First Business Financial Services, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The company is a Wisconsin bank holding company serving businesses and individuals through First Business Bank and First Business Bank–Milwaukee, with trust, investment, and equipment-finance operations. Unless noted, amounts are in U.S. dollars.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $10.8 million | $10.2 million | $21.6 million | $20.4 million |
| Non-interest income | $2.4 million | $2.2 million | $4.7 million | $4.1 million |
| Total revenue (net interest income plus non-interest income) | $13.2 million | $12.4 million | $26.3 million | $24.5 million |
| Net income | $3.5 million | $3.1 million | $6.8 million | $6.4 million |
| Diluted EPS | $0.88 | $0.80 | $1.72 | $1.62 |
| Net interest margin | 3.52% | 3.46% | 3.55% | 3.50% |
| Efficiency ratio | 58.87% | 59.93% | 59.35% | 59.55% |
- Balance sheet at June 30: Assets were $1.307 billion, up 3.0% from December 31, 2013. Net loans and leases were $993.7 million, up 2.8%; deposits were $1.167 billion, up $36.8 million. Stockholders’ equity was $115.6 million.
- Credit and funding: Non-performing assets were $14.5 million, or 1.11% of assets, versus $16.2 million, or 1.28%, at year-end. Non-accrual loans declined to $14.2 million. The allowance was $14.0 million, or 1.39% of gross loans, versus 1.42% at year-end.
- Debt and capital: FHLB and other borrowings were $7.9 million, down from $11.9 million; junior subordinated notes were $10.3 million. The company repaid $4.0 million of subordinated debt during January. Management reported regulatory capital compliance; both banks were categorized as well capitalized.
- Liquidity and cash flow: Cash and cash equivalents were $86.0 million, compared with $81.3 million at year-end. First-half operating cash flow was $6.6 million; investing cash flow was negative $33.1 million and financing cash flow was positive $31.2 million. Management reported $293.7 million of immediate on-balance-sheet liquidity and brokered deposits equal to 37.5% of deposits.
Changes versus comparable periods
- Q2 revenue rose 6.4% and net income rose approximately 11.9%; first-half revenue rose 7.0% and net income rose approximately 7.3%. Diluted EPS increased in both comparisons.
- Net interest income growth reflected loan and lease growth and lower funding costs, partly offset by lower yields on loans. Net interest margin improved six basis points in Q2 and five basis points for the first half.
- Non-interest income increased 8.5% in Q2 and 13.4% for the first half, led by trust and investment-services fees. Non-interest expense rose 3.5% and 6.4%, respectively; Q2 professional fees included acquisition-related costs, while lower other expense partly offset increases.
- Asset quality improved overall, with lower non-accrual loans and non-performing assets. The company recorded a negative $91,000 loan-loss provision in Q2, compared with a $54,000 expense a year earlier; first-half provision was $89,000 versus $134,000.
Outlook, transaction, risks, and unusual items
- Management said it expects loan and lease activity to exceed normal amortization and support continued growth, while maintaining underwriting standards. Its stated priorities include asset quality, in-market transaction deposits, fee revenue, and operating efficiency. No specific full-year earnings or revenue guidance was provided.
- The pending acquisition of Aslin Group, including Alterra Bank, was announced May 22, 2014. The estimated transaction value is $30.1 million, comprising approximately $16.6 million of First Business stock and $13.5 million cash. It remained subject to regulatory and Aslin shareholder approvals and other closing conditions, with closing expected in late 2014. The company expected to complete a subordinated-debt offering before closing to fund the cash consideration.
- Management identified integration, employee and customer retention, regulatory conditions, transaction expenses, and failure to close as acquisition risks. Merger-related costs recorded through June 30 totaled $320,000; management cautioned that total transaction and integration costs could exceed expected near-term savings.
- The company transferred securities with $44.6 million amortized cost from available-for-sale to held-to-maturity. The transfer-date fair value was $43.7 million, including an $874,000 unrealized loss retained in equity and to be amortized over the securities’ remaining lives. Management cited interest-rate-risk management and intent and ability to hold to maturity. No other-than-temporary impairment was recorded.
- Interest-rate and credit risks include competitive pressure on loan pricing, exposure to changing rates, borrower defaults, and the commercial-real-estate concentration (about 63% of loans). Management noted further charge-offs or provisions could arise if credit conditions or borrower circumstances deteriorate. Brokered deposits were below the company’s 50% operating goal, but their balance had increased.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It stated ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the Aslin/Alterra acquisition receives approvals, closes on the expected schedule, and is funded on the anticipated terms; monitor final transaction and integration costs.
- Whether loan growth, loan yields, deposit mix, and brokered-deposit levels sustain net interest margin and liquidity.
- Whether non-performing assets continue to decline and whether the allowance remains adequate, particularly given commercial real-estate exposure and the $29.3 million of loans classified as substandard.
- How the securities reclassification, interest-rate movements, and available-for-sale portfolio values affect equity and future interest income.
- Whether reported earnings growth persists after acquisition costs and other unusual period-to-period expense items.