FIRST BUSINESS FINANCIAL SERVICES, INC. - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



þ		Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2017



¨		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 001-34095

FIRST BUSINESS FINANCIAL SERVICES, INC.

(Exact name of registrant as specified in its charter)



Wisconsin		39-1576570

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)



401 Charmany Drive, Madison, WI		53719

(Address of Principal Executive Offices)		(Zip Code)

(608) 238-8008

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 þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting 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. (Check one):



Large accelerated filer ¨	Accelerated filer þ	Non-accelerated filer ¨	Smaller reporting company ¨	Emerging growth company ¨
		(Do not check if a smaller reporting company)

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. ¨

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

The number of shares outstanding of the registrant’s sole class of common stock, par value $0.01 per share, on April 21, 2017 was 8,718,307 shares.

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FIRST BUSINESS FINANCIAL SERVICES, INC.

INDEX — FORM 10-Q



PART I. Financial Information	1
Item 1. Financial Statements	1
Consolidated Balance Sheets	1
Consolidated Statements of Income (Unaudited)	2
Consolidated Statements of Comprehensive Income (Unaudited)	3
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)	4
Consolidated Statements of Cash Flows (Unaudited)	5
Notes to Unaudited Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
Item 3. Quantitative and Qualitative Disclosures about Market Risk	57
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	58
Item 4. Mine Safety Disclosures	58
Item 5. Other Information	59
Item 6. Exhibits	59
Signatures	60

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PART I. Financial Information

Item 1. Financial Statements

First Business Financial Services, Inc.

Consolidated Balance Sheets



		March 31, 2017			December 31, 2016
		(unaudited)
	(In Thousands, Except Share Data)
Assets
Cash and due from banks		$	15,465		$	14,596
Short-term investments		45,434			62,921
Cash and cash equivalents		60,899			77,517
Securities available-for-sale, at fair value		147,058			145,893
Securities held-to-maturity, at amortized cost		38,485			38,612
Loans held for sale		3,924			1,111
Loans and leases receivable, net of allowance for loan and lease losses of $21,666 and $20,912, respectively		1,459,305			1,429,763
Premises and equipment, net		3,955			3,772
Foreclosed properties		1,472			1,472
Bank-owned life insurance		39,358			39,048
Federal Home Loan Bank and Federal Reserve Bank stock, at cost		4,782			2,131
Goodwill and other intangible assets		12,774			12,773
Accrued interest receivable and other assets		28,578			28,607
Total assets		$	1,800,590		$	1,780,699
Liabilities and Stockholders’ Equity
Deposits		$	1,492,714		$	1,538,855
Federal Home Loan Bank advances and other borrowings		121,841			59,676
Junior subordinated notes		10,008			10,004
Accrued interest payable and other liabilities		11,893			10,514
Total liabilities		1,636,456			1,619,049
Stockholders’ equity:
Preferred stock, $0.01 par value, 2,500,000 shares authorized, none issued or outstanding		—			—
Common stock, $0.01 par value, 25,000,000 shares authorized, 8,961,789 and 8,959,239 shares issued, 8,718,307 and 8,715,856 shares outstanding at March 31, 2017 and December 31, 2016, respectively		90			90
Additional paid-in capital		77,818			77,542
Retained earnings		93,581			91,317
Accumulated other comprehensive loss		(576		)	(522		)
Treasury stock, 243,482 and 243,383 shares at March 31, 2017 and December 31, 2016, respectively, at cost		(6,779		)	(6,777		)
Total stockholders’ equity		164,134			161,650
Total liabilities and stockholders’ equity		$	1,800,590		$	1,780,699

See accompanying Notes to Unaudited Consolidated Financial Statements.

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First Business Financial Services, Inc.

Consolidated Statements of Income (Unaudited)



	For the Three Months Ended March 31,
	2017		2016
	(In Thousands, Except Per Share Data)
Interest income
Loans and leases	$	17,522	$	18,445
Securities income	779		722
Short-term investments	146		176
Total interest income	18,447		19,343
Interest expense
Deposits	2,673		3,053
Federal Home Loan Bank advances and other borrowings	612		474
Junior subordinated notes	274		277
Total interest expense	3,559		3,804
Net interest income	14,888		15,539
Provision for loan and lease losses	572		525
Net interest income after provision for loan and lease losses	14,316		15,014
Non-interest income
Trust and investment services fee income	1,629		1,273
Gain on sale of Small Business Administration loans	360		1,376
Gain on sale of residential mortgage loans	11		145
Service charges on deposits	765		742
Loan fees	458		609
Increase in cash surrender value of bank-owned life insurance	311		243
Other non-interest income	529		206
Total non-interest income	4,063		4,594
Non-interest expense
Compensation	8,683		8,370
Occupancy	475		508
Professional fees	1,010		861
Data processing	584		651
Marketing	370		734
Equipment	283		280
Computer software	683		494
FDIC insurance	380		291
Collateral liquidation costs	92		47
Impairment of tax credit investments	113		112
Small Business Administration recourse provision	6		—
Other non-interest expense	881		351
Total non-interest expense	13,560		12,699
Income before income tax expense	4,819		6,909
Income tax expense	1,422		2,356
Net income	$	3,397	$	4,553
Earnings per common share
Basic	$	0.39	$	0.52
Diluted	0.39		0.52
Dividends declared per share	0.13		0.12

See accompanying Notes to Unaudited Consolidated Financial Statements.

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First Business Financial Services, Inc.

Consolidated Statements of Comprehensive Income (Unaudited)



	For the Three Months Ended March 31,
	2017			2016
	(In Thousands)
Net income	$	3,397		$	4,553
Other comprehensive (loss) income, before tax
Securities available-for-sale:
Net unrealized securities (losses) gains arising during the period	(83		)	876
Securities held-to-maturity:
Amortization of net unrealized losses transferred from available-for-sale	26			40
Income tax benefit (expense)	3			(354		)
Total other comprehensive (loss) income	$	(54	)	$	562
Comprehensive income	$	3,343		$	5,115

See accompanying Notes to Unaudited Consolidated Financial Statements.

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First Business Financial Services, Inc.

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)



	Common Shares Outstanding		Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Treasury Stock			Total
	(In Thousands, Except Share Data)
Balance at December 31, 2015	8,699,410		$	89	$	76,549	$	80,584		$	(80	)	$	(6,310	)	$	150,832
Net income	—		—		—		4,553			—			—			4,553
Other comprehensive income	—		—		—		—			562			—			562
Share-based compensation - restricted shares	861		—		296		—			—			—			296
Cash dividends ($0.12 per share)	—		—		—		(1,042		)	—			—			(1,042		)
Treasury stock purchased	(99	)	—		—		—			—			(2		)	(2		)
Balance at March 31, 2016	8,700,172		$	89	$	76,845	$	84,095		$	482		$	(6,312	)	$	155,199



	Common Shares Outstanding		Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Loss			Treasury Stock			Total
	(In Thousands, Except Share Data)
Balance at December 31, 2016	8,715,856		$	90	$	77,542	$	91,317		$	(522	)	$	(6,777	)	$	161,650
Net income	—		—		—		3,397			—			—			3,397
Other comprehensive loss	—		—		—		—			(54		)	—			(54		)
Share-based compensation - restricted shares	2,550		—		276		—			—			—			276
Cash dividends ($0.13 per share)	—		—		—		(1,133		)	—			—			(1,133		)
Treasury stock purchased	(99	)	—		—		—			—			(2		)	(2		)
Balance at March 31, 2017	8,718,307		$	90	$	77,818	$	93,581		$	(576	)	$	(6,779	)	$	164,134

See accompanying Notes to Unaudited Consolidated Financial Statements.

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First Business Financial Services, Inc.

Consolidated Statements of Cash Flows (Unaudited)



	For the Three Months Ended March 31,
	2017			2016
	(In Thousands)
Operating activities
Net income	$	3,397		$	4,553
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes, net	(75		)	(98		)
Impairment of tax credit investments	113			112
Provision for loan and lease losses	572			525
Depreciation, amortization and accretion, net	384			243
Share-based compensation	276			296
Increase in value of bank-owned life insurance policies	(311		)	(243		)
Origination of loans for sale	(10,646		)	(13,986		)
Sale of loans originated for sale	10,244			22,288
Gain on sale of loans originated for sale	(371		)	(1,521		)
Excess tax benefit from share-based compensation	(7		)	(6		)
Returns on investments in limited partnerships	92			—
Net increase in accrued interest receivable and other assets	(159		)	(657		)
Net increase (decrease) in accrued interest payable and other liabilities	1,379			(1,685		)
Net cash provided by operating activities	4,888			9,821
Investing activities
Proceeds from maturities, redemptions and paydowns of available-for-sale securities	9,434			9,126
Proceeds from maturities, redemptions and paydowns of held-to-maturity securities	730			802
Purchases of available-for-sale and held-to-maturity securities	(11,517		)	(8,802		)
Net increase in loans and leases	(32,061		)	(23,321		)
Investment in Federal Home Loan Bank and Federal Reserve Bank Stock	(3,495		)	(7		)
Proceeds from the sale of Federal Home Loan Bank Stock	844			116
Purchases of leasehold improvements and equipment, net	(363		)	(113		)
Net cash used in investing activities	(36,428		)	(22,199		)
Financing activities
Net (decrease) increase in deposits	(46,133		)	4,412
Repayment of Federal Home Loan Bank advances	(115,916		)	(1,500		)
Proceeds from Federal Home Loan Bank advances	178,416			—
Net (decrease) increase in other borrowed funds	(310		)	1,800
Cash dividends paid	(1,133		)	(1,042		)
Purchase of treasury stock	(2		)	(2		)
Net cash provided by financing activities	14,922			3,668
Net decrease in cash and cash equivalents	(16,618		)	(8,710		)
Cash and cash equivalents at the beginning of the period	77,517			113,564
Cash and cash equivalents at the end of the period	$	60,899		$	104,854
Supplementary cash flow information
Cash paid during the period for:
Interest paid on deposits and borrowings	$	3,386		$	3,633
Income taxes paid	(314		)	1,521
Non-cash investing and financing activities:
Transfer of loans from held-to-maturity to held-for-sale	2,040			5,776

See accompanying Notes to Unaudited Consolidated Financial Statements.

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Notes to Unaudited Consolidated Financial Statements

Note 1 — Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations. The accounting and reporting practices of First Business Financial Services, Inc. (the “Corporation”), its wholly owned subsidiaries, First Business Bank (“FBB”), First Business Bank – Milwaukee (“FBB – Milwaukee”) and Alterra Bank (“Alterra”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB, FBB – Milwaukee and Alterra are sometimes referred to together as the “Banks.” FBB operates as a commercial banking institution in the Madison, Wisconsin market, consisting primarily of Dane County and the surrounding areas, with loan production offices in Northeast Wisconsin. FBB also offers trust and investment services through First Business Trust & Investments (“FBTI”), a division of FBB. FBB – Milwaukee operates as a commercial banking institution in the Milwaukee, Wisconsin market, consisting primarily of Waukesha County, Milwaukee County and the surrounding areas, with a loan production office in Kenosha, Wisconsin. Alterra operates as a commercial banking institution in the Kansas City market and the surrounding areas. The Banks provide a full range of financial services to businesses, business owners, executives, professionals and high net worth individuals. The Banks are subject to competition from other financial institutions and service providers and are also subject to state and federal regulations. FBB has the following wholly owned subsidiaries: First Business Capital Corp. (“FBCC”), First Madison Investment Corp. (“FMIC”), First Business Equipment Finance, LLC (“FBEF”), Rimrock Road Investment Fund, LLC (“Rimrock Road”), BOC Investment, LLC (“BOC”) and Mitchell Street Apartments Investment, LLC (“Mitchell Street”). FMIC is located in and was formed under the laws of the state of Nevada. FBB-Milwaukee has one subsidiary, FBB – Milwaukee Real Estate, LLC (“FBBMRE”).

On January 12, 2017, the Corporation announced plans to consolidate the charters of the Banks into a single charter. The Corporation’s charter consolidation plans have been approved by the board of directors of the Corporation and the Banks, as well as by the applicable federal and state banking regulators. The plans are expected to take effect during the second quarter of 2017.

Basis of Presentation. The accompanying unaudited Consolidated Financial Statements were prepared in accordance with GAAP and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Corporation’s Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2016. The unaudited Consolidated Financial Statements include the accounts of the Corporation and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. In accordance with the provisions of Accounting Standards Codification (“ASC”) Topic 810, the Corporation’s ownership interest in FBFS Statutory Trust II (“Trust II”) has not been consolidated into the financial statements.

Management of the Corporation is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities, level of the allowance for loan and lease losses, lease residuals, property under operating leases, goodwill, level of the Small Business Administration (“SBA”) recourse reserve and income taxes. The results of operations for the three month period ended March 31, 2017 are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2017. Certain amounts in prior periods may have been reclassified to conform to the current presentation. Subsequent events have been evaluated through the date of the issuance of the unaudited Consolidated Financial Statements. No significant subsequent events have occurred through this date requiring adjustment to the financial statements or disclosures.

The Corporation has not changed its significant accounting and reporting policies from those disclosed in the Corporation’s Form 10-K for the year ended December 31, 2016.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” with an original effective date for annual reporting periods beginning after December 15, 2016. The ASU is a converged standard between the FASB and the IASB that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and industries. The primary objective of the ASU is revenue recognition that represents the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of ASU 2014-09 to annual and interim reporting periods in fiscal years beginning after December 15, 2017. Earlier application is permitted only as of annual and interim reporting periods in fiscal years beginning after December 15, 2016. In March 2016,

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the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net.” The ASU intends to improve the operability and understandability of the implementation guidance of ASU 2014-09 on principal versus agent considerations. In April, May and December 2016, the FASB also issued ASU No. 2016-10, No. 2016-12 and No. 2016-20, respectively, related to Topic 606. The amendments do not change the core principals of the previously issued guidance, but instead further clarify and provide implementation guidance for certain aspects of the original ASU. The Corporation intends to adopt the accounting standards during the first quarter of 2018, as required. The Corporation has conducted its initial assessment and is currently evaluating contracts to assess and quantify accounting methodology changes resulting from the adoption of this standard. The adoption of this accounting standard is not expected to have a material impact on the Corporation's consolidated financial statements. The FASB continues to release new accounting guidance related to the adoption of this standard, which could impact the Corporation's initial assessment and may change the conclusions reached as to the application of this new guidance.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The ASU intends to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities and disclosing key information about leasing arrangements. The ASU will require lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessees’ obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The new lease guidance simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Corporation intends to adopt the accounting standard during the first quarter of 2019, as required, and is currently evaluating the impact on its results of operations, financial position and liquidity.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments- Credit Losses (Topic 326).” The ASU replaces the incurred loss impairment methodology for recognizing credit losses with a methodology that reflects all expected credit losses. The ASU also requires consideration of a broader range of information to inform credit loss estimates, including such factors as past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, and any other financial asset not excluded from the scope that have the contractual right to receive cash. Entities will apply the amendments in the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The ASU is effective for public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal years beginning after December 15, 2018. The Corporation intends to adopt the accounting standard during the first quarter of 2020, as required, and is currently evaluating the impact on its results of operations, financial position and liquidity.

Note 2 — Earnings per Common Share

Earnings per common share are computed using the two-class method. Basic earnings per common share are computed by dividing net income allocated to common shares by the weighted average number of shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends, or dividend equivalents, at the same rate as holders of the Corporation’s common stock. Diluted earnings per share are computed by dividing net income allocated to common shares, adjusted for reallocation of undistributed earnings of unvested restricted shares, by the weighted average number of shares determined for the basic earnings per common share computation plus the dilutive effect of common stock equivalents using the treasury stock method.

There were no anti-dilutive employee share-based awards for the three months ended March 31, 2017 and 2016.

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	For the Three Months Ended March 31,
	2017		2016
	(Dollars in Thousands, Except Share Data)
Basic earnings per common share
Net income	$	3,397	$	4,553
Less: earnings allocated to participating securities	45		70
Basic earnings allocated to common shareholders	$	3,352	$	4,483
Weighted-average common shares outstanding, excluding participating securities	8,600,620		8,565,050
Basic earnings per common share	$	0.39	$	0.52

Diluted earnings per common share
Earnings allocated to common shareholders, diluted	$	3,352	$	4,483
Weighted-average diluted common shares outstanding, excluding participating securities	8,600,620		8,565,050
Diluted earnings per common share	$	0.39	$	0.52

Note 3 — Share-Based Compensation

The Corporation adopted the 2012 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2012. The Plan is administered by the Compensation Committee of the Board of Directors of the Corporation and provides for the grant of equity ownership opportunities through incentive stock options and nonqualified stock options (together, “Stock Options”), restricted stock, restricted stock units, dividend equivalent units and any other type of award permitted by the Plan. As of March 31, 2017, 272,031 shares were available for future grants under the Plan. Shares covered by awards that expire, terminate or lapse will again be available for the grant of awards under the Plan. The Corporation may issue new shares and shares from its treasury stock for shares delivered under the Plan.

