10-Q 1 fbiz2019930-10qq32019.htm FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

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

For the quarterly period ended September 30, 2019
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, Madison, WI |  | 53719
(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 and such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company, 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 þ |  | 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 October 18, 2019 was 8,589,422 shares.

Table of Contents
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) | 4
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) | 5
Consolidated Statements of Cash Flows (Unaudited) | 7
Notes to Unaudited Consolidated Financial Statements | 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 38
Item 3. Quantitative and Qualitative Disclosures about Market Risk | 57
Item 4. Controls and Procedures | 58
PART II. Other Information | 58
Item 1. Legal Proceedings | 58
Item 1A. Risk Factors | 58
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | 58
Item 3. Defaults Upon Senior Securities | 58
Item 4. Mine Safety Disclosures | 59
Item 5. Other Information | 59
Item 6. Exhibits | 60
Signatures | 60

Table of Contents
PART I. Financial Information
Item 1. Financial Statements
First Business Financial Services, Inc.
Consolidated Balance Sheets

|  | September 30, 2019 |  | December 31, 2018
|  | (Unaudited) |  |
| (In Thousands, Except Share Data)
Assets |  |  |  |
Cash and due from banks |  | $ | 33,594 |  |  | $ | 23,319 |
Short-term investments |  | 27,364 |  |  | 63,227 |
Cash and cash equivalents |  | 60,958 |  |  | 86,546 |
Securities available-for-sale, at fair value |  | 160,665 |  |  | 138,358 |
Securities held-to-maturity, at amortized cost |  | 33,400 |  |  | 37,731 |
Loans held for sale |  | 3,070 |  |  | 5,287 |
Loans and leases receivable, net of allowance for loan and lease losses of $20,170 and $20,425, respectively |  | 1,700,372 |  |  | 1,597,230 |
Premises and equipment, net |  | 2,740 |  |  | 3,284 |
Foreclosed properties |  | 2,902 |  |  | 2,547 |
Right-of-use assets |  | 7,524 |  |  | — |
Bank-owned life insurance |  | 42,432 |  |  | 41,538 |
Federal Home Loan Bank stock, at cost |  | 8,315 |  |  | 7,240 |
Goodwill and other intangible assets |  | 11,946 |  |  | 12,045 |
Accrued interest receivable and other assets |  | 58,469 |  |  | 34,651 |
Total assets |  | $ | 2,092,793 |  |  | $ | 1,966,457 |
Liabilities and Stockholders’ Equity |  |  |  |
Deposits |  | $ | 1,508,816 |  |  | $ | 1,455,299 |
Federal Home Loan Bank advances and other borrowings |  | 332,897 |  |  | 298,944 |
Junior subordinated notes |  | 10,044 |  |  | 10,033 |
Lease liabilities |  | 7,866 |  |  | — |
Accrued interest payable and other liabilities |  | 42,378 |  |  | 21,474 |
Total liabilities |  | 1,902,001 |  |  | 1,785,750 |
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, 9,157,010 and 9,069,199 shares issued, 8,636,085 and 8,785,480 shares outstanding at September 30, 2019 and December 31, 2018, respectively |  | 92 |  |  | 91 |
Additional paid-in capital |  | 80,740 |  |  | 79,623 |
Retained earnings |  | 124,628 |  |  | 110,310 |
Accumulated other comprehensive loss |  | (1,655 | ) |  | (1,684 | )
Treasury stock, 520,925 and 283,719 shares at September 30, 2019 and December 31, 2018, respectively, at cost |  | (13,013 | ) |  | (7,633 | )
Total stockholders’ equity |  | 190,792 |  |  | 180,707 |
Total liabilities and stockholders’ equity |  | $ | 2,092,793 |  |  | $ | 1,966,457 |

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 September 30, |  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | 2019 |  | 2018
|  | (In Thousands, Except Per Share Data)
Interest income |  |  |  |  |  |  |  |
Loans and leases |  | $ | 23,922 |  |  | $ | 22,266 |  |  | $ | 72,033 |  |  | $ | 63,171 |
Securities |  | 1,194 |  |  | 1,002 |  |  | 3,464 |  |  | 2,796 |
Short-term investments |  | 322 |  |  | 295 |  |  | 930 |  |  | 787 |
Total interest income |  | 25,438 |  |  | 23,563 |  |  | 76,427 |  |  | 66,754 |
Interest expense |  |  |  |  |  |  |  |
Deposits |  | 6,006 |  |  | 4,232 |  |  | 18,060 |  |  | 10,271 |
Federal Home Loan Bank advances and other borrowings |  | 2,376 |  |  | 1,957 |  |  | 6,153 |  |  | 5,424 |
Junior subordinated notes |  | 280 |  |  | 280 |  |  | 832 |  |  | 832 |
Total interest expense |  | 8,662 |  |  | 6,469 |  |  | 25,045 |  |  | 16,527 |
Net interest income |  | 16,776 |  |  | 17,094 |  |  | 51,382 |  |  | 50,227 |
Provision for loan and lease losses |  | 1,349 |  |  | (546 | ) |  | 613 |  |  | 4,508 |
Net interest income after provision for loan and lease losses |  | 15,427 |  |  | 17,640 |  |  | 50,769 |  |  | 45,719 |
Non-interest income |  |  |  |  |  |  |  |
Trust and investment service fees |  | 2,060 |  |  | 1,941 |  |  | 6,125 |  |  | 5,826 |
Gain on sale of Small Business Administration loans |  | 454 |  |  | 641 |  |  | 993 |  |  | 1,184 |
Service charges on deposits |  | 795 |  |  | 788 |  |  | 2,314 |  |  | 2,292 |
Loan fees |  | 439 |  |  | 459 |  |  | 1,316 |  |  | 1,375 |
Increase in cash surrender value of bank-owned life insurance |  | 305 |  |  | 301 |  |  | 894 |  |  | 890 |
Net loss on sale of securities |  | (4 | ) |  | — |  |  | (5 | ) |  | — |
Commercial loan swap fees |  | 374 |  |  | 306 |  |  | 1,898 |  |  | 1,009 |
Other non-interest income |  | 1,369 |  |  | 435 |  |  | 2,699 |  |  | 943 |
Total non-interest income |  | 5,792 |  |  | 4,871 |  |  | 16,234 |  |  | 13,519 |
Non-interest expense |  |  |  |  |  |  |  |
Compensation |  | 10,324 |  |  | 9,819 |  |  | 30,991 |  |  | 28,006 |
Occupancy |  | 580 |  |  | 560 |  |  | 1,730 |  |  | 1,632 |
Professional fees |  | 751 |  |  | 1,027 |  |  | 2,745 |  |  | 2,990 |
Data processing |  | 654 |  |  | 512 |  |  | 1,923 |  |  | 1,748 |
Marketing |  | 548 |  |  | 593 |  |  | 1,611 |  |  | 1,518 |
Equipment |  | 277 |  |  | 403 |  |  | 938 |  |  | 1,089 |
Computer software |  | 859 |  |  | 814 |  |  | 2,485 |  |  | 2,235 |
FDIC insurance |  | 1 |  |  | 457 |  |  | 595 |  |  | 1,125 |
Collateral liquidation costs |  | 110 |  |  | 230 |  |  | 108 |  |  | 454 |
Net loss on foreclosed properties |  | 262 |  |  | 30 |  |  | 241 |  |  | 30 |
Tax credit investment (recovery) impairment |  | (120 | ) |  | 113 |  |  | 3,982 |  |  | 554 |
SBA recourse (benefit) provision |  | (427 | ) |  | 314 |  |  | 167 |  |  | 118 |
Other non-interest expense |  | 897 |  |  | 874 |  |  | 2,406 |  |  | 2,621 |
Total non-interest expense |  | 14,716 |  |  | 15,746 |  |  | 49,922 |  |  | 44,120 |
Income before income tax expense (benefit) |  | 6,503 |  |  | 6,765 |  |  | 17,081 |  |  | 15,118 |
Income tax expense (benefit) |  | 1,418 |  |  | 1,464 |  |  | (475 | ) |  | 2,879 |
Net income |  | $ | 5,085 |  |  | $ | 5,301 |  |  | $ | 17,556 |  |  | $ | 12,239 |

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Earnings per common share |  |  |  |  |  |  |  |
Basic |  | $ | 0.59 |  |  | $ | 0.60 |  |  | $ | 2.01 |  |  | $ | 1.40 |
Diluted |  | 0.59 |  |  | 0.60 |  |  | 2.01 |  |  | 1.40 |
Dividends declared per share |  | 0.15 |  |  | 0.14 |  |  | 0.45 |  |  | 0.42 |

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 September 30, |  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | 2019 |  | 2018
|  | (In Thousands)
Net income |  | $ | 5,085 |  |  | $ | 5,301 |  |  | $ | 17,556 |  |  | $ | 12,239 |
Other comprehensive income, before tax |  |  |  |  |  |  |  |
Securities available-for-sale: |  |  |  |  |  |  |  |
Unrealized securities gains (losses) arising during the period |  | 68 |  |  | (634 | ) |  | 3,307 |  |  | (2,524 | )
Securities held-to-maturity: |  |  |  |  |  |  |  |
Amortization of net unrealized losses transferred from available-for-sale |  | 14 |  |  | 18 |  |  | 42 |  |  | 54 |
Interest rate swaps: |  |  |  |  |  |  |  |
Unrealized (losses) gains on interest rate swaps arising during the period |  | (846 | ) |  | 382 |  |  | (3,310 | ) |  | 1,412 |
Income tax benefit (expense) |  | 195 |  |  | 58 |  |  | (10 | ) |  | 296 |
Total other comprehensive (loss) income |  | (569 | ) |  | (176 | ) |  | 29 |  |  | (762 | )
Comprehensive income |  | $ | 4,516 |  |  | $ | 5,125 |  |  | $ | 17,585 |  |  | $ | 11,477 |

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, 2018 |  | 8,763,539 |  |  | $ | 90 |  |  | $ | 78,620 |  |  | $ | 98,906 |  |  | $ | (1,238 | ) |  | $ | (7,100 | ) |  | $ | 169,278 |
Net income |  | — |  |  | — |  |  | — |  |  | 3,649 |  |  | — |  |  | — |  |  | 3,649 |
Other comprehensive loss |  | — |  |  | — |  |  | — |  |  | — |  |  | (503 | ) |  | — |  |  | (503 | )
Share-based compensation - restricted shares, net |  | 1,055 |  |  | — |  |  | 286 |  |  | — |  |  | — |  |  | — |  |  | 286 |
Cash dividends ($0.14 per share) |  | — |  |  | — |  |  | — |  |  | (1,226 | ) |  | — |  |  | — |  |  | (1,226 | )
Treasury stock purchased |  | (174 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | (4 | ) |  | (4 | )
Balance at March 31, 2018 |  | 8,764,420 |  |  | 90 |  |  | 78,906 |  |  | 101,329 |  |  | (1,741 | ) |  | (7,104 | ) |  | 171,480 |
Net income |  | — |  |  | — |  |  | — |  |  | 3,289 |  |  | — |  |  | — |  |  | 3,289 |
Other comprehensive loss |  | — |  |  | — |  |  | — |  |  | — |  |  | (83 | ) |  | — |  |  | (83 | )
Share-based compensation - restricted shares, net |  | (4,087 | ) |  | — |  |  | 220 |  |  | — |  |  | — |  |  | — |  |  | 220 |
Cash dividends ($0.14 per share) |  | — |  |  | — |  |  | — |  |  | (1,227 | ) |  | — |  |  | — |  |  | (1,227 | )
Treasury stock purchased |  | (230 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | (7 | ) |  | (7 | )
Balance at June 30, 2018 |  | 8,760,103 |  |  | 90 |  |  | 79,126 |  |  | 103,391 |  |  | (1,824 | ) |  | (7,111 | ) |  | 173,672 |
Net income |  | — |  |  | — |  |  | — |  |  | 5,301 |  |  | — |  |  | — |  |  | 5,301 |
Other comprehensive loss |  | — |  |  | — |  |  | — |  |  | — |  |  | (176 | ) |  | — |  |  | (176 | )
Share-based compensation - restricted shares, net |  | 45,831 |  |  | 1 |  |  | 243 |  |  | — |  |  | — |  |  | — |  |  | 244 |
Cash dividends ($0.14 per share) |  | — |  |  | — |  |  | — |  |  | (1,232 | ) |  | — |  |  | — |  |  | (1,232 | )
Treasury stock purchased |  | (11,993 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | (267 | ) |  | (267 | )
Balance at September 30, 2018 |  | 8,793,941 |  |  | $ | 91 |  |  | $ | 79,369 |  |  | $ | 107,460 |  |  | $ | (2,000 | ) |  | $ | (7,378 | ) |  | $ | 177,542 |

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|  | Common Shares Outstanding |  | Common Stock |  | Additional Paid-in Capital |  | Retained Earnings |  | Accumulated Other Comprehensive Loss (Income) |  | Treasury Stock |  | Total
|  | (In Thousands, Except Share Data)
Balance at January 1, 2019 |  | 8,785,480 |  |  | $ | 91 |  |  | $ | 79,623 |  |  | $ | 110,310 |  |  | $ | (1,684 | ) |  | $ | (7,633 | ) |  | $ | 180,707 |
Cumulative effect of adoption of ASC Topic 842 |  | — |  |  | — |  |  | — |  |  | 687 |  |  | — |  |  | — |  |  | 687 |
Net income |  | — |  |  | — |  |  | — |  |  | 5,899 |  |  | — |  |  | — |  |  | 5,899 |
Other comprehensive income |  | — |  |  | — |  |  | — |  |  | — |  |  | 279 |  |  | — |  |  | 279 |
Share-based compensation - restricted shares, net |  | 49,730 |  |  | — |  |  | 318 |  |  | — |  |  | — |  |  | — |  |  | 318 |
Cash dividends ($0.15 per share) |  | — |  |  | — |  |  | — |  |  | (1,312 | ) |  | — |  |  | — |  |  | (1,312 | )
Treasury stock purchased |  | (70,074 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | (1,478 | ) |  | (1,478 | )
Balance at March 31, 2019 |  | 8,765,136 |  |  | 91 |  |  | 79,941 |  |  | 115,584 |  |  | (1,405 | ) |  | (9,111 | ) |  | 185,100 |
Net income |  | — |  |  | — |  |  | — |  |  | 6,572 |  |  | — |  |  | — |  |  | 6,572 |
Other comprehensive income |  | — |  |  | — |  |  | — |  |  | — |  |  | 319 |  |  | — |  |  | 319 |
Share-based compensation - restricted shares, net |  | 31,151 |  |  | — |  |  | 410 |  |  | — |  |  | — |  |  | — |  |  | 410 |
Cash dividends ($0.15 per share) |  | — |  |  | — |  |  | — |  |  | (1,315 | ) |  | — |  |  | — |  |  | (1,315 | )
Treasury stock purchased |  | (96,831 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | (2,231 | ) |  | (2,231 | )
Balance at June 30, 2019 |  | 8,699,456 |  |  | 91 |  |  | 80,351 |  |  | 120,841 |  |  | (1,086 | ) |  | (11,342 | ) |  | 188,855 |
Net income |  | — |  |  | — |  |  | — |  |  | 5,085 |  |  | — |  |  | — |  |  | 5,085 |
Other comprehensive loss |  | — |  |  | — |  |  | — |  |  | — |  |  | (569 | ) |  | — |  |  | (569 | )
Share-based compensation - restricted shares, net |  | 6,930 |  |  | 1 |  |  | 389 |  |  | — |  |  | — |  |  | — |  |  | 390 |
Cash dividends ($0.15 per share) |  | — |  |  | — |  |  | — |  |  | (1,298 | ) |  | — |  |  | — |  |  | (1,298 | )
Treasury stock purchased |  | (70,301 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | (1,671 | ) |  | (1,671 | )
Balance at September 30, 2019 |  | 8,636,085 |  |  | $ | 92 |  |  | $ | 80,740 |  |  | $ | 124,628 |  |  | $ | (1,655 | ) |  | $ | (13,013 | ) |  | $ | 190,792 |

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 Nine Months Ended September 30,
|  | 2019 |  | 2018
|  | (In Thousands)
Operating activities |  |  |  |
Net income |  | $ | 17,556 |  |  | $ | 12,239 |
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |
Deferred income taxes, net |  | 105 |  |  | 382 |
Impairment of tax credit investments |  | 3,982 |  |  | 554 |
Provision for loan and lease losses |  | 613 |  |  | 4,508 |
SBA recourse provision |  | 167 |  |  | 118 |
Depreciation, amortization and accretion, net |  | 2,252 |  |  | 1,099 |
Share-based compensation |  | 1,118 |  |  | 750 |
Net loss on sale of available-for-sale securities |  | 5 |  |  | — |
Gain on sale of a state tax credit |  | (206 | ) |  | — |
Increase in value of bank-owned life insurance policies |  | (894 | ) |  | (890 | )
Origination of loans for sale |  | (39,799 | ) |  | (68,246 | )
Sale of loans originated for sale |  | 43,009 |  |  | 66,912 |
Gain on sale of SBA loans originated for sale |  | (993 | ) |  | (1,184 | )
Net loss on foreclosed properties, including impairment valuation |  | 241 |  |  | 30 |
Loan servicing right impairment valuation |  | 25 |  |  | 69 |
Excess tax benefit from share-based compensation |  | (74 | ) |  | (43 | )
Payments on operating leases |  | (1,143 | ) |  | — |
Net increase in accrued interest receivable and other assets |  | (24,918 | ) |  | (1,242 | )
Net increase in accrued interest payable and other liabilities |  | 19,710 |  |  | 4,827 |
Net cash provided by operating activities |  | 20,756 |  |  | 19,883 |
Investing activities |  |  |  |
Proceeds from maturities, redemptions, and paydowns of available-for-sale securities |  | 21,225 |  |  | 26,719 |
Proceeds from maturities, redemptions, and paydowns of held-to-maturity securities |  | 4,282 |  |  | 2,655 |
Proceeds from sale of available-for-sale securities |  | 15,249 |  |  | — |
Purchases of available-for-sale securities |  | (55,608 | ) |  | (38,486 | )
Purchases of held-to-maturity securities |  | — |  |  | (4,867 | )
Net increase in loans and leases |  | (104,229 | ) |  | (100,185 | )
Investments in limited partnerships |  | (1,250 | ) |  | — |
Returns of investments in limited partnerships |  | 1,499 |  |  | 729 |
Investment in historic development entities |  | (4,505 | ) |  | (905 | )
Investment in Federal Home Loan Bank stock |  | (4,700 | ) |  | (8,118 | )
Proceeds from the sale of Federal Home Loan Bank stock |  | 3,625 |  |  | 6,898 |
Purchases of leasehold improvements and equipment, net |  | (108 | ) |  | (720 | )
Net cash used in investing activities |  | (124,520 | ) |  | (116,280 | )
Financing activities |  |  |  |
Net increase in deposits |  | 53,517 |  |  | 14,572 |
Repayment of Federal Home Loan Bank advances |  | (401,000 | ) |  | (698,600 | )
Proceeds from Federal Home Loan Bank advances |  | 435,000 |  |  | 772,100 |
Repayment of subordinated notes payable |  | (15,000 | ) |  | — |
Proceeds from issuance of subordinated notes payable |  | 15,000 |  |  | — |
Net (decrease) increase in long-term borrowed funds |  | (36 | ) |  | 42 |
Cash dividends paid |  | (3,925 | ) |  | (3,685 | )
Purchase of treasury stock |  | (5,380 | ) |  | (278 | )
Net cash provided by financing activities |  | 78,176 |  |  | 84,151 |
Net decrease in cash and cash equivalents |  | (25,588 | ) |  | (12,246 | )
Cash and cash equivalents at the beginning of the period |  | 86,546 |  |  | 52,539 |
Cash and cash equivalents at the end of the period |  | $ | 60,958 |  |  | $ | 40,293 |
Supplementary cash flow information |  |  |  |
Cash paid during the period for: |  |  |  |
Interest paid on deposits and borrowings |  | $ | 25,828 |  |  | $ | 15,214 |
Income taxes paid |  | 1,303 |  |  | 882 |
Non-cash investing and financing activities: |  |  |  |
Transfer from loans and leases to foreclosed properties |  | 596 |  |  | 415 |

