UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2021

OR

☐						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									53719
Madison			Wisconsin
(Address of Principal Executive Offices)									(Zip Code)

(608) 238-8008

Registrant’s telephone number, including area code

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

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $0.01 par value

FBIZ

The Nasdaq Stock Market LLC

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨

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

Large accelerated filer

¨

Accelerated filer

þ

Non-accelerated filer

¨

Smaller reporting company

☑

Emerging growth 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 July 26, 2021 was 8,533,972 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 (Unaudited)			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			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			40
Item 3. Quantitative and Qualitative Disclosures about Market Risk			64
Item 4. Controls and Procedures			65
PART II. Other Information			65
Item 1. Legal Proceedings			65
Item 1A. Risk Factors			65
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			65
Item 3. Defaults Upon Senior Securities			65
Item 4. Mine Safety Disclosures			65
Item 5. Other Information			65
Item 6. Exhibits			65
Signatures			66

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PART I. Financial Information

Item 1. Financial Statements

First Business Financial Services, Inc.

Consolidated Balance Sheets

						June 30, 2021						December 31, 2020
						(Unaudited)
			(In Thousands, Except Share Data)
Assets
Cash and due from banks						$	24,577					$	29,538
Short-term investments						365,400						27,371
Cash and cash equivalents						389,977						56,909
Securities available-for-sale, at fair value						171,219						183,925
Securities held-to-maturity, at amortized cost						22,382						26,374
Loans held for sale						6,059						8,695
Loans and leases receivable, net of allowance for loan and lease losses of $25,675 and $28,521, respectively						2,117,886						2,117,449
Premises and equipment, net						1,747						1,998
Foreclosed properties						179						34
Right-of-use assets, net						5,472						5,814
Bank-owned life insurance						52,887						52,188
Federal Home Loan Bank stock, at cost						13,451						13,578
Goodwill and other intangible assets						12,178						12,018
Derivatives						32,377						49,377
Accrued interest receivable and other assets						39,855						39,478
Total assets						$	2,865,669					$	2,567,837
Liabilities and Stockholders’ Equity
Deposits						$	2,160,707					$	1,855,516
Federal Home Loan Bank advances and other borrowings						420,113						419,167
Junior subordinated notes						10,069						10,062
Lease liabilities						6,005						6,386
Derivatives						36,109						54,927
Accrued interest payable and other liabilities						11,214						15,617
Total liabilities						2,644,217						2,361,675
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, 9,323,605 and 9,234,460 shares issued, 8,617,761 and 8,566,960 shares outstanding at June 30, 2021 and December 31, 2020, respectively						93						92
Additional paid-in capital						84,343						83,125
Retained earnings						155,300						140,431
Accumulated other comprehensive loss						(763)						(933)
Treasury stock, 705,844 and 667,500 shares at June 30, 2021 and December 31, 2020, respectively, at cost						(17,521)						(16,553)
Total stockholders’ equity						221,452						206,162
Total liabilities and stockholders’ equity						$	2,865,669					$	2,567,837

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 June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
						(In Thousands, Except Per Share Data)
Interest income
Loans and leases						$	23,591					$	21,548					$	46,386					$	43,397
Securities						816						1,070						1,669						2,258
Short-term investments						192						143						351						477
Total interest income						24,599						22,761						48,406						46,132
Interest expense
Deposits						943						1,924						1,962						6,040
Federal Home Loan Bank advances and other borrowings						1,727						1,672						3,377						3,600
Junior subordinated notes						277						277						552						555
Total interest expense						2,947						3,873						5,891						10,195
Net interest income						21,652						18,888						42,515						35,937
Provision for loan and lease losses						(958)						5,469						(3,026)						8,651
Net interest income after provision for loan and lease losses						22,610						13,419						45,541						27,286
Non-interest income
Private wealth management service fees						2,744						2,124						5,151						4,235
Gain on sale of Small Business Administration loans						1,203						574						2,281						839
Service charges on deposits						941						829						1,859						1,647
Loan fees						569						451						1,114						936
Increase in cash surrender value of bank-owned life insurance						350						377						699						672
Net gain (loss) on sale of securities						29						—						29						(4)
Swap fees						—						1,655						684						3,336
Other non-interest income						485						309						1,699						1,072
Total non-interest income						6,321						6,319						13,516						12,733
Non-interest expense
Compensation						13,255						10,796						25,912						21,848
Occupancy						533						554						1,085						1,126
Professional fees						913						859						1,778						1,678
Data processing						798						710						1,569						1,386
Marketing						511						352						902						813
Equipment						261						304						506						595
Computer software						1,129						966						2,244						1,856
FDIC insurance						280						239						642						448
Collateral liquidation costs						84						115						178						236
Net (gain) loss on foreclosed properties						(1)						348						1						450
Impairment of tax credit investments						—						1,841						—						1,954
SBA recourse provision (benefit)						245						(30)						115						(5)
Loss on early extinguishment of debt						—						744						—						744
Other non-interest expense						176						545						582						1,359
Total non-interest expense						18,184						18,343						35,514						34,488
Income before income tax expense (benefit)						10,747						1,395						23,543						5,531
Income tax expense (benefit)						2,512						(1,928)						5,577						(1,070)
Net income						$	8,235					$	3,323					$	17,966					$	6,601
Earnings per common share
Basic						$	0.95					$	0.38					$	2.08					$	0.77
Diluted						0.95						0.38						2.08						0.77
Dividends declared per share						0.18						0.165						0.36						0.33

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 June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
						(In Thousands)
Net income						$	8,235					$	3,323					$	17,966					$	6,601
Other comprehensive income (loss), before tax
Securities available-for-sale:
Unrealized securities gains (losses) arising during the period						662						(264)						(1,576)						4,237
Reclassification adjustment for net (gain) loss realized in net income						(29)						—						(29)						4
Securities held-to-maturity:
Amortization of net unrealized losses transferred from available-for-sale						7						10						15						20
Interest rate swaps:
Unrealized (losses) gains on interest rate swaps arising during the period						(271)						(418)						1,818						(4,043)
Income tax (expense) benefit						(94)						171						(58)						(56)
Total other comprehensive income (loss)						275						(501)						170						162
Comprehensive income						$	8,510					$	2,822					$	18,136					$	6,763

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						Treasury Stock						Total
						(In Thousands, Except Share Data)
Balance at January 1, 2020						8,566,044						$	92					$	81,188					$	129,105					$	(1,348)					$	(14,881)					$	194,156
Net income						—						—						—						3,278						—						—						3,278
Other comprehensive income						—						—						—						—						663						—						663
Share-based compensation - restricted shares, net						63,684						—						417						—						—						—						417
Cash dividends ($0.165 per share)						—						—						—						(1,410)						—						—						(1,410)
Treasury stock purchased						(58,594)						—						—						—						—						(1,447)						(1,447)
Balance at March 31, 2020						8,571,134						$	92					$	81,605					$	130,973					$	(685)					$	(16,328)					$	195,657
Net income						—						—						—						3,323						—						—						3,323
Other comprehensive loss						—						—						—						—						(501)						—						(501)
Share-based compensation - restricted shares, net						5,357						—						516						—						—						—						516
Cash dividends ($0.165 per share)						—						—						—						(1,414)						—						—						(1,414)
Treasury stock purchased						(1,357)						—						—						—						—						(19)						(19)
Balance at June 30, 2020						8,575,134						$	92					$	82,121					$	132,882					$	(1,186)					$	(16,347)					$	197,562

						Common Shares Outstanding						Common Stock						Additional Paid-in Capital						Retained Earnings						Accumulated Other Comprehensive Loss						Treasury Stock						Total
						(In Thousands, Except Share Data)
Balance at January 1, 2021						8,566,960						$	92					$	83,125					$	140,431					$	(933)					$	(16,553)					$	206,162
Net income						—						—						—						9,731						—						—						9,731
Other comprehensive loss						—						—						—						—						(105)						—						(105)
Share-based compensation - restricted shares and employee stock purchase plan						84,255						1						530						—						—						—						531
Issuance of common stock under the employee stock purchase plan						1,775						—						39						—						—						—						39
Cash dividends ($0.18 per share)						—						—						—						(1,541)						—						—						(1,541)
Treasury stock purchased						(14,795)						—						—						—						—						(326)						(326)
Balance at March 31, 2021						8,638,195						$	93					$	83,694					$	148,621					$	(1,038)					$	(16,879)					$	214,491
Net income						—						—						—						8,235						—						—						8,235
Other comprehensive income						—						—						—						—						275						—						275
Share-based compensation - restricted shares and employee stock purchase plan						1,421						—						607						—						—						—						607
Issuance of common stock under the employee stock purchase plan						1,694						—						42						—						—						—						42
Cash dividends ($0.18 per share)						—						—						—						(1,556)						—						—						(1,556)
Treasury stock purchased						(23,549)						—						—						—						—						(642)						(642)
Balance at June 30, 2021						8,617,761						$	93					$	84,343					$	155,300					$	(763)					$	(17,521)					$	221,452

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 Six Months Ended June 30,
						2021						2020
						(In Thousands)
Operating activities
Net income						$	17,966					$	6,601
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes, net						(1,359)						(133)
Impairment of tax credit investments						—						1,954
Provision for loan and lease losses						(3,026)						8,651
SBA recourse provision (benefit)						115						(5)
Derivative credit valuation adjustment						(376)						—
Depreciation, amortization and accretion, net						1,845						1,637
Loss on disposal of equipment						56						—
Share-based compensation						1,138						933
Net (gain) loss on sale of securities						(29)						4
Increase in bank-owned life insurance policies						(699)						(672)
Origination of loans for sale						(48,137)						(39,931)
Sale of SBA loans originated for sale						53,054						32,303
Gain on sale of loans originated for sale						(2,281)						(839)
Net loss on foreclosed properties, including impairment valuation						1						450
Loan servicing right impairment valuation						(78)						—
Excess tax (benefit) expense from share-based compensation						(16)						19
Payments on operating lease liabilities						(788)						(775)
Payments received on operating leases						82						56
Net increase in accrued interest receivable and other assets						(1,152)						(50,989)
Net (decrease) increase in accrued interest payable and other liabilities						(1,345)						42,042
Net cash provided by operating activities						14,971						1,306
Investing activities
Proceeds from maturities, redemptions, and paydowns of available-for-sale securities						31,315						22,457
Proceeds from maturities, redemptions, and paydowns of held-to-maturity securities						3,969						2,844
Proceeds from sale of available-for-sale securities						14,955						839
Purchases of available-for-sale securities						(35,559)						(17,753)
Proceeds from sale of foreclosed properties						—						1,160
Net decrease (increase) in loans and leases						2,444						(343,016)
Returns of investments in limited partnerships						60						—
Investment in historic development entities						—						(259)
Distribution from historic development entities						57						30
Investment in low-income housing						(1,307)						—
Investment in Federal Home Loan Bank and Federal Reserve Bank stock						(6,314)						(6,892)
Proceeds from the sale of Federal Home Loan Bank stock						6,440						1,375
Purchases of leasehold improvements and equipment, net						(135)						(141)
Proceeds from sale of leasehold improvements and equipment						12						—
Purchases of bank-owned life insurance policies						—						(8,000)
Net cash provided (used) in investing activities						15,937						(347,356)
Financing activities
Net increase in deposits						305,191						179,996
Proceeds from Federal Home Loan Bank advances						510,300						498,500
Repayment of Federal Home Loan Bank advances						(517,000)						(383,243)

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Loss on early extinguishment of debt						—						744
Proceeds from the Federal Reserve Paycheck Protection Program Lending Facility						—						29,605
Net increase in long-term borrowed funds						7,653						27
Cash dividends paid						(3,097)						(2,824)
Proceeds from issuance of common stock under ESPP						81						—
Purchase of treasury stock						(968)						(1,466)
Net cash provided by financing activities						302,160						321,339
Net increase (decrease) in cash and cash equivalents						333,068						(24,711)
Cash and cash equivalents at the beginning of the period						56,909						67,102
Cash and cash equivalents at the end of the period						$	389,977					$	42,391
Supplementary cash flow information
Cash paid during the period for:
Interest paid on deposits and borrowings						$	7,469					$	11,064
Income taxes paid						7,658						1,356
Non-cash investing and financing activities:
Increase in right-of-use exchange for operating lease liability						316						—
Transfer from loans and leases to foreclosed properties						149						80

See accompany 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. (“FBFS” or the “Corporation”), through our wholly-owned subsidiary, First Business Bank (“FBB” or the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB operates as a commercial banking institution primarily in Wisconsin and the greater Kansas City Metro. The Bank provides a full range of financial services to businesses, business owners, executives, professionals, and high net worth individuals. FBB also offers private wealth management services and bank consulting services. The Bank is subject to competition from other financial institutions and service providers, and is also subject to state and federal regulations. FBB has the following wholly-owned subsidiaries: First Business Specialty Finance, LLC (“FBSF”), First Madison Investment Corp. (“FMIC”), ABKC Real Estate, LLC (“ABKC”), FBB Real Estate 2, LLC (“FBB RE 2”), Rimrock Road Investment Fund, LLC (“Rimrock Road”), BOC Investment, LLC (“BOC”), Mitchell Street Apartments Investment, LLC (“Mitchell Street”), and FBB Tax Credit Investment, LLC (“FBB Tax Credit”). FMIC is located in and was formed under the laws of the state of Nevada.

Basis of Presentation

The accompanying unaudited Consolidated Financial Statements were prepared in accordance with GAAP and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Corporation’s Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020. 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 which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities and interest rate swaps, level of the allowance for loan and lease losses, lease residuals, property under operating leases, goodwill, level of the Small Business Administration (“SBA”) recourse reserve, and income taxes. The results of operations for the three and six months ended June 30, 2021, are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2021. 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, 2020.

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments- Credit Losses (Topic 326),” which is often referred to as CECL. The ASU replaces the incurred loss impairment methodology for recognizing credit losses with a methodology that reflects all expected credit losses. The ASU also requires consideration of a broader range of information to inform credit loss estimates, including such factors as past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, and any other financial asset not excluded from the scope under which the Corporation has the contractual right to receive cash. Entities will apply the amendments in the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. In November 2019, the FASB issued ASU No. 2019-10, “Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842).” The ASU delays the effective date for the credit losses standard from January 2020 to January 2023 for certain entities, including certain Securities and Exchange Commission filers, public business entities, and private companies. As a smaller reporting company, the Corporation is eligible for the delay and will be deferring adoption. The Corporation has established a cross-functional committee and has implemented a third-party software solution to assist with the adoption of the standard. Management has gathered all necessary data and reviewed potential methods to calculate the expected credit losses. Management is currently calculating sample expected loss computations and developing the allowance

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methodology and assumptions that will be used under the new standard. Management will continue to progress on its implementation project plan and improve the Corporation’s approach throughout the deferral period.

In March 2020, the FASB issued ASU 2020-04 “Reference Rate Reform (Topic 848),” which provides temporary, optional practical expedients and exceptions to ease the potential burden of transitioning to the new reference rates which will replace LIBOR and other reference rates expected to be discontinued. Adoption of the provisions of ASU 2020-04 is optional. The amendments are effective for all entities from the beginning of the interim period that includes the issuance date of the ASU. An entity may elect to apply the amendments prospectively through December 31, 2022. The Corporation is currently evaluating the impact of ASU 2020-04 on its financial position, results of operations and liquidity. The adoption of this standard is not expected to have a material effect on the Corporation's operating results or financial condition.

In January, 2021, the FASB released ASU 2021-01, “Reference Rate Reform (Topic 848),” which clarifies that certain optional expedients and exceptions in topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition related to reference rate reform. The amendments in this update are effective immediately for all entities. An entity may elect to apply the amendments in the update on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued. The Corporation does not expect this amendment to have a material effect on its financial statements.

Note 2 — Other Events

On March 11, 2020, the World Health Organization declared COVID-19, the disease caused by the novel coronavirus, a pandemic as a result of the global spread of the coronavirus illness. In response to the outbreak, federal and state authorities in the U.S. introduced various measures to try to limit or slow the spread of the virus, including travel restrictions, nonessential business closures, stay-at-home orders, and strict social distancing. The Corporation activated its Pandemic Preparedness Plan to protect the health of employees and clients, which included temporarily limiting lobby hours and transitioning the vast majority of the Corporation’s workforce to remote work. The Corporation did not incur any significant disruptions to its business activities during this time of transition and extended remote work.

The second half of 2020 saw improvements in economic trends, but continued waves of new cases of COVID-19 created continued uncertainty in the economic environment. However, at the end of the fourth quarter of 2020 and into the first quarter of 2021, the rollout of new vaccines and the ratification of two additional stimulus laws resulted in lower infection rates and significant improvement in the outlook of the economy. In the second quarter of 2021, the Corporation communicated return to office plans to employees. Based on the national and local guidelines, the Corporation developed a phased-in approach for returning to the office. Under this phased-in approach, offices opened in early June 2021. The return to office included enhanced safety protocols and processes to provide the best working environment possible for employees.

The full long-term impact of the COVID-19 pandemic is unknown and continues to evolve. It has caused substantial disruption in international and U.S. economies, markets, and employment. The outbreak has had a significant adverse impact on certain industries the Corporation serves, including retail, restaurants and food services, hospitality, and entertainment. As of June 30, 2021, the Corporation’s aggregate outstanding exposure in these segments was $195.5 million, or 9.6% of the Corporation’s gross loans and leases less net PPP loans. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation’s loan portfolio.

The Corporation provided loan payment deferrals for certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation’s loan modification program. As of June 30, 2021, the Corporation had five deferral requests outstanding, representing $20.5 million in total loans, or 1.0% of gross loans and leases, excluding net PPP loans, compared to $27.0 million, or 1.4% of gross loans and leases, excluding net PPP loans as of December 31, 2020. Of the $20.5 million of deferred loans outstanding as of June 30, 2021, $19.8 million relate to two hospitality credits which went on deferral during the second quarter of 2021 and are both accruing interest and current on payments. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts will be moved to the end of the loan term. The loans will not be reported as past due during the deferral period.

