BYLINE BANCORP, INC. (BY) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following is a discussion and analysis of our financial condition and results of operations and should be read in conjunction with our financial statements and notes thereto included in Item 8 of this report. In addition to historical information, this discussion contains forward‑looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections entitled “Special Note Regarding Forward‑Looking Statements” and “Risk Factors”. Byline assumes no obligation to update any of these forward‑looking statements.

Management’s discussion focuses on 2021 results compared to 2020. For a discussion of 2020 results compared to 2019, refer to Part I, Item 7 of our 2020 Annual Report filed on Form 10-K, which was filed with the SEC on March 4, 2021.

Executive Summary

Our results of operations depend substantially on net interest income, which is the difference between interest income on interest-earning assets, consisting primarily of interest income on loans and lease receivables, including accretion income on loans, investment securities and other short-term investments, and interest expense on interest-bearing liabilities, consisting primarily of deposits and borrowings. Our results of operations are also dependent upon our generation of non-interest income, consisting primarily of income from fees and service charges on deposits, loan servicing revenue, wealth management and trust income, ATM and interchange fees, and net gains on sales of investment securities and loans. Other factors contributing to our results of operations include our provisions for loan and lease losses, provision for income taxes, and non-interest expenses, such as salaries and employee benefits, occupancy and equipment expenses and other miscellaneous operating costs.

We reported consolidated net income of $92.8 million for the year ended December 31, 2021, compared to net income of $37.5 million for the year ended December 31, 2020, an increase of $55.3 million. The increase in net income was attributable to a $21.4 million increase in net interest income, a $54.5 million decrease in the provision for loan and lease losses, and a $12.2 million increase in non-interest income, offset by a $17.2 million increase in provision for income taxes, and a $15.5 million increase in non-interest expense. The increase in net interest income during the year ended December 31, 2021 was primarily a result of an increase in average interest earning assets. The decrease in provision for loan and lease losses was mainly driven by decreases in the general reserves driven by decreases in qualitative factors due to the continued economic recovery. The increase in non-interest income was primarily driven by gains on the sales of loans. The increase in provision for income taxes was mostly driven by an increase in net income before provision for income taxes during the period. The increase in non-interest expense was mainly due to an increase in salaries and employee benefits as a result of new hires and increases in incentive compensation.

Dividends declared and paid on preferred shares were $783,000 for the years ended December 31, 2021 and 2020. Dividends declared on common shares were $11.4 million for the year ended December 31, 2021. Dividends paid on common shares were $11.3 million and $5.7 million for the years ended December 31, 2021 and 2020, respectively. For the years ended December 31, 2021 and 2020, net income available to common stockholders was $92.0 million, or $2.45 per basic and $2.40 per diluted common share, and $36.7 million, or $0.96 per basic and diluted common share, respectively. Our results of operations for the years ended December 31, 2021 and 2020, produced an annual return on average assets of 1.40% and 0.61% and a return on average stockholders’ equity of 11.31% and 4.78%, respectively.

Since our recapitalization in June 2013, our branch network has been reduced from 88 to 44, including 13 branches added through acquisition. During 2020 and 2021 we consolidated 17 branches within our network with minimal impact on our customer service levels, convenience, and business development capabilities. In December 2021 we announced plans to consolidate six branches during the second quarter of 2022. We expect these consolidations to generate over $5.3 million in annual cost savings. We expect to reinvest approximately 70% of the anticipated annualized cost savings into talent and technology that will further enhance our digital banking capabilities.

Critical accounting policies and estimates

Our accounting and reporting policies conform to GAAP and to general practices within the banking industry. To prepare financial statements and interim financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes; and are based on information available as of the date of the financial statements. As this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements. In particular, management has identified several accounting policies that, due to the estimates, assumptions and judgments inherent in those policies, are critical in understanding our financial statements.

These critical accounting policies and estimates include (i) acquisition‑related fair value computations, (ii) the carrying value of loans and leases, (iii) determining the provision and allowance for loan and lease losses, (iv) the valuation of intangible assets such as goodwill, servicing assets and core deposit intangibles, (v) the determination of fair value for financial instruments, including other-than-temporary-impairment losses, (vi) the valuation of real estate held for sale, and (vii) the valuation or recognition of deferred tax assets and liabilities.

The JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the financial statements included in this annual report on Form 10-K, as well as any financial statements that we file in the future, will not be subject to all new

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or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period provided for under the JOBS Act.

The following is a discussion of the critical accounting policies and significant estimates that require us to make complex and subjective judgments. Additional information about these policies can be found in Note 1 of our audited consolidated financial statements contained in Item 8 of this report.

Business combinations

We account for business combinations under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations (“ASC 805”). We recognize the fair value of the assets acquired and liabilities assumed as of the date of acquisition, with any excess of the fair value of consideration provided over the fair value of the identifiable net tangible and intangible assets acquired recorded as goodwill. Transaction costs are expensed as incurred. Application of the acquisition method requires extensive use of accounting estimates and judgments to determine the fair values of the identifiable assets acquired and liabilities assumed at the acquisition date.

In accordance with ASC 805, the acquiring company retains the right to make appropriate adjustments to the assets and liabilities of the acquired entity for information obtained during the measurement period about facts and circumstances that existed as of the acquisition date. The measurement period ends as of the earlier of (i) one year from the acquisition date or (ii) the date when the acquirer receives the information necessary to complete the business combination accounting.

