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Nature of Operations and Summary of Significant Accounting Policies | 3 Months Ended
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Mar. 31, 2023
Organization, Consolidation and Presentation of Financial Statements [Abstract] |
Nature of Operations and Summary of Significant Accounting Policies | Note 1 — Nature of Operations and Summary of Significant Accounting Policies Nature of Operations The accounting and reporting practices of First Business Financial Services, Inc. (“FBFS” or the “Corporation”), through our wholly-owned subsidiary, First Business Bank (“FBB” or the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). FBB operates as a commercial banking institution primarily in Wisconsin and the greater Kansas City metropolitan area. The Bank provides a full range of financial services to businesses, business owners, executives, professionals, and high net worth individuals. FBB also offers bank consulting services to community banks. The Bank is subject to competition from other financial institutions and service providers, and is also subject to state and federal regulations. As of March 31, 2023, FBB had the following wholly-owned subsidiaries: First Business Specialty Finance, LLC (“FBSF”), First Madison Investment Corp. (“FMIC”), ABKC Real Estate, LLC (“ABKC”), FBB Real Estate 2, LLC (“FBB RE 2”), Mitchell Street Apartments Investment, LLC (“Mitchell Street”), and FBB Tax Credit Investment, LLC (“FBB Tax Credit”). 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, 2022. 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. Management of the Corporation is required to make estimates and assumptions which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that could significantly change in the near-term include the value of securities and interest rate swaps, level of the allowance for credit losses, lease residuals, property under operating leases, goodwill, and income taxes. The results of operations for the three months ended March 31, 2023, are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2023. 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. Other than the adoption of new standards, 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, 2022. Adoption of new accounting standards ASU 2016 - 13 On January 1, 2023, the Corporation adopted ASU 2016-03 Financial Instruments - Credit losses (“ASC 326”): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. The measurement expected credit losses under CECL methodology is applicable to financial assets measured at amortized cost, included loan receivables and held-to-maturity debit securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with ASC 842 on leases. In addition, ASC 326 made changes to the accounting for available for sale and held to maturity debt securities. The Corporation adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable U.S. GAAP. The Corporation recorded a net decrease to retained earnings of $1.4 million as of January 1, 2023 for the cumulative effect of adopting ASC 326. The transition adjustment to allowance for credit losses (“ACL”) includes $1.3 million related to off-balance sheet credit exposures and $484,000 related to loans. The following table illustrates the impact of ASC 326:
|  | January 1, 2023
(In thousands) |  | As Reported Under ASC 326 |  | Pre-ASC 326 Adoption |  | Impact of ASC 326 Adoption
Assets: |  |  |  |  |  |
Loans |  | $ | 2,443,215 |  |  | $ | 2,443,215 |  |  | $ | — |
ACL on loans |  |  |  |  |  |
Commercial real estate — owner occupied |  | 1,548 |  |  | 1,766 |  |  | (218) |
Commercial real estate — non-owner occupied |  | 4,811 |  |  | 5,108 |  |  | (297) |
Construction |  | 1,755 |  |  | 1,646 |  |  | 109 |
Multi-family |  | 2,243 |  |  | 2,634 |  |  | (391) |
1-4 family |  | 147 |  |  | 207 |  |  | (60) |
Commercial and industrial |  | 13,762 |  |  | 12,403 |  |  | 1,359 |
Consumer and other |  | 448 |  |  | 466 |  |  | (18) |
Total ACL on loans |  | $ | 24,714 |  |  | $ | 24,230 |  |  | $ | 484 |
Net deferred tax asset |  | $ | 12,176 |  |  | $ | 11,711 |  |  | $ | 465 |
Liabilities: |  |  |  |  |  |
ACL on unfunded credit commitments |  | $ | 1,334 |  |  | $ | — |  |  | $ | 1,334 |
Stockholders’ equity: |  | $ | 259,287 |  |  | $ | 260,640 |  |  | $ | (1,353) |
ACL - Available For Sale (“AFS”) Debt Securities For AFS debt securities in an unrealized loss position, the Corporation first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security's amortized cost basis is written down to fair value through income. For AFS debt securities that do not meet the aforementioned criteria, the Corporation evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any decline in fair value that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of applicable taxes. Changes in the ACL are recorded as a provision for (or recovery of) credit loss expense. Losses are charged against allowance when management believes that uncollectibility of an AFS debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest receivable on AFS debt securities totaled $1.0 million at March 31, 2023 and is excluded from the estimate of credit losses. ACL - Held To Maturity (“HTM”) Debt Securities Management measures expected credit losses on HTM debt securities on a collective basis by major security type. Accrued interest receivable on HTM debt securities totaled $74,000 at March 31, 2023 and is excluded from the estimate of credit losses. The HTM securities portfolio includes residential mortgaged backed securities (“MBS”) commercial MBS, and municipal securities. All residential and commercial