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Bank First Corp - Quarter Report: 2019 March (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C.  20549

 

FORM 10-Q

(Mark One)

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2019

 

OR

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to ____________

 

Commission file number: 001-38676

 

BANK FIRST NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

WISCONSIN   39-1435359
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
402 North 8th Street, Manitowoc, Wisconsin   54220
(Address of principal executive offices)   (Zip Code)

 

(920) 652-3100

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x    No  o

 

Indicate by check mark whether the registrant has submitted electronically, if any, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes  x    No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨
Non-accelerated filer x Smaller reporting company x
  Emerging growth company x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol(s)   Name on each exchange on which registered
Common Stock, par value $0.01 per share   BFC   The Nasdaq Stock Market LLC

 

The number of shares of the issuer’s common stock, par value $0.01, outstanding as of May 8, 2019 was 6,577,045 shares.

 

 

 

 

 

 

TABLE OF CONTENTS

 

    Page Number
Part I. Financial Information 3
ITEM 1. Financial Statements 3
  Consolidated Balance Sheets – March 31, 2019 (unaudited) and December 31, 2018 3
  Consolidated Statements of Income – Three Months Ended March 31, 2019 and 2018 (unaudited) 4
  Consolidated Statements of Comprehensive Income – Three Months Ended March 31, 2019 and 2018 (unaudited) 5
  Consolidated Statements of Changes in Stockholders’ Equity – Three Months Ended March 31, 2019 and 2018 (unaudited) 6
  Consolidated Statements of Cash Flows – Three Months Ended March 31, 2019 and 2018 (unaudited) 7
  Notes to Unaudited Consolidated Financial Statements 9
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 31
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 56
ITEM 4. Controls and Procedures 58
Part II. Other Information 58
ITEM 1. Legal Proceedings 58
ITEM 1A. Risk Factors 58
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 58
ITEM 3. Defaults Upon Senior Securities 59
ITEM 4. Mine Safety Disclosures 59
ITEM 5. Other Information 59
ITEM 6. Exhibits 60
Signatures   61

 

 2 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS:

 

BANK FIRST NATIONAL CORPORATION

Consolidated Balance Sheets
(In thousands, except share and per share data)

 

 

   March 31, 2019   December 31, 2018 
   (Unaudited)   (Audited) 
    
Assets          
Cash and due from banks  $29,478   $41,435 
Interest-bearing deposits   17,642    21,830 
Federal funds sold   62,058    44,478 
Cash and cash equivalents   109,178    107,743 
Securities held to maturity, at amortized cost ($41,112 and $40,477 fair value at March 31, 2019 and December 31, 2018, respectively)   40,769    40,768 
Securities available for sale, at fair value   122,761    118,906 
Loans held for sale   596    - 
Loans, net   1,419,285    1,416,246 
Premises and equipment, net   26,915    24,489 
Goodwill   15,024    15,024 
Other investments   4,427    4,555 
Cash value of life insurance   24,331    24,178 
Intangible assets, net   5,136    5,297 
Other real estate owned (“OREO”)   3,880    3,592 
Investment in minority-owned subsidiaries   26,263    25,397 
Other assets   6,843    6,970 
TOTAL ASSETS  $1,805,408   $1,793,165 
           
Liabilities and Stockholders' Equity          
Liabilities:          
Deposits:          
Interest-bearing deposits  $1,108,823   $1,108,402 
Noninterest-bearing deposits   464,854    448,765 
Total deposits   1,573,677    1,557,167 
Securities sold under repurchase agreements   25,484    31,489 
Subordinated notes   11,500    11,500 
Other liabilities   15,570    18,686 
Total liabilities   1,626,231    1,618,842 
Stockholders' equity:          
Serial preferred stock - $0.01 par value          
Authorized - 5,000,000 shares   -    - 
Common stock - $0.01 par value          
Authorized - 20,000,000 shares          
Issued - 7,368,083 shares as of March 31, 2019 and December 31, 2018          
Outstanding - 6,577,045 and 6,610,358 shares as of March 31, 2019 and December 31, 2018, respectively   74    74 
Additional paid-in capital   27,305    27,601 
Retained earnings   173,644    168,363 
Treasury stock, at cost - 791,038 and 757,725 shares as of March 31, 2019 and December 31, 2018, respectively   (23,333)   (21,349)
Accumulated other comprehensive income (loss)   1,487    (366)
Total stockholders' equity   179,177    174,323 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $1,805,408   $1,793,165 

 

See accompanying notes to unaudited consolidated financial statements.

 3 

 

 

ITEM 1. Financial Statements Continued:

 

BANK FIRST NATIONAL CORPORATION

Consolidated Statements of Income

(In thousands, except per share data) (Unaudited)

 

   Three months ended March 31, 
   2019   2018 
     
Interest income:          
Loans, including fees  $18,226   $17,725 
Securities:          
Taxable   744    703 
Tax-exempt   426    466 
Other   327    415 
Total interest income   19,723    19,309 
Interest expense:          
Deposits   4,225    2,363 
Securities sold under repurchase agreements   130    93 
Borrowed funds   168    571 
Total interest expense   4,523    3,027 
Net interest income   15,200    16,282 
Provision for loan losses   625    485 
Net interest income after provision for loan losses   14,575    15,797 
Noninterest income:          
Service charges   679    846 
Income from Ansay and Associates, LLC (“Ansay”)   875    1,196 
Income from UFS, LLC (“UFS”)   594    609 
Loan servicing income   223    242 
Net gain on sales of mortgage loans   87    157 
Noninterest income from strategic alliances   19    23 
Other   829    370 
Total noninterest income   3,306    3,443 
Noninterest expense:          
Salaries, commissions, and employee benefits   5,310    5,317 
Occupancy   849    1,350 
Data processing   913    939 
Postage, stationery, and supplies   123    167 
Net loss on sales and valuations of OREO   36    136 
Net gain on sales of securities   -   (3)
Net gain on sale of other investments   (234)   - 
Advertising   74    52 
Charitable contributions   131    373 
Outside service fees   684    520 
Amortization of intangibles   161    189 
Other   1,255    937 
Total noninterest expense   9,302    9,977 
Income before provision for income taxes   8,579    9,263 
Provision for income taxes   1,992    2,200 
Net Income  $6,587   $7,063 
Earnings per share - basic  $1.00   $1.05 
Earnings per share - diluted  $1.00   $1.05 
Dividends per share  $0.20   $0.16 

 

See accompanying notes to unaudited consolidated financial statements

 

 4 

 

 

ITEM 1. Financial Statements Continued:

 

BANK FIRST NATIONAL CORPORATION

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)

 

   Three Months Ended 
   March 31, 
   2019   2018 
         
Net Income  $6,587   $7,063 
Other comprehensive income (loss):          
Unrealized gains (losses) on available for sale securities:          
Unrealized holding gains (losses) arising during period   2,357    (1,774)
Amortization of unrealized holding gains on securities transferred from available for sale to held to maturity   (11)   (40)
Reclassification adjustment for gains included in net income   -   (3)
Income tax benefit (expense)   (493)   465 
Total other comprehensive income (loss)   1,853    (1,352)
Comprehensive income  $8,440   $5,711 

 

See accompanying notes to unaudited consolidated financial statements.

 5 

 

 

ITEM 1. Financial Statements Continued:

 

BANK FIRST NATIONAL CORPORATION

Consolidated Statement of Stockholders’ Equity

(In thousands, except per share data) (Unaudited)

 

                       Accumulated     
   Serial       Additional           Other   Total 
   Preferred   Common   Paid-in   Retained   Treasury   Comprehensive   Stockholders' 
   Stock   Stock   Capital   Earnings   Stock   Income (Loss)   Equity 
   (In Thousands, except share and per share amounts) 
                             
Balance at January 1, 2018  $-   $74   $27,528   $145,879   $(12,730)  $977   $161,728 
Net income   -    -    -    7,063    -    -    7,063 
Other comprehensive loss   -    -    -    -    -    (1,352)   (1,352)
Purchase of treasury stock   -    -    -    -    (5,648)   -    (5,648)
Sale of treasury stock   -    -    -    -    951    -    951 
Cash dividends ($0.16 per share)   -    -    -    (1,067)   -    -    (1,067)
Amortization of stock-based compensation   -    -    121    -    -    -    121 
Vesting of restricted stock awards          -    -    (433)   -    433    -    - 
                                    
Balance at March 31, 2018  $-   $74   $27,216   $151,875   $(16,994)  $(375)  $161,796 
                                    
Balance at January 1, 2019  $-   $74   $27,601   $168,363   $(21,349)  $(366)  $174,323 
Net income   -    -    -    6,587    -    -    6,587 
Other comprehensive income   -    -    -    -    -    1,853    1,853 
Purchase of treasury stock   -    -    -    -    (2,489)   -    (2,489)
Issuance of treasury stock as                                   
deferred compensation payout   -    -    14    -    43    -    57 
Cash dividends ($0.20 per share)   -    -    -    (1,306)   -    -    (1,306)
Amortization of stock-based compensation   -    -    152    -    -    -    152 
Vesting of restricted stock awards   -    -    (462)   -    462    -    - 
                                    
Balance at March 31, 2019  $-   $74   $27,305   $173,644   $(23,333)  $1,487   $179,177 

 

See accompanying notes to unaudited consolidated financial statements.

 6 

 

 

ITEM 1. Financial Statements Continued:

 

BANK FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows

(In thousands) (Unaudited)

 

   Three Months Ended March 31, 
   2019   2018 
   (In Thousands) 
Cash flows from operating activities:
Net income  $6,587   $7,063 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Provision for loan losses   625    485 
Depreciation and amortization of premises and equipment   277    306 
Amortization of intangibles   161    189 
Net amortization of securities   94    110 
Amortization of stock-based compensation   152    121 
Accretion of purchase accounting valuations   (1,024)   (1,981)
Net change in deferred loan fees and costs   (99)   (93)
Change in fair value of mortgage servicing rights (“MSR”)   (536)   70 
Loss from sale and disposal of premises and equipment   23    123 
Loss on sale of OREO and valuation allowance   36    136 
Proceeds from sales of mortgage loans   7,382    7,542 
Originations of mortgage loans held for sale   (7,977)   (7,915)
Gain on sales of mortgage loans   (87)   (157)
Realized gain on sale of securities available for sale and other investments   (234)   (3)
Undistributed income of UFS joint venture   (594)   (609)
Undistributed income of Ansay joint venture   (875)   (1,196)
Net earnings on life insurance   (153)   (149)
(Increase) decrease in other assets   (366)   1,333 
Decrease in other liabilities   (4,786)   (5,278)
Net cash provided by (used in) operating activities   (1,394)   97 
Cash flows from investing activities:
Activity in securities available for sale and held to maturity:          
Sales   -    86 
Maturities, prepayments, and calls   1,411    3,779 
Purchases   (3,015)   (10,175)
Net increase in loans   (3,314)   (6,451)
Dividends received from UFS   284    286 
Dividends received from Ansay   319    251 
Proceeds from sale of OREO   402    828 
Proceeds from sale of other investments   984    2,639 
Proceeds from sale of premises and equipment   -    149 
Purchases of premises and equipment   (999)   (5,600)
Net cash used in investing activities   (3,928)   (14,208)

 

 7 

 

 

ITEM 1. Financial Statements Continued:

 

BANK FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows (Continued)

(In thousands) (Unaudited)

 

   Three Months ended March 31, 
   2019   2018 
   (In Thousands) 
Cash flows from financing activities:
Net increase (decrease) in deposits  $16,557   $(38,160)
Net decrease in securities sold under repurchase agreements   (6,005)   (21,689)
Proceeds from advances of borrowed funds   -    217,000 
Repayment of borrowed funds   -    (200,000)
Repayment of notes payable   -    (1,500)
Dividends paid   (1,306)   (1,067)
Proceeds from sales of treasury stock   -    951 
Repurchase of common stock   (2,489)   (5,648)
Net cash (used in) provided by financing activities   6,757    (50,113)
Net increase (decrease) in cash and cash equivalents   1,435    (64,224)
Cash and cash equivalents at beginning of period   107,743    101,977 
Cash and cash equivalents at end of period  $109,178   $37,753 
           
Supplemental disclosures of cash flow information:
           
Cash paid during the period for:          
Interest  $4,211   $2,886 
Income taxes   -    - 
Supplemental schedule of noncash activities:          
Loans transferred to OREO   726    620 
MSR resulting from sale of loans   78    70 
Amortization of unrealized holding gains on securities transferred from available for sale to held to maturity recognized in other comprehensive income, net of tax   (9)   (32)
Change in unrealized gain (loss) on investment securities available for sale, net of tax   1,862    (1,406)
Payment of deferred compensation through issuance of treasury stock   57    - 

 

See accompanying notes to unaudited consolidated financial statements.

 

 8 

 

 

BANK FIRST NATIONAL CORPORATION

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

 

NOTE 1 – BASIS OF PRESENTATION

 

Bank First National Corporation (the “Company”) provides a variety of financial services to individual and corporate customers through its wholly-owned subsidiary, Bank First, N.A. (the “Bank”). The Bank operates as a full-service financial institution with a primary market area including, but not limited to, the counties in which the Bank’s branches are located. The Bank has eighteen locations located in Manitowoc, Outagamie, Brown, Winnebago, Sheboygan, Waupaca and Barron counties in Wisconsin. The Company and Bank are subject to the regulations of certain federal agencies and undergo periodic examinations by those regulatory authorities.

 

These interim unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures required by GAAP have been omitted or abbreviated. These unaudited consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“Annual Report”).

 

The unaudited consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods. The results for interim periods are not necessarily indicative of results for a full year.

 

Critical Accounting Policies and Estimates

 

Preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses (“ALL”), valuation of loans in acquisition transactions, useful lives for depreciation and amortization, fair value of financial instruments, other-than-temporary impairment calculations, valuation of deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the ALL, the determination and assessment of deferred tax assets and liabilities, and the valuation of loans acquired in acquisition transactions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking or tax regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.

 

There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as previously disclosed in the Company’s Annual Report.

 

 9 

 

 

Recent Accounting Developments Adopted

  

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” The update required lessees to recognize right-of-use assets and lease liabilities for all leases not considered short-term leases. The provisions of the update also include (a) defining direct costs to only include those incremental costs that would not have been incurred if the lease had not been entered into, (b) circumstances under which the transfer contract in a sale-leaseback transaction should be accounted for as the sale of an asset by the seller-lessee and the purchase of an asset by the buyer-lessor, and (c) additional disclosure requirements. The provisions of this update became effective for interim and annual periods beginning after December 15, 2018. Adoption of this guidance required the Company to record a right-of-use asset approximating $1.7 million, included in premises and equipment, and a corresponding lease liability, included in other liabilities.

 

In March 2017, the FASB issued ASU 2017-08, “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount, which continue to be amortized to maturity. This guidance became effective for interim and annual periods beginning after December 15, 2018. The adoption of this update did not have a material impact on the Company’s consolidated financial statements.

 

Recently Issued Not Yet Effective Accounting Standards

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as, the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will become effective for interim and annual periods beginning after December 15, 2019. Management is currently evaluating the potential impact of this update, although the general expectation in the banking industry is that the implementation of this standard will result in higher required balances in the ALL.

 

NOTE 2 – ACQUISITIONS

 

On October 27, 2017, the Company completed a merger with Waupaca Bancorporation, Inc. (“Waupaca”), a bank holding company headquartered in Waupaca, Wisconsin, pursuant to the Agreement and Plan of Bank Merger, dated as of May 11, 2017 and as amended on July 20, 2017, by and among the Company, BFNC Merger Sub, LLC, a wholly-owned subsidiary of the Company, and Waupaca, whereby Waupaca merged with and into the Company, and First National Bank, Waupaca’s wholly-owned banking subsidiary, was merged with and into the Bank. Waupaca’s principal activity was the ownership and operation of First National Bank, a national banking institution that operated eight (8) branches in Wisconsin at the time of closing. The merger consideration totaled approximately $78.1 million, 70% of which was distributed in cash and 30% of which was distributed in the form of Company common stock.

 

For more information concerning this acquisition, see “Note 2 – Acquisition” in the Company’s audited consolidated financial statements included in the Company’s Annual Report.

 

The Company entered into an Agreement and Plan of Merger with Partnership Community Bancshares, Inc. (“Partnership”), a Wisconsin Corporation, dated as of January 22, 2019 and as amended on April 30, 2019, under which Partnership will merge with and into the Company and Partnership’s banking subsidiary, Partnership Bank, will merge with and into the Bank. The transaction is expected to close early in the third quarter of 2019 and is subject to, among other items, approval by the shareholders of Partnership and regulatory agencies (received subsequent to March 31, 2019). Merger consideration will consist 65% of common stock of the Company and 35% of cash, and will total approximately $40.8 million, subject to the fair market valuation of the Company’s common stock on the date of closing. Based on results as of March 31, 2019, the combined company would have total assets of approximately $2.1 billion, loans of approximately $1.7 billion and deposits of approximately $1.8 billion.

 

 10 

 

 

NOTE 3 – EARNINGS PER SHARE

 

Basic earnings per share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share are computed by dividing net income by the sum of the weighted average number of shares of common stock outstanding and potential common shares using the treasury stock method.