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. (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 the Wisconsin and greater Kansas City markets. FBB also offers trust and investment services through First Business Trust & Investments (“FBTI”) and investment portfolio administrative and asset/liability management services through First Business Consulting Services (“FBCS”), both divisions of FBB. The Bank provides a full range of financial services to businesses, business owners, executives, professionals, and high net worth individuals. 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 Capital Corp. (“FBCC”), First Madison Investment Corp. (“FMIC”), First Business Equipment Finance, LLC (“FBEF”), 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, 2018. The unaudited Consolidated Financial Statements include the accounts of the Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. In accordance with the provisions of Accounting Standards Codification (“ASC”) Topic 810, the Corporation’s ownership interest in FBFS Statutory Trust II (“Trust II”) has not been consolidated into the financial statements.
Management of the Corporation is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities 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 nine month periods ended September 30, 2019 are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2019. 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, 2018.
Special Note Regarding Smaller Reporting Company Status
In June 2018, the SEC issued Release 33-10513; 34-83550, Amendments to Smaller Reporting Company Definition, which changes the definition of a smaller reporting company in Rule 12b-2 of the Securities Exchange Act of 1934, as amended. Under this release, the new thresholds for qualifying are (1) public float of less than $250 million or (2) annual revenue of less than $100 million and public float of less than $700 million (including no public float). The rule change was effective on September 10, 2018. Under this release, the Corporation currently qualifies as a smaller reporting company based on its public float as of the last business day of its second fiscal quarter of fiscal year 2019. A smaller reporting company may choose to comply with scaled or non-scaled financial and non-financial disclosure requirements on an item-by-item basis. The Corporation has not scaled its disclosures of financial and non-financial information in this Quarterly Report. The Corporation may determine to provide scaled disclosures of financial or non-financial information in future quarterly reports, annual reports and/or proxy statements if it remains a smaller reporting company under SEC rules.
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Recent Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments- Credit Losses (Topic 326).” The ASU replaces the incurred loss impairment methodology for recognizing credit losses with a methodology that reflects all expected credit losses. The ASU also requires consideration of a broader range of information to inform credit loss estimates, including such factors as past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, and any other financial asset not excluded from the scope 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. The ASU is effective for public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. A cross-functional committee has been established and a third-party software solution has been implemented 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 methodology and assumptions that will be used under the new standard.
In October 2019, the FASB voted to delay the effective date for the credit losses standard 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. Management will continue to progress on its implementation project plan and improve the Corporation’s approach throughout the deferral period.
In August 2018, the FASB issued ASU No. 2018-15, “Intangibles-Goodwill and Other Internal-Use Software (Subtopic 350-40).” The ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Implementation costs incurred in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post implementation stages are expensed as the activities are performed. The amendment also requires entities to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement and in the same income statement line item as the fees associated with the hosting element. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. The Corporation is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on its results of operations, financial position, and liquidity.
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Note 2 — Earnings per Common Share
Earnings per common share are computed using the two-class method. Basic earnings per common share are computed by dividing net income allocated to common shares by the weighted-average number of shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends, or dividend equivalents, at the same rate as holders of the Corporation’s common stock. Diluted earnings per share are computed by dividing net income allocated to common shares, adjusted for reallocation of undistributed earnings of unvested restricted shares, by the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of common stock equivalents using the treasury stock method.

|  | For the Three Months Ended September 30, |  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | 2019 |  | 2018
|  | (Dollars in Thousands, Except Share Data)
Basic earnings per common share |  |  |  |  |  |  |  |
Net income |  | $ | 5,085 |  |  | $ | 5,301 |  |  | $ | 17,556 |  |  | $ | 12,239 |
Less: earnings allocated to participating securities |  | 111 |  |  | 77 |  |  | 340 |  |  | 180 |
Basic earnings allocated to common stockholders |  | $ | 4,974 |  |  | $ | 5,224 |  |  | $ | 17,216 |  |  | $ | 12,059 |
Weighted-average common shares outstanding, excluding participating securities |  | 8,492,445 |  |  | 8,650,057 |  |  | 8,546,192 |  |  | 8,634,890 |
Basic earnings per common share |  | $ | 0.59 |  |  | $ | 0.60 |  |  | $ | 2.01 |  |  | $ | 1.40 |
Diluted earnings per common share |  |  |  |  |  |  |  |
Earnings allocated to common stockholders, diluted |  | $ | 4,974 |  |  | $ | 5,224 |  |  | $ | 17,216 |  |  | $ | 12,059 |
Weighted-average diluted common shares outstanding, excluding participating securities |  | 8,492,445 |  |  | 8,650,057 |  |  | 8,546,192 |  |  | 8,634,890 |
Diluted earnings per common share |  | $ | 0.59 |  |  | $ | 0.60 |  |  | $ | 2.01 |  |  | $ | 1.40 |

Note 3 — Share-Based Compensation
The Corporation adopted the 2019 Equity Incentive Plan (the “Plan”) during the quarter ended June 30, 2019. 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. The Plan authorized 185,000 shares, plus all shares previously available for grant under the 2012 Equity Incentive Plan (the “2012 Plan”). No new grants will be made under the 2012 Plan. As of September 30, 2019, 261,095 shares were available for future grants under the Plan. Shares covered by awards that expire, terminate, or lapse will again be available for the grant of awards under the Plan. The Corporation may issue new shares and shares from its treasury stock for shares delivered under the Plan.
Restricted Stock
Under the Plan, the Corporation may grant restricted stock 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 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.
Beginning in 2019, the Corporation issued 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 Equity (“ROE”) 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 ROE metric will be adjusted if there is a change in the expectation of ROE. 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, 2018 and the nine months ended September 30, 2019 was as follows:

|  | Number of Restricted Shares/Units |  | Weighted Average Grant-Date Fair Value
Nonvested balance as of January 1, 2018 |  | 130,441 |  |  | $ | 21.43 |
Granted |  | 66,498 |  |  | 20.57 |
Vested |  | (46,034 | ) |  | 21.01 |
Forfeited |  | (19,284 | ) |  | 22.25 |
Nonvested balance as of December 31, 2018 |  | 131,621 |  |  | 21.02 |
Granted (1) |  | 89,555 |  |  | 23.58 |
Vested |  | (42,270 | ) |  | 20.50 |
Forfeited |  | (1,744 | ) |  | 23.67 |
Nonvested balance as of September 30, 2019 |  | 177,162 |  |  | $ | 22.41 |

(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 September 30, 2019, the Corporation had $3.5 million of unvested compensation expense, which the Corporation expects to recognize over a weighted-average period of approximately 2.70 years.
Share-based compensation expense related to restricted stock included in the unaudited Consolidated Statements of Income was as follows:

| For the Three Months Ended September 30, |  | For the Nine Months Ended September 30,
| 2019 |  | 2018 |  | 2019 |  | 2018
| (In Thousands)
Share-based compensation expense | $ | 390 |  |  | $ | 244 |  |  | $ | 1,118 |  |  | $ | 750 |

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Note 4 — Securities
The amortized cost and fair value of securities available-for-sale and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

|  | As of September 30, 2019
|  | Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
|  | (In Thousands)
Available-for-sale: |  |  |  |  |  |  |  |
U.S. government agency securities - government-sponsored enterprises |  | $ | 1,000 |  |  | $ | 1 |  |  | $ | — |  |  | $ | 1,001 |
Municipal securities |  | 160 |  |  | — |  |  | — |  |  | 160 |
Mortgage backed securities - government issued |  | 48,221 |  |  | 472 |  |  | (74 | ) |  | 48,619 |
Mortgage backed securities - government-sponsored enterprises |  | 107,751 |  |  | 1,159 |  |  | (258 | ) |  | 108,652 |
Other securities |  | 2,205 |  |  | 28 |  |  | — |  |  | 2,233 |
|  | $ | 159,337 |  |  | $ | 1,660 |  |  | $ | (332 | ) |  | $ | 160,665 |

|  | As of December 31, 2018
|  | Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
|  | (In Thousands)
Available-for-sale: |  |  |  |  |  |  |  |
U.S. government agency securities - government-sponsored enterprises |  | $ | 999 |  |  | $ | — |  |  | $ | (9 | ) |  | $ | 990 |
Municipal securities |  | 5,953 |  |  | 2 |  |  | (69 | ) |  | 5,886 |
Mortgage backed securities - government issued |  | 20,007 |  |  | 47 |  |  | (426 | ) |  | 19,628 |
Mortgage backed securities - government-sponsored enterprises |  | 110,928 |  |  | 279 |  |  | (1,729 | ) |  | 109,478 |
Other securities |  | 2,450 |  |  | — |  |  | (74 | ) |  | 2,376 |
|  | $ | 140,337 |  |  | $ | 328 |  |  | $ | (2,307 | ) |  | $ | 138,358 |

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 September 30, 2019
|  | Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
|  | (In Thousands)
Held-to-maturity: |  |  |  |  |  |  |  |
Municipal securities |  | $ | 19,744 |  |  | $ | 317 |  |  | $ | (1 | ) |  | $ | 20,060 |
Mortgage backed securities - government issued |  | 6,219 |  |  | 46 |  |  | (7 | ) |  | 6,258 |
Mortgage backed securities - government-sponsored enterprises |  | 7,437 |  |  | 219 |  |  | (11 | ) |  | 7,645 |
|  | $ | 33,400 |  |  | $ | 582 |  |  | $ | (19 | ) |  | $ | 33,963 |

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|  | As of December 31, 2018
|  | Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
|  | (In Thousands)
Held-to-maturity: |  |  |  |  |  |  |  |
Municipal securities |  | $ | 21,066 |  |  | $ | 72 |  |  | $ | (59 | ) |  | $ | 21,079 |
Mortgage backed securities - government issued |  | 7,358 |  |  | — |  |  | (172 | ) |  | 7,186 |
Mortgage backed securities - government-sponsored enterprises |  | 9,307 |  |  | 2 |  |  | (165 | ) |  | 9,144 |
|  | $ | 37,731 |  |  | $ | 74 |  |  | $ | (396 | ) |  | $ | 37,409 |

U.S. government agency securities - government-sponsored enterprises represent securities issued by the Federal Home Loan Bank (“FHLB”), the Federal Home Loan Mortgage Corporation (“FHLMC”), and the Federal National Mortgage Association (“FNMA”). Municipal securities include securities issued by various municipalities located primarily within the State of Wisconsin and are primarily general obligation bonds that are tax-exempt in nature. Mortgage backed securities - government issued represent securities guaranteed by the Government National Mortgage Association and the SBA. Mortgage backed securities - government-sponsored enterprises include securities guaranteed by FHLMC and FNMA. Other securities represent certificates of deposit of insured banks and savings institutions with an original maturity greater than three months. There were 37 and 46 sales of available-for-sale securities that occurred during the three and nine months ended September 30, 2019, respectively. No sales of available-for-sale securities occurred during the three and nine months ended September 30, 2018.
At September 30, 2019 and December 31, 2018, securities with a fair value of $33.7 million and $11.5 million, respectively, were pledged to secure various obligations, including interest rate swap contracts and municipal deposits.
The amortized cost and fair value of securities by contractual maturity at September 30, 2019 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 |  | $ | 1,160 |  |  | $ | 1,161 |  |  | $ | 770 |  |  | $ | 772 |
Due in one year through five years |  | 9,247 |  |  | 9,305 |  |  | 13,706 |  |  | 13,856 |
Due in five through ten years |  | 30,985 |  |  | 31,461 |  |  | 13,935 |  |  | 14,277 |
Due in over ten years |  | 117,945 |  |  | 118,738 |  |  | 4,989 |  |  | 5,058 |
|  | $ | 159,337 |  |  | $ | 160,665 |  |  | $ | 33,400 |  |  | $ | 33,963 |

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 September 30, 2019 and December 31, 2018. At September 30, 2019, the Corporation held 42 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 September 30, 2019, the Corporation held 30 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 nine months ended September 30, 2019 and 2018.
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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 September 30, 2019
|  | 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: |  |  |  |  |  |  |  |  |  |  |  |
Mortgage backed securities - government issued |  | $ | 4,493 |  |  | $ | 5 |  |  | $ | 5,220 |  |  | $ | 69 |  |  | $ | 9,713 |  |  | $ | 74 |
Mortgage backed securities - government-sponsored enterprises |  | 17,382 |  |  | 98 |  |  | 18,246 |  |  | 160 |  |  | 35,628 |  |  | 258 |
|  | $ | 21,875 |  |  | $ | 103 |  |  | $ | 23,466 |  |  | $ | 229 |  |  | $ | 45,341 |  |  | $ | 332 |

|  | As of December 31, 2018
|  | 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 |  | $ | — |  |  | $ | — |  |  | $ | 990 |  |  | $ | 9 |  |  | $ | 990 |  |  | $ | 9 |
Municipal securities |  | — |  |  | — |  |  | 4,371 |  |  | 69 |  |  | 4,371 |  |  | 69 |
Mortgage backed securities - government issued |  | — |  |  | — |  |  | 13,748 |  |  | 426 |  |  | 13,748 |  |  | 426 |
Mortgage backed securities - government-sponsored enterprises |  | 8,178 |  |  | 46 |  |  | 69,602 |  |  | 1,683 |  |  | 77,780 |  |  | 1,729 |
Other securities |  | 238 |  |  | 7 |  |  | 2,138 |  |  | 67 |  |  | 2,376 |  |  | 74 |
|  | $ | 8,416 |  |  | $ | 53 |  |  | $ | 90,849 |  |  | $ | 2,254 |  |  | $ | 99,265 |  |  | $ | 2,307 |

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 September 30, 2019 and December 31, 2018. At September 30, 2019, the Corporation held 10 held-to-maturity securities that were in an unrealized loss position. Such securities have not experienced credit rating downgrades; however, they have primarily declined in value due to the current interest rate environment. There were seven held-to-maturity securities that had been in a continuous loss position for twelve months or greater as of September 30, 2019. 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 nine months ended September 30, 2019 and 2018.
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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 September 30, 2019
|  | 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 |  | $ | 612 |  |  | $ | 1 |  |  | $ | — |  |  | $ | — |  |  | $ | 612 |  |  | $ | 1 |
Mortgage backed securities - government issued |  | — |  |  | — |  |  | 1,021 |  |  | 7 |  |  | 1,021 |  |  | 7 |
Mortgage backed securities - government-sponsored enterprises |  | — |  |  | — |  |  | 1,187 |  |  | 11 |  |  | 1,187 |  |  | 11 |
|  | $ | 612 |  |  | $ | 1 |  |  | $ | 2,208 |  |  | $ | 18 |  |  | $ | 2,820 |  |  | $ | 19 |

|  | As of December 31, 2018
|  | 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 |  | $ | 6,876 |  |  | $ | 14 |  |  | $ | 4,364 |  |  | $ | 45 |  |  | $ | 11,240 |  |  | $ | 59 |
Mortgage backed securities - government issued |  | — |  |  | — |  |  | 7,186 |  |  | 172 |  |  | 7,186 |  |  | 172 |
Mortgage backed securities - government-sponsored enterprises |  | 4,038 |  |  | 24 |  |  | 4,338 |  |  | 141 |  |  | 8,376 |  |  | 165 |
|  | $ | 10,914 |  |  | $ | 38 |  |  | $ | 15,888 |  |  | $ | 358 |  |  | $ | 26,802 |  |  | $ | 396 |

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Note 5 — Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses
Loan and lease receivables consist of the following:

|  | September 30, 2019 |  | December 31, 2018
|  | (In Thousands)
Commercial real estate: |  |  |  |
Commercial real estate — owner occupied |  | $ | 226,307 |  |  | $ | 203,476 |
Commercial real estate — non-owner occupied |  | 503,102 |  |  | 484,427 |
Land development |  | 49,184 |  |  | 42,666 |
Construction |  | 111,848 |  |  | 161,562 |
Multi-family |  | 227,330 |  |  | 167,868 |
1-4 family |  | 31,226 |  |  | 34,340 |
Total commercial real estate |  | 1,148,997 |  |  | 1,094,339 |
Commercial and industrial |  | 513,672 |  |  | 462,321 |
Direct financing leases, net |  | 28,987 |  |  | 33,170 |
Consumer and other: |  |  |  |
Home equity and second mortgages |  | 7,373 |  |  | 8,438 |
Other |  | 22,140 |  |  | 20,789 |
Total consumer and other |  | 29,513 |  |  | 29,227 |
Total gross loans and leases receivable |  | 1,721,169 |  |  | 1,619,057 |
Less: |  |  |  |
Allowance for loan and lease losses |  | 20,170 |  |  | 20,425 |
Deferred loan fees |  | 627 |  |  | 1,402 |
Loans and leases receivable, net |  | $ | 1,700,372 |  |  | $ | 1,597,230 |

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

|  | September 30, 2019 |  | December 31, 2018
|  | (In Thousands)
Retained, unguaranteed portions of sold SBA loans |  | $ | 22,201 |  |  | $ | 23,898 |
Other SBA loans(1) |  | 22,237 |  |  | 22,024 |
Total SBA loans |  | $ | 44,438 |  |  | $ | 45,922 |

(1) | Primarily consisted of SBA CAPLine, Express, and impaired loans that were repurchased from the secondary market, all of which are not saleable.

