Byline Bancorp, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Byline is a Chicago-based bank holding company serving small and medium-sized businesses, commercial real estate and consumer customers, with additional SBA/USDA lending and equipment leasing businesses. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and reporting period
Results reflect the May 31, 2018 acquisition of First Evanston Bancorp. Its operations are included from June 1, materially increasing Byline’s assets, loans, deposits, staff and share count. Management said the acquisition expanded its Chicago-area footprint, diversified commercial banking and strengthened core deposits. Byline also signed an agreement on October 17, 2018 to acquire Oak Park River Forest Bankshares; closing was expected in the first half of 2019, subject to approvals and other conditions.
Key financial metrics
| Metric | Three months ended Sept. 30, 2018 | Three months ended Sept. 30, 2017 | Nine months ended Sept. 30, 2018 | Nine months ended Sept. 30, 2017 |
|---|---|---|---|---|
| Net interest income | $52.6 | $31.4 | $125.3 | $90.8 |
| Non-interest income | $11.1 | $11.9 | $37.1 | $37.4 |
| Provision for loan and lease losses | $5.8 | $3.9 | $14.9 | $9.3 |
| Non-interest expense | $38.0 | $31.1 | $115.6 | $89.2 |
| Net income | $14.5 | $9.8 | $24.1 | $22.5 |
| Income available to common shareholders | $14.3 | $9.6 | $23.5 | $11.4 |
| Diluted EPS | $0.39 | $0.32 | $0.71 | $0.43 |
| Net interest margin | 4.73% | 4.18% | 4.56% | 4.07% |
Q3 total revenue (net interest income plus non-interest income) was $63.7 million versus $43.3 million, up 47.1%. Nine-month total revenue was $162.4 million versus $128.2 million. Q3 diluted EPS improved year over year; nine-month common income and EPS also benefited from preferred dividends of only $0.6 million in 2018 versus $11.1 million in 2017.
Balance sheet at September 30, 2018: Assets were $4.92 billion, gross loans and leases $3.46 billion, deposits $3.74 billion, and stockholders’ equity $629.9 million. Compared with December 31, 2017, assets rose 46.1%, gross loans and leases 51.7%, and deposits 53.1%, primarily reflecting First Evanston and organic growth. Cash and cash equivalents were $144.8 million. Available-for-sale securities were $795.4 million and held-to-maturity securities $102.7 million.
Cash flow, nine months: Operating activities provided $62.2 million (versus $12.8 million); investing activities used $309.3 million (versus $5.9 million provided); financing activities provided $333.5 million (versus $3.0 million used). Cash increased $86.4 million to $144.8 million, with acquisition-related asset growth and net loan growth among the major investing outflows.
Funding, liquidity and capital: FHLB advances were $425.0 million, up from $361.5 million at year-end, at a 2.30% weighted average cost; junior subordinated debentures had a $36.6 million carrying value. The line of credit was undrawn. Management reported $1.1 billion of available aggregate borrowing capacity, plus $55 million of uncommitted federal funds lines, and $627.3 million of unpledged securities. The Bank was described as well-capitalized. At the holding company, CET1 was 11.26%, Tier 1 capital 12.71%, and total capital 13.37%; ratios were lower than at December 2017.
Credit and asset quality: The allowance for loan and lease losses was $23.4 million, or 0.68% of loans and leases before the allowance. Nine-month net charge-offs were $8.2 million; the annualized net charge-off ratio was 0.40%. Nonperforming loans and leases were $30.2 million, or 0.87% of loans, and nonperforming assets were $35.1 million, or 0.71% of assets. Nonaccrual loans and leases increased to $28.6 million from $15.8 million at year-end; allowance coverage of nonperforming loans was 77.66%. Commercial real estate loans represented 36.8% of gross loans, and non-owner-occupied commercial real estate was 253.3% of total capital.
Material changes versus comparable periods
- Q3 net interest income rose 67.4%; the nine-month increase was 38.1%. Management attributed growth to First Evanston, organic originations, higher loan yields and rate increases. Higher funding costs partly offset asset yield gains: Q3 cost of deposits rose to 0.64% from 0.33%.