 

A reconciliation of the numerators and denominators of the earnings per common share and earnings per common share assuming dilution, for the three months ended March 31, 2019 and 2018, are presented below:

 

   Three Months Ended March 31, 
   2019   2018 
Net income from operations  $6,587   $7,063 
           
Weighted average common shares outstanding   6,574,362    6,714,347 
Effect of dilutive potential common shares   33,911    - 
Diluted weighted average common shares outstanding   6,608,273    6,714,347 
           
Earnings per share - basic  $1.00   $1.05 
Earnings per share - diluted  $1.00   $1.05 

 

NOTE 4 – SECURITIES

 

The Company’s securities available for sale as of March 31, 2019 and December 31, 2018 is summarized as follows:

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Estimated 
   Cost   Gains   Losses   Fair Value 
                 
March 31, 2019                    
Obligations of states and political subdivisions  $51,158   $1,471   $(14)  $52,615 
Mortgage-backed securities   53,124    520    (150)   53,494 
Corporate notes   16,735    31    (114)   16,652 
Total available for sale securities  $121,017   $2,022   $(278)  $122,761 
                     
December 31, 2018                    
Obligations of states and political subdivisions  $51,292   $709   $(108)  $51,893 
Mortgage-backed securities   51,519    66    (1,016)   50,569 
Corporate notes   16,708    -    (264)   16,444 
Total available for sale securities  $119,519   $775   $(1,388)  $118,906 

 

 11 

 

 

The Company’s securities held to maturity as of March 31, 2019 and December 31, 2018 is summarized as follows:

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Estimated 
   Cost   Gains   Losses   Fair Value 
                 
March 31, 2019                       
U.S. Treasury securities   $28,977   $384   $(52)  $29,309 
Obligations of states and political subdivisions   11,792    11    -    11,803 
Total held to maturity securities  $40,769   $395   $(52)  $41,112 
                     
December 31, 2018                    
U.S. Treasury securities  $28,975   $92   $(389)  $28,678 
Obligations of states and political subdivisions   11,793    6    -    11,799 
Total held to maturity securities  $40,768   $98   $(389)  $40,477 

 

The following table shows the fair value and gross unrealized losses of securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

 

   Less Than 12 Months   Greater Than 12 Months   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
March 31, 2019 - Available for Sale                              
Obligations of states and political subdivisions  $1,035   $(2)  $2,498   $(12)  $3,533   $(14)
Mortgage-backed securities   -    -    28,050    (150)   28,050    (150)
Corporate notes   -    -    7,757    (114)   7,757    (114)
Totals  $1,035   $(2)  $38,305   $(276)  $39,340   $(278)
                               
March 31, 2019 - Held to Maturity                              
U.S. Treasury securities  $-   $-   $12,887   $(52)  $12,887   $(52)
                               
December 31, 2018 - Available for Sale                              
Obligations of states and political subdivisions  $10,024   $(64)  $4,132   $(44)  $14,156   $(108)
Mortgage-backed securities   13,352    (183)   31,718    (833)   45,070    (1,016)
Corporate notes   -    -    12,531    (264)   12,531    (264)
Totals  $23,376   $(247)  $48,381   $(1,141)  $71,757   $(1,388)
                               
December 31, 2018 - Held to Maturity                              
U.S. Treasury securities  $8,422   $(46)  $11,580   $(343)  $20,002   $(389)

 

 12 

 

 

As of March 31, 2019, the Company does not consider its securities with unrealized losses to be other-than-temporarily impaired, as the unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase, not credit deterioration. The Company has the intent and ability to hold its securities to maturity. There were no other-than-temporary impairments charged to earnings during the three months ended March 31, 2019 and 2018.

 

The following is a summary of amortized cost and estimated fair value of securities by contractual maturity as of March 31, 2019. Contractual maturities will differ from expected maturities for mortgage-backed securities because borrowers may have the right to call or prepay obligations without penalties.

 

   Available for Sale   Held to Maturity 
   Amortized   Estimated   Amortized   Estimated 
   Cost   Fair Value   Cost   Fair Value 
Due in one year or less  $4,010   $4,048   $2,927   $2,920 
Due after one year through five years   18,705    18,741    14,602    14,715 
Due after five years through ten years   12,714    13,062    19,460    19,697 
Due after ten years   32,464    33,416    3,780    3,780 
Subtotal   67,893    69,267    40,769    41,112 
Mortgage-backed securities   53,124    53,494    -    - 
Total  $121,017   $122,761   $40,769   $41,112 

  

The following is a summary of the proceeds from sales of securities available for sale, as well as gross gains and losses for the three months ended March 31, 2019 and 2018:

 

   2019   2018 
Proceeds from sales of securities  $-   $86 
Gross gains on sales   -    3 
Gross losses on sales   -    - 

 

 13 

 

 

NOTE 5 – LOANS, ALLOWANCE FOR LOAN LOSSES, AND CREDIT QUALITY

 

The following table presents total loans by portfolio segment and class of loan as of March 31, 2019 and December 31, 2018:

 

   March 31,   December 31, 
   2019   2018 
         
Commercial/industrial  $293,220   $297,576 
Commercial real estate - owner occupied   412,126    416,097 
Commercial real estate - non-owner occupied   258,310    252,717 
Construction and development   67,537    60,927 
Residential 1-4 family   367,518    368,673 
Consumer   27,242    26,854 
Other   6,165    6,369 
Subtotals   1,432,118    1,429,213 
ALL   (12,213)   (12,248)
Loans, net of ALL   1,419,905    1,416,965 
Deferred loan fees and costs   (620)   (719)
Loans, net  $1,419,285   $1,416,246 

 

The ALL by loan type as of March 31, 2019 and 2018 is summarized as follows:

 

   Commercial /
Industrial
   Commercial
Real Estate -
Owner
Occupied
   Commercial
Real Estate -
Non - Owner
Occupied
   Construction
and
Development
   Residential
1-4 Family
   Consumer   Other   Unallocated   Total 
                                     
ALL - January 1, 2019  $3,021   $3,459   $2,100   $725   $2,472   $148   $32   $291   $12,248 
Charge-offs   (586)   (78)   (54)   -    (8)   (11)   (5)   -    (742)
Recoveries   -    1    -    -    78    1    2    -    82 
Provision   (166)   1,723    (136)   (329)   (508)   (3)   12    32    625 
ALL - March 31, 2019   2,269    5,105    1,910    396    2,034    135    41    323    12,213 
                                              
ALL ending balance individually  evaluated for impairment   -    2,058    -    -    -    -    -    -    2,058 
                                              
ALL ending balance collectively  evaluated for impairment  $2,269   $3,047   $1,910   $396   $2,034   $135   $41   $323   $10,155 
                                              
Loans outstanding - March 31, 2019  $293,220   $412,126   $258,310   $67,537   $367,518   $27,242   $6,165   $-   $1,432,118 
Loans ending balance individually  evaluated for impairment   -    9,786    -    -    179    -    -    -    9,965 
                                              
Loans ending balance collectively  evaluated for impairment  $293,220   $402,340   $258,310   $67,537   $367,339   $27,242   $6,165   $-   $1,422,153 

 

 14 

 

  

   Commercial /
Industrial
   Commercial
Real Estate –
Owner Occupied
   Commercial
Real Estate -
Non - Owner
Occupied
   Construction
and
Development
   Residential
1-4 Family
   Consumer   Other   Unallocated   Total 
                                     
                                     
ALL - January 1, 2018  $2,362   $2,855   $1,987   $945   $2,728   $191   $23   $521   $11,612 
Charge-offs   -   (11)   -    (83)   (79)   (3)   (19)   -    (195)
Recoveries   1    2    1    -    202    2    3    -    211 
Provision   306    253    127    (128)   (39)   35   44    (113)   485 
ALL - March 31, 2018   2,669    3,099    2,115    734    2,812    225    51    408    12,113 
                                              
ALL ending balance individually evaluated for impairment   -    160    -    -    121    -    -    -    281 
                                              
ALL ending balance collectively evaluated for impairment  $2,669   $2,939   $2,115   $734   $2,691   $225   $51   $408   $11,832 
                                              
Loans outstanding -                                             
March 31, 2018  $283,993   $417,456   $226,265   $58,905   $373,542   $37,588   $7,891   $-   $1,405,640 
Loans ending balance individually evaluated for impairment   -    275    -    -    709    -    -    -    984 
                                              
Loans ending balance collectively evaluated for impairment  $283,993   $417,181   $226,265   $58,905   $372,833   $37,588   $7,891   $-   $1,404,656 

 

The Company’s past due loans as of March 31, 2019 is summarized as follows:

 

       90 Days         
   30-89 Days   or more         
   Past Due   Past Due         
   Accruing   and Accruing   Non-Accrual   Total 
                 
Commercial/industrial  $612   $-   $713   $1,325 
Commercial real estate - owner occupied   293    -    14,070    14,363 
Commercial real estate - non-owner occupied   28    -    222    250 
Construction and development   -    -    -    - 
Residential 1-4 family   1,162    293    963    2,418 
Consumer   5    1    4    10 
Other   -    -    -    - 
   $2,100   $294   $15,972   $18,366 

 

 15 

 

 

The Company’s past due loans as of December 31, 2018 is summarized as follows:

 

       90 Days         
   30-89 Days   or more         
   Past Due   Past Due         
   Accruing   and Accruing   Non-Accrual   Total 
                 
Commercial/industrial  $76   $-   $8,001   $8,077 
Commercial real estate - owner occupied   59    -    10,311    10,370 
Commercial real estate - non-owner occupied   -    58    233    291 
Construction and development   -    -    -    - 
Residential 1-4 family   275    362    1,549    2,186 
Consumer   9    3    5    17 
Other   -    -    -    - 
   $419   $423   $20,099   $20,941 

 

We utilize a numerical risk rating system for commercial relationships. All other types of relationships (ex: residential, consumer, other) are assigned a “Pass” rating, unless they have fallen 90 days past due or more, at which time they receive a rating of 7. The Company uses split ratings for government guaranties on loans. The portion of a loan that is supported by a government guaranty is included with other Pass credits.

 

The determination of a commercial loan risk rating begins with completion of a matrix, which assigns scores based on the strength of the borrower’s debt service coverage, collateral coverage, balance sheet leverage, industry outlook, and customer concentration. A weighted average is taken of these individual scores to arrive at the overall rating. This rating is subject to adjustment by the loan officer based on facts and circumstances pertaining to the borrower. Risk ratings are subject to independent review.

 

Commercial borrowers with ratings between 1 and 5 are considered Pass credits, with 1 being most acceptable and 5 being just above the minimum level of acceptance.

 

Commercial borrowers rated 6 have potential weaknesses which may jeopardize repayment ability.

 

Borrowers rated 7 have a well-defined weakness or weaknesses such as the inability to demonstrate significant cash flow for debt service based on analysis of the company’s financial information. These loans remain on accrual status provided full collection of principal and interest is reasonably expected. Otherwise they are deemed impaired and placed on nonaccrual status. Borrowers rated 8 are the same as 7 rated credits with one exception: collection or liquidation in full is not probable.

 

The breakdown of loans by risk rating as of March 31, 2019 is as follows:

 

   Pass (1-5)   6   7   8   Total 
                     
Commercial/industrial  $278,102   $3,190   $11,928   $-   $293,220 
Commercial real estate - owner occupied   370,657    3,777    37,692    -    412,126 
Commercial real estate - non-owner occupied   253,792    1,503    3,015    -    258,310 
Construction and development   67,476    -    61    -    67,537 
Residential 1-4 family   364,403    98    3,017    -    367,518 
Consumer   27,228    -    14    -    27,242 
Other   6,165    -    -    -    6,165 
                          
   $1,367,823   $8,568   $55,727   $-   $1,432,118 

 

 16 

 

 

The breakdown of loans by risk rating as of December 31, 2018 is as follows:

 

   Pass (1-5)   6   7   8   Total 
                     
Commercial/industrial  $277,993   $7,309   $12,274   $-   $297,576 
Commercial real estate - owner occupied   375,614    5,670    34,789    24    416,097 
Commercial real estate - non-owner occupied   249,625    -    3,092    -    252,717 
Construction and development   60,866    -    61    -    60,927 
Residential 1-4 family   364,289    664    3,718    2    368,673 
Consumer   26,835    -    18    1    26,854 
Other   6,369    -    -    -    6,369 
                          
   $1,361,591   $13,643   $53,952   $27   $1,429,213 

 

The ALL represents management’s estimate of probable and inherent credit losses in the loan portfolio. Estimating the amount of the ALL requires the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset on the consolidated balance sheets. Loan losses are charged off against the ALL, while recoveries of amounts previously charged off are credited to the ALL. A provision for loan losses (PFLL) is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

 

The ALL consists of specific reserves for certain individually evaluated impaired loans and general reserves for collectively evaluated non-impaired loans. Specific reserves reflect estimated losses on impaired loans from management’s analyses developed through specific credit allocations. The specific reserves are based on regular analyses of impaired, non-homogenous loans greater than $250,000. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based in part on the Bank’s historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as 1) changes in lending policies and/or underwriting practices, 2) national and local economic conditions, 3) changes in portfolio volume and nature, 4) experience, ability and depth of lending management and other relevant staff, 5) levels of and trends in past-due and nonaccrual loans and quality, 6) changes in loan review and oversight, 7) impact and effects of concentrations and 8) other issues deemed relevant.

 

There are many factors affecting ALL; some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses could be required that could adversely affect the Company’s earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged off or for which an actual loss is realized. As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

 

 17 

 

 

A summary of impaired loans individually evaluated as of March 31, 2019 is as follows:

 

   Commercial/
Industrial
   Commercial
Real Estate -
Owner
Occupied
   Commercial
Real Estate -
Non - Owner
Occupied
   Construction
and
Development
   Residential
1-4 Family
   Consumer   Other   Unallocated   Total 
                                     
With an allowance recorded:                                             
Recorded investment  $  -   $6,489   $     -   $       -   $    -   $    -   $    -   $   -   $6,489 
Unpaid principal balance   -    6,489    -    -    -    -    -    -    6,489 
Related allowance   -    2,058    -    -    -    -    -    -    2,058 
                                              
With no related allowance recorded:                                             
Recorded investment  $-   $3,297   $-   $-   $179   $-   $-   $-   $3,476 
Unpaid principal balance   -    3,297    -    -    179    -    -    -    3,476 
Related allowance   -    -    -    -    -    -    -    -    - 
                                              
Total:                                             
Recorded investment  $-   $9,786   $-   $-   $179   $-   $-   $-   $9,965 
Unpaid principal balance   -    9,786    -    -    179    -    -    -    9,965 
Related allowance   -    2,058    -    -    -    -    -    -    2,058 
                                              
Average recorded investment  $2,834   $8,791   $-   $-   $441   $-   $-   $-   $12,066 

 

 18 

 

 

A summary of impaired loans individually evaluated as of December 31, 2018 is as follows:

 

   Commercial/
Industrial
   Commercial
Real Estate -
Owner
Occupied
   Commercial
Real Estate -
Non - Owner
Occupied
   Construction
and
Development
   Residential
1-4 Family
   Consumer   Other   Unallocated   Total 
                                     
With an allowance recorded:                                             
Recorded investment  $5,667   $2,099   $     -   $     -   $523   $     -   $     -   $     -   $8,289 
Unpaid principal balance   5,667    2,099    -    -    523    -    -    -    8,289 
Related allowance   566    353    -    -    160    -    -    -    1,079 
                                              
With no related allowance recorded:                                             
Recorded investment  $-   $5,697   $-   $-   $179   $-   $-   $-   $5,876 
Unpaid principal balance   -    5,697    -    -    179    -    -    -    5,876 
Related allowance   -    -    -    -    -    -    -    -    - 
                                              
Total:                                             
Recorded investment  $5,667   $7,796   $-   $-   $702   $-   $-   $-   $14,165 
Unpaid principal balance   5,667    7,796    -    -    702    -    -    -    14,165 
Related allowance   566    353    -    -    160    -    -    -    1,079 
                                              
Average recorded investment  $2,834   $4,036   $-   $-   $706   $-   $-   $-   $7,576 

 

Interest recognized while these loans were impaired is considered immaterial to the consolidated financial statements for the three months ended March 31, 2019 and 2018.

 

The following table presents loans acquired with deteriorated credit quality as of March 31, 2019 and December 31, 2018. No loans in this table had a related allowance at either date, and therefore, the below disclosures were not expanded to include loans with and without a related allowance.

 

   March 31, 2019   December 31, 2018 
   Recorded
Investment
   Unpaid
Principal
Balance
   Recorded
Investment
   Unpaid
Principal
Balance
 
Commercial & Industrial  $665   $696   $555   $701 
Commercial real estate - owner occupied   1,326    1,939    1,558    2,069 
Commercial real estate - non-owner occupied   222    463    233    475 
Construction and development   123    123    171    171 
Residential 1-4 family   1,354    1,485    1,664    1,828 
Consumer   -    -    -    - 
Other   -    -    -    - 
   $3,690   $4,706   $4,181   $5,244 

 

Due to the nature of these loan relationships, prepayment expectations have not been considered in the determination of future cash flows. Management regularly monitors these loan relationships, and if information becomes available that indicates expected cash flows will differ from initial expectations, it may necessitate reclassification between accretable and non-accretable components of the original discount calculation.