On December 27, 2020, the Consolidated Appropriations Act, 2021 (“CAA”) was signed into law. The CAA is a $2.3 trillion spending bill that combines $900 billion in stimulus relief for the COVID-19 pandemic in the United States with a $1.4 trillion omnibus spending bill for the 2021 federal fiscal year and prevents a government shutdown. The CAA allows for a second draw for certain businesses under the PPP. Like the original program, loan proceeds are available to help fund payroll and group health benefit costs, as well as certain mortgage interest, rent and utilities. In addition, authorized costs now also include

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COVID-19 related worker protection costs, uninsured property damage costs due to looting or vandalism during 2020 and certain supplier costs and expenses for operations. The CAA also expands benefit costs to include group dental, vision, life and disability benefits. All of these changes are generally retroactive to the original CARES Act, meaning that the changes may be taken into account in processing loan forgiveness with respect to an original PPP loan. The Corporation began accepting and processing applications for second draw PPP loans on January 13, 2021.

As of June 30, 2021, the Corporation had $123.8 million in gross PPP loans outstanding and deferred processing fees outstanding of $3.1 million. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. During the three and six months ended June 30, 2021, $2.5 million and $4.8 million, respectively, was recognized in loans and leases interest income in the unaudited Consolidated Statements of Income. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.

Note 3 — Earnings per Common Share

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

						For the Three Months Ended June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
						(Dollars in Thousands, Except Share Data)
Basic earnings per common share
Net income						$	8,235					$	3,323					$	17,966					$	6,601
Less: earnings allocated to participating securities						238						93						493						173
Basic earnings allocated to common shareholders						$	7,997					$	3,230					$	17,473					$	6,428
Weighted-average common shares outstanding, excluding participating securities						8,385,069						8,392,197						8,381,868						8,379,696
Basic earnings per common share						$	0.95					$	0.38					$	2.08					$	0.77
Diluted earnings per common share
Earnings allocated to common shareholders, diluted						$	7,997					$	3,230					$	17,473					$	6,428
Weighted-average diluted common shares outstanding, excluding participating securities						8,385,069						8,392,197						8,381,868						8,379,696
Diluted earnings per common share						$	0.95					$	0.38					$	2.08					$	0.77

Note 4 — Share-Based Compensation

The Corporation adopted the 2019 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2019. At the 2021 annual shareholders meeting, an amendment to the 2019 equity plan was approved, increasing the number of shares in the plan by 180,000. 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 (“Stock Options”), restricted stock, restricted stock units, dividend equivalent units, and any other type of award permitted by the Plan. As of June 30, 2021, 219,531 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.

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Restricted Stock

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

The Corporation may issue a combination of performance-based restricted stock units and restricted stock awards to its executive officers. Vesting of the performance based restricted stock units will be measured on Total Shareholder Return (“TSR”) and Return on Average Equity (“ROAE”) and will cliff-vest after a three-year measurement period based on the Corporation’s performance relative to a custom peer group. At the end of the performance period, the number of actual shares to be awarded varies between 0% and 200% of target amounts. The restricted stock awards issued to executive officers will vest ratably over a three-year period. Compensation expense is recognized for performance-based restricted stock units over the requisite service and performance period of generally three years for the entire expected award on a straight-line basis. The compensation expense for the awards expected to vest for the percentage of performance-based restricted stock units subject to the ROAE metric will be adjusted if there is a change in the expectation of ROAE. The compensation expense for the awards expected to vest for the percentage of performance based restricted stock units subject to the TSR metric are never adjusted, and are amortized utilizing the accounting fair value provided using a Monte Carlo pricing model.

Restricted stock activity for the year ended December 31, 2020 and the six months ended June 30, 2021 was as follows:

						Number of Restricted Shares						Weighted Average Grant-Date Fair Value
Nonvested balance as of January 1, 2020						176,935						$	22.51
Granted (1)						78,775						25.82
Vested						(56,904)						22.26
Forfeited						(11,002)						22.86
Nonvested balance as of December 31, 2020						187,804						24.29
Granted (1)						90,055						23.39
Vested						(34,070)						22.61
Forfeited						(4,379)						23.39
Nonvested balance as of June 30, 2021						239,410						$	24.21

(1)The number of restricted shares/units shown includes the shares that would be granted if the target level of performance is achieved related to the performance based restricted stock units. The number of shares actually issued may vary.

As of June 30, 2021, the Corporation had $4.1 million of unvested compensation expense, which the Corporation expects to recognize over a weighted-average period of approximately 2.4 years.

Employee Stock Purchase Plan

During 2020, an employee stock purchase plan ("ESPP") was approved by the Corporation’s shareholders and is offered to all qualifying employees. The Company is authorized to issue up to 250,000 shares of common stock under the ESPP. The plan qualifies as an employee stock purchase plan under section 423 of the Internal Revenue Code of 1986. Under the ESPP, eligible employees may enroll in a three month offer period that begins January, April, July, and October of each year. Employees may elect to purchase a limited number of shares on the Corporation's common stock at 90% of the fair market value on the last day of the offering period. The ESPP is treated as a compensatory item for purposes of share-based compensation expense.

During the six months ended June 30, 2021, the Corporation issued 3,469 shares of common stock under the ESPP. As of June 30, 2021, 242,564 shares remained available for issuance under the ESPP.

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Share-based compensation expense related to restricted stock included in the unaudited Consolidated Statements of Income was as follows:

			For the Three Months Ended June 30,												For the Six Months Ended June 30,
			2021						2020						2021						2020
			(In Thousands)
Share-based compensation expense			$	607					$	516					$	1,138					$	933

Note 5 — Securities

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

						As of June 30, 2021
						Amortized Cost						Gross Unrealized Gains						Gross Unrealized Losses						Fair Value
						(In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises						$	20,929					$	279					$	(64)					$	21,144
Municipal securities						28,081						547						(148)						28,480
Residential mortgage-backed securities - government issued						11,872						364						—						12,236
Residential mortgage-backed securities - government-sponsored enterprises						78,669						1,479						(265)						79,883
Commercial mortgage-backed securities - government issued						3,988						102						—						4,090
Commercial mortgage-backed securities - government-sponsored enterprises						22,736						533						(138)						23,131
Other securities						2,205						50						—						2,255
						$	168,480					$	3,354					$	(615)					$	171,219

						As of December 31, 2020
						Amortized Cost						Gross Unrealized Gains						Gross Unrealized Losses						Fair Value
						(In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises						$	22,699					$	9					$	(79)					$	22,629
Municipal securities						24,067						716						(4)						24,779
Residential mortgage-backed securities - government issued						9,894						509						—						10,403
Residential mortgage-backed securities - government-sponsored enterprises						102,843						2,212						(49)						105,006
Commercial mortgage-backed securities - government issued						5,289						175						—						5,464
Commercial mortgage-backed securities - government-sponsored enterprises						12,584						781						—						13,365
Other securities						2,205						74						—						2,279
						$	179,581					$	4,476					$	(132)					$	183,925

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

						As of June 30, 2021
						Amortized Cost						Gross Unrealized Gains						Gross Unrealized Losses						Fair Value
						(In Thousands)
Held-to-maturity:
Municipal securities						$	14,710					$	316					$	(10)					$	15,016
Residential mortgage-backed securities - government issued						2,783						81						—						2,864
Residential mortgage-backed securities - government-sponsored enterprises						2,879						99						—						2,978
Commercial mortgage-backed securities - government-sponsored enterprises						2,010						245						—						2,255
						$	22,382					$	741					$	(10)					$	23,113

						As of December 31, 2020
						Amortized Cost						Gross Unrealized Gains						Gross Unrealized Losses						Fair Value
						(In Thousands)
Held-to-maturity:
Municipal securities						$	17,106					$	417					$	(15)					$	17,508
Residential mortgage-backed securities - government issued						3,564						112						—						3,676
Residential mortgage-backed securities - government-sponsored enterprises						3,693						163						—						3,856
Commercial mortgage-backed securities - government-sponsored enterprises						2,011						282						—						2,293
						$	26,374					$	974					$	(15)					$	27,333

U.S. government agency securities - government-sponsored enterprises represent securities issued by Federal National Mortgage Association (“FNMA”) and the SBA. Municipal securities include securities issued by various municipalities located primarily within Wisconsin and are primarily general obligation bonds that are tax-exempt in nature. Residential and commercial mortgage-backed securities - government issued represent securities guaranteed by the Government National Mortgage Association. Residential and commercial mortgage-backed securities - government-sponsored enterprises include securities guaranteed by the Federal Home Loan Mortgage Corporation, FNMA, and the FHLB. Other securities represent certificates of deposit of insured banks and savings institutions with an original maturity greater than three months. There were seven sales of available-for-sale securities that occurred during the three and six months ended June 30, 2021. There were no sales of available-for-sale securities that occurred during three months ended June 30, 2020 and one sale that occurred during the six months ended June 30, 2020.

At June 30, 2021 and December 31, 2020, securities with a fair value of $37.0 million and $73.7 million, respectively, were pledged to secure various obligations, including interest rate swap contracts.

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The amortized cost and fair value of securities by contractual maturity at June 30, 2021 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						$	1,225					$	1,251					$	3,882					$	3,909
Due in one year through five years						7,546						7,707						8,427						8,570
Due in five through ten years						42,803						43,827						8,359						8,845
Due in over ten years						116,906						118,434						1,714						1,789
						$	168,480					$	171,219					$	22,382					$	23,113

The tables below show the Corporation’s gross unrealized losses and fair value of available-for-sale investments aggregated by investment category and length of time that individual investments were in a continuous loss position at June 30, 2021 and December 31, 2020. At June 30, 2021, the Corporation held 23 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 June 30, 2021, the Corporation held no 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 and six months ended June 30, 2021 and 2020.

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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 June 30, 2021
						Less than 12 Months												12 Months or Longer												Total
						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses
						(In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises						$	3,436					$	64					$	—					$	—					$	3,436					$	64
Municipal securities						9,144						148						—						—						9,144						148
Residential mortgage-backed securities - government-sponsored enterprises						30,349						265						—						—						30,349						265
Commercial mortgage-backed securities - government-sponsored enterprises						12,160						138						—						—						12,160						138
						$	55,089					$	615					$	—					$	—					$	55,089					$	615

						As of December 31, 2020
						Less than 12 Months												12 Months or Longer												Total
						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses
						(In Thousands)
Available-for-sale:
U.S. government agency securities - government-sponsored enterprises						$	11,602					$	45					$	4,031					$	34					$	15,633					$	79
Municipal securities						2,863						4						—						—						2,863						4
Residential mortgage-backed securities - government-sponsored enterprises						19,078						49						—						—						19,078						49
						$	33,543					$	98					$	4,031					$	34					$	37,574					$	132

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 June 30, 2021 and December 31, 2020. At June 30, 2021, the Corporation held two held-to-maturity securities that were in an unrealized loss position and had been in a continuous loss position for twelve months or greater. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. It is expected that the Corporation will recover the entire amortized cost basis of each held-to-maturity security based upon an evaluation of aforementioned factors. Accordingly, no other-than-temporary impairment was recorded in the unaudited Consolidated Statements of Income for the three and six months ended June 30, 2021 and 2020.

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 June 30, 2021
						Less than 12 Months												12 Months or Longer												Total
						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses
						(In Thousands)
Held-to-maturity:
Municipal securities						$	—					$	—					$	493					$	10					$	493					$	10

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						As of December 31, 2020
						Less than 12 Months												12 Months or Longer												Total
						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses						Fair Value						Unrealized Losses
						(In Thousands)
Held-to-maturity:
Municipal securities						$	276					$	13					$	213					$	2					$	489					$	15

Note 6 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses

Loan and lease receivables consist of the following:

						June 30, 2021						December 31, 2020
						(In Thousands)
Commercial real estate:
Commercial real estate — owner occupied						$	253,600					$	253,882
Commercial real estate — non-owner occupied						614,289						564,532
Land development						45,056						49,839
Construction						139,943						141,043
Multi-family						319,351						311,556
1-4 family						19,769						38,284
Total commercial real estate						1,392,008						1,359,136
Commercial and industrial						695,442						732,318
Direct financing leases						18,142						22,331
Consumer and other:
Home equity and second mortgages						5,740						7,833
Other						36,567						28,897
Total consumer and other						42,307						36,730
Total gross loans and leases receivable						2,147,899						2,150,515
Less:
Allowance for loan and lease losses						25,675						28,521
Deferred loan fees						4,338						4,545
Loans and leases receivable, net						$	2,117,886					$	2,117,449

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As of June 30, 2021 and December 31, 2020, the Corporation had $123.8 million and $228.9 million, respectively, in gross PPP loans outstanding included in the commercial and industrial loan category and deferred processing fees outstanding of $3.1 million and $3.5 million, respectively, included in deferred loan fees. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any at all, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.

The total amount of the Corporation’s ownership of SBA loans is comprised of the following:

						June 30, 2021						December 31, 2020
						(In Thousands)
SBA 7(a) loans						$	28,367					$	36,266
SBA 504 loans						33,547						26,327
SBA Express loans and lines of credit						765						1,251
SBA PPP loans						123,838						228,870
Total SBA loans						$	186,517					$	292,714

As of June 30, 2021 and December 31, 2020, $3.4 million and $9.3 million of SBA loans were considered impaired, respectively.

Loans transferred to third parties consist of the guaranteed portions of SBA loans which the Corporation sold in the secondary market and participation interests in other, non-SBA originated loans. The total principal amount of the guaranteed portions of SBA loans sold during the three months ended June 30, 2021, and 2020, was $9.0 million and $6.5 million, respectively. The total principal amount of the guaranteed portions of SBA loans sold during the six months ended June 30, 2021, and 2020, was $19.6 million and $9.2 million, respectively. Each of the transfers of these financial assets met the qualifications for sale accounting, and therefore all of the loans transferred during the three and six months ended June 30, 2021, and 2020, have been derecognized in the unaudited Consolidated Financial Statements. The guaranteed portions of SBA loans were transferred at their fair value and the related gain was recognized upon the transfer as non-interest income in the unaudited Consolidated Financial Statements. The total outstanding balance of sold SBA loans at June 30, 2021, and December 31, 2020, was $87.8 million and $79.5 million, respectively.

The total principal amount of transferred participation interests in other, non-SBA originated loans during the three months ended June 30, 2021, and 2020, was $11.8 million and $10.3 million, respectively. The total principal amount of transferred participation interests in other, non-SBA originated loans during the six months ended June 30, 2021, and 2020, was $16.9 million and $22.2 million, respectively, all of which were treated as sales and derecognized under the applicable accounting guidance at the time of transfer. No gain or loss was recognized on participation interests in other, non-SBA originated loans as they were transferred at or near the date of loan origination and the payments received for servicing the portion of the loans participated represents adequate compensation. The total outstanding balance of these transferred loans at June 30, 2021, and December 31, 2020, was $157.9 million and $153.6 million, respectively. As of June 30, 2021, and December 31, 2020, the total amount of the Corporation’s partial ownership of these transferred loans on the unaudited Consolidated Balance Sheets was $269.5 million and $276.5 million, respectively. As of June 30, 2021 and December 31, 2020, the non-SBA originated participation portfolio contained an impaired loan totaling $3.0 million with a sold portion of $4.2 million. The Corporation does not share in the participant’s portion of any potential charge-offs. There were no loan participations purchased on the unaudited Consolidated Balance Sheets as of June 30, 2021, and the total of loan participations purchased as of December 31, 2020 was $410,000.

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The following tables illustrate ending balances of the Corporation’s loan and lease portfolio, including impaired loans by class of receivable, and considering certain credit quality indicators:

						June 30, 2021
						Category
						I						II						III						IV						Total
						(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied						$	209,728					$	24,892					$	16,855					$	2,125					$	253,600
Commercial real estate — non-owner occupied						501,162						73,182						36,947						2,998						614,289
Land development						44,304						752						—						—						45,056
Construction						92,465						15,954						31,524						—						139,943
Multi-family						287,944						31,407						—						—						319,351
1-4 family						18,440						636						649						44						19,769
Total commercial real estate						1,154,043						146,823						85,975						5,167						1,392,008
Commercial and industrial						612,572						31,714						44,940						6,216						695,442
Direct financing leases, net						12,469						555						5,069						49						18,142
Consumer and other:
Home equity and second mortgages						5,630						—						75						35						5,740
Other						36,402						154						—						11						36,567
Total consumer and other						42,032						154						75						46						42,307
Total gross loans and leases receivable						$	1,821,116					$	179,246					$	136,059					$	11,478					$	2,147,899
Category as a % of total portfolio						84.79		%				8.35		%				6.33		%				0.53		%				100.00		%

						December 31, 2020
						Category
						I						II						III						IV						Total
						(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied						$	185,943					$	34,917					$	27,593					$	5,429					$	253,882
Commercial real estate — non-owner occupied						432,053						90,942						37,754						3,783						564,532
Land development						47,777						987						185						890						49,839
Construction						104,083						26,444						10,516						—						141,043
Multi-family						278,145						23,386						10,025						—						311,556
1-4 family						35,053						620						2,315						296						38,284
Total commercial real estate						1,083,054						177,296						88,388						10,398						1,359,136
Commercial and industrial						623,346						27,201						65,616						16,155						732,318
Direct financing leases, net						15,597						730						5,955						49						22,331
Consumer and other:
Home equity and second mortgages						7,206						496						91						40						7,833
Other						28,701						175						—						21						28,897
Total consumer and other						35,907						671						91						61						36,730
Total gross loans and leases receivable						$	1,757,904					$	205,898					$	160,050					$	26,663					$	2,150,515
Category as a % of total portfolio						81.75		%				9.57		%				7.44		%				1.24		%				100.00		%

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

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the stated risk rating. In addition to its nine grade risk rating system, the Corporation groups loans into four loan and related risk categories which determine the level and nature of review by management.