As of September 30, 2019 and December 31, 2018, $14.7 million and $13.2 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 September 30, 2019 and 2018 was $4.9 million and $7.8 million, respectively. The total principal amount of the guaranteed portions of SBA loans sold during the nine months ended September 30, 2019 and 2018 was $10.5 million and $10.8 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 nine months ended September 30, 2019 and 2018 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 September 30, 2019 and December 31, 2018 was $74.7 million and $83.3 million, respectively.
The total principal amount of transferred participation interests in other, non-SBA originated loans during the three months ended September 30, 2019 and 2018 was $7.5 million and $17.2 million, respectively. The total principal amount of transferred
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participation interests in other, non-SBA originated loans during the nine months ended September 30, 2019 and 2018 was $31.5 million and $51.6 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 September 30, 2019 and December 31, 2018 was $136.9 million and $129.7 million, respectively. As of September 30, 2019 and December 31, 2018, the total amount of the Corporation’s partial ownership of these transferred loans on the unaudited Consolidated Balance Sheets was $231.5 million and $208.9 million, respectively. No loans in this participation portfolio were considered impaired as of September 30, 2019 and December 31, 2018. The Corporation does not share in the participant’s portion of any potential charge-offs. The total amount of loan participations purchased on the unaudited Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018 was $512,000 and $569,000, respectively.
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:

|  | September 30, 2019
|  | Category |  |
|  | I |  | II |  | III |  | IV |  | Total
|  | (Dollars in Thousands)
Commercial real estate: |  |  |  |  |  |  |  |  |  |
Commercial real estate — owner occupied |  | $ | 190,014 |  |  | $ | 24,044 |  |  | $ | 8,166 |  |  | $ | 4,083 |  |  | $ | 226,307 |
Commercial real estate — non-owner occupied |  | 461,236 |  |  | 40,435 |  |  | 1,431 |  |  | — |  |  | 503,102 |
Land development |  | 46,654 |  |  | 908 |  |  | — |  |  | 1,622 |  |  | 49,184 |
Construction |  | 111,691 |  |  | — |  |  | 157 |  |  | — |  |  | 111,848 |
Multi-family |  | 215,755 |  |  | 11,575 |  |  | — |  |  | — |  |  | 227,330 |
1-4 family |  | 30,446 |  |  | 91 |  |  | 210 |  |  | 479 |  |  | 31,226 |
Total commercial real estate |  | 1,055,796 |  |  | 77,053 |  |  | 9,964 |  |  | 6,184 |  |  | 1,148,997 |
Commercial and industrial |  | 405,570 |  |  | 43,919 |  |  | 47,593 |  |  | 16,590 |  |  | 513,672 |
Direct financing leases, net |  | 21,746 |  |  | 4,065 |  |  | 3,176 |  |  | — |  |  | 28,987 |
Consumer and other: |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | 7,213 |  |  | 68 |  |  | 92 |  |  | — |  |  | 7,373 |
Other |  | 21,979 |  |  | — |  |  | — |  |  | 161 |  |  | 22,140 |
Total consumer and other |  | 29,192 |  |  | 68 |  |  | 92 |  |  | 161 |  |  | 29,513 |
Total gross loans and leases receivable |  | $ | 1,512,304 |  |  | $ | 125,105 |  |  | $ | 60,825 |  |  | $ | 22,935 |  |  | $ | 1,721,169 |
Category as a % of total portfolio |  | 87.86 | % |  | 7.27 | % |  | 3.54 | % |  | 1.33 | % |  | 100.00 | %

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|  | December 31, 2018
|  | Category |  |
|  | I |  | II |  | III |  | IV |  | Total
|  | (Dollars in Thousands)
Commercial real estate: |  |  |  |  |  |  |  |  |  |
Commercial real estate — owner occupied |  | $ | 177,222 |  |  | $ | 15,085 |  |  | $ | 5,506 |  |  | $ | 5,663 |  |  | $ | 203,476 |
Commercial real estate — non-owner occupied |  | 458,185 |  |  | 24,873 |  |  | 1,338 |  |  | 31 |  |  | 484,427 |
Land development |  | 39,472 |  |  | 981 |  |  | — |  |  | 2,213 |  |  | 42,666 |
Construction |  | 161,360 |  |  | — |  |  | 202 |  |  | — |  |  | 161,562 |
Multi-family |  | 167,868 |  |  | — |  |  | — |  |  | — |  |  | 167,868 |
1-4 family |  | 32,004 |  |  | 1,451 |  |  | 707 |  |  | 178 |  |  | 34,340 |
Total commercial real estate |  | 1,036,111 |  |  | 42,390 |  |  | 7,753 |  |  | 8,085 |  |  | 1,094,339 |
Commercial and industrial |  | 374,371 |  |  | 19,370 |  |  | 51,474 |  |  | 17,106 |  |  | 462,321 |
Direct financing leases, net |  | 26,013 |  |  | 6,090 |  |  | 1,067 |  |  | — |  |  | 33,170 |
Consumer and other: |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | 8,385 |  |  | 3 |  |  | 50 |  |  | — |  |  | 8,438 |
Other |  | 20,499 |  |  | — |  |  | — |  |  | 290 |  |  | 20,789 |
Total consumer and other |  | 28,884 |  |  | 3 |  |  | 50 |  |  | 290 |  |  | 29,227 |
Total gross loans and leases receivable |  | $ | 1,465,379 |  |  | $ | 67,853 |  |  | $ | 60,344 |  |  | $ | 25,481 |  |  | $ | 1,619,057 |
Category as a % of total portfolio |  | 90.51 | % |  | 4.19 | % |  | 3.73 | % |  | 1.57 | % |  | 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 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 subcommittees of the Bank’s Loan Committee.
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 subcommittees of the Bank’s Loan Committee 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
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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 subcommittees of the Bank’s Loan Committee on a monthly basis.
The delinquency aging of the loan and lease portfolio by class of receivable was as follows:
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|  | September 30, 2019
|  | 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 |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 222,224 |  |  | $ | 222,224 |
Non-owner occupied |  | — |  |  | — |  |  | — |  |  | — |  |  | 503,102 |  |  | 503,102 |
Land development |  | — |  |  | — |  |  | — |  |  | — |  |  | 47,562 |  |  | 47,562 |
Construction |  | — |  |  | — |  |  | — |  |  | — |  |  | 111,848 |  |  | 111,848 |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | 227,330 |  |  | 227,330 |
1-4 family |  | — |  |  | — |  |  | — |  |  | — |  |  | 30,893 |  |  | 30,893 |
Commercial and industrial |  | 238 |  |  | — |  |  | — |  |  | 238 |  |  | 496,844 |  |  | 497,082 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | 28,987 |  |  | 28,987 |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | 7,373 |  |  | 7,373 |
Other |  | — |  |  | — |  |  | — |  |  | — |  |  | 21,979 |  |  | 21,979 |
Total |  | 238 |  |  | — |  |  | — |  |  | 238 |  |  | 1,698,142 |  |  | 1,698,380 |
Non-accruing loans and leases |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | — |  |  | — |  |  | 342 |  |  | 342 |  |  | 3,741 |  |  | 4,083 |
Non-owner occupied |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Land development |  | — |  |  | — |  |  | — |  |  | — |  |  | 1,622 |  |  | 1,622 |
Construction |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | — |  |  | — |  |  | — |  |  | — |  |  | 333 |  |  | 333 |
Commercial and industrial |  | 1,701 |  |  | 304 |  |  | 5,895 |  |  | 7,900 |  |  | 8,690 |  |  | 16,590 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other |  | — |  |  | — |  |  | 157 |  |  | 157 |  |  | 4 |  |  | 161 |
Total |  | 1,701 |  |  | 304 |  |  | 6,394 |  |  | 8,399 |  |  | 14,390 |  | — |  | 22,789 |
Total loans and leases |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | — |  |  | — |  |  | 342 |  |  | 342 |  |  | 225,965 |  |  | 226,307 |
Non-owner occupied |  | — |  |  | — |  |  | — |  |  | — |  |  | 503,102 |  |  | 503,102 |
Land development |  | — |  |  | — |  |  | — |  |  | — |  |  | 49,184 |  |  | 49,184 |
Construction |  | — |  |  | — |  |  | — |  |  | — |  |  | 111,848 |  |  | 111,848 |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | 227,330 |  |  | 227,330 |
1-4 family |  | — |  |  | — |  |  | — |  |  | — |  |  | 31,226 |  |  | 31,226 |
Commercial and industrial |  | 1,939 |  |  | 304 |  |  | 5,895 |  |  | 8,138 |  |  | 505,534 |  |  | 513,672 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | 28,987 |  |  | 28,987 |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | 7,373 |  |  | 7,373 |
Other |  | — |  |  | — |  |  | 157 |  |  | 157 |  |  | 21,983 |  |  | 22,140 |
Total |  | $ | 1,939 |  |  | $ | 304 |  |  | $ | 6,394 |  |  | $ | 8,637 |  |  | $ | 1,712,532 |  |  | $ | 1,721,169 |
Percent of portfolio |  | 0.11 | % |  | 0.02 | % |  | 0.37 | % |  | 0.50 | % |  | 99.50 | % |  | 100.00 | %

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|  | December 31, 2018
|  | 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 |  | $ | 157 |  |  | $ | — |  |  | $ | — |  |  | $ | 157 |  |  | $ | 197,656 |  |  | $ | 197,813 |
Non-owner occupied |  | — |  |  | 2,272 |  |  | — |  |  | 2,272 |  |  | 482,124 |  |  | 484,396 |
Land development |  | — |  |  | — |  |  | — |  |  | — |  |  | 40,453 |  |  | 40,453 |
Construction |  | 14,824 |  |  | — |  |  | — |  |  | 14,824 |  |  | 146,738 |  |  | 161,562 |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | 167,868 |  |  | 167,868 |
1-4 family |  | 363 |  |  | 60 |  |  | — |  |  | 423 |  |  | 33,917 |  |  | 34,340 |
Commercial and industrial |  | 826 |  |  | 247 |  |  | — |  |  | 1,073 |  |  | 444,144 |  |  | 445,217 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | 33,170 |  |  | 33,170 |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | 8,438 |  |  | 8,438 |
Other |  | — |  |  | — |  |  | — |  |  | — |  |  | 20,499 |  |  | 20,499 |
Total |  | 16,170 |  |  | 2,579 |  |  | — |  |  | 18,749 |  |  | 1,575,007 |  |  | 1,593,756 |
Non-accruing loans and leases |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | 483 |  |  | — |  |  | 5,180 |  |  | 5,663 |  |  | — |  |  | 5,663 |
Non-owner occupied |  | — |  |  | — |  |  | 31 |  |  | 31 |  |  | — |  |  | 31 |
Land development |  | — |  |  | — |  |  | 119 |  |  | 119 |  |  | 2,094 |  |  | 2,213 |
Construction |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Commercial and industrial |  | 2,322 |  |  | — |  |  | 12,108 |  |  | 14,430 |  |  | 2,674 |  |  | 17,104 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other |  | — |  |  | — |  |  | 279 |  |  | 279 |  |  | 11 |  |  | 290 |
Total |  | 2,805 |  |  | — |  |  | 17,717 |  |  | 20,522 |  |  | 4,779 |  |  | 25,301 |
Total loans and leases |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | 640 |  |  | — |  |  | 5,180 |  |  | 5,820 |  |  | 197,656 |  |  | 203,476 |
Non-owner occupied |  | — |  |  | 2,272 |  |  | 31 |  |  | 2,303 |  |  | 482,124 |  |  | 484,427 |
Land development |  | — |  |  | — |  |  | 119 |  |  | 119 |  |  | 42,547 |  |  | 42,666 |
Construction |  | 14,824 |  |  | — |  |  | — |  |  | 14,824 |  |  | 146,738 |  |  | 161,562 |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | 167,868 |  |  | 167,868 |
1-4 family |  | 363 |  |  | 60 |  |  | — |  |  | 423 |  |  | 33,917 |  |  | 34,340 |
Commercial and industrial |  | 3,148 |  |  | 247 |  |  | 12,108 |  |  | 15,503 |  |  | 446,818 |  |  | 462,321 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | 33,170 |  |  | 33,170 |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | 8,438 |  |  | 8,438 |
Other |  | — |  |  | — |  |  | 279 |  |  | 279 |  |  | 20,510 |  |  | 20,789 |
Total |  | $ | 18,975 |  |  | $ | 2,579 |  |  | $ | 17,717 |  |  | $ | 39,271 |  |  | $ | 1,579,786 |  |  | $ | 1,619,057 |
Percent of portfolio |  | 1.17 | % |  | 0.16 | % |  | 1.09 | % |  | 2.42 | % |  | 97.58 | % |  | 100.00 | %

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

|  | September 30, 2019 |  | December 31, 2018
|  | (In Thousands)
Non-accrual loans and leases |  |  |  |
Commercial real estate: |  |  |  |
Commercial real estate — owner occupied |  | $ | 4,083 |  |  | $ | 5,663 |
Commercial real estate — non-owner occupied |  | — |  |  | 31 |
Land development |  | 1,622 |  |  | 2,213 |
Construction |  | — |  |  | — |
Multi-family |  | — |  |  | — |
1-4 family |  | 333 |  |  | — |
Total non-accrual commercial real estate |  | 6,038 |  |  | 7,907 |
Commercial and industrial |  | 16,590 |  |  | 17,104 |
Direct financing leases, net |  | — |  |  | — |
Consumer and other: |  |  |  |
Home equity and second mortgages |  | — |  |  | — |
Other |  | 161 |  |  | 290 |
Total non-accrual consumer and other loans |  | 161 |  |  | 290 |
Total non-accrual loans and leases |  | 22,789 |  |  | 25,301 |
Foreclosed properties, net |  | 2,902 |  |  | 2,547 |
Total non-performing assets |  | 25,691 |  |  | 27,848 |
Performing troubled debt restructurings |  | 146 |  |  | 180 |
Total impaired assets |  | $ | 25,837 |  |  | $ | 28,028 |

|  | September 30, 2019 |  | December 31, 2018
Total non-accrual loans and leases to gross loans and leases |  | 1.32 | % |  | 1.56 | %
Total non-performing assets to total gross loans and leases plus foreclosed properties, net |  | 1.49 |  |  | 1.72 |
Total non-performing assets to total assets |  | 1.23 |  |  | 1.42 |
Allowance for loan and lease losses to gross loans and leases |  | 1.17 |  |  | 1.26 |
Allowance for loan and lease losses to non-accrual loans and leases |  | 88.51 |  |  | 80.73 |

As of September 30, 2019 and December 31, 2018, $19.0 million and $7.6 million of the non-accrual loans and leases were considered troubled debt restructurings, respectively. There were no unfunded commitments associated with troubled debt restructured loans and leases as of September 30, 2019.
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.
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:
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|  | For the Three Months Ended September 30, |  | For the Nine Months Ended September 30,
|  | 2019
|  | 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 |  |  | $ | 3,774 |  |  | $ | 3,741 |  |  | 2 |  |  | $ | 3,774 |  |  | $ | 3,741 |
Commercial and industrial |  | 2 |  |  | 2,804 |  |  | 2,804 |  |  | 16 |  |  | 13,412 |  |  | 13,023 |
Total |  | 4 |  |  | $ | 6,578 |  |  | $ | 6,545 |  |  | 18 |  |  | $ | 17,186 |  |  | $ | 16,764 |

During the three and nine months ended September 30, 2018, no loans were modified to a troubled debt restructuring. There were no loans and leases modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the three and nine months ended September 30, 2019 and 2018.
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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 Nine Months Ended September 30, 2019
|  | 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 |  | $ | 342 |  |  | $ | 342 |  |  | $ | — |  |  | $ | 3,993 |  |  | $ | 55 |  |  | $ | 354 |  |  | $ | (299 | )
Non-owner occupied |  | — |  |  | — |  |  | — |  |  | 77 |  |  | 1 |  |  | — |  |  | 1 |
Land development |  | 1,622 |  |  | 5,918 |  |  | — |  |  | 1,937 |  |  | 41 |  |  | 6 |  |  | 35 |
Construction |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | 479 |  |  | 484 |  |  | — |  |  | 315 |  |  | 14 |  |  | 40 |  |  | (26 | )
Commercial and industrial |  | 6,721 |  |  | 8,063 |  |  | — |  |  | 13,889 |  |  | 798 |  |  | 376 |  |  | 422 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 7 |  |  | (7 | )
Other |  | 156 |  |  | 823 |  |  | — |  |  | 203 |  |  | 36 |  |  | — |  |  | 36 |
Total |  | 9,320 |  |  | 15,630 |  |  | — |  |  | 20,414 |  |  | 945 |  |  | 783 |  |  | 162 |
With impairment reserve recorded: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | 3,741 |  |  | 5,100 |  |  | 753 |  |  | 1,062 |  |  | 314 |  |  | — |  |  | 314 |
Non-owner occupied |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Land development |  | — |  |  | — |  | — |  | — |  |  | — |  | — |  | — |  | — |  | — |  |  | — |
Construction |  | — |  |  | — |  | — |  | — |  |  | — |  | — |  | — |  | — |  | — |  |  | — |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Commercial and industrial |  | 9,869 |  |  | 10,475 |  |  | 3,561 |  |  | 3,357 |  |  | 854 |  |  | — |  |  | 854 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other |  | 5 |  |  | 5 |  |  | 5 |  |  | 2 |  |  | — |  |  | — |  |  | — |
Total |  | 13,615 |  |  | 15,580 |  |  | 4,319 |  |  | 4,421 |  |  | 1,168 |  |  | — |  |  | 1,168 |
Total: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | 4,083 |  |  | 5,442 |  |  | 753 |  |  | 5,055 |  |  | 369 |  |  | 354 |  |  | 15 |
Non-owner occupied |  | — |  |  | — |  |  | — |  |  | 77 |  |  | 1 |  |  | — |  |  | 1 |
Land development |  | 1,622 |  |  | 5,918 |  |  | — |  |  | 1,937 |  |  | 41 |  |  | 6 |  |  | 35 |
Construction |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | 479 |  |  | 484 |  |  | — |  |  | 315 |  |  | 14 |  |  | 40 |  |  | (26 | )
Commercial and industrial |  | 16,590 |  |  | 18,538 |  |  | 3,561 |  |  | 17,246 |  |  | 1,652 |  |  | 376 |  |  | 1,276 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 7 |  |  | (7 | )
Other |  | 161 |  |  | 828 |  |  | 5 |  |  | 205 |  |  | 36 |  |  | — |  |  | 36 |
Grand total |  | $ | 22,935 |  |  | $ | 31,210 |  |  | $ | 4,319 |  |  | $ | 24,835 |  |  | $ | 2,113 |  |  | $ | 783 |  |  | $ | 1,330 |

(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, 2018
|  | 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 |  | $ | 1,273 |  |  | $ | 1,273 |  |  | $ | — |  |  | $ | 6,638 |  |  | $ | 756 |  |  | $ | 197 |  |  | $ | 559 |
Non-owner occupied |  | 31 |  |  | 72 |  |  | — |  |  | 33 |  |  | 2 |  |  | — |  |  | 2 |
Land development |  | 2,213 |  |  | 6,510 |  |  | — |  |  | 2,366 |  |  | 68 |  |  | — |  |  | 68 |
Construction |  | — |  |  | — |  |  | — |  |  | 2,148 |  |  | 219 |  |  | — |  |  | 219 |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | 178 |  |  | 183 |  |  | — |  |  | 808 |  |  | 42 |  |  | 81 |  |  | (39 | )
Commercial and industrial |  | 6,828 |  |  | 7,527 |  |  | — |  |  | 8,809 |  |  | 1,058 |  |  | 980 |  |  | 78 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | 1 |  |  | — |  |  | 46 |  |  | (46 | )
Other |  | 279 |  |  | 945 |  |  | — |  |  | 305 |  |  | 55 |  |  | — |  |  | 55 |
Total |  | 10,802 |  |  | 16,510 |  |  | — |  |  | 21,108 |  |  | 2,200 |  |  | 1,304 |  |  | 896 |
With impairment reserve recorded: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | 4,390 |  |  | 5,749 |  |  | 675 |  |  | 635 |  |  | 182 |  |  | — |  |  | 182 |
Non-owner occupied |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Land development |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Construction |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Commercial and industrial |  | 10,278 |  |  | 10,278 |  |  | 3,710 |  |  | 4,687 |  |  | 1,096 |  |  | — |  |  | 1,096 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other |  | 11 |  |  | 11 |  |  | 11 |  |  | 1 |  |  | — |  |  | — |  |  | — |
Total |  | 14,679 |  |  | 16,038 |  |  | 4,396 |  |  | 5,323 |  |  | 1,278 |  |  | — |  |  | 1,278 |
Total: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied |  | 5,663 |  |  | 7,022 |  |  | 675 |  |  | 7,273 |  |  | 938 |  |  | 197 |  |  | 741 |
Non-owner occupied |  | 31 |  |  | 72 |  |  | — |  |  | 33 |  |  | 2 |  |  | — |  |  | 2 |
Land development |  | 2,213 |  |  | 6,510 |  |  | — |  |  | 2,366 |  |  | 68 |  |  | — |  |  | 68 |
Construction |  | — |  |  | — |  |  | — |  |  | 2,148 |  |  | 219 |  |  | — |  |  | 219 |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | 178 |  |  | 183 |  |  | — |  |  | 808 |  |  | 42 |  |  | 81 |  |  | (39 | )
Commercial and industrial |  | 17,106 |  |  | 17,805 |  |  | 3,710 |  |  | 13,496 |  |  | 2,154 |  |  | 980 |  |  | 1,174 |
Direct financing leases, net |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | — |  |  | — |  |  | 1 |  |  | — |  |  | 46 |  |  | (46 | )
Other |  | 290 |  |  | 956 |  |  | 11 |  |  | 306 |  |  | 55 |  |  | — |  |  | 55 |
Grand total |  | $ | 25,481 |  |  | $ | 32,548 |  |  | $ | 4,396 |  |  | $ | 26,431 |  |  | $ | 3,478 |  |  | $ | 1,304 |  |  | $ | 2,174 |