 

 19 

 

 

The following table represents the change in the accretable and non-accretable components of discounts on loans acquired with deteriorated credit quality for the periods ended March 31, 2019, and December 31, 2018:

 

   March 31, 2019   December 31, 2018 
   Accretable   Non-accretable   Accretable   Non-accretable 
   discount   discount   discount   discount 
                 
Balance at beginning of period  $318   $745   $583   $800 
Acquired balance, net   -    -    -    - 
Reclassifications between accretable and non-accretable   -    -    55    (55)
Accretion to loan interest income   (47)   -    (320)   - 
Disposals of loans   -    -    -    - 
Balance at end of period  $271   $745   $318   $745 

 

A troubled debt restructuring (TDR) includes a loan modification where a borrower is experiencing financial difficulty and we grant a concession to that borrower that we would not otherwise consider except for the borrower’s financial difficulties. A TDR may be either on accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability. If a TDR is placed on nonaccrual status, it remains there until a sufficient period of performance under the restructured terms has occurred at which time it is returned to accrual status, generally six months. As of March 31, 2019 and December 31, 2018 the Company had specific reserves of $2.1 million and $0.4 million for TDRs, respectively, and none of them have subsequently defaulted. There were no loan modifications resulting in TDRs during the three months ended March 31, 2019 and 2018.

 

NOTE 6 – MORTGAGE SERVICING RIGHTS

 

Loans serviced for others are not included in the accompanying consolidated balance sheets. Mortgage servicing rights (MSRs) are recognized as separate assets when loans sold in the secondary market are sold with servicing retained. The Company utilizes a third-party consulting firm to determine an accurate assessment of the mortgage servicing rights fair value. The third-party firm collects relevant data points from numerous sources. Some of these data points relate directly to the pricing level or relative value of the mortgage servicing while other data points relate to the assumptions used to derive fair value. In addition, the valuation evaluates specific collateral types, and current and historical performance of the collateral in question. The valuation process focuses on the non-distressed secondary servicing market, common industry practices and current regulatory standards. The primary determinants of the fair value of mortgage servicing rights are servicing fee percentage, ancillary income, expected loan life or prepayment speeds, discount rates, costs to service, delinquency rates, foreclosure losses and recourse obligations. The valuation data also contains interest rate shock analyses for monitoring fair value changes in differing interest rate environments.

 

 20 

 

 

Following is an analysis of activity in the mortgage servicing rights asset:

 

   Three Months Ended   Year Ended 
   March 31, 2019   December 31, 2018 
         
Fair value at beginning of year  $3,085   $2,610 
Servicing asset additions   78    356 
Loan payments and payoffs   (106)   (475)
Changes in valuation inputs and assumptions used in the valuation model   28    594 
Amount recognized through earnings   -    475 
Fair value at end of period  $3,085   $3,085 
           
Unpaid principal balance of loans serviced for others  $316,504   $316,480 
Mortgage servicing rights as a percent of loans serviced for others   0.97    0.97 

 

The primary economic assumptions utilized by the Company in measuring the value of MSRs were constant prepayment speeds of 8.3 months as of March 31, 2019 and December 31, 2018, and discount rates of 10% as of both period ends.

 

NOTE 7 – NOTES PAYABLE

 

From time to time the Company utilizes short-term Federal Home Loan Bank (FHLB) advances to fund liquidity. The Bank had no advances outstanding from FHLB at March 31, 2019 or December 31, 2018.

 

The Company maintains a $5.0 million line of credit with a commercial bank. At March 31, 2019 and December 31, 2018, the Company had no outstanding balances on this note. The note requires monthly payments of interest at a variable rate, and is due in full on May 25, 2019.

 

The Company maintains a $5.0 million line of credit with another commercial bank. There were no outstanding balances on this note at March 31, 2019 or December 31, 2018. The note requires monthly payments of interest at a variable rate, and is due in full on May 19, 2019.

 

NOTE 8 – SUBORDINATED NOTES

 

During September 2017, the Company entered into subordinated note agreements with three separate commercial banks. The Company had outstanding balances of $11.5 million under these agreements as of March 31, 2019 and December 31, 2018. These notes were all issued with 10-year maturities, carry interest at a variable rate payable quarterly, are callable on or after the sixth anniversary of the issuance dates, and qualify for Tier 2 capital for regulatory purposes.

 

NOTE 9 – REGULATORY MATTERS

 

Banks and certain bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

 

The Economic Growth, Regulatory Relief, and Consumer Protection Act, signed into law in May 2018 raised the threshold for those bank holding companies subject to the Federal Reserve’s Small Bank Holding Company Policy Statement to $3 billion. As a result, as of the effective date of that change in 2018, the Company was no longer required to comply with the risk-based capital rules applicable to the Bank. The Federal Reserve may, however, require smaller bank holding companies to maintain certain minimum capital levels, depending upon general economic conditions and a bank holding company’s particular condition, risk profile and growth plans.

 

 21 

 

 

Under regulatory guidance for non-advanced approaches institutions, the Bank is required to maintain minimum amounts and ratios of common equity Tier I capital to risk-weighted assets. Additionally, under Basel III rules, the decision was made to opt-out of including accumulated other comprehensive income in regulatory capital. As of March 31, 2019 and December 31, 2018, the Bank met all capital adequacy requirements to which they are subject.

 

Beginning in 2016, an additional conservation buffer was added to the minimum requirements for capital adequacy purposes, subject to a three year phase-in period. As of December 31, 2018, the buffer was 1.88%. The capital conservation buffer was fully phased in January 1, 2019 at 2.50%.

 

Actual and required capital amounts and ratios are presented below at period-end:

 

               To Be Well 
           Minimum Capital   Capitalized Under 
       For Capital   Adeqaucy with   Prompt Corrective 
   Actual   Adequacy Purposes   Capital Buffer   Action Provisions 
   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                                 
March 31, 2019                                        
Total capital (to risk-weighted assets):                               
Company  $184,328    11.53%   NA    NA    NA    NA    NA    NA 
Bank  $181,904    11.40%  $127,706    8.00%  $167,614    10.50%  $159,632    10.00%
Tier 1 capital (to risk-weighted assets):                               
Company  $160,615    10.05%   NA    NA    NA    NA    NA    NA 
Bank  $169,691    10.63%  $95,779    6.00%  $135,687    8.50%  $127,706    8.00%
Common Equity Tier 1 capital (to risk-weighted assets):                          
Company  $160,615    10.05%   NA    NA    NA    NA    NA    NA 
Bank  $169,691    10.63%  $71,834    4.50%  $111,742    7.00%  $103,761    6.50%
Tier 1 capital (to average assets):                                
Company  $160,615    9.15%   NA    NA    NA    NA    NA    NA 
Bank  $169,691    9.68%  $70,124    4.00%   70,124    4.00%  $87,655    5.00%
December 31, 2018                                     
Total capital (to risk-weighted assets):                               
Company  $181,201    11.35%   NA    NA    NA    NA    NA    NA 
Bank  $178,668    11.21%  $127,497    8.00%  $157,459    9.88%  $159,372    10.00%
Tier 1 capital (to risk-weighted assets):                               
Company  $157,453    9.86%   NA    NA    NA    NA    NA    NA 
Bank  $166,420    10.44%  $95,623    6.00%  $125,585    7.88%  $127,497    8.00%
Common Equity Tier 1 capital (to risk-weighted assets):                          
Company  $157,453    9.86%   NA    NA    NA    NA    NA    NA 
Bank  $166,420    10.44%  $71,717    4.50%  $101,679    6.38%  $103,592    6.50%
Tier 1 capital (to average assets):                                
Company  $157,453    9.06%   NA    NA    NA    NA    NA    NA 
Bank  $166,420    9.59%  $69,410    4.00%   69,410    4.00%  $86,762    5.00%

 

NOTE 10 – COMMITMENTS AND CONTINGENCIES

 

The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate-lock commitments). Rate-lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements and for fixed rate commitments also considers the difference between current levels of interest rates and committed rates. The notional amount of rate-lock commitments at March 31, 2019 and December 31, 2018, was approximately $8.7 million and $3.3 million, respectively.

 

 22 

 

 

The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

 

The Company’s exposure to credit loss is represented by the contractual or notional amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments. Since some of the commitments are expected to expire without being drawn upon and some of the commitments may not be drawn upon to the total extent of the commitment, the notional amount of these commitments does not necessarily represent future cash requirements.

 

The following commitments were outstanding:

 

   Notional Amount 
   March 31, 2019   December 31, 2018 
Commitments to extend credit:          
Fixed  $44,954   $57,911 
Variable   264,160    268,541 
Credit card arrangements   7,507    7,119 
Letters of credit   25,021    25,261 

 

NOTE 11 – FAIR VALUE MEASUREMENTS

 

Accounting guidance establishes a fair value hierarchy to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.

 

Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

 23 

 

 

Information regarding the fair value of assets measured at fair value on a recurring basis is as follows:

 

   Instruments   Markets   Other   Significant 
   Measured   for Identical   Observable   Unobservable 
   At Fair   Assets   Inputs   Inputs 
   Value   (Level 1)   (Level 2)   (Level 3) 
                 
March 31, 2019                    
Assets                    
Securities available for sale                    
Obligations of states and political subdivisions  $52,615   $-   $52,215   $400 
Mortgage-backed securities   53,494    -    53,494    - 
Corporate notes   16,652    -    16,652    - 
Mortgage servicing rights   3,085    -    3,085    - 
Other investments   816    -    816    - 
                     
December 31, 2018                    
Assets                    
Securities available for sale                    
Obligations of states and political subdivisions  $51,893   $-   $51,493   $400 
Mortgage-backed securities   50,569    -    50,569    - 
Corporate notes   16,444    -    16,444    - 
Mortgage servicing rights   3,085    -    3,085    - 

 

Fair value of assets measured on a recurring basis using significant unobservable inputs (Level 3) are as follows:

 

   March 31, 2019   December 31, 2018 
         
Total securities at beginning of period  $400   $500 
Included in earnings   -    - 
Included in other comprehensive income   -    - 
Purchases, issuance, and settlements   -    (100)
Transfer in and/or out of level 3   -    - 
Total securities at end of period  $400   $400 

 

 24 

 

 

Information regarding the fair value of assets measured at fair value on a non-recurring basis is as follows:

 

       Quoted Prices         
       In Active   Significant     
   Assets   Markets   Other   Significant 
   Measured   for Identical   Observable   Unobservable 
   At Fair   Assets   Inputs   Inputs 
   Value   (Level 1)   (Level 2)   (Level 3) 
March 31, 2019                    
Other real estate owned  $3,880   $-   $-   $3,880 
Impaired Loans, net of impairment reserve   15,228    -    -    15,228 
   $19,108   $-   $-   $19,108 
December 31, 2018                    
Other real estate owned  $3,592   $-   $-   $3,592 
Impaired Loans, net of impairment reserve   20,872    -    -    20,872 
   $24,464   $-   $-   $24,464 

 

The following is a description of the valuation methodologies used by the Company for the items noted in the table above, including the general classification of such instruments in the fair value hierarchy. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell. The following table shows significant unobservable inputs used in the fair value measurement of Level 3 assets:

 

   Valuation
Technique
  Unobservable
Inputs
  Range of
Discounts
  Weighted
Average
Discount
 
As of March 31, 2019             
Other real estate owned  Third party appraisals, sales contracts or brokered price options  Collateral discounts and estimated costs to sell  0% - 87%  21.7%
Impaired loans  Third party appraisals and discounted cash flows  Collateral discounts and discount rates  0% - 100%  5.4%
               
As of December 31, 2018              
Other real estate owned  Third party appraisals, sales contracts or brokered price options  Collateral discounts and estimated costs to sell  0% - 40%  18.6%
Impaired loans  Third party appraisals and discounted cash flows  Collateral discounts and discount rates  0% - 100%  9.3%

 

 25 

 

 

The following methods and assumptions were used by the Company to estimate fair value of financial instruments.

 

Cash and cash equivalents — Fair value approximates the carrying amount.

 

Securities — The fair value measurement is obtained from an independent pricing service and is based on recent sales of similar securities and other observable market data.

 

Loans held for sale — Fair value is based on commitments on hand from investors or prevailing market prices.

 

Loans — Fair value of variable rate loans that reprice frequently are based on carrying value. Fair value of other loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings. Fair value of impaired and other nonperforming loans are estimated using discounted expected future cash flows or the fair value of the underlying collateral, if applicable.

 

Other investments — The carrying amount reported in the consolidated balance sheets for other investments approximates the fair value of these assets.

 

Mortgage servicing rights — Fair values were determined using the present value of future cash flows.

 

Cash value of life insurance — The carrying amount approximates its fair value.

 

Deposits — Fair value of deposits with no stated maturity, such as demand deposits, savings, and money market accounts, by definition, is the amount payable on demand on the reporting date. Fair value of fixed-rate time deposits is estimated using discounted cash flows applying interest rates currently offered on similar time deposits.

 

Securities sold under repurchase agreements — The fair value of securities sold under repurchase agreements with variable rates or due on demand is the amount payable at the reporting date. The fair value of securities sold under repurchase agreements with fixed terms is estimated using discounted cash flows with discount rates at interest rates currently offered for securities sold under repurchase agreements of similar remaining values.

 

Subordinated notes — Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Fair value of borrowings is estimated by discounting future cash flows using the current rates at which similar borrowings would be made. Fair value of borrowed funds due on demand is the amount payable at the reporting date.

 

Off-balance-sheet instruments — Fair value is based on quoted market prices of similar financial instruments where available. If a quoted market price is not available, fair value is based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the company’s credit standing. Since this amount is immaterial, no amounts for fair value are presented.

 

 26 

 

 

The carrying value and estimated fair value of financial instruments at March 31, 2019 and December 31, 2018 are as follows:

 

       Fair Value 
March 31, 2019  Carrying
amount
   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and cash equivalents  $109,178   $109,178   $-   $-   $109,178 
Securities held to maturity   40,769    -    41,112    -    41,112 
Securities available for sale   122,761    -    122,361    400    122,761 
Loans, net   1,419,285    -    -    1,405,581    1,405,581 
Loans held for sale   596    -    -    596    596 
Other investments   4,427    -    869    3,558    4,427 
Mortgage servicing rights   3,085    -    3,085    -    3,085 
Cash surrender value of life insurance   24,331    24,331    -    -    24,331 
                          
Financial liabilities:                         
Deposits  $1,573,677   $-   $-   $1,476,102   $1,476,102 
Securities sold under repurchase agreements   25,484    -    25,484    -    25,484 
Subordinated notes   11,500    -    11,500    -    11,500 

 

       Fair Value 
December 31, 2018  Carrying
amount
   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and cash equivalents  $107,743   $107,743   $-   $-   $107,743 
Securities held to maturity   40,768    -    40,477    -    40,477 
Securities available for sale   118,906    -    118,506    400    118,906 
Loans, net   1,416,246    -    -    1,400,538    1,400,538 
Other investments, at cost   4,555    -    -    4,555    4,555 
Mortgage servicing rights   3,085    -    3,085    -    3,085 
Cash surrender value of life insurance   24,178    24,178    -    -    24,178 
                          
Financial liabilities:                         
Deposits  $1,557,167   $-   $-   $1,449,552   $1,449,552 
Securities sold under repurchase agreements   31,489    -    31,489    -    31,489 
Subordinated notes   11,500    -    11,500    -    11,500 

 

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Consequently, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

 

Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters that could affect the estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.

 

 27 

 

 

Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the consolidated balance sheet. Significant assets and liabilities that are not considered financial assets and liabilities include premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

 

NOTE 12 – STOCK BASED COMPENSATION

 

The Company has made restricted share grants pursuant to the Bank First National Corporation 2011 Equity Plan. The purpose of the Plan is to provide financial incentives for selected employees and for the non-employee Directors of the Company, thereby promoting the long-term growth and financial success of the Company. The Company stock to be offered under the Plan pursuant to Stock Appreciation Rights (SAR), performance unit awards, and restricted stock and unrestricted Company stock awards must be Company stock previously issued and outstanding and reacquired by the Company. The number of shares of Company stock that may be issued pursuant to awards under the Plan shall not exceed, in the aggregate, 659,250. As of March 31, 2019 and December 31, 2018, 177,377 and 160,362 shares of Company stock have been awarded under the Plan, respectively. Compensation expense for restricted stock is based on the fair value of the awards of Bank First National Corporation common stock at the time of grant. The value of restricted stock grants that are expected to vest is amortized into expense over the vesting periods. For the three months ended March 31, 2019 and 2018, compensation expense of $0.2 million and $0.1 million, respectively, was recognized related to restricted stock awards.

 

As of March 31, 2019, there was $2.1 million of unrecognized compensation cost related to non-vested restricted stock awards granted under the Plan. That cost is expected to be recognized over a weighted average period of 3.33 years. The aggregate grant date fair value of restricted stock awards that vested during the three months ended March 31, 2019, was approximately $0.5 million. The table below summarizes the number of restricted stock granted under the Plan and the weighted-average fair value of the grant for the three months ended March 31, 2019 and 2018.

 

   For the three months ended March 31, 2019   For the three months ended March 31, 2018 
                 
       Weighted-       Weighted- 
       Average Grant-       Average Grant- 
   Shares   Date Fair Value   Shares   Date Fair Value 
Restricted Stock                    
Outstanding at beginning of period   51,776   $34.27    53,619   $26.59 
Granted   17,015    56.62    15,500    45.40 
Vested   (16,039)   28.82    (18,395)   23.53 
Forfeited or cancelled   (176)   22.90    -    - 
Outstanding at end of period   52,576   $43.31    50,724   $33.45 

 

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NOTE 13 – LEASES

 

In February 2016, the FASB established Topic 842, Leases, by issuing Accounting Standards Update (ASU) No. 2016-02, which requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. Subsequently, amendments ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; and ASU No. 2018-11, Targeted Improvements were issued. ASC 842 establishes a right-of-use (“ROU”) model that requires a lessee to recognize a ROU lease asset and liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.