MBS are U.S. government issued or U.S. government sponsored and substantially all municipal bonds are rated A or above. The estimate of expected credit losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. At the time of adoption, the estimated reserve was immaterial. ACL - Loans The ACL is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes that the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency level, or term as well as changes in external conditions, such as changes in unemployment rates, property values, or other relevant factors. Accrued interest receivable on loans totaled $8.9 million at March 31, 2023 and is excluded from the estimate of credit losses. ACL - Loans - Collectively Evaluated The ACL is measured on a collective pool basis when similar risk characteristics exist. The Corporation has identified the following portfolio segments: Commercial Real Estate: Commercial real estate portfolio segments utilize substantially similar processes and controls. Due to the collateral types, availability of data, and results of the Loss Driver Analysis (“LDA”), management utilizes a unique forecast model for each portfolio segment along with a separate analysis of subjective factors. •Construction - Loans secured by real estate used to finance land development or construction. •1-4 Family - Loans secured by 1-4 family residential property •Multi-family - Loans secured by multi-family residential property •Owner Occupied - Loans secured by nonfarm, nonresidential owner-occupied property •Non-owner Occupied - Loans secured by other nonfarm, nonresidential property Commercial and Industrial Lending: Commercial and industrial lending is a portfolio segment where management uses a common forecast due to common risk management, similarity in collateral types, availability of data, and results of the LDA. Management has distinct processes, controls, and procedures which enable more precise development of subjective factors at the pool level. •Commercial - Loans to small- to medium-sized companies in our primary markets in Wisconsin, Kansas, and Missouri, predominantly through lines of credit and term loans to businesses with annual sales of up to $150 million. •Asset Based Lending - Products include revolving lines of credit and term loans for strategic acquisitions, capital expenditures, working capital, bank debt refinancing, debt restructuring, and corporate turnaround strategies. •Floorplan - Floor plan financing for independent auto dealerships nationwide. •SBA - Loans originated in accordance with the guidelines of the Small Business Administration (“SBA”). As the Corporation prefers to sell the guaranteed portion, the on-balance sheet loans are primarily unguaranteed. •Equipment finance - Loans and leases secured by a broad range of equipment to commercial clients in a variety of industries. Consumer and other - Consumer loans consisting of marketable security loans, home equity, first and second mortgages, and other personal loans for executives and high net-worth individuals. The Corporation uses a unique forecast model and subjective factors for this portfolio segment due to the client type and data availability. Measures of the allowance for credit losses are as follows:
Portfolio Segment |  | Pool |  | Measurement Method |  | Loss Driver
Commercial real estate |  |  |  |  |  |
Owner occupied |  |  |  | Discounted Cash Flow |  | National unemployment, National GDP
Non-owner occupied |  |  |  | Discounted Cash Flow |  | National unemployment, National GDP
Construction |  |  |  | Discounted Cash Flow |  | National unemployment, National GDP
Multi-family |  |  |  | Discounted Cash Flow |  | National unemployment, National GDP
1-4 Family |  |  |  | Discounted Cash Flow |  | National unemployment, National GDP
Commercial and industrial |  |  |  |  |  |
|  | Commercial |  | Discounted Cash Flow |  | National unemployment, National GDP
|  | ABL |  | Discounted Cash Flow |  | National unemployment, National GDP
|  | Floorplan |  | Discounted Cash Flow |  | National unemployment, National GDP
|  | SBA |  | Weighted Average Remaining Maturity |  | N/A
|  | Equipment Finance |  | Discounted Cash Flow |  | National unemployment, National GDP
Consumer and other |  |  |  | Discounted Cash Flow |  | National unemployment, National GDP
The Corporation utilized a discounted cash flow (DCF) or Weighted Average Remaining Maturity (WARM) method to estimate the quantitative portion of the allowance for credit losses for loans evaluated on a collective pooled basis. For each segment, a LDA was performed in order to identify loss drivers and create a regression model for use in forecasting cash flows. For all DCF-based pools, the LDA analyses utilized the Corporation’s and peer data from the Federal Financial Institutions Examination Council's (“FFIEC”) Call Report filings. In creating the DCF model, the Corporation has established a one-year reasonable and supportable forecast period with a one-year straight line reversion to the long-term historical average. Due to the infrequency of losses, the Corporation elected to use peer data for a more statistically sound calculation. Key inputs into the DCF model include loan-level detail, including the amortized cost basis of individual loans, payment structure, loss history, and forecasted loss drivers. The Corporation utilizes a third party to provide economic forecasts under various scenarios, which are assessed quarterly considering the scenarios in the context of the current economic environment and presumed risk of loss. Expected credit losses are estimated over the contractual term of the loans, adjusted for