(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 $8.3 million and $7.1 million as of September 30, 2019 and December 31, 2018, respectively, represents partial charge-offs of loans and leases resulting from losses due to the appraised value of the collateral securing the loans and leases being below the carrying values of the loans and leases. Impaired loans and leases also included $146,000 and $180,000 of loans as of September 30, 2019 and December 31, 2018, 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 September 30, 2019
|  | Commercial Real Estate |  | Commercial and Industrial |  | Consumer and Other |  | Total
|  | (In Thousands)
Beginning balance |  | $ | 11,269 |  |  | $ | 7,892 |  |  | $ | 658 |  |  | $ | 19,819 |
Charge-offs |  | — |  |  | (1,097 | ) |  | (2 | ) |  | (1,099 | )
Recoveries |  | 1 |  |  | 99 |  |  | 1 |  |  | 101 |
Net recoveries (charge-offs) |  | 1 |  |  | (998 | ) |  | (1 | ) |  | (998 | )
Provision for loan and lease losses |  | (132 | ) |  | 1,517 |  |  | (36 | ) |  | 1,349 |
Ending balance |  | $ | 11,138 |  |  | $ | 8,411 |  |  | $ | 621 |  |  | $ | 20,170 |

|  | As of and for the Three Months Ended September 30, 2018
|  | Commercial Real Estate |  | Commercial and Industrial |  | Consumer and Other |  | Total
|  | (In Thousands)
Beginning balance |  | $ | 11,147 |  |  | $ | 9,237 |  |  | $ | 548 |  |  | $ | 20,932 |
Charge-offs |  | (1,826 | ) |  | (75 | ) |  | (13 | ) |  | (1,914 | )
Recoveries |  | 7 |  |  | 1,974 |  |  | 2 |  |  | 1,983 |
Net (charge-offs) recoveries |  | (1,819 | ) |  | 1,899 |  |  | (11 | ) |  | 69 |
Provision for loan and lease losses |  | 2,365 |  |  | (3,252 | ) |  | 341 |  |  | (546 | )
Ending balance |  | $ | 11,693 |  |  | $ | 7,884 |  |  | $ | 878 |  |  | $ | 20,455 |

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|  | As of and for the Nine Months Ended September 30, 2019
|  | Commercial Real Estate |  | Commercial and Industrial |  | Consumer and Other |  | Total
|  | (In Thousands)
Beginning balance |  | $ | 11,662 |  |  | $ | 8,079 |  |  | $ | 684 |  |  | $ | 20,425 |
Charge-offs |  | — |  |  | (1,158 | ) |  | (4 | ) |  | (1,162 | )
Recoveries |  | 74 |  |  | 191 |  |  | 29 |  |  | 294 |
Net recoveries (charge-offs) |  | 74 |  |  | (967 | ) |  | 25 |  |  | (868 | )
Provision for loan and lease losses |  | (598 | ) |  | 1,299 |  |  | (88 | ) |  | 613 |
Ending balance |  | $ | 11,138 |  |  | $ | 8,411 |  |  | $ | 621 |  |  | $ | 20,170 |

|  | As of and for the Nine Months Ended September 30, 2018
|  | Commercial Real Estate |  | Commercial and Industrial |  | Consumer and Other |  | Total
|  | (In Thousands)
Beginning balance |  | $ | 10,131 |  |  | $ | 8,225 |  |  | $ | 407 |  |  | $ | 18,763 |
Charge-offs |  | (4,122 | ) |  | (732 | ) |  | (50 | ) |  | (4,904 | )
Recoveries |  | 22 |  |  | 1,993 |  |  | 73 |  |  | 2,088 |
Net (charge-offs) recoveries |  | (4,100 | ) |  | 1,261 |  |  | 23 |  |  | (2,816 | )
Provision for loan and lease losses |  | 5,662 |  |  | (1,602 | ) |  | 448 |  |  | 4,508 |
Ending balance |  | $ | 11,693 |  |  | $ | 7,884 |  |  | $ | 878 |  |  | $ | 20,455 |

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

|  | As of September 30, 2019
|  | Commercial Real Estate |  | Commercial and Industrial |  | Consumer and Other |  | Total
|  | (In Thousands)
Allowance for loan and lease losses: |  |  |  |  |  |  |  |
Collectively evaluated for impairment |  | $ | 10,385 |  |  | $ | 4,850 |  |  | $ | 616 |  |  | $ | 15,851 |
Individually evaluated for impairment |  | 753 |  |  | 3,561 |  |  | 5 |  |  | 4,319 |
Loans acquired with deteriorated credit quality |  | — |  |  | — |  |  | — |  |  | — |
Total |  | $ | 11,138 |  |  | $ | 8,411 |  |  | $ | 621 |  |  | $ | 20,170 |
Loans and lease receivables: |  |  |  |  |  |  |  |
Collectively evaluated for impairment |  | $ | 1,142,813 |  |  | $ | 526,069 |  |  | $ | 29,352 |  |  | $ | 1,698,234 |
Individually evaluated for impairment |  | 6,170 |  |  | 16,590 |  |  | 161 |  |  | 22,921 |
Loans acquired with deteriorated credit quality |  | 14 |  |  | — |  |  | — |  |  | 14 |
Total |  | $ | 1,148,997 |  |  | $ | 542,659 |  |  | $ | 29,513 |  |  | $ | 1,721,169 |

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|  | As of December 31, 2018
|  | Commercial Real Estate |  | Commercial and Industrial |  | Consumer and Other |  | Total
|  | (In Thousands)
Allowance for loan and lease losses: |  |  |  |  |  |  |  |
Collectively evaluated for impairment |  | $ | 10,987 |  |  | $ | 4,369 |  |  | $ | 673 |  |  | $ | 16,029 |
Individually evaluated for impairment |  | 675 |  |  | 3,710 |  |  | 11 |  |  | 4,396 |
Loans acquired with deteriorated credit quality |  | — |  |  | — |  |  | — |  |  | — |
Total |  | $ | 11,662 |  |  | $ | 8,079 |  |  | $ | 684 |  |  | $ | 20,425 |
Loans and lease receivables: |  |  |  |  |  |  |  |
Collectively evaluated for impairment |  | $ | 1,086,254 |  |  | $ | 478,385 |  |  | $ | 28,937 |  |  | $ | 1,593,576 |
Individually evaluated for impairment |  | 7,914 |  |  | 17,104 |  |  | 290 |  |  | 25,308 |
Loans acquired with deteriorated credit quality |  | 171 |  |  | 2 |  |  | — |  |  | 173 |
Total |  | $ | 1,094,339 |  |  | $ | 495,491 |  |  | $ | 29,227 |  |  | $ | 1,619,057 |

Note 6 — Leases
The Corporation leases various office spaces, loan production offices, and specialty financing production offices under non-cancelable operating leases which expire on various dates through 2028. The Corporation also leases office equipment. The Corporation recognizes an operating lease liability and a right-of-use asset for all leases, with the exception of short-term leases. The lease payments on short-term leases are recognized as rent expense on a straight-line basis.
For the three and nine months ended September 30, 2019, total operating lease costs were $391,000 and $1.2 million, respectively.
Quantitative information regarding the Corporation’s operating leases was as follows:

|  | September 30, 2019
Weighted-average remaining lease term (in years) |  | 6.73 |
Weighted-average discount rate |  | 3.11 | %

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

(In Thousands) |
2019 | $ | 384 |
2020 | 1,541 |
2021 | 1,382 |
2022 | 1,373 |
2023 | 1,015 |
Thereafter | 3,063 |
Total undiscounted cash flows | 8,758 |
Discount on cash flows | (892 | )
Total lease liability | $ | 7,866 |

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Note 7 — Other Assets
A summary of accrued interest receivable and other assets was as follows:

|  | September 30, 2019 |  | December 31, 2018
|  | (In Thousands)
Accrued interest receivable |  | $ | 5,599 |  |  | $ | 5,684 |
Net deferred tax asset |  | 1,983 |  |  | 3,172 |
Investment in historic development entities |  | 2,013 |  |  | 1,653 |
Investment in a community development entity |  | 5,699 |  |  | 6,081 |
Investment in limited partnerships |  | 4,924 |  |  | 4,176 |
Investment in Trust II |  | 315 |  |  | 315 |
Fair value of interest rate swaps |  | 23,128 |  |  | 4,637 |
Prepaid expenses |  | 2,749 |  |  | 2,894 |
Other assets |  | 12,059 |  |  | 6,039 |
Total accrued interest receivable and other assets |  | $ | 58,469 |  |  | $ | 34,651 |

Note 8 — Deposits
The composition of deposits is shown below. Average balances represent year to date averages.

|  | September 30, 2019 |  | December 31, 2018
|  | Balance |  | Average Balance |  | Average Rate |  | Balance |  | Average Balance |  | Average Rate
|  | (Dollars in Thousands)
Non-interest-bearing transaction accounts |  | $ | 280,990 |  |  | $ | 265,121 |  |  | — | % |  | $ | 280,769 |  |  | $ | 241,529 |  |  | — | %
Interest-bearing transaction accounts |  | 206,267 |  |  | 222,513 |  |  | 1.67 |  |  | 229,612 |  |  | 269,943 |  |  | 0.99 |
Money market accounts |  | 678,993 |  |  | 597,487 |  |  | 1.84 |  |  | 516,045 |  |  | 491,756 |  |  | 1.09 |
Certificates of deposit |  | 154,707 |  |  | 159,390 |  |  | 2.48 |  |  | 153,022 |  |  | 94,172 |  |  | 1.70 |
Wholesale deposits |  | 187,859 |  |  | 243,254 |  |  | 2.24 |  |  | 275,851 |  |  | 302,440 |  |  | 1.95 |
Total deposits |  | $ | 1,508,816 |  |  | $ | 1,487,765 |  |  | 1.62 |  |  | $ | 1,455,299 |  |  | $ | 1,399,840 |  |  | 1.11 |

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Note 9 — FHLB Advances, Other Borrowings and Junior Subordinated Notes
The composition of borrowed funds is shown below. Average balances represent year to date averages.

|  | September 30, 2019 |  | December 31, 2018
|  | Balance |  | Weighted Average Balance |  | Weighted Average Rate |  | Balance |  | Weighted Average Balance |  | Weighted Average Rate
|  | (Dollars in Thousands)
Federal funds purchased |  | $ | — |  |  | $ | 49 |  |  | 2.70 | % |  | $ | — |  |  | $ | 119 |  |  | 2.43 | %
FHLB advances |  | 308,500 |  |  | 280,539 |  |  | 2.20 |  |  | 274,500 |  |  | 274,382 |  |  | 2.06 |
Line of credit |  | — |  |  | — |  |  | — |  |  | — |  |  | 3 |  |  | 4.47 |
Other borrowings |  | 675 |  |  | 675 |  |  | 8.09 |  |  | 675 |  |  | 675 |  |  | 7.94 |
Subordinated notes payable(1) |  | 23,722 |  |  | 24,772 |  |  | 7.93 |  |  | 23,769 |  |  | 23,739 |  |  | 6.64 |
Junior subordinated notes |  | 10,044 |  |  | 10,038 |  |  | 11.05 |  |  | 10,033 |  |  | 10,025 |  |  | 11.10 |
|  | $ | 342,941 |  |  | $ | 316,073 |  |  | 2.95 |  |  | $ | 308,977 |  |  | $ | 308,943 |  |  | 2.72 |
Short-term borrowings |  | $ | 119,000 |  |  |  |  |  |  | $ | 136,500 |  |  |  |  |
Long-term borrowings |  | 223,941 |  |  |  |  |  |  | 172,477 |  |  |  |  |
|  | $ | 342,941 |  |  |  |  |  |  | $ | 308,977 |  |  |  |  |

(1) | Weighted average rate of subordinated notes payable reflects the accelerated amortization of subordinated debt issuance costs as a result of the early redemption of a subordinated note during the third quarter of 2019.

As of September 30, 2019 and December 31, 2018, 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, 2019, the Corporation pays a commitment fee on this line of credit. During both the nine months ended September 30, 2019 and 2018, the Corporation incurred interest expense due to this fee of $10,000.
Note 10 — 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 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 $1.6 million at September 30, 2019, which is reported in accrued interest payable and other liabilities on the unaudited Consolidated Balance Sheet.
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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 September 30, |  | As of and for the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | 2019 |  | 2018
|  | (In Thousands)
Balance at the beginning of the period |  | $ | 2,068 |  |  | $ | 2,415 |  |  | $ | 2,956 |  |  | $ | 2,849 |
SBA recourse (benefit) provision |  | (427 | ) |  | 314 |  |  | 167 |  |  | 118 |
Charge-offs, net |  | 2 |  |  | — |  |  | (1,480 | ) |  | (238 | )
Balance at the end of the period |  | $ | 1,643 |  |  | $ | 2,729 |  |  | $ | 1,643 |  |  | $ | 2,729 |

Note 11 — 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:

|  | September 30, 2019
|  | 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 |  | $ | — |  |  | $ | 1,001 |  |  | $ | — |  |  | $ | 1,001 |
Municipal securities |  | — |  |  | 160 |  |  | — |  |  | 160 |
Mortgage backed securities - government issued |  | — |  |  | 48,619 |  |  | — |  |  | 48,619 |
Mortgage backed securities - government-sponsored enterprises |  | — |  |  | 108,652 |  |  | — |  |  | 108,652 |
Other securities |  | — |  |  | 2,233 |  |  | — |  |  | 2,233 |
Interest rate swaps |  | — |  |  | 23,128 |  |  | — |  |  | 23,128 |
Liabilities: |  |  |  |  |  |  |  |
Interest rate swaps |  | — |  |  | 26,580 |  |  | — |  |  | 26,580 |

|  | December 31, 2018
|  | 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 |  | $ | — |  |  | $ | 990 |  |  | $ | — |  |  | $ | 990 |
Municipal securities |  | — |  |  | 5,886 |  |  | — |  |  | 5,886 |
Mortgage backed securities - government issued |  | — |  |  | 19,628 |  |  | — |  |  | 19,628 |
Mortgage backed securities - government-sponsored enterprises |  | — |  |  | 109,478 |  |  | — |  |  | 109,478 |
Other securities |  | — |  |  | 2,376 |  |  | — |  |  | 2,376 |
Interest rate swaps |  | — |  |  | 4,637 |  |  | — |  |  | 4,637 |
Liabilities: |  |  |  |  |  |  |  |
Interest rate swaps |  | — |  |  | 4,779 |  |  | — |  |  | 4,779 |

For assets and liabilities measured at fair value on a recurring basis, there were no transfers between the levels during the three and nine months ended September 30, 2019 or the year ended December 31, 2018 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:

|  | September 30, 2019
|  | Fair Value Measurements Using |  |
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
|  | (In Thousands)
Impaired loans |  | $ | — |  |  | $ | — |  |  | $ | 17,689 |  |  | $ | 17,689 |
Foreclosed properties |  | — |  |  | — |  |  | 2,902 |  |  | 2,902 |
Loan servicing rights |  | — |  |  | — |  |  | 1,210 |  |  | 1,210 |

|  | December 31, 2018
|  | Fair Value Measurements Using |  |
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
|  | (In Thousands)
Impaired loans |  | $ | — |  |  | $ | — |  |  | $ | 15,706 |  |  | $ | 15,706 |
Foreclosed properties |  | — |  |  | — |  |  | 2,547 |  |  | 2,547 |
Loan servicing rights |  | — |  |  | — |  |  | 1,278 |  |  | 1,278 |

Impaired loans were written down to the fair value of their underlying collateral less costs to sell of $17.7 million and $15.7 million at September 30, 2019 and December 31, 2018, 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% - 50% as of the measurement date of September 30, 2019. The weighted-average of those unobservable inputs was 22%. The majority of the impaired loans are considered collateral dependent loans or are supported by a 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 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:

|  | September 30, 2019
|  | Carrying Amount |  | Fair Value
|  |  |  | Total |  | Level 1 |  | Level 2 |  | Level 3
|  | (In Thousands)
Financial assets: |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 60,958 |  |  | $ | 60,957 |  |  | $ | 55,057 |  |  | $ | 5,900 |  |  | $ | — |
Securities available-for-sale |  | 160,665 |  |  | 160,665 |  |  | — |  |  | 160,665 |  |  | — |
Securities held-to-maturity |  | 33,400 |  |  | 33,963 |  |  | — |  |  | 33,963 |  |  | — |
Loans held for sale |  | 3,070 |  |  | 3,347 |  |  | — |  |  | 3,347 |  |  | — |
Loans and lease receivables, net |  | 1,700,372 |  |  | 1,698,648 |  |  | — |  |  | — |  |  | 1,698,648 |
Federal Home Loan Bank stock |  | 8,315 |  |  | N/A |  |  | N/A |  |  | N/A |  |  | N/A |
Accrued interest receivable |  | 5,599 |  |  | 5,599 |  |  | 5,599 |  |  | — |  |  | — |
Interest rate swaps |  | 23,128 |  |  | 23,128 |  |  | — |  |  | 23,128 |  |  | — |
Financial liabilities: |  |  |  |  |  |  |  |  |  |
Deposits |  | 1,508,816 |  |  | 1,509,438 |  |  | 1,166,250 |  |  | 343,188 |  |  | — |
Federal Home Loan Bank advances and other borrowings |  | 332,897 |  |  | 332,509 |  |  | — |  |  | 332,509 |  |  | — |
Junior subordinated notes |  | 10,044 |  |  | 9,966 |  |  | — |  |  | — |  |  | 9,966 |
Accrued interest payable |  | 3,019 |  |  | 3,019 |  |  | 3,019 |  |  | — |  |  | — |
Interest rate swaps |  | 26,580 |  |  | 26,580 |  |  | — |  |  | 26,580 |  |  | — |
Off-balance sheet items: |  |  |  |  |  |  |  |  |  |
Standby letters of credit |  | 53 |  |  | 53 |  |  | — |  |  | — |  |  | 53 |

