First Business Financial Services, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. The company is a Wisconsin bank holding company serving businesses, business owners and other clients through First Business Bank and First Business Bank–Milwaukee. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2012 / June 30, 2012 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $9.61 million; +7.1% year over year | $8.97 million in Q2 2011 |
| Non-interest income | $1.90 million; +9.2% year over year | $1.74 million in Q2 2011 |
| Total revenue (net interest income plus non-interest income) | $11.51 million; +7.5% year over year | $10.71 million in Q2 2011 |
| Net income / diluted EPS | $1.57 million / $0.60 | $2.51 million / $0.97 in Q2 2011 |
| Six-month net income / diluted EPS | $3.78 million / $1.44 | $3.86 million / $1.49 in 2011 |
| Net interest margin | 3.49% for Q2; 3.32% for six months | 3.39% and 3.27%, respectively, in 2011 |
| Total assets | $1,160.0 million | $1,177.2 million at Dec. 31, 2011 |
| Loans and leases, net | $847.7 million | $836.7 million at Dec. 31, 2011 |
| Deposits | $1,029.2 million | $1,051.3 million at Dec. 31, 2011 |
| Stockholders’ equity | $67.8 million | $64.2 million at Dec. 31, 2011 |
Q2 provision for loan and lease losses was $2.05 million, up from $1.47 million in Q2 2011. Six-month provision was $2.55 million versus $2.88 million. Non-interest expense was $7.13 million in Q2 (+7.4%) and $13.96 million for six months (+4.2%). Six-month operating cash flow was $8.51 million versus $6.79 million; investing activities used $39.88 million and financing activities used $20.35 million. Cash and cash equivalents declined $51.72 million to $78.37 million.
At June 30, the allowance for loan and lease losses was $14.82 million, or 1.72% of gross loans, compared with 1.66% at year-end. Non-accrual loans were $15.45 million, down from $21.77 million; non-performing assets were $17.39 million, or 1.50% of assets, versus $24.00 million, or 2.04%, at year-end. The six-month effective tax rate was 34.6%, compared with 15.9% in 2011. The filing attributes much of the comparison to prior-year discrete Wisconsin tax benefits.
Changes versus comparable periods
- Revenue rose in both Q2 and the first half, driven by higher net interest income and fee income. Lower deposit funding costs—especially from allowing higher-cost brokered certificates of deposit to mature—supported net interest income and margin.
- Despite revenue growth, Q2 net income fell 37.7% year over year and six-month net income fell 2.3%. Q2 pre-tax income declined, while the higher Q2 2011 net income benefited from a substantial, nonrecurring Wisconsin tax benefit. Six-month pre-tax income increased to $5.78 million from $4.59 million.
- Net interest margin improved modestly, but yields on earning assets fell as low-yielding short-term funds and mortgage securities weighed on returns. The company reported a large short-term investment balance and said excess liquidity depressed margin.
- Loans and leases grew modestly from year-end, while deposits contracted. Brokered deposits declined to $396.5 million, 38.5% of deposits, from $446.7 million, 42.5%, at year-end. In-market deposits were 60.2% of average deposits for the first half versus 50.4% in the prior-year period.
- Credit quality improved on several reported measures: non-accrual loans and non-performing assets declined, and six-month net charge-offs fell to $1.89 million from $3.21 million. However, Q2 provision increased, and the allowance ratio rose from year-end.
Liquidity, debt and capital
Immediate on-balance-sheet liquidity was $254.8 million, defined by the company as short-term investments plus unpledged available-for-sale securities. Brokered deposits were below the Banks’ 75% policy limit and the stated goal is 50% or less. Management reported available liquidity sufficient for approximately 27 months of brokered-deposit maturities and said the Banks could also use Federal Home Loan Bank or Federal Reserve borrowing, deposit gathering and cash flows from loans and securities.
Balance-sheet borrowings included $42.4 million of Federal Home Loan Bank and other borrowings and $10.3 million of junior subordinated notes. The company also reported $39.0 million of subordinated notes payable; during Q1 it issued approximately $6.2 million of fixed-rate, 7.5% subordinated debentures, due in 2022, to replace part of existing subordinated notes. The company was in compliance with senior line-of-credit covenants.
At June 30, consolidated total risk-based capital was 13.31%, Tier 1 risk-based capital 8.04%, and Tier 1 leverage 6.55%. The filing states both Banks were categorized as well capitalized under prompt corrective action rules. Shareholders received $0.07 per share in Q2 dividends; the six-month dividend was $0.14 per share.
Management outlook, risks and unusual items
- Management’s 2012 strategic priorities include improving asset quality, growing commercial and industrial relationships and in-market deposits, increasing fee income, and adding business development officers as appropriate. It expected loan activity to be sufficient to offset normal amortization, while noting weak demand from qualified borrowers and increased competition.
- Management said deploying excess short-term liquidity into loans or approved securities could improve margin, all else equal. It also expected elevated impaired-loan levels in the near term despite recent asset-quality improvement, and cautioned that additional provisions or charge-offs could result from economic weakness, falling collateral values or new credit deterioration.
- Key exposures include commercial real estate concentration (approximately 68% of the loan and lease portfolio), borrower defaults, collateral values, interest-rate changes, competition, and deposit funding—particularly brokered-deposit availability and repricing. Management described its interest-rate sensitivity as not materially changed since year-end. No specific earnings or revenue guidance was provided.
- Q2 2011 included a substantial tax benefit from a Wisconsin tax-law change and other discrete tax items; these did not recur in 2012. In the first half of 2012, the company recorded $119,000 of foreclosed-property impairment losses. It reported no securities other-than-temporarily impaired and no material change to previously disclosed risk factors. Management said ordinary-course legal proceedings were not expected to have a material adverse effect.
- Disclosure controls were reported effective at June 30, 2012, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether credit improvement continues: non-accruals, criticized/substandard loans, troubled debt restructurings, charge-offs, provision expense and allowance coverage.
- Whether revenue growth translates into earnings after compensation and other expenses, and how results compare after accounting for the prior-year tax benefit.
- Margin sensitivity to rates and the company’s ability to redeploy excess liquidity without taking on unacceptable credit, duration or prepayment risk.
- Funding mix and concentration: brokered-deposit maturities, in-market deposit growth, liquidity coverage and the terms and refinancing implications of subordinated debt.
- Regulatory capital and dividend capacity, including the Banks’ ability to upstream dividends to the holding company.