Originated loans and leases

We account for originated loans and leases and purchased loans and leases not acquired through business combinations as originated loans and leases. The new loans that management has the intent and ability to hold for the foreseeable future are reported at their outstanding principal balances net of any allowance for loan and lease losses, unamortized deferred fees and costs and unamortized premiums or discounts. The net amount of nonrefundable loan origination fees and certain direct costs associated with the lending process are deferred and amortized to interest income over the contractual lives of the new loans using methods which approximate the level yield method. Discounts and premiums are amortized or accreted to interest income over the estimated term of the new loans using methods that approximate the effective yield method. Interest income on new loans is accrued based on the unpaid principal balance outstanding. Additionally, once an acquired non-impaired loan reaches its contractual maturity date, it is re-underwritten, and if renewed, it is classified as an originated loan.

Acquired loans and leases

Acquired loans and leases are recorded at fair value as of the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either acquired impaired or acquired non‑impaired. Acquired impaired loans reflect evidence of credit deterioration since origination for which it is probable that all contractually required principal and interest will not be collected by us. Subsequent to acquisition, we periodically update for changes in cash flow expectations, which are reflected in interest income over the life of the loan as accretable yield. Any subsequent decreases in expected cash flow attributable to credit deterioration are recognized by recording a provision for loan losses.

For acquired non‑impaired loans and leases, the excess or deficit of the loan and lease principal balance over the fair value is recorded as a premium or discount at acquisition and is accreted through interest income over the life of the loan or lease. Subsequent to acquisition, these loans and leases are evaluated for credit deterioration and a provision for loan and lease losses would be recorded when probable loss is incurred. These loans and leases are evaluated for impairment consistent with originated loans and leases.

Provision and allowance for loan and lease losses

The provision for loan and lease losses reflects the amount required to maintain the allowance for loan and lease losses (“ALLL”) at an appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves.

The ALLL is maintained at a level that management believes is appropriate to provide for known and inherent incurred loan and lease losses as of the dates of the Consolidated Statements of Financial Condition, and we have established methodologies for the determination of its adequacy. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are determined on an individual loan basis. We increase our ALLL by charging provisions for probable losses against our income and decrease by charge‑offs, net of recoveries.

The evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. While management uses available information to recognize losses on loans and leases, changes in economic or other conditions may necessitate revision of the estimate in future periods.

The ALLL is maintained at a level management believes is sufficient to provide for probable losses based upon an ongoing review of the originated and acquired non‑impaired loan and lease portfolios by portfolio category, which include consideration of actual loss experience, peer loss experience, changes in the size and risk profile of the portfolio, identification of individual problem loan and lease situations which may affect a borrower’s ability to repay, and evaluation of prevailing economic conditions.

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For acquired impaired loans, a specific valuation allowance is established when it is probable that we will be unable to collect all of the cash flows expected at acquisition, plus the additional cash flows expected to be collected arising from changes in estimates after acquisition.

The credit quality of loans in these loan portfolios are impacted by delinquency status and debt service coverage generated by the borrowers’ businesses and fluctuations in the value of real estate collateral.

Acquired non‑impaired loans and originated loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreements. All acquired non‑impaired loans and originated loans of $100,000 or greater with an internal risk rating of substandard or below, or on nonaccrual, as well as loans classified as TDR, are reviewed individually for impairment on a quarterly basis.

In March of 2020, the CARES Act was enacted by the U.S. government in response to the economic disruption caused by the COVID-19 pandemic. The CARES Act provided that a qualified loan modification is exempt by law from classification as a TDR, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States terminates. The Consolidation Appropriations Act further extended the suspension period until the earlier of January 1, 2022 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States terminates. We have modifications under these Acts. The underlying loans and leases are subject to the same underwriting, risk-rating and accrual standards as the rest of the loan portfolio.

Goodwill and intangible assets

Goodwill. Goodwill represents the excess of the purchase consideration over the fair value of net assets acquired in connection with our recapitalization and acquisitions using the acquisition method of accounting. Goodwill is not amortized but is periodically evaluated for impairment under the provisions of ASC Topic 350, Intangibles—Goodwill and Other (“ASC 350”).

Impairment testing is performed using either a qualitative or quantitative approach at the reporting unit level. Our goodwill is allocated to Byline Bank, which is our only applicable reporting unit for the purposes of testing goodwill for impairment. We have selected November 30 as the date to perform the annual goodwill impairment test. Additionally, we perform a goodwill impairment evaluation on an interim basis when events or circumstances indicate impairment potentially exists.

Servicing assets. Servicing assets are recognized separately when they are acquired through sales of loans or when the rights to service loans are purchased. When loans are sold with servicing rights retained, servicing assets are recorded at fair value in accordance with ASC Topic 860, Transfers and Servicing (“ASC 860”). Fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The fair value of servicing rights is highly sensitive to changes in underlying assumptions. Changes in the prepayment speed and discount rate assumptions have the most significant impact on the fair value of servicing rights. See Note 7 and Note 18 of the notes to our audited consolidated financial statements contained in Item 8 of this report for additional information.

Core deposit intangible assets. Other intangible assets primarily consist of core deposit intangible assets. In valuing core deposit intangibles, we consider variables such as deposit servicing costs, attrition rates and market discount rates. Core deposit intangibles are reviewed annually, or more frequently when events or changes in circumstances occur that indicate that their carrying values may not be recoverable. If the recoverable amount of the core deposit intangibles is determined to be less than its carrying value, we would then measure the amount of impairment based on an estimate of the fair value at that time. We also evaluate whether the events or circumstances have occurred that warrant a revision to the remaining useful lives of intangible assets. In cases where a revision is deemed appropriate, the remaining carrying amounts of the intangible assets are amortized over the revised remaining useful life. Core deposit intangibles are currently amortized over an approximate ten-year period.