Category I — Loans and leases in this category are performing in accordance with the terms of the contract and generally exhibit no immediate concerns regarding the security and viability of the underlying collateral, financial stability of the borrower, integrity or strength of the borrowers’ management team, or the industry in which the borrower operates. The Corporation monitors Category I loans and leases through payment performance, continued maintenance of its personal relationships with such borrowers, and continued review of such borrowers’ compliance with the terms of their respective agreements.

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

Category III — Loans and leases in this category are identified by management as warranting special attention. However, the balance in this category is not intended to represent the amount of adversely classified assets held by the Bank. Category III loans and leases generally exhibit undesirable characteristics, such as evidence of adverse financial trends and conditions, managerial problems, deteriorating economic conditions within the related industry, or evidence of adverse public filings and may exhibit collateral shortfall positions. Management continues to believe that it will collect all contractual principal and interest in accordance with the original terms of the contracts relating to the loans and leases in this category, and therefore Category III loans are considered performing with no specific reserves established for this category. Category III loans are monitored by management and asset quality review committees on a monthly basis.

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

The delinquency aging of the loan and lease portfolio by class of receivable was as follows:

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						June 30, 2021
						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						$	—					$	—					$	—					$	—					$	251,475					$	251,475
Non-owner occupied						—						—						—						—						611,291						611,291
Land development						—						—						—						—						45,056						45,056
Construction						—						—						—						—						139,943						139,943
Multi-family						—						—						—						—						319,351						319,351
1-4 family						354						—						—						354						19,371						19,725
Commercial and industrial						268						68						—						336						688,946						689,282
Direct financing leases, net						—						—						—						—						18,093						18,093
Consumer and other:
Home equity and second mortgages						—						—						—						—						5,705						5,705
Other						—						—						—						—						36,556						36,556
Total						622						68						—						690						2,135,787						2,136,477
Non-accruing loans and leases
Commercial real estate:
Owner occupied						—						—						268						268						1,857						2,125
Non-owner occupied						—						—						—						—						2,998						2,998
Land development						—						—						—						—						—						—
Construction						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—
1-4 family						—						—						44						44						—						44
Commercial and industrial						53						75						1,800						1,928						4,232						6,160
Direct financing leases, net						—						—						—						—						49						49
Consumer and other:
Home equity and second mortgages						—						—						—						—						35						35
Other						—						—						11						11						—						11
Total						53						75						2,123						2,251						9,171						11,422
Total loans and leases
Commercial real estate:
Owner occupied						—						—						268						268						253,332						253,600
Non-owner occupied						—						—						—						—						614,289						614,289
Land development						—						—						—						—						45,056						45,056
Construction						—						—						—						—						139,943						139,943
Multi-family						—						—						—						—						319,351						319,351
1-4 family						354						—						44						398						19,371						19,769
Commercial and industrial						321						143						1,800						2,264						693,178						695,442
Direct financing leases, net						—						—						—						—						18,142						18,142
Consumer and other:
Home equity and second mortgages						—						—						—						—						5,740						5,740
Other						—						—						11						11						36,556						36,567
Total						$	675					$	143					$	2,123					$	2,941					$	2,144,958					$	2,147,899
Percent of portfolio						0.03		%				0.01		%				0.10		%				0.14		%				99.86		%				100.00		%

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						December 31, 2020
						30-59 Days Past Due						60-89 Days Past Due						Greater Than 90 Days Past Due						Total Past Due						Current						Total Loans and Leases
						(Dollars in Thousands)
Accruing loans and leases
Commercial real estate:
Owner occupied						$	—					$	—					$	—					$	—					$	248,453					$	248,453
Non-owner occupied						—						—						—						—						560,749						560,749
Land development						7,784						—						—						7,784						41,165						48,949
Construction						—						—						—						—						141,043						141,043
Multi-family						—						—						—						—						311,556						311,556
1-4 family						—						46						—						46						37,988						38,034
Commercial and industrial						663						111						—						774						715,389						716,163
Direct financing leases, net						—						—						—						—						22,282						22,282
Consumer and other:
Home equity and second mortgages						—						—						—						—						7,793						7,793
Other						—						—						—						—						28,876						28,876
Total						8,447						157						—						8,604						2,115,294						2,123,898
Non-accruing loans and leases
Commercial real estate:
Owner occupied						—						—						272						272						5,157						5,429
Non-owner occupied						—						—						3,783						3,783						—						3,783
Land development						890						—						—						890						—						890
Construction						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—
1-4 family						—						—						—						—						250						250
Commercial and industrial						103						342						7,557						8,002						8,153						16,155
Direct financing leases, net						—						—						—						—						49						49
Consumer and other:
Home equity and second mortgages						—						—						—						—						40						40
Other						—						—						21						21						—						21
Total						993						342						11,633						12,968						13,649						26,617
Total loans and leases
Commercial real estate:
Owner occupied						—						—						272						272						253,610						253,882
Non-owner occupied						—						—						3,783						3,783						560,749						564,532
Land development						8,674						—						—						8,674						41,165						49,839
Construction						—						—						—						—						141,043						141,043
Multi-family						—						—						—						—						311,556						311,556
1-4 family						—						46						—						46						38,238						38,284
Commercial and industrial						766						453						7,557						8,776						723,542						732,318
Direct financing leases, net						—						—						—						—						22,331						22,331
Consumer and other:
Home equity and second mortgages						—						—						—						—						7,833						7,833
Other						—						—						21						21						28,876						28,897
Total						$	9,440					$	499					$	11,633					$	21,572					$	2,128,943					$	2,150,515
Percent of portfolio						0.44		%				0.02		%				0.54		%				1.00		%				99.00		%				100.00		%

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The Corporation’s total impaired assets consisted of the following:

						June 30, 2021						December 31, 2020
						(In Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate — owner occupied						$	2,125					$	5,429
Commercial real estate — non-owner occupied						2,998						3,783
Land development						—						890
Construction						—						—
Multi-family						—						—
1-4 family						44						250
Total non-accrual commercial real estate						5,167						10,352
Commercial and industrial						6,160						16,155
Direct financing leases, net						49						49
Consumer and other:
Home equity and second mortgages						35						40
Other						11						21
Total non-accrual consumer and other loans						46						61
Total non-accrual loans and leases						11,422						26,617
Foreclosed properties, net						179						34
Total non-performing assets						11,601						26,651
Performing troubled debt restructurings						56						46
Total impaired assets						$	11,657					$	26,697

						June 30, 2021						December 31, 2020
Total non-accrual loans and leases to gross loans and leases						0.53		%				1.24		%
Total non-performing assets to total gross loans and leases plus foreclosed properties, net						0.54						1.24
Total non-performing assets to total assets						0.40						1.04
Allowance for loan and lease losses to gross loans and leases						1.20						1.33
Allowance for loan and lease losses to non-accrual loans and leases						224.79						107.15

As of June 30, 2021, and December 31, 2020, $523,000 and $6.5 million of the non-accrual loans and leases were considered troubled debt restructurings, respectively. No specific reserves were allocated to troubled debt restructurings as of June 30, 2021 and $760,000 were allocated as of December 31, 2020. There were no unfunded commitments associated with troubled debt restructured loans and leases as of June 30, 2021.

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.

During the three and six months ended June 30, 2021, no loans were modified to a troubled debt restructuring.

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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:

						For the Three Months Ended June 30,																		For the Six Months Ended June 30,
						2020
						Number of Loans						Pre-Modification Recorded Investment						Post-Modification Recorded Investment						Number of Loans						Pre-Modification Recorded Investment						Post-Modification Recorded Investment
						(Dollars in Thousands)
Commercial real estate:
Commercial real estate — owner occupied						—						$	—					$	—					2						$	299					$	272
Commercial and industrial						1						4,986						4,986						3						6,007						5,756
Total						1						$	4,986					$	4,986					5						$	6,306					$	6,028

Restructured loan modifications may include payment schedule modifications, interest rate concessions, maturity date extensions, principal reduction, or some combination of these concessions. During the three and six months ended June 30, 2020, the modification of terms primarily consisted of payment schedule modifications or principal reductions.

There were no loans modified in troubled debt restructurings during the previous 12 months which subsequently defaulted during the three and six months ended June 30, 2021. There were two commercial and industrial loans totaling $2.7 million and four owner-occupied commercial real estate loans totaling $3.8 million modified in a troubled debt restructuring which subsequently defaulted during the three and six months ended June 30, 2020.

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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 Six Months Ended June 30, 2021
						Recorded Investment(1)						Unpaid Principal Balance						Impairment Reserve						Average Recorded Investment(2)						Foregone Interest Income						Interest Income Recognized						Net Foregone Interest Income
						(In Thousands)
With no impairment reserve recorded:
Commercial real estate:
Owner occupied						$	1,026					$	1,026					$	—					$	2,159					$	100					$	—					$	100
Non-owner occupied						2,998						5,778						—						3,114						265						15						250
Land development						—						—						—						15						—						—						—
Construction						—						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—						—
1-4 family						44						49						—						276						46						13						33
Commercial and industrial						3,834						4,216						—						11,071						388						110						278
Direct financing leases, net						—						—						—						—						—						—						—
Consumer and other:
Home equity and second mortgages						35						35						—						79						10						7						3
Other						11						678						—						16						18						—						18
Total						7,948						11,782						—						16,730						827						145						682
With impairment reserve recorded:
Commercial real estate:
Owner occupied						1,099						1,129						432						1,048						124						7						117
Non-owner occupied						—						—						—						—						—						—						—
Land development						—						—						—						—						—						—						—
Construction						—						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—						—
1-4 family						—						—						—						—						—						—						—
Commercial and industrial						2,382						2,382						1,540						1,593						129						1						128
Direct financing leases, net						49						49						49						49						1						—						1
Consumer and other:
Home equity and second mortgages						—						—						—						—						—						—						—
Other						—						—						—						—						—						—						—
Total						3,530						3,560						2,021						2,690						254						8						246
Total:
Commercial real estate:
Owner occupied						2,125						2,155						432						3,207						224						7						217
Non-owner occupied						2,998						5,778						—						3,114						265						15						250
Land development						—						—						—						15						—						—						—
Construction						—						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—						—
1-4 family						44						49						—						276						46						13						33
Commercial and industrial						6,216						6,598						1,540						12,664						517						111						406
Direct financing leases, net						49						49						49						49						1						—						1
Consumer and other:
Home equity and second mortgages						35						35						—						79						10						7						3
Other						11						678						—						16						18						—						18
Grand total						$	11,478					$	15,342					$	2,021					$	19,420					$	1,081					$	153					$	928

(1)The recorded investment represents the unpaid principal balance net of any partial charge-offs.

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

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						As of and for the Year Ended December 31, 2020
						Recorded Investment(1)						Unpaid Principal Balance						Impairment Reserve						Average Recorded Investment(2)						Foregone Interest Income						Interest Income Recognized						Net Foregone Interest Income
						(In Thousands)
With no impairment reserve recorded:
Commercial real estate:
Owner occupied						$	4,338					$	4,365					$	—					$	4,565					$	291					$	72					$	219
Non-owner occupied						3,783						6,563						—						1,519						486						—						486
Land development						890						5,187						—						1,192						14						—						14
Construction						—						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—						—
1-4 family						46						51						—						307						31						141						(110)
Commercial and industrial						9,888						12,337						—						13,951						1,219						423						796
Direct financing leases, net						—						—						—						89						—						—						—
Consumer and other:
Home equity and second mortgages						—						—						—						1						—						—						—
Other						21						688						—						85						41						—						41
Total						18,966						29,191						—						21,709						2,082						636						1,446
With impairment reserve recorded:
Commercial real estate:
Owner occupied						1,091						4,792						471						2,349						384						—						384
Non-owner occupied						—						—						—						—						—						—						—
Land development						—						—						—						—						—						—						—
Construction						—						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—						—
1-4 family						250						250						29						21						—						—						—
Commercial and industrial						6,267						6,972						3,125						3,585						324						—						324
Direct financing leases, net						49						49						49						39						3						—						3
Consumer and other:
Home equity and second mortgages						40						40						7						—						1						—						1
Other						—						—						—						—						—						—						—
Total						7,697						12,103						3,681						5,994						712						—						712
Total:
Commercial real estate:
Owner occupied						5,429						9,157						471						6,914						675						72						603
Non-owner occupied						3,783						6,563						—						1,519						486						—						486
Land development						890						5,187						—						1,192						14						—						14
Construction						—						—						—						—						—						—						—
Multi-family						—						—						—						—						—						—						—
1-4 family						296						301						29						328						31						141						(110)
Commercial and industrial						16,155						19,309						3,125						17,536						1,543						423						1,120
Direct financing leases, net						49						49						49						128						3						—						3
Consumer and other:
Home equity and second mortgages						40						40						7						1						1						—						1
Other						21						688						—						85						41						—						41
Grand total						$	26,663					$	41,294					$	3,681					$	27,703					$	2,794					$	636					$	2,158

(1)The recorded investment represents the unpaid principal balance net of any partial charge-offs.

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

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The difference between the recorded investment of loans and leases and the unpaid principal balance of $3.9 million and $14.6 million as of June 30, 2021, and December 31, 2020, respectively, represents partial charge-offs of loans and leases resulting from losses due to the valuation of the collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $56,000 and $46,000 of loans as of June 30, 2021, and December 31, 2020, 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 June 30, 2021
						Commercial Real Estate						Commercial and Industrial						Consumer and Other						Total
						(In Thousands)
Beginning balance						$	18,445					$	9,544					$	993					$	28,982
Charge-offs						(249)						(2,621)						(24)						(2,894)
Recoveries						84						460						1						545
Net charge-offs						(165)						(2,161)						(23)						(2,349)
Provision for loan and lease losses						(1,404)						498						(52)						(958)
Ending balance						$	16,876					$	7,881					$	918					$	25,675

						As of and for the Three Months Ended June 30, 2020
						Commercial Real Estate						Commercial and Industrial						Consumer and Other						Total
						(In Thousands)
Beginning balance						$	12,597					$	9,322					$	829					$	22,748
Charge-offs						(27)						(784)						(6)						(817)
Recoveries						2						62						—						64
Net charge-offs						(25)						(722)						(6)						(753)
Provision for loan and lease losses						3,866						1,579						24						5,469
Ending balance						$	16,438					$	10,179					$	847					$	27,464

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						As of and for the Six Months Ended June 30, 2021
						Commercial Real Estate						Commercial and Industrial						Consumer and Other						Total
						(In Thousands)
Beginning balance						$	17,157					$	10,593					$	771					$	28,521
Charge-offs						(249)						(2,765)						(24)						(3,038)
Recoveries						2,303						913						2						3,218
Net recoveries (charge-offs)						2,054						(1,852)						(22)						180
Provision for loan and lease losses						(2,335)						(860)						169						(3,026)
Ending balance						$	16,876					$	7,881					$	918					$	25,675

						As of and for the Six Months Ended June 30, 2020
						Commercial Real Estate						Commercial and Industrial						Consumer and Other						Total
						(In Thousands)
Beginning balance						$	10,852					$	8,078					$	590					$	19,520
Charge-offs						(27)						(909)						(12)						(948)
Recoveries						3						238						—						241
Net charge-offs						(24)						(671)						(12)						(707)
Provision for loan and lease losses						5,610						2,772						269						8,651
Ending balance						$	16,438					$	10,179					$	847					$	27,464

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The following tables provide information regarding the allowance for loan and lease losses and balances by type of allowance methodology.

						As of June 30, 2021
						Commercial Real Estate						Commercial and Industrial						Consumer and Other						Total
						(In Thousands)
Allowance for loan and lease losses:
Collectively evaluated for impairment						$	16,444					$	6,292					$	918					$	23,654
Individually evaluated for impairment						432						1,589						—						2,021
Total						$	16,876					$	7,881					$	918					$	25,675
Loans and lease receivables:
Collectively evaluated for impairment						$	1,386,842					$	707,319					$	42,260					$	2,136,421
Individually evaluated for impairment						5,167						6,265						47						11,479
Total						$	1,392,009					$	713,584					$	42,307					$	2,147,900

						As of December 31, 2020
						Commercial Real Estate						Commercial and Industrial						Consumer and Other						Total
						(In Thousands)
Allowance for loan and lease losses:
Collectively evaluated for impairment						$	16,657					$	7,419					$	764					$	24,840
Individually evaluated for impairment						500						3,174						7						3,681
Total						$	17,157					$	10,593					$	771					$	28,521
Loans and lease receivables:
Collectively evaluated for impairment						$	1,348,738					$	738,445					$	36,669					$	2,123,852
Individually evaluated for impairment						10,398						16,204						61						26,663
Total						$	1,359,136					$	754,649					$	36,730					$	2,150,515

Note 7 — Leases

The Corporation leases various office spaces and specialty financing production offices under non-cancellable operating leases which expire on various dates through 2028. The Corporation also leases office equipment. The Corporation recognizes a right-of-use asset and an operating lease liability for all leases, with the exception of short-term leases. Right-of-use assets represent the right to use an underlying asset for the lease term and lease liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. Lease expense for operating leases and short-term leases is recognized on a straight-line basis over the lease term. During 2021, the Corporation extended the term of two of its office spaces by one and three years, resulting in a $316,000 increase in the right-of-use assets in exchange for a lease liability.

The Corporation entered into a sublease for office space it vacated in its Kansas City Metro market which expires in 2023.