- Acquired-loan accretion supported reported margins: 74 basis points of Q3 2018 margin versus 29 basis points a year earlier; nine-month contribution was 52 versus 28 basis points. Margin excluding accretion was 3.99% for Q3 and 4.04% for the nine-month period.
- Non-interest expense rose 22.2% in Q3 and 29.7% year to date, including higher staffing and acquisition integration costs. Nine-month data processing expense increased to $15.4 million from $7.3 million, primarily due to an $8.1 million core-system contract termination charge.
- Non-interest income was slightly lower year to date, as reduced loan-sale gains and servicing fees offset new wealth-management income and higher customer derivative fees. Q3 loan-sale gains were $5.0 million versus $7.5 million.
- Q3 efficiency ratio improved to 56.57% from 69.92%, while the nine-month ratio edged up to 68.87% from 67.76%. Management cited stronger Q3 revenue and year-to-date acquisition and conversion costs, respectively. Adjusted ratios are non-GAAP measures.
- Available-for-sale securities had $27.8 million of gross unrealized losses at quarter-end; nine-month other comprehensive loss was $6.5 million, primarily reflecting securities valuation changes, partly offset by cash-flow hedge gains.
Outlook, commentary, risks and unusual items
- Management expected the 2018 effective tax rate to be approximately 27%–29%. The filing reports a 20.0% nine-month effective rate in MD&A, while the tax note reports 24.4%; the reported values do not reconcile clearly to each other and should be checked.
- Byline anticipated completing its core processing platform conversion to FIS Integrated Banking Services during 2019. It warned that conversion costs, integration difficulties or failure to realize expected benefits could affect profitability, growth and customer experience. The filing includes substantial conversion and merger-related expense; adjusted performance measures exclude certain such items.
- The proposed Oak Park River Forest acquisition was expected to close in the first half of 2019. Risks include regulatory and shareholder approvals, integration, customer and employee reactions, and whether anticipated cost savings and other benefits are realized.
- Interest-rate risk is significant. The company’s simulation estimated that an immediate +100 basis-point parallel shift could increase net interest income by 4.3% over the following 12 months, while a -100 basis-point shift could reduce it by 6.0%. Management cautioned that results are hypothetical and depend on assumptions, deposit repricing, prepayments and balance-sheet changes.
- Other stated risks include borrower and commercial real estate credit deterioration, funding costs and liquidity availability, competition, SBA/USDA program changes, cybersecurity and third-party technology disruptions, and acquisition integration. Management said it did not expect material losses from lending commitments and letters of credit; ordinary-course legal proceedings were not expected to have a material adverse effect.
- Unusual comparability items include a $4.6 million Illinois deferred-tax benefit in Q3 2017 and a $0.7 million federal tax-related benefit in Q1 2018. First Evanston’s preliminary purchase accounting included $73.0 million of goodwill, described as nondeductible for tax purposes.
Most important facts for investors to verify
- Whether acquired and organic loan growth, deposit growth and margin performance persist after separating First Evanston’s contribution and acquired-loan accretion.
- Credit trends behind rising nonaccrual loans, the commercial loan relationship reserve, government-guaranteed portfolio impairments, and the increase in nonperforming assets; assess allowance coverage and CRE concentration.
- Actual remaining integration and core-system conversion costs, timing, execution risk and realized efficiencies, especially after the $8.1 million contract termination charge.
- The Oak Park River Forest transaction’s approvals, closing timetable, purchase economics and expected synergies.
- The nine-month effective tax-rate discrepancy between the MD&A and tax note, and the basis for management’s 27%–29% full-year estimate.
- Funding repricing and liquidity: deposit costs are rising, $250 million of fixed-rate FHLB advances matured in December 2018, and additional variable-rate advances had near-term maturities.
- How unrealized securities losses, interest-rate sensitivity and non-GAAP adjusted measures compare with GAAP results and affect capital and earnings quality.