Customer relationship intangible. Other intangible assets also include our customer relationship intangible asset. In valuing our customer relationship intangibles, we consider variables such as assets under management, attrition rates, and fee structure. Customer relationship intangibles are currently amortized over a 12-year period.

Fair value of financial instruments

ASC Topic 820, Fair Value Measurement defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date.

The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not available, management judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.

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See Note 18 of the notes to our audited consolidated financial statements contained in Item 8 of this report for a complete discussion of our use of fair value of financial assets and liabilities and their related measurement practices.

Valuation of real estate held for sale

Other real estate owned. OREO includes real estate assets that have been acquired through, or in lieu of, loan foreclosure or repossession and are to be sold. OREO assets are initially recorded at fair value, less estimated costs to sell, of the collateral of the loan, on the date of foreclosure or repossession, establishing a new cost basis. Adjustments that reduce loan balances to fair value at the time of foreclosure or repossession are recognized as charge‑offs in the allowance for loan and lease losses. Positive adjustments, if any, at the time of foreclosure or repossession are recognized as a reduction in non‑interest expense. After foreclosure or repossession, management periodically obtains new valuations and real estate or other assets may be adjusted to a lower carrying amount, determined by the fair value of the asset, less estimated costs to sell. Any subsequent write‑downs are recorded as a decrease in the asset and charged against other real estate owned valuation adjustments, included within non-interest expense. Operating expenses of such properties, net of related income, are included in non‑interest expense, and gains and losses on their disposition are included in non‑interest expense. Gains on internally financed other real estate owned sales are accounted for in accordance with the methods stated in ASC Topic 360‑20, Real Estate Sales (“ASC 360‑20”). Any losses on the sales of other real estate owned properties are recognized immediately.

Assets held for sale. Assets held for sale consist of former branch locations and real estate purchased for expansion. Assets are considered held for sale when management has approved a plan to sell the assets following a branch closure or other events. The properties are being actively marketed and transferred to assets held for sale based at the lower of its carrying value or its fair value, less estimated costs to sell. Adjustments to reduce the asset balances to fair value are recorded at the time of transfer and are recognized through a charge against income. An assessment of the recoverability of other long-lived assets associated with all branches is periodically performed, resulting in impairment losses that are reflected in other non-interest expense.

Income taxes

We use the asset and liability method to account for income taxes. The objective of the asset and liability method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the income tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. Our annual tax rate is based on our income, statutory tax rates and available tax planning opportunities. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining tax expense and in evaluating tax positions, including evaluating uncertainties.

Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss carryforwards. We review our deferred tax positions quarterly for changes which may impact realizability. We evaluate the recoverability of these future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. We use short and long‑range business forecasts to provide additional information for its evaluation of the recoverability of deferred tax assets. It is our policy to recognize interest and penalties associated with uncertain tax positions, if applicable, as components of non‑interest expense.

A deferred tax valuation allowance is established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not that all or some of the deferred tax asset will not be realized. See Note 12 of the notes to our audited consolidated financial statements contained in Item 8 of this report for further information on income taxes.

Recently Issued Accounting Pronouncements

For a discussion of recent accounting pronouncements, including the effective dates of adoption and anticipated effects on our results of operations and finance as condition, see Note 2 of the notes to our audited consolidated financial statements contained in Item 8 of this report.

Primary Factors Used to Evaluate Our Business

As a financial institution, we manage and evaluate various aspects of both our results of operations and our financial condition. We evaluate the levels and trends of the line items included in our consolidated financial statements as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against our own historical performance, our budgeted performance and the final condition and performance of comparable financial institutions in our region. Comparison of our financial performance against other financial institutions is impacted by the accounting for acquired non‑impaired and acquired impaired loans.

These factors and metrics described in this annual report on Form 10-K may not provide an appropriate basis to compare our results or financial condition to the results or financial condition of other financial services companies, given our limited operating history and strategic acquisitions since our recapitalization.

Selected Financial Data.

The following table summarizes certain selected historical consolidated financial data of Byline as of or for the fiscal years ended December 31, 2021, 2020, and 2019, and is derived from our audited financial statements. You should read this information in conjunction with our consolidated financial statements and related notes included in Item 8 of this report. Management uses the non-GAAP financial measures set forth herein in its analysis of our performance, and believes that these non-GAAP financial measures

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provide useful information to management and investors; however, you should not view these disclosures as a substitute for results determined in accordance with GAAP financial measures.

(1)
Represents a non-GAAP financial measure. See “GAAP Reconciliation and Management Explanation of non-GAAP Financial Measures” for a reconciliation of Byline’s Non-GAAP measures to the most directly comparable GAAP financial measure.

(2)
Calculation excludes impairment charges, merger-related expenses, and core system conversion expenses.

(3)
Calculation excludes incremental income tax expense or benefit related to changes in corporate income tax rates and reversal of valuation allowance on net deferred tax assets.

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(4)
Represents loans and leases, net of acquisition accounting adjustments, unearned deferred fees and costs and initial indirect costs.

(5)
Represents the remaining unamortized premium or unaccreted discount as a result of applying the fair value acquisition accounting adjustment at the time of the business combination on acquired loans.

(6)
Represents non-interest expense less amortization of intangible assets divided by net interest income and non-interest income.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

Some of the financial measures included in Item 6. “Selected Financial Data” are not measures of financial performance in accordance with GAAP. Our management uses the non‑GAAP financial measures set forth below in its analysis of our performance.

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“Adjusted net income” and “adjusted diluted earnings per share” exclude certain significant items, which include incremental income tax benefit related to the reversal of the valuation allowance on our net deferred tax assets, incremental income tax benefit related to Illinois corporate income tax rate increases, incremental income tax expense or benefit related to federal corporate income tax reductions, impairment charges on assets held for sale and right-of use asset ("ROU"), merger-related expenses, and core system conversion expenses adjusted for applicable income tax. Management believes the significant items are not indicative of or useful to measure our operating performance on an ongoing basis.