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The components of total lease expense were as follows:

						For the Three Months Ended June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
						(In Thousands)
Operating lease cost						$	374					$	372					$	749					$	745
Short-term lease cost						49						48						88						122
Variable lease cost						111						126						239						253
Less: sublease income						(43)						(28)						(82)						(56)
Total lease cost, net						$	491					$	518					$	994					$	1,064

Quantitative information regarding the Corporation’s operating leases was as follows:

						June 30, 2021						December 31, 2020
Weighted-average remaining lease term (in years)						5.37						5.80
Weighted-average discount rate						2.94		%				3.03		%

The following maturity analysis shows the undiscounted cash flows due on the Corporation’s operating lease liabilities:

(In Thousands)
2021			$	795
2022			1,585
2023			1,059
2024			790
2025			666
Thereafter			1,641
Total undiscounted cash flows			6,536
Discount on cash flows			(531)
Total lease liability			$	6,005

Note 8 — Other Assets

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

						June 30, 2021						December 31, 2020
						(In Thousands)
Accrued interest receivable						$	5,857					$	8,564
Net deferred tax asset						7,256						7,217
Investment in historic development entities						2,299						2,356
Investment in low-income housing development entity						1,307						—
Investment in a community development entity						5,306						5,306
Investment in limited partnerships						7,712						6,673
Investment in Trust II						315						315
Prepaid expenses						2,804						2,165
Other assets						6,999						6,882
Total accrued interest receivable and other assets						$	39,855					$	39,478

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Note 9 — Deposits

The composition of deposits is shown below. Average balances represent year to date averages.

						June 30, 2021																		December 31, 2020
						Balance						Average Balance						Average Rate						Balance						Average Balance						Average Rate
						(Dollars in Thousands)
Non-interest-bearing transaction accounts						$	774,253					$	506,767					—		%				$	472,818					$	412,825					—		%
Interest-bearing transaction accounts						511,698						510,024						0.20						503,992						392,576						0.37
Money market accounts						685,127						660,319						0.17						641,504						651,402						0.44
Certificates of deposit						45,137						51,677						1.12						64,694						111,698						1.97
Wholesale deposits						144,492						164,654						0.75						172,508						142,591						1.71
Total deposits						$	2,160,707					$	1,893,441					0.21						$	1,855,516					$	1,711,092					0.52

A summary of annual maturities of in-market and wholesale certificates of deposit at June 30, 2021 is as follows:

(In Thousands)
Maturities during the year ended December 31,
2021						$	41,925
2022						29,710
2023						1,948
2024						369
2025						321
Thereafter						356
						$	74,629

Wholesale deposits include $29.5 million and $115.0 million of wholesale certificates of deposit and non-reciprocal interest-bearing transaction accounts, respectively, at June 30, 2021, compared to $47.5 million and $125.0 million of wholesale certificates of deposit and non-reciprocal interest-bearing transaction accounts, respectively, at December 31, 2020.

Deposits include $12.4 million and $28.7 million of certificates of deposit and wholesale deposits which are denominated in amounts of $250,000 or more at June 30, 2021 and December 31, 2020, respectively.

Note 10 — FHLB Advances, Other Borrowings and Junior Subordinated Notes

The composition of borrowed funds is shown below. Average balances represent year to date averages.

						June 30, 2021																		December 31, 2020
						Balance						Weighted Average Balance						Weighted Average Rate						Balance						Weighted Average Balance						Weighted Average Rate
						(Dollars in Thousands)
Federal funds purchased						$	—					$	—					—		%				$	—					$	71					0.69		%
Federal Reserve PPPLF						—						—						—						—						15,207						0.35
FHLB advances						387,800						386,371						1.31						394,500						379,891						1.45
Line of credit						—						151						2.88						—						—						—
Other borrowings						8,545						5,979						4.34						920						676						12.60
Subordinated notes payable						23,768						23,756						5.94						23,747						23,725						5.95
Junior subordinated notes						10,069						10,064						10.96						10,062						10,054						11.09
						$	430,182					$	426,321					1.84						$	429,229					$	429,624					1.91

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A summary of annual maturities of borrowings at June 30, 2021 is as follows:

(In Thousands)
Maturities during the year ended December 31,
2021						$	138,275
2022						34,000
2023						37,300
2024						35,500
2025						20,596
Thereafter						164,511
						$	430,182

During the second quarter of 2020, the Corporation tested its ability to borrow from the Federal Reserve Paycheck Protection Program Liquidity Facility (“PPPLF”) in the event funding was required to support the Banks PPP lending efforts. On April 28, 2020, the Corporation borrowed $29.6 million from the PPPLF at a rate of 0.35%. As of November 2, 2020, the borrowing was paid in full.

As of June 30, 2021, the Corporation had other borrowings of $8.5 million, which consisted of $7.6 million of sold loans accounted for as secured borrowings because they did not qualify for true sale accounting, and borrowings associated with our investment in a community development entity.

As of June 30, 2021 and December 31, 2020, 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, 2021, the Corporation pays a fee on this line of credit. During the six months ended June 30, 2021 and 2020, the Corporation incurred interest expense of $6,600 and $7,000, respectively, due to this fee.

Note 11 — Commitments and Contingencies

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

The Corporation sells the guaranteed portions of SBA 7(a) loans, as well as participation interests in other, non-SBA originated, loans to third parties. The Corporation has a continuing involvement in each of the transferred lending arrangements by way of relationship management and servicing the loans, as well as being subject to normal and customary requirements of the SBA loan program and standard representations and warranties related to sold amounts. In the event of a loss resulting from default and a determination by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Corporation, the SBA may require the Corporation to repurchase the loan, deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from the Corporation. The Corporation must comply with applicable SBA regulations in order to maintain the guaranty. In addition, the Corporation retains the option to repurchase the sold guaranteed portion of an SBA loan if the loan defaults.

Management has assessed estimated losses inherent in the outstanding guaranteed portions of SBA loans sold in accordance with ASC 450, Contingencies, and determined a recourse reserve based on the probability of future losses for these loans to be $830,000 at June 30, 2021, which is reported in accrued interest payable and other liabilities on the unaudited Consolidated Balance Sheets.

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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 June 30,												As of and for the Six Months Ended June 30,
						2021						2020						2021						2020
						(In Thousands)
Balance at the beginning of the period						$	593					$	1,086					$	723					$	1,345
SBA recourse provision (benefit)						245						(30)						115						(5)
Charge-offs, net						(8)						(49)						(8)						(333)
Balance at the end of the period						$	830					$	1,007					$	830					$	1,007

Note 12 — Fair Value Disclosures

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

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

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

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:

						June 30, 2021
						Fair Value Measurements Using
						Level 1						Level 2						Level 3						Total
						(In Thousands)
Assets:
Securities available-for-sale:
U.S. government agency securities - government-sponsored enterprises						$	—					$	21,144					$	—					$	21,144
Municipal securities						—						28,480						—						28,480
Residential mortgage-backed securities - government issued						—						12,236						—						12,236
Residential mortgage-backed securities - government-sponsored enterprises						—						79,883						—						79,883
Commercial mortgage-backed securities - government issued						—						4,090						—						4,090
Commercial mortgage-backed securities - government-sponsored enterprises						—						23,131						—						23,131
Other securities						—						2,255						—						2,255
Interest rate swaps						—						32,377						—						32,377
Liabilities:
Interest rate swaps						—						36,109						—						36,109

						December 31, 2020
						Fair Value Measurements Using
						Level 1						Level 2						Level 3						Total
						(In Thousands)
Assets:
Securities available-for-sale:
U.S. government agency securities - government-sponsored enterprises						$	—					$	22,629					$	—					$	22,629
Municipal securities						—						24,779						—						24,779
Residential mortgage-backed securities - government issued						—						10,403						—						10,403
Residential mortgage-backed securities - government-sponsored enterprises						—						105,006						—						105,006
Commercial mortgage-backed securities - government issued						—						5,464						—						5,464
Commercial mortgage-backed securities - government-sponsored enterprises						—						13,365						—						13,365
Other securities						—						2,279						—						2,279
Interest rate swaps						—						49,377						—						49,377
Liabilities:
Interest rate swaps						—						54,927						—						54,927

For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the three and six months ended June 30, 2021 or the year ended December 31, 2020 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:

						June 30, 2021
						Fair Value Measurements Using
						Level 1						Level 2						Level 3						Total
						(In Thousands)
Impaired loans						$	—					$	—					$	7,935					$	7,935
Foreclosed properties						—						—						179						179
Loan servicing rights						—						—						1,500						1,500

						December 31, 2020
						Fair Value Measurements Using
						Level 1						Level 2						Level 3						Total
						(In Thousands)
Impaired loans						$	—					$	—					$	17,203					$	17,203
Foreclosed properties						—						—						34						34
Loan servicing rights						—						—						1,325						1,325

Impaired loans were written down to the fair value of their underlying collateral less costs to sell of $7.9 million and $17.2 million at June 30, 2021 and December 31, 2020, respectively, through the establishment of specific reserves or by recording charge-offs when the carrying value exceeded the fair value of the underlying collateral of impaired loans. Valuation techniques consistent with the market approach, income approach, or cost approach were used to measure fair value. These techniques included observable inputs for the individual impaired loans being evaluated, such as current appraisals, recent sales of similar assets, or other observable market data, and unobservable inputs, typically when discounts are applied to appraisal values to adjust such values to current market conditions or to reflect net realizable values. The quantification of unobservable inputs for Level 3 impaired loan values range from 10% - 90% as of the measurement date of June 30, 2021. The weighted average of those unobservable inputs was 25%. The majority of the impaired loans are considered collateral dependent loans or are supported by an SBA guaranty.

Foreclosed properties, upon initial recognition, are remeasured and reported at fair value through a charge-off to the allowance for loan and lease losses, if deemed necessary, based upon the fair value of the foreclosed property. The fair value of a foreclosed property, upon initial recognition, is estimated using a market approach or based on observable market data, typically a current appraisal, or based upon assumptions specific to the individual property or equipment, such as management applied discounts used to further reduce values to a net realizable value when observable inputs become stale.

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

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

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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:

						June 30, 2021
						Carrying Amount						Fair Value
												Total						Level 1						Level 2						Level 3
						(In Thousands)
Financial assets:
Cash and cash equivalents						$	389,977					$	389,977					$	389,977					$	—					$	—
Securities available-for-sale						171,219						171,219						—						171,219						—
Securities held-to-maturity						22,382						23,113						—						23,113						—
Loans held for sale						6,059						6,604						—						6,604						—
Loans and lease receivables, net						2,117,886						2,117,775						—						—						2,117,775
Federal Home Loan Bank stock						13,451						N/A						N/A						N/A						N/A
Accrued interest receivable						5,857						5,857						5,857						—						—
Interest rate swaps						32,377						32,377						—						32,377						—
Financial liabilities:
Deposits						2,160,707						2,161,332						2,086,078						75,254						—
Federal Home Loan Bank advances and other borrowings						420,113						428,967						—						428,967						—
Junior subordinated notes						10,069						9,994						—						—						9,994
Accrued interest payable						1,303						1,303						1,303						—						—
Interest rate swaps						36,109						36,109						—						36,109						—
Off-balance sheet items:
Standby letters of credit						115						115						—						—						115

N/A = The fair value is not applicable due to restrictions placed on transferability

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						December 31, 2020
						Carrying Amount						Fair Value
												Total						Level 1						Level 2						Level 3
						(In Thousands)
Financial assets:
Cash and cash equivalents						$	56,909					$	56,909					$	56,909					$	—					$	—
Securities available-for-sale						183,925						183,925						—						183,925						—
Securities held-to-maturity						26,374						27,333						—						27,333						—
Loans held for sale						8,695						9,478						—						9,478						—
Loans and lease receivables, net						2,117,449						2,121,107						—						—						2,121,107
Federal Home Loan Bank stock						13,578						N/A						N/A						N/A						N/A
Accrued interest receivable						8,564						8,564						8,564						—						—
Interest rate swaps						49,377						49,377						—						49,377						—
Financial liabilities:
Deposits						1,855,516						1,856,910						1,743,314						113,596						—
Federal Home Loan Bank advances and other borrowings						419,167						429,347						—						429,347						—
Junior subordinated notes						10,062						9,986						—						—						9,986
Accrued interest payable						1,578						1,578						1,578						—						—
Interest rate swaps						54,927						54,927						—						54,927						—
Off-balance sheet items:
Standby letters of credit						75						75						—						—						75

N/A = The fair value is not applicable due to restrictions placed on transferability

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

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

Loans Held for Sale: Loans held for sale, which consist of the guaranteed portions of SBA 7(a) loans, are carried at the lower of cost or estimated fair value. The estimated fair value is based on what secondary markets are currently offering for portfolios with similar characteristics.

Interest Rate Swaps: The carrying amount and fair value of existing derivative financial instruments are based upon independent valuation models, which use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative contract. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the

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respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Corporation considers the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

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

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

Note 13 — Derivative Financial Instruments

The Corporation offers interest rate swap products directly to qualified commercial borrowers. The Corporation economically hedges client derivative transactions by entering into offsetting interest rate swap contracts executed with a third party. Derivative transactions executed as part of this program are not considered hedging instruments and are marked-to-market through earnings each period. The derivative contracts have mirror-image terms, which results in the positions’ changes in fair value offsetting through earnings each period. The credit risk and risk of non-performance embedded in the fair value calculations is different between the dealer counterparties and the commercial borrowers which may result in a difference in the changes in the fair value of the mirror-image swaps. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the counterparty’s risk in the fair value measurements. When evaluating the fair value of its derivative contracts for the effects of non-performance and credit risk, the Corporation considered the impact of netting and any applicable credit enhancements such as collateral postings, thresholds, and guarantees. During the three and six months ended June 30, 2021, the credit valuation adjustment was adjusted resulting in a benefit of $206,000 and $376,000, respectively.

At June 30, 2021, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $637.0 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 January 2024 and March 2038. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported on the unaudited Consolidated Balance Sheet as a derivative asset of $32.4 million and a derivative liability of $4.7 million.

At June 30, 2021, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $637.0 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 January 2024 through March 2038. Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported on the unaudited Consolidated Balance Sheet as a net derivative liability of $27.7 million. The gross amount of dealer counterparty swaps, without regard to the enforceable master netting agreement, was a gross derivative liability of $32.4 million and $4.7 million gross derivative asset. No right of offset existed with dealer counterparty swaps as of June 30, 2021.

All changes in the fair value of these instruments are recorded in other non-interest income. Given the mirror-image terms of the outstanding derivative portfolio, the change in fair value for the three and six months ended June 30, 2021 and 2020 had an insignificant impact on the unaudited Consolidated Statements of Income.

The Corporation also enters into interest rate swaps to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The instruments are designated as cash flow hedges as the receipt of floating rate interest from the counterparty is used to manage interest rate risk associated with forecasted issuances of short-term FHLB advances. The change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings.

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As of June 30, 2021, the aggregate notional value of interest rate swaps designated as cash flow hedges was $114.0 million. These interest rate swaps mature between December 2021 and December 2027. A pre-tax unrealized loss of $271,000 and gain of $1.8 million was recognized in other comprehensive income for the three and six months ended June 30, 2021, and there was no ineffective portion of these hedges.

Information about the balance sheet location and fair value of the Corporation’s derivative instruments below:

						Interest Rate Swap Contracts
						Asset Derivatives												Liability Derivatives
						Balance Sheet Location						Fair Value						Balance Sheet Location						Fair Value
						(In Thousands)
Derivatives not designated as hedging instruments
June 30, 2021						Derivatives						$	32,377					Derivatives						$	32,377
December 31, 2020						Derivatives						$	49,377					Derivatives						$	49,377
Derivatives designated as hedging instruments
June 30, 2021						Accumulated other comprehensive income (1)						$	3,732					Derivatives						$	3,732
December 31, 2020						Accumulated other comprehensive income (1)						$	5,550					Derivatives						$	5,550

(1)The fair value of derivatives designated as hedging instruments included in accumulated other comprehensive income represent pre-tax amounts, which are reported net of tax on the unaudited Consolidated Balance Sheets.

Note 14 — Regulatory Capital

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

As a bank holding company, the Corporation’s ability to pay dividends is affected by the policies and enforcement powers of the Board of Governors of the Federal Reserve system (the “Federal Reserve”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring, or significantly reducing dividends if: (i) net income available to common 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 and prospective financial condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios. Management intends, when appropriate under regulatory guidelines, to consult with the Federal Reserve 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 shareholders with preferential rights superior to those shareholders receiving the dividend.

The Bank is 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 Bank to the Corporation is one of the sources of funds the

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Corporation could use to pay dividends, if any, in the future and to make other payments. Future dividend decisions by the Bank and the Corporation will continue to be subject to compliance with various legal, regulatory, and other restrictions as defined from time to time.

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

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As of June 30, 2021, the Corporation’s capital levels exceeded the regulatory minimums and the Bank’s capital levels remained characterized as well capitalized under the regulatory framework. The following tables summarize both the Corporation’s and the Bank’s capital ratios and the ratios required by their federal regulators:

						As of June 30, 2021
						Actual												Minimum Required for Capital Adequacy Purposes												For Capital Adequacy Purposes Plus Capital Conservation Buffer												Minimum Required to Be Well Capitalized Under Prompt Corrective Action Requirements
						Amount						Ratio						Amount						Ratio						Amount						Ratio						Amount						Ratio
						(Dollars in Thousands)
Total capital (to risk-weighted assets)
Consolidated						$	271,536					11.22		%				$	193,679					8.00		%				$	254,203					10.50		%				N/A						N/A
First Business Bank						265,450						10.99						193,309						8.00						253,719						10.50						241,637						10.00		%
Tier 1 capital (to risk-weighted assets)
Consolidated						$	221,178					9.14		%				$	145,259					6.00		%				$	205,784					8.50		%				N/A						N/A
First Business Bank						238,860						9.89						144,982						6.00						205,391						8.50						193,309						8.00
Common equity tier 1 capital (to risk-weighted assets)
Consolidated						$	211,109					8.72		%				$	108,944					4.50		%				$	169,469					7.00		%				N/A						N/A
First Business Bank						238,860						9.89						108,737						4.50						169,146						7.00						157,064						6.50
Tier 1 leverage capital (to adjusted assets)
Consolidated						$	221,178					8.48		%				$	104,310					4.00		%				$	104,310					4.00		%				N/A						N/A
First Business Bank						238,860						9.18						104,081						4.00						104,081						4.00						130,102						5.00

						As of December 31, 2020
						Actual												Minimum Required for Capital Adequacy Purposes												For Capital Adequacy Purposes Plus Capital Conservation Buffer												Minimum Required to Be Well Capitalized Under Prompt Corrective Action Requirements
						Amount						Ratio						Amount						Ratio						Amount						Ratio						Amount						Ratio
						(Dollars in Thousands)
Total capital (to risk-weighted assets)
Consolidated						$	258,607					11.25		%				$	183,965					8.00		%				$	241,454					10.50		%				N/A						N/A
First Business Bank						251,116						10.97						183,053						8.00						240,257						10.50						228,816						10.00		%
Tier 1 capital (to risk-weighted assets)
Consolidated						$	206,104					8.96		%				$	137,974					6.00		%				$	195,463					8.50		%				N/A						N/A
First Business Bank						222,500						9.72						137,290						6.00						194,494						8.50						183,053						8.00
Common equity tier 1 capital (to risk-weighted assets)
Consolidated						$	196,042					8.53		%				$	103,480					4.50		%				$	160,970					7.00		%				N/A						N/A
First Business Bank						222,500						9.72						102,967						4.50						160,171						7.00						148,731						6.50
Tier 1 leverage capital (to adjusted assets)
Consolidated						$	206,104					7.99		%				$	103,228					4.00		%				$	103,228					4.00		%				N/A						N/A
First Business Bank						222,500						8.67						102,635						4.00						102,635						4.00						128,294						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 subsidiary. “FBB” or the “Bank” refers to our subsidiary, First Business Bank.

