First Business Financial Services, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. The unaudited company is a Wisconsin commercial bank holding company serving businesses and individuals through First Business Bank and First Business Bank—Milwaukee.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $9.915 million | $9.104 million | $28.450 million | $26.557 million |
| Non-interest income | $2.249 million | $1.728 million | $6.003 million | $5.145 million |
| Total revenue (net interest income plus non-interest income) | $12.164 million | $10.832 million | $34.453 million | $31.702 million |
| Provision for loan and lease losses | $0.850 million | $0.435 million | $3.399 million | $3.313 million |
| Income before taxes | $4.063 million | $3.647 million | $9.839 million | $8.241 million |
| Net income | $2.622 million | $2.179 million | $6.397 million | $6.040 million |
| Diluted earnings per share | $0.99 | $0.83 | $2.43 | $2.32 |
| Net interest margin | 3.50% | 3.40% | 3.38% | 3.31% |
- Q3 revenue grew 12.3% and net income grew 20.3% year over year. Nine-month revenue grew 8.7%; net income rose 5.9%, despite the prior-year period benefiting from a one-time Wisconsin tax-law-related benefit.
- Q3 non-interest expense was $7.251 million, up 7.4%; nine-month expense was $21.215 million, up 5.3%. Compensation growth reflected new strategic hires and merit increases.
- For the nine months, operating cash flow was $12.383 million, investing cash flow was negative $63.167 million, and financing cash flow was $8.533 million. Cash and cash equivalents declined $42.251 million to $87.842 million.
Financial position, funding and asset quality
- At September 30, 2012, total assets were $1.192 billion, up from $1.177 billion at year-end 2011. Net loans and leases were $863.486 million, up 3.2%; deposits were $1.061 billion, up $9.946 million.
- Cash and cash equivalents were $87.842 million; available-for-sale securities were $202.805 million. Management reported immediate on-balance-sheet liquidity of $250.2 million, defined as short-term investments plus unpledged securities.
- Balance-sheet borrowings were $39.482 million, with a further $10.315 million of junior subordinated notes. Total liabilities were $1.122 billion and stockholders’ equity was $70.549 million. The company reported compliance with debt covenants and applicable regulatory capital requirements; both banks were categorized as well capitalized.
- Brokered deposits were $390.728 million, or 36.8% of ending deposits, down from $446.665 million, or 42.5%, at year-end. Management’s goal is to reduce reliance on brokered funding while growing in-market deposits.
- Asset quality improved: non-accrual loans and leases fell to $12.846 million from $21.766 million at year-end; non-performing assets were $15.033 million, or 1.26% of assets, versus $24.002 million, or 2.04%. The allowance was $14.706 million, 1.67% of gross loans, versus 1.66% at year-end. Nine-month net charge-offs were $2.848 million, down from $5.443 million.
Material changes, outlook and risks
- Management attributed stronger net interest income to commercial and industrial loan growth and lower deposit funding costs, especially as higher-cost brokered certificates matured. Excess short-term liquidity and low investment yields constrained margin improvement.
- Management intends to continue growing commercial and industrial relationships and in-market deposits, reduce excess short-term cash, and deploy liquidity into loans or securities while maintaining underwriting standards. It expects loan activity to exceed normal amortization and support growth; it also expects margin to benefit if excess liquidity is redeployed. No specific earnings or revenue guidance was provided.
- Trust and investment fee income increased, but management noted that a large client diversified assets among managers in Q3, reducing assets managed by the company. Trust assets under management were $581.8 million at September 30.
- Q3 other income included a one-time $144,000 gain on sale of the credit-card portfolio; outstanding balances had been approximately $968,000. Q3 loan fees also benefited from contractual administration fees collected as certain relationships exited. The 2011 nine-month comparison includes a substantial one-time tax benefit; effective tax rates were 35.0% in 2012 and 26.7% in 2011.
- Key risks include concentrated Wisconsin lending, commercial real estate exposure (about 67% of loans), borrower defaults and collateral-value declines, persistently low rates or rate shifts, competition for quality loans and deposits, brokered-funding reliance, and regulatory changes. Management expects impaired loans to remain historically elevated and cautions that new problem loans, further provisions or charge-offs may arise despite current improvement.
- Off-balance-sheet commitments included $250.3 million of commitments to originate loans and $10.0 million of standby letters of credit. Management did not expect losses from these commitments. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether asset-quality improvement is sustainable, especially given CRE concentration, $4.1 million of accruing loans 30–89 days delinquent, and management’s expectation of continued new non-accrual loans.
- Whether lower funding costs and redeployment of excess liquidity can offset low asset yields and sustain net interest margin gains.
- The durability of fee income, including the lost trust-client assets and the nonrecurring credit-card sale gain and loan-exit fees.
- The quality and maturity profile of brokered deposits, and the effect of the scheduled December 31, 2012 expiration of the FDIC Transaction Account Guarantee Program.
- Reconcile deposit concentration disclosures: consolidated brokered deposits were reported at 36.8% of deposits, while the risk discussion separately cited 42.8% for First Business Bank and 9.4% for First Business Bank—Milwaukee.
- Confirm the debt and contractual-obligation note classifications and amounts: the balance sheet reports $39.482 million of FHLB and other borrowings plus $10.315 million of junior subordinated notes, while the contractual-obligations table labels its $39.0 million and $10.315 million note rows differently from the debt note.