 

The Company leases certain properties under operating leases that resulted in the recognition of ROU lease assets of approximately $1.7 million and corresponding lease liabilities of the same value on the Company’s Consolidated Balance Sheets.

 

ASC 842 was effective on January 1, 2019. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. The Company chose to use the effective date approach.  As such, all periods presented after January 1, 2019 are under ASC 842 whereas periods presented prior to January 1, 2019 are in accordance with prior lease accounting of ASC 840.  Financial information was not updated and the disclosures required under ASC 842 was not provided for dates and periods before January 1, 2019.  

 

ASC 842 provides a number of optional practical expedients in transition. The Company has elected the ‘package of practical expedients,’ which permits the Company not to reassess under the new standard the prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected the use of the hindsight, a practical expedient which permits the use of information available after lease inception to determine the lease term via the knowledge of renewal options exercised not available as of the leases inception.  The practical expedient pertaining to land easements is not applicable to the Company.  

 

ASC 842 also requires certain accounting elections for ongoing application of ASC 842.  The Company elected the short-term lease recognition exemption for all leases that qualify, meaning those with terms under twelve months.  ROU assets or lease liabilities are not to be recognized for short-term leases. The Company also elected the practical expedient to not separate lease and non-lease components for all leases, the majority of which consist of real estate common area maintenance expenses.   However, since these non-lease items are subject to change, they are treated and disclosed as variable payments in the quantitative disclosures below.  Consequently, ASC 842’s changed guidance on contract components will not significantly affect our financial reporting.  Similarly, ASC 842’s narrowed definition of initial direct costs will not significantly affect financial reporting.

 

Lessee Leases

 

The Company’s lessee leases are operating leases, and consist of leased real estate for branches.  Options to extend and renew leases are generally exercised under normal circumstances.  Advance notification is required prior to termination, and any noticing period is often limited to the months prior to renewal. Rent escalations are generally specified by a payment schedule, or are subject to a defined formula.  The Company also elected the practical expedient to not separate lease and non-lease components for all leases, the majority of which consist of real estate common area maintenance expenses.  Generally, leases do not include guaranteed residual values, but instead typically specify that the leased premises are to be returned in satisfactory condition with the Company liable for damages.  

 

For operating leases, the lease liability and ROU asset (before adjustments) are recorded at the present value of future lease payments.  ASC 842 requires the use of the lease interest rate; however, this rate is typically not known.  As an alternative, ASC 842 permits the use of an entity’s fully secured incremental borrowing rate.  The Company is electing to utilize the Wall Street Journal Prime Rate on the date of lease commencement.  

 

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    Three-month
period ended
 
    Mar. 31, 2019  
Amortization of ROU Assets - Finance Leases   $ 16  
Interest on Lease Liabilities - Finance Leases     16  
Operating Lease Cost (Cost resulting from lease payments)     32  
New ROU Assets - Operating Leases     1,744  
Weighted Average Lease Term (Years) - Operating Leases   31.68  
Weighted Average Discount Rate - Operating Leases     5.50 %

  

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liabilities as of March 31, 2019 is as follows:

 

   Mar. 31, 2019 
Operating lease payments due:     
Within one year  $133 
After one but within two years   136 
After two but within three years   136 
After three but within four years   103 
After four years but within five years   85 
After five years   3,475 
Total undiscounted cash flows   4,068 
Discount on cash flows   (2,341)
Total operating lease liabilities  $1,727 

  

 30 

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2018, included in our Annual Report and with our unaudited condensed accompanying notes set forth in this Quarterly Report on Form 10-Q for the quarterly period March 31, 2019.

 

FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this report are forward-looking statements within the meaning of and subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements relating to the Company’s assets, business, cash flows, condition (financial or otherwise), credit quality, financial performance, liquidity, short and long-term performance goals, prospects, results of operations, strategic initiatives, potential future acquisitions, disposition and other growth opportunities. These statements, which are based upon certain assumptions and estimates and describe the Company’s future plans, results, strategies and expectations, can generally be identified by the use of the words and phrases “may,” “will,” “should,” “could,” “would,” “goal,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target,” “aim,” “predict,” “continue,” “seek,” “projection” and other variations of such words and phrases and similar expressions. These forward-looking statements are not historical facts, and are based upon current expectations, estimates and projections about the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control. The inclusion of these forward-looking statements should not be regarded as a representation by the Company or any other person that such expectations, estimates and projections will be achieved. Accordingly, the Company cautions investors that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict and that are beyond the Company’s control. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable as of the date of this report, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements. A number of factors could cause actual results to differ materially from those contemplated by the forward-looking statement in this report including, without limitation, the risks and other factors set forth in the Company’s Annual Report under the captions “Cautionary Note Regarding Forward-Looking Statements” and “Risk factors.” Many of these factors are beyond the Company’s ability to control or predict. If one or more events related to these or other risks or uncertainties materialize, or if the Company’s underlying assumptions prove to be incorrect, actual results may differ materially from the forward-looking statements. Accordingly, investors should not place undue reliance on any such forward-looking statements. Any forward-looking statements speaks only as of the date of this report, and the Company does not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by law. New risks and uncertainties may emerge from time to time, and it is not possible for the Company to predict their occurrence or how they will affect the Company.

 

We qualify all of our forward-looking statements by these cautionary statements.

 

OVERVIEW

 

Bank First National Corporation is a Wisconsin corporation that was organized primarily to serve as the holding company for Bank First, N.A. Bank First, N.A., which was incorporated in 1894, is a nationally-chartered bank headquartered in Manitowoc, Wisconsin. It is a member of the Board of Governors of the Federal Reserve System (“Federal Reserve”), and is regulated by the Office of the Comptroller of the Currency (“OCC”). Including its headquarters in Manitowoc, Wisconsin, the Bank has 18 banking locations in Manitowoc, Outagamie, Brown, Winnebago, Sheboygan, Waupaca and Barron counties in Wisconsin. The Bank offers loan, deposit and treasury management products at each of its banking locations.

 

As with most community banks, the Bank derives a significant portion of its income from interest received on loans and investments. The Bank’s primary source of funding is deposits, both interest-bearing and noninterest-bearing. In order to maximize the Bank’s net interest income, or the difference between the income on interest-earning assets and the expense of interest-bearing liabilities, the Bank must not only manage the volume of these balance sheet items, but also the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities. To account for credit risk inherent in all loans, the Bank maintains an ALL to absorb possible losses on existing loans that may become uncollectible. The Bank establishes and maintains this allowance by charging a provision for loan losses against operating earnings. Beyond its net interest income, the Bank further receives income through the net gain on sale of loans held for sale as well as servicing income which is retained on those sold loans. In order to maintain its operations and bank locations, the Bank incurs various operating expenses which are further described within the “Results of Operations” later in this section.

 

The Bank is a 49.8% member of a data processing subsidiary, UFS, LLC which provides core data processing, endpoint management cloud services, cyber security and digital banking solutions for over 50 Midwest banks. The Bank, through its 100% owned subsidiary TVG Holdings, Inc., also holds a 30% ownership interest in Ansay & Associates, LLC, an insurance agency providing clients throughout Wisconsin with insurance and risk management solutions. These unconsolidated subsidiary interests contribute noninterest income to the Bank through their underlying annual earnings.

 

On October 27, 2017, the Company consummated its merger with Waupaca pursuant to the Agreement and Plan of Bank Merger, dated as of May 11, 2017 and as amended on July 20, 2017, by and among the Company, BFNC Merger Sub, LLC, a wholly-owned subsidiary of the Company, and Waupaca, whereby Waupaca was merged with and into the Company, and First National Bank, Waupaca’s wholly owned banking subsidiary, was merged with and into the Bank. The system integration was completed, and six branches of First National Bank opened on October 30, 2017 as branches of the Bank, expanding the Bank’s presence into Barron and Waupaca counties.

 

The Company entered into an Agreement and Plan of Merger with Partnership Community Bancshares, Inc., a Wisconsin Corporation, dated as of January 22, 2019 and as amended on April 30, 2019, under which Partnership will merge with and into the Company and Partnership’s banking subsidiary, Partnership Bank, will merge with and into the Bank. The transaction is expected to close early in the third quarter of 2019 and is subject to, among other items, approval by the shareholders of Partnership and regulatory agencies (received subsequent to March 31, 2019). Merger consideration will consist 65% of common stock of the Company and 35% of cash, and will total approximately $40.8 million, subject to the fair market valuation of the Company’s common stock on the date of closing. Based on results as of March 31, 2019, the combined company would have total assets of approximately $2.10 billion, loans of approximately $1.70 billion and deposits of approximately $1.80 billion.

 

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

 

The following tables present certain selected historical consolidated financial data as of the dates or for the period indicated:

 

   At or for the Three Months Ended 
(In thousands, except per share data)  3/31/2019   12/31/2018   9/30/2018   6/30/2018   3/31/2018 
                     
Results of Operations:                         
                          
Interest income  $19,723   $19,753   $19,510   $19,372   $19,309 
Interest expense   4,523    4,240    3,974    3,604    3,027 
                          
Net interest income   15,200    15,513    15,536    15,768    16,282 
Provision for loan losses   625    750    800    900    485 
                          
Net interest income after provision for loan losses   14,575    14,763    14,736    14,868    15,797 
                          
Noninterest income   3,306    2,553    2,508    3,027    3,443 
Noninterest expense   9,302    9,893    9,708    10,064    9,977 
                          
Income before income tax expense   8,579    7,423    7,536    7,831    9,263 
Income tax expense   1,992    1,362    1,604    1,431    2,200 
                          
Net income  $6,587   $6,061   $5,932   $6,400   $7,063 
                          
Earnings per common share - basic  $1.00   $0.91   $0.89   $0.96   $1.05 
Earnings per common share - diluted   1.00    0.91    0.89    0.96    1.05 
                          
Common Shares:                         
                          
Basic weighted average   6,574,362    6,647,586    6,661,337    6,672,344    6,714,347 
Diluted weighted average   6,608,273    6,647,586    6,661,337    6,672,344    6,714,347 
Outstanding   6,577,045    6,610,358    6,659,021    6,662,292    6,692,407 
                          
Noninterest income / noninterest expense:                         
                          
Service charges  $679   $890   $971   $786   $846 
Income from Ansay   875    180    176    562    1,196 
Income from UFS   594    708    660    586    609 
Loan servicing income   223    372    260    604    242 
Net gain on sales of mortgage loans   87    188    144    128    157 
Noninterest income from strategic alliances   19    22    24    21    23 
Other noninterest income   829    193    273    340    370 
                          
Total noninterest income  $3,306   $2,553   $2,508   $3,027   $3,443 
                          
Personnel expense  $5,310   $5,532   $5,205   $5,446   $5,317 
Occupancy, equipment and office   849    799    817    532    1,350 
Data processing   913    899    856    925    939 
Postage, stationery and supplies   123    156    138    159    167 
Net (gain) loss on sales of other real estate owned   36    (79)   233    (38)   136 
Net (gain) loss on sales of securities   (234)   -    (19)   47    (3)
Advertising   74    78    36    54    52 
Charitable contributions   131    121    169    322    373 
Outside service fees   684    899    817    896    520 
Amortization of intangibles   161    189    189    189    189 
Other noninterest income   1,255    1,299    1,267    1,532    937 
                          
Total noninterest expense  $9,302   $9,893   $9,708   $10,064   $9,977 
                          
Period-end balances:                         
                          
Loans  $1,431,498   $1,428,494   $1,441,477   $1,434,504   $1,405,245 
Allowance for loan losses   12,213    12,248    11,560    13,047    12,113 
Investment securities available-for-sale, at fair value   122,761    118,906    119,623    121,550    124,238 
Investment securities held-to-maturity, at cost   40,769    40,768    40,882    41,203    39,082 
Goodwill and other intangibles, net   20,160    20,321    20,425    20,614    20,413 
Total assets   1,805,408    1,793,165    1,735,754    1,741,874    1,703,623 
Deposits   1,573,677    1,557,167    1,486,470    1,495,424    1,468,713 
Stockholders' equity   179,177    174,323    169,133    165,200    161,795 
Book value per common share   27.24    26.37    25.40    24.80    24.18 
Tangible book value per common share (1)   24.65    23.76    22.78    22.15    21.52 
                          
Average balances:                         
                          
Loans  $1,434,283   $1,435,745   $1,437,832   $1,424,604   $1,404,766 
Interest-earning assets   1,652,106    1,637,080    1,654,966    1,676,017    1,671,358 
Total assets   1,773,345    1,755,835    1,772,768    1,794,227    1,786,306 
Deposits   1,548,306    1,510,978    1,487,865    1,474,952    1,470,579 
Interest-bearing liabilities   1,141,177    1,144,202    1,185,391    1,215,923    1,211,571 
Goodwill and other intangibles, net   20,259    20,377    20,610    20,474    20,503 
Stockholders' equity   175,058    170,992    167,651    162,860    161,331 
                          
Financial ratios (2):                         
                          
Return on average assets   1.49%   1.37%   1.33%   1.42%   1.57%
Return on average common equity   15.05%   14.06%   14.04%   15.59%   17.37%
Average equity to average assets   9.87%   9.74%   9.46%   9.08%   9.03%
Stockholders' equity to assets   9.92%   9.72%   9.74%   9.48%   9.50%
Tangible equity to tangible assets (1)   9.06%   8.85%   8.83%   8.56%   8.54%
Loan yield   5.15%   5.09%   4.98%   5.04%   5.12%
Earning asset yield   4.93%   4.88%   4.76%   4.72%   4.77%
Cost of funds   1.61%   1.47%   1.33%   1.19%   1.01%
Net interest margin, taxable equivalent   3.82%   3.85%   3.81%   3.86%   4.04%
Net loan charge-offs to average loans   0.18%   0.00%   0.16%   0.00%   0.00%
Nonperforming loans to total loans   1.14%   1.44%   1.99%   1.43%   1.45%
Nonperforming assets to total assets   1.07%   1.30%   1.79%   1.32%   1.44%
Allowance for loan losses to loans   0.85%   0.86%   0.80%   0.91%   0.86%

 

(1)These measures are not measures prepared in accordance with GAAP, and are therefore considered to be non-GAAP financial measures. See "GAAP reconciliation and management explanation of nonGAAP finanical measures" for a reconciliation of these measures to their most comparable GAAP measures.
(2)Income statement-related ratios for partial year periods are annualized.

 

GAAP RECONCILIATION AND MANAGEMENT EXPLANATION OF NON-GAAP FINANCIAL MEASURES

 

We identify certain financial measures discussed in the Report as being “non-GAAP financial measures.” The non-GAAP financial measures presented in this Report are tangible book value per common share and tangible equity to tangible assets.

 

In accordance with the SEC’s rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows.

 

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The non-GAAP financial measures that we discuss in this Report should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in our selected historical consolidated financial data may differ from that of other companies reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have presented in our selected historical consolidated financial data when comparing such non-GAAP financial measures. The following discussion and reconciliations provide a more detailed analysis of these non-GAAP financial measures. Tangible book value per common share and tangible equity to tangible assets are non-GAAP measures that exclude the impact of goodwill and other intangibles used by the Company’s management to evaluate capital adequacy. Because intangible assets such as goodwill and other intangibles vary extensively from company to company, we believe that the presentation of this information allows investors to more easily compare the Company’s capital position to other companies. The most directly comparable financial measures calculated in accordance with GAAP are book value per common share, return on average common equity and stockholders’ equity to total assets.

 

   At or for the Three Months Ended 
(In thousands, except per share data)  3/31/2019   12/31/2018   9/30/2018   6/30/2018   3/31/2018 
                     
Tangible Assets                         
Total assets  $1,805,408   $1,793,165   $1,735,754   $1,741,874   $1,703,623 
Adjustments:                         
Goodwill   (15,024)   (15,024)   (15,024)   (15,024)   (15,024)
Core deposit intangible, net of amortization   (2,051)   (2,212)   (2,401)   (2,590)   (2,779)
Tangible assets  $1,788,333   $1,775,929   $1,718,329   $1,724,260   $1,685,820 
                          
Tangible Common Equity                         
Total stockholders' equity  $179,177   $174,323   $169,133   $165,200   $161,795 
Adjustments:                         
Goodwill   (15,024)   (15,024)   (15,024)   (15,024)   (15,024)
Core deposit intangible, net of amortization   (2,051)   (2,212)   (2,401)   (2,590)   (2,779)
Tangible common equity  $162,102   $157,087   $151,708   $147,586   $143,992 
                          
Book value per common share  $27.24   $26.37   $25.40   $24.80   $24.18 
Tangible book value per common share   24.65    23.76    22.78    22.15    21.52 
                          
Total stockholders' equity to total assets   9.92%   9.72%   9.74%   9.48%   9.50%
Tangible common equity to tangible assets   9.06%   8.85%   8.83%   8.56%   8.54%

 

RESULTS OF OPERATIONS

 

Results of Operations for the Three Months Ended March 31, 2019 and March 31, 2018

 

General.   Net income decreased $0.5 million to $6.6 million for three months ended March 31, 2019, compared to $7.1 million for the same period in 2018. This decrease was primarily due to the reduced level of accretion to net interest income from purchase accounting marks on the loans and deposits acquired in the Waupaca acquisition during the fourth quarter of 2017. This accretion added $1.5 million to net interest income during the first quarter of 2018 compared to $0.8 million in the first quarter of 2019, a reduction of $0.7 million (pre-tax).