Forward-Looking Statements

    This report may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect our current views with respect to future events and financial performance. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results, or other developments. Forward-looking statements are based on management’s expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Such statements are subject to risks and uncertainties, including among other things:

•Adverse changes in the economy or business conditions, either nationally or in our markets, including, without limitation, the adverse effects of the COVID-19 pandemic on the global, national, and local economy, which may affect the Corporation’s credit quality, revenue, and business operations.

•Competitive pressures among depository and other financial institutions nationally and 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 our internet banking activities.

•Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portions 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 stockholders and potential investors. See Part I, Item 1A — Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2020 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.

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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 subsidiary, FBB. All of our operations are conducted through FBB and First Business Specialty Finance, LLC (“FBSF”), a wholly-owned subsidiary 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 and medium-sized businesses, business owners, executives, professionals, and high net worth individuals. Our products and services include those for business banking, private wealth, and bank consulting. Within business banking, we offer commercial lending, consumer and other lending, asset-based lending, accounts receivable financing, equipment financing, floorplan financing, vendor financing, SBA lending and servicing, treasury management services, and company retirement plans. Our private wealth services for executives and individuals include trust and estate administration, financial planning, investment management, and private banking. For other financial institutions, our bank consulting experts provide investment portfolio administrative services, asset liability management services, and asset liability management process validation. We do not utilize a branch network to attract retail clients. Our operating philosophy is predicated on deep client relationships within our commercial bank markets and skilled expertise within our nationwide specialty finance business lines, combined with the efficiency of centralized administrative functions, such as information technology, loan and deposit operations, finance and accounting, credit administration, compliance, marketing, and human resources. Our focused model allows experienced staff to provide the level of financial expertise needed to develop and maintain long-term relationships with our clients.

Financial Performance Summary

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

•Net income totaled $8.2 million, or diluted earnings per share of $0.95, for the three months ended June 30, 2021, compared to $3.3 million, or diluted earnings per share of $0.38, for the same period in 2020. Net income totaled $18.0 million, or diluted earnings per share of $2.08, for the six months ended June 30, 2021, compared to $6.6 million, or diluted earnings per share of $0.77, for the same period in 2020.

•Annualized return on average assets and annualized return on average equity for the three months ended June 30, 2021 measured 1.26% and 15.09%, respectively, compared to 0.55% and 6.70% for the same period in 2020. Annualized return on average assets and annualized return on average equity for the six months ended June 30, 2021 measured 1.38% and 16.75%, respectively, compared to 0.58% and 6.92% for the same period in 2020.

•Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled $10.0 million for the three months ended June 30, 2021, up 2.4% from the same period in 2020. Pre-tax, pre-provision adjusted return on average assets was 1.53% for the three months ended June 30, 2021, compared to 1.61% for the same period in 2020. Pre-tax, pre-provision adjusted earnings totaled $20.6 million for the six months ended June 30, 2021, up 18.9% from the same period in 2020. Pre-tax, pre-provision adjusted return on average assets was 1.59% for the six months ended June 30, 2021, compared to 1.53% for the same period in 2020.

•Net interest margin was 3.49% for the three months ended June 30, 2021, up from 3.34% for the same period in 2020. Adjusted net interest margin, which excludes certain one-time and volatile items, was 3.20% for the three months ended June 30, 2021 compared to 3.32% for the same period in 2020. Net interest margin was 3.46% for the six months ended June 30, 2021, up from 3.39% for the same period in 2020. Adjusted net interest margin was 3.20% for the six months ended June 30, 2021 compared to 3.32% for the same period in 2020.

•Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled $3.5 million for the three months ended June 30, 2021 compared to $2.3 million for the three months ended June 30, 2020. Fees in lieu of interest totaled $6.6 million for the six months ended June 30, 2021 compared to $3.1 million for the six months ended June 30, 2020.

•Top line revenue, defined as net interest income plus non-interest income, totaled $28.0 million for the three months ended June 30, 2021, up 11.0% from the same period in 2020. Top line revenue totaled $56.0 million for the six months ended June 30, 2021, up 15.1% from the same period in 2020.

•Provision for loan and lease losses was a benefit of $958,000 for the three months ended June 30, 2021 compared to an expense of $5.5 million for the same period in 2020. Provision for loan and lease losses was a benefit of $3.0 million for the six months ended June 30, 2021 compared to an expense of $8.7 million for the same period in 2020.

•Non-interest income totaled $6.3 million for both the three months ended June 30, 2021 and 2020. Non-interest income totaled $13.5 million for the six months ended June 30, 2021, up 6.1% from the same period in 2020.

•Non-interest expense was $18.2 million for the three months ended June 30, 2021 compared to $18.3 million for the three months ended June 30, 2020. Operating expense, which excludes certain one-time and discrete items, totaled $17.9 million for the three months ended June 30, 2021, up 16.2% compared to $15.4 million for the three months ended June 30, 2020. Non-interest expense was $35.5 million for the six months ended June 30, 2021 compared to

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$34.5 million for the six months ended June 30, 2020. Operating expense totaled $35.4 million for the six months ended June 30, 2021, up 12.9% compared to $31.3 million for the six months ended June 30, 2020.

•The efficiency ratio was 64.17% for the three months ended June 30, 2021, up from 61.22% for the three months ended June 30, 2020. The efficiency ratio improved to 63.18% for the six months ended June 30, 2021, down from 64.36% for the six months ended June 30, 2020.

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

•Period-end gross loans and leases receivable were $2.144 billion and $2.146 billion as of June 30, 2021 and December 31, 2020, respectively. Average gross loans and leases of $2.223 billion increased $240.2 million, or 12.1%, for the three months ended June 30, 2021, compared to $1.983 billion for the same period in 2020.

•Period-end gross loans and leases receivable, excluding net PPP loans, at June 30, 2021 increased $102.2 million, or 10.6% annualized, to $2.023 billion from $1.921 billion as of December 31, 2020. Average gross loans and leases, excluding net PPP loans, of $1.994 billion increased $263.9 million, or 15.3%, for the three months ended June 30, 2021, compared to $1.730 billion for the same period in 2020.

•Period-end gross PPP loans and PPP deferred processing fees were $123.8 million and $3.1 million, respectively, at June 30, 2021. Average PPP loans, net of deferred processing fees, were $229.2 million for the three months ended June 30, 2021.

•Non-performing assets were $11.6 million and 0.40% of total assets as of June 30, 2021, compared to $26.7 million and 1.04% of total assets as of December 31, 2020. Non-performing assets to total assets, excluding net PPP loans, was 0.42% as of June 30, 2021, compared to 1.14% as of December 31, 2020.

•The allowance for loan and lease losses decreased $2.8 million, or 10.0%, compared to December 31, 2020. The allowance for loan and lease losses decreased to 1.20% of total loans, compared to 1.33% at December 31, 2020. Excluding net PPP loans, the allowance for loan and lease losses decreased to 1.27% of total loans as of June 30, 2021, compared to 1.48% as of December 31, 2020.

•Period-end in-market deposits at June 30, 2021 increased $333.2 million to $2.016 billion from $1.683 billion as of December 31, 2020. Average in-market deposits of $1.735 billion increased $164.8 million, or 10.5%, for the six months ended June 30, 2021, compared to $1.571 billion for the same period in 2020.

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

COVID-19 Update

Paycheck Protection Program

On December 27, 2020, the Consolidated Appropriations Act, 2021 (“CAA”) was signed into law. The CAA is a $2.3 trillion spending bill that combines $900 billion in stimulus relief for the COVID-19 pandemic in the United States with a $1.4 trillion omnibus spending bill for the 2021 federal fiscal year and prevents a government shutdown. The CAA allows for a second draw for certain businesses under the PPP. Like the original program, loan proceeds are available to help fund payroll and group health benefit costs, as well as certain mortgage interest, rent and utilities. In addition, authorized costs now also include COVID-19 related worker protection costs, uninsured property damage costs due to looting or vandalism during 2020 and certain supplier costs and expenses for operations. The CAA also expands benefit costs to include group dental, vision, life and disability benefits. All of these changes are generally retroactive to the original CARES Act, meaning that the changes may be taken into account in processing loan forgiveness with respect to an original PPP loan. The Corporation began accepting and processing applications for second draw PPP loans on January 13, 2021.

As of June 30, 2021, the Corporation had $123.8 million in gross PPP loans outstanding and deferred processing fees outstanding of $3.1 million. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. During the three and six months ended June 30, 2021, $2.5 million and $4.8 million, respectively, was recognized in loans and leases interest income in the unaudited Consolidated Statements of Income. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. As loan losses are expected to be immaterial, if any at all, due to the guaranty, management excluded the PPP loans from the allowance for loan and lease losses calculation. Management funded these short-term loans primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.

Deferral Requests

The Corporation provided loan modifications deferring payments for certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation’s loan modification program. Excluding gross PPP loans, as of June 30, 2021, the Corporation had deferred loans outstanding of $20.5 million, or 1.0% of gross loans and leases, compared to $27.0 million, or 1.4% of gross loans and leases as of December 31, 2020. Of the $20.5 million of deferred loans outstanding, which relate to five credits in total, $19.8 million relates to two hospitality credits that went on deferral during the

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second quarter of 2021 and are both accruing and current on payments. Management believes there will be no losses associated with these two credits.

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

						As of
						June 30, 2021
												Collateral Type
Industries Description						Balance						Real Estate						Non Real Estate
						(In Thousands)
Accommodation and Food Services						$	19,811					$	19,811					$	—
Manufacturing						310						310						—
Agriculture, Forestry, Fishing, and Hunting						210						—						210
Educational Services						195						195						—
Total deferred loan balances						$	20,526					$	20,316					$	210

The following table is a further breakdown of the deferred loan balances by certain credit quality indicators. Please refer to Note 6 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses for the risk category definitions.

						As of
						June 30, 2021
						Category
						I						II						III						IV						Total
						(Dollars in Thousands)
Total deferred loan balances						$	505					$	210					$	19,811					$	—					$	20,526
% of Total						2.5		%				1.0		%				96.5		%				—		%				100.0		%

						As of
						December 31, 2020
						Category
						I						II						III						IV						Total
						(Dollars in Thousands)
Total deferred loan balances						$	13,466					$	13,448					$	58					$	38					$	27,010
% of Total						49.9		%				49.8		%				0.2		%				0.1		%				100.0		%

Exposure to Stressed Industries

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

						As of
						June 30, 2021												December 31, 2020
Industries:						Balance						% Gross Loans and Leases (1)						Balance						% Gross Loans and Leases (1)
						(Dollars in Thousands)
Retail (2) (3)						$	75,588					3.7		%				$	62,719					3.3		%
Hospitality						82,818						4.1		%				80,832						4.2		%
Entertainment						13,729						0.7		%				14,208						0.7		%
Restaurants & food service						23,340						1.2		%				24,854						1.3		%
Total outstanding exposure						$	195,475					9.6		%				$	182,613					9.5		%

(1)Excluding net PPP loans.

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

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

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

    Because of the uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation’s loan portfolio.

Results of Operations

Top Line Revenue

    Top line revenue, comprised of net interest income and non-interest income, increased 11.0% for the three months ended June 30, 2021 compared to the same period in 2020 primarily due to a $2.8 million, or 14.6%, increase in net interest income. The increase in net interest income was driven by an increase in average loans and leases receivable and loan fees in lieu of interest. Top line revenue increased 15.1% for the six months ended June 30, 2021 compared to the same period in 2020 primarily due to higher net interest income driven by an increase average loans and leases receivable and fees in lieu of interest. Non-interest income increased due to stronger gains on the sale of SBA loans and private wealth fee income, which was partially offset by a decrease in swap fees from our commercial loan interest rate swap program.

    The components of top line revenue were as follows:

						For the Three Months Ended June 30,																								For the Six Months Ended June 30,
						2021						2020						$ Change						% Change						2021						2020						$ Change						% Change
						(Dollars in Thousands)
Net interest income						$	21,652					$	18,888					$	2,764					14.6		%				$	42,515					$	35,937					$	6,578					18.3		%
Non-interest income						6,321						6,319						2						—						13,516						12,733						783						6.1
Top line revenue						$	27,973					$	25,207					$	2,766					11.0						$	56,031					$	48,670					$	7,361					15.1

Annualized Return on Average Assets and Annualized Return on Average Equity

    ROAA for the three and six months ended June 30, 2021 increased significantly to 1.26% and 1.38%, compared to 0.55% and 0.58% for the three and six months ended June 30, 2020. The increase in ROAA was primarily due to a decrease in the provision for loan and lease losses related to a large loan recovery received in January 2021 and continued credit quality improvement following significant reserve build during the COVID-19 pandemic. ROAA also benefited from an increase in fees in lieu of interest, strong gains on sale of SBA loans, and consistently strong and growing private wealth fee income. The increase in profitability was partially offset by a decrease in commercial loan interest rate swap fee income and increase in non-interest expense. We consider ROAA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures.

    ROAE for the three and six months ended June 30, 2021 was 15.09% and 16.75%, compared to 6.70% and 6.92% for the three and six months ended June 30, 2020. The reasons for the increase in ROAE are consistent with the explanations discussed above with respect to ROAA. We view ROAE as an important measurement for monitoring profitability and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses, and minimizing our costs of credit.

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

    Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse benefit or provision, impairment of tax credit investments, net gains or losses on foreclosed properties, amortization of other intangible assets, losses on early extinguishment of debt, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized net gains or losses on securities, if any. Pre-tax, pre-provision adjusted earnings is defined as operating revenue less operating expense. In the judgment of the Corporation’s management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation’s operating expenses in relation to its core operating revenue by removing the volatility associated with certain one-time items and other discrete items.

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    The efficiency ratio was 64.17% and 63.18% for the three and six months ended June 30, 2021, compared to 61.22% and 64.36% for the three and six months ended June 30, 2020. Operating expense growth exceeded operating revenue growth for the three months ended June 30, 2021 compared to the same period in 2020 primarily due to a $2.5 million, or 22.8%, increase in compensation principally driven by increased headcount and incentive compensation as compared to the same periods in 2020, reflecting in part the Corporation’s continued execution of its growth strategy and vastly improved performance for the six months ended June 30, 2021 compared to the same period in 2020. Operating revenue growth outpaced the change in operating expense for the six months ended June 30, 2021 compared to the same period in 2020, resulting in positive operating leverage for the first half of the year. This improvement was attributable to an increase in net interest income driven by a 12.1% increase in average loans and leases receivable, a $1.3 million increase in fees in lieu of interest. In addition, non-interest income increased $783,000, or 6.1%, as the increase in gains on the sale of SBA loans and private wealth fee income offset the decline in commercial loan swap fees. The increase in fees in lieu of interest included $2.5 million in PPP processing fees. The increase in operating revenue was partially offset by a $4.1 million, or 18.6%, increase in compensation expense . We believe we will continue to generate modest positive operating leverage annually and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth. These initiatives include efforts to expand our specialized lending commercial banking business lines, increase our commercial banking market share, and scale our private wealth management business in our less mature commercial banking markets.

    We believe the efficiency ratio and pre-tax, pre-provision adjusted earnings allow investors and analysts to better assess the Corporation’s operating expenses in relation to its top line revenue by removing the volatility that is associated with certain non-recurring and other discrete items. The efficiency ratio and pre-tax, pre-provision adjusted earnings also allow management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.