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“Net interest income, fully taxable-equivalent” and “net interest margin, fully taxable-equivalent” are adjusted to reflect tax-exempt interest income on an equivalent before-tax basis using tax rates effective as of the end of the period. Management believes the metric provides useful comparable information to investors and that these measures may be useful for peer comparison.

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“Adjusted non-interest expense” is non-interest expense excluding certain significant items, which include impairment charges on assets held for sale and ROU asset, merger-related expenses, and core system conversion expenses.

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“Adjusted efficiency ratio” is adjusted non-interest expense less amortization of intangible assets divided by net interest income and non-interest income. Management believes the metric is an important measure of our operating performance on an ongoing basis.

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“Adjusted non-interest expense to average assets” is adjusted non-interest expense divided by average assets. Management believes the metric is an important measure of our operating performance on an ongoing basis.

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“Adjusted return on average stockholders’ equity” is adjusted net income divided by average stockholders’ equity. Management believes the metric is an important measure of our operating performance on an ongoing basis.

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“Adjusted return on average assets” is adjusted net income divided by average assets. Management believes the metric is an important measure of our operating performance on an ongoing basis.

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“Non-interest income to total revenues” is non-interest income divided by net interest income plus non-interest income. Management believes that it is standard practice in the industry to present non-interest income as a percentage of total revenue. Accordingly, management believes providing these measures may be useful for peer comparison.

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“Pre‑tax pre‑provision net income” is pre‑tax income plus the provision for loan and lease losses. Management believes this metric is important due to the tax benefit resulting from the reversal of the net deferred tax asset valuation allowance, the decrease in the federal corporate income tax rate, and the increase in the Illinois state corporate income tax rate. The metric demonstrates income excluding the tax provision or benefit and the provision for loan and lease losses, and enables investors and others to assess our ability to generate capital to cover credit losses through a credit cycle.

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“Adjusted pre-tax pre-provision net income” is pre-tax pre-provision net income excluding certain significant items, which include impairment charges on assets held for sale and ROU asset, merger-related expenses, and core system conversion expenses. Management believes the metric is an important measure of our operating performance on an ongoing basis.

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“Pre‑tax pre‑provision return on average assets” is pre-tax income plus the provision for loan and lease losses, divided by average assets. Management believes this metric is important due to the change in tax expense or benefit resulting from the recent decrease in the federal corporate income tax rate and the recent increase in the Illinois state income tax rate. The ratio demonstrates profitability excluding the tax provision or benefit and excludes the provision for loan and lease losses. “Adjusted pre-tax pre-provision return on average assets” excludes certain significant items, which include impairment charges on assets held for sale and ROU asset, merger-related expenses, and core system conversion expenses.

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“Tangible common equity” is defined as total stockholders’ equity reduced by preferred stock and goodwill and other intangible assets. Management does not consider servicing assets as an intangible asset for purposes of this calculation.

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“Tangible assets” is defined as total assets reduced by goodwill and other intangible assets. Management does not consider servicing assets as an intangible asset for purposes of this calculation.

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“Tangible book value per common share” is calculated as tangible common equity, which is stockholders’ equity reduced by preferred stock and goodwill and other intangible assets, divided by total shares of common stock outstanding. Management believes this metric is important due to the relative changes in the book value per share exclusive of changes in intangible assets.

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“Tangible common equity to tangible assets” is calculated as tangible common equity divided by tangible assets, which is total assets reduced by goodwill and other intangible assets. Management believes this metric is important to investors and analysts interested in relative changes in the ratio of total stockholders’ equity to total assets, each exclusive of changes in intangible assets.

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“Tangible net income available to common stockholders” is net income available to common stockholders excluding after-tax intangible asset amortization.

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“Adjusted tangible net income available to common stockholders” is tangible net income available to common stockholders excluding certain significant items. Management believes the metric is an important measure of our operating performance on an ongoing basis.

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“Return on average tangible common stockholders’ equity” is tangible net income available to common stockholders divided by average tangible common stockholders’ equity. Management believes the metric is an important measure of our operating performance on an ongoing basis.

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“Adjusted return on average tangible common stockholders’ equity” is adjusted tangible net income available to common stockholders divided by average tangible common stockholders’ equity. Management believes the metric is an important measure of our operating performance on an ongoing basis.

We believe that these non‑GAAP financial measures provide useful information to its management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that our non‑GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP financial measures that we and other companies use. Management also uses these measures for peer comparison.

The following reconciliation tables provide a more detailed analysis of the non‑GAAP financial measures discussed herein:

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Results of Operations

Net interest income

Net interest income, representing interest income less interest expense, is a significant contributor to our revenues and earnings. We generate interest income from interest and dividends on interest-earning assets, which include loans, leases and investment securities we own. We incur interest expense from interest paid on interest-bearing liabilities, which include interest-bearing deposits, subordinated notes, junior subordinated debentures and other borrowings. To evaluate net interest income, we measure and monitor (i) yields on our loans and other interest-earning assets, (ii) the costs of our deposits and other funding sources, (iii) our net interest spread and (iv) our net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as the net interest income divided by average interest-earning assets. Because non-interest-bearing sources of funds, such as non-interest-bearing deposits and stockholders’ equity, also fund interest-earning assets, net interest margin includes the benefit of these non-interest-bearing sources.