N/A = The fair value is not applicable due to restrictions placed on transferability
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|  | December 31, 2018
|  | Carrying Amount |  | Fair Value
|  |  |  | Total |  | Level 1 |  | Level 2 |  | Level 3
|  | (In Thousands)
Financial assets: |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 86,546 |  |  | $ | 86,546 |  |  | $ | 67,246 |  |  | $ | 19,300 |  |  | $ | — |
Securities available-for-sale |  | 138,358 |  |  | 138,358 |  |  | — |  |  | 138,358 |  |  | — |
Securities held-to-maturity |  | 37,731 |  |  | 37,409 |  |  | — |  |  | 37,409 |  |  | — |
Loans held for sale |  | 5,287 |  |  | 5,816 |  |  | — |  |  | 5,816 |  |  | — |
Loans and lease receivables, net |  | 1,597,230 |  |  | 1,589,323 |  |  | — |  |  | — |  |  | 1,589,323 |
Federal Home Loan Bank stock |  | 7,240 |  |  | N/A |  |  | N/A |  |  | N/A |  |  | N/A |
Accrued interest receivable |  | 5,684 |  |  | 5,684 |  |  | 5,684 |  |  | — |  |  | — |
Interest rate swaps |  | 4,637 |  |  | 4,637 |  |  | — |  |  | 4,637 |  |  | — |
Financial liabilities: |  |  |  |  |  |  |  |  |  |
Deposits |  | 1,455,299 |  |  | 1,453,482 |  |  | 1,026,648 |  |  | 426,834 |  |  | — |
Federal Home Loan Bank advances and other borrowings |  | 298,944 |  |  | 294,127 |  |  | — |  |  | 294,127 |  |  | — |
Junior subordinated notes |  | 10,033 |  |  | 9,955 |  |  | — |  |  | — |  |  | 9,955 |
Accrued interest payable |  | 3,696 |  |  | 3,696 |  |  | 3,696 |  |  | — |  |  | — |
Interest rate swaps |  | 4,779 |  |  | 4,779 |  |  | — |  |  | 4,779 |  |  | — |
Off-balance sheet items: |  |  |  |  |  |  |  |  |  |
Standby letters of credit |  | 59 |  |  | 59 |  |  | — |  |  | — |  |  | 59 |

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 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 12 — 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.
At September 30, 2019, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $256.4 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 March 2021 and July 2034. 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 $23.1 million, included in accrued interest receivable and other assets. As of September 30, 2019, no interest rate swaps were in default.
At September 30, 2019, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $256.4 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 March 2021 through July 2034. 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 $23.1 million, included in accrued interest payable and other liabilities. The gross amount of dealer counterparty swaps, without regard to the enforceable master netting agreement, was a gross derivative liability of $23.1 million and no gross derivative asset. No right of offset existed with dealer counterparty swaps as of September 30, 2019.
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 nine months ended September 30, 2019 and 2018 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.
As of September 30, 2019, the aggregate notional value of interest rate swaps designated as cash flow hedges was $54.0 million. These interest rate swaps mature between December 2021 and December 2027. A pre-tax unrealized loss of $846,000
and $3.3 million was recognized in other comprehensive income for the three and nine months ended September 30, 2019, respectively, 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 |  |  |  |  |  |  |  |
September 30, 2019 |  | Accrued interest receivable and other assets |  | $ | 23,128 |  |  | Accrued interest payable and other liabilities |  | $ | 23,128 |
December 31, 2018 |  | Accrued interest receivable and other assets |  | $ | 4,637 |  |  | Accrued interest payable and other liabilities |  | $ | 4,637 |
Derivatives designated as hedging instruments |  |  |  |  |  |  |  |
September 30, 2019 |  | Accumulated other comprehensive income (1) |  | $ | 3,452 |  |  | Accrued interest payable and other liabilities |  | $ | 3,452 |
December 31, 2018 |  | Accumulated other comprehensive income (1) |  | $ | 142 |  |  | Accrued interest payable and other liabilities |  | $ | 142 |

(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 13 — Regulatory Capital
The Corporation and the Bank are subject to various regulatory capital requirements administered by Federal and the State of 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” or “FRB”). Federal Reserve guidance urges financial institutions to strongly consider eliminating, deferring, or significantly reducing dividends if: (i) net income available to common stockholders 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 stockholders with preferential rights superior to those stockholders receiving the dividend.
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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 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.
In July 2013, the FRB and the Federal Deposit Insurance Corporation approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks. These rules are applicable to all financial institutions that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as bank and savings and loan holding companies other than “small bank holding companies”. Under the final rules, minimum requirements increased for both the quantity and quality of capital held by the Corporation. The rules include a new Common Equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. The rules also permit banking organizations with less than $15 billion in assets to retain, through a one-time election, the past treatment for accumulated other comprehensive income, which did not affect regulatory capital. The Corporation elected to retain this treatment, which reduces the volatility of regulatory capital ratios. A new capital conservation buffer, comprised of Common Equity Tier 1 capital, was also established above the regulatory minimum capital requirements. This capital conservation buffer was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increased each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019.
As of September 30, 2019, the Bank’s capital levels remained characterized as well capitalized under the regulatory framework. The following tables summarize the Bank’s capital ratios and the ratios required by its federal regulator:

|  | As of September 30, 2019
|  | 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)
First Business Bank |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total capital (to risk-weighted assets) |  | $ | 231,159 |  |  | 11.69 | % |  | $ | 158,238 |  |  | 8.00 | % |  | $ | 207,687 |  |  | 10.50 | % |  | $ | 197,797 |  |  | 10.00 | %
Tier 1 capital (to risk-weighted assets) |  | 209,346 |  |  | 10.58 |  |  | 118,678 |  |  | 6.00 |  |  | 168,127 |  |  | 8.50 |  |  | 158,238 |  |  | 8.00 |
Common equity tier 1 capital (to risk-weighted assets) |  | 209,346 |  |  | 10.58 |  |  | 89,009 |  |  | 4.50 |  |  | 138,458 |  |  | 7.00 |  |  | 128,568 |  |  | 6.50 |
Tier 1 leverage capital (to adjusted assets) |  | 209,346 |  |  | 10.10 |  |  | 82,907 |  |  | 4.00 |  |  | 82,907 |  |  | 4.00 |  |  | 103,633 |  |  | 5.00 |

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|  | As of December 31, 2018
|  | 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)
First Business Bank |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total capital (to risk-weighted assets) |  | $ | 220,474 |  |  | 11.49 | % |  | $ | 153,456 |  |  | 8.00 | % |  | $ | 189,422 |  |  | 9.875 | % |  | $ | 191,820 |  |  | 10.00 | %
Tier 1 capital (to risk-weighted assets) |  | 197,093 |  |  | 10.27 |  |  | 115,092 |  |  | 6.00 |  |  | 151,058 |  |  | 7.875 |  |  | 153,456 |  |  | 8.00 |
Common equity tier 1 capital (to risk-weighted assets) |  | 197,093 |  |  | 10.27 |  |  | 86,319 |  |  | 4.50 |  |  | 122,285 |  |  | 6.375 |  |  | 124,683 |  |  | 6.50 |
Tier 1 leverage capital (to adjusted assets) |  | 197,093 |  |  | 10.20 |  |  | 77,301 |  |  | 4.00 |  |  | 77,301 |  |  | 4.00 |  |  | 96,626 |  |  | 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:

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

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

• | Increases in defaults by borrowers and other delinquencies.

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

• | Fluctuations in interest rates and market prices.

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

• | Changes in tax or accounting requirements.

• | 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 portion of SBA loans.

These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our 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, 2018 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 is 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 the Bank and its subsidiaries. We operate as a business bank focusing on delivering a full line of commercial banking products and services tailored to meet the specific needs of small- to medium-sized businesses, business owners, executives, professionals, and high net worth individuals. Our products and services include commercial lending, SBA lending and servicing, asset-based lending, equipment financing, factoring, trust and investment services, investment portfolio administrative services, asset/liability management services, treasury management services, and a broad range of deposit products. We do not utilize a branch network to attract retail clients. Our operating philosophy is predicated on deep client relationships fostered by local banking partners and specialized business lines where we provide skilled expertise, combined with the efficiency of centralized administrative functions such as information technology, loan and deposit operations, finance and accounting, credit administration, compliance, and human resources. Our focused model allows experienced staff to provide the level of financial expertise needed to develop and maintain long-term relationships with our clients.
Operational Summary
Results for the three and nine months ended September 30, 2019 include:

• | Total assets increased to $2.093 billion as of September 30, 2019 compared to $1.966 billion as of December 31, 2018.

• | Net income for the three months ended September 30, 2019 was $5.1 million compared to $5.3 million for the three months ended September 30, 2018. Net income for the nine months ended September 30, 2019 was $17.6 million compared to $12.2 million for the nine months ended September 30, 2018.

• | Diluted earnings per common share for the three months ended September 30, 2019 were $0.59 compared to $0.60 for the three months ended September 30, 2018. Diluted earnings per common share for the nine months ended September 30, 2019 were $2.01 compared to $1.40 for the nine months ended September 30, 2018.

• | Annualized return on average assets (“ROAA”) and annualized return on average equity (“ROAE”) were 0.97% and 10.68%, respectively, for the three month period ended September 30, 2019, compared to 1.11% and 12.06%, respectively, for the same time period in 2018. ROAA and ROAE were 1.15% and 12.77%, respectively, for the nine month period ended September 30, 2019 compared to 0.86% and 9.53%, respectively, for the same period in 2018.

• | Net interest income was $16.8 million for the three months ended September 30, 2019 compared to $17.1 million for the three months ended September 30, 2018. Net interest income was $51.4 million for the nine months ended September 30, 2019 compared to $50.2 million for the nine months ended September 30, 2018.

• | Top line revenue, the sum of net interest income and non-interest income, increased 2.7% to $22.6 million for the three months ended September 30, 2019 compared to $22.0 million for the three months ended September 30, 2018. For the nine months ended September 30, 2019, top line revenue increased 6.1% to $67.6 million compared to $63.7 million for the nine months ended September 30, 2018.

• | Net interest margin decreased 35 basis points to 3.40% for the three months ended September 30, 2019 compared to 3.75% for the three months ended September 30, 2018. Net interest margin decreased 16 basis points to 3.57% for the nine months ended September 30, 2019 compared to 3.73% for the nine months ended September 30, 2018.

• | Efficiency ratio was 66.41% for the three months ended September 30, 2019 compared to 69.55% for the three months ended September 30, 2018. Efficiency ratio was 67.29% for the nine months ended September 30, 2019 compared to 68.05% for the same time period in 2018.

• | Provision for loan and lease losses was $1.3 million for the three months ended September 30, 2019 compared to a provision benefit of $546,000 for the three months ended September 30, 2018. Provision for loan and lease losses was $613,000 for the nine months ended September 30, 2019 compared to $4.5 million for the same time period in 2018.

• | SBA recourse provision was a net benefit of $427,000 for the three months ended September 30, 2019 compared to an SBA recourse provision of $314,000 for the three months ended September 30, 2018. SBA recourse provision was $167,000 for the nine months ended September 30, 2019 compared to $118,000 for the same time period in 2018.

• | Net charge-offs for the three months ended September 30, 2019 were $998,000, or 0.23% of average loans and leases annualized, compared to net recoveries of $69,000, or 0.02% of average loans and leases annualized, for the three months ended September 30, 2018. Net charge-offs for the nine months ended September 30, 2019 were $868,000, or 0.07% of average loans and leases annualized, compared to net charge-offs of $2.8 million, or 0.24% of average loans and leases annualized, for the nine months ended September 30, 2018.

• | Period-end gross loans and leases receivable increased $102.9 million, or 8.5% annualized, to $1.721 billion at September 30, 2019 from $1.618 billion at December 31, 2018. Average gross loans and leases receivable increased $106.8 million, or 9.0% annualized, to $1.690 billion, at September 30, 2019 from $1.584 billion at December 31, 2018.

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• | Allowance for loan and lease losses as a percentage of gross loans and leases was 1.17% at September 30, 2019 compared to 1.26% at December 31, 2018.

• | Non-performing assets decreased $2.2 million, or 7.7%, to $25.7 million, or 1.23% of total assets, at September 30, 2019 from $27.8 million, or 1.42% of total assets, at December 31, 2018.

• | Period-end in-market deposits increased $141.5 million, or 16.0% annualized, to $1.321 billion at September 30, 2019 from $1.179 billion at December 31, 2018. Average in-market deposits increased $147.1 million, or 17.9% annualized, to $1.245 billion at September 30, 2019 from $1.097 billion at December 31, 2018.

Results of Operations
Top Line Revenue
Top line revenue is comprised of net interest income and non-interest income. For the three months ended September 30, 2019, top line revenue increased 2.7% compared to the same period in the prior year primarily due to an increase in non-interest income driven by a gain on the sale of a state tax credit and above average returns on investments in mezzanine funds, partially offset by a decrease in net interest income. For the nine months ended September 30, 2019, top line revenue increased 6.1% compared to the same period in the prior year primarily due to an increase in both the rate and volume of average loans and leases outstanding, combined with an increase in commercial loan swap fees, gains recognized on end-of-term buyout agreements related to the Company’s equipment financing business line, above average returns on investments in mezzanine funds, and gain on the sale of a state tax credit. These favorable increases were partially offset by an increase in the rate paid on interest-bearing in-market deposits.
The components of top line revenue were as follows:

|  | For the Three Months Ended September 30, |  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | Change |  | 2019 |  | 2018 |  | Change
|  | (Dollars in Thousands)
Net interest income |  | $ | 16,776 |  |  | $ | 17,094 |  |  | (1.9 | )% |  | $ | 51,382 |  |  | $ | 50,227 |  |  | 2.3 | %
Non-interest income |  | 5,792 |  |  | 4,871 |  |  | 18.9 |  |  | 16,234 |  |  | 13,519 |  |  | 20.1 |
Total top line revenue |  | $ | 22,568 |  |  | $ | 21,965 |  |  | 2.7 |  |  | $ | 67,616 |  |  | $ | 63,746 |  |  | 6.1 |

Annualized Return on Average Assets and Annualized Return on Average Equity
ROAA for the three months ended September 30, 2019 decreased to 0.97% compared to 1.11% for the three months ended September 30, 2018. The decrease in ROAA was primarily due to a reduction in net interest margin and an increase in provision for loan and lease losses. This reduction in profitability was partially offset by a decrease in SBA recourse provision, above average returns on investments in mezzanine funds, and gain on the sale of a state tax credit. ROAA for the nine months ended September 30, 2019 increased to 1.15% compared to 0.86% for the nine months ended September 30, 2018. The increase in ROAA can be attributed principally to an increase in earnings as net income increased 43.4% during the same time period. The increase in net income was primarily due to a decrease in the provision for loan and lease losses, increase in commercial loan interest rate swap fee income, gains recognized on end-of-term buyout agreements related to the Company’s equipment financing business line, above average returns on investments in mezzanine funds, gain on the sale of a state tax credit, and recognition of historic tax credits, net of the corresponding impairment of tax credit investments. ROAA is a critical metric we use to measure the profitability of our organization and how efficiently our assets are deployed. It is a measurement that allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage that can ultimately influence return on equity measures.
ROAE for the three months ended September 30, 2019 was 10.68% compared to 12.06% for the three months ended September 30, 2018. ROAE for the nine months ended September 30, 2019 was 12.77% compared to 9.53% for the nine months ended September 30, 2018. The reasons for the increase in ROAE are consistent with the explanations discussed above with respect to ROAA. We view ROAE to be an important measure of profitability and we continue to focus on improving the return to our stockholders by enhancing the overall profitability of our client relationships, controlling expenses, and seeking to minimize credit costs.
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Efficiency Ratio
Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse provision, impairment of tax credit investments, net gains or losses on foreclosed properties, amortization of other intangible assets, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less net realized gains on securities.
The efficiency ratio was 66.41% and 67.29% for the three and nine months ended September 30, 2019 compared to 69.55% and 68.05% for the three and nine months ended September 30, 2018. Operating revenue growth outpaced the change in operating expense for both the three and nine months ended September 30, 2019, resulting in positive operating leverage. For the three months ended September 30, 2019, operating revenue increased 2.8% while operating expense decreased 1.9%. For the nine months ended September 30, 2019, operating revenue increased 6.1% while operating expense increased 4.9%. The producers hired over the past 18 months are now generating new business and, as a result, management believes operating revenue will continue increasing at a greater rate than operating expense, generating positive operating leverage and moving the efficiency ratio back toward the Company’s long-term operating goal of 58%-62%.
We believe the efficiency ratio allows investors and analysts to better assess the Corporation’s operating expenses in relation to its operating revenue by removing the volatility that is associated with certain non-recurring or discrete items. The efficiency ratio also allows management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.
Please refer to both the Non-Interest Income and Non-Interest Expense sections below for discussion on the primary drivers of the year-over-year improvement in the efficiency ratio.

|  | For the Three Months Ended September 30, |  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | $ Change |  | % Change |  | 2019 |  | 2018 |  | $ Change |  | % Change
|  | (Dollars in Thousands)
Total non-interest expense |  | $ | 14,716 |  |  | $ | 15,746 |  |  | $ | (1,030 | ) |  | (6.5 | )% |  | $ | 49,922 |  |  | $ | 44,120 |  |  | $ | 5,802 |  |  | 13.2 | %
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net loss on foreclosed properties |  | 262 |  |  | 30 |  |  | 232 |  |  | NM |  |  | 241 |  |  | 30 |  |  | 211 |  |  | NM |
Amortization of other intangible assets |  | 11 |  |  | 12 |  |  | (1 | ) |  | (8.3 | ) |  | 33 |  |  | 36 |  |  | (3 | ) |  | (8.3 | )
SBA recourse (benefit) provision |  | (427 | ) |  | 314 |  |  | (741 | ) |  | NM |  |  | 167 |  |  | 118 |  |  | 49 |  |  | 41.5 |
Tax credit investment (recovery) impairment |  | (120 | ) |  | 113 |  |  | (233 | ) |  | NM |  |  | 3,982 |  |  | 554 |  |  | 3,428 |  |  | NM |
Total operating expense |  | $ | 14,990 |  |  | $ | 15,277 |  |  | $ | (287 | ) |  | (1.9 | ) |  | $ | 45,499 |  |  | $ | 43,382 |  |  | $ | 2,117 |  |  | 4.9 |
Net interest income |  | $ | 16,776 |  |  | $ | 17,094 |  |  | $ | (318 | ) |  | (1.9 | ) |  | $ | 51,382 |  |  | $ | 50,227 |  |  | $ | 1,155 |  |  | 2.3 |
Total non-interest income |  | 5,792 |  |  | 4,871 |  |  | 921 |  |  | 18.9 |  |  | 16,234 |  |  | 13,519 |  |  | 2,715 |  |  | 20.1 |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net loss on sale of securities |  | (4 | ) |  | — |  |  | (4 | ) |  | NM |  |  | (5 | ) |  | — |  |  | (5 | ) |  | NM |
Total operating revenue |  | $ | 22,572 |  |  | $ | 21,965 |  |  | $ | 607 |  |  | 2.8 |  |  | $ | 67,621 |  |  | $ | 63,746 |  |  | $ | 3,875 |  |  | 6.1 |
Efficiency ratio |  | 66.41 | % |  | 69.55 | % |  |  |  |  |  |  |  | 67.29 | % |  | 68.05 | % |  |  |  |  |