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

						For the Three Months Ended June 30,																								For the Six Months Ended June 30,
						2021						2020						$ Change						% Change						2021						2020						$ Change						% Change
						(Dollars in Thousands)
Total non-interest expense						$	18,184					$	18,343					$	(159)					(0.9)		%				$	35,514					$	34,488					$	1,026					3.0		%
Less:
Net loss on foreclosed properties						(1)						348						(349)						NM						1						450						(449)						(99.8)
Amortization of other intangible assets						8						9						(1)						(11.1)						15						18						(3)						(16.7)
SBA recourse (benefit) provision						245						(30)						275						NM						115						(5)						120						NM
Tax credit investment impairment						—						1,841						(1,841)						NM						—						1,954						(1,954)						NM
Loss on early extinguishment of debt						—						744						(744)						NM						—						744						(744)						NM
Total operating expense						$	17,932					$	15,431					$	2,501					16.2						$	35,383					$	31,327					$	4,056					12.9
Net interest income						21,652						18,888						2,764						14.6						$	42,515					$	35,937					$	6,578					18.3
Total non-interest income						6,321						6,319						2						—						13,516						12,733						783						6.1
Less:
Net loss on sale of securities						29						—						29						NM						29						(4)						33						NM
Adjusted non-interest income						6,292						6,319						(27)						(0.4)						$	13,487					$	12,737					$	750					5.9
Total operating revenue						$	27,944					$	25,207					$	2,737					10.9						$	56,002					$	48,674					$	7,328					15.1
Efficiency ratio						64.17		%				61.22		%																63.18		%				64.36		%
Pre-tax, pre-provision adjusted earnings						$	10,012					$	9,776					$	236					2.4						$	20,619					$	17,347					$	3,272					18.9
Average total assets						2,621,340						2,425,767						195,573						8.1						2,599,373						2,265,315						334,058						14.7
Pre-tax, pre-provision adjusted return on average assets						1.53		%				1.61		%																1.59		%				1.53		%

NM = Not Meaningful

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 and six months ended June 30, 2021 compared to the same period in 2020. The change in net interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) has been allocated to the rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

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						Increase (Decrease) for the Three Months Ended June 30,																		Increase (Decrease) for the Six Months Ended June 30,
						2021 Compared to 2020																		2021 Compared to 2020
						Rate						Volume												Net						Rate						Volume												Net
						(In Thousands)
Interest-earning assets
Commercial real estate and other mortgage loans(1)						$	(1,263)					$	1,900											$	637					$	(4,395)					$	4,037											$	(358)
Commercial and industrial loans(1)						986						542												1,528						(375)						3,671												3,296
Direct financing leases(1)						(81)						(92)												(173)						94						(131)												(37)
Consumer and other loans(1)						(26)						77												51						(78)						166												88
Total loans and leases receivable						(384)						2,427												2,043						(4,754)						7,743												2,989
Mortgage-related securities						(162)						(119)												(281)						(460)						(216)												(676)
Other investment securities						(27)						54												27						(53)						140												87
FHLB and FRB Stock						1						48												49						(116)						114												(2)
Short-term investments						2						(2)												—						(102)						(22)												(124)
Total net change in income on interest-earning assets						(570)						2,408												1,838						(5,485)						7,759												2,274
Interest-bearing liabilities
Transaction accounts						(127)						84												(43)						(821)						381												(440)
Money market accounts						(100)						14												(86)						(1,703)						23												(1,680)
Certificates of deposit						(233)						(282)												(515)						(484)						(605)												(1,089)
Wholesale deposits						(576)						239												(337)						(1,298)						429												(869)
Total deposits						(1,036)						55												(981)						(4,306)						228												(4,078)
FHLB advances						57						(56)												1						(448)						139												(309)
Federal reserve PPP lending facility						—						(18)												(18)						—						(18)												(18)
Other borrowings						(36)						108												72						(49)						153												104
Junior subordinated notes						—						—												—						(4)						1												(3)
Total net change in expense on interest-bearing liabilities						(1,015)						89												(926)						(4,807)						503												(4,304)
Net change in net interest income						$	445					$	2,319											$	2,764					$	(678)					$	7,256											$	6,578

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

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

						For the Three Months Ended June 30,
						2021																		2020
						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)						$	1,386,187					$	13,087					3.78		%				$	1,192,530					$	12,450					4.18		%
Commercial and industrial loans(1)						772,257						9,875						5.11						726,862						8,347						4.59
Direct financing leases(1)						19,883						222						4.47						27,115						395						5.83
Consumer and other loans(1)						45,026						407						3.62						36,614						356						3.89
Total loans and leases receivable(1)						2,223,353						23,591						4.24						1,983,121						21,548						4.35
Mortgage-related securities(2)						149,253						631						1.69						174,113						912						2.10
Other investment securities(3)						41,569						185						1.78						30,194						158						2.09
FHLB and FRB stock						14,172						176						4.97						10,301						127						4.93
Short-term investments						55,100						16						0.12						61,030						16						0.10
Total interest-earning assets						2,483,447						24,599						3.96						2,258,759						22,761						4.03
Non-interest-earning assets						137,893																		167,008
Total assets						$	2,621,340																	$	2,425,767
Interest-bearing liabilities
Transaction accounts						$	499,040					248						0.20						$	368,844					291						0.32
Money market accounts						662,919						282						0.17						637,714						368						0.23
Certificates of deposit						45,993						112						0.97						123,581						627						2.03
Wholesale deposits						162,580						301						0.74						105,597						638						2.42
Total interest-bearing deposits						1,370,532						943						0.28						1,235,736						1,924						0.62
FHLB advances						405,855						1,284						1.27						409,281						1,283						1.25
Federal reserve PPPLF						—						—						—						20,821						18						0.35
Other borrowings						32,447						443						5.46						24,681						371						6.01
Junior subordinated notes						10,066						277						11.01						10,052						277						11.02
Total interest-bearing liabilities						1,818,900						2,947						0.65						1,700,571						3,873						0.91
Non-interest-bearing demand deposit accounts						527,441																		440,413
Other non-interest-bearing liabilities						56,691																		86,504
Total liabilities						2,403,032																		2,227,488
Stockholders’ equity						218,308																		198,279
Total liabilities and stockholders’ equity						$	2,621,340																	$	2,425,767
Net interest income												$	21,652																	$	18,888
Interest rate spread																		3.31		%																3.12		%
Net interest-earning assets						$	664,547																	$	558,188
Net interest margin																		3.49		%																3.34		%
Average interest-earning assets to average interest-bearing liabilities						136.54		%																132.82		%
Return on average assets(4)						1.26																		0.55
Return on average equity(4)						15.09																		6.70
Average equity to average assets						8.33																		8.17
Non-interest expense to average assets(4)						2.77																		3.02

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

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

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

(4)Represents annualized yields/rates.

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						For the Six Months Ended June 30,
						2021																		2020
						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)						$	1,371,744					$	25,615					3.73		%				$	1,173,251					$	25,973					4.43		%
Commercial and industrial loans(1)						765,117						19,500						5.10						621,399						16,204						5.22
Direct financing leases(1)						21,071						466						4.42						27,538						503						3.65
Consumer and other loans(1)						45,335						805						3.55						36,244						717						3.96
Total loans and leases receivable(1)						2,203,267						46,386						4.21						1,858,432						43,397						4.67
Mortgage-related securities(2)						156,249						1,297						1.66						177,352						1,973						2.22
Other investment securities(3)						41,871						372						1.78						26,737						285						2.13
FHLB and FRB stock						13,323						329						4.94						9,407						331						7.04
Short-term investments						39,922						22						0.11						48,396						146						0.60
Total interest-earning assets						2,454,632						48,406						3.94						2,120,324						46,132						4.35
Non-interest-earning assets						144,741																		144,991
Total assets						$	2,599,373																	$	2,265,315
Interest-bearing liabilities
Transaction accounts						$	510,024					498						0.20						$	320,188					938						0.59
Money market accounts						660,319						557						0.17						653,598						2,237						0.68
Certificates of deposit						51,677						288						1.11						128,791						1,377						2.14
Wholesale deposits						164,654						619						0.75						119,032						1,488						2.50
Total interest-bearing deposits						1,386,674						1,962						0.28						1,221,609						6,040						0.99
FHLB advances						386,371						2,533						1.31						367,604						2,842						1.55
Federal reserve PPPLF						—						—						—						10,410						18						0.35
Other borrowings						29,886						844						5.65						24,533						740						6.03
Junior subordinated notes						10,064						552						10.97						10,050						555						11.04
Total interest-bearing liabilities						1,812,995						5,891						0.65						1,634,206						10,195						1.25
Non-interest-bearing demand deposit accounts						506,767																		365,771
Other non-interest-bearing liabilities						65,146																		74,436
Total liabilities						2,384,908																		2,074,413
Stockholders’ equity						214,465																		190,902
Total liabilities and stockholders’ equity						$	2,599,373																	$	2,265,315
Net interest income												$	42,515																	$	35,937
Interest rate spread																		3.29		%																3.10		%
Net interest-earning assets						$	641,637																	$	486,118
Net interest margin																		3.46		%																3.39		%
Average interest-earning assets to average interest-bearing liabilities						135.39		%																129.75		%
Return on average assets(4)						1.38																		0.58
Return on average equity(4)						16.75																		6.92
Average equity to average assets						8.25																		8.43
Non-interest expense to average assets(4)						2.73																		3.04

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

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

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

(4)Represents annualized yields/rates.

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

    Net interest income increased $2.8 million, or 14.6%, during the three months ended June 30, 2021 compared to the three months ended June 30, 2020. The increase in net interest income reflected an increase in average gross loans and leases, an increase in fees in lieu of interest, and a decrease in interest expense, partially offset by a reduction in the yield on average interest-earning assets. Fees in lieu of interest, which can vary from quarter to quarter, totaled $3.5 million for the three months ended June 30, 2021, compared to $2.3 million for the same period in 2020. Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $1.5 million, or 9.7%. Average gross loans and leases for the three months ended June 30, 2021 increased $240.2 million, or 12.1%, compared to the three months ended June 30, 2020. Excluding net PPP loans, average gross loans and leases for the three months ended June 30, 2021 increased $263.9 million, or 15.3%, compared to the three months ended June 30, 2020. Net interest income increased $6.6 million, or 18.3%, during the six months ended June 30, 2021 compared to the six months ended June 30, 2020. The reasons for the increase in net income for the six months ended June 30, 2021 are consistent with the explanations discussed above with respect to the three months ended June 30, 2021. Fees in lieu of interest totaled $6.6 million for the six months ended June 30, 2021, compared to $3.1 million for the same period in 2020. Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $2.5 million, or 7.7%. Average gross loans and leases for the six months ended June 30, 2021 increased $344.8 million, or 18.6%, compared to the six months ended June 30, 2020. Excluding net PPP loans, average gross loans and leases for the six months ended June 30, 2021 increased $235.6 million, or 13.6%, compared to the six months ended June 30, 2020.

    The yield on average loans and leases for the three and six months ended June 30, 2021 declined to 4.24% and 4.21%, respectively, compared to 4.35% and 4.67% for the three and six months ended June 30, 2020, respectively. Excluding the impact of fees in lieu of interest and PPP loan interest income, the yield on average loans and leases excluding net PPP loans for the three and six months ended June 30, 2021 was 3.91% and 3.92%, respectively, compared to 4.31% and 4.58% for the three and six months ended June 30, 2020, respectively. Similarly, the yield on average interest-earning assets for the three and six months ended June 30, 2021 measured 3.96% and 3.94%, respectively, compared to 4.03% and 4.35% three and six months ended June 30, 2020, respectively. Excluding fees in lieu of interest and PPP loan interest income, the yield on average interest-earning assets excluding net PPP loans for the three and six months ended June 30, 2021 was 3.64% and 3.66%, respectively, compared to 3.96% and 4.26% for the three and six months ended June 30, 2020, respectively. The decline in yields for both periods of comparison was primarily due to the decrease in LIBOR and Prime rates and related impact on variable-rate loans, in addition to the renewal of fixed-rate loans and reinvestment of security cash flows at historically low interest rates.

    The average rate paid on total interest-bearing liabilities for the both three and six months ended June 30, 2021 decreased to 0.65% compared to 0.91% and 1.25% for the three and six months ended June 30, 2020, respectively. Total interest-bearing liabilities include interest-bearing deposits, federal funds purchased, FHLB advances, subordinated and junior subordinated notes payable, and other borrowings. The average rate paid declined as the Corporation decreased deposit rates in response to the Federal Open Market Committee’s (“FOMC”) decision to lower the target federal funds rate 150 basis points from January 2020 to March 2020. For the six months ended June 30, 2021 compared to the six months ended June 30, 2020, the average target federal funds rate decreased 58 basis points.    

Consistent with the Corporation’s longstanding funding strategy to manage interest rate risk and use the most efficient and cost effective source of wholesale funds, a combination of fixed rate wholesale deposits and fixed rate FHLB advances are used at various maturity terms to meet the Corporation’s funding needs. Average FHLB advances for the three months ended June 30, 2021 decreased $3.4 million to $405.9 million at an average rate paid of 1.27%, compared to $409.3 million at an average rate paid of 1.25% for the three months ended June 30, 2020. Average FHLB advances for the six months ended June 30, 2021 increased $18.8 million to $386.4 million at an average rate paid of 1.31%, compared to $367.6 million at an average rate paid of 1.55% for the six months ended June 30, 2020. As of June 30, 2021, the weighted average original maturity of our FHLB term advances was 6.1 years, compared to 5.3 years as of June 30, 2020. Average wholesale deposits, consisting of brokered certificates of deposit, deposits gathered from internet listing services, and non-reciprocal interest bearing transaction accounts, for the three months ended June 30, 2021 increased $57.0 million to $162.6 million at an average rate paid of 0.74%, compared to $105.6 million at an average rate paid of 2.42%. The increase in wholesale deposits was primarily due to adding non-maturity brokered deposits at a favorable rate compared to alternative funding sources. Average wholesale deposits for the six months ended June 30, 2021 increased $45.6 million to $164.7 million at an average rate paid of 0.75%, compared to $119.0 million at an average rate paid of 2.50%. As of June 30, 2021, the weighted average original maturity of our termed wholesale deposits was 3.5 years, compared to 4.6 years as of June 30, 2020. The rate paid on average wholesale funding is greater than the cost of in-market deposits and changes more gradually because the portfolio includes longer original maturities as the Corporation match-funds its longer-term fixed rate loans to mitigate interest rates risk.

                Net interest margin was 3.49% and 3.46% for the three and six months ended June 30, 2021, respectively, compared to 3.34% and 3.39% for the three and six months ended June 30, 2020, respectively. Excluding fees in lieu of interest, PPP loan interest income, Federal Reserve interest income, and FHLB dividends, adjusted net interest margin measured 3.20% for both

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the three and six months ended June 30, 2021, compared to 3.32% and 3.32% for the three and six months ended June 30, 2020, respectively. The decrease in adjusted net interest margin for both periods of comparison was primarily due to the decrease in average yield on loans and leases receivable and investment securities, partially offset by a decrease in the average rate paid on in-market deposits and wholesale funding.

    Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in existing higher-yielding specialized lending commercial banking products will allow the Corporation to achieve a net interest margin of at least 3.50%, on average, over the long-term. However, the collection of loan fees in lieu of interest is an expected source of volatility to quarterly net interest income and net interest margin, particularly given the nature of the Corporation’s asset-based lending business and the Corporation’s participation in the PPP. Net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status or the accumulation of significant short-term deposit inflows.

Despite an uncertain rate environment, management expects to effectively manage the Corporation’s liability structure in both term and rate. Further, we expect to attract new in-market deposit relationships which we believe will contribute to our ability to maintain an appropriate cost of funds. In-market deposits, comprised of all transaction accounts, money market accounts, and non-wholesale deposits, increased $333.2 million, or 39.6% annualized, to $2.016 billion at June 30, 2021, compared to $1.683 billion at December 31, 2020. The large increase in deposits was partially due to the proceeds of a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in third quarter. Excluding this temporary deposit, total period-end in-market deposits increased $108.2 million to $1.791 billion, or 12.9% annualized. Average in-market deposits increased $164.8 million, or 10.5%, to $1.735 billion for the three months ended June 30, 2021, compared to $1.571 billion for the three months ended June 30, 2020. This significant increase in deposits was due to successful business development efforts combined with excess liquidity resulting from our clients’ participation in the PPP.

Provision for Loan and Lease Losses

    We determine our provision for loan and lease losses pursuant to our allowance for loan and lease loss methodology, which is based on the magnitude of current and historical net charge-offs recorded throughout the established look-back period, the evaluation of several qualitative factors for each portfolio category, and the amount of specific reserves established for impaired loans that present collateral shortfall positions. Refer to Allowance for Loan and Lease Losses, below, for further information regarding our allowance for loan and lease loss methodology.    

    The long-term impact of COVID-19 on the economy is unknown, however, economic conditions have improved steadily in 2021 following the vaccine rollout and the termination of various pandemic safety protocols by states and businesses. While the outbreak did have a temporary adverse impact on certain industries the Corporation serves, including retail, hospitality, entertainment, and restaurants and food services, management believes the long-term impact it may have on the Corporation’s loan portfolio will be limited. Additional detail about certain exposure to stressed industries is included in the section titled COVID-19 Update, above.

    The Corporation recognized a $1.0 million and $3.0 million provision benefit for the three and six months ended June 30, 2021, respectively, compared to provision expense of $5.5 million and $8.7 million for the three and six months ended June 30, 2020, respectively. The provision benefit for the three months ended June 30, 2021 was primarily due to a $1.7 million reduction in the general reserve from improving historical loss rates and a $1.5 million decrease in specific reserves. These decreases were partially offset by $2.3 million in net charge-offs and a $498,000 increase in the general reserve due to loan growth. Net charge-offs for the quarter principally consisted of a $2.2 million charge-off of one previously identified and partially reserved for legacy SBA loan. The provision benefit for the six months ended June 30, 2021 was primarily due to a $2.7 million reduction in the general reserve from improving historical loss rates and a $1.7 million decrease in specific reserves. These decreases were partially offset by a $1.1 million increase in the general reserve due to loan growth.