We also recognize income from the accretable discounts associated with the purchase of interest-earning assets. Because of our recapitalization and acquisitions, we derive a portion of our interest income from the accretable discounts on acquired loans. The accretion is generally recognized over the life of the loan and is impacted by changes in expected cash flows on the loan. This accretion will continue to have an impact on our net interest income as long as loans acquired with a discount at acquisition represent a meaningful portion of our interest-earning assets. As of December 31, 2021, acquired loans with evidence of credit deterioration accounted for under ASC Topic 310-30, Accounting for Purchased Loans with Deteriorated Credit Quality, represented 2.8% of our total loan portfolio, compared to 4.7 % at December 31, 2020.

Changes in the market interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and non-interest-bearing liabilities, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. In addition, our interest income includes the accretion of the discounts on our acquired loans, which will also affect our net interest spread, net interest margin and net interest income.

The following tables present, for the periods indicated, information about (i) average balances, the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense

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on interest-bearing liabilities and the resultant average rates; (iii) net interest income; (iv) the interest rate spread; and (v) the net interest margin. Yields have been calculated on a pre-tax basis (dollars in thousands):

(1)
Loan and lease balances are net of deferred origination fees and costs and initial direct costs. Non-accrual loans and leases are included in total loan and lease balances.

(2)
Interest income and rates include the effects of a tax equivalent adjustment to adjust tax-exempt investment income on tax-exempt investment securities to a fully taxable basis, assuming a federal income tax rate of 21%.

(3)
Represents the average rate earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.

(4)
Represents net interest income divided by total average interest-earning assets.

(5)
Average balances are average daily balances.

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Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following tables set forth the effects of changing rates and volumes on our net interest income during the periods shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes applicable to both volume and rate have been allocated to volume. Yields have been calculated on a pre-tax basis. The tables below are a summary of the increases and decreases in interest income and interest expense resulting from changes in average balances (volume) and changes in average interest rates (dollars in thousands):

(1)
Includes loans and leases on non-accrual status.

(2)
Interest income and rates include the effects of a tax equivalent adjustment to adjust tax-exempt investment income on tax-exempt investment securities to a fully taxable basis, assuming a federal income tax rate of 21%.

Net interest income for the year ended December 31, 2021 was $236.4 million, an increase of $21.4 million, or 10.0% compared to the same period in 2020. The increase in interest income of $9.7 million was principally a result of increased average interest-earning assets. The average balance of interest-earning assets was $6.1 billion for the year ended December 31, 2021, an increase of $489.5 million, or 8.6%, compared to 2020, primarily due to increased loan and lease originations and higher fees related to Paycheck Protection Program ("PPP") loan forgiveness offset by a $6.6 million decrease in net loan accretion. We expect net loan accretion to continue to decline and estimate $1.7 million in projected loan accretion for 2022. Interest expense decreased by $11.7 million for the year ended December 31, 2021 compared to the same period in 2020, mostly due to declining rates on time deposits. Average total interest-bearing deposits decreased $33.0 million, or 1.1%.

Interest expense on borrowings for the year ended December 31, 2021 was $8.0 million compared to $7.6 million for the year ended December 31, 2020, an increase of $409,000, or 5.4%. This increase was primarily driven by increases in average balances of borrowed funds.

The net interest margin for the year ended December 31, 2021 was 3.84%, an increase of four basis points compared to 3.80% for the year ended December 31, 2020. The average yield on interest-earning assets decreased 17 basis points for the year ended December 31, 2021 compared to the year ended December 31, 2020, while the average rate paid on interest-bearing liabilities decreased by 32 basis points, for an increase in the interest rate spread of 15 basis points. The primary driver of the increase was the decrease in average yields on interest-bearing liabilities.

Provision for loan and lease losses

The provision for loan and lease losses represents a charge to earnings necessary to establish an allowance for loan and lease losses that, in management’s evaluation, is appropriate to provide coverage for probable losses incurred in the loan and lease portfolio. The allowance for loan and lease losses is increased by the provision for loan and lease losses and is decreased by charge-offs, net of recoveries on prior charge-offs.

Provisions for loan and lease losses for the year ended December 31, 2021 were $1.5 million compared to $55.9 million for the year ended December 31, 2020, a decrease of $54.5 million, or 97.4%. The decrease reflects the decreases to our general reserves as the economic uncertainty caused by the COVID-19 pandemic continues to subside, offset by increases for loan and lease originations. The ALLL as a percentage of loans and leases decreased from 1.53% at December 31, 2020 to 1.21% at December 31, 2021.

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Non-interest income

Non-interest income was $74.3 million for the year ended December 31, 2021, compared to $62.1 million for the year ended December 31, 2020, an increase of $12.2 million or 19.6%. The increase in non-interest income was mostly due to an increase in net gains on sale of loans.

The following table presents the major components of our non-interest income for the periods indicated (dollars in thousands):

Fees and service charge on deposits was $7.3 million for the year ended December 31, 2021, compared to $6.5 million for the year ended December 31, 2020, an increase of $783,000 or 12.1%. The increase was a result of higher average balances of deposits.

Loan servicing revenue was $12.7 million for the year ended December 31, 2021, compared to $11.3 million for the year ended December 31, 2020, an increase of $1.4 million, or 12.1%. The increase was primarily driven by an increase in total loans serviced due to additional U.S. government guaranteed loans sold with retained servicing rights. At December 31, 2021 and 2020, the outstanding balances of U.S. government guaranteed loans serviced, were $1.7 billion and $1.5 billion, respectively.