Restricted Stock

Under the Plan, the Corporation may grant restricted stock to plan participants, subject to forfeiture upon the occurrence of certain events until the dates specified in the participant’s award agreement. While restricted stock is subject to forfeiture, with the exception of restricted stock units, which do not have voting rights and are provided dividend equivalents, restricted stock participants may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares. The restricted stock granted under the Plan is typically subject to a vesting period. Compensation expense is recognized over the requisite service period of generally four years for the entire award on a straight-line basis. Upon vesting of restricted stock, the benefit of tax deductions in excess of recognized compensation expense is reflected as an income tax benefit in the unaudited Consolidated Statements of Income.

Restricted stock activity for the year ended December 31, 2016 and the three months ended March 31, 2017 was as follows:



	Number of Restricted Shares/Units		Weighted Average Grant-Date Fair Value
Nonvested balance as of December 31, 2015	135,471		$	20.13
Granted	60,415		22.74
Vested	(56,090	)	18.71
Forfeited	(23,551	)	20.90
Nonvested balance as of December 31, 2016	116,245		21.13
Granted	2,550		25.52
Vested	(2,163	)	23.91
Forfeited	—		—
Nonvested balance as of March 31, 2017	116,632		$	21.17

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As of March 31, 2017, the Corporation had $2.0 million of deferred unvested compensation expense, which the Corporation expects to recognize over a weighted-average period of approximately 2.60 years.

For the three months ended March 31, 2017 and 2016, share-based compensation expense related to restricted stock included in the unaudited Consolidated Statements of Income was as follows:



	For the Three Months Ended March 31,
	2017		2016
	(In Thousands)
Share-based compensation expense	$	276	$	296

Note 4 — Securities

The amortized cost and fair value of securities available-for-sale and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:



	As of March 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
Available-for-sale:
U.S. Government agency obligations - government-sponsored enterprises	$	6,299	$	10	$	(9	)	$	6,300
Municipal obligations	8,218		8		(50		)	8,176
Asset-backed securities	1,067		—		(17		)	1,050
Collateralized mortgage obligations - government issued	27,744		403		(160		)	27,987
Collateralized mortgage obligations - government-sponsored enterprises	104,381		159		(995		)	103,545
	$	147,709	$	580	$	(1,231	)	$	147,058



	As of December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
Available-for-sale:
U.S. Government agency obligations - government-sponsored enterprises	$	6,298	$	7	$	(10	)	$	6,295
Municipal obligations	8,246		2		(92		)	8,156
Asset-backed securities	1,116		—		(35		)	1,081
Collateralized mortgage obligations - government issued	30,936		423		(146		)	31,213
Collateralized mortgage obligations - government-sponsored enterprises	99,865		252		(969		)	99,148
	$	146,461	$	684	$	(1,252	)	$	145,893

The amortized cost and fair value of securities held-to-maturity and the corresponding amounts of gross unrealized gains and losses were as follows:

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	As of March 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
Held-to-maturity:
U.S. Government agency obligations - government-sponsored enterprises	$	1,497	$	2	$	(3	)	$	1,496
Municipal obligations	21,764		192		(37		)	21,919
Collateralized mortgage obligations - government issued	8,675		17		(34		)	8,658
Collateralized mortgage obligations - government-sponsored enterprises	6,549		—		(67		)	6,482
	$	38,485	$	211	$	(141	)	$	38,555



	As of December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
Held-to-maturity:
U.S. Government agency obligations - government-sponsored enterprises	$	1,497	$	2	$	(5	)	$	1,494
Municipal obligations	21,173		62		(78		)	21,157
Collateralized mortgage obligations - government issued	9,148		17		(38		)	9,127
Collateralized mortgage obligations - government-sponsored enterprises	6,794		6		(58		)	6,742
	$	38,612	$	87	$	(179	)	$	38,520

U.S. Government agency obligations - government-sponsored enterprises represent securities issued by the Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”). Municipal obligations include securities issued by various municipalities located primarily within the State of Wisconsin and are primarily general obligation bonds that are tax-exempt in nature. Asset-backed securities represent securities issued by the Student Loan Marketing Association (“SLMA”) which are 97% guaranteed by the U.S. Government. Collateralized mortgage obligations - government issued represent securities guaranteed by the Government National Mortgage Association (“GNMA”). Collateralized mortgage obligations - government-sponsored enterprises include securities guaranteed by the FHLMC and the FNMA. No sales of available-for-sale securities occurred during the three months ended March 31, 2017 and 2016, respectively.

At March 31, 2017 and December 31, 2016, securities with a fair value of $20.4 million and $22.4 million, respectively, were pledged to secure interest rate swap contracts, outstanding FHLB advances and additional FHLB availability.

The amortized cost and fair value of securities by contractual maturity at March 31, 2017 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay certain obligations with or without call or prepayment penalties.



	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In Thousands)
Due in one year or less	$	5,084	$	5,083	$	—	$	—
Due in one year through five years	15,961		15,933		8,928		8,978
Due in five through ten years	63,774		63,937		13,284		13,370
Due in over ten years	62,890		62,105		16,273		16,207
	$	147,709	$	147,058	$	38,485	$	38,555

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The tables below show the Corporation’s gross unrealized losses and fair value of available-for-sale investments with unrealized losses, aggregated by investment category and length of time that individual investments were in a continuous loss position at March 31, 2017 and December 31, 2016. At March 31, 2017, the Corporation held 121 available-for-sale securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. At March 31, 2017, the Corporation held 11 available-for-sale securities that had been in a continuous unrealized loss position for twelve months or greater.

The Corporation also has not specifically identified available-for-sale securities in a loss position that it intends to sell in the near term and does not believe that it will be required to sell any such securities. The Corporation reviews its securities on a quarterly basis to monitor its exposure to other-than-temporary impairment. Consideration is given to such factors as the length of time and extent to which the security has been in an unrealized loss position, changes in security ratings and an evaluation of the present value of expected future cash flows, if necessary. Based on the Corporation’s evaluation, it is expected that the Corporation will recover the entire amortized cost basis of each security. Accordingly, no other-than-temporary impairment was recorded in the unaudited Consolidated Statements of Income for the three months ended March 31, 2017 and 2016.

A summary of unrealized loss information for securities available-for-sale, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows:



	As of March 31, 2017
	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
Available-for-sale:
U.S. Government agency obligations - government-sponsored enterprises	$	3,791	$	9	$	—	$	—	$	3,791	$	9
Municipal obligations	4,951		47		959		3		5,910		50
Asset-backed securities	—		—		1,050		17		1,050		17
Collateralized mortgage obligations - government issued	10,144		145		475		15		10,619		160
Collateralized mortgage obligations - government-sponsored enterprises	70,580		944		2,318		51		72,898		995
	$	89,466	$	1,145	$	4,802	$	86	$	94,268	$	1,231

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	As of December 31, 2016
	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
Available-for-sale:
U.S. Government agency obligations - government-sponsored enterprises	$	1,991	$	10	$	—	$	—	$	1,991	$	10
Municipal obligations	7,207		89		406		3		7,613		92
Asset-backed securities	—		$	—	1,081		35		1,081		35
Collateralized mortgage obligations - government issued	10,552		130		493		16		11,045		146
Collateralized mortgage obligations - government-sponsored enterprises	54,843		931		1,819		38		56,662		969
	$	74,593	$	1,160	$	3,799	$	92	$	78,392	$	1,252

The tables below show the Corporation’s gross unrealized losses and fair value of held-to-maturity investments, aggregated by investment category and length of time that individual investments were in a continuous loss position at March 31, 2017 and December 31, 2016. At March 31, 2017, the Corporation held 22 held-to-maturity securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. There were five held-to-maturity securities that had been in a continuous loss position for twelve months or greater as of March 31, 2017. It is expected that the Corporation will recover the entire amortized cost basis of each held-to-maturity security based upon an evaluation of aforementioned factors. Accordingly, no other-than-temporary impairment was recorded in the unaudited Consolidated Statements of Income for the three months ended March 31, 2017 and 2016.

A summary of unrealized loss information for securities held-to-maturity, categorized by security type and length of time for which the security has been in a continuous unrealized loss position, follows:



	As of March 31, 2017
	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
Held-to-maturity:
U.S. Government agency obligations - government-sponsored enterprises	$	1,000	$	3	$	—	$	—	$	1,000	$	3
Municipal obligations	2,615		37		—		—		2,615		37
Collateralized mortgage obligations - government issued	3,537		20		852		14		4,389		34
Collateralized mortgage obligations - government-sponsored enterprises	2,345		35		4,204		32		6,549		67
	$	9,497	$	95	$	5,056	$	46	$	14,553	$	141

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	As of December 31, 2016
	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
Held-to-maturity:
U.S. Government agency obligations - government-sponsored enterprises	$	1,000	$	5	$	—	$	—	$	1,000	$	5
Municipal obligations	9,472		78		—		—		9,472		78
Collateralized mortgage obligations - government issued	6,980		38		—		—		6,980		38
Collateralized mortgage obligations - government-sponsored enterprises	4,682		58		—		—		4,682		58
	$	22,134	$	179	$	—	$	—	$	22,134	$	179

Note 5 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses

Loan and lease receivables consist of the following:



	March 31, 2017		December 31, 2016
	(In Thousands)
Commercial real estate:
Commercial real estate — owner occupied	$	183,016	$	176,459
Commercial real estate — non-owner occupied	492,366		473,158
Land development	52,663		56,638
Construction	91,343		101,206
Multi-family	107,669		92,762
1-4 family	40,036		45,651
Total commercial real estate	967,093		945,874
Commercial and industrial	458,778		450,298
Direct financing leases, net	29,330		30,951
Consumer and other:
Home equity and second mortgages	8,237		8,412
Other	18,859		16,329
Total consumer and other	27,096		24,741
Total gross loans and leases receivable	1,482,297		1,451,864
Less:
Allowance for loan and lease losses	21,666		20,912
Deferred loan fees	1,326		1,189
Loans and leases receivable, net	$	1,459,305	$	1,429,763

As of March 31, 2017 and December 31, 2016, the total amount of the Corporation’s ownership of SBA loans on the Consolidated Balance Sheets was $67.4 million and $62.1 million, respectively. As of March 31, 2017 and December 31, 2016, $11.1 million and $5.5 million of loans in this portfolio were considered impaired, respectively.

Loans transferred to third parties consist of the guaranteed portion of SBA loans which the Corporation sold in the secondary market, as well as participation interests in other originated loans. The total principal amount of the guaranteed portion of SBA loans sold during the three months ended March 31, 2017 and 2016 was $3.3 million and $13.1 million, respectively. Each of

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the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred during the three months ended March 31, 2017 and 2016 have been derecognized in the unaudited Consolidated Financial Statements. The guaranteed portion of SBA loans were transferred at their fair value and the related gain was recognized upon the transfer as non-interest income in the unaudited Consolidated Financial Statements. The total outstanding balance of sold SBA loans at March 31, 2017 and December 31, 2016 was $101.7 million and $105.1 million, respectively, while the retained, unguaranteed portion of sold SBA loans on the unaudited Consolidated Balance Sheets was $31.4 million and $32.2 million as of March 31, 2017 and December 31, 2016, respectively. The total outstanding balance of the retained, unguaranteed portion of sold SBA loans considered impaired as of March 31, 2017 and December 31, 2016 was $1.5 million and $2.5 million, respectively.

The total principal amount of transferred participation interests in other originated commercial loans during the three months ended March 31, 2017 and 2016 was $5.6 million and $375,000, respectively, all of which were treated as sales and derecognized under the applicable accounting guidance at the time of transfer. No gain or loss was recognized on participation interests in other originated loans as they were transferred at or near the date of loan origination and the payments received for servicing the portion of the loans participated represents adequate compensation. The total outstanding balance of these transferred loans at March 31, 2017 and December 31, 2016 was $86.6 million and $102.7 million, respectively. As of March 31, 2017 and December 31, 2016, the total amount of the Corporation’s partial ownership of these transferred loans on the unaudited Consolidated Balance Sheets was $127.4 million and $106.1 million, respectively. No loans in this participation portfolio were considered impaired as of March 31, 2017 and December 31, 2016. The Corporation does not share in the participant’s portion of any potential charge-offs. The total amount of loan participations purchased on the unaudited Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016 was $707,000 and $1.2 million, respectively.

The Corporation also sells residential real estate loans, servicing released, in the secondary market. The total principal amount of residential real estate loans sold during the three months ended March 31, 2017 and 2016 was $1.0 million and $7.2 million, respectively. Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred have been derecognized in the unaudited Consolidated Financial Statements. The loans were transferred at their fair value and the related gain was recognized as non-interest income upon the transfer in the unaudited Consolidated Financial Statements.

According to ASC 310-30, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, purchased credit-impaired loans exhibit evidence of deterioration in credit quality since origination for which it is probable at acquisition that the Corporation will be unable to collect all contractually required payments. Purchased credit-impaired loans are initially recorded at fair value, which is estimated by discounting the cash flows expected to be collected at the acquisition date. Because the estimate of expected cash flows reflects an estimate of future credit losses expected to be incurred over the life of the loans, an allowance for credit losses is not recorded at the acquisition date. The excess of cash flows expected at acquisition over the estimated fair value, referred to as the accretable yield, is recognized in interest income over the remaining life of the loan on a level-yield basis, contingent on the subsequent evaluation of future expected cash flows. The difference between the contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. A subsequent decrease in the estimate of cash flows expected to be received on purchased credit-impaired loans generally results in the recognition of an allowance for loan and lease losses. Subsequent increases in cash flows result in reversal of any nonaccretable difference (or allowance for loan and lease losses to the extent any has been recorded) with a positive impact on interest income recognized. The measurement of cash flows involves assumptions and judgments for interest rates, prepayments, default rates, loss severity and collateral values. All of these factors are inherently subjective and significant changes in the cash flow estimates over the life of the loan can result.

The following table reflects the contractually required payments receivable and fair value of the Corporation’s purchased credit-impaired loans as of March 31, 2017 and December 31, 2016:



	March 31, 2017		December 31, 2016
	(In Thousands)
Contractually required payments	$	2,986	$	3,265
Fair value of purchased credit-impaired loans	1,234		1,432

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The following table presents a rollforward of the accretable yield as of March 31, 2017 and December 31, 2016:



	As of and for the Three Months Ended March 31, 2017			As of and for the Year Ended December 31, 2016
	(In Thousands)
Accretable yield, beginning of period	$	135		$	414
Accretion recognized in interest income	(3		)	(129		)
Reclassification to nonaccretable difference for loans with changing cash flows⁽¹⁾	(3		)	(244		)
Changes in accretable yield for non-credit related changes in expected cash flows⁽²⁾	(5		)	94
Accretable yield, end of period	$	124		$	135


(1)	Represents changes in accretable yield for those loans that are driven primarily by credit performance.


(2)	Represents changes in accretable yield for those loans that are driven primarily by changes in actual and estimated payments.

The following information illustrates ending balances of the Corporation’s loan and lease portfolio, including impaired loans by class of receivable, and considering certain credit quality indicators as of March 31, 2017 and December 31, 2016:



	March 31, 2017
	Category
	I			II			III			IV			Total
	(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied	$	146,120		$	19,410		$	11,992		$	5,494		$	183,016
Commercial real estate — non-owner occupied	465,826			22,813			1,748			1,979			492,366
Land development	48,206			814			288			3,355			52,663
Construction	84,930			799			1,012			4,602			91,343
Multi-family	107,518			151			—			—			107,669
1-4 family	34,546			1,561			1,394			2,535			40,036
Total commercial real estate	887,146			45,548			16,434			17,965			967,093
Commercial and industrial	354,072			33,188			51,963			19,555			458,778
Direct financing leases, net	27,930			1,400			—			—			29,330
Consumer and other:
Home equity and second mortgages	7,734			485			11			7			8,237
Other	18,065			100			—			694			18,859
Total consumer and other	25,799			585			11			701			27,096
Total gross loans and leases receivable	$	1,294,947		$	80,721		$	68,408		$	38,221		$	1,482,297
Category as a % of total portfolio	87.36		%	5.45		%	4.61		%	2.58		%	100.00		%

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	December 31, 2016
	Category
	I			II			III			IV			Total
	(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied	$	142,704		$	20,294		$	11,174		$	2,287		$	176,459
Commercial real estate — non-owner occupied	447,895			20,933			2,721			1,609			473,158
Land development	52,082			823			293			3,440			56,638
Construction	93,510			3,154			1,624			2,918			101,206
Multi-family	87,418			1,937			3,407			—			92,762
1-4 family	38,504			3,144			1,431			2,572			45,651
Total commercial real estate	862,113			50,285			20,650			12,826			945,874
Commercial and industrial	348,201			42,949			46,675			12,473			450,298
Direct financing leases, net	29,351			1,600			—			—			30,951
Consumer and other:
Home equity and second mortgages	8,271			121			12			8			8,412
Other	15,714			—			11			604			16,329
Total consumer and other	23,985			121			23			612			24,741
Total gross loans and leases receivable	$	1,263,650		$	94,955		$	67,348		$	25,911		$	1,451,864
Category as a % of total portfolio	87.04		%	6.54		%	4.64		%	1.78		%	100.00		%

Credit underwriting through a committee process is a key component of the Corporation’s operating philosophy. Commercial lenders have relatively low individual lending authority limits, and thus a significant portion of the Corporation’s new credit extensions require approval from a loan approval committee regardless of the type of loan or lease, asset quality grade of the credit, amount of the credit or the related complexities of each proposal.

