First Business Financial Services, Inc. — Q2 2011 Form 10-Q
Business context and reporting period
Wisconsin bank holding company operating through First Business Bank and First Business Bank–Milwaukee, focused on commercial banking, equipment finance, and trust and investment services. The filing covers the quarter and six months ended June 30, 2011; balance-sheet comparisons are to December 31, 2010. Financial amounts below are in U.S. dollars.
Financial performance and position
- Q2 earnings: Net income was $2.5 million, or $0.98 per diluted share, compared with a $1.5 million net loss, or $0.60 loss per share, in Q2 2010. The prior-year quarter included a $2.7 million goodwill impairment; excluding it, prior-year Q2 net income was $1.2 million and diluted EPS was $0.46.
- First-half earnings and revenue: Net income was $3.9 million, or $1.49 per diluted share, versus a $626,000 net loss in H1 2010. The prior-year period included the same $2.7 million goodwill impairment; excluding it, H1 2010 net income was $2.1 million and diluted EPS was $0.81. Net interest income plus non-interest income rose 10.7% to $20.9 million.
- Interest income and margin: Q2 net interest income increased 16.6% to $9.0 million; H1 increased 12.3% to $17.5 million. Net interest margin was 3.39% for Q2 and 3.27% for H1, up from 2.96% and 2.98%, respectively. Management attributed improvement chiefly to lower deposit costs.
- Other income and expenses: Non-interest income was $1.7 million in Q2 and $3.4 million in H1, up 3.5% and 3.1%, respectively. Non-interest expense declined 28.0% in Q2 to $6.6 million and 15.0% in H1 to $13.4 million, largely reflecting the absence of the 2010 goodwill impairment and lower FDIC insurance and collateral liquidation costs. Compensation expense increased.
- Cash flow: H1 operating cash flow was $6.8 million; investing activities used $1.5 million and financing activities used $13.2 million. Cash and cash equivalents decreased $7.9 million to $42.9 million.
- Balance sheet and funding: Total assets were $1.096 billion, down $10.7 million from year-end 2010. Net loans and leases were $844.8 million, down $16.2 million; deposits were $977.5 million, down $10.8 million. Borrowings were $39.5 million, with $10.3 million of junior subordinated notes outstanding; total stockholders’ equity was $59.8 million.
- Credit quality: Non-accrual loans and leases were $34.6 million, or 4.02% of gross loans, versus $38.4 million and 4.37% at year-end. Non-performing assets were $36.0 million, or 3.29% of assets, down from $40.2 million, or 3.63%. H1 net charge-offs were $3.2 million, compared with $1.4 million in H1 2010; the allowance was $15.9 million, or 1.85% of gross loans, unchanged as a percentage from year-end.
- Liquidity and capital: Management reported $224.2 million of immediate on-balance-sheet liquidity, defined as short-term investments plus unpledged available-for-sale securities. Brokered deposits were $496.7 million, 50.8% of deposits. The Banks were reported as well capitalized; June 30 total risk-based capital ratios were 12.54% for First Business Bank and 15.16% for First Business Bank–Milwaukee.
Material changes versus comparable periods
- Profitability improved substantially year over year, though the 2010 comparisons include the one-time $2.7 million goodwill impairment. Management’s non-GAAP adjusted comparisons show higher 2011 earnings even after excluding that impairment.
- Net interest margin improved as deposit funding costs fell, despite a lower yield on average earning assets in H1. Management noted that collections of previously foregone interest and loan fees also supported reported loan yields.
- Credit indicators improved versus December 2010 as non-accrual balances and non-performing assets declined, but H1 net charge-offs increased materially year over year.
- Cash and deposits declined, while available-for-sale securities increased to $168.3 million from $153.4 million. Loan balances also contracted, with repayments, amortization, and non-accrual loan payoffs exceeding new lending.
Outlook, risks, contingencies, and unusual items
- Management expected net interest margin to remain stable at its then-current level for the remainder of 2011, but cautioned that results depend on competition, deposit and loan mix, asset-liability management, and the yield curve. No assurance was given.
- Management expected elevated impaired-loan levels to continue and said loan growth would likely remain significantly below historical rates. Further charge-offs or provisions could result from deteriorating credit conditions or collateral values; regulators may also require different classifications or charge-offs.
- Commercial real estate represented 71.4% of the loan and lease portfolio. Construction and land development credits accounted for approximately 40.4% of H1 charge-offs. Brokered deposits remained a substantial funding source, creating exposure to renewal availability and pricing.
- Trust assets under management were $456.1 million, up from $324.9 million a year earlier. Management expected continued growth in assets under management, while warning that market volatility could affect balances and fee income.
- In June 2011, the Wisconsin Department of Revenue tax assessment matter was settled confidentially. The settlement did not create a liability materially different from the amount previously accrued. Management reported no material change in other legal proceedings or risk factors.
- The company renewed $31.0 million of subordinated debt in June 2011, maturing August 2016, at LIBOR plus 4.75% subject to a 6.00% floor. It reported compliance with senior-line debt covenants and applicable regulatory capital requirements, while noting that its Capital and Liquidity Action Plan was being updated. Dividend decisions remain subject to regulatory considerations.
- The filing provides no formal full-year earnings or revenue guidance. Forward-looking statements are subject to economic, regulatory, interest-rate, loan-demand, borrower-default, and competitive risks.
Most important facts for investors to verify
- Whether lower funding costs can sustain the reported net interest margin as deposits reprice and market rates or the yield curve change.
- Whether credit quality continues to improve, especially given elevated non-accrual loans, rising H1 net charge-offs, commercial real estate concentration, and potential further collateral write-downs.
- Whether deposit balances and brokered-funding access remain adequate and competitively priced, and how management progresses toward its goal of reducing brokered-deposit dependence.
- Whether reported earnings remain durable after accounting for provision needs, collections of previously foregone interest, one-time fees, and the nonrecurrence of the prior-year goodwill impairment.
- The effects of the updated capital and liquidity plan, regulatory dividend considerations, and the subordinated-debt renewal on future capital flexibility.