Loan servicing asset revaluation represents net changes in the fair value of our servicing assets. Loan servicing asset revaluation had a downward adjustment of $6.7 million for the year ended December 31, 2021, compared to a downward adjustment of $5.0 million for the year ended December 31, 2020, an increase of $1.7 million, or 34.5%. The variances was primarily driven by the change in fair value of the servicing asset as a result of changes to valuation assumptions, including prepayment speeds, discount rates, and expected average loan life on U.S. government guaranteed loans based on the current interest rate environment, and were impacted by secondary market volatility caused by the economic uncertainty from the COVID-19 pandemic.

ATM and interchange fees were $4.5 million for the year ended December 31, 2021 compared to $4.2 million for the year ended December 31, 2020, an increase of $311,000 or 7.5%. The increase was primarily driven by higher interchange volume and rates.

Gains on sales of securities were $1.4 million for the year ended December 31, 2021 compared to $5.3 million for the year ended December 31, 2020, a decrease of $3.9 million or 72.9%. The variance was due to sales volume and changing market conditions. We sold $201.5 million and $209.0 million of securities during the years ended December 31, 2021 and 2020, respectively.

Net gains on sales of loans were $46.3 million for the year ended December 31, 2021 compared to $33.3 million for the year ended December 31, 2020, an increase of $12.9 million, or 38.8%. The increase in net gains on sales was primarily driven by higher volume of government guaranteed loans sold and higher market premiums for government guaranteed loans. We sold $392.6 million and $369.0 million of U.S. government guaranteed loans during the years ended December 31, 2021 and 2020, respectively.

Wealth management and trust income represents fees charged to customers for investment, trust, or wealth management services and are primarily determined by total assets under management. Wealth management and trust income was $3.1 million for the year ended December 31, 2021 compared to $2.7 million for the year ended December 31, 2020, an increase of $389,000 or 14.5% primarily due to market conditions and an increase in new business. Assets under management were $663.4 million and $569.4 million as of December 31, 2021 and 2020, respectively.

Other non-interest income was $5.8 million for the year ended December 31, 2021 compared to $3.0 million for the year ended December 31, 2020, an increase of $2.8 million or 92.6%. Customer derivative products fee income was $1.5 million for the year ended December 31, 2021 compared to $414,000 for the year ended December 31, 2020, an increase of $1.1 million. Increase in cash surrender value of bank owned life insurance was $1.5 million for the year ended December 31, 2021 compared to $259,000 for the year ended December 31, 2020, an increase of $1.2 million. During 2021, we made additional investments in Bank Owned Life Insurance of $68.6 million.

Non-interest expense

We reported non-interest expense for the year ended December 31, 2021 of $185.0 million compared to $169.4 million for the year ended December 31, 2020, an increase of $15.5 million or 9.2%. The increase was primarily due to increases in salaries and employee benefits and an increase in impairment charges on assets held for sale.

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The following table presents the major components of our non-interest expense for the periods indicated (dollars in thousands):

Salaries and employee benefits expense for the year ended December 31, 2021 was $101.2 million compared to $89.8 million for the year ended December 31, 2020, an increase of $11.5 million or 12.8%, primarily due to new hires and increased incentive compensation expense. Our staffing increased from 918 full-time equivalent employees as of December 31, 2020 to 970 as of December 31, 2021.

Occupancy expense for the year ended December 31, 2021 was $16.6 million compared to $19.4 million for the year ended December 31, 2020, a decrease of $2.8 million, or 14.7%. The decrease was primarily a result of decreased rental expense, offset by an increase in real estate taxes.

Equipment expense for the year ended December 31, 2021 was $4.1 million compared to $3.6 million for the year ended December 31, 2020, an increase of $504,000 or 14.2%. The increase was primarily a result of increased investment in equipment and technology assets.

Impairment charge on assets held for sale was $12.3 million for the year ended December 31, 2021 compared to $4.8 million for the year ended December 31, 2020, an increase of $7.6 million. The increase was primarily a result of impairments taken as part of our strategic branch consolidation efforts and real estate strategy we announced on December 10, 2021.

Legal, audit and other professional fees for the year ended December 31, 2021 were $10.2 million compared to $8.1 million for the year ended December 31, 2020, an increase of $2.1 million or 25.3%. The increase is driven by increases in professional services.

Data processing expense for the year ended December 31, 2021 was $11.8 million compared to $10.9 million for the year ended December 31, 2020, an increase of $880,000 or 8.1% primarily due to increases to technology spending.

Net loss recognized on other real estate owned and other related expenses were $1.1 million for the year ended December 31, 2021 compared to $1.8 million for the year ended December 31, 2020, a decrease in expense of $741,000, or 40.7%. The variance was primarily due to decreased valuation adjustments and increased gains on other real estate owned assets.

Regulatory assessments for the year ended December 31, 2021 were $1.7 million compared to $2.2 million for the year ended December 31, 2020, a decrease of $504,000, or 22.7%. The decrease was primarily driven by a decrease in FDIC insurance assessments.

Advertising and promotions for the year ended December 31, 2021 were $1.8 million compared to $1.3 million for the year ended December 31, 2020, an increase of $513,000 or 39.8%, primarily due to an increase in advertising campaigns and sponsorships.

Telecommunications expense for the year ended December 31, 2021 was $1.2 million compared to $1.7 million for the year ended December 31, 2020, a decrease of $573,000 or 33.2%. The decrease was primarily a result of our cost savings initiatives.

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Other non-interest expense for the year ended December 31, 2021 was $10.0 million compared to $12.3 million for the year ended December 31, 2020, a decrease of $2.2 million, or 18.1%. The decrease was primarily a result of decreased provision for unfunded commitments of $1.2 million and a decrease in Directors fees of $785,000.