Each credit is evaluated for proper risk rating upon origination, at the time of each subsequent renewal, upon receipt and evaluation of updated financial information from the Corporation’s borrowers or as other circumstances dictate. The Corporation uses a nine grade risk rating system to monitor the ongoing credit quality of its loans and leases. The risk rating grades follow a consistent definition and are then applied to specific loan types based on the nature of the loan. Each risk rating is subjective and, depending on the size and nature of the credit, subject to various levels of review and concurrence on the stated risk rating. In addition to its nine grade risk rating system, the Corporation groups loans into four loan and related risk categories which determine the level and nature of review by management.

Category I — Loans and leases in this category are performing in accordance with the terms of the contract and generally exhibit no immediate concerns regarding the security and viability of the underlying collateral, financial stability of the borrower, integrity or strength of the borrowers’ management team or the industry in which the borrower operates. Loans and leases in this category are not subject to additional monitoring procedures above and beyond what is required at the origination or renewal of the loan or lease. The Corporation monitors Category I loans and leases through payment performance, continued maintenance of its personal relationships with such borrowers and continued review of such borrowers’ compliance with the terms of their respective agreements.

Category II — Loans and leases in this category are beginning to show signs of deterioration in one or more of the Corporation’s core underwriting criteria such as financial stability, management strength, industry trends or collateral values. Management will place credits in this category to allow for proactive monitoring and resolution with the borrower to possibly mitigate the area of concern and prevent further deterioration or risk of loss to the Corporation. Category II loans are considered performing but are monitored frequently by the assigned business development officer and by subcommittees of the Banks’ loan committees.

Category III — Loans and leases in this category are identified by management as warranting special attention. However, the balance in this category is not intended to represent the amount of adversely classified assets held by the Banks. Category III loans and leases generally exhibit undesirable characteristics, such as evidence of adverse financial trends and conditions, managerial problems, deteriorating economic conditions within the related industry or evidence of adverse public filings and may exhibit collateral shortfall positions. Management continues to believe that it will collect all contractual principal and

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interest in accordance with the original terms of the contracts relating to the loans and leases in this category, and therefore Category III loans are considered performing with no specific reserves established for this category. Category III loans are monitored by management and the Banks’ loan committees on a monthly basis and the Banks’ boards of directors at each of their regularly scheduled meetings.

Category IV — Loans and leases in this category are considered to be impaired. Impaired loans and leases have been placed on non-accrual as management has determined that it is unlikely that the Banks will receive the contractual principal and interest in accordance with the original terms of the agreement. Impaired loans are individually evaluated to assess the need for the establishment of specific reserves or charge-offs. When analyzing the adequacy of collateral, the Corporation obtains external appraisals at least annually for impaired loans and leases. External appraisals are obtained from the Corporation’s approved appraiser listing and are independently reviewed to monitor the quality of such appraisals. To the extent a collateral shortfall position is present, a specific reserve or charge-off will be recorded to reflect the magnitude of the impairment. Loans and leases in this category are monitored by management and the Banks’ loan committees on a monthly basis and the Banks’ boards of directors at each of their regularly scheduled meetings.

Utilizing regulatory classification terminology, the Corporation identified $46.3 million and $34.3 million of loans and leases as Substandard as of March 31, 2017 and December 31, 2016, respectively. No loans were considered Special Mention, Doubtful or Loss as of either March 31, 2017 or December 31, 2016. The population of Substandard loans is a subset of Category III and Category IV loans.

The delinquency aging of the loan and lease portfolio by class of receivable as of March 31, 2017 and December 31, 2016 were as follows:

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	March 31, 2017
	30-59 Days Past Due			60-89 Days Past Due			Greater Than 90 Days Past Due			Total Past Due			Current			Total Loans and Leases
	(Dollars in Thousands)
Accruing loans and leases
Commercial real estate:
Owner occupied	$	—		$	—		$	—		$	—		$	177,583		$	177,583
Non-owner occupied	—			266			—			266			490,121			490,387
Land development	—			—			—			—			49,308			49,308
Construction	431			166			—			597			86,144			86,741
Multi-family	—			—			—			—			107,669			107,669
1-4 family	—			—			—			—			38,125			38,125
Commercial and industrial	327			—			—			327			438,906			439,233
Direct financing leases, net	—			—			—			—			29,330			29,330
Consumer and other:
Home equity and second mortgages	—			—			—			—			8,237			8,237
Other	7			—			—			7			18,158			18,165
Total	$	765		$	432		$	—		$	1,197		$	1,443,581		$	1,444,778
Non-accruing loans and leases
Commercial real estate:
Owner occupied	$	—		$	429		$	4,416		$	4,845		$	588		$	5,433
Non-owner occupied	—			—			1,941			1,941			38			1,979
Land development	—			—			—			—			3,355			3,355
Construction	—			—			2,539			2,539			2,063			4,602
Multi-family	—			—			—			—			—			—
1-4 family	—			—			1,606			1,606			305			1,911
Commercial and industrial	239			—			12,455			12,694			6,851			19,545
Direct financing leases, net	—			—			—			—			—			—
Consumer and other:
Home equity and second mortgages	—			—			—			—			—			—
Other	82			—			612			694			—			694
Total	$	321		$	429		$	23,569		$	24,319		$	13,200		$	37,519
Total loans and leases
Commercial real estate:
Owner occupied	$	—		$	429		$	4,416		$	4,845		$	178,171		$	183,016
Non-owner occupied	—			266			1,941			2,207			490,159			492,366
Land development	—			—			—			—			52,663			52,663
Construction	431			166			2,539			3,136			88,207			91,343
Multi-family	—			—			—			—			107,669			107,669
1-4 family	—			—			1,606			1,606			38,430			40,036
Commercial and industrial	566			—			12,455			13,021			445,757			458,778
Direct financing leases, net	—			—			—			—			29,330			29,330
Consumer and other:
Home equity and second mortgages	—			—			—			—			8,237			8,237
Other	89			—			612			701			18,158			18,859
Total	$	1,086		$	861		$	23,569		$	25,516		$	1,456,781		$	1,482,297
Percent of portfolio	0.07		%	0.06		%	1.59		%	1.72		%	98.28		%	100.00		%

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	December 31, 2016
	30-59 Days Past Due			60-89 Days Past Due			Greater Than 90 Days Past Due			Total Past Due			Current			Total Loans and Leases
	(Dollars in Thousands)
Accruing loans and leases
Commercial real estate:
Owner occupied	$	—		$	—		$	—		$	—		$	174,236		$	174,236
Non-owner occupied	—			—			—			—			471,549			471,549
Land development	—			—			—			—			53,198			53,198
Construction	—			—			—			—			98,288			98,288
Multi-family	—			—			—			—			92,762			92,762
1-4 family	75			—			—			75			43,639			43,714
Commercial and industrial	55			468			—			523			437,312			437,835
Direct financing leases, net	—			—			—			—			30,951			30,951
Consumer and other:
Home equity and second mortgages	—			—			—			—			8,412			8,412
Other	—			—			—			—			15,725			15,725
Total	$	130		$	468		$	—		$	598		$	1,426,072		$	1,426,670
Non-accruing loans and leases
Commercial real estate:
Owner occupied	$	—		$	—		$	1,183		$	1,183		$	1,040		$	2,223
Non-owner occupied	—			—			—			—			1,609			1,609
Land development	—			—			—			—			3,440			3,440
Construction	2,482			—			436			2,918			—			2,918
Multi-family	—			—			—			—			—			—
1-4 family	—			—			1,240			1,240			697			1,937
Commercial and industrial	3,345			168			6,740			10,253			2,210			12,463
Direct financing leases, net	—			—			—			—			—			—
Consumer and other:
Home equity and second mortgages	—			—			—			—			—			—
Other	186			—			378			564			40			604
Total	$	6,013		$	168		$	9,977		$	16,158		$	9,036		$	25,194
Total loans and leases
Commercial real estate:
Owner occupied	$	—		$	—		$	1,183		$	1,183		$	175,276		$	176,459
Non-owner occupied	—			—			—			—			473,158			473,158
Land development	—			—			—			—			56,638			56,638
Construction	2,482			—			436			2,918			98,288			101,206
Multi-family	—			—			—			—			92,762			92,762
1-4 family	75			—			1,240			1,315			44,336			45,651
Commercial and industrial	3,400			636			6,740			10,776			439,522			450,298
Direct financing leases, net	—			—			—			—			30,951			30,951
Consumer and other:
Home equity and second mortgages	—			—			—			—			8,412			8,412
Other	186			—			378			564			15,765			16,329
Total	$	6,143		$	636		$	9,977		$	16,756		$	1,435,108		$	1,451,864
Percent of portfolio	0.42		%	0.04		%	0.69		%	1.15		%	98.85		%	100.00		%

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The Corporation’s total impaired assets consisted of the following at March 31, 2017 and December 31, 2016, respectively.



	March 31, 2017		December 31, 2016
	(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate — owner occupied	$	5,433	$	2,223
Commercial real estate — non-owner occupied	1,979		1,609
Land development	3,355		3,440
Construction	4,602		2,918
Multi-family	—		—
1-4 family	1,911		1,937
Total non-accrual commercial real estate	17,280		12,127
Commercial and industrial	19,545		12,463
Direct financing leases, net	—		—
Consumer and other:
Home equity and second mortgages	—		—
Other	694		604
Total non-accrual consumer and other loans	694		604
Total non-accrual loans and leases	37,519		25,194
Foreclosed properties, net	1,472		1,472
Total non-performing assets	38,991		26,666
Performing troubled debt restructurings	702		717
Total impaired assets	$	39,693	$	27,383



	March 31, 2017		December 31, 2016
Total non-accrual loans and leases to gross loans and leases	2.53	%	1.74	%
Total non-performing assets to total gross loans and leases plus foreclosed properties, net	2.63		1.83
Total non-performing assets to total assets	2.17		1.50
Allowance for loan and lease losses to gross loans and leases	1.46		1.44
Allowance for loan and lease losses to non-accrual loans and leases	57.75		83.00

As of March 31, 2017 and December 31, 2016, $12.4 million and $12.8 million of the non-accrual loans and leases were considered troubled debt restructurings, respectively. There were no unfunded commitments associated with troubled debt restructured loans and leases as of March 31, 2017.

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The following table provides the number of loans modified in a troubled debt restructuring and the pre- and post-modification recorded investment by class of receivable as of March 31, 2017 and December 31, 2016.



	As of March 31, 2017					As of December 31, 2016
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
	(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied	3	$	1,065	$	919	3	$	1,065	$	930
Commercial real estate — non-owner occupied	1	158		38		1	158		39
Land development	1	5,745		3,354		1	5,745		3,440
Construction	—	—		—		2	331		314
Multi-family	—	—		—		—	—		—
1-4 family	11	1,391		1,371		11	1,391		1,393
Commercial and industrial	10	8,094		7,053		10	8,094		7,058
Consumer and other:
Home equity and second mortgage	1	37		7		1	37		8
Other	1	2,076		368		1	2,076		378
Total	28	$	18,566	$	13,110	30	$	18,897	$	13,560

All loans and leases modified as a troubled debt restructuring are measured for impairment. The nature and extent of the impairment of restructured loans, including those which have experienced a default, is considered in the determination of an appropriate level of the allowance for loan and lease losses.

As of March 31, 2017 and December 31, 2016, the Corporation’s troubled debt restructurings grouped by type of concession were as follows:



	As of March 31, 2017			As of December 31, 2016
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
	(Dollars in Thousands)
Commercial real estate:
Extension of term	1	$	4	1	$	8
Interest rate concession	1	51		1	52
Combination of extension of term and interest rate concession	14	5,627		16	6,056
Commercial and industrial:
Combination of extension of term and interest rate concession	10	7,053		10	7,058
Consumer and other:
Extension of term	1	368		1	378
Combination of extension of term and interest rate concession	1	7		1	8
Total	28	$	13,110	30	$	13,560

There were three loans modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the three months ended March 31, 2017. The total recorded investment of these loans was $878,000 as of March 31, 2017. There were no loans and leases modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the three months ended March 31, 2016.

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The following represents additional information regarding the Corporation’s impaired loans and leases, including performing troubled debt restructurings, by class:



	As of and for the Three Months Ended March 31, 2017
	Recorded Investment		Unpaid Principal Balance			Impairment Reserve		Average Recorded Investment⁽¹⁾			Foregone Interest Income			Interest Income Recognized		Net Foregone Interest Income
	(In Thousands)
With no impairment reserve recorded:
Commercial real estate:
Owner occupied	$	5,066	$	5,066		$	—	$	2,921		$	205		$	—	$	205
Non-owner occupied	1,979		2,019			—		1,996			36			—		36
Land development	3,355		6,025			—		3,422			24			—		24
Construction	2,120		2,120			—		917			12			—		12
Multi-family	—		—			—		3			—			—		—
1-4 family	2,463		2,463			—		2,473			16			—		16
Commercial and industrial	7,146		7,146			—		318			83			—		83
Direct financing leases, net	—		—			—		—			—			—		—
Consumer and other:
Home equity and second mortgages	7		7			—		7			—			—		—
Other	367		1,035			—		368			15			—		15
Total	$	22,503	$	25,881		$	—	$	12,425		$	391		$	—	$	391
With impairment reserve recorded:
Commercial real estate:
Owner occupied	$	428	$	428		$	42	$	432		$	6		$	—	$	6
Non-owner occupied	—		—			—		—			—			—		—
Land development	—		—		—	—		—		—	—		—	—		—
Construction	2,482		2,482		—	1,777		2,482		—	63		—	—		63
Multi-family	—		—			—		—			—			—		—
1-4 family	72		77			2		72			1			—		1
Commercial and industrial	12,409		12,409			4,010		12,355			251			—		251
Direct financing leases, net	—		—			—		—			—			—		—
Consumer and other:
Home equity and second mortgages	—		—			—		—			—			—		—
Other	327		327			327		113			—			—		—
Total	$	15,718	$	15,723		$	6,158	$	15,454		$	321		$	—	$	321
Total:
Commercial real estate:
Owner occupied	$	5,494	$	5,494		$	42	$	3,353		$	211		$	—	$	211
Non-owner occupied	1,979		2,019			—		1,996			36			—		36
Land development	3,355		6,025			—		3,422			24			—		24
Construction	4,602		4,602			1,777		3,399			75			—		75
Multi-family	—		—			—		3			—			—		—
1-4 family	2,535		2,540			2		2,545			17			—		17
Commercial and industrial	19,555		19,555			4,010		12,673			334			—		334
Direct financing leases, net	—		—			—		—			—			—		—
Consumer and other:
Home equity and second mortgages	7		7			—		7			—			—		—
Other	694		1,362			327		481			15			—		15
Grand total	$	38,221	$	41,604		$	6,158	$	27,879		$	712		$	—	$	712


(1)	Average recorded investment is calculated primarily using daily average balances.

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	As of and for the Year Ended December 31, 2016
	Recorded Investment		Unpaid Principal Balance		Impairment Reserve		Average Recorded Investment⁽¹⁾		Foregone Interest Income		Interest Income Recognized		Net Foregone Interest Income
	(In Thousands)
With no impairment reserve recorded:
Commercial real estate:
Owner occupied	$	1,788	$	1,788	$	—	$	3,577	$	328	$	118	$	210
Non-owner occupied	1,609		1,647		—		1,318		91		79		12
Land development	3,440		6,111		—		3,898		107		—		107
Construction	436		438		—		291		20		—		20
Multi-family	—		—		—		—		1		134		(133		)
1-4 family	2,379		2,379		—		2,755		125		94		31
Commercial and industrial	1,307		1,307		—		709		79		62		17
Direct financing leases, net	—		—		—		6		—		—		—
Consumer and other:
Home equity and second mortgages	8		8		—		307		16		127		(111		)
Other	378		1,044		—		510		71		—		71
Total	$	11,345	$	14,722	$	—	$	13,371	$	838	$	614	$	224
With impairment reserve recorded:
Commercial real estate:
Owner occupied	$	499	$	499	$	70	$	111	$	28	$	—	$	28
Non-owner occupied	—		—		—		—		—		—		—
Land development	—		—		—		—		—		—		—
Construction	2,482		2,482		1,790		834		45		—		45
Multi-family	—		—		—		—		—		—		—
1-4 family	193		199		39		203		5		—		5
Commercial and industrial	11,166		11,166		3,700		8,448		701		—		701
Direct financing leases, net	—		—		—		—		—		—		—
Consumer and other:
Home equity and second mortgages	—		—		—		—		—		—		—
Other	226		226		—		19		—		—		—
Total	$	14,566	$	14,572	$	5,599	$	9,615	$	779	$	—	$	779
Total:
Commercial real estate:
Owner occupied	$	2,287	$	2,287	$	70	$	3,688	$	356	$	118	$	238
Non-owner occupied	1,609		1,647		—		1,318		91		79		12
Land development	3,440		6,111		—		3,898		107		—		107
Construction	2,918		2,920		1,790		1,125		65		—		65
Multi-family	—		—		—		—		1		134		(133		)
1-4 family	2,572		2,578		39		2,958		130		94		36
Commercial and industrial	12,473		12,473		3,700		9,157		780		62		718
Direct financing leases, net	—		—		—		6		—		—		—
Consumer and other:
Home equity and second mortgages	8		8		—		307		16		127		(111		)
Other	604		1,270		—		529		71		—		71
Grand total	$	25,911	$	29,294	$	5,599	$	22,986	$	1,617	$	614	$	1,003


(1)	Average recorded investment is calculated primarily using daily average balances.

