First Business Financial Services, Inc. — Q3 2014 Form 10-Q
Business context and reporting period
Commercial bank holding company serving businesses and individuals primarily in Wisconsin, with commercial banking, equipment finance, and trust and investment services. This unaudited filing covers the quarter and nine months ended September 30, 2014; balance-sheet comparisons are with December 31, 2013. The acquisition of Aslin Group and Alterra Bank closed on November 1, 2014, after the reporting period.
Financial performance and position
- Q3 earnings: Net interest income was $10.9 million versus $10.7 million a year earlier. Net income was $3.6 million versus $3.6 million; diluted EPS was $0.89 versus $0.91. Top-line revenue (net interest income plus non-interest income) rose 4.5% to $13.4 million.
- Nine-month earnings: Net interest income was $32.5 million versus $31.1 million; net income was $10.4 million versus $10.0 million; diluted EPS was $2.62 versus $2.54. Top-line revenue increased 6.2% to $39.7 million.
- Margins and expenses: Net interest margin was 3.44% in Q3 versus 3.56% in Q3 2013, and 3.51% for the nine months versus 3.52%. The efficiency ratio rose to 60.15% for Q3 from 56.11%, and to 59.62% year to date from 58.37%. Higher compensation and professional fees, including acquisition-related expenses, contributed to expense growth.
- Balance sheet: Total assets were $1.428 billion, up 12.5% from year-end. Net loans and leases were $1.028 billion, up 6.3%; deposits were $1.269 billion, up $139.3 million. Stockholders’ equity was $118.2 million.
- Credit quality: The allowance was $13.9 million, or 1.34% of gross loans, versus 1.42% at year-end. Non-performing assets were $15.9 million, or 1.12% of total assets, versus $16.2 million, or 1.28%. The nine-month loan-loss provision was zero; Q3 included a negative provision of $89,000.
- Cash flow and liquidity: Nine-month operating cash flow was $11.2 million; investing used $65.7 million and financing provided $147.7 million. Cash and cash equivalents rose to $174.5 million. Management reported immediate on-balance-sheet liquidity of $374.6 million, elevated by large, late-quarter client deposits that it expected to be temporary.
- Debt and capital: At quarter-end, FHLB and other borrowings were $22.9 million and junior subordinated notes were $10.3 million. The company issued $15.0 million of subordinated notes in August, bearing 6.50% fixed interest for five years, then three-month LIBOR plus 470 basis points through maturity in 2024. The company and banks met applicable capital requirements; both banks were classified as well capitalized.
Material changes versus comparable periods
- Q3 net income was broadly flat, but diluted EPS declined from $0.91 to $0.89. Year-to-date net income and diluted EPS increased from $10.0 million and $2.54 to $10.4 million and $2.62.
- Q3 non-interest income increased 15.8%, led by trust and investment services fees; non-interest expense rose 12.6%, with compensation up 13.2% and professional fees up 34.8%.
- Loan growth was led by commercial and industrial lending, up 14.7% from year-end; commercial real estate represented about 63% of gross loans.
- Deposit growth and cash balances were unusually high late in the quarter due to client transactions. Management said it did not expect to retain most of those excess balances.
- The company reclassified $44.6 million of securities’ amortized cost from available-for-sale to held-to-maturity in Q2. The transfer-date unrealized loss of $874,000 remained in equity and is to be amortized over the securities’ remaining lives.
Outlook, commentary, risks and unusual items
- Management emphasized maintaining underwriting standards, growing in-market transaction deposits and fee revenue, investing in talent and technology, and pursuing organic growth. It said competitive loan pricing and the low-rate environment pressured asset yields; it expected elevated excess deposits could temporarily compress margin through year-end.
- No specific earnings or revenue guidance was provided. Management expected most late-quarter deposit balances to leave the balance sheet or move into trust services, and anticipated continued but potentially slower improvement in non-accrual loans.
- The $30.1 million Aslin Group transaction was funded partly with the new subordinated notes and included 360,081 company shares. The filing reported $424,000 of merger-related costs through September 30 and warned that additional integration charges could be significant and exceed near-term savings; remaining charges were expected before December 31, 2014.
- Key risks include acquisition integration and retention of Alterra clients and employees; borrower defaults and credit deterioration; competitive pricing and interest-rate changes; deposit volatility and brokered-deposit availability; and regulatory capital or dividend constraints. The company identified no material legal proceeding and reported effective disclosure controls.
Most important facts for investors to verify
- Post-close acquisition results, integration costs, realized synergies, client and employee retention, and the final purchase accounting.
- How much of the unusually large quarter-end deposit and liquidity increase persisted, and the resulting effect on net interest margin.
- Loan-credit trends, especially commercial real estate concentration, non-accrual balances, and allowance adequacy.
- Expense trajectory and efficiency ratio, including ongoing compensation, professional, and merger-related costs.
- Capital and funding effects of the subordinated notes, share issuance, and future dividend decisions.