 

Net Interest Income.    The management of interest income and expense is fundamental to our financial performance. Net interest income, the difference between interest income and interest expense, is the largest component of the Company’s total revenue. Management closely monitors both total net interest income and the net interest margin (net interest income divided by average earning assets). We seek to maximize net interest income without exposing the Company to an excessive level of interest rate risk through our asset and liability policies. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. Our net interest margin can also be adversely impacted by the reversal of interest on nonaccrual loans and the reinvestment of loan payoffs into lower yielding investment securities and other short-term investments.

 

Net interest and dividend income decreased by $1.1 million to $15.2 million for the three months ended March 31, 2019, compared to $16.3 million for three months ended March 31, 2018. The decrease in net interest income was primarily due to the previously mentioned reduction in purchase accounting accretion from the first quarter of 2018 to the first quarter of 2019. Interest income on loans increased by $0.5 million, or 2.83%, during the same period. Total average interest-earning assets decreased to $1.65 billion for the three months ended March 31, 2019, down from $1.67 billion for the same period in 2018. Tax equivalent net interest margin decreased 0.22% to 3.82% for the three-months ended March 31, 2019, down from 4.04% for the same period in 2018. Net interest margin declined by 0.24% due to the reduction in purchase accounting accretion quarter-over-quarter which was minimally offset by an increase of 0.02% in core net interest margin. Net interest margin and net interest income are influenced by internal and external factors. Internal factors include balance sheet changes on both volume and mix and pricing decisions, and external factors include changes in market interest rates, competition and the shape of the interest rate yield curve.

 

Interest Income. Total interest income increased $0.4 million, or 2.14%, to $19.7 million for the three months ended March 31, 2019 compared to $19.3 million for the same period in 2018. The increase in total interest income was primarily due a rising interest rate environment, which was offset by the reduction in purchase accounting accretion. The average balance of loans increased by $29.5 million during the three months ended March 31, 2019 compared to the same period in 2018.

 

Interest Expense. Interest expense increased $1.5 million, or 49.4%, to $4.5 million for the three months ended March 31, 2019 compared to $3.0 million for the same period in 2018. The increase in interest expense was primarily due to an increasing interest rate environment.

 

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Interest expense on interest-bearing deposits increased by $1.9 million to $4.1 million for the three months ended March 31, 2019, from $2.4 million for the same period in 2018. This increase was primarily due to an increasing interest rate environment. The average cost of interest-bearing deposits was 1.55% for the three months ended March 31, 2019, compared to 0.90% for the same period in 2018.

 

Provision for Loan Losses. Credit risk is inherent in the business of making loans. We establish an ALL through charges to earnings, which are shown in the statements of operations as the provision for loan losses. Specifically identifiable and quantifiable known losses are promptly charged off against the allowance. The provision for loan losses is determined by conducting a quarterly evaluation of the adequacy of our ALL and charging the shortfall or excess, if any, to the current quarter’s expense. This has the effect of creating variability in the amount and frequency of charges to earnings. The provision for loan losses and level of allowance for each period are dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in our market area. The determination of the amount is complex and involves a high degree of judgment and subjectivity.

 

We recorded a provision for loan losses of $0.6 million for the three months ended March 31, 2019, compared to $0.5 million for the same period in 2018. We recorded net charge-offs of $0.7 million for the three months ended March 31, 2019 compared to negligible net charge offs for the same period in 2018. The ALL was $12.2 million, or 0.85% of total loans, at March 31, 2019 compared to $12.1 million, or 0.86% of total loans, at March 31, 2018.

 

Noninterest Income. Noninterest income is an important component of our total revenues. A significant portion of our noninterest income is associated with service charges and income from the Bank’s subsidiaries, Ansay & Associates, LLC and UFS, LLC. Other sources of noninterest income include loan servicing fees, gains on sales of mortgage loans, and other income from strategic alliances.

 

Noninterest income decreased $0.1 million to $3.3 million for the three months ended March 31, 2019 compared to $3.4 million for the same period in 2018. The primary reason for the decrease in noninterest income was a lower contribution from our investment in Ansay & Associates, LLC (Ansay). Due to a change in accounting standards, income from Ansay, which has historically been concentrated in the first two quarters of every year, will be realized much more ratably throughout the year for 2019 and years thereafter. As a result of this change, year-over-year income contributions by this investment decreased by $0.3 million for the first quarter. Other noninterest income was positively impacted during the first quarter of 2019 by a revaluing of an investment which the Company holds in common stock of another financial institution, historically recorded at its cost basis, to fair value based on recent observable prices in orderly stock transactions, resulting in income of $0.6 million. The major components of our noninterest income are listed below:

 

   Three Months Ended March 31 
   2019   2018   $ Change   % Change 
(In thousands)                    
Noninterest Income                    
Service charges  $679   $846   $(167)   (20)%
Income from Ansay & Associates, LLC   875    1,196    (321)   (27)%
Income from UFS, LLC   594    609    (15)   (2)%
Loan servicing income   223    242    (19)   (8)%
Net gain on sales of mortgage loans   87    157    (70)   (45)%
Noninterest income from strategic alliances   19    23    (4)   (17)%
Other   829    370    459    124%
Total Noninterest Income  $3,306   $3,443   $(137)   (5)%

 

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Noninterest Expense. Noninterest expense decreased $0.7 million to $9.3 million for the three months ended March 31, 2019 compared to $10.0 million for the same period in 2018. The decrease in noninterest expense was a product of many offsetting increases and decreases in the individual components of noninterest expense. Occupancy expenses decreased $0.5 million from $1.3 million in the first quarter of 2018 to $0.8 million in the first quarter of 2019, the result of significant investments made during the first quarter of 2018 for equipment and facilities of branch locations acquired in the Waupaca acquisition, a cost that was not repeated in the first quarter of 2019. Losses from sales of ORE, nearly all of which were acquired in the Waupaca acquisition or resulted from foreclosures on loans acquired in that transaction, were elevated in the first quarter of 2018, the first full quarter after that acquisition closed, and declined significantly for the first quarter of 2019. Net gains on sales of securities and other investments, which offset noninterest expense in each quarter, were significantly higher in 2019 due to the sale of common stock of another financial institution, which the Company had held since 2016, resulting in a realized gain of $0.2 million. Charitable contributions declined significantly from the first quarter of 2018 to the first quarter of 2019 due primarily to one multi-year contribution commitment of $0.3 million made to an organization during the first quarter of 2018 which was fully accrued for in that quarter and not repeated in the first quarter of 2019. Outside service fees and other noninterest expense increased by a combined $0.5 million, due primarily to expenses incurred in 2019 resulting from the Company’s public company status and pending acquisition of Partnership, neither of which existed in the first quarter of 2018.

 

The major components of our noninterest expense are listed below:

 

   Three Months Ended March 2018 
   2019   2018   $ Change   % Change 
   (In thousands)         
Noninterest Expense                    
Salaries, commissions and employee benefits  $5,310   $5,317   $(7)   (0)%
Occupancy   849    1,350    (501)   (37)%
Data processing   913    939    (26)   (3)%
Postage, stationary, and supplies   123    167    (44)   (26)%
Net loss on sales and valuation of ORE   36    136    (100)   (74)%
Net gain on sales of securities and other investments   (234)   (3)   (231)   NM 
Advertising   74    52    22    42%
Charitable contributions   131    373    (242)   (65)%
Outside service fees   684    520    164    32%
Amortization of intangibles   161    189    (28)   (15)%
Other   1,255    937    318    34%
Total Noninterest Expenses  $9,302   $9,977   $(675)   (7)%

 

Income Tax Expense. We recorded a provision for income taxes of $2.0 million for the three months ended March 31, 2019 compared to a provision of $2.2 million for the same period during 2018, reflecting effective tax rates of 23.2% and 23.8%, respectively. The effective tax rates were reduced from the statutory federal and state income tax rates largely as a result of tax-exempt interest income produced by certain qualifying loans and investments in the Bank’s portfolios.

 

NET INTEREST MARGIN

 

Net interest income represents the difference between interest earned, primarily on loans and investments, and interest paid on funding sources, primarily deposits and borrowings. Interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate paid on total interest-bearing liabilities. Net interest margin is the amount of net interest income, on a fully taxable-equivalent basis, expressed as a percentage of average interest-earning assets. The average rate earned on earning assets is the amount of annualized taxable equivalent interest income expressed as a percentage of average earning assets. The average rate paid on interest-bearing liabilities is equal to annualized interest expense as a percentage of average interest-bearing liabilities.

 

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The following tables set forth the distribution of our average assets, liabilities and stockholders’ equity, and average rates earned or paid on a fully taxable equivalent basis for each of the periods indicated:

 

   Three Months Ended March 31 
   2019   2018 
   Average
Balance
   Interest
Income/
Expenses(1)
   Rate
Earned/
Paid(1)
   Average
Balance
   Interest
Income/
Expenses(1)
   Rate
Earned/
Paid(1)
 
   (dollars in thousands) 
ASSETS                              
Interest-earning assets                              
Loans(2)                              
Taxable  $1,340,489   $70,007    5.22%  $1,321,159   $68,509    5.19%
Tax-exempt   93,794    4,950    5.28%   83,547    4,275    5.12%
Securities                              
Taxable (available for sale)   71,417    2,243    3.14%   67,832    2,158    3.18%
Tax-exempt (available for sale)   51,954    1,917    3.69%   58,240    2,099    3.60%
Taxable (held to maturity)   28,975    718    2.48%   25,428    584    2.30%
Tax-exempt (held to maturity)   11,793    337    2.86%   14,230    431    3.03%
Cash and due from banks   53,684    1,326    2.47%   100,922    1,682    1.67%
Total interest-earning assets   1,652,106    81,498    4.93%   1,671,358    79,738    4.77%
Non interest-earning assets   133,404              126,742           
Allowance for loan losses   (12,165)             (11,794)          
Total assets  $1,773,345             $1,786,306           
LIABILITIES AND STOCKHOLDERS’ EQUITY                              
Interest-bearing deposits                              
Checking accounts  $78,957   $1,697    2.15%  $116,699   $1,084    0.93%
Savings accounts   221,622    2,259    1.02%   140,797    267    0.19%
Money market accounts   406,422    4,583    1.13%   447,551    3,931    0.88%
Certificates of deposit   383,422    8,087    2.11%   365,201    4,303    1.18%
Brokered deposits   17,711    507    2.86%            
Total interest-bearing deposits   1,108,134    17,133    1.55%   1,070,248    9,585    0.90%
Other borrowed funds   33,043    1,207    3.65%   141,323    2,690    1.90%
Total interest-bearing liabilities   1,141,177    18,340    1.61%   1,211,571    12,275    1.01%
Non-interest-bearing liabilities                              
Demand deposits   440,172              400,331           
Other liabilities   16,938              13,073           
Total liabilities   1,598,287              1,624,975           
Stockholders’ equity   175,058              161,331           
Total liabilities & stockholders’ equity  $1,773,345             $1,786,306           
Net interest income on a fully taxable equivalent basis        63,158              67,463      
Less taxable equivalent adjustment        (1,513)             (1,436)     
Net interest income       $61,645             $66,027      
Net interest spread(3)             3.33%             3.76%
Net interest margin(4)             3.82%             4.04%

  

(1)Annualized on a fully taxable equivalent basis calculated using a federal tax rate of 21% for the three months ended March 31, 2019 and 2018.
(2)Nonaccrual loans are included in average amounts outstanding.
(3)Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(4)Net interest margin represents net interest income on a fully tax equivalent basis as a percentage of average interest-earning assets.

  

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Rate/Volume Analysis

 

The following tables describe the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volumes (changes in average balance multiplied by prior year average rate) and (ii) changes attributable to changes in rate (change in average interest rate multiplied by prior year average balance), while (iii) changes attributable to the combined impact of volumes and rates have been allocated proportionately to separate volume and rate categories.

 

   Three Months Ended March 31, 2019
Compared with
Three Months Ended March 31, 2018
 
   Increase/(Decrease)
Due to Change in
 
   Volume   Rate   Total 
   (dollars in thousands) 
Interest income               
Loans               
Taxable  $1,002   $496   $1,498 
Tax-exempt   524    151    675 
Securities               
Taxable (available for sale)   114    (29)   85 
Tax-exempt (available for sale)   (227)   45    (182)
Taxable (held to maturity)   81    53    134 
Tax-exempt (held to maturity)   (74)   (20)   (94)
Cash and due from banks   (787)   431    (356)
Total interest income   635    1,125    1,760 
Interest expense               
Deposits               
Checking accounts   (351)   964    613 
Savings accounts   153    1,839    1,992 
Money market accounts   (361)   1,013    652 
Certificates of deposit   215    3,569    3,784 
Brokered deposits   507    -    507 
Total interest-bearing deposits   (344)   7,892    7,548 
Other borrowed funds   (2,061)   578    (1,483)
Total interest expense   (2,405)   8,470    6,065 
Change in net interest income  $3,039   $(7,344)  $(4,305)

 

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CHANGES IN FINANCIAL CONDITION

 

Total Assets. Total assets increased $12.2 million, or 0.7%, to $1.81 billion at March 31, 2019, from $1.79 billion at December 31, 2018.

 

Cash and Cash Equivalents. Cash and cash equivalents increased by $1.5 million to $109.2 million at March 31, 2019 from $107.7 million at December 31, 2018.

 

Investment Securities. The carrying value of total investment securities increased by $3.8 million to $163.5 million at March 31, 2019, from $159.7 million at December 31, 2018.

 

Loans. Net loans increased by $3.0 million, totaling $1.42 billion at March 31, 2019 and December 31, 2018.

 

Bank-Owned Life Insurance. At March 31, 2019, our investment in bank-owned life insurance was $24.3 million, an increase of $0.1 million from $24.2 million at December 31, 2018.

 

Deposits. Deposits increased $16.5 million, or 1.1%, to $1.57 billion at March 31, 2019 from $1.56 billion at December 31, 2018.

 

Borrowings. At March 31, 2019, borrowings consisted of subordinated debt to other banks. Subordinated debt remained at $11.5 million at March 31, 2019, the same balance at December 31, 2018.

 

Stockholders’ Equity. Total stockholders’ equity increased $4.9million, or 2.8%, to $179.2 million at March 31, 2019, from $174.3 million at December 31, 2018.

 

LOANS

 

Our lending activities are conducted principally in Wisconsin. The Bank makes commercial and industrial loans, commercial real estate loans, construction and development loans, residential real estate loans, and a variety of consumer loans and other loans. Much of the loans made by the Bank are secured by real estate collateral. The Bank’s commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower, with liquidation of the underlying real estate collateral typically being viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are also often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment. Repayment of the Bank’s residential loans are generally dependent on the health of the employment market in the borrowers’ geographic areas and that of the general economy with liquidation of the underlying real estate collateral being typically viewed as the primary source of repayment in the event of borrower default.

 

Our loan portfolio is our most significant earning asset, comprising 79.3% and 79.7% of our total assets as of March 31, 2019 and December 31, 2018, respectively. Our strategy is to grow our loan portfolio by originating quality commercial and consumer loans that comply with our credit policies and that produce revenues consistent with our financial objectives. We believe our loan portfolio is well-balanced, which provides us with the opportunity to grow while monitoring our loan concentrations.

 

Loans increased $3.0 million, or 0.2%, to $1.43 billion as of March 31, 2019 as compared to $1.43 billion as of December 31, 2018. Our loan growth during the three months ended March 31, 2019 compared to the year ended December 31, 2018 has been comprised of an increase of $4.3 million, or 1.5%, in commercial and industrial loans, an increase of $1.7 million, or 0.3%, in commercial real estate loans, an increase of $6.6 million, or 10.9%, in construction and development loans, a decrease of $1.2 million, or 0.3%, in residential 1-4 family loans and an increase of $0.2 million, or 0.6%, in consumer and other loans. The increase in loans during the three months ended March 31, 2019 is attributable to modest organic loan growth, which was offset by a planned reduction of a portion of the loan portfolio acquired from Waupaca. The reduction of a portion of the loan portfolio acquired from Waupaca focused on out of market loans as well as loans of poor asset quality. This reduction occurred without incurring significant losses.