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The difference between the loans and leases recorded investment and the unpaid principal balance of $3.4 million as of March 31, 2017 and December 31, 2016 represents partial charge-offs resulting from losses due to the appraised value of the collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $702,000 and $717,000 of loans as of March 31, 2017 and December 31, 2016, respectively, that were performing troubled debt restructurings, and although not on non-accrual, were reported as impaired due to the concession in terms. When a loan is placed on non-accrual, interest accrual is discontinued and previously accrued but uncollected interest is deducted from interest income. Cash payments collected on non-accrual loans are first applied to such loan’s principal. Foregone interest represents the interest that was contractually due on the loan but not received or recorded. To the extent the amount of principal on a non-accrual loan is fully collected and additional cash is received, the Corporation will recognize interest income.

To determine the level and composition of the allowance for loan and lease losses, the Corporation categorizes the portfolio into segments with similar risk characteristics. First, the Corporation evaluates loans and leases for potential impairment classification. The Corporation analyzes each loan and lease determined to be impaired on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of expected cash flows. The Corporation applies historical trends from established risk factors to each category of loans and leases that has not been individually evaluated for the purpose of establishing the general portion of the allowance.

A summary of the activity in the allowance for loan and lease losses by portfolio segment is as follows:



	As of and for the Three Months Ended March 31, 2017
	Commercial Real Estate			Commercial and Industrial			Consumer and Other			Total
	(Dollars in Thousands)
Allowance for loan and lease losses:
Beginning balance	$	12,384		$	7,970		$	558		$	20,912
Charge-offs	(67		)	(55		)	(87		)	(209		)
Recoveries	104			246			41			391
Provision	396			(218		)	394			572
Ending balance	$	12,817		$	7,943		$	906		$	21,666
Ending balance: individually evaluated for impairment	$	1,821		$	4,010		$	327		$	6,158
Ending balance: collectively evaluated for impairment	$	10,996		$	3,933		$	579		$	15,508
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—
Loans and lease receivables:
Ending balance, gross	$	967,093		$	488,108		$	27,096		$	1,482,297
Ending balance: individually evaluated for impairment	$	16,693		$	19,545		$	702		$	36,940
Ending balance: collectively evaluated for impairment	$	949,128		$	468,554		$	26,394		$	1,444,076
Ending balance: loans acquired with deteriorated credit quality	$	1,272		$	9		$	—		$	1,281
Allowance as % of gross loans and leases	1.33		%	1.63		%	3.34		%	1.46		%

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	As of and for the Year Ended December 31, 2016
	Commercial Real Estate			Commercial and Industrial			Consumer and Other			Total
	(Dollars in Thousands)
Allowance for loan and lease losses:
Beginning balance	$	11,220		$	4,387		$	709		$	16,316
Charge-offs	(1,194		)	(2,273		)	(127		)	(3,594		)
Recoveries	274			91			7			372
Provision	2,084			5,765			(31		)	7,818
Ending balance	$	12,384		$	7,970		$	558		$	20,912
Ending balance: individually evaluated for impairment	$	1,899		$	3,700		$	—		$	5,599
Ending balance: collectively evaluated for impairment	$	10,485		$	4,270		$	558		$	15,313
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—
Loans and lease receivables:
Ending balance, gross	$	945,874		$	481,249		$	24,741		$	1,451,864
Ending balance: individually evaluated for impairment	$	11,222		$	12,452		$	612		$	24,286
Ending balance: collectively evaluated for impairment	$	933,048		$	468,776		$	24,129		$	1,425,953
Ending balance: loans acquired with deteriorated credit quality	$	1,604		$	21		$	—		$	1,625
Allowance as % of gross loans and leases	1.31		%	1.66		%	2.26		%	1.44		%

Note 6 — Other Assets

The Corporation is a limited partner in several limited partnership investments. The Corporation is not the general partner, does not have controlling ownership and is not the primary beneficiary in any of these limited partnerships and the limited partnerships have not been consolidated. These investments are accounted for using the equity method of accounting and are evaluated for impairment at the end of each reporting period. For historic rehabilitation tax credits, the Corporation begins to evaluate its investments for impairment at the time the credit is earned, which is typically in the year the project is placed in service, through the end of its five-year compliance period. New market tax credits are also evaluated for impairment beginning at the time the tax credits are earned on the project through the seven-year compliance period.

Historic Rehabilitation Tax Credits

In 2015, the Corporation invested in a development entity through BOC, a wholly-owned subsidiary of FBB, to acquire, rehabilitate and operate a historic building in Madison, Wisconsin. At March 31, 2017 and December 31, 2016 the net carrying value of the investment was $174,000. During 2016, the Corporation recognized $3.8 million in historic tax credits related to this investment and $3.3 million in impairment of the underlying investment.

In 2016, the Corporation also invested in a development entity through Mitchell Street, a wholly-owned subsidiary of FBB, to rehabilitate a historic building in Milwaukee, Wisconsin. At March 31, 2017 and December 31, 2016, the net carrying value of the investment was $563,000. The aggregate capital contributions to the project will depend upon the final amount of the certified project costs, but are expected to approximate $5.5 million. The Corporation is also anticipating the sale of a portion of the state credits associated with the investment to a third party. No historic tax credits were received at March 31, 2017. The credits are expected to be taken in the fourth quarter of 2017 when the project is placed in service and are subject to a five-year recapture period.

New Market Tax Credits

The Corporation invested in a community development entity (“CDE”) through Rimrock Road, a wholly-owned subsidiary of FBB, to develop and operate a real estate project located in a low-income community. At March 31, 2017 and December 31, 2016, Rimrock had one CDE investment with a net carrying value of $7.0 million and $7.1 million, respectively. The investment provides federal new market tax credits over a seven-year credit allowance period through 2020. The remaining federal new market tax credit to be utilized over a maximum of seven years was $1.7 million as of March 31, 2017. The Corporation’s usage of the federal new market tax credit was approximately $113,000 during the three months ended March 31, 2017 and 2016.

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Other Investments

The Corporation had an equity investment in Aldine Capital Fund, LP, a mezzanine fund, of $940,000 and $883,000 recorded as of March 31, 2017 and December 31, 2016, respectively. The Corporation’s equity investment in Aldine Capital Fund II, LP, also a mezzanine fund, totaled $3.0 million and $3.1 million as of March 31, 2017 and December 31, 2016, respectively. The Corporation’s share of these partnerships’ income included in the unaudited Consolidated Statements of Income for the three months ended March 31, 2017 and 2016 was $112,000 and $274,000, respectively.

The Corporation is the sole owner of $315,000 of common securities issued by Trust II, a Delaware business trust. The purpose of Trust II was to complete the sale of $10.0 million of 10.50% fixed rate preferred securities. Trust II, a wholly owned subsidiary of the Corporation, was not consolidated into the financial statements of the Corporation. The investment in Trust II of $315,000 as of March 31, 2017 and December 31, 2016 is included in accrued interest receivable and other assets.

A summary of accrued interest receivable and other assets is as follows:



	March 31, 2017		December 31, 2016
	(In Thousands)
Accrued interest receivable	$	4,426	$	4,677
Net deferred tax asset	4,145		4,052
Investment in historic development entities	737		737
Investment in a CDE	6,974		7,106
Investment in limited partnerships	3,983		3,963
Investment in Trust II	315		315
Fair value of interest rate swaps	405		352
Prepaid expenses	3,312		3,074
Other assets	4,281		4,331
Total accrued interest receivable and other assets	$	28,578	$	28,607

Note 7 — Deposits

The composition of deposits at March 31, 2017 and December 31, 2016 is as follows:



	March 31, 2017						December 31, 2016
	Balance		Average Balance		Average Rate		Balance		Average Balance		Average Rate
	(Dollars in Thousands)
Non-interest-bearing transaction accounts	$	227,947	$	228,323	—	%	$	252,638	$	246,182	—	%
Interest-bearing transaction accounts	205,912		192,297		0.48		183,992		169,571		0.27
Money market accounts	616,557		627,188		0.42		627,090		642,784		0.48
Certificates of deposit	53,865		55,393		0.94		58,454		65,608		0.90
Wholesale deposits	388,433		400,672		1.65		416,681		467,826		1.62
Total deposits	$	1,492,714	$	1,503,873	0.71		$	1,538,855	$	1,591,971	0.74

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Note 8 — FHLB Advances, Other Borrowings and Junior Subordinated Notes

The composition of borrowed funds at March 31, 2017 and December 31, 2016 is shown below. Average balances represent year-to-date averages.



	March 31, 2017						December 31, 2016
	Balance		Weighted Average Balance		Weighted Average Rate		Balance		Weighted Average Balance		Weighted Average Rate
	(Dollars in Thousands)
Federal funds purchased	$	—	$	244	1.15	%	$	—	$	178	0.92	%
FHLB advances	96,057		60,703		1.01		33,578		14,485		0.97
Line of credit	1,010		1,010		3.54		1,010		2,079		3.26
Other borrowings	2,262		2,164		8.26		2,590		1,739		7.64
Subordinated notes payable	22,512		22,503		7.12		22,498		22,467		7.13
Junior subordinated notes	10,008		10,006		10.97		10,004		9,997		11.07
	$	131,849	$	96,630	3.67		$	69,680	$	50,945	6.03

Short-term borrowings	$	78,067					$	20,588
Long-term borrowings	53,782						49,092
	$	131,849					$	69,680

As of March 31, 2017 and December 31, 2016, the Corporation was in compliance with its debt covenants under its third-party secured senior line of credit. Per the promissory note dated February 19, 2017, the Corporation pays a commitment fee on this line of credit. During the three months ended March 31, 2017 and 2016, the Corporation incurred interest expense due to this fee of $3,000.

Note 9 — Commitments and Contingencies

In the ordinary course of business, the Corporation sells the guaranteed portion of SBA loans, as well as participation interests in other originated loans, to third parties. The Corporation has a continuing involvement in each of the transferred lending arrangements by way of relationship management, servicing the loans, as well as being subject to normal and customary requirements of the SBA loan program; however, there are no further obligations to the third-party participant required of the Corporation, other than standard representations and warranties related to sold amounts. In the event of a loss resulting from default and a determination by the SBA that there is a deficiency in the manner in which the loan was originated, funded or serviced by the Corporation, the SBA may require the Corporation to repurchase the loan, deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from the Corporation. The Corporation must comply with applicable SBA regulations in order to maintain the guaranty. In addition, the Corporation retains the option to repurchase the sold guaranteed portion of an SBA loan if the loan defaults.

Management has assessed estimated losses inherent in the outstanding guaranteed portion of SBA loans sold in accordance with ASC 450, Contingencies, and determined a recourse reserve based on the probability of future losses for these loans to be $1.7 million at March 31, 2017, which is reported in accrued interest payable and other liabilities on the unaudited Consolidated Balance Sheets. During the three months ended March 31, 2017, a $6,000 recourse provision was recorded. To date, the Corporation has not experienced significant losses related to the guaranteed portion of SBA loans.

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The summary of the activity in the SBA recourse reserve is as follows:



	As of and for the Three Months Ended March 31, 2017			As of and for the Year Ended December 31, 2016
	(In Thousands)
Balance at the beginning of the period	$	1,750		$	—
SBA recourse provision	6			2,068
Charge-offs, net	(91		)	(318		)
Balance at the end of the period	$	1,665		$	1,750

In the normal course of business, various legal proceedings involving the Corporation are pending. Management, based upon advice from legal counsel, does not anticipate any significant losses as a result of these actions. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations and cash flows.

Note 10 — Fair Value Disclosures

The Corporation determines the fair values of its financial instruments based on the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is defined as the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date and is based on exit prices. Fair value includes assumptions about risk, such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. The standard describes three levels of inputs that may be used to measure fair value.

Level 1 — Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date.

Level 2 — Level 2 inputs are inputs, other than quoted prices included with Level 1, that are observable for the asset or liability either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 — Level 3 inputs are supported by little or no market activity and are significant to the fair value of the assets or liabilities.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

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Assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy level, are summarized below:



	March 31, 2017
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total
	(In Thousands)
Assets:
Securities available-for-sale:
U.S. Government agency obligations - government-sponsored enterprises	$	—	$	6,300	$	—	$	6,300
Municipal obligations	—		8,176		—		8,176
Asset backed securities	—		1,050		—		1,050
Collateralized mortgage obligations - government issued	—		27,987		—		27,987
Collateralized mortgage obligations - government-sponsored enterprises	—		103,545		—		103,545
Interest rate swaps	—		405		—		405
Liabilities:
Interest rate swaps	—		405		—		405



	December 31, 2016
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total
	(In Thousands)
Assets:
Securities available-for-sale:
U.S. Government agency obligations - government-sponsored enterprises	$	—	$	6,295	$	—	$	6,295
Municipal obligations	—		8,156		—		8,156
Asset backed securities	—		1,081		—		1,081
Collateralized mortgage obligations - government issued	—		31,213		—		31,213
Collateralized mortgage obligations - government-sponsored enterprises	—		99,148		—		99,148
Interest rate swaps	—		352		—		352
Liabilities:
Interest rate swaps	—		352		—		352

For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the three months ended March 31, 2017 or the year ended December 31, 2016 related to the above measurements.

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Assets and liabilities measured at fair value on a non-recurring basis, segregated by fair value hierarchy are summarized below:



	March 31, 2017
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total
	(In Thousands)
Impaired loans	$	—	$	13,994	$	2,016	$	16,010
Foreclosed properties	—		1,472		—		1,472
Loan servicing rights	—		—		1,920		1,920



	December 31, 2016
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total
	(In Thousands)
Impaired loans	$	—	$	12,268	$	1,097	$	13,365
Foreclosed properties	—		1,472		—		1,472
Loan servicing rights	—		—		1,906		1,906

Impaired loans were written down to the fair value of their underlying collateral less costs to sell of $16.0 million and $13.4 million at March 31, 2017 and December 31, 2016, respectively, through the establishment of specific reserves or by recording charge-offs when the carrying value exceeded the fair value of the underlying collateral of impaired loans. Valuation techniques consistent with the market approach, income approach or cost approach were used to measure fair value and primarily included observable inputs for the individual impaired loans being evaluated such as current appraisals, recent sales of similar assets or other observable market data, and are reflected within Level 2 of the hierarchy. In cases where an input is unobservable, specifically when discounts are applied to appraisal values to adjust such values to current market conditions or to reflect net realizable value, the impaired loan balance is reflected within Level 3 of the hierarchy. The quantification of unobservable inputs for Level 3 impaired loan values range from 15% - 90% as of the measurement date of March 31, 2017. The weighted average of those unobservable inputs was 35%. The majority of the impaired loans in the Level 3 category are considered collateral dependent loans.

Foreclosed properties, upon initial recognition, are remeasured and reported at fair value through a charge-off to the allowance for loan and lease losses, if deemed necessary, based upon the fair value of the foreclosed property. The fair value of a foreclosed property, upon initial recognition, is estimated using a market approach or Level 2 inputs based on observable market data, typically a current appraisal, or Level 3 inputs based upon assumptions specific to the individual property or equipment. Level 3 inputs typically include unobservable inputs such as management applied discounts used to further reduce values to a net realizable value and may be used in situations when observable inputs become stale. Foreclosed property fair value inputs may transition to Level 1 upon receipt of an accepted offer for the sale of the related foreclosed property.

Loan servicing rights represent the asset retained upon sale of the guaranteed portion of certain SBA loans. When SBA loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The servicing rights are subsequently measured using the amortization method, which requires amortization into interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

The Corporation periodically reviews this portfolio for impairment and engages a third-party valuation firm to assess the fair value of the overall servicing rights portfolio. Loan servicing rights do not trade in an active, open market with readily observable prices. While sales of loan servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Corporation utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its loan servicing rights. The valuation model incorporates prepayment assumptions to project loan servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the loan servicing rights. The valuation model considers portfolio characteristics of the underlying serviced portion of the SBA loans and uses the following significant unobservable inputs: (1) constant prepayment rate (“CPR”) assumptions based on the SBA sold pools historical CPR as quoted in Bloomberg and (2) a discount rate of 10%. Due to the nature of the valuation inputs, loan servicing rights are classified in Level 3 of the fair value hierarchy.