NM = Not Meaningful
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Net Interest Income
Net interest income levels depend on the amount of and yield on interest-earning assets as compared to the amount of and rate paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes.
The following table provides information with respect to (1) the change in net interest income attributable to changes in rate (changes in rate multiplied by prior volume) and (2) the change in net interest income attributable to changes in volume (changes in volume multiplied by prior rate) for the three and nine months ended September 30, 2019 compared to the same period in 2018. The change in net interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) has been allocated to the rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

|  | Increase (Decrease) for the Three Months Ended September 30, |  | Increase (Decrease) for the Nine Months Ended September 30,
|  | 2019 Compared to 2018 |  | 2019 Compared to 2018
|  | Rate |  | Volume |  |  | Net |  | Rate |  | Volume |  |  | Net
|  | (In Thousands)
Interest-earning assets |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate and other mortgage loans(1) |  | $ | (49 | ) |  | $ | 862 |  |  |  | $ | 813 |  |  | $ | 2,115 |  |  | $ | 2,537 |  |  |  | $ | 4,652 |
Commercial and industrial loans(1) |  | (213 | ) |  | 1,045 |  |  |  | 832 |  |  | 1,569 |  |  | 2,528 |  |  |  | 4,097 |
Direct financing leases(1) |  | 19 |  |  | (16 | ) |  |  | 3 |  |  | 27 |  |  | 11 |  |  |  | 38 |
Consumer and other loans(1) |  | (7 | ) |  | 15 |  |  |  | 8 |  |  | 19 |  |  | 56 |  |  |  | 75 |
Total loans and leases receivable |  | (250 | ) |  | 1,906 |  |  |  | 1,656 |  |  | 3,730 |  |  | 5,132 |  |  |  | 8,862 |
Mortgage-related securities |  | 59 |  |  | 168 |  |  |  | 227 |  |  | 303 |  |  | 424 |  |  |  | 727 |
Other investment securities |  | 15 |  |  | (50 | ) |  |  | (35 | ) |  | 50 |  |  | (109 | ) |  |  | (59 | )
FHLB and FRB Stock |  | (4 | ) |  | — |  |  |  | (4 | ) |  | 70 |  |  | (12 | ) |  |  | 58 |
Short-term investments |  | 28 |  |  | 3 |  |  |  | 31 |  |  | 249 |  |  | (164 | ) |  |  | 85 |
Total net change in income on interest-earning assets |  | (152 | ) |  | 2,027 |  |  |  | 1,875 |  |  | 4,402 |  |  | 5,271 |  |  |  | 9,673 |
Interest-bearing liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |
Transaction accounts |  | 288 |  |  | (154 | ) |  |  | 134 |  |  | 1,382 |  |  | (424 | ) |  |  | 958 |
Money market accounts |  | 832 |  |  | 612 |  |  |  | 1,444 |  |  | 4,009 |  |  | 891 |  |  |  | 4,900 |
Certificates of deposit |  | 236 |  |  | 363 |  |  |  | 599 |  |  | 907 |  |  | 1,196 |  |  |  | 2,103 |
Wholesale deposits |  | 247 |  |  | (650 | ) |  |  | (403 | ) |  | 740 |  |  | (912 | ) |  |  | (172 | )
Total deposits |  | 1,603 |  |  | 171 |  |  |  | 1,774 |  |  | 7,038 |  |  | 751 |  |  |  | 7,789 |
FHLB advances |  | 51 |  |  | 76 |  |  |  | 127 |  |  | 403 |  |  | 40 |  |  |  | 443 |
Other borrowings |  | 234 |  |  | 58 |  |  |  | 292 |  |  | 238 |  |  | 48 |  |  |  | 286 |
Junior subordinated notes |  | — |  |  | — |  |  |  | — |  |  | (1 | ) |  | 1 |  |  |  | — |
Total net change in expense on interest-bearing liabilities |  | 1,888 |  |  | 305 |  |  |  | 2,193 |  |  | 7,678 |  |  | 840 |  |  |  | 8,518 |
Net change in net interest income |  | $ | (2,040 | ) |  | $ | 1,722 |  |  |  | $ | (318 | ) |  | $ | (3,276 | ) |  | $ | 4,431 |  |  |  | $ | 1,155 |

(1) | Includes non-accrual loans and leases and loans held for sale.

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The table below shows our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three and nine months ended September 30, 2019 and 2018. The average balances are derived from average daily balances.

|  | For the Three Months Ended September 30,
|  | 2019 |  | 2018
|  | 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) |  | $ | 1,153,591 |  |  | $ | 14,568 |  |  | 5.05 | % |  | $ | 1,085,315 |  |  | $ | 13,755 |  |  | 5.07 | %
Commercial and industrial loans(1) |  | 517,043 |  |  | 8,697 |  |  | 6.73 |  |  | 455,242 |  |  | 7,865 |  |  | 6.91 |
Direct financing leases(1) |  | 29,600 |  |  | 316 |  |  | 4.27 |  |  | 31,197 |  |  | 313 |  |  | 4.01 |
Consumer and other loans(1) |  | 31,195 |  |  | 341 |  |  | 4.37 |  |  | 29,798 |  |  | 333 |  |  | 4.47 |
Total loans and leases receivable(1) |  | 1,731,429 |  |  | 23,922 |  |  | 5.53 |  |  | 1,601,552 |  |  | 22,266 |  |  | 5.56 |
Mortgage-related securities(2) |  | 167,113 |  |  | 1,060 |  |  | 2.54 |  |  | 140,227 |  |  | 833 |  |  | 2.38 |
Other investment securities(3) |  | 24,755 |  |  | 134 |  |  | 2.17 |  |  | 34,140 |  |  | 169 |  |  | 1.98 |
FHLB and FRB stock |  | 7,692 |  |  | 85 |  |  | 4.42 |  |  | 7,722 |  |  | 89 |  |  | 4.61 |
Short-term investments |  | 40,707 |  |  | 237 |  |  | 2.33 |  |  | 40,201 |  |  | 206 |  |  | 2.05 |
Total interest-earning assets |  | 1,971,696 |  |  | 25,438 |  |  | 5.16 |  |  | 1,823,842 |  |  | 23,563 |  |  | 5.17 |
Non-interest-earning assets |  | 121,589 |  |  |  |  |  |  | 91,359 |  |  |  |  |
Total assets |  | $ | 2,093,285 |  |  |  |  |  |  | $ | 1,915,201 |  |  |  |  |
Interest-bearing liabilities |  |  |  |  |  |  |  |  |  |  |  |
Transaction accounts |  | $ | 217,870 |  |  | 919 |  |  | 1.69 |  |  | $ | 263,928 |  |  | 785 |  |  | 1.19 |
Money market accounts |  | 642,385 |  |  | 2,857 |  |  | 1.78 |  |  | 472,866 |  |  | 1,413 |  |  | 1.20 |
Certificates of deposit |  | 154,095 |  |  | 983 |  |  | 2.55 |  |  | 88,903 |  |  | 384 |  |  | 1.73 |
Wholesale deposits |  | 211,528 |  |  | 1,247 |  |  | 2.36 |  |  | 327,146 |  |  | 1,650 |  |  | 2.02 |
Total interest-bearing deposits |  | 1,225,878 |  |  | 6,006 |  |  | 1.96 |  |  | 1,152,843 |  |  | 4,232 |  |  | 1.47 |
FHLB advances |  | 307,060 |  |  | 1,673 |  |  | 2.18 |  |  | 292,465 |  |  | 1,546 |  |  | 2.11 |
Other borrowings |  | 27,545 |  |  | 703 |  |  | 10.21 |  |  | 24,420 |  |  | 411 |  |  | 6.73 |
Junior subordinated notes |  | 10,041 |  |  | 280 |  |  | 11.15 |  |  | 10,027 |  |  | 280 |  |  | 11.17 |
Total interest-bearing liabilities |  | 1,570,524 |  |  | 8,662 |  |  | 2.21 |  |  | 1,479,755 |  |  | 6,469 |  |  | 1.75 |
Non-interest-bearing demand deposit accounts |  | 283,675 |  |  |  |  |  |  | 239,594 |  |  |  |  |
Other non-interest-bearing liabilities |  | 48,688 |  |  |  |  |  |  | 19,989 |  |  |  |  |
Total liabilities |  | 1,902,887 |  |  |  |  |  |  | 1,739,338 |  |  |  |  |
Stockholders’ equity |  | 190,398 |  |  |  |  |  |  | 175,863 |  |  |  |  |
Total liabilities and stockholders’ equity |  | $ | 2,093,285 |  |  |  |  |  |  | $ | 1,915,201 |  |  |  |  |
Net interest income |  |  |  | $ | 16,776 |  |  |  |  |  |  | $ | 17,094 |  |  |
Interest rate spread |  |  |  |  |  | 2.95 | % |  |  |  |  |  | 3.42 | %
Net interest-earning assets |  | $ | 401,172 |  |  |  |  |  |  | $ | 344,087 |  |  |  |  |
Net interest margin |  |  |  |  |  | 3.40 | % |  |  |  |  |  | 3.75 | %
Average interest-earning assets to average interest-bearing liabilities |  | 125.54 | % |  |  |  |  |  | 123.25 | % |  |  |  |
Return on average assets(4) |  | 0.97 |  |  |  |  |  |  | 1.11 |  |  |  |  |
Return on average equity(4) |  | 10.68 |  |  |  |  |  |  | 12.06 |  |  |  |  |
Average equity to average assets |  | 9.10 |  |  |  |  |  |  | 9.18 |  |  |  |  |
Non-interest expense to average assets(4) |  | 2.81 |  |  |  |  |  |  | 3.29 |  |  |  |  |

(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 collected in lieu of interest.

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

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

(4) | Represents annualized yields/rates.

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|  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018
|  | 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) |  | $ | 1,135,596 |  |  | $ | 44,012 |  |  | 5.17 | % |  | $ | 1,068,605 |  |  | $ | 39,360 |  |  | 4.91 | %
Commercial and industrial loans(1) |  | 492,247 |  |  | 26,012 |  |  | 7.05 |  |  | 443,188 |  |  | 21,915 |  |  | 6.59 |
Direct financing leases(1) |  | 31,143 |  |  | 967 |  |  | 4.14 |  |  | 30,789 |  |  | 929 |  |  | 4.02 |
Consumer and other loans(1) |  | 31,391 |  |  | 1,042 |  |  | 4.43 |  |  | 29,693 |  |  | 967 |  |  | 4.34 |
Total loans and leases receivable(1) |  | 1,690,377 |  |  | 72,033 |  |  | 5.68 |  |  | 1,572,275 |  |  | 63,171 |  |  | 5.36 |
Mortgage-related securities(2) |  | 158,407 |  |  | 3,022 |  |  | 2.54 |  |  | 135,135 |  |  | 2,295 |  |  | 2.26 |
Other investment securities(3) |  | 27,849 |  |  | 442 |  |  | 2.12 |  |  | 34,966 |  |  | 501 |  |  | 1.91 |
FHLB and FRB stock |  | 7,210 |  |  | 261 |  |  | 4.83 |  |  | 7,614 |  |  | 203 |  |  | 3.55 |
Short-term investments |  | 36,139 |  |  | 669 |  |  | 2.47 |  |  | 47,592 |  |  | 584 |  |  | 1.64 |
Total interest-earning assets |  | 1,919,982 |  |  | 76,427 |  |  | 5.31 |  |  | 1,797,582 |  |  | 66,754 |  |  | 4.95 |
Non-interest-earning assets |  | 109,395 |  |  |  |  |  |  | 91,657 |  |  |  |  |
Total assets |  | $ | 2,029,377 |  |  |  |  |  |  | $ | 1,889,239 |  |  |  |  |
Interest-bearing liabilities |  |  |  |  |  |  |  |  |  |  |  |
Transaction accounts |  | $ | 222,513 |  |  | 2,779 |  |  | 1.67 |  |  | $ | 278,042 |  |  | 1,821 |  |  | 0.87 |
Money market accounts |  | 597,487 |  |  | 8,231 |  |  | 1.84 |  |  | 487,395 |  |  | 3,331 |  |  | 0.91 |
Certificates of deposit |  | 159,390 |  |  | 2,965 |  |  | 2.48 |  |  | 80,630 |  |  | 862 |  |  | 1.43 |
Wholesale deposits |  | 243,254 |  |  | 4,085 |  |  | 2.24 |  |  | 302,262 |  |  | 4,257 |  |  | 1.88 |
Total interest-bearing deposits |  | 1,222,644 |  |  | 18,060 |  |  | 1.97 |  |  | 1,148,329 |  |  | 10,271 |  |  | 1.19 |
FHLB advances |  | 280,538 |  |  | 4,629 |  |  | 2.20 |  |  | 277,866 |  |  | 4,186 |  |  | 2.01 |
Other borrowings |  | 25,497 |  |  | 1,524 |  |  | 7.97 |  |  | 24,571 |  |  | 1,238 |  |  | 6.72 |
Junior subordinated notes |  | 10,038 |  |  | 832 |  |  | 11.05 |  |  | 10,023 |  |  | 832 |  |  | 11.07 |
Total interest-bearing liabilities |  | 1,538,717 |  |  | 25,045 |  |  | 2.17 |  |  | 1,460,789 |  |  | 16,527 |  |  | 1.51 |
Non-interest-bearing demand deposit accounts |  | 265,121 |  |  |  |  |  |  | 236,208 |  |  |  |  |
Other non-interest-bearing liabilities |  | 42,276 |  |  |  |  |  |  | 21,055 |  |  |  |  |
Total liabilities |  | 1,846,114 |  |  |  |  |  |  | 1,718,052 |  |  |  |  |
Stockholders’ equity |  | 183,263 |  |  |  |  |  |  | 171,187 |  |  |  |  |
Total liabilities and stockholders’ equity |  | $ | 2,029,377 |  |  |  |  |  |  | $ | 1,889,239 |  |  |  |  |
Net interest income |  |  |  | $ | 51,382 |  |  |  |  |  |  | $ | 50,227 |  |  |
Interest rate spread |  |  |  |  |  | 3.14 | % |  |  |  |  |  | 3.44 | %
Net interest-earning assets |  | $ | 381,265 |  |  |  |  |  |  | $ | 336,793 |  |  |  |  |
Net interest margin |  |  |  |  |  | 3.57 | % |  |  |  |  |  | 3.73 | %
Average interest-earning assets to average interest-bearing liabilities |  | 124.78 | % |  |  |  |  |  | 123.06 | % |  |  |  |
Return on average assets(4) |  | 1.15 |  |  |  |  |  |  | 0.86 |  |  |  |  |
Return on average equity(4) |  | 12.77 |  |  |  |  |  |  | 9.53 |  |  |  |  |
Average equity to average assets |  | 9.03 |  |  |  |  |  |  | 9.06 |  |  |  |  |
Non-interest expense to average assets(4) |  | 3.28 |  |  |  |  |  |  | 3.11 |  |  |  |  |

(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 collected in lieu of interest.

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

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

(4) | Represents annualized yields/rates.

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Comparison of Net Interest Income for the Three and Nine Months Ended September 30, 2019 and 2018
Net interest income decreased $318,000, or 1.9%, during the three months ended September 30, 2019 compared to the three months ended September 30, 2018. The decrease in net interest income was principally due to net interest margin compression, a moderate decrease in loan fees received in lieu of interest, and one-time expense related to exercising call options on subordinated debt and brokered deposits, partially offset by an increase in average loans and leases outstanding. Fees in lieu of interest totaled $1.1 million for the three months ended September 30, 2019, compared to $1.4 million for the three months ended September 30, 2018. The one-time expense related to subordinated debt and brokered deposits totaled $261,000 and $47,000, respectively. The decision to exercise the call options on subordinated debt and brokered deposits will benefit the net interest margin moving forward as the funding was replaced at lower rates. Excluding one-time expense and fees collected in lieu of interest, net interest income increased $356,000, or 2.3%, compared to the three months ended September 30, 2018. Average gross loans and leases for the three months ended September 30, 2019 increased $129.9 million, or 8.1%, compared to the three months ended September 30, 2018. Net interest income for the nine months ended September 30, 2019 increased $1.2 million, or 2.3%, compared to the nine months ended September 30, 2018. The increase in net interest income was principally due to an increase in average loans and leases outstanding combined with an increase in loan fees received in lieu of interest, partially offset by an increase in rate paid on average in-market deposits and the aforementioned one-time expense related to exercising call options. Fees in lieu of interest totaled $4.5 million for the nine months ended September 30, 2019, compared to $3.8 million for the nine months ended September 30, 2018. Excluding the one-time expense and fees collected in lieu of interest, net interest income increased $825,000, or 1.8%, compared to the nine months ended September 30, 2018. Average gross loans and leases for the nine months ended September 30, 2019 increased $118.1 million, or 7.5%, compared to the nine months ended September 30, 2018.
The yield on average loans and leases for the three months ended September 30, 2019 declined to 5.53% compared to 5.56% for the three months ended September 30, 2018. The yield on average loans and leases for the nine months ended September 30, 2019 increased to 5.68% compared to 5.36% for the same period in 2018. Both periods of comparison were impacted by fees collected in lieu of interest. Without the impact of these fees, the yield on average loans and leases for the three and nine months ended September 30, 2019 was 5.28% and 5.33%, respectively, compared to 5.20% and 5.03% for the three and nine months ended, September 30, 2018, respectively. Similarly, the yield on average interest-earning assets for the three and nine months ended September 30, 2019 measured 5.16% and 5.31%, respectively, compared to 5.17% and 4.95% for the three and nine months ended September 30, 2018, respectively. Excluding fees collected in lieu of interest, the yield on average interest-earning assets for the three and nine months ended September 30, 2019 was 4.94% and 5.00%, respectively, compared to 4.85% and 4.67% for the three and nine months ended September 30, 2018, respectively. For both periods of comparison, excluding the impact of fees in lieu of interest, the increase in yields was primarily due to the net increase in LIBOR and Prime during the time period of comparison and proportionately greater growth from our higher-yielding specialty finance business.
The average rate paid on total interest-bearing liabilities for the three and nine months ended September 30, 2019 increased to 2.21% and 2.17%, respectively, compared to 1.75% and 1.51% for the three and nine months ended September 30, 2018, respectively. Rates during the three and nine months ended September 30, 2019 were impacted by one-time expense related to exercising call options on subordinated debt and brokered deposits. Excluding the impact of this one-time expense, the average rate paid on total interest bearing liabilities measured 2.13% and 2.14%, for the three and nine months ended September 30, 2019, 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 on total in-market deposits — comprised of all transaction accounts, money market accounts, and non-wholesale deposits — for the three and nine months ended September 30, 2019 increased to 1.47% and 1.50%, respectively, up from 0.97% and 0.74% for the three and nine months end September 30, 2018, respectively. Average total in-market deposits increased $232.7 million, or 21.8%, and $162.2 million, or 15.0%, for the three and nine months ended September 30, 2019, respectively, compared to the same periods in the prior year. The average rate paid on total in-market deposits increased in both periods of comparison as the Company increased deposit rates in response to competitive market pressures stemming from the Federal Reserve’s decision to increase the target fed funds rate 125 basis points from December 2017 through December 2018.
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 September 30, 2019 increased $14.6 million to $307.1 million at an average rate paid of 2.18%, compared to $292.5 million at an average rate paid of 2.11% for the three months ended September 30, 2018. Average FHLB advances for the nine months ended September 30, 2019 increased $2.7 million to $280.5 million at an average rate paid of 2.20%, compared to $277.9 million at an average rate paid of 2.01% for the nine months ended September 30, 2018. As of September 30, 2019, the
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weighted average original maturity of our FHLB term advances was 5.23 years. Average wholesale deposits, consisting of brokered certificates of deposit and deposits gathered from internet listing services, for the three months ended September 30, 2019 decreased $115.6 million to $211.5 million at an average rate paid of 2.36%, compared to $327.1 million at an average rate paid of 2.02%. Average wholesale deposits for the nine months ended September 30, 2019 decreased $59.0 million to $243.3 million at an average rate paid of 2.24%, compared to $302.3 million at an average rate paid of 1.88%. As of September 30, 2019, the weighted average original maturity of our wholesale deposits was 5.51 years.
The average rate paid on total Bank funding for the three and nine months ended September 30, 2019 increased to 1.69% and 1.71%, respectively, compared to 1.37% and 1.16% for the three and nine months ended September 30, 2018, respectively. Total bank funding is defined as total deposits plus FHLB advances.
Net interest margin decreased 35 basis points to 3.40% for the three months ended September 30, 2019 compared to 3.75% for the three months ended September 30, 2018. The decrease was primarily due to an increase in the rate paid on in-market deposits, a moderate decrease in fees collected in lieu of interest, and the one-time expense related to exercising call options on subordinated debt and brokered deposits. These unfavorable variances were partially offset by a reduction in wholesale funding, consisting of wholesale deposits and FHLB advances. Excluding the one-time expense and fees collected in lieu of interest, net interest margin measured 3.25% for the third quarter of 2019, compared to 3.44% in the third quarter of 2018. Net interest margin decreased 16 basis points to 3.57% for the nine months ended September 30, 2019 compared to 3.73% for the nine months ended September 30, 2018. The decrease for the nine months ended September 30, 2019 was primarily due to an increase in the rate paid on in-market deposits, partially offset by an increase in fees collected in lieu of interest and an increase in the securities portfolio yield. Excluding the one-time expense and fees collected in lieu of interest, net interest margin measured 3.28% for the nine months ended September 30, 2019, compared to 3.44% for the nine months ended September 30, 2018.
Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in our higher-yielding specialty finance line of business will allow the Corporation to return to a net interest margin of 3.50% or better as short-term interest rates stabilize. 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. 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.
Provision for Loan and Lease Losses
We determine our provision for loan and lease losses based upon credit risk and other subjective factors pursuant to our allowance for loan and lease loss methodology, the magnitude of current and historical net charge-offs recorded in the period, and the amount of reserves established for impaired loans that present collateral shortfall positions. Refer to the section titled Allowance for Loan and Lease Losses, below, for further information regarding our allowance for loan and lease loss methodology.
We recorded provision for loan and lease losses of $1.3 million and $613,000 for the three and nine months ended September 30, 2019, respectively, compared to a benefit of $546,000 and an expense of $4.5 million for the three and nine months ended September 30, 2018, respectively. The increase in provision for the third quarter of 2019 was in large part due to increases in specific reserves related to the impaired legacy SBA portfolio. The decrease in provision for the nine months ended was principally driven by a decrease in net charge-offs, a net reduction in specific reserves, and a net reduction in historic loss rates, partially offset by an increase in provision related to loan growth. Net charge-offs were $998,000 and $868,000 for the three and nine months ended September 30, 2019, respectively, compared to net recoveries of $69,000 and net charge-offs of $2.8 million for the three and nine months ended September 30, 2018, respectively.
The legacy on-balance sheet SBA portfolio, defined as outstanding SBA loans originated prior to 2017, has been a source of elevated non-performing assets. Total non-performing on-balance sheet legacy loans were $14.7 million at September 30, 2019, compared to $13.0 million and $11.9 million at December 31, 2018 and September 30, 2018, respectively. Total performing on-balance sheet legacy loans were $21.8 million at September 30, 2018, compared to $26.3 million and $29.3 million at December 31, 2018 and September 30, 2018, respectively. As of September 30, 2019, total on-balance sheet legacy loans were $36.5 million, down from $39.3 million and $41.2 million at December 31, 2018 and September 30, 2018, respectively.
New specific reserves are established on impaired loans when collateral shortfalls or government guaranty deficiencies are present, while conversely specific reserves are released when previously established reserves 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
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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 the section titled Asset Quality, below, for further information regarding the overall credit quality of our loan and lease portfolio.
Comparison of Non-Interest Income for the Three and Nine Months Ended September 30, 2019 and 2018
Non-Interest Income
Non-interest income primarily consists of fees earned for trust and investment services, gains on sale of SBA loans, service charges on deposits, loan fee income, and commercial loan interest rate swap fee income. For the three months ended September 30, 2019 non-interest income increased by $921,000, or 18.9%, to $5.8 million from $4.9 million for the same period in 2018. For the nine months ended September 30, 2019 non-interest income increased by $2.7 million, or 20.1%, to $16.2 million from $13.5 million for the same period in 2018.
Management continues to focus on revenue growth from multiple non-interest income sources in order to maintain a diversified revenue stream through greater contribution from fee-based revenues. Total non-interest income accounted for 25.7% and 24.0% of our total revenues for the three and nine months ended September 30, 2019, respectively, compared to 22.2% and 21.2% for the three and nine months ended September 30, 2018, respectively. Management believes the expected gradual expansion of our SBA lending program, fees from commercial loan interest rate swap activity with our commercial borrowers, and the geographic expansion of our trust and investments division will allow us to maintain our strategic target of 25% over the long-term.
The components of non-interest income were as follows:

|  | For the Three Months Ended September 30, |  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | $ Change |  | % Change |  | 2019 |  | 2018 |  | $ Change |  | % Change
|  | (Dollars in Thousands)
Trust and investment services fee income |  | $ | 2,060 |  |  | $ | 1,941 |  |  | $ | 119 |  |  | 6.1 | % |  | $ | 6,125 |  |  | $ | 5,826 |  |  | $ | 299 |  |  | 5.1 | %
Gain on sale of SBA loans |  | 454 |  |  | 641 |  |  | (187 | ) |  | (29.2 | ) |  | 993 |  |  | 1,184 |  |  | (191 | ) |  | (16.1 | )
Service charges on deposits |  | 795 |  |  | 788 |  |  | 7 |  |  | 0.9 |  |  | 2,314 |  |  | 2,292 |  |  | 22 |  |  | 1.0 |
Loan fees |  | 439 |  |  | 459 |  |  | (20 | ) |  | (4.4 | ) |  | 1,316 |  |  | 1,375 |  |  | (59 | ) |  | (4.3 | )
Increase in cash surrender value of bank-owned life insurance |  | 305 |  |  | 301 |  |  | 4 |  |  | 1.3 |  |  | 894 |  |  | 890 |  |  | 4 |  |  | 0.4 |
Commercial loan swap fees |  | 374 |  |  | 306 |  |  | 68 |  |  | 22.2 |  |  | 1,898 |  |  | 1,009 |  |  | 889 |  |  | 88.1 |
Net loss on sale of securities |  | (4 | ) |  | — |  |  | (4 | ) |  | NM |  |  | (5 | ) |  | — |  |  | (5 | ) |  | NM |
Other non-interest income |  | 1,369 |  |  | 435 |  |  | 934 |  |  | NM |  |  | 2,699 |  |  | 943 |  |  | 1,756 |  |  | NM |
Total non-interest income |  | $ | 5,792 |  |  | $ | 4,871 |  |  | $ | 921 |  |  | 18.9 |  |  | $ | 16,234 |  |  | $ | 13,519 |  |  | $ | 2,715 |  |  | 20.1 |
Fee income ratio(1) |  | 25.7 | % |  | 22.2 | % |  |  |  |  |  | 24.0 | % |  | 21.2 | % |  |  |  |

(1) | Fee income ratio is non-interest income divided by top line revenue (defined as net interest income plus non-interest income).

Trust and investment services fee income increased $119,000, or 6.1%, and $299,000, or 5.1%, for the three and nine months ended September 30, 2019, respectively, compared to the three and nine months ended September 30, 2018. This increase was driven by growth in assets under management and administration attributable to new client relationships and increased market values. As of September 30, 2019, trust assets under management and administration totaled a record $1.801 billion, increasing $170.2 million, or 13.9% annualized, compared to $1.630 billion as of December 31, 2018 and increasing $79.6 million, or 4.6%, compared to $1.721 billion as of September 30, 2018.
Commercial loan interest rate swap fee income was $374,000 and $1.9 million for the three and nine months ended September 30, 2019, respectively, compared to $306,000 and $1.0 million for the three and nine months ended September 30, 2018, respectively. Interest rate swaps continue to be an attractive product for the Bank’s commercial borrowers, though
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associated fee income can be variable period to period based on client demand and the interest rate environment in any given quarter.
Other non-interest income for the three and nine months ended September 30, 2019 totaled $1.4 million and $2.7 million, respectively, compared to $435,000 and $943,000 for three and nine months ended September 30, 2018, respectively. The increase for the three month period was primarily due to above average returns from the Corporation’s investments in mezzanine funds and a gain on sale of a state tax credit. The nine month period ended September 30, 2019 also benefited from gains recognized on end-of-term buyout agreements related to the Company’s equipment financing business line.
Comparison of Non-Interest Expense for the Three and Nine Months Ended September 30, 2019 and 2018
Non-Interest Expense
The components of non-interest expense were as follows:

|  | For the Three Months Ended September 30, |  | For the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | $ Change |  | % Change |  | 2019 |  | 2018 |  | $ Change |  | % Change
|  | (Dollars in Thousands)
Compensation |  | $ | 10,324 |  |  | $ | 9,819 |  |  | $ | 505 |  |  | 5.1 | % |  | $ | 30,991 |  |  | $ | 28,006 |  |  | $ | 2,985 |  |  | 10.7 | %
Occupancy |  | 580 |  |  | 560 |  |  | 20 |  |  | 3.6 |  |  | 1,730 |  |  | 1,632 |  |  | 98 |  |  | 6.0 |
Professional fees |  | 751 |  |  | 1,027 |  |  | (276 | ) |  | (26.9 | ) |  | 2,745 |  |  | 2,990 |  |  | (245 | ) |  | (8.2 | )
Data processing |  | 654 |  |  | 512 |  |  | 142 |  |  | 27.7 |  |  | 1,923 |  |  | 1,748 |  |  | 175 |  |  | 10.0 |
Marketing |  | 548 |  |  | 593 |  |  | (45 | ) |  | (7.6 | ) |  | 1,611 |  |  | 1,518 |  |  | 93 |  |  | 6.1 |
Equipment |  | 277 |  |  | 403 |  |  | (126 | ) |  | (31.3 | ) |  | 938 |  |  | 1,089 |  |  | (151 | ) |  | (13.9 | )
Computer software |  | 859 |  |  | 814 |  |  | 45 |  |  | 5.5 |  |  | 2,485 |  |  | 2,235 |  |  | 250 |  |  | 11.2 |
FDIC insurance |  | 1 |  |  | 457 |  |  | (456 | ) |  | (99.8 | ) |  | 595 |  |  | 1,125 |  |  | (530 | ) |  | (47.1 | )
Collateral liquidation costs |  | 110 |  |  | 230 |  |  | (120 | ) |  | (52.2 | ) |  | 108 |  |  | 454 |  |  | (346 | ) |  | (76.2 | )
Net loss on foreclosed properties |  | 262 |  |  | 30 |  |  | 232 |  |  | NM |  |  | 241 |  |  | 30 |  |  | 211 |  |  | NM |
Tax credit investment (recovery) impairment |  | (120 | ) |  | 113 |  |  | (233 | ) |  | NM |  |  | 3,982 |  |  | 554 |  |  | 3,428 |  |  | NM |
SBA recourse (benefit) provision |  | (427 | ) |  | 314 |  |  | (741 | ) |  | NM |  |  | 167 |  |  | 118 |  |  | 49 |  |  | 41.5 |
Other non-interest expense |  | 897 |  |  | 874 |  |  | 23 |  |  | 2.6 |  |  | 2,406 |  |  | 2,621 |  |  | (215 | ) |  | (8.2 | )
Total non-interest expense |  | $ | 14,716 |  |  | $ | 15,746 |  |  | $ | (1,030 | ) |  | (6.5 | ) |  | $ | 49,922 |  |  | $ | 44,120 |  |  | $ | 5,802 |  |  | 13.2 |
Total operating expense(1) |  | $ | 14,990 |  |  | $ | 15,277 |  |  |  |  |  |  | $ | 45,499 |  |  | $ | 43,382 |  |  |  |  |
Full-time equivalent employees |  | 281 |  |  | 275 |  |  |  |  |  |  | 281 |  |  | 275 |  |  |  |  |

(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.

Non-interest expense for the three months ended September 30, 2019 decreased by $1.0 million, or 6.5%, to $14.7 million compared to $15.7 million for the same period in 2018. The decrease in non-interest expense was primarily due to a FDIC insurance credit, a tax credit investment recovery, and a net benefit in SBA recourse provision, partially offset by an increase in compensation. Non-interest expense for the nine months ended September 30, 2019 increased $5.8 million, or 13.2%, to $49.9 million compared to $44.1 million for the same period in 2018. The increase in non-interest expense was mainly due to an increase in compensation and impairment of tax credit investments, offset slightly by a FDIC insurance credit.
Compensation expense for the three months ended September 30, 2019 was $10.3 million, an increase of $505,000 compared to the three months ended September 30, 2018. The increase in compensation expense reflects an increase in employees, annual merit increases, and incentive compensation tied to individual and Company performance. Compensation expense for the nine months ended September 30, 2019 was $31.0 million, an increase of $3.0 million compared to the nine months ended September 30, 2018. The reasons for the increase in compensation for the nine months ended September 30, 2018 are consistent with the explanation of the variance for the three months ended September 30, 2019. Full-time equivalent employees were 281 at September 30, 2019 compared to 275 at September 30, 2018.
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Tax credit investments had a recovery of $120,000 for the three months ended September 30, 2019 compared to expense of $113,000 for the same period in the 2018. The benefit for the three months ended September 30, 2019 was the result of discounts received on previously impaired tax credit investments. Tax credit impairment expense for the nine months ended September 30, 2019 was $4.0 million, an increase of $3.4 million compared to the nine months ended September 30, 2018. During the nine months ended September 30, 2019, the Company recognized $3.6 million in expense due to the impairment of federal historic tax credit investments, which corresponded with the recognition of a $5.2 million in tax credits. Management intends to continue actively pursuing in-market tax credit opportunities throughout 2019 and beyond.
SBA recourse provision was a net benefit of $427,000 for the three months ended September 30, 2019 compared to expense of $314,000 for the three months ended September 30, 2018. SBA recourse provision for the nine months ended September 30, 2019 was $167,000 compared to $118,000 for the nine months ended September 30, 2018. The net benefit for the three months ended was primarily due to the declining balance of the outstanding legacy SBA loan sold portfolio, a reduction in the loss rate applied to the portfolio, and payments received resulting in a reduction in specific recourse reserves. The total recourse reserve balance was $1.6 million, or 2.2% of total sold SBA loans outstanding, at September 30, 2019, compared to $3.0 million, or 3.6%, at December 31, 2018, and $2.7 million, or 3.0%, at September 30, 2018. Total sold legacy SBA loans at September 30, 2019 were $47.6 million, down from $62.0 million and $72.1 million at December 31, 2018 and September 30, 2018, respectively. Total performing sold legacy SBA loans were $40.3 million at September 30, 2019, compared to $49.0 million and $54.6 million at December 31, 2018 and September 30, 2018, respectively. Total non-performing sold legacy SBA loans were $7.3 million at September 30, 2019, compared to $13.0 million and $17.5 million at December 31, 2018 and September 30, 2018, respectively. Changes to SBA recourse reserves may be a source of non-interest expense volatility in future quarters, though the magnitude of this volatility should diminish over time as the outstanding balance of sold legacy SBA loans continues to decline.
FDIC expense for the three and nine months ended September 30, 2019 benefited from a reduction in FDIC insurance expense Deposit Insurance Fund (“DIF”) reached 1.38%, exceeding the statutorily required minimum ratio of 1.35% and requiring the FDIC to distribute assessment credits to small banks for their portion of their assessments that contributed to the growth in the reserve ratio. The Company received a credit of $315,000 in the third quarter of 2019 and management expects another reduction in FDIC insurance, but to a lesser extent, during the fourth quarter of 2019 due to the remaining portion of the Company’s assessment credit.
Income Taxes
Income tax was a benefit of $475,000 for the nine months ended September 30, 2019 compared to income tax expense of $2.9 million for the nine months ended September 30, 2018. The income tax benefit for the nine months ended September 30, 2019 primarily reflects the recognition of $5.2 million in federal historic tax credits, which corresponded with the $3.6 million impairment of federal historic tax credit investments during the same time period. The effective tax rate for the nine months ended September 30, 2019, excluding these discrete items, was 22.3%. For 2019, the Company expects to report an effective tax rate of 21%-23%, excluding discrete items. Management intends to continue actively pursuing in-market tax credit opportunities throughout 2019 and beyond.
Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. The rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change.
Financial Condition
General
Total assets increased by $126.3 million, or 6.4%, to $2.093 billion as of September 30, 2019 compared to $1.966 billion at December 31, 2018. The increase in total assets was primarily driven by growth in our loan and lease portfolio and securities portfolio, partially offset by a decrease in short-term investments and cash and cash equivalents.
Short-Term Investments
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Short-term investments decreased by $35.9 million, or 56.7%, to $27.4 million at September 30, 2019 from $63.2 million at December 31, 2018. Our short-term investments primarily consist of interest-bearing deposits held at the FRB and commercial paper. We value the safety and soundness provided by the FRB and therefore incorporate short-term investments in our on-balance sheet liquidity program. As of September 30, 2019, our total investment in commercial paper was $5.9 million compared to $19.3 million at December 31, 2018. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio. The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to be in a position to benefit from an anticipated change in the yield curve level and shape. In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio. Please refer to the section titled Liquidity and Capital Resources for further discussion.
Securities
Total securities, including available-for-sale and held-to-maturity, increased by $18.0 million, or 10.2%, to $194.1 million at September 30, 2019 compared to $176.1 million at December 31, 2018. During the nine months ended September 30, 2019, due to declining interest rates, we recognized unrealized gains of $3.3 million before income taxes through other comprehensive income. As of September 30, 2019 and December 31, 2018, our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 4.3 years and 4.1 years, respectively. Generally, our investment philosophy remains as stated in our most recent Annual Report on Form 10-K.
We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, 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 September 30, 2019. We sold approximately $15.2 million securities during the nine months ended September 30, 2019 to proactively manage our securities portfolio to meet our long-term investment objectives.
Loans and Leases Receivable
Loans and leases receivable, net of allowance for loan and lease losses, increased by $103.1 million, or 6.5%, to $1.700 billion at September 30, 2019 from $1.597 billion at December 31, 2018. As of September 30, 2019, commercial and industrial (“C&I”) loans were a significant contributor to loan growth increasing $51.4 million to $513.7 million from $462.3 million at December 31, 2018. Total commercial real estate (“CRE”) also contributed to growth, increasing $54.7 million to $1.149 billion from $1.094 billion at December 31, 2018. Multi-family loans were the largest contributors to CRE loan growth as of September 30, 2019, increasing $59.5 million from December 31, 2018.
There continues to be a concentration in CRE loans, however, in general our composition of total loans and leases has remained relatively consistent due to balanced growth across our product offerings. CRE loans represented 66.8% and 67.6% of our total loans as of September 30, 2019 and December 31, 2018, respectively. As of September 30, 2019, 19.7% of the CRE loans were owner-occupied CRE, compared to 18.6% as of December 31, 2018. 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.
As mentioned above, our C&I portfolio increased $51.4 million, or 11.1%, to $513.7 million at September 30, 2019 from $462.3 million at December 31, 2018 reflecting growth in both conventional lending and specialty finance. We will continue to emphasize actively pursuing C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management, and trust and investment relationships which generate additional fee revenue.
While we continue to experience significant competition 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 quarters. The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K.
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Non-accrual loans decreased $2.5 million, or 9.9%, to $22.8 million at September 30, 2019, compared to $25.3 million at December 31, 2018. The Corporation’s non-accrual loans as a percentage of total gross loans and leases measured 1.32% and 1.56% at September 30, 2019 and December 31, 2018, respectively. Likewise, the ratio of non-performing assets to total assets decreased to 1.23% at September 30, 2019, compared to 1.42% at December 31, 2018. Please refer to the section titled Asset Quality, below, for additional information.
Deposits
As of September 30, 2019, deposits increased by $53.5 million, or 3.7% to $1.509 billion from $1.455 billion at December 31, 2018 primarily due to a $162.9 million increase in money market accounts partially offset by a $88.0 million decrease in wholesale deposits. 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 service and maintain existing and new client relationships.
Our strategic efforts remain focused on adding in-market deposit relationships. Successful deposit campaigns supporting our private banking strategy complemented our traditional strength in commercial banking and wealth management, contributing to in-market deposit growth during the first nine months of 2019. 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 $1.245 billion, or 70.4% of total bank funding for the nine months ended September 30, 2019. This compares to average in-market deposits of $1.082 billion, or 65.1% of total funding for the same period in 2018. Total bank funding is defined as total deposits plus FHLB advances.
FHLB Advances and Other Borrowings
As of September 30, 2019, FHLB advances and other borrowings increased by $34.0 million, or 11.4%, to $332.9 million from $298.9 million at December 31, 2018. While total wholesale funding has decreased meaningfully overall due to significant in-market deposit growth, we continue to replace some of our maturing brokered certificates of deposit with FHLB advances at lower rates. Consistent with our funding philosophy to manage interest rate risk, we will continue to utilize FHLB advances and wholesale deposits to manage liquidity and contingency funding.
Our targeted operating range of wholesale funds to total bank funding is 25%-40%. Wholesale funds include brokered certificates of deposit, deposits gathered from internet listing services, and FHLB advances. Total bank funding is defined as total deposits plus FHLB advances. Management recently updated this range from the previously disclosed 30%-40% to reflect a reduced need for on-balance sheet wholesale funding to match-fund long-term, fixed rate loans due to greater client demand for interest rate swaps, which results in a floating rate loan on our balance sheet. As of September 30, 2019, the ratio of end of period bank wholesale funds to end of period total bank funds was 27.3%. 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. 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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Asset Quality
Impaired Assets
Total impaired assets consisted of the following at September 30, 2019 and December 31, 2018, respectively:

