First Business Financial Services, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. The company operates as a commercial bank primarily in Wisconsin and the greater Kansas City area, serving businesses, professionals and high-net-worth clients.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net interest income | $28.6 million | $25.9 million | $83.0 million | $71.0 million |
| Non-interest income | $8.4 million | $8.2 million | $24.2 million | $22.5 million |
| Net income | $9.9 million | $10.8 million | $27.3 million | $30.7 million |
| Net income available to common shareholders | $9.7 million | $10.6 million | $26.6 million | $30.2 million |
| Diluted EPS | $1.17 | $1.25 | $3.19 | $3.57 |
| Net interest margin | 3.76% | 4.01% | 3.81% | 3.71% |
| Provision for credit losses | $1.8 million | $12,000 | $5.6 million | Benefit of $4.6 million |
- Q3 top-line revenue, defined as net interest income plus non-interest income, rose 8.6% to $37.0 million; nine-month revenue rose 14.8% to $107.3 million. Higher loan yields and loan growth supported revenue, while deposit costs, credit provision and expenses pressured earnings.
- Q3 return on average assets was 1.19% versus 1.54%; return on average common equity was 14.62% versus 17.44%. Nine-month figures were 1.13% versus 1.49% and 13.72% versus 16.97%, respectively.
- At September 30, total assets were $3.419 billion, up 14.9% from year-end 2022. Gross loans and leases were $2.764 billion, up $320.6 million; deposits were $2.657 billion, up $488.8 million. Stockholders’ equity was $280.8 million.
- Cash and cash equivalents totaled $132.9 million. Nine-month operating cash flow was $39.0 million; investing cash outflow was $395.4 million, largely reflecting loan growth and securities purchases; financing cash inflow was $386.7 million, primarily from deposit growth.
- Borrowings were $363.9 million, down from $456.8 million at December 31, 2022. The company issued $15 million of 8% subordinated debentures in September, due 2033 and qualifying as Tier 2 capital.
- Reported readily available liquidity was $661.3 million; total liquidity including additional funding capacity was $1.797 billion. Uninsured deposits net of collateral were $887.2 million, or 33.4% of deposits.
Material changes and credit quality
- Deposit interest expense increased sharply as market rates rose: Q3 deposit expense was $19.8 million versus $3.2 million a year earlier. Management reported higher deposit betas and anticipated that deposit costs could continue rising.
- Loan growth lifted interest income, but Q3 NIM fell 25 basis points year over year as funding costs rose and fees in lieu of interest declined. Nine-month NIM increased 10 basis points year over year. Adjusted NIM, a non-GAAP measure, was 3.66% for Q3 and 3.68% year to date.
- Non-performing loans increased to $17.6 million, or 0.64% of gross loans, from $3.7 million, or 0.15%, at year-end. The increase was concentrated in commercial and industrial lending, including Equipment Finance and Asset-Based Lending. Management expects full repayment of a $10.9 million ABL loan in default; excluding it, non-performing assets were $8.1 million.
- The allowance for credit losses, including unfunded commitment reserves, was $31.0 million, or 1.12% of gross loans, versus $24.2 million and 0.99% at year-end. The company recorded $622,000 in net charge-offs for the first nine months. Two distressed C&I loans totaling $716,000 were modified through payment deferrals.
- Available-for-sale securities had $34.2 million of gross unrealized losses at quarter-end, primarily attributed by management to market factors, including interest rates; no securities credit-loss provision was recorded. Management said it did not intend, and did not expect to be required, to sell securities in loss positions.
Outlook, risks and unusual items
- Management expects loan growth to moderate from the recent pace, with C&I growth expected to move to lower double-digit levels. It said NIM may gradually decline as deposit betas rise, but expects it to stabilize above the company’s 3.50% strategic-plan goal.
- Management expects an effective tax rate of 21%–22% for 2023 and 20%–21% for 2024. The filing provides no specific earnings or revenue guidance.
- Management identified economic conditions, borrower defaults, competition, interest-rate movements, deposit outflows and uninsured-deposit exposure, cybersecurity and fraud, regulatory changes, SBA compliance, and potentially higher FDIC assessments as risks.
- CECL adoption on January 1, 2023 increased the allowance by $484,000 and unfunded-commitment reserve by $1.3 million, and reduced retained earnings by approximately $1.4 million after tax effects. Management’s credit-loss estimates rely on forecasts and other assumptions that may change.
- Non-interest expense rose 15.8% in Q3 and 14.9% for the first nine months. Increases included FDIC insurance, compensation and other expenses; the latter included higher liquidation costs related to an ABL relationship.
- The company stated that ordinary-course legal proceedings are not expected to have a material adverse effect. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts investors should verify
- Whether the $10.9 million ABL default is repaid as management expects, and how Equipment Finance and other C&I credits perform.
- Subsequent trends in non-performing loans, charge-offs, specific reserves and the overall adequacy of the $31.0 million credit-loss allowance.
- Deposit mix and pricing, especially wholesale funding usage, uninsured deposits and the effect of higher funding costs on NIM and earnings.
- Whether loan growth moderates as projected and whether NIM stabilizes above the stated 3.50% strategic goal.
- The duration and potential realized impact of securities’ unrealized losses, and maintenance of reported liquidity and regulatory capital levels.