 

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The following table presents the balance and associated percentage of each major category in our loan portfolio at March 31 2019, December 31, 2018, and March 31, 2018:

 

   March 31,   December 31,   March 31, 
   2019   % of
Total
   2018   % of
Total
   2018   % of
Total
 
                         
Commercial & Industrial                              
Commercial & industrial  $293,220    20%  $297,576    21%  $283,993    20%
Deferred costs net of unearned fees   (223)   0%   (248)   0%   (269)   0%
Total commercial & industrial   292,997    20%   297,328    21%   283,724    20%
Commercial real estate                              
Owner Occupied   412,126    29%   416,097    29%   417,456    30%
Non-owner occupied   258,310    18%   252,717    18%   226,265    16%
Deferred costs net of unearned fees   (409)   0%   (465)   0%   (374)   0%
Total commercial real estate   670,027    47%   668,349    47%   643,347    46%
Construction & Development                              
Construction & Development   67,537    5%   60,927    4%   58,905    4%
Deferred costs net of unearned fees   (116)   0%   (125)   0%   (47)   0%
Total construction & development   67,421    5%   60,802    4%   58,858    4%
Residential 1 – 4 family                              
Residential 1 – 4 family   367,518    26%   368,673    26%   373,542    27%
Deferred costs net of unearned fees   23    0%   17    0%   205    0%
Total residential 1 – 4 family   367,541    26%   368,690    26%   373,747    27%
Consumer                              
Consumer   27,242    2%   26,854    2%   37,588    3%
Deferred costs net of unearned fees   105    0%   101    0%   90    0%
Total consumer   27,347    2%   26,955    2%   37,678    3%
Other Loans                              
Other   6,165    0%   6,369    0%   7,891    0%
Deferred costs net of unearned fees       0%   1    0%       0%
Total other loans   6,165    0%   6,370    0%   7,891    0%
Total loans  $1,431,498    100%  $1,428,494    100%  $1,405,245    100%

 

Our directors and officers and their associates are customers of, and have other transactions with, the Bank in the normal course of business. All loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than normal risk of collection or present other unfavorable features. At March 31, 2019 and December 31, 2018, total loans outstanding to such directors and officers and their associates were $84.6 million and $84.1 million, respectively. During the three months ended March 31, 2019, $9.7 million of additions and $9.2 million of repayments were made to these loans. At March 31, 2019 and December 31, 2018, all of the loans to directors and officers were performing according to their original terms.

 

Loan categories

 

The principal categories of our loan portfolio are discussed below:

 

Commercial and Industrial (C&I). Our C&I portfolio totaled $293.0 million and $297.3 million at March 31, 2019 and December 31, 2018, respectively, and represented 20% and 21% of our total loans at those dates.

 

Our C&I loan customers represent various small and middle-market established businesses involved in professional services, accommodation and food services, health care, financial services, wholesale trade, manufacturing, distribution, retailing and non-profits. Most clients are privately owned with markets that range from local to national in scope. Many of the loans to this segment are secured by liens on corporate assets and the personal guarantees of the principals. The regional economic strength or weakness impacts the relative risks in this loan category. There is little concentration in any one business sector, and loan risks are generally diversified among many borrowers.

 

Commercial Real Estate (CRE). Our CRE loan portfolio totaled $670.0 million and $668.3 million at March 31, 2019 and December 31, 2018, respectively, and represented 47% of our total loans at both of those dates.

 

Our CRE loans are secured by a variety of property types including multifamily dwellings, retail facilities, office buildings, commercial mixed use, lodging and industrial and warehouse properties. We do not have any specific industry or customer concentrations in our CRE portfolio. Our commercial real estate loans are generally for terms up to ten years, with loan-to-values that generally do not exceed 80%. Amortization schedules are long term and thus a balloon payment is generally due at maturity. Under most circumstances, the Bank will offer to rewrite or otherwise extend the loan at prevailing interest rates.

 

Construction and Development (C&D). Our C&D loan portfolio totaled $67.4 million and $60.8 million at March 31, 2019 and December 31, 2018, respectively, and represented 5% and 4% of our total loans at those dates.

 

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Our C&D loans are generally for the purpose of creating value out of real estate through construction and development work, and also include loans used to purchase recreational use land. Borrowers typically provide a copy of a construction or development contract which is subject to bank acceptance prior to loan approval. Disbursements are handled by a title company. Borrowers are required to inject their own equity into the project prior to any note proceeds being disbursed. These loans are, by their nature, intended to be short term and are refinanced into other loan types at the end of the construction and development period.

 

Residential 1 – 4 Family. Residential 1 – 4 family loans held in portfolio amounted to $367.5 million and $368.7 million at March 31, 2019 and December 31, 2018, respectively, and represented 26% of our total loans at both of those dates.

 

We offer fixed and adjustable-rate residential mortgage loans with maturities up to 30 years. One-to-four family residential mortgage loans are generally underwritten according to Fannie Mae guidelines, and we refer to loans that conform to such guidelines as “conforming loans.” We generally originate both fixed and adjustable-rate mortgage loans in amounts up to the maximum conforming loan limits as established by the Federal Housing Finance Agency, which is generally $424,100 for one-unit properties. In addition, we also offer loans above conforming lending limits typically referred to as “jumbo” loans. These loans are typically underwritten to the same guidelines as conforming loans; however, we may choose to hold a jumbo loan within our portfolio with underwriting criteria that does not exactly match conforming guidelines.

 

We do not offer reverse mortgages nor do we offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on his loan, resulting in an increased principal balance during the life of the loan. We also do not offer “subprime loans” (loans that are made with low down payments to borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (defined as loans having less than full documentation).

 

Residential real estate loans are originated both for sale to the secondary market as well as for retention in the Bank’s loan portfolio. The decision to sell a loan to the secondary market or retain within the portfolio is determined based on a variety of factors including but not limited to our asset/liability position, the current interest rate environment, and customer preference. Servicing rights are retained on all loans sold to the secondary market.

 

We were servicing mortgage loans sold to others without recourse of approximately $316.5 million at both March 31, 2019 and December 31, 2018.

 

Loans sold with the retention of servicing assets result in the capitalization of servicing rights. Loan servicing rights are included in other assets and are carried at fair value. The net balance of capitalized servicing rights amounted to $3.1 million at both March 31, 2019 and December 31, 2018.

 

Consumer Loans. Our consumer loan portfolio totaled $27.3 million and $27.0 million at March 31, 2019 and December 31, 2018, respectively, and represented 2% of our total loans at those dates. Consumer loans include secured and unsecured loans, lines of credit and personal installment loans.

 

Consumer loans generally have greater risk compared to longer-term loans secured by improved, owner-occupied real estate, particularly consumer loans that are secured by rapidly depreciable assets. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan repayments are dependent on the borrower’s continuing financial stability and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

 

Other Loans. Our other loans totaled $6.2 million and $6.4 million at March 31, 2019 and December 31, 2018, respectively, and are immaterial to the overall loan portfolio. The other loans category consists primarily of overdrafted depository accounts, loans utilized to purchase or carry securities and loans to nonprofit organizations.

 

Loan Portfolio Maturities. The following tables summarize the dollar amount of loans maturing in our portfolio based on their loan type and contractual terms to maturity at March 31, 2019 and December 31, 2018, respectively. The tables do not include any estimate of prepayments, which can significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

 

As of March 31, 2019  One Year
or Less
   One to
Five Years
   Over Five
Years
   Total 
   (dollars in thousands) 
Commercial & Industrial  $89,397   $107,295   $96,305   $292,997 
Commercial real estate   118,874    304,618    246,535    670,027 
Construction & Development   27,996    24,654    14,771    67,421 
Residential 1 – 4 family   29,390    63,844    274,307    367,541 
Consumer and other   5,906    20,214    7,392    33,512 
Total  $271,563   $520,625   $639,310   $1,431,498 

 

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As of December 31, 2018  One Year
or Less
   One to
Five Years
   Over Five
Years
   Total 
   (dollars in thousands) 
Commercial & Industrial  $89,358   $111,354   $96,616   $297,328 
Commercial real estate   114,017    313,836    240,496    668,349 
Construction & Development   28,357    19,721    12,724    60,802 
Residential 1 – 4 family   27,987    69,206    271,497    368,690 
Consumer and other   4,980    21,385    6,960    33,325 
Total  $264,699   $535,502   $628,293   $1,428,494 

 

The following tables summarize the dollar amount of loans maturing in our portfolio based on whether the loan has a fixed or variable rate of interest and their contractual terms to maturity at March 31, 2019 and December 31, 2018, respectively. The tables do not include any estimate of prepayments, which can significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

 

As of March 31, 2019  One Year 
or Less
   One to
Five Years
   Over Five
Years
   Total 
   (dollars in thousands) 
Predetermined interest rates  $140,476   $411,576   $267,321   $819,373 
Floating or adjustable interest rates   131,087    109,049    371,989    612,125 
Total  $271,563   $520,625   $639,310   $1,431,498 

 

As of December 31, 2018  One Year 
or Less
   One to
Five Years
   Over Five
Years
   Total 
   (dollars in thousands) 
Predetermined interest rates  $143,333   $412,100   $267,221   $822,654 
Floating or adjustable interest rates   121,366    123,402    361,072    605,840 
Total  $264,699   $535,502   $628,293   $1,428,494 

 

NONPERFORMING LOANS AND TROUBLED DEBT RESTRUCTURINGS

 

In order to operate with a sound risk profile, we focus on originating loans that we believe to be of high quality. We have established loan approval policies and procedures to assist us in maintaining the overall quality of our loan portfolio. When delinquencies in our loans exist, we rigorously monitor the levels of such delinquencies for any negative or adverse trends. From time to time, we may modify loans to extend the term or make other concessions to help a borrower with a deteriorating financial condition stay current on their loan and to avoid foreclosure. We generally do not forgive principal or interest on loans or modify the interest rates on loans to rates that are below market rates. Furthermore, we are committed to collecting on all of our loans and, as a result, at times have lower net charge-offs compared to many of our peer banks. We believe that our commitment to collecting on all of our loans results in higher loan recoveries.

 

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Our nonperforming assets consist of nonperforming loans and foreclosed real estate. Nonperforming loans are those on which the accrual of interest has stopped, as well as loans that are contractually 90 days past due on which interest continues to accrue. The composition of our nonperforming assets is as follows:

 

   March 31,   December 31,   March 31, 
   2019   2018   2018 
   (dollars in thousands) 
Nonaccruals  $15,972   $20,099   $18,098 
Loans past due > 90 days, but still accruing   294    423    2,266 
Total nonperforming loans  $16,266   $20,522   $20,364 
Accruing troubled debt restructured loans  $179   $179   $186 
Nonperforming loans as a percent of gross loans   1.14%   1.44%   1.45%
Nonperforming loans as a percent of total assets   0.90%   1.14%   1.20%

 

At March 31, 2019 and December 31, 2018, impaired loans had specific reserves of $2.1 million and $1.1 million, respectively.

 

Nonaccrual Loans

 

Loans are typically placed on nonaccrual status when any payment of principal and/or interest is 90 days or more past due, unless the collateral is sufficient to cover both principal and interest and the loan is in the process of collection. Loans are also placed on nonaccrual status when management believes, after considering economic and business conditions, that the principal or interest will not be collectible in the normal course of business. We monitor closely the performance of our loan portfolio. In addition to the monitoring and review of loan performance internally, we have also contracted with an independent organization to review our commercial and retail loan portfolios. The status of delinquent loans, as well as situations identified as potential problems, is reviewed on a regular basis by senior management.

 

Troubled Debt Restructurings

 

A troubled debt restructuring includes a loan modification where a borrower is experiencing financial difficulty and we grant a concession to that borrower that we would not otherwise consider except for the borrower’s financial difficulties. These concessions may include modifications of the terms of the debt such as deferral of payments, extension of maturity, reduction of principal balance, reduction of the stated interest rate other than normal market rate adjustments, or a combination of these concessions. Debt may be bifurcated with separate terms for each tranche of the restructured debt. Restructuring a loan in lieu of aggressively enforcing the collection of the loan may benefit the Company by increasing the ultimate probability of collection.

 

A TDR may be either on accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability. If a TDR is placed on nonaccrual status, which would occur based on the same criteria as non-TDR loans, it remains there until a sufficient period of performance under the restructured terms has occurred at which it returned to accrual status, generally 6 months.

 

As of March 31, 2019 and December 31, 2018 the Company had specific reserves of $2.1 million and $0.4 million for TDRs, respectively, and none of them have subsequently defaulted.

 

Classified loans

 

Accounting standards require the Company to identify loans, where full repayment of principal and interest is doubtful, as impaired loans. These standards require that impaired loans be valued at the present value of expected future cash flows, discounted at the loan’s effective interest rate, or using one of the following methods: the observable market price of the loan or the fair value of the underlying collateral if the loan is collateral dependent. We have implemented these standards in our quarterly review of the adequacy of the ALL, and identify and value impaired loans in accordance with guidance on these standards. As part of the review process, we also identify loans classified as watch, which have a potential weakness that deserves management’s close attention.

 

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Loans totaling $64.3 million were classified substandard under the Bank’s policy at March 31, 2019 and loans totaling $67.6 million were classified substandard under the Bank’s policy as of December 31, 2018. The following table sets forth information related to the credit quality of our loan portfolio at March 31, 2019 and December 31, 2018.

 

Loan type (in thousands)  Pass   Watch   Substandard   Total 
As of March 31, 2019                    
Commercial & industrial  $226,068   $51,811   $15,118   $292,997 
Commercial real estate   504,175    119,865    45,987    670,027 
Construction & Development   64,538    2,822    61    67,421 
Residential 1 – 4 family   354,380    10,046    3,115    367,541 
Consumer   27,289    44    14    27,347 
Other loans   2,615    3,550        6,165 
Total loans  $1,179,065   $188,138   $64,295   $1,431,498 

 

Loan type (in thousands)  Pass   Watch   Substandard   Total 
As of December 31, 2018                    
Commercial & industrial  $237,367   $40,377   $19,584   $297,328 
Commercial real estate   497,871    126,904    43,574    668,349 
Construction & Development   57,967    2,774    61    60,802 
Residential 1 – 4 family   351,772    12,534    4,384    368,690 
Consumer   26,887    49    19    26,955 
Other loans   3,112    3,258        6,370 
Total loans  $1,174,976   $185,896   $67,622   $1,428,494 

 

ALLOWANCE FOR LOAN LOSSES

 

ALL represents management’s estimate of probable and inherent credit losses in the loan portfolio. Estimating the amount of the ALL require the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows or impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset on the consolidated balance sheets. Loan losses are charged off against the ALL, while recoveries of amounts previously charged off are credited to the ALL. A provision for loan losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

 

The ALL consists of specific reserves for certain individually evaluated impaired loans and general reserves for collectively evaluated non-impaired loans. Specific reserves reflect estimated losses on impaired loans from management’s analyses developed through specific credit allocations. The specific reserves are based on regular analyses of impaired, non-homogenous loans greater than $250,000. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based in part on the Bank’s historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as (1) changes in lending policies and/or underwriting practices, (2) national and local economic conditions, (3) changes in portfolio volume and nature, (4) experience, ability and depth of lending management and other relevant staff, (5) levels of and trends in past-due and nonaccrual loans and quality, (6) changes in loan review and oversight, (7) impact and effects of concentrations and (8) other issues deemed relevant.

 

 43 

 

 

There are many factors affecting ALL; some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged off or for which an actual loss is realized. As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

 

The following table summarizes the changes in our ALL for the periods indicated:

 

   Three months
ended March 31,
2019
  

Year ended
 December 31,

2018

   Three months
ended March 31,
2018
 
   (dollars in thousands) 
Period-end loans outstanding (net of unearned discount and deferred loan fees)  $1,431,498   $1,428,494   $1,405,245 
Average loans outstanding (net of unearned discount and deferred loan fees)  $1,434,283   $1,425,867   $1,404,766 
Balance of allowance for loan losses at the beginning of period  $12,248   $11,612   $11,612 
Loans charged-off:               
Commercial and industrial   586    35    0 
Commercial real estate – owner occupied   78    2,374    11 
Commercial real estate – non-owner occupied   54    0    0 
Construction & Development   0    83    83 
Residential 1 – 4 family   8    140    79 
Consumer   11    48    3 
Other Loans   5    37    19 
Total loans charged-off  742   2,717   195 
Recovery of loans previously charged-off:               
Commercial and industrial   0    2    1 
Commercial real estate – owner occupied   1    158    2 
Commercial real estate – non-owner occupied   0    3    1 
Construction & Development   0    0    0 
Residential 1 – 4 family   78    233    202 
Consumer   1    12    2 
Other Loans   2    10    3 
Total recoveries of loans previously charged-off   82    418    211 
Net loan charge-offs (recoveries)  $660   $2,299   $(16)
Provision charged to operating expense   625    2,935    485 
Balance at end of period  $12,213   $12,248   $12,113 
Ratio of net charge-offs (recoveries) during the period to average loans outstanding   0.18%   0.16%   (0.00%)
Ratio of allowance for loan losses to loans outstanding   0.85%   0.86%   0.86%

 

 44 

 

 

The level of charge-offs depends on many factors, including the national and regional economy. Cyclical lagging factors may result in charge-offs being higher than historical levels. Although the allowance is allocated between categories, the entire allowance is available to absorb losses attributable to all loan categories. Management believes that the current ALL is adequate.

 

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

 

   March 31, 2019  

December 31, 2018

   March 31, 2018 
(in thousands, except %)  Amount   % of
Loans
   Amount   % of
loans
   Amount   % of
loans
 
Loan Type:                              
Commercial and industrial  $2,269    20%  $3,021    21%  $2,669    20%
Commercial real estate – owner occupied   5,105    29%   3,459    29%   3,099    30%
Commercial real estate – non-owner occupied   1,910    18%   2,100    18%   2,115    16%
Construction & Development   396    5%   725    4%   734    4%
Residential 1 – 4 family   2,034    26%   2,472    26%   2,812    27%
Consumer   135    2%   148    2%   225    3%
Other Loans   41    0%   32    0%   51    0%
Unallocated   323         291         408      
Total allowance  $12,213    100%  $12,248    100%  $12,113    100%

 

 45 

 

 

SOURCES OF FUNDS

 

General. Deposits traditionally have been our primary source of funds for our investment and lending activities. We also borrow from the FHLB of Chicago to supplement cash needs, to lengthen the maturities of liabilities for interest rate risk management purposes and to manage our cost of funds. Our additional sources of funds are scheduled payments and prepayments of principal and interest on loans and investment securities and fee income and proceeds from the sales of loans and securities.