prepayments when appropriate. The contractual term excludes extensions, renewals, and modifications unless the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Corporation. Additional key assumptions in the DCF model include the probability of default (“PD”), loss given default (“LGD”), and prepayment/curtailment rates. The Corporation utilizes the model-driven PD and a LGD derived using a method referred to as Frye Jacobs. The Frye Jacobs method is a mathematical formula that traces the relationship between LGD and PD over time and projects the LGD based on the level of PD forecasted. In all cases, the Frye Jacobs method is utilized to calculate LGDs during the forecast period, reversion period and long-term historical average. Prepayment and curtailment rates were calculated through third party studies of the Corporation’s own data. When the DCF method is used to determine the allowance for credit losses, management adjusts the effective interest rate used to discount expected cash flows to incorporate expected prepayments. For the WARM-based SBA pool, Corporation-specific data was used to develop the model assumptions. The Corporation developed a reasonable and supportable estimate for the remaining maturity and estimated loss through analysis of historical data. The remaining maturity calculation excludes loans originated under the Paycheck Protection Program as such loans are inconsistent with the current portfolio composition. The quarterly loss rate data includes 2017 to current as the SBA lending policies and procedures were realigned in 2016 following the acquisition of Alterra Bank. Only the unguaranteed portion of the SBA loans are assessed via WARM. The risk of a failed guarantee claim is captured under ASC 450 contingency accounting. Qualitative factors for DCF and WARM methodologies include the following: •The Corporation’s lending policies and procedures, including changes in lending strategies, underwriting standards and practices for collections, write-offs, and recoveries; •Actual and expected changes in international, national, regional, and local economic and business conditions and developments in which the Corporation operates that affect the collectability of financial assets; •The experience, ability, and depth of the Corporation’s lending, investment, collection, and other relevant management and staff; •The volume of past due financial assets, the volume of non-performing assets, and the volume and severity of adversely classified or graded assets; •The existence and effect of industry concentrations of credit; •The nature and volume of the portfolio segment or class; •The quality of the Corporation’s credit review function and; •The effect of other external factors such as the regulatory, legal and technological environments, competition, and events such as natural disasters or pandemics ACL - Loans - Individually Evaluated Loans that do not share risk characteristics are evaluated on an individual basis and are excluded from the collective evaluation. The Corporation has determined that any loans which have been placed on non-performing status will be individually evaluated. Individual analysis will establish a specific reserve for loans in scope. Specific reserves on non-performing loans are typically based on management’s best estimate of the fair value of collateral securing these loans, adjusted for selling costs as appropriate. ACL - Off-Balance Sheet Credit Exposures The Corporation estimates expected credit losses over the contractual period in which the Corporation is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Corporation. The allowance for credit losses on off-balance sheet credit exposure is adjusted as a provision for credit loss expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. Funding rates are based on a historical analysis of the Corporation’s portfolio, while estimates of credit losses are determined using the same loss rates as funded loans. Regulatory capital As permitted by the federal banking regulatory agencies, the Corporation has elected the option to delay the impact of the day one adoption of ASC 326. The transition adjustments of $1.4 million will be phased into the regulatory capital calculations over a three year period, with 25% of the adjustment recognized in 2023, 50% of the adjustment recognized in 2024, 75% of the adjustment recognized in 2025, and 100% of the adjustment recognized in 2026. ASU 2022-02 Troubled Debt Restructurings Concurrent with the adoption of ASU 2016-03, the Corporation adopted ASU 2022-02 "Financial Instruments-Credit Losses (“ASC 326”): Troubled Debt Restructurings and Vintage Disclosures", as amended. The update eliminates the accounting guidance for troubled debt restructurings (“TDRs”) by creditors in Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. ASU 2020-04 Reference Rate Reform In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The accounting standards update (ASU) provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. In January 2021, the FASB issued ASU 2021-01 which clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Corporation has adopted the standard and utilized the LIBOR transition relief allowed under ASU 2020-04 and ASU 2020-01. The impact was immaterial as all transactions enacted under LIBOR were able to be transitioned to another referenced (predominately Secured Overnight Financing Rate “SOFR”). Certain contracts were transitioned in 2023. In all cases, the Corporation was able to meet the criteria for practical expedients and there was no impact on the financial results.

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