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Fair Value of Financial Instruments

The Corporation is required to disclose estimated fair values for its financial instruments. Fair value estimates, methods and assumptions, consistent with exit price concepts for fair value measurements, are set forth below:



	March 31, 2017
	Carrying Amount		Fair Value
			Total		Level 1		Level 2		Level 3
	(In Thousands)
Financial assets:
Cash and cash equivalents	$	60,899	$	60,899	$	47,394	$	13,505	$	—
Securities available-for-sale	147,058		147,058		—		147,058		—
Securities held-to-maturity	38,485		38,555		—		38,555		—
Loans held for sale	3,924		3,924		—		3,924		—
Loans and lease receivables, net	1,459,305		1,476,988		—		13,994		1,462,994
Bank-owned life insurance	39,358		39,358		—		39,358		—
Federal Home Loan Bank and Federal Reserve Bank stock	4,782		4,781		—		—		4,781
Accrued interest receivable	4,426		4,426		4,426		—		—
Interest rate swaps	405		405		—		405		—
Financial liabilities:
Deposits	1,492,714		1,493,233		1,050,416		442,817		—
Federal Home Loan Bank advances and other borrowings	121,841		123,552		—		123,552		—
Junior subordinated notes	10,008		8,972		—		—		8,972
Accrued interest payable	1,938		1,938		1,938		—		—
Interest rate swaps	405		405		—		405		—
Off-balance-sheet items:
Standby letters of credit	119		119		119		—		—

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	December 31, 2016
	Carrying Amount		Fair Value
			Total		Level 1		Level 2		Level 3
	(In Thousands)
Financial assets:
Cash and cash equivalents	$	77,517	$	77,517	$	55,622	$	21,895	$	—
Securities available-for-sale	145,893		145,893		—		145,893		—
Securities held-to-maturity	38,612		38,520		—		38,520		—
Loans held for sale	1,111		1,111		—		1,111		—
Loans and lease receivables, net	1,429,763		1,447,044		—		12,268		1,434,776
Bank-owned life insurance	39,048		39,048		—		39,048		—
Federal Home Loan Bank and Federal Reserve Bank stock	2,131		2,131		—		2,131		—
Accrued interest receivable	4,677		4,677		4,677		—		—
Interest rate swaps	352		352		—		352		—
Financial liabilities:
Deposits	1,538,855		1,539,413		1,063,720		475,693		—
Federal Home Loan Bank advances and other borrowings	59,676		60,893		—		60,893		—
Junior subordinated notes	10,004		9,072		—		—		9,072
Accrued interest payable	1,765		1,765		1,765		—		—
Interest rate swaps	352		352		—		352		—
Off-balance-sheet items:
Standby letters of credit	58		58		—		—		58

Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the unaudited Consolidated Balance Sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Corporation.

Cash and Cash Equivalents: The carrying amount reported for cash and due from banks and interest-bearing deposits held by the Corporation approximates fair value because of its immediate availability and because it does not present unanticipated credit concerns. As of March 31, 2017 and December 31, 2016, the Corporation held $12.4 million and $20.3 million, respectively, of commercial paper. The fair value of commercial paper is classified as a Level 2 input due to the lack of available independent pricing sources. The carrying value of brokered certificates of deposit purchased approximates the fair value for these instruments. The fair value of brokered certificates of deposits purchased is based on the discounted value of contractual cash flows using a discount rate reflective of rates currently offered for deposits of similar remaining maturities. As of both March 31, 2017 and December 31, 2016, the Corporation held $1.1 million and $1.6 million of brokered certificates of deposits, respectively.

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Securities: The fair value measurements of investment securities are determined by a third-party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information and the securities’ terms and conditions, among other things. The fair value measurements are subject to independent verification by another pricing source on a quarterly basis to review for reasonableness. Any significant differences in pricing are reviewed with appropriate members of management who have the relevant technical expertise to assess the results. The Corporation has determined that these valuations are classified in Level 2 of the fair value hierarchy. When the independent pricing service does not provide a fair value measurement for a particular security, the Corporation will estimate the fair value based on specific information about each security. Fair values derived in this manner are classified in Level 3 of the fair value hierarchy.

Loans Held for Sale: Loans held for sale, which consist of residential real estate mortgage loans and the guaranteed portion of SBA loans, are carried at the lower of cost or estimated fair value. The estimated fair value is based on what secondary markets are currently offering for portfolios with similar characteristics.

Loans and Lease Receivables, net: The fair value estimation process for the loan portfolio uses an exit price concept and reflects discounts that the Corporation believes are consistent with liquidity discounts in the market place. Fair values are estimated for portfolios of loans with similar financial characteristics. The fair value of performing and nonperforming loans is calculated by discounting scheduled and expected cash flows through the estimated maturity using estimated market rates that reflect the credit and interest rate risk inherent in the portfolio of loans and then applying a discount factor based upon the embedded credit risk of the loan and the fair value of collateral securing nonperforming loans when the loan is collateral dependent. The estimate of maturity is based on the Banks’ historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. Significant unobservable inputs include, but are not limited to, discounts (investor yield premiums) applied to fair value calculations to further determine the exit price value of a portfolio of loans.

Federal Home Loan Bank and Federal Reserve Bank Stock: The carrying amount of FHLB and FRB stock equals its fair value because the shares may be redeemed by the FHLB and the FRB at their carrying amount of $100 per share.

Bank-Owned Life Insurance: The carrying amount of the cash surrender value of life insurance approximates its fair value as the carrying value represents the current settlement amount.

Accrued Interest Receivable and Accrued Interest Payable: The carrying amounts reported for accrued interest receivable and accrued interest payable approximate fair value because of their immediate availability and because they do not present unanticipated credit concerns.

Deposits: The fair value of deposits with no stated maturity, such as demand deposits and money market accounts, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates do not include the intangible value that results from the funding provided by deposit liabilities compared to borrowing funds in the market.

Borrowed Funds: Market rates currently available to the Corporation and Banks for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.

Interest Rate Swaps: The carrying amount and fair value of existing derivative financial instruments are based upon independent valuation models, which use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative contract. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Corporation considers the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.

Financial Instruments with Off-Balance-Sheet Risks: The fair value of the Corporation’s off-balance-sheet instruments is based on quoted market prices and fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the credit standing of the related counterparty. Commitments to extend credit and standby letters of credit are generally not marketable. Furthermore, interest rates on any amounts drawn under such commitments would generally be established at market rates at the time of the draw. Fair value would principally derive from the present value of fees received for those products.

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Limitations: Fair value estimates are made at a discrete point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holding of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and are not considered in the estimates.

Note 11 — Derivative Financial Instruments

The Corporation offers interest rate swap products directly to qualified commercial borrowers. The Corporation economically hedges client derivative transactions by entering into offsetting interest rate swap contracts executed with a third party. Derivative transactions executed as part of this program are not designated as accounting hedge relationships and are marked- to-market through earnings each period. The derivative contracts have mirror-image terms, which results in the positions’ changes in fair value primarily offsetting through earnings each period. The credit risk and risk of non-performance embedded in the fair value calculations is different between the dealer counterparties and the commercial borrowers which may result in a difference in the changes in the fair value of the mirror-image swaps. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the counterparty’s risk in the fair value measurements. When evaluating the fair value of its derivative contracts for the effects of non-performance and credit risk, the Corporation considered the impact of netting and any applicable credit enhancements such as collateral postings, thresholds and guarantees.

At March 31, 2017, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $33.6 million. The Corporation receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These interest rate swaps mature between August 2018 and July 2027. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported on the unaudited Consolidated Balance Sheets as a derivative asset of $405,000, included in accrued interest receivable and other assets. In the event of default on a commercial borrower interest rate swap by the counterparty, a right of offset exists to allow for the commercial borrower to set off amounts due against the related commercial loan. As of March 31, 2017, no interest rate swaps were in default and therefore all values for the commercial borrower swaps are recorded on a gross basis on the unaudited Consolidated Balance Sheets.

At March 31, 2017, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $33.6 million. The Corporation pays fixed rates and receives floating rates based upon LIBOR on the swaps with dealer counterparties. These interest rate swaps mature in August 2018 through July 2027. Dealer counterparty swaps are subject to master netting agreements among the contracts within each of our Banks and are reported on the unaudited Consolidated Balance Sheets as a net derivative liability of $405,000. The value of these swaps was included in accrued interest payable and other liabilities as of March 31, 2017. The gross amount of dealer counterparty swaps was also $405,000 as no right of offset existed with the dealer counterparty swaps as of March 31, 2017.

The table below provides information about the location and fair value of the Corporation’s derivative instruments as of March 31, 2017 and December 31, 2016.

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Interest Rate Swap Contracts

Asset Derivatives

Liability Derivatives

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

(In Thousands)

Derivatives not designated as hedging instruments

March 31, 2017

Accrued interest receivable and other assets

405

Accrued interest payable and other liabilities

405

December 31, 2016

Accrued interest receivable and other assets

352

Accrued interest payable and other liabilities

352

No derivative instruments held by the Corporation for the three months ended March 31, 2017 were considered hedging instruments. All changes in the fair value of these instruments are recorded in other non-interest income. Given the mirror-image terms of the outstanding derivative portfolio, the change in fair value for the three months ended March 31, 2017 and 2016 had an insignificant impact on the unaudited Consolidated Statements of Income.

Note 12 — Regulatory Capital

The Corporation and the Banks are subject to various regulatory capital requirements administered by Federal, State of Wisconsin and State of Kansas banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions on the part of regulators, that if undertaken, could have a direct material effect on the Banks’ assets, liabilities and certain off-balance-sheet items as calculated under regulatory practices. The Corporation’s and the Banks’ capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. The Corporation regularly reviews and updates when appropriate its Capital and Liquidity Action Plan (the “Capital Plan”), which is designed to help ensure appropriate capital adequacy, to plan for future capital needs and to ensure that the Corporation serves as a source of financial strength to the Banks. The Corporation’s and the Banks’ Boards of Directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their respective capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.

As a bank holding company, the Corporation’s ability to pay dividends is affected by the policies and enforcement powers of the Board of Governors of the Federal Reserve system (the “Federal Reserve”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring or significantly reducing dividends if: (i) net income available to common shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividend; (ii) the prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current prospective financial condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios. Management intends, when appropriate under regulatory guidelines, to consult with the Federal Reserve Bank of Chicago and provide it with information on the Corporation’s then-current and prospective earnings and capital position in advance of declaring any cash dividends. As a Wisconsin corporation, the Corporation is subject to the limitations of the Wisconsin Business Corporation Law, which prohibit the Corporation from paying dividends if such payment would: (i) render the Corporation unable to pay its debts as they become due in the usual course of business, or (ii) result in the Corporation’s assets being less than the sum of its total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of any stockholders with preferential rights superior to those stockholders receiving the dividend.

The Banks are also subject to certain legal, regulatory and other restrictions on their ability to pay dividends to the Corporation. As a bank holding company, the payment of dividends by the Banks to the Corporation is one of the sources of funds the Corporation could use to pay dividends, if any, in the future and to make other payments. Future dividend decisions by the Banks and the Corporation will continue to be subject to compliance with various legal, regulatory and other restrictions as defined from time to time.

Qualitative measures established by regulation to ensure capital adequacy require the Corporation and the Banks to maintain minimum amounts and ratios of Total, Common Equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to adjusted total assets. These risk-based capital requirements presently address credit risk related to both recorded and off-balance-sheet commitments and obligations.

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In July 2013, the FRB and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for U.S. banks. These rules are applicable to all financial institutions that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as bank and savings and loan holding companies other than “small bank holding companies” (generally non-publicly traded bank holding companies with consolidated assets of less than $1 billion). Under the final rules, minimum requirements increased for both the quantity and quality of capital held by the Corporation. The rules include a new Common Equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. The rules also permit banking organizations with less than $15 billion in assets to retain, through a one-time election, the past treatment for accumulated other comprehensive income, which did not affect regulatory capital. The Corporation elected to retain this treatment, which reduces the volatility of regulatory capital ratios. A new capital conservation buffer, comprised of Common Equity Tier 1 capital, was also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and will increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. As of March 31, 2017, both the Corporation’s and the Banks’ capital levels remained characterized as well capitalized under the new rules.

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The following table summarizes both the Corporation’s and Banks’ capital ratios and the ratios required by their federal regulators at March 31, 2017 and December 31, 2016, respectively:



	Actual				Minimum Required for Capital Adequacy Purposes				For Capital Adequacy Purposes Plus Capital Conservation Buffer				Minimum Required to Be Well Capitalized Under Prompt Corrective Action Requirements
	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
As of March 31, 2017
Total capital (to risk-weighted assets)
Consolidated	$	206,010	11.55	%	$	142,712	8.00	%	165,011		9.250	%	N/A		N/A
First Business Bank	148,557		11.35		104,691		8.00		121,049		9.250		$	130,863	10.00	%
First Business Bank — Milwaukee	24,865		10.51		18,920		8.00		21,876		9.250		23,650		10.00
Alterra Bank	31,562		13.23		19,079		8.00		22,060		9.250		23,849		10.00
Tier 1 capital (to risk-weighted assets)
Consolidated	$	163,413	9.16	%	$	107,034	6.00	%	$	129,333	7.250	%	N/A		N/A
First Business Bank	134,629		10.29		78,518		6.00		94,876		7.250		$	104,691	8.00	%
First Business Bank — Milwaukee	22,787		9.64		14,190		6.00		17,146		7.250		18,920		8.00
Alterra Bank	28,548		11.97		14,309		6.00		17,290		7.250		19,079		8.00
Common equity tier 1 capital (to risk-weighted assets)
Consolidated	$	153,405	8.60	%	$	80,276	4.50	%	$	102,574	5.750	%	N/A		N/A
First Business Bank	134,629		10.29		58,888		4.50		75,246		5.750		$	85,061	6.50	%
First Business Bank — Milwaukee	22,787		9.64		10,642		4.50		13,599		5.750		15,372		6.50
Alterra Bank	28,548		11.97		10,732		4.50		13,713		5.750		15,502		6.50
Tier 1 leverage capital (to adjusted assets)
Consolidated	$	163,413	9.26	%	$	70,575	4.00	%	$	70,575	4.00	%	N/A		N/A
First Business Bank	134,629		10.38		51,862		4.00		51,862		4.00		$	64,827	5.00	%
First Business Bank — Milwaukee	22,787		8.93		10,206		4.00		10,206		4.00		12,757		5.00
Alterra Bank	28,548		11.55		9,888		4.00		9,888		4.00		12,360		5.00

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	Actual				Minimum Required for Capital Adequacy Purposes				For Capital Adequacy Purposes Plus Capital Conservation Buffer				Minimum Required to Be Well Capitalized Under Prompt Corrective Action Requirements
	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
As of December 31, 2016
Total capital (to risk-weighted assets)
Consolidated	$	204,117	11.74	%	$	139,101	8.00	%	$	149,968	8.625	%	N/A		N/A
First Business Bank	147,811		11.55		102,362		8.00		110,360		8.625		$	127,953	10.00	%
First Business Bank — Milwaukee	24,347		11.02		17,680		8.00		19,062		8.625		22,101		10.00
Alterra Bank	31,699		13.27		19,106		8.00		20,599		8.625		23,882		10.00
Tier 1 capital (to risk-weighted assets)
Consolidated	$	160,964	9.26	%	$	104,326	6.00	%	$	115,193	6.625	%	N/A		N/A
First Business Bank	134,208		10.49		76,772		6.00		84,769		6.625		$	102,362	8.00	%
First Business Bank — Milwaukee	22,323		10.10		13,260		6.00		14,642		6.625		17,680		8.00
Alterra Bank	28,685		12.01		14,329		6.00		15,822		6.625		19,106		8.00
Common equity tier 1 capital (to risk-weighted assets)
Consolidated	$	150,960	8.68	%	$	78,244	4.50	%	$	89,111	5.125	%	N/A		N/A
First Business Bank	134,208		10.49		57,579		4.50		65,576		5.125		$	83,170	6.50	%
First Business Bank — Milwaukee	22,323		10.10		9,945		4.50		11,327		5.125		14,365		6.50
Alterra Bank	28,685		12.01		10,747		4.50		12,240		5.125		15,524		6.50
Tier 1 leverage capital (to adjusted assets)
Consolidated	$	160,964	9.07	%	$	70,985	4.00	%	$	70,985	4.00	%	N/A		N/A
First Business Bank	134,208		10.40		51,600		4.00		51,600		4.00		$	64,500	5.00	%
First Business Bank — Milwaukee	22,323		9.15		9,758		4.00		9,758		4.00		12,198		5.00
Alterra Bank	28,685		10.58		10,842		4.00		10,842		4.00		13,552		5.00

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

Unless otherwise indicated or unless the context requires otherwise, all references in this Report to the “Corporation,” “we,” “us,” “our,” or similar references mean First Business Financial Services, Inc. together with our subsidiaries. “FBB”, “FBB - Milwaukee” and “Alterra” are used to refer to our subsidiaries, First Business Bank, First Business Bank - Milwaukee, and Alterra Bank, respectively, and the “Banks” is used to refer to FBB, FBB - Milwaukee, and Alterra together.