For the years ended December 31, 2021 and 2020 , our efficiency ratio was 57.27% and 58.40%, respectively. The improvement in our efficiency ratio was primarily attributable to increased net interest income. For the years ended December 31, 2021 and 2020, our adjusted efficiency ratio was 51.98% and 56.68%, respectively. Please refer to the “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” included in Item 6 of this report, for more information on how our adjusted efficiency ratio is calculated.

Income Taxes

Income tax expense was $31.4 million for the year ended December 31, 2021, compared to $14.2 million for the year ended December 31, 2020. The increase in income tax expense was primarily due to increased income before provision for income taxes during the period.

Our effective tax rate was 25.3% for the year ended December 31, 2021 and 27.5% for the year ended December 31, 2020. The decrease in our effective tax rate was primarily driven by a reduction in state income tax rate, net of federal benefit. We expect our effective tax rate for 2022 to be approximately 25% to 27%.

Financial Condition

Balance sheet analysis

Our total assets increased by $305.5 million, or 4.8%, to $6.7 billion at December 31, 2021, compared to $6.4 billion at December 31, 2020. The increase in total assets includes an increase of $196.6 million, or 4.5%, in loans and leases from $4.3 billion at December 31, 2020 to $4.5 billion at December 31, 2021. Our originated loan and lease portfolio increased by $425.9 million and our acquired loan and lease portfolio decreased by $229.3 million. The increase in our originated portfolio was mostly attributed to organic loan and lease growth. The decrease in our acquired portfolio was due to renewals reflected in originated loans, payoffs and pay downs during the period.

Total liabilities increased by $274.6 million, or 4.9%, to $5.9 billion at December 31, 2021 compared to $5.6 billion at December 31, 2020. The increase is a result of an increase in total deposits of $403.0 million, or 8.5%, primarily attributed growth in non-interest bearing deposits.

Investment portfolio

Our investment securities portfolio consists of securities classified as equity and other securities, at fair value, available-for-sale, and held-to-maturity. There were no securities classified as trading in our investment portfolio as of or for the years ended December 31, 2021 and 2020. All available-for sale securities are carried at fair value and may be used for liquidity purposes should management consider it to be in our best interest. Securities available-for-sale consist primarily of residential mortgage-backed securities, commercial mortgage-backed securities and U.S. government agencies securities.

Securities available-for-sale increased $7.3 million, or 0.5%, from $1.4 billion at December 31, 2020 to $1.5 billion at December 31, 2021.

Our held-to-maturity securities portfolio consists of municipal securities. We carry these securities at amortized cost. Securities held-to-maturity were $3.9 million and $4.4 million at December 31, 2021 and 2020, respectively.

The fair value of our equity and other securities portfolio was $10.6 million at December 31, 2021, and $8.8 million at December 31, 2020.

We had no securities that were classified as having other-than-temporary-impairment (“OTTI”) as of December 31, 2021 and 2020.

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The following tables summarize the fair value of the available-for-sale and held-to-maturity securities portfolio as of the dates presented (dollars in thousands):

Certain securities have fair values less than amortized cost and, therefore, contain unrealized losses. At December 31, 2021, we evaluated the securities which had an unrealized loss for OTTI and determined all declines in value to be temporary. There were 104 investment securities with unrealized losses at December 31, 2021. We anticipate full recovery of amortized cost with respect to these securities by maturity, or sooner in the event of a more favorable market interest rate environment. We do not intend to sell these securities and it is not more likely than not that we will be required to sell them before recovery of their amortized cost basis, which may be at maturity.

The following table (dollars in thousands) set forth certain information regarding contractual maturities and the weighted average yields of our debt securities as of December 31, 2021. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

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(1)
The weighted average yields are based on amortized cost.

As of December 31, 2021 and 2020, investment securities indexed to LIBOR were $58.2 million and $44.3 million, respectively.

Total non-taxable securities classified as obligations of states, municipalities and political subdivisions were $61.7 million at December 31, 2021, a decrease of $15.8 million from December 31, 2020.

There were no holdings of securities of any one issuer, other than U.S. government-sponsored entities and agencies, with total outstanding balances greater than 10% of our stockholders’ equity as of December 31, 2021 and 2020.

Restricted stock

As a member of the Federal Home Loan Bank system, Byline Bank is required to maintain an investment in the capital stock of the FHLB. No market exists for this stock, and it has no quoted market value. The stock is redeemable at par by the FHLB and is, therefore, carried at cost. In addition, Byline Bank owns stock of Bankers’ Bank, which is redeemable at par and carried at cost. As of December 31, 2021 and 2020, we held $22.0 million and $10.5 million, respectively, in FHLB and Bankers’ Bank stock. We evaluate impairment of our investment in FHLB and Bankers’ Bank based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. We did not identify any indicators of impairment of FHLB and Bankers’ Bank stock as of December 31, 2021 and 2020.

Loan and lease portfolio

Lending-related income is the most important component of our net interest income and is the main driver of the results of our operations. Total loans and leases at December 31, 2021 and 2020 were $4.5 billion and $4.3 billion, respectively, an increase of $196.6 million or 4.5%. The growth in the originated loan and lease portfolio was primarily driven by increases in commercial real estate, commercial and industrial loans and leases, and leasing financing receivables. Acquired impaired loans and acquired non-impaired loans and leases were $442.8 million at December 31, 2021 a decrease of $229.3 million or 34.1%, compared to $672.1 million at December 31, 2020. The decrease in the acquired loan and lease portfolio was driven by renewals that are reflected within originated loans, payoffs, and maturities during the period.

