First Business Financial Services, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. The company is a commercial bank holding company serving businesses and individuals in Wisconsin and the Kansas City area. Alterra Bank, acquired November 1, 2014, materially affects year-over-year comparability.
Financial performance and position
| Metric | Q2 2015 | Six months 2015 |
|---|---|---|
| Net income | $3.9 million, versus $3.5 million | $8.1 million, versus $6.8 million |
| Diluted EPS | $0.89, versus $0.88 | $1.86, versus $1.72 |
| Net interest income | $14.2 million, up 31.4% | $29.1 million, up 34.8% |
| Net interest margin | 3.61%, versus 3.52% | 3.70%, versus 3.55% |
| Non-interest income | $4.1 million, up 75.0% | $8.0 million, up 70.4% |
| Non-interest expense | $12.0 million, up 54.5% | $23.7 million, up 52.0% |
| Provision for loan and lease losses | $520,000, versus a $91,000 benefit | $1.2 million, versus $89,000 |
At June 30, 2015, total assets were $1.684 billion, up 3.3% from year-end 2014. Net loans and leases were reported as $1.334 billion on the balance sheet; gross loans and leases were $1.352 billion, up 5.5% from year-end. Deposits totaled $1.471 billion, up $32.8 million. Cash and cash equivalents were $88.8 million. Stockholders’ equity was $144.3 million.
Balance-sheet borrowings included $47.4 million of Federal Home Loan Bank and other borrowings and $10.3 million of junior subordinated notes. The debt note separately reports $57.7 million of total borrowed funds, including $22.9 million of subordinated notes payable; investors should verify the classifications. The company reported compliance with debt covenants and regulatory capital requirements; its banks were characterized as well capitalized.
For the first six months, operating cash flow was $10.8 million, investing cash outflow was $69.8 million, and financing cash inflow was $44.7 million. Cash and cash equivalents declined $14.4 million to $88.8 million. Immediate on-balance-sheet liquidity was $299.5 million. The six-month dividend declared was $0.44 per share.
Changes and operating trends
- Revenue growth was primarily attributable to Alterra and larger loan balances. Top-line revenue increased 39.2% in Q2 and 41.2% year to date.
- Net interest margin improved, helped by lower deposit funding costs and $542,000 of net accretion/amortization from Alterra purchase-accounting adjustments in Q2. Management cautioned that this accretion may vary with loan prepayments.
- Expenses rose substantially, mainly from Alterra, added staff, technology investment, marketing, and professional fees. The efficiency ratio increased to 65.28% in Q2 from 58.87%, and to 63.85% year to date from 59.35%.
- Annualized return on average assets and equity declined year over year: Q2 ROAA was 0.93% and ROAE 10.73%; six-month ROAA was 0.96% and ROAE 11.35%. Management attributed the declines chiefly to asset and equity growth outpacing earnings growth after the acquisition.
Outlook, risks and unusual items
- Management plans to grow loans organically, preserve asset quality, expand transaction accounts and fee-generating services, and invest in technology and personnel while maintaining operating efficiency. It expects loan activity to exceed normal amortization and support further growth; no quantified earnings or margin guidance was provided.
- Non-accrual loans rose to $15.2 million from $9.8 million at year-end; non-performing assets were 1.01% of total assets, versus 0.70%. A $6.2 million commercial relationship was identified as impaired in Q2 and, after quarter-end, received a concession and was classified as a troubled debt restructuring. Management said it did not view the increase as systemic.
- Commercial real estate represented approximately 62% of gross loans. The allowance was $15.2 million, or 1.12% of gross loans, unchanged as a percentage from year-end. Management noted that future charge-offs or provisions could increase if credit conditions or loan-specific facts change.
- Wholesale deposits were $444.5 million, or 30.2% of deposits. Management cited interest-rate and funding-market risks, competitive loan pricing, borrower defaults, and economic conditions as important uncertainties. Market-rate changes could affect earnings and asset values.
- Other unusual items included $1.7 million of gains on loan sales year to date, principally SBA-guaranteed and residential mortgage loans. The company recorded no other-than-temporary impairment on securities. Management reported no material subsequent events requiring adjustment, no material change in disclosed risk factors, and effective disclosure controls.
Key facts for investors to verify
- How much of reported growth and profitability is attributable to the Alterra acquisition versus ongoing organic performance?
- What is the expected resolution and credit-loss exposure of the $6.2 million relationship restructured after quarter-end, and how will it affect non-performing asset trends?
- How sustainable are loan-sale gains, purchase-accounting accretion, the improved net interest margin, and deposit funding costs?
- What are the precise classifications, maturities, rates, and covenants for subordinated and other borrowings, given differing presentations in the filing?
- Can expense growth moderate as technology and staffing investments continue, and can the efficiency ratio improve?