131.6%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 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

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

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.

Non-interest expense for the three months ended September 30, 2021 increased by $1.7 million, or 10.3%, to $18.5 million compared to $16.8 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 $1.8 million, or 11.1%, to $18.5 million for the three months ended September 30, 2021 compared to $16.7 million for the same period in 2020.

Non-interest expense for the nine months ended September 30, 2021 increased by $2.8 million, or 5.4%, to $54.0 million compared to $51.2 million for the same period in 2020.

Operating expense increased $5.9 million, or 12.3%, to $53.9 million for the nine months ended September 30, 2021 compared to $48.0 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.

The components of non-interest expense were as follows :

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

For the Three Months Ended September 30, For the Nine Months Ended September 30,

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

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Collateral liquidation costs 47 45 2 4.4 224 281 (57) (20.3)

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

Net loss (gain) on foreclosed properties 6 (121) 127 NM 7 329 (322) (97.9)

Impairment on tax credit investments — 113 (113) NM — 2,066 (2,066) (100.0)

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(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 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.

Compensation expense for the three and nine months ended September 30, 2021 was $13.4 million, an increase of $1.5 million, or 12.6%, and $39.3 million, an increase of $5.6 million, or 16.5%, respectively, compared to the three and nine months ended September 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.

The annual corporate bonus and individual incentive compensation plans for the three and nine months ended September 30, 2021 totaled $2.6 million and $6.7 million, respectively, due to strong Bank performance driven by effective business development efforts and continued improvement in credit, compared to $1.7 million and $3.9 million for three and nine months ended September 30, 2020, respectively.

Average full-time equivalent employees for the nine months ended September 30, 2021 increased to 309, up 7.7%, compared to 287 for the nine months ended September 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 $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.

Data processing expense increased $67,000, or 9.9%, and $249,000, or 12.1%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020.

The increase in data processing expense was due to the increase in deposit accounts and implementation costs for various client-facing products and functionality.

Management expects data processing expense to continue to increase modestly commensurate with the increase in deposit accounts.

Marketing expense increased $216,000, or 60.7%, and $305,000, or 26.1%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 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 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.

Computer software expense decreased $18,000, or 1.8%, and increased $371,000, or 12.9%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020.

The increase for the nine months ended September 30, 2021 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.

Management expects computer software expense growth to moderate in 2022 and beyond and generally increase commensurate with headcount and the related increase in software licensing costs.

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

The impairment on tax credit investments for the three and nine months ended September 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 2022 and beyond.

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.

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.

Other non-interest expense increased $99,000, or 16.0%, and decreased $677,000, or 34.2%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020.

The increase for the three months ended September 30, 2021 was due to an increase in travel and other general business-related expenses.

The decrease for the nine months ended September 30, 2021 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 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.

There was no CVA as of September 30, 2020.

Income tax expense totaled $8.4 million for the nine months ended September 30, 2021 compared to an income tax expense of $73,000 for the nine months ended September 30, 2020.

The income tax expense for the nine months ended September 30, 2020 reflects a benefit from the recognition of $2.5 million in tax credits which correspond with the $1.7 million impairment of relationship-based historic tax credit investments during the same period.

The effective tax rate, excluding tax credits and other discrete items, for the nine months ended September 30, 2021 was 23.5% compared to 19.3% for the nine months ended September 30, 2020.

Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items.

The rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any.

If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used.

We re-evaluate the income tax rates each quarter.

Therefore, the current projected effective tax rate for the entire year may change.

Financial Condition

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.

Total assets increased by $16.6 million, or 0.6%, to $2.584 billion as of September 30, 2021 compared to $2.568 billion at December 31, 2020.

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

Short-Term Investments

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.

Short-term investments increased by $63.1 million to $90.4 million at September 30, 2021 from $27.4 million at December 31, 2020.

The increase in short-term investments was primarily due to solid in-market deposit growth and PPP loan forgiveness proceeds.

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

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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 $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.

Total securities, including available-for-sale and held-to-maturity, increased by $5.0 million, or 2.4%, to $215.3 million at September 30, 2021 compared to $210.3 million at December 31, 2020.

During the nine months ended September 30, 2021 we recognized unrealized losses of $3.0 million before income taxes through other comprehensive income, compared to gains of $3.9 million for the same period in 2020.

As of September 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 5.7 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 June 30, 2021.

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

Loans and Leases Receivable

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.

Loans and leases receivable, net of allowance for loan and lease losses, decreased by $18.8 million to $2.099 billion at September 30, 2021 from $2.117 billion at December 31, 2020 which was driven by PPP loan forgiveness, partially offset by commercial loan growth.

Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by $142.1 million, or 10.0% annualized, to $2.034 billion at September 30, 2021 from December 31, 2020.

Excluding net PPP loans, C&I loans increased $109.6 million, or 28.8% annualized, to $616.6 million from $507.0 million at December 31, 2020 primarily due to an increase in asset-based lending, small-ticket equipment financing, and dealer floorplan financing.

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 $51.3 million to $681.1 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 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.

Total commercial real estate (“CRE”) loans increased $28.6 million to $1.388 billion, up from $1.359 billion at December 31, 2020.

Non-owner occupied CRE and multi-family loans drove CRE loan growth as of September 30, 2021, increasing $74.9 million, and $2.2 million, respectively, from December 31, 2020.

There continues to be a concentration in CRE loans which represented 67.3% and 70.6% of our total loans, excluding net PPP loans, as of September 30, 2021 and December 31, 2020, respectively.

As of September 30, 2021, 17.4% 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 borrowers have characteristics such as robust liquidity, strong operating performance, and collateral positions.

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

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In addition, we make every reasonable effort to ensure that there is appropriate collateral or a government guarantee at the time of origination to protect our interest in the related loan or lease.

To monitor the ongoing credit quality of our loans and leases, each credit is evaluated for proper risk rating using a nine grade risk rating system at the time of origination, subsequent renewal, evaluation of updated financial information from our borrowers, or as other circumstances dictate.

To monitor the ongoing credit quality of our loans and leases, each credit is evaluated for risk at the time of origination, subsequent renewal, evaluation of updated financial information from our borrowers, or as other circumstances dictate.

While we continue to experience significant competition from banks operating in our primary geographic areas, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio.

We continue to expect our new loan and lease activity to be adequate to replace normal amortization, allowing us to continue growing in future years.

We continue to expect our new loan and lease activity to be more than adequate to replace normal amortization, allowing us to continue growing in future years.

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 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.

As of September 30, 2021, deposits increased by $48.8 million, or 3.5% annualized, to $1.904 billion from $1.856 billion at December 31, 2020 primarily due to a $66.5 million and $87.2 million increase in transaction accounts and money market accounts, respectively, partially offset by a decrease in wholesale deposits and certificates of deposit of $97.9 million and $7.1 million, respectively.

The large increase in deposits was primarily due to successful business development efforts and PPP forgiveness proceeds.

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 $1.729 billion for the six months ended June 30, 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 $1.756 billion for the nine months ended September 30, 2021, up 16.0% annualized, compared to $1.569 billion for the year ended December 31, 2020.

FHLB Advances and Other Borrowings

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.

As of September 30, 2021, FHLB advances and other borrowings decreased by $25.1 million, or 6.0%, to $394.1 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, 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.

As of September 30, 2021 and December 31, 2020, the Corporation had other borrowings of $12.5 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, in addition to 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.

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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 $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.

The aggregate amortizing notional value of interest rate swaps with various borrowers increased $4.9 million, or 0.8%, to $634.0 million as of September 30, 2021, compared to $629.1 million as of December 31, 2020.

The fair value of these interest rate swaps decreased $20.7 million, or 41.9%, to $28.7 million as of September 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 September 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 June 30, 2021 and December 31, 2020, respectively:

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

September 30,

2021 December 31,

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Allowance for loan and lease losses to non-accrual loans and leases 331.98 107.15

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

Net PPP loans outstanding as of September 30, 2021 and December 31, 2020, were $64.5 million and $225.3 million, respectively.

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

September 30,

2021 December 31,

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Allowance for loan and lease losses to gross loans and leases 1.20 1.48

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.

Non-accrual loans decreased $19.2 million, or 72.1%, to $7.4 million at September 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 $3.4 million of charge-offs, of which $2.2 million was from the legacy SBA portfolio.

All charge-offs for the nine months ended September 30, 2021 were previously identified impaired loans and 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.

The Corporation’s non-accrual loans as a percentage of total gross loans and leases

measured 0.35% and 1.24% at September 30, 2021 and December 31, 2020, respectively.

Non-accrual loans as a percentage of total gross loans and leases, excluding net PPP loans, was 0.36% and 0.96% at September 30, 2021 and December 31, 2020, respectively.

As of September 30, 2021 and December 31, 2020, $857,000 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 0.40% 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.

Non-performing assets as a percentage of total assets decreased to 0.29% at September 30, 2021 from 1.04% at December 31, 2020.

As of September 30, 2021, the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.8% 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 June 30, 2021, as well as in all previous reporting periods, there were no loans over 90 days past due and still accruing interest.