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We strive to maintain a relatively diversified loan and lease portfolio to help reduce the risk inherent in concentration in certain types of collateral. Our exposure to certain industries as of December 31, 2021 represents the following percentages of the portfolio: 33.4% real estate, 15.0% manufacturing, 7.8% wholesale trade, 6.6% retail trade, 5.4% consumer, 5.2% finance and insurance , and all other industries represent less than 5% of the portfolio or 26.6% of the total loan and lease portfolio. As of December 31, 2021, the loan portfolio included $425.8 million of unguaranteed SBA 7(a) and USDA loans with exposure to the following top three industries: 16.1% accommodation and food services, 14.8% retail trade and 13.0% manufacturing. The following table shows our allocation of originated, acquired impaired and acquired non-impaired loans and leases as of the dates presented (dollars in thousands):

Loans collateralized by real estate comprised 54.5% and 51.4% of the loan and lease portfolio at December 31, 2021 and 2020, respectively. Commercial real estate loans comprised the largest portion of the real estate loan portfolio as of December 31, 2021 and 2020, and totaled $1.7 billion, or 67.4%, of real estate loans and 36.7% of the total loan and lease portfolio at December 31, 2021. At December 31, 2020, commercial real estate loans totaled $1.4 billion and comprised 63.9% of real estate loans and 32.8% of the total loan and lease portfolio. Acquired impaired commercial real estate loans decreased from $108.5 million as of December 31, 2020 to $72.2 million as of December 31, 2021, or 33.5%. At December 31, 2021 and 2020, commercial real estate loans, including both owner-occupied and non-owner occupied, as a percentage of total capital were 302.5% and 285.2%, respectively. Non-owner occupied commercial real estate loans were $637.1 million and $533.9 million, or 84.6% and 79.0% of total capital, at December 31, 2021 and 2020, respectively.

Residential real estate loans totaled $480.5 million at December 31, 2021 compared to $572.3 million at December 31, 2020, a decrease of $91.8 million or 16.0%. The residential real estate loan portfolio comprised 19.4% and 25.7% of real estate loans as of December 31, 2021 and 2020, respectively, and 10.6% and 13.3% of total loans and leases at December 31, 2021 and 2020, respectively. Acquired impaired residential real estate loans decreased from $78.8 million as of December 31, 2020 to $49.4 million as of December 31, 2021, or 37.3%.

Construction, land development and other land loans totaled $325.4 million at December 31, 2021 compared to $230.7 million at December 31, 2020, an increase of $94.7 million or 41.0%. The construction, land development and other land loan portfolio comprised 13.2% and 10.4% of real estate loans as of December 31, 2021 and 2020, respectively, and 7.2% and 5.3% of the total loan and lease portfolio as of December 31, 2021 and 2020, respectively.

Commercial and industrial loans totaled $1.6 billion and $1.4 billion at December 31, 2021 and 2020, respectively, an increase of $213.1 million, or .7%, primarily due to organic growth. The commercial and industrial loan portfolio comprised 34.9% and 31.5% of the total loan and lease portfolio as of December 31, 2021 and 2020, respectively.

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PPP loans totaled $123.7 million, or 2.7% of total loans and leases, at December 31, 2021 compared to $517.8 million or 11.9% of total loans and leases at December 31, 2020. PPP loans decreased $394.1 million, or 76.1%, primarily as a result of SBA loan forgiveness.

Lease financing receivables comprised 7.9% and 5.2% of the loan and lease portfolio as of December 31, 2021 and 2020, respectively. Total lease financing receivables were $358.4 million and $227.1 million at December 31, 2021 and 2020, respectively, an increase of $131.3 million, or 57.8%, primarily due to higher origination levels.

Loan and lease portfolio maturities and interest rate sensitivity

The following table shows our loan and lease portfolio by scheduled maturity at December 31, 2021 (dollars in thousands):

As of December 31, 2021, 46.4% of the loan and lease portfolio bears interest at fixed rates and 53.6% at floating rates. In addition, $1.5 billion, or 33.2%, of the loan and lease portfolio had interest rate floors of which $1.3 billion were at the interest rate floor as of December 31, 2021. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without penalties. Because a portion of the portfolio is accounted for under ASC 310-30, the carrying value is significantly affected by estimates and it is impracticable to allocate scheduled payments for those loans based on those estimates. Consequently, the tables presented include information limited to contractual maturities of the underlying loans. As of December 31, 2021, we had $1.2 billion in loans indexed to LIBOR.

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Allowance for loan and lease losses

The ALLL is determined by us on a quarterly basis, although we are engaged in monitoring the appropriate level of the allowance on a more frequent basis. The ALLL reflects management’s estimate of probable incurred credit losses inherent in the loan and lease portfolios. The computation includes elements of judgment and high levels of subjectivity.

Factors considered by us include, but are not limited to, actual loss experience, peer loss experience, changes in size and risk profile of the portfolio, identification of individual problem loan and lease situations that may affect a borrower’s ability to repay, and evaluation of the prevailing economic conditions. Changes in conditions may necessitate revision of the estimate in future periods.

We assess the ALLL based on three categories: (i) originated loans and leases, (ii) acquired non-impaired loans and leases, and (iii) acquired impaired loans with further credit deterioration after the acquisitions or our recapitalization.

Total ALLL was $55.0 million at December 31, 2021 compared to $66.3 million at December 31, 2020, a decrease of $11.3 million, or 17.1%. The decrease was primarily due to a decreases in the general reserve driven by the recovery from the uncertainty caused by the COVID-19 pandemic. Total ALLL to total loans and leases held for investment, net before ALLL was 1.21% and 1.53% of total loans and leases at December 31, 2021 and 2020, respectively. As of December 31, 2021, approximately $32.2 million of the ALLL was allocated to unguaranteed loans.

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The following table presents an analysis of the allowance of the loan and lease losses for the periods presented (dollars in thousands):