First Business Financial Services, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. The company is a Wisconsin-based bank holding company operating through First Business Bank, focused on commercial banking, specialty finance, SBA lending, equipment finance, and trust and investment services. This unaudited report covers the quarter and nine months ended September 30, 2019; balance-sheet comparisons are with December 31, 2018. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2019 / Sept. 30, 2019 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $16.8 million | $17.1 million in Q3 2018 |
| Non-interest income | $5.8 million | $4.9 million in Q3 2018 |
| Net income | $5.1 million; diluted EPS $0.59 | $5.3 million and $0.60 in Q3 2018 |
| Net interest margin | 3.40% | 3.75% in Q3 2018 |
| Total assets | $2.093 billion | $1.966 billion at Dec. 31, 2018 |
| Gross loans and leases | $1.721 billion | $1.619 billion at Dec. 31, 2018 |
| Deposits | $1.509 billion | $1.455 billion at Dec. 31, 2018 |
| Stockholders’ equity | $190.8 million | $180.7 million at Dec. 31, 2018 |
- For the first nine months, net interest income was $51.4 million versus $50.2 million; non-interest income was $16.2 million versus $13.5 million; and net income was $17.6 million versus $12.2 million. Diluted EPS was $2.01 versus $1.40.
- Nine-month top-line revenue—net interest income plus non-interest income—increased 6.1% to $67.6 million. Q3 revenue rose 2.7% to $22.6 million.
- Nine-month net interest margin was 3.57%, down from 3.73%. The efficiency ratio improved to 66.41% for Q3 and 67.29% for the nine months, from 69.55% and 68.05%, respectively.
- Allowance for loan and lease losses was $20.2 million, or 1.17% of gross loans, versus $20.4 million, or 1.26%, at year-end. Non-performing assets were $25.7 million, 1.23% of assets, down from $27.8 million, or 1.42%.
- Nine-month cash flows: $20.8 million provided by operating activities, $124.5 million used in investing, and $78.2 million provided by financing. Cash and cash equivalents declined $25.6 million to $61.0 million.
- Immediate on-balance-sheet liquidity was $261.2 million. Bank regulatory capital ratios remained above well-capitalized thresholds; the Bank’s total capital ratio was 11.69% and its Tier 1 leverage ratio was 10.10%.
Material changes and management commentary
- Loan growth and higher fee income supported nine-month revenue and earnings. C&I loans increased $51.4 million and commercial real estate loans increased $54.7 million from year-end; multifamily lending was a major contributor to CRE growth.
- Q3 net interest income declined 1.9%, primarily reflecting deposit-cost pressure, lower loan fees collected in lieu of interest, and $308,000 of one-time costs related to exercising call options on subordinated debt and brokered deposits. Management said the funding changes should benefit margins going forward. Rising in-market deposit rates were a key pressure on margin.
- Q3 provision for loan losses was $1.3 million, compared with a $546,000 benefit in Q3 2018; management attributed the increase largely to specific reserves on impaired legacy SBA loans. Nine-month provision fell to $613,000 from $4.5 million, with lower net charge-offs and reserve reductions contributing.
- Nine-month non-interest expense rose 13.2% to $49.9 million, including $4.0 million of tax-credit investment impairment. The company recognized $5.2 million of federal historic tax credits, contributing to a nine-month income-tax benefit of $475,000; excluding discrete items, the effective tax rate was 22.3%.
- Management’s stated goals include returning net interest margin to 3.50% or better as short-term rates stabilize and moving the efficiency ratio toward its long-term target range of 58%–62%. It expected a 2019 effective tax rate of 21%–23%, excluding discrete items. These are forward-looking expectations, not guarantees.
Risks, contingencies, and unusual items
- Credit risk remains a focus: non-accrual loans were $22.8 million, and $19.0 million of non-accrual balances were troubled debt restructurings. Legacy SBA exposures contributed to impaired assets and quarterly provision volatility. The SBA recourse reserve was $1.6 million.
- Commercial real estate represented 66.8% of gross loans. Management cautioned that additional charge-offs or provisions could arise as workout situations develop.
- Other stated risks include competition, adverse economic conditions, borrower defaults, interest-rate and market changes, growth-management challenges, cybersecurity and fraud, regulatory or tax changes, and maintaining SBA loan-guarantee compliance.
- Legal proceedings were described as ordinary-course matters; management did not expect them to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors and no significant subsequent events requiring disclosure.
- The company adopted the new lease standard in 2019, recording $7.5 million of right-of-use assets and $7.9 million of lease liabilities at quarter-end. It planned to defer adoption of the expected-credit-loss standard following the FASB’s October 2019 delay for eligible entities.
Important facts for investors to verify
- Whether loan growth continues without deterioration in credit quality, particularly in commercial real estate and legacy SBA portfolios.
- Whether deposit pricing and funding mix stabilize enough to support management’s margin expectations.
- How recurring earnings develop after separating ordinary operations from historic tax credits, tax-credit impairment, mezzanine investment returns, equipment-finance buyout gains, and one-time funding costs.
- Whether the $20.2 million loan-loss allowance and $1.6 million SBA recourse reserve remain adequate as impaired loans are worked out.
- Future liquidity, wholesale-funding levels, capital ratios, and the capacity to sustain dividends and share repurchases.