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

						For the Three Months Ended June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
						(In Thousands)
Change in general reserve due to subjective factor changes						$	(652)					$	2,388					$	430					$	5,224
Change in general reserve due to historical loss factor changes						(1,687)						(54)						(2,671)						(334)
Charge-offs						2,894						817						3,038						948
Recoveries						(545)						(64)						(3,218)						(241)
Change in specific reserves on impaired loans, net						(1,466)						2,122						(1,660)						2,559
Change due to loan growth, net						498						260						1,055						495
Total provision for loan and lease losses						$	(958)					$	5,469					$	(3,026)					$	8,651

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

			As of
			June 30, 2021						March 31, 2021																		June 30, 2020
			(In Thousands)
Performing loans:
Off-balance sheet loans			$	14,161					$	17,523																	$	28,843
On-balance sheet loans			6,836						7,340																		16,554
Gross loans			20,997						24,863																		45,397
Non-performing loans:
Off-balance sheet loans			3,943						1,835																		1,640
On-balance sheet loans			1,800						6,832																		9,725
Gross loans			5,743						8,667																		11,365
Total loans:
Off-balance sheet loans			18,104						19,358																		30,483
On-balance sheet loans			8,636						14,172																		26,279
Gross loans			$	26,740					$	33,530																	$	56,762

    The addition of specific reserves on impaired loans represents new specific reserves established when collateral shortfalls or government guaranty deficiencies 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. This amount is net of the release of any specific reserve that may have already been provided. 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 loss rate. Refer to Asset Quality, below, for further information regarding the overall credit quality of our loan and lease portfolio.

Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its potential effects on clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation’s loan portfolio.

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

Non-Interest Income

    Non-interest income was $6.3 million for both the three months ended June 30, 2021 and June 30, 2020. Non-interest income increased $783,000, or 6.1%, to $13.5 million for the six months ended June 30, 2021 compared to $12.7 million for the same period in 2020. Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream. Total non-interest income accounted for 22.6% and 24.1% of total revenues for the three and six months ended June 30, 2021, compared to 25.1% and 26.2% for the three and six months ended June 30, 2020. The decline in fee revenue compared to total revenue is primarily due to an increase in net interest income and a reduction in commercial loan swap fees. Management believes the continued gradual expansion of its SBA lending program and the geographic expansion of its private wealth management division in bank markets outside of South Central Wisconsin will allow the Corporation to sustain a strategic target of 25% over the long-term.

    The components of non-interest income were as follows:

						For the Three Months Ended June 30,																								For the Six Months Ended June 30,
						2021						2020						$ Change						% Change						2021						2020						$ Change						% Change
						(Dollars in Thousands)
Private wealth management services fee income						$	2,744					$	2,124					$	620					29.2		%				$	5,151					$	4,235					$	916					21.6		%
Gain on sale of SBA loans						1,203						574						629						109.6						2,281						839						1,442						171.9
Service charges on deposits						941						829						112						13.5						1,859						1,647						212						12.9
Loan fees						569						451						118						26.2						1,114						936						178						19.0
Increase in cash surrender value of bank-owned life insurance						350						377						(27)						(7.2)						699						672						27						4.0
Net loss on sale of securities						29						—						29						NM						29						(4)						33						NM
Swap fees						—						1,655						(1,655)						(100.0)						684						3,336						(2,652)						(79.5)
Other non-interest income						485						309						176						57.0						1,699						1,072						627						58.5
Total non-interest income						$	6,321					$	6,319					$	2					—						$	13,516					$	12,733					$	783					6.1
Fee income ratio(1)						22.6		%				25.1		%																24.1		%				26.2		%

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

    Private wealth management service fees increased $620,000, or 29.2%, and $916,000, or 21.6%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020. Private wealth management services fee income is primarily driven by the amount of assets under management and administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets. This increase was driven by growth in assets under management and administration attributable to both new client relationships and increased equity market values. As of June 30, 2021, private wealth and trust assets under management and administration totaled a record $2.564 billion, increasing $315.4 million, or 14.0%, compared to $2.249 billion as of December 31, 2020 and $691.0 million, or 36.9%, compared to $1.873 billion as of June 30, 2020.

    No commercial loan interest rate swap fee income was recognized for the three months ended June 30, 2021, compared to $1.7 million for the same period in 2020. Commercial loan interest rate swap fee income was $684,000 for the six months ended June 30, 2021, compared to $3.3 million for the six months ended June 30, 2020. We originate commercial real estate loans in which we offer clients a floating rate and an interest rate swap. The client’s swap is then offset with a counter-party dealer. The execution of these transactions generates swap fee income. The aggregate amortizing notional value of interest rate swaps with various borrowers was $637.0 million as of June 30, 2021, compared to $467.1 million as of June 30, 2020. Interest rate swaps can be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter.

    Gains on sale of SBA loans increased $629,000, or 109.6%, and $1.4 million, or 171.9%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020. Gross SBA loan commitments closed for the three and six months ended June 30, 2021 totaled $9.7 million and $19.4 million, respectively, compared to $18.1 million and $24.2 million for the same period in 2020. Management believes the gain on sale of traditional SBA loans, while variable based on timing of closings, will continue to increase annually at a measured pace.

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    Other non-interest income increased $176,000, or 57.0%, and $627,000, or 58.5%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020. The increase in both periods of comparison was primarily due to an increase in returns from the Corporation’s investments in mezzanine funds and an increase in bank consulting services fee income.

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

Non-Interest Expense    

Non-interest expense for the three months ended June 30, 2021 decreased by $159,000, or 0.9%, to $18.2 million compared to $18.3 million for the same period in 2020. Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased $2.5 million, or 16.2%, to $17.9 million for the three months ended June 30, 2021 compared to $15.4 million for the same period in 2020. Non-interest expense for the six months ended June 30, 2021 increased by $1.0 million, or 3.0%, to $35.5 million compared to $34.5 million for the same period in 2020. Operating expense increased $4.1 million, or 12.9%, to $35.4 million for the six months ended June 30, 2021 compared to $31.3 million for the same period in 2020. The increase in operating expense in both periods of comparison was primarily due to an increase in compensation, marketing, computer software, and FDIC insurance expense, partially offset by a decrease in other non-interest expense.    

The components of non-interest expense were as follows:

						For the Three Months Ended June 30,																											For the Six Months Ended June 30,
						2021						2020						$ Change						% Change									2021						2020						$ Change						% Change
						(Dollars in Thousands)
Compensation						$	13,255					$	10,796					$	2,459					22.8		%							$	25,912					$	21,848					$	4,064					18.6		%
Occupancy						533						554						(21)						(3.8)									1,085						1,126						(41)						(3.6)
Professional fees						913						859						54						6.3									1,778						1,678						100						6.0
Data processing						798						710						88						12.4									1,569						1,386						183						13.2
Marketing						511						352						159						45.2									902						813						89						10.9
Equipment						261						304						(43)						(14.1)									506						595						(89)						(15.0)
Computer software						1,129						966						163						16.9									2,244						1,856						388						20.9
FDIC insurance						280						239						41						17.2									642						448						194						43.3
Collateral liquidation costs						84						115						(31)						(27.0)									178						236						(58)						(24.6)
Net (gain) loss on foreclosed properties						(1)						348						(349)						NM									1						450						(449)						(99.8)
Impairment on tax credit investments						—						1,841						(1,841)						NM									—						1,954						(1,954)						(100.0)
SBA recourse (benefit) provision						245						(30)						275						NM									115						(5)						120						NM
Loss on early extinguishment of debt						—						744						(744)						NM									—						744						(744)						NM
Other non-interest expense						176						545						(369)						(67.7)									582						1,359						(777)						(57.2)
Total non-interest expense						$	18,184					$	18,343					$	(159)					(0.9)									$	35,514					$	34,488					$	1,026					3.0
Total operating expense(1)						$	17,932					$	15,431					$	2,501					16.2									$	35,383					$	31,327					$	4,056					12.9
Full-time equivalent employees						319						283																					319						283

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

    Compensation expense for the three and six months ended June 30, 2021 was $13.3 million, an increase of $2.5 million, or 22.8%, and $25.9 million, an increase of $4.1 million, or 18.6%, respectively, compared to the three and six months ended June 30, 2020. The increase in both periods of comparison reflects new hires, annual merit increases, growth in employee benefit costs, and an increase in the expected payout on annual corporate and individual incentive compensation plans. The annual corporate bonus and individual incentive compensation plans for the three and six months ended June 30, 2021 totaled $2.5 million and $4.1 million, respectively, due to strong Bank performance driven by effective business development efforts and continued improvement in credit, compared to $1.2 million and $2.2 million for three and six months ended June 30, 2020,

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respectively. Average full-time equivalent employees increased to 312, up 11.0% for the quarter ended June 30, 2021, compared to 281 for the quarter ended June 30, 2020. We expect to continue investing in talent, both in the form of additional business development and operational staff, to support our long-term strategic plan.

    Computer software expense increased $163,000, or 16.9%, and $388,000, or 20.9%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020. The increase was principally due to investments in and maintenance of technology platforms to improve the client experience and continuing our strategic focus on scaling the Corporation to efficiently execute our growth strategy.

Marketing expense increased $159,000, or 45.2%, and $89,000, or 10.9%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020. Management expects marketing expense to continue to increase modestly and return to pre-pandemic levels over the next several quarters primarily driven by sponsorships and business development activities.

FDIC insurance expense increased $41,000, or 17.2%, and $194,000, or 43.3%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020. Management expects FDIC insurance expense to increase commensurate with asset growth going forward.

    No historic tax credits or related impairment were recognized for the three and six months ended June 30, 2021. The impairment on tax credit investments for the three and six months ended June 30, 2020 are related to a new market and historic tax credits. The impairment on tax credits are more than offset by a reduction to income tax expense resulting in a net benefit to earnings in the year the credits are earned. Management intends to continue actively pursuing in-market tax credit opportunities throughout 2021 and beyond.

    SBA recourse provision expense totaled $245,000 and $115,000 for the three and six months ended June 30, 2021, respectively, compared to recourse benefit of $30,000 and $5,000 for the three and six months ended June 30, 2020, respectively. The total recourse reserve balance was $830,000, or 0.9% of total sold SBA loans outstanding, at June 30, 2021, compared to $723,000, or 0.9%, at December 31, 2020, and $1.0 million, or 1.4%, at June 30, 2020. Changes to SBA recourse reserves may be a source of non-interest expense volatility in future quarters, though the magnitude of this volatility should continue to diminish over time as the outstanding balance of sold legacy SBA loans continues to decline.

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

Other non-interest expense decreased $369,000, or 67.7%, and $777,000, or 57.2%, for the three and six months ended June 30, 2021, respectively, compared to the three and six months ended June 30, 2020. The decrease was principally due to a reduction in the credit valuation adjustment (“CVA”) related to the commercial loan interest rate swap program and a reduction in the loan servicing valuation adjustment related to the Bank’s SBA portfolio. The CVA represents a change in the market value of the Company’s commercial loan interest rate swaps to estimate potential borrower credit risk within the portfolio. The CVA can vary from period to period based on the size of the portfolio, credit metrics, and the interest rate environment in any given quarter. There was no CVA as of June 30, 2020.

Income Taxes

    Income tax expense totaled $5.6 million for the six months ended June 30, 2021 compared to an income tax benefit of $1.1 million for the six months ended June 30, 2020. The effective tax rate, excluding tax credits and other discrete items, for the six months ended June 30, 2021 was 23.6% compared to 18.6% for the six months ended June 30, 2020.

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Financial Condition

General

    Total assets increased by $297.8 million, or 11.6%, to $2.866 billion as of June 30, 2021 compared to $2.568 billion at December 31, 2020. The increase in total assets was primarily driven by short-term investments, partially offset by a decrease in securities and loans and leases receivable.

Short-Term Investments

    Short-term investments increased by $338.0 million to $365.4 million at June 30, 2021 from $27.4 million at December 31, 2020. The large increase in short-term investments was primarily due to the proceeds of a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in July, and PPP loan forgiveness proceeds. Excluding the temporary business sale proceeds, total short-term investments increased $113.1 million to $140.4 million. Our short-term investments primarily consist of interest-bearing deposits held at the FRB. We value the safety and soundness provided by the FRB and therefore incorporate short-term investments in our on-balance sheet liquidity program. In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio. Please refer to the section entitled Liquidity and Capital Resources for further discussion.

Securities

    Total securities, including available-for-sale and held-to-maturity, decreased by $16.7 million, or 7.9%, to $193.6 million at June 30, 2021 compared to $210.3 million at December 31, 2020. During the six months ended June 30, 2021 we recognized unrealized losses of $1.6 million before income taxes through other comprehensive income, compared to gains of $4.2 million for the same period in 2020. As of June 30, 2021 and December 31, 2020, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 5.6 years and 5.0 years, respectively. Our investment philosophy remains as stated in our most recent Annual Report on Form 10-K.

    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, data integrity validation primarily through comparison of current price to an expectation-based analysis of movement in prices based upon the changes in the related yield curves, and other market factors. No securities within our portfolio were deemed to be other-than-temporarily impaired as of June 30, 2021.

Loans and Leases Receivable    

    Loans and leases receivable, net of allowance for loan and lease losses, increased by $437,000 to $2.118 billion at June 30, 2021 from $2.117 billion at December 31, 2020 which was driven by commercial loan growth, partially offset by PPP loan forgiveness. Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by $105.0 million, or 11.1% annualized, to $1.997 billion at June 30, 2021 from December 31, 2020.

Excluding net PPP loans, C&I loans increased $67.7 million, or 26.7% annualized, to $574.7 million from $507.0 million at December 31, 2020 primarily due to a $59.9 million increase in loans from our specialized lending business lines. The majority of our specialized lending commercial banking business lines are early stage and faster growing while the more mature business lines, like asset-based lending, have historically experienced counter cyclical growth, growing during and following times of economic stress. Management expects specialized lending volume to continue to increase in 2021 and 2022 following the proactive investments made prior to and during the COVID-19 pandemic. Including net PPP loans, our C&I portfolio decreased $36.9 million to $695.4 million from $732.3 million at December 31, 2020.

Total commercial real estate (“CRE”) increased $32.9 million to $1.392 billion, up from $1.359 billion at December 31, 2020. Non-owner occupied CRE and multi-family loans were the largest contributors to CRE loan growth as of June 30, 2021, increasing $49.8 million, and $7.8 million, respectively, from December 31, 2020.

There continues to be a concentration in CRE loans which represented 68.7% and 70.6% of our total loans, excluding net PPP loans, as of June 30, 2021 and December 31, 2020, respectively. As of June 30, 2021, 18.2% of the CRE loans were owner-occupied CRE, compared to 18.7% as of December 31, 2020. We consider owner-occupied CRE more characteristic of the Corporation’s C&I portfolio as, in general, the client’s primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property. Management has elevated its underwriting standards during the

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COVID-19 pandemic to ensure business owners and guarantors have robust liquidity, operating performance, and collateral positions. Even with these higher standards, the Corporation has been able to grow loans and deepen banking relationships.

Underwriting of new credit is primarily through approval from a serial sign-off or committee process and is a key component of our operating philosophy. Business development officers have no individual lending authority limits, and thus, a significant portion of our new credit extensions require approval from a loan approval committee regardless of the type of loan or lease, amount of the credit, or the related complexities of each proposal. In addition, we make every reasonable effort to ensure that there is appropriate collateral or a government guarantee at the time of origination to protect our interest in the related loan or lease. To monitor the ongoing credit quality of our loans and leases, each credit is evaluated for proper risk rating using a nine grade risk rating system at the time of origination, subsequent renewal, evaluation of updated financial information from our borrowers, or as other circumstances dictate.

    While we continue to experience significant competition from banks operating in our primary geographic areas, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to expect our new loan and lease activity to be adequate to replace normal amortization, allowing us to continue growing in future years. 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.

Deposits

    As of June 30, 2021, deposits increased by $305.2 million, or 32.9% annualized, to $2.161 billion from $1.856 billion at December 31, 2020 primarily due to a $309.1 million and $43.6 million increase in transaction accounts and money market accounts, respectively, partially offset by a decrease in wholesale deposits and certificates of deposit of $28.0 million and $19.6 million, respectively. The large increase in deposits was primarily due to the proceeds of a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in July, and PPP forgiveness proceeds. Excluding the temporary deposits described above, total deposits increased $80.2 million to $1.936 billion, or 8.6% annualized. Excluding the temporary deposits, transaction and money market accounts increased $84.2 million. Period-end deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to maintain existing and new client relationships.

    Our strategic efforts remain focused on adding in-market deposit relationships. We measure the success of in-market deposit gathering efforts based on the number and average balances of our deposit accounts as compared to ending balances due to the volatility of some of our larger relationships. The Bank’s average in-market deposits, consisting of all transaction accounts, money market accounts, and certificates of deposit, were approximately $1.729 billion for the six months ended June 30, 2021, compared to $1.569 billion for the year ended December 31, 2020.

FHLB Advances and Other Borrowings

    As of June 30, 2021, FHLB advances and other borrowings increased by $946,000, or 0.5% annualized, to $420.1 million from $419.2 million at December 31, 2020. While total wholesale funding as a percentage of total bank funding has decreased meaningfully overall due to significant in-market deposit growth, we continue to replace the majority of our maturing brokered certificates of deposit with FHLB advances at lower rates, as needed, to match-fund fixed rate loans and mitigate interest rate risk. Total bank funding is defined as total deposits plus FHLB advances, and Federal Reserve Discount Window advances.

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

    During the second quarter of 2020, the Corporation tested its ability to borrow from the Federal Reserve PPPLF in the event funding was required to support the Banks PPP lending efforts. On April 28, 2020, the Corporation borrowed $29.6 million from the PPPLF at a rate of 0.35%. As of November 2, 2020, the borrowing was paid in full.

    Consistent with our funding philosophy to manage interest rate risk, we will use the most efficient and cost effective source of wholesale funds. We will utilize FHLB advances to the extent we maintain an adequate level of excess borrowing capacity for liquidity and contingency funding purposes and pricing remains favorable in comparison to the wholesale deposit alternative. We will use FHLB advances and/or brokered certificates of deposit in specific maturity periods needed, typically three to five years, to match-fund fixed rate loans and effectively mitigate the interest rate risk measured through our asset/liability management process and to support asset growth initiatives while taking into consideration our operating goals and desired level of usage of wholesale funds. Please refer to the section titled Liquidity and Capital Resources, below, for further information regarding our use and monitoring of wholesale funds.