 

Deposits. Our current deposit products include non-interest bearing and interest-bearing checking accounts, savings accounts, money market accounts, and certificate of deposits. As of March 31, 2019, deposit liabilities accounted for approximately 87.2% of our total liabilities and equity. We accept deposits primarily from customers in the communities in which our branches and offices are located, as well as from small businesses and other customers throughout our lending area. We rely on our competitive pricing and products, quality customer service, and convenient locations and hours to attract and retain deposits. Deposit rates and terms are based primarily on current business strategies, market interest rates, liquidity requirements and our deposit growth goals.

 

Total deposits were $1.57 billion and $1.56 billion as of March 31, 2019 and December 31, 2018, respectively. Noninterest-bearing deposits at March 31, 2019 and December 31, 2018, were $464.9 million and $448.8 million, respectively, while interest-bearing deposits were $1.11 billion at both March 31, 2019 and December 31, 2018.

 

At March 31, 2019, we had a total of $398.6 million in certificates of deposit, including $17.7 million of brokered deposits. Based on historical experience and our current pricing strategy, we believe we will retain a majority of these accounts upon maturity, although our long-term strategy is to minimize reliance on certificates of deposits by increasing relationship deposits in lower earning savings and demand deposit accounts.

 

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

 

  

Three months ended

March 31, 2019

   Year ended December 31, 2018  

Three months ended

March 31, 2018

 
   Amount   Percent   Weighted
average
rate
   Amount   Percent   Weighted
average
rate
   Amount   Percent   Weighted
average
rate
 
   (dollars in thousands) 
Noninterest-bearing demand deposits  $440,172    28.5%   N/A   $408,403    27.5%   N/A    400,331    27.3%   N/A 
Interest-bearing checking deposits   78,957    5.1%   2.15%   99,894    6.7%   1.13%   116,699    7.9%   0.93%
Savings accounts   221,622    14.3%   1.02%   168,254    11.3%   0.52%   140,797    9.6%   0.19%
Money market accounts   406,422    26.2%   1.13%   428,052    28.8%   0.99%   447,551    30.4%   0.88%
Certificates of depots   383,422    24.8%   2.11%   371,332    25.0%   1.57%   365,201    24.8%   1.18%
Brokered deposits   17,711    1.1%   2.86%   10,476    0.7%   2.91%            
Total  $1,548,306    100%       $1,486,411    100.0%       $1,470,579    100%     

 

 46 

 

 

Certificates of deposit of $100,000 or greater by maturity are as follows:

 

   March 31,
2019
   December 31,
2018
   March 31,
2018
 
   (dollars in thousands) 
Less than 3 months remaining  $46,691   $26,366   $25,233 
Over 3 to 6 months remaining   19,341    46,593    24,508 
Over 6 to 12 months remaining   42,557    35,932    38,505 
Over 12 months or more remaining   89,329    89,501    78,084 
Total  $197,918   $198,392   $166,330 

 

Retail certificates of deposit of $100,000 or greater totaled $197.9 million and $198.4 million at March 31, 2019 and December 31, 2018, respectively. Interest expense on retail certificates of deposit of $100,000 or greater was $0.9 million for the three months ended March 31, 2019, and $2.5 million for the year ended December 31, 2018.

 

The following table sets forth certificates of deposit classified by interest rate as of the dates indicated:

 

   March 31,
2019
  

December 31,

2018

   March 31,
2018
 
   (Dollars in thousands) 
Interest Rate:               
Less than 1.00%  $863   $1,824   $8,727 
1.00% to 1.99%   127,041    164,366    281,618 
2.00% to 2.99%   238,226    204,825    71,092 
3.00% to 3.99%   32,435    29,142    393 
Total  $398,565   $400,157   $361,830 

 

Borrowings

 

Securities sold under repurchase agreements

 

The Company has securities sold under repurchase agreements which have contractual maturities up to one year from the transaction date with variable and fixed rate terms. The agreements to repurchase require that the Company (seller) repurchase identical securities as those that are sold. The securities underlying the agreements are under the Company’s control.

 

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

 

(dollars in thousands)  Three months ended
March 31, 2019
  

Year ended
December 31, 2018

   Three months ended
March 31, 2018
 
Average daily amount of securities sold under repurchase agreements during the period  $21,543   $22,315   $26,023 
Weighted average interest rate on average daily securities sold under repurchase agreements   2.45%   1.79%   1.46%
Maximum outstanding securities sold under repurchase agreements at any month-end  $25,484   $48,010   $30,299 
Securities sold under repurchase agreements at period end  $25,484   $31,489   $25,879 
Weighted average interest rate on short-term borrowings at period end   2.44%   2.43%   1.68%

 

 

 47 

 

 

Short-term borrowings

 

The Company’s short-term borrowings have historically consisted primarily of short-term FHLB of Chicago advances collateralized by a blanket pledge agreement on the Company’s FHLB capital stock and retail and commercial loans held in the Company’s portfolio. There were no advances outstanding from the FHLB at March 31, 2019 or December 31, 2018. From time to time the Company utilized short-term FHLB advances to fund liquidity during 2018.

 

The total loans pledged as collateral were $705.3 million at March 31, 2019 and $697.3 million at December 31, 2018. Outstanding letters of credit from the FHLB totaled $55.0 million at both March 31, 2019 and December 31, 2018.

 

The following table summarizes short-term borrowings (borrowings with maturities of one year or less), which consist of borrowings from the FHLB, and the weighted average interest rates paid:

 

(dollars in thousands)  Three months ended
March 31, 2019
  

Year ended
December 31, 2018

   Three months ended
March 31, 2018
 
Average daily amount of short-term borrowings outstanding during the period  $   $73,464   $95,556 
Weighted average interest rate on average daily short-term borrowings   NA    1.75%   1.48%
Maximum outstanding short-term borrowings outstanding at any month-end  $   $100,000   $100,000 
Short-term borrowings outstanding at period end  $   $   $17,000 
Weighted average interest rate on short-term borrowings at period end   NA    NA    1.80%

 

Lines of credit and other borrowings.

 

We maintain a $5.0 million line of credit with a commercial bank. There were no outstanding balances on this note as of March 31, 2019 or December 31, 2018. Any future borrowings under this note would carry interest at a variable rate with a floor of 3.50%, due in full on May 25, 2019.

 

We also maintain a $5.0 million line of credit with another commercial bank. There were no outstanding balances on this note as of March 31, 2019 or December 31, 2018. Any future borrowings under this note would carry interest at a variable rate with a floor of 3.25%, due in full on May 19, 2019.

 

During September 2017, the Company entered into subordinated note agreements with three separate commercial banks, where the Company had up to twelve months from entering these agreements to borrow funds up to a maximum availability of $22.5 million. As of March 31, 2019 and December 31, 2018, outstanding balances under these agreements totaled $11.5 million. These notes were all issued with 10-year maturities, carry interest at a variable rate payable quarterly, are callable on or after the sixth anniversary of their issuance dates, and qualify for Tier 2 capital for regulatory purposes.

 

 48 

 

  

INVESTMENT SECURITIES

 

Our securities portfolio consists of securities available for sale and securities held to maturity. Securities are classified as held to maturity or available for sale at the time of purchase. U.S. Treasury securities, obligations of states and political subdivisions and mortgage-backed securities, all of which are issued by U.S. government agencies or U.S. government-sponsored enterprises, make up the largest components of the securities portfolio. We manage our investment portfolio to provide an adequate level of liquidity as well as to maintain neutral interest rate-sensitive positions, while earning an adequate level of investment income without taking undue or excessive risk.

 

Securities available for sale consist of obligations of states and political subdivision, mortgage-backed securities, and corporate notes. Securities classified as available for sale, which management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in stockholders’ equity as a separate component of other comprehensive income. The fair value of securities available for sale totaled $122.8 million and included gross unrealized gains of $2.0 million and gross unrealized losses of $0.3 million at March 31, 2019. At December, 31 2018, the fair value of securities available for sale totaled $118.9 million and included gross unrealized gains of $0.8 million and gross unrealized losses of $1.4 million.

 

Securities classified as held to maturity consist of U.S. Treasury securities and obligations of states and political subdivisions. These securities, which management has the intent and ability to hold to maturity, are reported at amortized cost. Securities held to maturity totaled $40.8 million at March 31, 2019 and December 31, 2018.

 

The Company recognized a net gain of $0.2 million on the sale of an investment previously classified as an “other investment” during the three-months ended March 31, 2019, and a gain on sale of available for sale security of $3,000 during the three-months ended March 31, 2018.

 

The following table sets forth the fair value of available for sale investment securities, the amortized costs of held to maturity and the percentage distribution at the dates indicated:

 

   March 31, 2019  

December 31, 2018

 
   Amount   Percent   Amount   Percent 
   (dollars in thousands) 
Available for sale securities, at estimated fair value                    
Obligations of states and political subdivisions  $52,615    43%  $51,893    44%
Mortgage-backed securities   53,494    44%   50,569    42%
Corporate notes   16,652    13%   16,444    14%
Total securities available for sale   122,761    100%   118,906    100%
Held to maturity securities, at amortized cost                    
U.S. Treasury securities   28,977    71%   28,975    71%
Obligations of states and political subdivisions   11,792    29%   11,793    29%
Total securities held to maturity   40,769    100%   40,768    100%
Total  $163,530        $159,674      

 

The following tables set forth the composition and maturities of investment securities as of March 31, 2019 and December 31, 2018. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 49 

 

  

   Within One Year   After One, But
Within Five Years
   After Five, But
Within Ten Years
   After Ten Years   Total 
   Amortized
Cost
   Weighted
Average
Yield(1)
   Amortized 
Cost
   Weighted
Average
Yield(1)
   Amortized 
Cost
   Weighted
Average
Yield(1)
   Amortized
Cost
   Weighted
Average
Yield(1)
   Amortized 
Cost
   Weighted
Average
Yield(1)
 
   (dollars in thousands) 
At March 31, 2019                                                  
Available for sale securities                                                  
Obligations of state and political 
subdivisions
  $4,010    3.4%  $6,911    3.3%  $7,773    3.5%  $32,464    3.9%  $51,158    3.7%
Mortgage-backed securities   1,190    1.8%   12,783    2.4%   37,426    2.9%   1,725    3.2%   53,124    2.8%
Corporate notes          —%   11,794    2.9%   4,941    3.3%         —%   16,735    3.0%
Total available for sale securities   5,200    3.0%   31,488    2.7%   50,140    3.0%   34,189    3.9%   121,017    3.2%
Held to maturity securities                                                  
U.S. Treasury Securities   1,493    2.0%   11,018    2.6%   16,466    2.5%         —%   28,977    2.5%
Obligations of state and political subdivisions   1,434    3.3%   3,584    2.4%   2,994    2.6%   3,780    3.6%   11,792    3.0%
Total held to maturity securities   2,927    2.6%   14,602    2.6%   19,460    2.5%   3,780    3.6%   40,769    2.6%
Total  $8,127    2.9%  $46,090    2.7%  $69,600    2.9%  $37,969    3.8%  $161,786    3.1%

 

   Within One Year   After One, But
Within Five Years
   After Five, But
Within Ten Years
   After Ten Years   Total 
   Amortized
Cost
   Weighted
Average
Yield(1)
   Amortized 
Cost
   Weighted
Average
Yield(1)
   Amortized 
Cost
   Weighted
Average
Yield(1)
   Amortized
Cost
   Weighted
Average
Yield(1)
   Amortized 
Cost
   Weighted
Average
Yield(1)
 
   (dollars in thousands) 
At December 31, 2018                                                  
Available for sale securities                                                  
Obligations of state and political 
subdivisions
  $3,681    3.4%  $6,438    3.3%  $8,092    3.5%  $33,081    3.9%  $51,292    3.7%
Mortgage-backed securities   1,838    1.6%   13,009    2.4%   34,810    2.9%   1,862    3.2%   51,519    2.7%
Corporate notes            —%   11,770    2.9%   4,938    3.3%         —%   16,708    3.0%
Total available for sale securities   5,519    2.8%   31,217    2.7%   47,840    3.0%   34,943    3.9%   119,519    3.2%
Held to maturity securities                                                  
U.S. Treasury Securities   1,492    2.0%   11,020    2.6%   16,463    2.5%         —%   28,975    2.5%
Obligations of state and political 
subdivisions
   1,434    3.3%   3,140    2.1%   3,440    2.8%   3,779    3.6%   11,793    3.0%
Total held to maturity securities   2,926    2.6%   14,160    2.5%   19,903    2.6%   3,779    3.6%   40,768    2.6%
Total  $8,445    2.7%  $45,377    2.7%  $67,743    2.9%  $38,722    3.8%  $160,287    3.0%

  

(1)Weighted Average Yield is shown on a fully taxable equivalent basis using a federal tax rate of 21% at March 31, 2019 and December 31, 2018, respectively.

  

 50 

 

 

The Company evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) credit quality of individual securities and their issuers are assessed; (2) the length of time and the extent to which the fair value has been less than cost; (3) the financial condition and near-term prospects of the issuer; and (4) that the Company does not have the intent to sell the security and it is more likely than not that it will not have to sell the security before recovery of its cost basis.

 

As of March 31, 2019, 32 debt securities had gross unrealized losses, with an aggregate depreciation of 0.20% from our amortized cost basis. The largest unrealized loss percentage of any single security was 3.23% (or $13,000) of its amortized cost. The largest unrealized dollar loss of any single security was $94,000 (or 2.37%) of its amortized cost.

 

As of December 31, 2018, 64 debt securities had gross unrealized losses, with an aggregate depreciation of 1.11% from our amortized cost basis. The largest unrealized loss percentage of any single security was 4.98% (or $148,000) of its amortized cost. This was also the largest unrealized dollar loss of any security.

 

The unrealized losses on these debt securities arose primarily due to changing interest rates and are considered to be temporary.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Impact of Inflation and Changing Prices. Our consolidated financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on our performance than they would on industrial companies.

 

Liquidity. Liquidity is defined as the Company’s ability to generate adequate cash to meet its needs for day-to-day operations and material long and short-term commitments. Liquidity is the risk of potential loss if we were unable to meet our funding requirements at a reasonable cost. We are expected to maintain adequate liquidity at the Bank to meet the cash flow requirements of customers who may be either depositors wishing to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Our asset and liability management policy is intended to cause the Bank to maintain adequate liquidity and, therefore, enhance our ability to raise funds to support asset growth, meet deposit withdrawals and lending needs, maintain reserve requirements and otherwise sustain our operations.

 

We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all of our short-term and long-term cash requirements. We manage our liquidity based on demand and specific events and uncertainties to meet current and future financial obligations of a short-term nature. We also monitor our liquidity requirements in light of interest rate trends, changes in the economy and the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits. Our objective in managing liquidity is to respond to the needs of depositors and borrowers as well as to increase earnings enhancement opportunities in a changing marketplace.

 

Our liquidity is maintained through investment portfolio, deposits, borrowings from the FHLB, and lines available from correspondent banks. Our highest priority is placed on growing noninterest bearing deposits through strong community involvement in the markets that we serve. Borrowings and brokered deposits are considered short-term supplements to our overall liquidity but are not intended to be relied upon for long-term needs. We believe that our present position is adequate to meet our current and future liquidity needs, and management knows of no trend or event that will have a material impact on the Company’s ability to maintain liquidity at satisfactory levels.

 

 51 

 

 

Capital Adequacy. Total stockholders’ equity was $179.2 million at March 31, 2019 compared to $174.3 million at December 31, 2018.

 

Our capital management consists of providing adequate equity to support our current and future operations. The Bank is subject to various regulatory capital requirements administered by state and federal banking agencies, including the Federal Reserve and the OCC. Failure to meet minimum capital requirements may prompt certain actions by regulators that, if undertaken, could have a direct material adverse effect on our financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measure of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the classifications are also subject to qualitative judgment by the regulator in regards to components, risk weighting and other factors.

 

The Bank is subject to the following risk-based capital ratios: a common equity Tier 1 (“CET1”) risk-based capital ratio, a Tier 1 risk-based capital ratio, which includes CET1 and additional Tier 1 capital, and a total capital ratio, which includes Tier 1 and Tier 2 capital. CET1 is primarily comprised of the sum of common stock instruments and related surplus net of treasury stock, retained earnings, and certain qualifying minority interests, less certain adjustments and deductions, including with respect to goodwill, intangible assets, mortgage servicing assets and deferred tax assets subject to temporary timing differences. Additional Tier 1 capital is primarily comprised of noncumulative perpetual preferred stock, tier 1 minority interests and grandfathered trust preferred securities. Tier 2 capital consists of instruments disqualified from Tier 1 capital, including qualifying subordinated debt, other preferred stock and certain hybrid capital instruments, and a limited amount of loan loss reserves up to a maximum of 1.25% of risk-weighted assets, subject to certain eligibility criteria. The capital rules also define the risk-weights assigned to assets and off-balance sheet items to determine the risk-weighted asset components of the risk-based capital rules, including, for example, certain “high volatility” commercial real estate, past due assets, structured securities and equity holdings.

 

The leverage capital ratio, which serves as a minimum capital standard, is the ratio of Tier 1 capital to quarterly average assets net of goodwill, certain other intangible assets, and certain required deduction items. The required minimum leverage ratio for all banks is 4%.