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

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

As of and for the Nine Months Ended September 30, As of and for the

Year Ended December 31,

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Proceeds from sale of foreclosed properties — (2,057) (2,582)

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

Net gain (loss) on sale of foreclosed properties — 34 (20)

Impairment adjustments (7) (363) (363)

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Allowance for Loan and Lease Losses

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.

The allowance for loan and lease losses decreased $3.8 million, or 13.5%, to $24.7 million as of September 30, 2021 from $28.5 million as of December 31, 2020 .

The allowance for loan and lease losses as a percentage of gross loans and leases decreased to 1.16% as of September 30, 2021 from 1.33% as of December 31, 2020 .

The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.20% as of September 30, 2021 compared to 1.48% 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 significant commercial real estate loan recoveries, 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.

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.

During the nine months ended September 30, 2021, we recorded net recoveries on impaired loans and leases of $1.5 million, comprised of $3.4 million of charge-offs and $4.9 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 remain at low levels based on total non-accrual loans and leases as a percentage of gross loans and leases of 0.35% at September 30, 2021;

which 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.

As of September 30, 2021 and December 31, 2020, our ratio of allowance for loan and lease losses to total non-accrual loans and leases was 331.98% 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.

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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 June 30, 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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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 such as the economic uncertainty related to the COVID-19 pandemic.

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.

As of September 30, 2021, the allowance for loan and lease losses included $733,000 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 June 30, 2021 are collateral dependent.

Many of the impaired loans as of September 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 $25.7 million, or 1.20% of gross loans and leases, at June 30, 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 $24.7 million, or 1.16% of gross loans and leases, at September 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 June 30, As of and for the Six Months Ended June 30,

As of and for the Three Months Ended September 30, As of and for the Nine Months Ended September 30,

2021 2020 2021 2020

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Commercial real estate — non-owner occupied

1,431 — 1,431 2

Construction and land development — — 2,078 —

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Allowance at end of period $ 24,676 $ 30,817 $ 24,676 $ 30,817

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 %

Annualized net (recoveries) charge-offs as a percent of average gross loans and leases (0.24) % 0.09 % (0.09) % 0.08 %

Annualized net (recoveries) charge-offs as a percent of average gross loans and leases, excluding average net PPP loans (0.25) % 0.11 % (0.10) % 0.09 %

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 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 principal liquidity requirements at September 30, 2021 were the interest payments due on subordinated and junior subordinated notes.

On July 30, 2021, the Bank’s Board of Directors declared a dividend in the aggregate amount of $3.0 million bringing year-to-date dividend declarations to $7.5 million.

The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect on September 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.

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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 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.

As of September 30, 2021 and December 31, 2020, our immediate on-balance sheet liquidity was $535.3 million and $640.2 million, respectively.

At September 30, 2021 and December 31, 2020, the Bank had $89.9 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 $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.

We had $432.4 million of outstanding wholesale funds at September 30, 2021, compared to $567.0 million of wholesale funds as of December 31, 2020, which represented 19.1% 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 unreciprocated deposits from reciprocal deposit programs.

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

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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.

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;

Period-end in-market deposits increased $146.6 million, or 11.6% annualized, to $1.830 billion at September 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 continue to grow;

however, deposit balances associated with those relationships will fluctuate.

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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

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.

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 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.

The Bank was in compliance with its policy limits as of September 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 September 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 June 30, 2021, the available liquidity was in excess of the stated policy minimum.

As of September 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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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.

As of September 30, 2021, total capital to risk-weighted assets was 11.14%, tier 1 capital to risk-weighted assets was 9.14%, tier 1 leverage capital to adjusted average assets was 8.69% and common equity tier 1 capital to risk-weighted assets was 8.73%.

In addition, as of September 30, 2021, tangible common equity to tangible assets was 8.28%.

As of September 30, 2021, the Corporation had purchased 157,520 shares of its common stock, since the adoption of its previously disclosed stock repurchase program, at a weighted average price of $26.90 per share, for a total value of $4.3 million.

The Corporation had $717,000 of buyback authority remaining under the program as of September 30, 2021.

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

The dividend was paid on August 19, 2021 to stockholders of record at the close of business on August 6, 2021.

Measured against third quarter 2021 diluted earnings per share of $1.07, the dividend represents a 16.8% 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.

During the nine months ended September 30, 2021, operating activities resulted in a net cash inflow of $24.8 million, which included net income of $27.2 million, partially offset by a $5.3 million provision for loan and lease loss benefit.

Net cash provided by investing activities for the nine months ended September 30, 2021 was $14.5 million primarily due to proceeds received from the sale of securities available for sale.

Net cash provided by financing activities was $14.5 million for the nine months ended September 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 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.

As of September 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