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Derivatives

The Corporation’s derivative financial instruments, under which the Corporation is required to either receive cash from or pay cash to counterparties depending on changes in interest rates applied to notional amounts, are carried at fair value on the consolidated balance sheets. We offer interest rate swap products directly to qualified commercial borrowers, originating a floating rate loan and an interest rate swap providing a fixed rate to the borrower. The client’s swap is then offset with a counter-party dealer. The execution of these transactions generates swap fee income. The aggregate amortizing notional value of interest rate swaps with various borrowers increased $7.9 million, or 1.3%, to $637.0 million as of June 30, 2021, compared to $629.1 million as of December 31, 2020. The fair value of these interest rate swaps decreased $17.0 million, or 34.4%, to $32.4 million as of June 30, 2021, compared to $49.4 million as of December 31, 2020. The decline in fair value of the derivative contracts is directly related to the level of interest rates as of June 30, 2021, compared to the maturity term and amortization rates when the derivative contracts were originally executed.

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

Asset Quality

Impaired Assets

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

						June 30, 2021						December 31, 2020
						(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied						$	2,125					$	5,429
Commercial real estate - non-owner occupied						2,998						3,783
Land development						—						890
Construction						—						—
Multi-family						—						—
1-4 family						44						250
Total non-accrual commercial real estate						5,167						10,352
Commercial and industrial						6,160						16,155
Direct financing leases, net						49						49
Consumer and other:
Home equity and second mortgages						35						40
Other						11						21
Total non-accrual consumer and other loans						46						61
Total non-accrual loans and leases						11,422						26,617
Foreclosed properties, net						179						34
Total non-performing assets						11,601						26,651
Performing troubled debt restructurings						56						46
Total impaired assets						$	11,657					$	26,697
Total non-accrual loans and leases to gross loans and leases						0.53		%				1.24		%
Total non-performing assets to gross loans and leases plus foreclosed properties, net						0.54						1.24
Total non-performing assets to total assets						0.40						1.04
Allowance for loan and lease losses to gross loans and leases						1.20						1.33
Allowance for loan and lease losses to non-accrual loans and leases						224.79						107.15

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    Net PPP loans outstanding as of June 30, 2021 and December 31, 2020, were $120.7 million and $225.3 million, respectively. The following asset quality ratios exclude net PPP loans as they are fully guaranteed by the SBA:

						June 30, 2021						December 31, 2020
Total non-accrual loans and leases to gross loans and leases						0.56		%				1.38		%
Total non-performing assets to gross loans and leases plus foreclosed properties, net						0.57						1.38
Total non-performing assets to total assets						0.42						1.14
Allowance for loan and lease losses to gross loans and leases						1.27						1.48

Non-accrual loans decreased $15.2 million, or 57.1%, to $11.4 million at June 30, 2021, compared to $26.6 million at December 31, 2020. The decrease in non-accrual loans was principally due to loan payoffs, loans returning to accrual status, and $3.0 million of charge-offs, of which $2.2 million was from the legacy SBA portfolio and $471,000 from the small ticket vendor finance program. All charge-offs for the six months ended June 30, 2021 were previously identified impaired loans, unrelated to the economic slowdown from the COVID-19 pandemic. Management does not view these charge-offs as being indicative of any systemic issues across the Corporation’s loan and lease portfolio. The Corporation’s non-accrual loans as a percentage of total gross loans and leases measured 0.53% and 1.24% at June 30, 2021 and December 31, 2020, respectively. Non-accrual loans as a percentage of total gross loans and leases, excluding net PPP loans, was 0.56% and 1.38% at June 30, 2021 and December 31, 2020, respectively. As of June 30, 2021 and December 31, 2020, $523,000 and $6.5 million of non-accrual loans and leases were considered troubled debt restructurings, respectively. Please refer to the section titled COVID-19 Update for additional information on credit quality.    

    We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio. Non-performing assets as a percentage of total assets decreased to 0.40% at June 30, 2021 from 1.04% at December 31, 2020. As of June 30, 2021, the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.9% of the total portfolio was in a current payment status, compared to 99.0% as of December 31, 2020. We also monitor asset quality through our established categories as defined in Note 6 – Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses of the Consolidated Financial Statements. 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 are proactively working with our impaired loan borrowers to find meaningful solutions to difficult situations that are in the best interests of the Bank.

    As of June 30, 2021, as well as in all previous reporting periods, there were no loans over 90 days past due and still accruing interest. Loans and leases greater than 90 days past due are considered impaired and are placed on non-accrual status. Cash received while a loan or a lease is on non-accrual status is generally applied solely against the outstanding principal. If collectability of the contractual principal and interest is not in doubt, payments received may be applied to both interest due on a cash basis and principal.

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

						As of and for the Six Months Ended June 30,												As of and for the Year Ended December 31,
						2021						2020						2020
						(In Thousands)
Impaired loans and leases with no impairment reserves required						$	7,948					$	10,742					$	18,966
Impaired loans and leases with impairment reserves required						3,530						13,402						7,697
Total impaired loans and leases						11,478						24,144						26,663
Less: Impairment reserve (included in allowance for loan and lease losses)						2,021						5,924						3,681
Net impaired loans and leases						$	9,457					$	18,220					$	22,982
Average impaired loans and leases						$	19,420					$	23,847					$	27,703
Foregone interest income attributable to impaired loans and leases						$	1,081					$	1,114					$	2,794
Less: Interest income recognized on impaired loans and leases						153						458						636
Net foregone interest income on impaired loans and leases						$	928					$	656					$	2,158

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

						As of and for the Six Months Ended June 30,												As of and for the Year Ended December 31,
						2021						2020						2020
						(In Thousands)
Balance at the beginning of the period						$	34					$	2,919					$	2,919
Transfer of loans and leases to foreclosed properties						149						80						80
Proceeds from sale of foreclosed properties						—						(1,160)						(2,582)
Net loss on sale of foreclosed properties						—						(54)						(20)
Impairment adjustments						(4)						(396)						(363)
Balance at the end of the period						$	179					$	1,389					$	34

Allowance for Loan and Lease Losses

    The allowance for loan and lease losses decreased $2.8 million, or 10.0%, from $28.5 million as of December 31, 2020 to $25.7 million as of June 30, 2021. The allowance for loan and lease losses as a percentage of gross loans and leases decreased from 1.33% as of December 31, 2020 to 1.20% as of June 30, 2021. The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.27% as of June 30, 2021 compared to 1.47% as of December 31, 2020. The decrease in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by a significant commercial real estate loan recovery during the first quarter of 2021, and the related impact it had on our commercial real estate historical loss factors, and the release of specific reserves following loan payoffs and charge-offs. These general and specific reserve releases were partially offset primarily by an increase in general reserve commensurate with loan growth.

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

    During the six months ended June 30, 2021, we recorded net recoveries on impaired loans and leases of $180,000, comprised of $3.0 million of charge-offs and $3.2 million of recoveries. While we likely will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed, management believes charge-offs in the foreseeable future will be at lower levels based on our total non-accrual loans and leases as a percentage of gross loans and leases of 0.53% at June 30, 2021, is the Corporation’s lowest level of non-accrual loans since the fourth quarter of 2006. Loans and leases with previously established specific reserves, however, may ultimately result in a charge-off under a variety of scenarios.

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    As of June 30, 2021 and December 31, 2020, our ratio of allowance for loan and lease losses to total non-accrual loans and leases was 224.79% and 107.15%, respectively. This ratio continues to increase due to the significant decline in non-accrual loans and as our remaining non-accrual loan and lease portfolio has a larger proportion of SBA loans when compared to December 31, 2020, which historically carry larger collateral shortfalls when compared to our conventional commercial loans. Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. 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 try to ensure that we have sufficient 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 with certainty that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease loss to non-accrual loans and leases ratio as compared to our peers or industry expectations. As asset quality strengthens, 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 would therefore expect this ratio to rise. Conversely, if we identify further impaired loans, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as of June 30, 2021.

    To determine the level and composition of the allowance for loan and lease losses, we break out the portfolio by segments with similar risk characteristics. First, we evaluate loans and leases for potential impairment classification. We analyze each loan and lease identified as 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. For each segment of loans and leases that has not been individually evaluated, management segregates the Bank’s loss factors into a quantitative general reserve component based on historical loss rates throughout the defined look back period. The quantitative general reserve component also considers an estimate of the historical loss emergence period, which is the period of time between the event that triggers the loss to the charge-off of that loss. The methodology also focuses on evaluation of several qualitative factors for each portfolio category, including but not limited to: management’s ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, existing economic conditions, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations of loans to specific industries, and other qualitative factors that could affect credit losses such as the economic uncertainty related to the COVID-19 pandemic. As of June 30, 2021, the allowance for loan and lease losses included $726,000 in general reserve related to economic uncertainty, compared to $947,000 as of December 31, 2020. Management removed qualitative factors due to COVID-19 uncertainty from the majority of our specialized lending and commercial and industrial portfolios reflecting continued strong performance while maintaining a general reserve on industries previously identified as stressed, specifically hospitality and retail.

    When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for loan and lease loss reserve to bring the loan or lease to its net realizable value. Many of the impaired loans as of June 30, 2021 are collateral dependent. It is typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment at least annually, or more frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, we have found that in general real estate values have been stable or improved; however, in specific situations current fair values collateralizing certain impaired loans were inadequate to support the entire amount of the outstanding debt. Foreclosure actions may have been initiated on certain of these commercial real estate and other mortgage loans.

    As a result of our review process, we have concluded an appropriate allowance for loan and lease losses for the existing loan and lease portfolio was $25.7 million, or 1.20% of gross loans and leases, at June 30, 2021. However, given ongoing complexities with current workout situations and the uncertainty surrounding future economic conditions, further charge-offs, and increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion. In addition, various federal and state regulatory agencies review the allowance for loan and lease losses. These agencies could require certain loan and lease balances to be classified differently or charged off when 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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    A summary of the activity in the allowance for loan and lease losses follows:

						As of and for the Three Months Ended June 30,												As of and for the Six Months Ended June 30,
						2021						2020						2021						2020
						(Dollars in Thousands)
Allowance at beginning of period						$	28,982					$	22,748					$	28,521					$	19,520
Charge-offs:
Commercial real estate:
Commercial real estate — owner occupied						(4)						(27)						(4)						(27)
Commercial real estate — non-owner occupied						—						—						—						—
Construction and land development						—						—						—						—
Multi-family						—						—						—						—
1-4 family						(245)						—						(245)						—
Commercial and industrial						(2,621)						(729)						(2,765)						(854)
Direct financing leases						—						(55)						—						(55)
Consumer and other:
Home equity and second mortgages						—						—						—						—
Other						(24)						(6)						(24)						(12)
Total charge-offs						(2,894)						(817)						(3,038)						(948)
Recoveries:
Commercial real estate:
Commercial real estate — owner occupied						84						—						225						1
Commercial real estate — non-owner occupied						—						2						—						2
Construction and land development						—						—						2,078						—
Multi-family						—						—						—						—
1-4 family						—						—						—						—
Commercial and industrial						460						62						913						238
Direct financing leases						—						—						—						—
Consumer and other:
Home equity and second mortgages						—						—						1						—
Other						1						—						1						—
Total recoveries						545						64						3,218						241
Net recoveries						(2,349)						(753)						180						(707)
Provision for loan and lease losses						(958)						5,469						(3,026)						8,651
Allowance at end of period						$	25,675					$	27,464					$	25,675					$	27,464
Annualized net charge-offs (recoveries) as a percent of average gross loans and leases						0.42		%				0.15		%				(0.02)		%				0.08		%
Annualized net charge-offs (recoveries) as a percent of average gross loans and leases, excluding average net PPP loans						0.47		%				0.17		%				(0.02)		%				0.08		%

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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 Bank. While the Bank is subject to certain generally applicable regulatory limitations regarding its ability to pay dividends to the Corporation, we do not believe that the Corporation will be adversely affected by these dividend limitations. The Corporation’s principal liquidity requirements at June 30, 2021 were the interest payments due on subordinated and junior subordinated notes. On April 30, 2021, the Bank’s Board of Directors declared a dividend in the aggregate amount of $2.5 million bringing year-to-date dividend declarations to $4.5 million. The capital ratios of the Bank met all applicable regulatory capital adequacy requirements in effect on June 30, 2021, and continue to meet the heightened requirements imposed by Basel III, including the capital conservation buffer that was fully phased-in as of January 1, 2019. The Corporation’s Board and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.

    The Bank maintains liquidity by obtaining funds from several sources. The Bank’s primary source of funds are principal and interest payments on loans receivable and mortgage-related securities, deposits, and other borrowings, such as federal funds, FHLB advances, and Federal Reserve Discount Window 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 available-for-sale, and our unencumbered pledged loans. As of June 30, 2021 and December 31, 2020, our immediate on-balance sheet liquidity was $829.0 million and $640.2 million, respectively. The increase as of June 30, 2021 compared to December 31, 2020 was principally due to the proceeds from a commercial client’s business sale late in the second quarter, the majority of which was moved off the balance sheet in July, and PPP forgiveness proceeds. Immediate on-balance sheet liquidity as of December 31, 2020 included $225.3 million of availability from the Federal Reserve’s PPPLF advance program. Excluding the temporary proceeds from the commercial client’s business sale and the PPPLF advance program, immediate on-balance sheet liquidity was $604.0 million and $414.9 million as of June 30, 2021 and December 31, 2020, respectively. This increase in on-balance sheet liquidity compared to December 31, 2020 is primarily due to excess cash held at the FRB due to PPP loan forgiveness proceeds. At June 30, 2021 and December 31, 2020, the Bank had $364.5 million and $26.7 million on deposit with the FRB recorded in short-term investments, respectively. Any excess funds not used for loan funding or satisfying other cash obligations were maintained as part of our on-balance sheet liquidity in our interest-bearing accounts with the FRB, as we value the safety and soundness provided by the FRB. We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow run off of maturing wholesale certificates of deposit or invest in securities to maintain adequate liquidity at an improved margin.

    We had $532.3 million of outstanding wholesale funds at June 30, 2021, compared to $567.0 million of wholesale funds as of December 31, 2020, which represented 20.9% and 25.2%, respectively, of ending balance total bank funding. Wholesale funds include FHLB advances, brokered certificates of deposit, deposits gathered from reciprocal deposit programs above the general cap if, applicable, and receive only deposits from reciprocal deposit programs. Total bank funding is defined as total deposits plus FHLB advances. We are committed to raising in-market deposits while utilizing wholesale funds to mitigate interest rate risk. Wholesale funds continue to be an efficient and cost effective source of funding for the Bank and allows it 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.

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

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certificates of deposit do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual maturity terms. The Bank limits the percentage of wholesale funds to total bank funds in accordance with liquidity policies approved by its Board. The Bank was in compliance with its policy limits as of June 30, 2021.

    The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the year ended June 30, 2021. In the event that there is a disruption in the availability of wholesale funds at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through on-balance sheet liquidity. These potential funding sources include deposits maintained at the FRB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As of June 30, 2021, the available liquidity was in excess of the stated policy minimum. We believe the Bank will also have access to the unused federal funds lines, cash flows from borrower repayments, and cash flows from security maturities. The Bank also has the ability to raise local market deposits by offering attractive rates to generate the level required to fulfill its liquidity needs.

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

The Corporation's capital ratios continued to exceed the highest required regulatory benchmark levels. As of June 30, 2021, total capital to risk-weighted assets was 11.22%, tier 1 capital to risk-weighted assets was 9.14%, tier 1 leverage capital to adjusted average assets was 8.48% and common equity tier 1 capital to risk-weighted assets was 8.72%. In addition, as of June 30, 2021, tangible common equity to tangible assets was 7.33%.

As of July 29, 2021, the Corporation had purchased 46,513 shares of its common stock, since the adoption of its previously disclosed stock repurchase program, at a weighted average price of $26.53 per share, for a total value of $1.2 million. The Corporation had $3.8 million of buyback authority remaining under the program as of July 29, 2021.

As previously announced, during the second quarter of 2021, the Corporation’s Board of Directors declared a regular quarterly dividend of $0.18 per share. The dividend was paid on May 24, 2021 to stockholders of record at the close of business on May 10, 2021. Measured against second quarter 2021 diluted earnings per share of $0.95, the dividend represents a 18.9% payout ratio. The Board of Directors routinely considers dividend declarations as part of its normal course of business.

    During the six months ended June 30, 2021, operating activities resulted in a net cash inflow of $15.0 million, which included net income of $18.0 million, partially offset by a $3.0 million provision for loan and lease loss benefit. Net cash provided by investing activities for the six months ended June 30, 2021 was $15.9 million primarily due to proceeds received from the sale of securities available for sale. Net cash provided by financing activities was $302.2 million for the six months ended June 30, 2021 primarily due to a net increase in deposits, partially offset by a net reduction in FHLB advances and cash dividends paid. Please refer to the Consolidated Statements of Cash Flows included in PART I., Item 1 for further details regarding significant sources of cash flow for the Corporation.

Contractual Obligations and Off-Balance Sheet Arrangements

    As of June 30, 2021, there were no material changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020. We continue to believe that we have adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

    Not applicable.

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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 June 30, 2021.

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 June 30, 2021 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, 2020.

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.

Item 5. Other Information

None.

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Item 6. Exhibits

10.1						Amendment to the First Business Financial Services, Inc. 2019 Equity Incentive Plan (incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement filed with the Securities and Exchange Commission on Schedule 14A on March 9, 2021 (File No. 001-34095)).
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 June 30, 2021, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2021 and December 31, 2020, (ii) Consolidated Statements of Income for the three and six months ended June 30, 2021 and 2020, (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2021 and 2020, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three and six months ended June 30, 2021 and 2020, (v) Consolidated Statements of Cash Flows for the three and six months ended June 30, 2021 and 2020, 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.
July 30, 2021			/s/ Corey A. Chambas
			Corey A. Chambas
			Chief Executive Officer
July 30, 2021			/s/ Edward G. Sloane, Jr.
			Edward G. Sloane, Jr.
			Chief Financial Officer
			(principal financial officer)

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