 

In addition, the capital rules require a capital conservation buffer of up to 2.5% above each of the minimum capital ratio requirements (CET1, Tier 1, and total risk-based capital), which is designed to absorb losses during periods of economic stress. These buffer requirements must be met for a bank to be able to pay dividends, engage in share buybacks or make discretionary bonus payments to executive management without restriction. This capital conservation buffer is being phased in, and was 1.875% as of January 1, 2018 and is 2.5% effective January 1, 2019.

 

Failure to be well-capitalized or to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our operations or financial condition. For example, only a well-capitalized depository institution may accept brokered deposits without prior regulatory approval. Failure to be well-capitalized or to meet minimum capital requirements could also result in restrictions on the Bank’s ability to pay dividends or otherwise distribute capital or to receive regulatory approval of applications or other restrictions on its growth.

 

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, requires the federal bank regulatory agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements. FDICIA establishes five regulatory capital tiers: “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, and “critically undercapitalized”. A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. The FDICIA imposes progressively more restrictive restraints on operations, management and capital distributions, depending on the category in which an institution is classified. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions may not accept brokered deposits absent a waiver from the FDIC, are subject to growth limitations and are required to submit capital restoration plans for regulatory approval. A depository institution’s holding company must guarantee any required capital restoration plan, up to an amount equal to the lesser of 5 percent of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. Federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. All of the federal bank regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels for federally insured depository institutions. The Bank was well capitalized at December 31, 2018, and brokered deposits are not restricted.

 

To be well-capitalized, the Bank must maintain at least the following capital ratios:

6.5% CET1 to risk-weighted assets;

 

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8.0% Tier 1 capital to risk-weighted assets;
10.0% Total capital to risk-weighted assets; and
5.0% leverage ratio.

 

The Bank’s regulatory capital ratios were above the applicable well-capitalized standards and met the then-applicable capital conservation buffer. Based on current estimates, we believe that the Bank will continue to exceed all applicable well-capitalized regulatory capital requirements and the capital conservation buffer in 2019.

 

The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”) signed into law in May 2018 scaled back certain requirements of the Dodd-Frank Act and provided other regulatory relief. Among the provisions of the Economic Growth Act was a requirement that the Federal Reserve raise the asset threshold for those bank holding companies subject to the Federal Reserve’s Small Bank Holding Company Policy Statement (“Policy Statement”) to $3 billion. As a result, as of the effective date of that change in 2018, the Company was no longer required to comply with the risk-based capital rules applicable to the Bank as described above. The Federal Reserve may however, require smaller bank holding companies subject to the Policy Statement to maintain certain minimum capital levels, depending upon general economic conditions and a bank holding company’s particular condition, risk profile and growth plans.

 

On November 21, 2018, the federal banking agencies jointly issued a proposed rule to simplify the regulatory capital requirements for eligible banks and holding companies with less than $10 billion in consolidated assets that opt into the Community Bank Leverage Ratio (“CBLR”) framework, as required by Section 201 of the Economic Growth, Relief and Consumer Protection Act (the “Regulatory Relief Act”). The Regulatory Relief Act mandates that the banking agencies develop a CBLR of not less than 8% and not more than 10% for qualifying community banking organizations. A qualifying community banking organization that exceeds the CBLR threshold would be exempt from the agencies’ current capital framework, including the risk-based capital requirements and capital conservation buffer described above, and would be deemed well-capitalized under the agencies’ prompt corrective action regulations. The Regulatory Relief Act defines a “qualifying community banking organization” as a depository institution or depository institution holding company with total consolidated assets of less than $10 billion. Under the proposed rule, if a qualifying community banking organization elects to use the CBLR framework, it will be considered “well-capitalized” so long as its CBLR is greater than 9%. The agencies are expected to issue a final rule in the first quarter of 2019.

 

On December 21, 2018, federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the upcoming implementation of the “current expected credit losses” (“CECL”) accounting standard under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking organizations are expected to experience upon adopting CECL; and (iii) require the use of CECL in stress tests beginning with the 2020 capital planning and stress testing cycle for certain banking organizations. In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update No. 2016-13, which introduced CECL as the methodology to replace the current “incurred loss” methodology for financial assets measured at amortized cost, and changed the approaches for recognizing and recording credit losses on available-for-sale debt securities and purchased credit impaired financial assets. Under the incurred loss methodology, credit losses are recognized only when the losses are probable or have been incurred; under CECL, companies are required to recognize the full amount of expected credit losses for the lifetime of the financial assets, based on historical experience, current conditions and reasonable and supportable forecasts. This change will result in earlier recognition of credit losses that the Company deems expected but not yet probable. For SEC reporting companies with December 31 fiscal-year ends, such as the Company, CECL will become effective beginning with the first quarter of 2020.

 

 53 

 

 

Federal banking regulators have issued risk-based capital guidelines, which assign risk factors to asset categories and off-balance-sheet items. The following table reflects capital ratios computed utilizing the implemented Basel III regulatory capital framework discussed above:

  

   Actual  Minimum Capital
Required For
Capital Adequacy
  Minimum Capital 
Required For Capital
Adequacy Plus
Capital Conservation
Buffer
Basel III Phase-In Schedule
  Minimum Capital 
Required For Capital
Adequacy Plus
Capital Conservation Buffer
Basel III Fully Phased In
  Minimum To Be
Well-Capitalized
Under
Prompt Corrective
Action Provisions
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio 
   (dollars in thousands) 
At March 31, 2019                                        
Bank First National Corporation:                                                  
Total capital (to risk-weighted assets)  $184,328    11.5%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Tier I capital (to risk-weighted assets)   160,615    10.1%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Common equity tier I capital (to risk-weighted assets)   160,615    10.1%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Tier I capital (to average assets)   160,615    9.1%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Bank First, N.A.:                                                  
Total capital (to risk-weighted assets)  $181,904    11.4%  $127,706    8.0%  $167,614    10.5%  $167,614    10.5%  $159,632    10.0%
Tier I capital (to risk-weighted assets)   169,691    10.6%   95,779    6.0%   135,687    8.5%   135,687    8.5%   127,706    8.0%
Common equity tier I capital (to risk-weighted assets)   169,691    10.6%   71,834    4.5%   111,742    7.0%   111,742    7.0%   103,761    6.5%
Tier I capital (to average assets)   169,691    9.7%   70,124    4.0%   70,124    4.0%   70,124    4.0%   87,655    5.0%
At December 31, 2018                                                  
Bank First National Corporation:                                                  
Total capital (to risk-weighted assets)  $181,201    11.4%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Tier I capital (to risk-weighted assets)   157,453    9.9%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Common equity tier I capital (to risk-weighted assets)   157,453    9.9%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Tier I capital (to average assets)   157,453    9.1%   N/A    N/A    N/A    N/A    N/A    N/A    N/A    N/A 
Bank First, N.A.:                                                  
Total capital (to risk-weighted assets)  $178,668    11.2%  $127,497    8.0%  $157,459    9.88%  $167,340    10.5%  $159,372    10.0%
Tier I capital (to risk-weighted assets)   166,420    10.4%   95,623    6.0%   125,585    7.88%   135,466    8.5%   127,497    8.0%
Common equity tier I capital (to risk-weighted assets)   166,420    10.4%   71,717    4.5%   101,679    6.38%   111,560    7.0%   103,592    6.5%
Tier I capital (to average assets)   166,420    9.6%   69,410    4.0%   69,410    4.00%   69,410    4.0%   86,762    5.0%

 

As previously mentioned, the Company carried $11.5 million of subordinated debt as of March 31, 2019 and December 31, 2018 which is included in total capital for the Company in the tables above.

 

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

 

We are party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to originate and sell loans, standby and direct pay letters of credit, unused lines of credit and unadvanced portions of construction and development loans. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in these particular classes of financial instruments.

 

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments, standby and direct pay letters of credit and unadvanced portions of construction and development loans is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

 

Off-Balance Sheet Arrangements. Our significant off-balance-sheet arrangements consist of the following:

 

· Unused lines of credit

· Standby and direct pay letters of credit

· Credit card arrangements

 

Off-balance sheet arrangement means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with the registrant is a party, under which the registrant has (1) any obligation under a guarantee contract, (2) retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement, (3) any obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument, or (4) any obligation, including a contingent obligation, arising out of a variable interest.

 

Loan commitments are made to accommodate the financial needs of our customers. Standby and direct pay letters of credit commit us to make payments on behalf of customers when certain specified future events occur. Both arrangements have credit risk essentially the same as that involved in extending loans to clients and are subject to our normal credit policies. Collateral (e.g., securities, receivables, inventory, equipment, etc.) is obtained based on management’s credit assessment of the customer.

 

 54 

 

  

Loan commitments and standby and direct pay letters of credit do not necessarily represent our future cash requirements because while the borrower has the ability to draw upon these commitments at any time, these commitments often expire without being drawn upon. Our off-balance sheet arrangements at the dates indicated were as follows:

 

   Amounts of Commitments Expiring – By Period as of March 31, 2019 
Other Commitments  Total   Less Than
One Year
   One to
Three
Years
   Three to
Five
Years
   After Five
Years
 
   (dollars in thousands) 
Unused lines of credit  $309,114   $195,027   $45,172   $44,106   $24,809 
Standby and direct pay letters of credit   25,021    11,706    2,568    8,581    2,166 
Credit card arrangements   7,507                7,507 
Total commitments  $341,642   $206,733   $47,740   $52,687   $34,482 
                          
   Amounts of Commitments Expiring – By Period as of December 31, 2018 
Other Commitments  Total   Less Than
One Year
   One to
Three
Years
   Three to
Five
Years
   After Five
Years
 
   (dollars in thousands) 
Unused lines of credit  $326,452   $205,200   $45,589   $51,371   $24,292 
Standby and direct pay letters of credit   25,261    11,501    2,964    8,630    2,166 
Credit card arrangements   7,119                7,119 
Total commitments  $358,832   $216,701   $48,553   $60,001   $33,577 

 

 55 

 

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest rate risk inherent in its lending, investment and deposit-taking activities. To that end, management actively monitors and manages its interest rate risk exposure.

 

Our profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact our earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. We monitor the impact of changes in interest rates on its net interest income using several tools.

 

Our primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on our net interest income and capital, while configuring our asset-liability structure to obtain the maximum yield-cost spread on that structure. We rely primarily on our asset-liability structure to control interest rate risk.

 

Interest Rate Sensitivity. Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (repricing risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay home mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR (basis risk).

 

An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.

 

The Company actively manages its interest rate sensitivity position. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve sustainable growth in net interest income. The Company’s ALCO, using policies and procedures approved by the Company’s board of directors, is responsible for the management of the Company’s interest rate sensitivity position. The Company manages interest rate sensitivity by changing the mix, pricing and re-pricing characteristics of its assets and liabilities, through the management of its investment portfolio, its offerings of loan and selected deposit terms and through wholesale funding. Wholesale funding consists of, but is not limited to, multiple sources including borrowings with the FHLB of Chicago, the Federal Reserve Bank of Chicago’s discount window and certificates of deposit from institutional brokers.

 

The Company uses several tools to manage its interest rate risk including interest rate sensitivity analysis, or gap analysis, market value of portfolio equity analysis, interest rate simulations under various rate scenarios and net interest margin reports. The results of these reports are compared to limits established by the Company’s ALCO policies and appropriate adjustments are made if the results are outside the established limits.

 

There are an infinite number of potential interest rate scenarios, each of which can be accompanied by differing economic/political/regulatory climates; can generate multiple differing behavior patterns by markets, borrowers, depositors, etc.; and, can last for varying degrees of time. Therefore, by definition, interest rate risk sensitivity cannot be predicted with certainty. Accordingly, the Company’s interest rate risk measurement philosophy focuses on maintaining an appropriate balance between theoretical and practical scenarios; especially given the primary objective of the Company’s overall asset/liability management process is to facilitate meaningful strategy development and implementation.

 

Therefore, we model a set of interest rate scenarios capturing the financial effects of a range of plausible rate scenarios; the collective impact of which will enable the Company to clearly understand the nature and extent of its sensitivity to interest rate changes. Doing so necessitates an assessment of rate changes over varying time horizons and of varying/sufficient degrees such that the impact of embedded options within the balance sheet are sufficiently examined.

 

The following tables demonstrate the annualized result of an interest rate simulation and the estimated effect that a parallel interest rate shift, or “shock,” in the yield curve and subjective adjustments in deposit pricing might have on the Company’s projected net interest income over the next 12 months.

 

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This simulation assumes that there is no growth in interest-earning assets or interest-bearing liabilities over the next 12 months. The changes to net interest income shown below are in compliance with the Company’s policy guidelines. As of March 31, 2019:

 

Change in Interest
Rates (in Basis Points)
  Percentage Change
in Net Interest Income
 
+400   6.8 
+300   5.2 
+200   3.5 
+100   1.8 
–100   (4.7)

 

As of December 31, 2018:

 

Change in Interest
Rates (in Basis Points)
  Percentage Change
in Net Interest Income
 
+400   5.0 
+300   3.9 
+200   2.7 
+100   1.5 
–100   (4.1)

 

Economic Value of Equity Analysis. We also analyze the sensitivity of the Company’s financial condition to changes in interest rates through our economic value of equity model. This analysis measures the difference between estimated changes in the present value of the Company’s assets and estimated changes in the present value of the Company’s liabilities assuming various changes in current interest rates. The Company’s economic value of equity analysis as of March 31, 2019 estimated that, in the event of an instantaneous 200 basis point increase in interest rates, the Company would experience a 4.9% increase in the economic value of equity. At the same date, our analysis estimated that, in the event of an instantaneous 100 basis point decrease in interest rates, the Company would experience a 6.8% decrease in the economic value of equity. The estimates of changes in the economic value of our equity require us to make certain assumptions including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturities and decay rates. These assumptions are inherently uncertain and, as a result, we cannot precisely predict the impact of changes in interest rates on the economic value of our equity. Although our economic value of equity analysis provides an indication of our interest rate risk exposure at a particular point in time, such estimates are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on the economic value of our equity and will differ from actual results.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), undertook an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report, and, based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, in recording, processing, summarizing and reporting in a timely manner the information that the Company is required to disclose in its reports under the Exchange Act and in accumulating and communicating to the Company’s management, including the Company’s CEO and CFO, such information as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control Over Financial Reporting

 

No changes were made to our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

PART II. OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS

 

We are a party to various litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

 

ITEM 1A.RISK FACTORS

 

Additional information regarding risk factors appears in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Statements” of this Form 10-Q and in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018. There have been no material changes during the quarterly period ended March 31, 2019 to the risk factors previously disclosed in the Company’s Annual Report.

 

ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a) On January 1, 2019, the Company issued 1,518 shares of restricted stock to a former member of Senior Management who had retired, pursuant to the terms of the Company’s Deferred Compensation Plan.

 

(b) None.

 

(c) Issuer Purchases of Equity Securities

 

The Company's Board of Directors authorized a $10 million share repurchase program that expired in April, 2019. This program was announced on May 14, 2018. The table below sets forth information regarding repurchases of our common stock during the first quarter of 2019 under that program. The Board renewed the share repurchase program in the amount of $10 million on April 16, 2019. The program was announced in a Current Report on Form 8-K on April 18, 2019.

 

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(in thousands,
except per
share data)
  Total Number of Shares
Repurchased
   Average Price Paid per
Share(1)
   Total Number
of Shares
Repurchased as
Part of
Publicly Announced
Plans or Programs
   Maximum Number
of Shares
that May Yet Be
Purchased Under
the
Plans or Programs(2)
 
January 2019   47,223   $47.24    47,223    54,481 
February 2019   0    0    0    54,481 
March 2019   4,447(3)   57.35    0    54,481 
Total   51,670   $48.11    47,223    54,481 

 

 

(1)The average price paid per share is calculated on a trade date basis for all open market transactions and excludes commissions and other transaction expenses.
(2)Based on the closing per share price as of March 31, 2019 ($58.93).
(3)Includes 3,077 shares repurchased to satisfy tax withholding obligations and 1,370 shares repurchased from the 401(k) Plan.

 

The foregoing repurchases during the first quarter of 2019 were purchased through open market transactions, including under plans complying with Rule 10b5-1 under the Exchange Act and pursuant to the Company’s 401(k) Plan and Equity Plan.

  

ITEM 3.DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.MINE SAFETY DISCLOSURES

 

None.

 

ITEM 5.OTHER INFORMATION

 

None

 

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ITEM 6.EXHIBITS

 

Exhibit Index

 

Exhibit
Number
  Description
2.1   First Amendment to Agreement and Plan of Merger, dated as of April 30, 2019, to that certain Agreement and Plan of Merger, dated as of January 22, 2019, by and between Bank First National Corporation and Partnership Community Bancshares, Inc.*
31.1   Rule 13a-14(a) Certification of Chief Executive Officer*
31.2   Rules 13a-14(a) Certification of Chief Financial Officer*
32.1   Section 1350 Certification of Chief Executive Officer and Chief Financial Officer**
101 INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

*Filed herewith.
**Furnished herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    BANK FIRST NATIONAL CORPORATION
     
       
DATE:  May 8, 2019 BY: /s/Kevin M. LeMahieu
      Kevin M. LeMahieu
      Chief Financial Officer
      (Principal Financial and Accounting Officer)

 

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