Forward-Looking Statements

When used in this report the words or phrases “may,” “could,” “should,” “hope,” “might,” “believe,” “expect,” “plan,” “assume,” “intend,” “estimate,” “anticipate,” “project,” “likely,” or similar expressions are intended to identify “forward-looking statements.” Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Such statements are subject to risks and uncertainties, including among other things:


•	Competitive pressures among depository and other financial institutions nationally and in our markets.


•	Adverse changes in the economy or business conditions, either nationally or in our markets.


•	Increases in defaults by borrowers and other delinquencies.


•	Our ability to manage growth effectively, including the successful expansion of our client support, administrative infrastructure and internal management systems.


•	Fluctuations in interest rates and market prices.


•	The consequences of continued bank acquisitions and mergers in our markets, resulting in fewer but much larger and financially stronger competitors.


•	Changes in legislative or regulatory requirements applicable to us and our subsidiaries.


•	Changes in tax requirements, including tax rate changes, new tax laws and revised tax law interpretations.


•	Fraud, including client and system failure or breaches of our network security, including with respect to our internet banking activities.


•	Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portion of SBA loans.

These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our shareholders and potential investors. See Part I, Item 1A — Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016 for discussion relating to risk factors impacting us. Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors described within this Form 10-Q could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods.

Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that, while our management believes such assumptions or bases are reasonable and are made in good faith, assumed facts or bases can vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, an expectation or belief is expressed as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.

We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements.

The following discussion and analysis is intended as a review of significant events and factors affecting our financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with the unaudited Consolidated Financial Statements and the Notes thereto presented in this Form 10-Q.

Overview

We are a registered bank holding company incorporated under the laws of the State of Wisconsin and are engaged in the commercial banking business through our wholly-owned banking subsidiaries, FBB, FBB-Milwaukee and Alterra. All of our operations are conducted through the Banks and certain subsidiaries of FBB. We operate as a business bank focusing on delivering a full line of commercial banking products and services tailored to meet the specific needs of small- to medium-sized businesses, business owners, executives, professionals and high net worth individuals. Our products and services include commercial lending, SBA lending and servicing, asset-based lending, equipment financing, factoring, trust and investment

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services, treasury management services and a broad range of deposit products. We do not utilize a branch network to attract retail clients. Our operating philosophy is predicated on deep client relationships fostered by local expertise from each of our primary banking locations in Madison, Brookfield and Appleton, Wisconsin and Leawood, Kansas combined with the efficiency of centralized administrative functions such as information technology, loan and deposit operations, finance and accounting, credit administration, compliance and human resources. We believe we have a niche business banking model and we consistently operate within our model. This allows our experienced staff to provide the level of financial expertise needed to develop and maintain long-term relationships with our clients.

Effective May 1, 2017, the Corporation will discontinue all secondary market residential mortgage loan origination activity. During the first quarter of 2017, management concluded that the operational inefficiencies due to lack of scale and inherent compliance risks outweighed any ancillary benefits and minimal revenue contribution.

Operational Summary

On January 12, 2017, we announced plans to consolidate the charters of the Banks into a single charter. The Corporation’s charter consolidation plans have been approved by the board of directors of the Corporation and the Banks, as well as by the applicable federal and state banking regulators. The plans are expected to take effect during the second quarter of 2017.

Highlights for the three months ended March 31, 2017 include:


•	Total assets increased to $1.801 billion as of March 31, 2017 compared to $1.781 billion as of December 31, 2016.


•	Net income for the three months ended March 31, 2017 was $3.4 million compared to net income of $4.6 million for the three months ended March 31, 2016.


•	Diluted earnings per common share for the three months ended March 31, 2017 were $0.39 compared to diluted earnings per common share of $0.52 for the three months ended March 31, 2016.


•	The Corporation increased its quarterly cash dividend declared in January 8.3% to $0.13 per share for the three months ended March 31, 2017, compared to $0.12 per share for the three months ended March 31, 2016.


•	Annualized return on average assets (“ROAA”) and return on average equity (“ROAE”) were 0.77% and 8.31%, respectively, for the three month period ended March 31, 2017, compared to 1.00% and 11.70%, respectively, for the same time period in 2016.


•	Trust and investment services fee income was $1.6 million for the three months ended March 31, 2017, compared to $1.3 million for the three months ended March 31, 2016.


•	Top line revenue, the sum of net interest income and non-interest income, decreased 5.9% to $19.0 million for the three months ended March 31, 2017 compared to $20.1 million for the three months ended March 31, 2016.


•	Net interest margin decreased by eight basis points to 3.51% for the three months ended March 31, 2017 compared to 3.59% for the three months ended March 31, 2016.


•	Our efficiency ratio was 70.85% for the three months ended March 31, 2017, compared to 62.44% for the three months ended March 31, 2016.


•	Our provision for loan and lease losses was $572,000 for the three months ended March 31, 2017 compared to $525,000 for the same period in the prior year.


•	Net recoveries of $182,000 represented an annualized 0.05% of average loans and leases for the three months ended March 31, 2017 compared to annualized net charge-offs of 0.04% for the three months ended March 31, 2016.


•	Gross loans and leases receivable increased $30.3 million, or 8.4% annualized, to $1.481 billion at March 31, 2017 from $1.451 billion at December 31, 2016.


•	Allowance for loan and lease losses as a percentage of gross loans and leases was 1.46% at March 31, 2017 compared to 1.44% at December 31, 2016.


•	Non-performing assets as a percentage of total assets was 2.17% at March 31, 2017 compared to 1.50% at December 31, 2016.


•	Non-accrual loans increased by $12.3 million, or 48.9%, to $37.5 million at March 31, 2017 from $25.2 million at December 31, 2016.

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Results of Operations

Top Line Revenue

Top line revenue is comprised of net interest income and non-interest income. This measurement is also commonly referred to as operating revenue. For the three months ended March 31, 2017 top line revenue decreased 5.9% compared to the same period in the prior year primarily due to the anticipated decline in the gain on sale of SBA loans based on management’s third quarter 2016 decision to temporarily slow production, as well as loan yield compression driven by competitive pricing pressure and a shift in the mix of loan originations toward lower-yielding conventional commercial loans in recent quarters, in line with market demand. These first quarter 2017 revenue headwinds were partially offset by record trust and investment services fee income, an increase in swap fee income and a decrease in interest expense guided by successful efforts to reduce various in-market deposit rates and utilize an efficient mix of wholesale funding sources. In addition, top line revenue benefited moderately from increased rates on certain variable-rate loans stemming from the Federal Open Market Committee (“FOMC”) raising the targeted federal funds rate by 25 basis points in December of 2016 and again in March of 2017.

The components of top line revenue were as follows:



	For the Three Months Ended March 31,
	2017		2016		Change
	(Dollars in Thousands)
Net interest income	$	14,888	$	15,539	(4.2	)%
Non-interest income	4,063		4,594		(11.6	)
Total top line revenue	$	18,951	$	20,133	(5.9	)

Return on Average Assets and Return on Average Equity

ROAA for the three months ended March 31, 2017 decreased to 0.77% compared to 1.00% for the three months ended March 31, 2016. The decline in ROAA for the three months ended March 31, 2017 was primarily due to muted average loan growth, loan yield compression driven by competitive pricing pressure and reduced operating efficiency resulting from management’s strategic decision to temporarily slow SBA production in order to accommodate significant investment in both SBA personnel and infrastructure. ROAA is a critical metric used by us to measure the profitability of our organization and how efficiently our assets are deployed. It is a measurement that allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage that can ultimately influence return on equity measures.

ROAE for the three months ended March 31, 2017 was 8.31% compared to 11.70% for the three months ended March 31, 2016. The reasons for the decline in ROAE are consistent with the explanations provided for the ROAA results discussed above. We view ROAE to be an important measure of profitability and we continue to focus on improving the return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses and seeking to minimize our credit costs.

Efficiency Ratio

Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse provision, impairment of tax credit investments, losses or gains on foreclosed properties, amortization of other intangible assets and other discrete items, if any, divided by adjusted operating revenue.

The efficiency ratio was 70.85% for the three months ended March 31, 2017, compared to 62.44% for the three months ended March 31, 2016. Despite this reported reduction in operating efficiency, during the first quarter of 2017 we believe we continued our progress towards enhancing the Corporation’s long-term efficiency ratio by continuing to invest significantly in the rebuild of our SBA platform. We believe we are building a best-in-class SBA infrastructure, with the people and processes in place to resume high-quality production in the quarters and years ahead. At the same time, we expect our pending charter consolidation and recently announced core system conversion to create capacity within our existing workforce to accommodate future growth in a highly efficient manner. We believe these strategic initiatives will act as a catalyst for earnings growth in 2018 and beyond. Management will continue to take proactive measures to drive positive operating leverage with the objective of moving the efficiency ratio back within the Corporation’s long-term operating goal of 58-62%.

We believe the efficiency ratio allows investors and analysts to better assess the Corporation’s operating expenses in relation to its operating revenue by removing the volatility that is associated with certain non-recurring or discrete items

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unrelated to its business. The efficiency ratio also allows management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.

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



	For the Three Months Ended March 31,						Change from Prior Year
	2017			2016			$ Change			% Change
	(Dollars in Thousands)
Total non-interest expense	$	13,560		$	12,699		$	861		6.8	%
Less:
Amortization of other intangible assets	14			16			(2		)	(12.5	)
SBA recourse provision	6			—			6			NM
Impairment of tax credit investments	113			112			1			0.9
Total adjusted operating expense	$	13,427		$	12,571		$	856		6.8
Net interest income	$	14,888		$	15,539		$	(651	)	(4.2	)
Total non-interest income	4,063			4,594			(531		)	(11.6	)
Total operating revenue	$	18,951		$	20,133		$	(1,182	)	(5.9	)
Efficiency ratio	70.85		%	62.44		%

NM = Not meaningful

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Net Interest Income

Net interest income levels depend on the amount of and yield on interest-earning assets as compared to the amount of and rate paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes.

The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three months ended March 31, 2017 compared to the same period in 2016. The change in net interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) has been allocated to the rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.



	Increase (Decrease) for the Three Months Ended March 31,
	2017 Compared to 2016
	Rate			Volume			Net
	(In Thousands)
Interest-earning assets
Commercial real estate and other mortgage loans⁽¹⁾	$	(677	)	$	265		$	(412	)
Commercial and industrial loans⁽¹⁾	(207		)	(280		)	(487		)
Direct financing leases	(12		)	(8		)	(20		)
Consumer and other loans	(11		)	8			(3		)
Total loans and leases receivable	(907		)	(15		)	(922		)
Mortgage-related securities	15			4			19
Other investment securities	8			30			38
FHLB and FRB Stock	1			2			3
Short-term investments	63			(97		)	(34		)
Total net change in income on interest-earning assets	(820		)	(76		)	(896		)
Interest-bearing liabilities
Transaction accounts	125			19			144
Money market accounts	(144		)	(24		)	(168		)
Certificates of deposit	21			(40		)	(19		)
Wholesale deposits	59			(396		)	(337		)
Total deposits	61			(441		)	(380		)
FHLB advances	(3		)	138			135
Other borrowings	21			(18		)	3
Junior subordinated notes	(3		)	—			(3		)
Total net change in expense on interest-bearing liabilities	76			(321		)	(245		)
Net change in net interest income	$	(896	)	$	245		$	(651	)


(1)	Includes loans held for sale.

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The table below shows our average balances, interest, average yields/rates, net interest margin and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three months ended March 31, 2017 and 2016. The average balances are derived from average daily balances.



	For the Three Months Ended March 31,
	2017							2016
	Average Balance			Interest		Average Yield/Rate⁽⁴⁾		Average Balance			Interest		Average Yield/Rate⁽⁴⁾
	(Dollars in Thousands)
Interest-earning assets
Commercial real estate and other mortgage loans⁽¹⁾	$	946,110		$	10,318	4.36	%	$	922,859		$	10,730	4.65	%
Commercial and industrial loans⁽¹⁾	451,552			6,595		5.84		470,503			7,082		6.02
Direct financing leases⁽¹⁾	30,123			323		4.29		30,845			343		4.45
Consumer and other loans⁽¹⁾	28,202			286		4.06		27,427			289		4.21
Total loans and leases receivable⁽¹⁾	1,455,987			17,522		4.81		1,451,634			18,444		5.08
Mortgage-related securities⁽²⁾	145,804			618		1.70		144,899			599		1.65
Other investment securities⁽³⁾	38,554			161		1.67		31,326			123		1.57
FHLB and FRB stock	3,150			24		3.05		2,802			21		2.92
Short-term investments	51,136			122		0.95		101,420			156		0.62
Total interest-earning assets	1,694,631			18,447		4.35		1,732,081			19,343		4.47
Non-interest-earning assets	80,254							88,361
Total assets	$	1,774,885						$	1,820,442
Interest-bearing liabilities
Transaction accounts	$	192,297		232		0.48		$	162,793		88		0.22
Money market accounts	627,188			660		0.42		646,362			828		0.51
Certificates of deposit	55,393			132		0.95		73,163			151		0.83
Wholesale deposits	400,672			1,649		1.65		497,274			1,986		1.60
Total interest-bearing deposits	1,275,550			2,673		0.84		1,379,592			3,053		0.89
FHLB advances	60,703			154		1.01		7,537			19		1.03
Other borrowings	25,921			458		7.07		27,006			455		6.74
Junior subordinated notes	10,006			274		10.97		9,991			277		11.09
Total interest-bearing liabilities	1,372,180			3,559		1.04		1,424,126			3,804		1.07
Non-interest-bearing demand deposit accounts	228,015							228,294
Other non-interest-bearing liabilities	11,223							12,337
Total liabilities	1,611,418							1,664,757
Stockholders’ equity	163,467							155,685
Total liabilities and stockholders’ equity	$	1,774,885						$	1,820,442
Net interest income				$	14,888						$	15,539
Interest rate spread						3.31	%						3.40	%
Net interest-earning assets	$	322,451						$	307,955
Net interest margin						3.51	%						3.59	%
Average interest-earning assets to average interest-bearing liabilities	123.50		%					121.62		%
Return on average assets⁽⁴⁾	0.77							1.00
Return on average equity⁽⁴⁾	8.31							11.70
Average equity to average assets	9.21							8.55
Non-interest expense to average assets⁽⁴⁾	3.06							2.79


(1)	The average balances of loans and leases include non-performing loans and leases and loans held for sale. Interest income related to non-performing loans and leases is recognized when collected. Interest income includes net loan fees collected in lieu of interest.


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


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


(4)	Represents annualized yields/rates.

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Net interest income decreased $651,000, or 4.2%, during the three months ended March 31, 2017 compared to the same period in 2016. The decrease in net interest income was primarily attributable to a decrease in the yield on average total loans and leases receivable, partially offset by a positive change in earning asset mix as average total loans and leases receivable represented 82.0% of total average assets for the three months ended March 31, 2017, compared to 79.7% for the same period in 2016. In addition, this overall decrease in net interest income was partially offset by successful efforts to decrease various deposit rates and increased rates on certain variable-rate loans stemming from the FOMC raising the targeted federal funds rate by 25 basis points in December of 2016 and again in March of 2017.

The yield on average earning assets for the three months ended March 31, 2017 decreased 12 basis points to 4.35%, compared to 4.47% for the three months ended March 31, 2016. This decrease was principally due to competitive loan pricing pressure on both new and renewed loans, a shift in the mix of loan originations toward lower-yielding conventional commercial loans and a year over year increase in average non-accrual loans, partially offset by a $53.7 million year over year decrease in average cash held at the Federal Reserve and the aforementioned federal funds rate increases.

The weighted average rate paid on our interest-bearing deposits was 0.84% for the three months ended March 31, 2017, a decrease of five basis point from 0.89% for the three months ended March 31, 2016. The decrease was primarily attributable to a positive interest-bearing deposit mix change, as average transaction accounts increased $29.5 million and average wholesale deposits decreased $96.6 million. The decrease in weighted average rate paid is also attributable to management’s successful efforts to reduce various in-market deposit rates as the average rate paid on money market accounts decreased nine basis points from 0.51% to 0.42%.

The overall weighted average rate paid on interest-bearing liabilities was 1.04% for the three months ended March 31, 2017, a decrease of three basis point from 1.07% for the three months ended March 31, 2016. The reasons for the decline are consistent with the explanations provided for the decrease in weighted average rate paid on interest-bearing deposits discussed above in addition to a positive change in the Corporation’s wholesale funding mix. Consistent with the Corporation’s longstanding funding strategy to use the most efficient and cost effective source of wholesale funds, management replaced maturing wholesale deposits with fixed rate FHLB advances at various maturity terms commensurate with the Banks funding needs during the quarter. Average FHLB advances for the three months ended March 31, 2017 increased $53.2 million to $60.7 million at a weighted average rate paid of 1.01%, compared to $7.5 million at a weighted average rate paid of 1.03% for the same period in 2016.