|  | September 30, 2019 |  | December 31, 2018
|  | (Dollars in Thousands)
Non-accrual loans and leases |  |  |  |
Commercial real estate: |  |  |  |
Commercial real estate - owner occupied |  | $ | 4,083 |  |  | $ | 5,663 |
Commercial real estate - non-owner occupied |  | — |  |  | 31 |
Land development |  | 1,622 |  |  | 2,213 |
Construction |  | — |  |  | — |
Multi-family |  | — |  |  | — |
1-4 family |  | 333 |  |  | — |
Total non-accrual commercial real estate |  | 6,038 |  |  | 7,907 |
Commercial and industrial |  | 16,590 |  |  | 17,104 |
Direct financing leases, net |  | — |  |  | — |
Consumer and other: |  |  |  |
Home equity and second mortgages |  | — |  |  | — |
Other |  | 161 |  |  | 290 |
Total non-accrual consumer and other loans |  | 161 |  |  | 290 |
Total non-accrual loans and leases |  | 22,789 |  |  | 25,301 |
Foreclosed properties, net |  | 2,902 |  |  | 2,547 |
Total non-performing assets |  | 25,691 |  |  | 27,848 |
Performing troubled debt restructurings |  | 146 |  |  | 180 |
Total impaired assets |  | $ | 25,837 |  |  | $ | 28,028 |
Total non-accrual loans and leases to gross loans and leases |  | 1.32 | % |  | 1.56 | %
Total non-performing assets to gross loans and leases plus foreclosed properties, net |  | 1.49 |  |  | 1.72 |
Total non-performing assets to total assets |  | 1.23 |  |  | 1.42 |
Allowance for loan and lease losses to gross loans and leases |  | 1.17 |  |  | 1.26 |
Allowance for loan and lease losses to non-accrual loans and leases |  | 88.51 |  |  | 80.73 |

As of September 30, 2019 and December 31, 2018, $19.0 million and $7.6 million of non-accrual loans and leases were considered troubled debt restructurings, respectively. This increase is the result of ongoing workout efforts on previously identified impaired loans.
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 decreased $2.2 million, or 7.7%, to $25.7 million at September 30, 2019 from $27.8 million at December 31, 2018. The decrease was primarily due to payments received and current year charge-offs of $1.2 million, the majority of which related to one legacy SBA relationship previously classified as impaired and fully reserved for.
We also monitor early stage delinquencies to assist in the identification of potential future problems. As of September 30, 2019, 99.99% of the loan and lease portfolio, excluding non-accrual loans and leases, was in a current payment status, compared to 98.82% at December 31, 2018. We also monitor asset quality through our established credit quality indicator categories. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to sell the underlying collateral, inadequate cash flow
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from the operations of the underlying businesses, liquidation events, or bankruptcy filings. We work proactively with our impaired loan borrowers to find solutions to difficult situations that are in the best interests of the Bank.
The following represents additional information regarding our impaired loans and leases:

|  | As of and for the Nine Months Ended September 30, |  | As of and for the Year Ended December 31,
|  | 2019 |  | 2018 |  | 2018
|  | (In Thousands)
Impaired loans and leases with no impairment reserves required |  | $ | 9,320 |  |  | $ | 16,971 |  |  | $ | 10,802 |
Impaired loans and leases with impairment reserves required |  | 13,615 |  |  | 13,829 |  |  | 14,679 |
Total impaired loans and leases |  | 22,935 |  |  | 30,800 |  |  | 25,481 |
Less: Impairment reserve (included in allowance for loan and lease losses) |  | 4,319 |  |  | 4,569 |  |  | 4,396 |
Net impaired loans and leases |  | $ | 18,616 |  |  | $ | 26,231 |  |  | $ | 21,085 |
Average impaired loans and leases |  | $ | 24,835 |  |  | $ | 26,471 |  |  | $ | 26,431 |
Foregone interest income attributable to impaired loans and leases |  | $ | 2,113 |  |  | $ | 2,544 |  |  | $ | 3,478 |
Less: Interest income recognized on impaired loans and leases |  | 783 |  |  | 760 |  |  | 1,304 |
Net foregone interest income on impaired loans and leases |  | $ | 1,330 |  |  | $ | 1,784 |  |  | $ | 2,174 |

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

| As of and for the Nine Months Ended September 30, |
| 2019 |  | 2018
| (In Thousands)
Balance at the beginning of the period | $ | 2,547 |  |  | $ | 1,069 |
Loans and leases transferred to foreclosed properties | 596 |  |  | 415 |
Increase in impairment valuation | (241 | ) |  | (30 | )
Balance at the end of the period | $ | 2,902 |  |  | $ | 1,454 |

Allowance for Loan and Lease Losses
The allowance for loan and lease losses decreased $255,000 from $20.4 million as of December 31, 2018 to $20.2 million as of September 30, 2019. The allowance for loan and lease losses as a percentage of gross loans and leases also decreased from 1.26% as of December 31, 2018 to 1.17% as of September 30, 2019. The decrease in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by a net reduction in specific reserves and historic loss rates, partially offset by an increase in allowance related to the 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 nine months ended September 30, 2019, we recorded net charge-offs on impaired loans and leases of $868,000, or 0.07% of average loans and leases annualized, comprised of $1.2 million of charge-offs and $294,000 of recoveries. During the nine months ended September 30, 2018, we recorded net charge-offs on impaired loans and leases of approximately $2.8 million, or 0.24% of average loans and leases annualized, comprised of $4.9 million of charge-offs and $2.1 million of recoveries. The current and prior year charge-offs were primarily related to legacy SBA loan relationships.
We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed. Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios. Based upon the application of our methodology for estimating the appropriate level of allowance for loan and lease loss reserves, which includes actively monitoring the asset quality and inherent risks within the loan and lease portfolio, management concluded that an allowance for loan and lease losses of $20.2 million, or 1.17% of total loans and leases, was appropriate as of September 30, 2019. Given ongoing complexities with current workout situations, further charge-offs and
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increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion.
As of September 30, 2019 and December 31, 2018, our allowance for loan and lease losses to total non-accrual loans and leases was 88.51% and 80.73%, respectively. Non-accrual loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we endeavor to have appropriate collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-accrual loans or leases either does not require additional specific reserves or requires only a minimal amount of required specific reserve, as we believe the loans and leases are adequately collateralized as of the measurement period. In addition, management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease losses to non-accrual loans and leases ratio as compared to our peers or industry expectations. Our allowance for loan and lease losses is measured more through general characteristics, including historical loss experience of our portfolio rather than through specific identification and we therefore expect to see this ratio rise as we continue to grow our loan and lease portfolio. Conversely, if we identify additional impaired loans or leases which are adequately collateralized and therefore require no specific or general reserve, this ratio could fall. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio was appropriate for the probable incurred losses inherent in our loan and lease portfolio as of September 30, 2019.
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A tabular summary of the activity in the allowance for loan and lease losses follows:

|  | As of and for the Three Months Ended September 30, |  | As of and for the Nine Months Ended September 30,
|  | 2019 |  | 2018 |  | 2019 |  | 2018
|  | (Dollars in Thousands)
Allowance at beginning of period |  | $ | 19,819 |  |  | $ | 20,932 |  |  | $ | 20,425 |  |  | $ | 18,763 |
Charge-offs: |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |
Commercial real estate — owner occupied |  | — |  |  | (1,826 | ) |  | — |  |  | (3,125 | )
Commercial real estate — non-owner occupied |  | — |  |  | — |  |  | — |  |  | — |
Construction and land development |  | — |  |  | — |  |  | — |  |  | (993 | )
Multi-family |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | — |  |  | — |  |  | — |  |  | (4 | )
Commercial and industrial |  | (1,097 | ) |  | (75 | ) |  | (1,158 | ) |  | (732 | )
Direct financing leases |  | — |  |  | — |  |  | — |  |  | — |
Consumer and other: |  |  |  |  |  |  |  |
Home equity and second mortgages |  | (2 | ) |  | — |  |  | (2 | ) |  | — |
Other |  | — |  |  | (13 | ) |  | (2 | ) |  | (50 | )
Total charge-offs |  | (1,099 | ) |  | (1,914 | ) |  | (1,162 | ) |  | (4,904 | )
Recoveries: |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |
Commercial real estate — owner occupied |  | — |  |  | 1 |  |  | 1 |  |  | 3 |
Commercial real estate — non-owner occupied |  | 1 |  |  | — |  |  | 73 |  |  | 1 |
Construction and land development |  | — |  |  | 5 |  |  | — |  |  | 5 |
Multi-family |  | — |  |  | — |  |  | — |  |  | — |
1-4 family |  | — |  |  | 1 |  |  | — |  |  | 13 |
Commercial and industrial |  | 99 |  |  | 1,974 |  |  | 191 |  |  | 1,992 |
Direct financing leases |  | — |  |  | — |  |  | — |  |  | 1 |
Consumer and other: |  |  |  |  |  |  |  |
Home equity and second mortgages |  | — |  |  | 2 |  |  | 26 |  |  | 73 |
Other |  | 1 |  |  | — |  |  | 3 |  |  | — |
Total recoveries |  | 101 |  |  | 1,983 |  |  | 294 |  |  | 2,088 |
Net (charge-offs) recoveries |  | (998 | ) |  | 69 |  |  | (868 | ) |  | (2,816 | )
Provision for loan and lease losses |  | 1,349 |  |  | (546 | ) |  | 613 |  |  | 4,508 |
Allowance at end of period |  | $ | 20,170 |  |  | $ | 20,455 |  |  | $ | 20,170 |  |  | $ | 20,455 |
Annualized net charge-offs (recoveries) as a % of average gross loans and leases |  | 0.23 | % |  | (0.02 | )% |  | 0.07 | % |  | 0.24 | %

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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 September 30, 2019 were the interest payments due on subordinated and junior subordinated notes. On October 25, 2019, the Bank’s Board of Directors declared a dividend in the amount of $4.5 million bringing year-to-date dividend declarations to $14.0 million. The capital ratios of the Corporation and its subsidiary continue to meet all applicable regulatory capital adequacy requirements. The Corporation’s and the Bank’s respective Boards of Directors and management teams adhere to the appropriate regulatory guidelines on decisions which affect their capital positions, including but not limited to, decisions relating to the payment of dividends and increasing indebtedness.
The Bank maintains liquidity by obtaining funds from several sources. The Bank’s primary sources of funds are principal and interest repayments on loans receivable and mortgage-related securities, deposits, and other borrowings, such as federal funds and FHLB advances. The scheduled payments of loans and mortgage-related securities are generally a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest rates, economic conditions, and competition.
On-balance sheet liquidity is a critical element to maintaining adequate liquidity to meet our cash and collateral obligations. We define our on-balance sheet liquidity as the total of our short-term investments, our unencumbered securities’ fair value, and our unencumbered pledged loans. As of September 30, 2019 and December 31, 2018, our immediate on-balance sheet liquidity was $261.2 million and $390.9 million, respectively. At September 30, 2019 and December 31, 2018, the Bank had $20.8 million and $43.6 million on deposit with the FRB, respectively. Any excess funds not used for loan funding or satisfying other cash obligations were maintained as part of our on-balance sheet liquidity in our interest-bearing accounts with the FRB, as we value the safety and soundness provided by the FRB. We plan to utilize excess liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow run-off of maturing bank wholesale funding, or invest in securities to maintain adequate liquidity at an improved margin.
We had $496.4 million of outstanding wholesale funds at September 30, 2019, compared to $550.4 million of wholesale funds as of December 31, 2018, which represented 27.3% and 31.8%, respectively, of ending balance total bank funding. Wholesale funds include brokered certificates of deposit, deposits gathered from internet listing services, and FHLB advances. Total bank funding is defined as total deposits plus FHLB advances. We are committed to raising in-market deposits while maintaining our overall target mix of wholesale funds and in-market deposits. Wholesale funds continue to be an efficient and cost effective source of funding for the 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.
Period-end in-market deposits increased $141.5 million, or 16.0% annualized, to $1.321 billion at September 30, 2019 from $1.179 billion at December 31, 2018. While these deposits were gathered from new and existing in-market relationships, the balances may fluctuate over time. We expect to continue establishing new client relationships and continue marketing efforts aimed at increasing the balances in existing clients’ deposit accounts in order to fund our loan growth and maintain in-market deposits to total bank funding within our operating range of 60%-75%. Management recently updated this range from the previously disclosed 60%-70% to reflect our sophisticated business clients’ increased use of commercial loan swaps to obtain long-term fixed rated financing, instead of conventional long-term fixed rate offerings where we would match-fund the loan through the wholesale market to mitigate interest rate risk. Nonetheless, we will continue to use wholesale funds in specific maturity periods, typically three to five years, needed to effectively mitigate the interest rate risk measured through our asset/liability management process or in shorter time periods if in-market deposit balances decline. In order to provide for ongoing liquidity and funding, all of our wholesale funds are certificates of deposit which do not allow for withdrawal at the option of the depositor before the stated maturity (with the exception of deposits accumulated through the internet listing service which have the same early withdrawal privileges and fees as do our other in-market deposits) and FHLB advances with contractual maturity terms and no call provisions. The Bank limits the percentage of wholesale funds to total bank funds in accordance with liquidity policies approved by its Board of Directors. The Corporation’s overall operating range of wholesale
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funds to total bank funds is 25%-40%. The Bank was in compliance with policy limits as of September 30, 2019 and December 31, 2018.
The Bank was able to access the wholesale deposit market as needed at rates and terms comparable to market standards during the nine month period ended September 30, 2019. In the event there is a disruption in the availability of wholesale deposits 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 with the FRB and borrowings from the FHLB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As of September 30, 2019, 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 their liquidity needs.
The Bank is required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. We believe the Bank has sufficient liquidity to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows.
During the nine months ended September 30, 2019, operating activities resulted in a net cash inflow of $20.8 million, which included net income of $17.6 million. Net cash used in investing activities for the nine months ended September 30, 2019 was approximately $124.5 million which consisted of cash outflows to fund net loan growth and reinvestment of cash flows within purchases of additional securities, partially offset by cash inflows from maturities, redemptions, and paydowns of available-for-sale and held-to-maturity securities. Net cash provided by financing activities resulted in a net cash inflow of $78.2 million for the nine months ended September 30, 2019 primarily due to a net increase in deposits. 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 September 30, 2019, 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, 2018. We continue to believe that we have adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our primary market risk is interest rate risk, which arises from exposure of our financial position to changes in interest rates. It is our strategy to reduce the impact of interest rate risk on net interest margin by maintaining a favorable match between the maturities and repricing dates of interest-earning assets and interest-bearing liabilities. This strategy is monitored by the Bank’s Asset/Liability Management Committee, in accordance with policies approved by the Bank’s Board of Directors. This committee meets regularly to review the sensitivity of the Bank’s assets and liabilities to changes in interest rates, liquidity needs and sources, and pricing and funding strategies.
We use two techniques to measure interest rate risk. The first is simulation of earnings. In this measurement technique the balance sheet is modeled as an ongoing entity whereby future growth, pricing, and funding assumptions are implemented. These assumptions are modeled under different rate scenarios that include a parallel, instantaneous, and sustained change in interest rates. Key assumptions include:

• | the behavior of interest rates and pricing spreads;

• | the changes in product balances; and

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

This analysis incorporates several assumptions, the most material of which relate to the re-pricing characteristics and balance fluctuations of deposits with indeterminate or non-contractual maturities, and is measured as a percentage change in net interest income for the next 12 months due to instantaneous movements in benchmark interest rates from a baseline scenario. Estimated changes are dependent upon material assumptions such as those previously discussed.
The earnings simulation analysis does not incorporate any management actions that may be used to mitigate negative consequences of actual interest rate movement. For that reason and others, they do not reflect the likely actual results but serve
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as conservative estimates of interest rate risk. The simulation analysis is not comparable to actual results or directly predictive of future values of other measures provided.
The second measurement technique used is static gap analysis. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. In general, a positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature in a time frame and a negative gap indicates the opposite. In addition to the gap position, other determinants of net interest income are the shape of the yield curve, general rate levels, and the corresponding effect of contractual interest rate floors, reinvestment spreads, balance sheet growth and mix, and interest rate spreads. Our success in attracting in-market deposits adds to the interest rate liability sensitivity of the organization.
We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity, and/or repricing characteristics based on market conditions. Wholesale certificates of deposit and FHLB advances are a significant source of our funding and we use a variety of maturities to augment our management of interest rate exposure. Currently, we do not employ any derivatives to assist in managing our interest rate risk exposure; however, management has the authorization, as permitted within applicable approved policies, and ability to utilize such instruments should they be appropriate to manage interest rate exposure.
The process of asset and liability management requires management to make a number of assumptions as to when an asset or liability will reprice or mature. Management believes that its assumptions approximate actual experience and considers these assumptions to be reasonable, although the actual amortization and repayment of assets and liabilities may vary substantially. Our economic sensitivity to changes in interest rates at September 30, 2019 has not changed materially since December 31, 2018.
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 September 30, 2019.
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 September 30, 2019 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, 2018.
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.
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Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
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Item 6. Exhibits

31.1 |  |  | Certification of the Chief Executive Officer
31.2 |  |  | Certification of the Chief Financial Officer
32 |  |  | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101 |  |  | The following financial information from First Business Financial Services, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2019 and 2018, (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and 2018, (iv) Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2019 and 2018, (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018, 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.
October 25, 2019 | /s/ Corey A. Chambas
| Corey A. Chambas
| Chief Executive Officer
October 25, 2019 | /s/ Edward G. Sloane, Jr.
| Edward G. Sloane, Jr.
| Chief Financial Officer
| (principal financial officer)

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