First Business Financial Services, Inc. — 2017 Form 10-K
Business context and reporting period
Reports the fiscal year ended December 31, 2017, with comparative results for 2016 and 2015. First Business is a Wisconsin bank holding company focused on commercial banking, lending, specialty finance, treasury management, and trust and investment services in Wisconsin and the Kansas City region. Effective June 1, 2017, its three bank charters were consolidated into First Business Bank. The company converted the Kansas City region’s core banking system in the fourth quarter.
Financial results and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue (net interest income plus non-interest income) | $77.3 million | $81.3 million |
| Net interest income | $60.6 million | $63.3 million |
| Net income | $11.9 million | $14.9 million |
| Diluted EPS | $1.36 | $1.71 |
| Net interest margin | 3.58% | 3.64% |
| Return on average assets / equity | 0.67% / 7.16% | 0.82% / 9.40% |
| Total assets at year-end | $1.794 billion | $1.781 billion |
| Gross loans and leases at year-end | $1.503 billion | $1.452 billion |
| Deposits at year-end | $1.394 billion | $1.539 billion |
| Stockholders’ equity at year-end | $169.3 million | $161.7 million |
- Credit costs and asset quality: Provision for loan and lease losses was $6.2 million, down from $7.8 million. Net charge-offs rose to $8.3 million, or 0.57% of average loans, from $3.2 million, or 0.22%. Non-performing assets were $27.5 million, 1.53% of assets, versus $26.7 million, or 1.50%. The allowance was $18.8 million, 1.25% of gross loans, compared with 1.44% a year earlier; allowance coverage of non-accrual loans declined to 71.10% from 83.00%.
- Portfolio concentration: Commercial real estate loans totaled $1.018 billion, 67.7% of gross loans. Construction and land-development loans were $165.3 million. Management reported 98.7% of the portfolio current on payments.
- Funding, debt and liquidity: Total borrowings, including junior subordinated notes, rose to $217.9 million from $69.7 million, primarily reflecting FHLB advances, which reached $183.5 million. Wholesale funds were 31.2% of total bank funding, within the company’s 30%–40% target range. Immediate on-balance-sheet liquidity was $401.1 million, down from $543.1 million. The company reported $204.7 million of unused capacity on its $388.2 million FHLB line.
- Cash flow: Operating activities provided $22.4 million; investing activities used $46.4 million; financing activities used $1.0 million. Cash and cash equivalents ended the year at $52.5 million, down from $77.5 million.
- Capital and shareholder returns: The Bank was well-capitalized; its year-end total capital, common equity Tier 1 and leverage ratios were 11.66%, 10.45% and 10.56%, respectively. Dividends declared were $0.52 per share for the year, up from $0.48.
Material changes versus 2016
- Revenue fell 5.0% and net income fell 20.1%. Net interest income declined 4.3%, while non-interest income declined 7.4%.
- SBA loan-sale gains decreased $2.8 million to $1.6 million as the company rebuilt its SBA platform and moderated production. Recurring loan fees collected in lieu of interest also fell $2.4 million to $4.4 million.
- Trust and investment service fees increased 24.5% to $6.7 million; assets under management and administration rose 27.6% to $1.536 billion. Swap fees increased to $909,000 from $76,000.
- Deposits decreased $144.5 million, including a $108.7 million reduction in wholesale deposits. FHLB advances increased as the company replaced some maturing brokered deposits with term funding.
- Non-interest expense was nearly flat at $56.9 million. Adjusted efficiency ratio, a non-GAAP measure, worsened to 66.48% from 61.12%.
- Net charge-offs increased substantially, including $5.0 million of charge-offs related to remaining energy-sector exposure. Provision also reflected estimated losses on a previously disclosed $6.7 million Wisconsin commercial-and-industrial impaired loan; management continued to pursue repayment sources.
Outlook, commentary, risks and unusual items
- Management expects modest loan and lease growth and intends to rebuild SBA production at a moderate pace. It cited the charter consolidation and core-system conversion as intended sources of operating efficiencies and workforce capacity. No formal earnings or revenue guidance is provided.
- Management’s long-term efficiency-ratio goal is 58%–62%. It expects to manage funding and liability structure to support a stable net interest margin, but does not specify a numerical margin target in the provided text.
- The Tax Cuts and Jobs Act lowered the federal corporate tax rate to 21% beginning in 2018. Revaluation of deferred tax assets produced $629,000 of additional 2017 tax expense; the 2017 effective tax rate was 16.3%. The company reported no valuation allowance on deferred tax assets.
- The company recorded $2.8 million of impairment expense on tax-credit investments and a $2.2 million SBA recourse provision. The SBA recourse reserve was $2.8 million at year-end, reflecting potential losses if SBA loan guarantees are found ineligible.
- Management identified credit quality, concentrated commercial real estate exposure, interest-rate and funding sensitivity, dependence on wholesale funding, SBA guarantee compliance, and technology/cybersecurity risks as material areas to monitor. The filing notes elevated operational risk associated with the recent core-system conversion.
- The company plans to adopt the current expected credit loss (CECL) standard in 2020 and was assessing its impact; management cautioned it could increase the allowance for credit losses. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Progress on the impaired Wisconsin commercial-and-industrial credit, energy-sector charge-offs, and non-performing assets; assess whether the allowance remains adequate as charge-offs and coverage change.
- Whether loan growth, SBA production and fee income recover, and whether trust-fee growth can offset lower SBA gains and loan fees.
- Deposit trends and the cost, maturity profile and availability of wholesale funding, including FHLB advances and brokered deposits; confirm liquidity remains within policy limits.
- Effects of rising interest rates on net interest margin, deposit pricing, borrower repayment capacity and securities values.
- Final accounting effects of the tax-law changes and the eventual CECL transition, including any effect on capital, earnings and the allowance.
- Execution and realized savings from the charter consolidation and core-system conversion, including any continuing conversion, cybersecurity or vendor-related issues.