Despite an uncertain rate environment, management expects to effectively manage the Corporation’s liability structure in both term and rate to deliver a stable net interest margin within our target range. Further, we expect continued success in attracting in-market deposit relationships in our Wisconsin and Kansas-based markets which we believe will contribute to our ability to maintain an appropriate cost of funds. Average in-market client deposits - comprised of all transaction accounts, money market accounts and non-wholesale deposits - remained relatively unchanged at $1.103 billion for the three months ended March 31, 2017 compared to $1.111 billion for the three months ended March 31, 2016.

Net interest margin decreased eight basis points to 3.51% for the three months ended March 31, 2017 compared to 3.59% for the three months ended March 31, 2016. Loan and lease growth at below portfolio average yields, combined with an increase in average non-accrual loans for the three months ended March 31, 2017 compared to the same period in 2016, drove a 12 basis point decrease in net interest margin. The Corporation’s success in attracting in-market transaction accounts and management’s successful efforts to reduce various in-market deposit rates across the franchise, positively affected our net interest margin by approximately eight basis points. Other factors, primarily the aforementioned increase in our fixed-rate FHLB advances portfolio, negatively influenced the net interest margin by four basis points in the aggregate.

To counter asset yield pressure, the Corporation continues to take actions, including pursuing non-interest bearing deposit accounts and attempting to manage deposit rates, to maintain a net interest margin of 3.50% or better.

Provision for Loan and Lease Losses

We determine our provision for loan and lease losses based upon credit risk and other subjective factors pursuant to our allowance for loan and lease loss methodology, the magnitude of current and historical net charge-offs recorded in the period and the amount of reserves established for impaired loans that present collateral shortfall positions. Refer to Allowance for Loan and Lease Losses for further information regarding our allowance for loan and lease loss methodology.

We recorded provision expense of $572,000 and $525,000 for the three months ended March 31, 2017 and 2016, respectively. Provision for the three months ended March 31, 2017 primarily reflected additions commensurate with loan

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growth, partially offset by a reduction in the historical loss factors applied in calculating the probable losses inherent within the loan and lease portfolio due to net recoveries of $182,000 during the three months ended March 31, 2017.

The addition of specific reserves on impaired loans represents new specific reserves established when collateral shortfalls are present, while conversely the release of specific reserves represents the reduction of previously established reserves that are no longer required. Changes in the allowance for loan and lease losses due to subjective factor changes reflect management’s evaluation of the level of risk within the portfolio based upon several factors for each portfolio segment. Charge-offs in excess of previously established specific reserves require an additional provision for loan and lease losses to maintain the allowance for loan and lease losses at a level deemed appropriate by management. Change in the inherent risk of the portfolio is primarily influenced by the overall growth in gross loans and leases and an analysis of loans previously charged off, as well as, movement of existing loans and leases in and out of an impaired loan classification where a specific evaluation of a particular credit may be required rather than the application of a general reserve ratio. Refer to Asset Quality for further information regarding the overall credit quality of our loan and lease portfolio.

Non-Interest Income

Non-interest income, which consists primarily of fees earned for trust and investment services, gains on sale of SBA loans, service charges on deposits and loan fee income, decreased by $531,000, or 11.6%, to $4.1 million for the three months ended March 31, 2017, from $4.6 million for the three months ended March 31, 2016. Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream through greater contribution from fee-based revenues. Total non-interest income accounted for 21.4% of our total revenues in the first quarter of 2017 compared to 22.8% in the first quarter of 2016.

The components of non-interest income were as follows for the three months ended March 31, 2017 and 2016:



	For the Three Months Ended March 31,						Change From Prior Year
	2017			2016			$ Change 2017			% Change 2017
	(In Thousands)
Trust and investment services fee income	$	1,629		$	1,273		$	356		28.0	%
Gain on sale of SBA loans	360			1,376			(1,016		)	(73.8	)
Gain on sale of residential mortgage loans	11			145			(134		)	(92.4	)
Service charges on deposits	765			742			23			3.1
Loan fees	458			609			(151		)	(24.8	)
Increase in cash surrender value of bank-owned life insurance	311			243			68			28.0
Other non-interest income	529			206			323			156.8
Total non-interest income	$	4,063		$	4,594		$	(531	)	(11.6	)
Fee income ratio⁽¹⁾	21.4		%	22.8		%

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

The decrease in total non-interest income primarily reflects lower gains from SBA loans sales stemming from the Corporation’s decision to temporarily slow production beginning in the third quarter of 2016, the decision to exit the residential mortgage loan origination business and lower loan fees. The decrease was partially offset by record trust and investment services fee income, an increase in loan swap fee income and allocation of net income/loss from its equity investments.

Gains on sale of SBA loans for the three months ended March 31, 2017 totaled $360,000, a decrease of $1.0 million, or 73.8%, from the same period in 2016. In order to meet market demand and drive high-quality growth in 2017 and beyond, we are working to ensure future growth is achieved in a sustainable manner. Consequently, management has temporarily slowed the SBA production while investments to enhance the infrastructure, processes, capacity and scalability of the SBA business line are completed.

Trust and investment services fee income increased by $356,000, or 28.0%, to a record $1.6 million for the three months ended March 31, 2017 from $1.3 million for the three months ended March 31, 2016. This increase was primarily driven by growth in assets under management and administration and an increase in equity market values over the period of comparison. At March 31, 2017, we had a record $1.127 billion of trust assets under management compared to $977.0 million at December 31, 2016 and $896.4 million at March 31, 2016. Assets under administration were $177.0 million at March 31,

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2017 compared to $227.4 million at December 31, 2016 and $210.4 million at March 31, 2016. The decrease in assets under administration reflects the transfer of client assets from assets under administration to assets under management. The retirement plan services industry is undergoing a migration from advised services to fiduciary services. Consequently, during the first quarter of 2017, one large and several smaller retirement plans changed their service model, which resulted in assets moving to full fiduciary status. We anticipate there will be similar migration of additional assets because of this in the future.

During the first quarter of 2017, the Corporation originated commercial real estate loans in which the Corporation offered the client a floating rate and interest rate swap and then offset the client swap with a counter-party dealer. The execution of these transactions generated $199,000 in swap fee income for the three months ended March 31, 2017 compared to no income for the three months ended March 31, 2016. We believe due to the markets assumption of a rising interest rate environment throughout 2017, our markets – particularly Madison, Milwaukee and Appleton – could see additional loan demand for these types of relationship-based opportunities.

The Corporation has historically reflected its quarterly allocation of net income/loss from its equity investments in two mezzanine funds in other non-interest expense. Due to the underlying funds being in an earnings position for a sustained period of time, the Corporation recognized its share of earnings in other non-interest income for the three months ended March 31, 2017.

Non-Interest Expense

Non-interest expense increased by $861,000, or 6.8%, to $13.6 million for the year ended March 31, 2017 from $12.7 million for the same period in 2016. The increase in non-interest expense was primarily due to an increase in compensation expense, professional fees, computer software expense and other non-interest expense, partially offset by a decrease in marketing costs.

The components of non-interest expense were as follows for the three months ended March 31, 2017 and 2016:



	For the Three Months Ended March 31,						Change From Prior Year
	2017			2016			$ Change 2017			% Change 2017
	(Dollars in Thousands)
Compensation	8,683			8,370			$	313		3.7	%
Occupancy	475			508			(33		)	(6.5	)
Professional fees	1,010			861			149			17.3
Data processing	584			651			(67		)	(10.3	)
Marketing	370			734			(364		)	(49.6	)
Equipment	283			280			3			1.1
Computer software	683			494			189			38.3
FDIC insurance	380			291			89			30.6
Collateral liquidation costs	92			47			45			95.7
Impairment on tax credit investments	113			112			1			0.9
SBA recourse provision	6			—			6			NM
Other non-interest expense	881			351			530			151.0
Total non-interest expense	$	13,560		$	12,699		$	861		6.8
Compensation expense to total non-interest expense	64.0		%	65.9		%
Full-time equivalent employees	258			255

Compensation expense increased by $313,000, or 3.7%, to $8.7 million for the three months ended March 31, 2017 from $8.4 million for the three months ended March 31, 2016. The overall increase reflected growth related to annual merit increases and employee benefit costs on a larger base of employees than in the comparative period of the prior year. Full time equivalent employees as of March 31, 2017 were 258, up 1.2% from 255 at March 31, 2016. We expect to continue to opportunistically invest in talent to support our strategic growth efforts, both in the form of additional business development and operational staff.

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Professional fees expense increased by $149,000, or 17.3%, to $1.0 million for the three months ended March 31, 2017 from $861,000 for the three months ended March 31, 2016. The increase was commensurate with ongoing activities surrounding our pending charter consolidation and core system conversion.

Computer software expense increased by $189,000, or 38.3%, to $683,000 for the three months ended March 31, 2017 from $494,000 for the three months ended March 31, 2016. The increase was principally due to investments in technology platforms, continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy.

Other non-interest expense increased by $530,000, or 151.0%, to $881,000 for the three months ended March 31, 2017 from $351,000 for the three months ended March 31, 2016. The increase was primarily due to routine annual vendor rate increases and allocation of net income/loss from its equity investments.

Marketing costs decreased $364,000, or 49.6%, to $370,000 for the three months ended March 31, 2017 from $734,000 for the three months ended March 31, 2016. The decrease primarily reflects the timing of rebranding efforts ahead of the Company’s expected consolidation of its bank charters during the second quarter of 2017.

Expense management and strategic investment are critical components of our strategy and our culture, from our limited branch network and unique funding model to our investments in talent and technology. We are diligently managing our operating costs to align with revenue expectations while continuing to make investments that enhance our business and our ability to serve current and prospective clients.

Income Taxes

Income tax expense was $1.4 million for the three months ended March 31, 2017, with an effective tax rate of 29.5%, compared to income tax expense of $2.4 million for the three months ended March 31, 2016, with an effective tax rate of 34.1%. No significant discrete items were recognized during the first quarter of 2017.

Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. Typically, the rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change.

Financial Condition

General

Total assets increased by $19.9 million, or 1.1%, to $1.801 billion as of March 31, 2017 compared to $1.781 billion at December 31, 2016. The increase in total assets was primarily driven by growth in our loan and lease receivable portfolio, partially offset by both a decrease in excess cash held at the Federal Reserve and investments in commercial paper.

Short-Term Investments

Short-term investments decreased by $17.5 million, or 27.8%, to $45.4 million at March 31, 2017 from $62.9 million at December 31, 2016. Our short-term investments primarily consist of interest-bearing deposits held at the FRB. We value the safety and soundness provided by the FRB and therefore we incorporate short-term investments in our on-balance-sheet liquidity program. The decrease in short-term investments primarily reflects a reduction in cash held at the FRB driven by a decrease in wholesale deposits. As of March 31, 2017, our total investment in commercial paper, which is also considered a short-term investment, was $12.4 million as compared to $20.3 million at December 31, 2016. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio. The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to take advantage of an anticipated rising-rate environment. In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan growth when opportunities are presented and the level of our available-for-sale securities portfolio. Please refer to Liquidity and Capital Resources for further discussion.

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Securities

Total securities, including available-for-sale and held-to-maturity, increased by $1.0 million to $185.5 million at March 31, 2017 compared to $184.5 million at December 31, 2016. During the three months ended March 31, 2017, we recognized unrealized losses of $83,000 before income taxes through other comprehensive income. As of March 31, 2017 and December 31, 2016, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted average expected maturity of 3.33 and 3.30 years, respectively. Generally, our investment philosophy remains as stated in our most recent Annual Report on Form 10-K.

We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification of a representative sample of the portfolio, data integrity validation through comparison of current price to prior period prices and an expectation-based analysis of movement in prices based upon the changes in the related yield curves and other market factors. No securities within our portfolio were deemed to be other-than-temporarily impaired as of March 31, 2017.

No securities were sold during the three months ended March 31, 2017.

Loans and Leases Receivable

Loans and leases receivable, net of allowance for loan and lease losses, increased by $29.5 million, or 2.1%, to $1.459 billion at March 31, 2017 from $1.430 billion at December 31, 2016. As of March 31, 2017, non owner-occupied commercial real estate (“CRE”) loans were the largest contributor to loan growth increasing $19.2 million, or 4.1%, to $492.4 million from $473.2 million at December 31, 2016, while total CRE loans increased $21.2 million, or 2.2%. While we continue to have a concentration in CRE, in general our composition of total loans and leases has remained relatively consistent due to balanced growth across our product offerings. CRE loans represented 65% of our total loans as of March 31, 2017 and December 31, 2016. As of March 31, 2017, approximately 19% of the CRE loans were owner-occupied CRE. We consider owner-occupied CRE more characteristic of the Corporation’s commercial and industrial (“C&I”) portfolio as, in general, the client’s primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property.

Our C&I portfolio increased $8.5 million, or 1.9%, to $458.8 million at March 31, 2017 from $450.3 million at December 31, 2016 primarily driven by continued business development success in our Milwaukee region, partially offset by a moderate decline in asset-based loans. The countercyclical nature of the asset-based lending business may result in increased payoffs and fees collected in lieu of interest in periods of economic stability, with increased loan fundings and interest income during weaker economic markets. We will continue to emphasize actively pursuing C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management and trust and investment relationships which generate additional fee revenue.

While we continue to experience significant competition as banks operating in our primary geographic areas attempt to deploy liquidity, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to expect our new loan and lease activity to be adequate to replace normal amortization and to continue to grow at a modest pace in future quarters. The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K.

Non-performing loans increased $12.3 million, or 48.9%, to $37.5 million at March 31, 2017, compared to $25.2 million at December 31, 2016. The Corporation’s non-performing loans as a percentage of total gross loans and leases measured 2.53% and 1.74% at March 31, 2017 and December 31, 2016, respectively. Likewise, the ratio of non-performing assets to total assets increased to 2.17% at March 31, 2017, compared to 1.50% at December 31, 2016. Please refer to Asset Quality for additional information.

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Deposits

As of March 31, 2017, deposits decreased by $46.1 million, or 3.0% to $1.493 billion from $1.539 billion at December 31, 2016. The decrease in deposits was primarily due to typical seasonality of our non-transaction accounts, in addition to a purposeful reduction in the level of wholesale deposits, which decreased by $28.2 million, or 6.8%, to $388.4 million at March 31, 2017 from $416.7 million at December 31, 2016. The decrease in wholesale deposits was partially offset by an increase in the level of interest-bearing transaction accounts, which increased by $21.9 million, or 11.9%, to $205.9 million at March 31, 2017 from $184.0 million at December 31, 2016. Deposit ending balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, our ability to service and maintain client relationships and new client deposit relationships.

Our strategic efforts continue to be focused on adding in-market relationships and related transaction deposit accounts. We measure the success of deposit gathering efforts based on our ability to maintain the average balances of our in-market deposit accounts consistent with our current period mix and recent trends. Our Banks’ in-market deposits, consisting of all transaction accounts, money market accounts and non-wholesale deposits, are obtained primarily from the South Central, Northeastern and Southeastern regions of Wisconsin and the greater Kansas City area. Of our total average bank funding sources, approximately $1.103 billion, or 70.5%, were considered in-market deposits for the three months ended March 31, 2017. This compares to in-market deposits of $1.111 billion, or 69.3%, for the same period in 2016.

FHLB Advances and Other Borrowings

As of March 31, 2017, FHLB advances and other borrowings increased by $62.2 million, or 104.2%, to $121.8 million from $59.7 million at December 31, 2016.

The Corporation’s targeted operating range of bank wholesale funds to total deposits is 30%-40%. As of March 31, 2017, the ratio of end of period bank wholesale funds to end of period total bank funds was 30.5%. Consistent with our funding philosophy to match-fund long-term fixed rate loans with the most efficient and cost effective source of wholesale funds, and given current market conditions, we expect to allow our brokered certificate of deposit portfolio to mature and/or amortize down to within 10%-15% of total assets and replace with the now more cost effective FHLB advances in order to lower our FDIC assessment rate in future periods. Refer to Liquidity and Capital Resources for further information regarding our use and monitoring of wholesale deposits.

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Asset Quality

Non-performing Assets

Our total impaired assets consisted of the following at March 31, 2017 and December 31, 2016, respectively:



	March 31, 2017			December 31, 2016
	(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied	$	5,433		$	2,223
Commercial real estate - non-owner occupied	1,979			1,609
Land development	3,355			3,440
Construction	4,602			2,918
Multi-family	—			—
1-4 family	1,911			1,937
Total non-accrual commercial real estate	17,280			12,127
Commercial and industrial	19,545			12,463
Direct financing leases, net	—			—
Consumer and other:
Home equity and second mortgages	—			—
Other	694			604
Total non-accrual consumer and other loans	694			604
Total non-accrual loans and leases	37,519			25,194
Foreclosed properties, net	1,472			1,472
Total non-performing assets	38,991			26,666
Performing troubled debt restructurings	702			717
Total impaired assets	$	39,693		$	27,383

Total non-accrual loans and leases to gross loans and leases	2.53		%	1.74		%
Total non-performing assets to gross loans and leases plus foreclosed properties, net	2.63			1.83
Total non-performing assets to total assets	2.17			1.50
Allowance for loan and lease losses to gross loans and leases	1.46			1.44
Allowance for loan and lease losses to non-accrual loans and leases	57.75			83.00

As of March 31, 2017 and December 31, 2016, $12.4 million and $12.8 million of the non-accrual loans were considered troubled debt restructurings, respectively.

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A summary of our non-accrual loan and lease activity from December 31, 2016 through March 31, 2017 is as follows:



(In Thousands)
Non-accrual loans and leases as of the beginning of the period	$	25,194
Loans and leases transferred to non-accrual status	14,609
Accretion of the fair value discount on purchased credit impaired loans	3
Non-accrual loans and leases returned to accrual status	—
Non-accrual loans and leases transferred to foreclosed properties	—
Non-accrual loans and leases partially or fully charged-off	(209		)
Cash received and applied to principal of non-accrual loans and leases	(2,078		)
Non-accrual loans and leases as of the end of the period	$	37,519

We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio. Non-performing assets increased $12.3 million, or 46.2%, to $39.0 million at March 31, 2017 from $26.7 million at December 31, 2016 primarily reflecting additional impaired loans related to three loan relationships. A $6.7 million commercial and industrial loan associated with a single Wisconsin-based borrower was moved to impaired status due to deterioration that directly impacted our source of repayment. Two unrelated SBA relationships, an owner-occupied commercial real estate loan and a construction loan, accounted for the remaining increase in non-performing assets during the first quarter. The owner-occupied loan represented the repurchase of a previously sold portion of an SBA loan, which the Corporation identified as impaired during 2016. The construction loan impairment was primarily driven by rapid deterioration of the client’s business that also impacted our source of repayment. The impaired loan increases related to these three loan relationships did not require additional specific reserves or charge-offs at March 31, 2017 due to their collateral positions.

We also monitor early stage delinquencies to assist in the identification of potential future problems. As of March 31, 2017, we believe the payment performance did not point to any new significant areas of concern, as 98.3% of the loan and lease portfolio was in a current payment status, compared to 98.8% as of December 31, 2016. We also monitor our asset quality through our established credit quality indicator categories. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to sell the underlying collateral, inadequate cash flow from the operations of the underlying businesses, liquidation events or bankruptcy filings. We work proactively with our impaired loan borrowers to find meaningful solutions to difficult situations that are in the best interests of the Banks.

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



	As of and for the Three Months Ended March 31,				As of and for the Year Ended December 31,
	2017		2016		2016
	(In Thousands)
Impaired loans and leases with no impairment reserves required	$	22,503	$	11,663	$	11,345
Impaired loans and leases with impairment reserves required	15,718		7,826		14,566
Total impaired loans and leases	38,221		19,489		25,911
Less:
Impairment reserve (included in allowance for loan and lease losses)	6,158		897		5,599
Net impaired loans and leases	$	32,063	$	18,592	$	20,312
Average impaired loans and leases	$	27,879	$	20,649	$	22,986
Foregone interest income attributable to impaired loans and leases	$	712	$	311	$	1,617
Less: Interest income recognized on impaired loans and leases	—		152		614
Net foregone interest income on impaired loans and leases	$	712	$	159	$	1,003

Non-performing assets also include foreclosed properties. A summary of our current-period foreclosed properties activity is as follows:



(In Thousands)
Foreclosed properties as of December 31, 2016	$	1,472
Loans transferred to foreclosed properties	—
Proceeds from sale of foreclosed properties	—
Net loss on sale of foreclosed properties	—
Increase in impairment valuation	—
Foreclosed properties as of March 31, 2017	$	1,472

Allowance for Loan and Lease Losses

The allowance for loan and lease losses as a percentage of gross loans and leases was 1.46% as of March 31, 2017 and 1.44% as of December 31, 2016. During the three months ended March 31, 2017, we recorded net recoveries on impaired loans and leases of approximately $182,000, or 0.05% of average loans and leases annualized, comprised of $209,000 of charge-offs and $391,000 of recoveries. During the three months ended March 31, 2016, we recorded net charge-offs on impaired loans and leases of approximately $157,000, or 0.04% of average loans and leases annualized, comprised of $244,000 of charge-offs and $87,000 of recoveries.

We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed. Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios. There have been no substantive changes to our methodology for estimating the appropriate level of allowance for loan and lease loss reserves from what was previously outlined in our most recent Annual Report on Form 10-K. Based upon this methodology, which includes actively monitoring the asset quality and inherent risks within the loan and lease portfolio, management concluded that an allowance for loan and lease losses of $21.7 million, or 1.46% of total loans and leases, was appropriate as of March 31, 2017. Given ongoing complexities with current workout situations and the measured pace of improvement in economic conditions, further charge-offs and increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion. In addition, various federal and state regulatory agencies review the appropriateness of the allowance for loan and lease losses. These agencies could require certain loan and lease balances to be classified differently or charged off if their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination.

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As of March 31, 2017 and December 31, 2016, our allowance for loan and lease losses to total non-accrual loans and leases was 57.75% and 83.00%, respectively. This ratio decreased due to the aforementioned increase in non-accrual loans associated with three loan relationships. As the impaired loans did not require additional specific reserves at March 31, 2017 due to their collateral positions, no significant corresponding increase was reflected in the allowance for loan and lease losses. Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we endeavor to have appropriate collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases either does not require additional specific reserves or requires only a minimal amount of required specific reserve, as we believe the loans and leases are adequately collateralized as of the measurement period. In addition, management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease losses to non-accrual loans and leases ratio as compared to our peers or industry expectations. Our allowance for loan and lease losses is measured more through general characteristics, including historical loss experience of our portfolio rather than through specific identification and we therefore expect to see this ratio rise as we continue to grow our loan and lease portfolio. Conversely, if we identify additional impaired loans or leases which are adequately collateralized and therefore require no specific or general reserve, this ratio could fall. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as of March 31, 2017.

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



	As of and for the Three Months Ended March 31,
	2017			2016
	(Dollars in Thousands)
Allowance at beginning of period	$	20,912		$	16,316
Charge-offs:
Commercial real estate:
Commercial real estate — owner occupied	(9		)	(41		)
Commercial real estate — non-owner occupied	(58		)	—
Construction and land development	—			—
Multi-family	—			—
1-4 family	—			—
Commercial and industrial	(55		)	(196		)
Direct financing leases	—			—
Consumer and other:
Home equity and second mortgages	—			—
Other	(87		)	(7		)
Total charge-offs	(209		)	(244		)
Recoveries:
Commercial real estate:
Commercial real estate — owner occupied	—			—
Commercial real estate — non-owner occupied	1			72
Construction and land development	101			—
Multi-family	—			—
1-4 family	2			12
Commercial and industrial	246			—
Direct financing leases	—			—
Consumer and other:
Home equity and second mortgages	1			1
Other	40			2
Total recoveries	391			87
Net recoveries (charge-offs)	182			(157		)
Provision for loan and lease losses	572			525
Allowance at end of period	$	21,666		$	16,684
Annualized net recoveries (charge-offs) as a % of average gross loans and leases	0.05		%	(0.04		)%

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Liquidity and Capital Resources

The Corporation expects to meet its liquidity needs through existing cash on hand, established cash flow sources, its third party senior line of credit and dividends received from the Banks. While the Banks are subject to certain regulatory limitations regarding their ability to pay dividends to the Corporation, we do not believe that the Corporation will be adversely affected by these dividend limitations. The Corporation’s principal liquidity requirements at March 31, 2017 were the interest payments due on subordinated and junior subordinated notes. On April 26, 2017, the FBB board of directors declared a dividend in the amount of $3.0 million bringing year-to-date dividend declarations to $6.5 million. The capital ratios of the Corporation and its subsidiaries continue to meet all applicable regulatory capital adequacy requirements. The Corporation’s and the Banks’ respective boards of directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.

The Banks maintain liquidity by obtaining funds from several sources. The Banks’ primary sources of funds are principal and interest repayments on loans receivable and mortgage-related securities, deposits and other borrowings, such as federal funds and FHLB advances. The scheduled payments of loans and mortgage-related securities are generally a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest rates, economic conditions and competition.

We view on-balance-sheet liquidity as a critical element to maintaining adequate liquidity to meet our cash and collateral obligations. We define our on-balance-sheet liquidity as the total of our short-term investments, our unencumbered securities’ fair value and our unencumbered pledged loans. As of March 31, 2017 and December 31, 2016, our immediate on-balance-sheet liquidity was $476.3 million and $543.1 million, respectively. At March 31, 2017 and December 31, 2016, the Banks had $31.8 million and $40.9 million on deposit with the FRB, respectively. Any excess funds not used for loan funding or satisfying other cash obligations were maintained as part of our on-balance-sheet liquidity in our interest-bearing accounts with the FRB, as we value the safety and soundness provided by the FRB. We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow run-off of maturing brokered certificates of deposit or invest in securities to maintain adequate liquidity at an improved margin.

We had $484.5 million of outstanding wholesale funds at March 31, 2017, compared to $450.3 million of wholesale funds as of December 31, 2016, which represented 30.5% and 28.6%, respectively, of ending balance total Bank funding. Wholesale funds include brokered certificates of deposit, deposits gathered from internet listing services and FHLB advances. Total Bank funding is defined as total deposits plus FHLB advances. We are committed to our continued efforts to raise in-market deposits while maintaining our overall target mix of wholesale funds and in-market deposits. Wholesale funds continue to be an efficient and cost effective source of funding for the Banks and allow them to gather funds across a larger geographic base at price levels and maturities that are more attractive than local time deposits when required to raise a similar level of in-market deposits within a short time period. Access to such deposits and borrowings allows us the flexibility to refrain from pursuing single service deposit relationships in markets that have experienced unfavorable pricing levels. In addition, the administrative costs associated with wholesale funds are considerably lower than those that would be incurred to administer a similar level of local deposits with a similar maturity structure. During the time frames necessary to accumulate wholesale funds in an orderly manner, we will use short-term FHLB advances to meet our temporary funding needs. The short-term FHLB advances will typically have terms of one week to one month to cover the overall expected funding demands.

Our in-market relationships remain stable; however, deposit balances associated with those relationships will fluctuate. We expect to establish new client relationships and continue marketing efforts aimed at increasing the balances in existing clients’ deposit accounts. Nonetheless, we will continue to use wholesale funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management process or in shorter time periods if in-market deposit balances decline. In order to provide for ongoing liquidity and funding, all of our wholesale funds are certificates of deposit which do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual maturity terms and no call provisions. The Banks limit the percentage of wholesale funds to total Bank funds in accordance with liquidity policies approved by their respective Boards of Directors. The Corporation’s overall operating range of wholesale funds to total Bank funds is 30%-40%. The Banks were in compliance with their respective policy limits as of March 31, 2017 and December 31, 2016.

The Banks were able to access the wholesale deposit market as needed at rates and terms comparable to market standards during the three month period ended March 31, 2017. In the event there is a disruption in the availability of wholesale deposits at maturity, the Banks have managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through on-balance-sheet liquidity. These potential funding sources include

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deposits with the FRB and borrowings from the FHLB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As of March 31, 2017, the available liquidity was in excess of the stated policy minimum. We believe the Banks will also have access to the unused federal funds lines, cash flows from borrower repayments and cash flows from security maturities. The Banks also have the ability to raise local market deposits by offering attractive rates to generate the level required to fulfill their liquidity needs.

The Banks are required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. We believe the Banks have sufficient liquidity to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows.

During the three months ended March 31, 2017, operating activities resulted in a net cash inflow of $4.9 million, which included net income of $3.4 million. Net cash used in investing activities for the three months ended March 31, 2017 was approximately $36.4 million which consisted of cash outflows to fund net loan growth and reinvestment of cash flows within purchases of additional securities available-for-sale offset by cash inflows from maturities, redemptions and paydowns of available-for-sale and held-to-maturity securities. Net cash provided by financing activities for the three months ended March 31, 2017 was $14.9 million primarily from net increases in FHLB advances, partially offset by net decreases in deposits and cash dividends paid to shareholders. Please refer to the Consolidated Statements of Cash Flows for further details regarding significant sources of cash flow for the Corporation.

Contractual Obligations and Off-Balance-Sheet Arrangements

As of March 31, 2017, there were no material changes to our contractual obligations and off-balance-sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016. We continue to believe that we have adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our primary market risk is interest rate risk, which arises from exposure of our financial position to changes in interest rates. It is our strategy to reduce the impact of interest rate risk on net interest margin by maintaining a favorable match between the maturities and repricing dates of interest-earning assets and interest-bearing liabilities. This strategy is monitored by the respective Banks’ Asset/Liability Management Committees, in accordance with policies approved by the respective Banks’ Boards. These committees meet regularly to review the sensitivity of their respective Bank’s assets and liabilities to changes in interest rates, liquidity needs and sources, and pricing and funding strategies.

We use two techniques to measure interest rate risk. The first is simulation of earnings. In this measurement technique the balance sheet is modeled as an ongoing entity whereby future growth, pricing and funding assumptions are implemented. These assumptions are modeled under different rate scenarios that include a parallel, instantaneous and sustained change in interest rates. Key assumptions include:


•	the behavior of interest rates and pricing spreads;


•	the changes in product balances; and


•	the behavior of loan and deposit clients in different rate environments.

This analysis incorporates several assumptions, the most material of which relate to the re-pricing characteristics and balance fluctuations of deposits with indeterminate or non-contractual maturities, and is measured as a percentage change in net interest income for the next 12 months due to instantaneous movements in benchmark interest rates from a baseline scenario. Estimated changes are dependent upon material assumptions such as those previously discussed.

The earnings simulation analysis does not incorporate any management actions that may be used to mitigate negative consequences of actual interest rate movement. For that reason and others, they do not reflect the likely actual results but serve as conservative estimates of interest rate risk. The simulation analysis is not comparable to actual results or directly predictive of future values of other measures provided.

The second measurement technique used is static gap analysis. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. In general, a positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature in a time frame and a negative gap indicates the opposite. In addition to the gap position, other determinants of net interest income are the shape of the yield curve, general rate levels and

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the corresponding effect of contractual interest rate floors, reinvestment spreads, balance sheet growth and mix, and interest rate spreads. Our success in attracting in-market deposits adds to the interest rate liability sensitivity of the organization.

We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity and/or repricing characteristics based on market conditions. Wholesale certificates of deposit and FHLB advances are a significant source of our funding and we use a variety of maturities to augment our management of interest rate exposure. Currently, we do not employ any derivatives to assist in managing our interest rate risk exposure; however, management has the authorization, as permitted within applicable approved policies, and ability to utilize such instruments should they be appropriate to manage interest rate exposure.

The process of asset and liability management requires management to make a number of assumptions as to when an asset or liability will reprice or mature. Management believes that its assumptions approximate actual experience and considers these assumptions to be reasonable, although the actual amortization and repayment of assets and liabilities may vary substantially. Our economic sensitivity to changes in interest rates at March 31, 2017 has not changed materially since December 31, 2016.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Corporation’s management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has evaluated the Corporation’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures were effective as of March 31, 2017.

Changes in Internal Control over Financial Reporting

There was no change in the Corporation’s internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) that occurred during the quarter ended March 31, 2017 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

PART II. Other Information

Item 1. Legal Proceedings

From time to time, the Corporation and its subsidiaries are engaged in legal proceedings in the ordinary course of their respective businesses. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations or cash flows.

Item 1A. Risk Factors

There were no material changes to the risk factors previously disclosed in Item 1A. to Part I of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2016.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds


(a)	None.


(b)	Not applicable.


(c)	None.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

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Item 5. Other Information

None.

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Item 6. Exhibits



31.1			Certification of the Chief Executive Officer

31.2			Certification of the Chief Financial Officer

32			Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

101			The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016, (ii) Consolidated Statements of Income for the three ended March 31, 2017 and 2016, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2017 and 2016, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2017 and 2016, (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016, and (vi) the Notes to Unaudited Consolidated Financial Statements

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.



	FIRST BUSINESS FINANCIAL SERVICES, INC.
April 28, 2017	/s/ Corey A. Chambas
	Corey A. Chambas
	Chief Executive Officer

April 28, 2017	/s/ Edward G. Sloane, Jr.
	Edward G. Sloane, Jr.
	Chief Financial Officer
	(principal financial officer)

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FIRST BUSINESS FINANCIAL SERVICES, INC.

Exhibit Index to Quarterly Report on Form 10-Q

Exhibit Number



31.1		Certification of the Chief Executive Officer

31.2		Certification of the Chief Financial Officer

32		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

101		The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016, (ii) Consolidated Statements of Income for the three ended March 31, 2017 and 2016, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2017 and 2016, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2017 and 2016, (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016, and (vi) the Notes to Unaudited Consolidated Financial Statements