First Business Financial Services, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. The company is a Wisconsin-based commercial bank serving businesses and individuals, with operations primarily in Wisconsin and the greater Kansas City area. Figures below are in millions of dollars unless stated otherwise.
Financial performance and condition
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net interest income | $25.9 | $21.2 | $71.0 | $63.7 |
| Net income | $10.8 | $9.2 | $30.7 | $27.2 |
| Net income available to common shareholders | $10.6 | $9.2 | $30.2 | $27.2 |
| Diluted earnings per common share | $1.25 | $1.07 | $3.57 | $3.15 |
| Non-interest income | $8.2 | $7.0 | $22.5 | $20.5 |
| Non-interest expense | $20.0 | $18.5 | $58.3 | $54.0 |
- Margins and returns: Net interest margin was 4.01% for Q3 and 3.71% year to date, compared with 3.45% and 3.46%, respectively, in 2021. Q3 return on average assets was 1.57%; return on average equity was 16.97%. The efficiency ratio improved to 58.46% in Q3 from 65.68%.
- Balance sheet at September 30: Assets were $2.851 billion, deposits $2.088 billion, gross loans and leases $2.331 billion, and FHLB advances and other borrowings $420.3 million. Compared with December 31, 2021, assets rose $197.9 million, deposits $129.6 million, and gross loans and leases $90.2 million.
- Credit quality: Allowance for loan and lease losses was $24.1 million, or 1.04% of gross loans, versus $24.3 million and 1.09% at year-end 2021. Nonperforming assets declined to $3.8 million (0.13% of assets) from $6.5 million (0.25%). The nine-month provision was a $4.6 million benefit, including $4.4 million of net recoveries and a $4.1 million recovery on a previously charged-off legacy SBA relationship.
- Cash flow and liquidity: Nine-month operating cash flow was $31.4 million; investing activities used $117.0 million and financing activities provided $139.5 million. Cash and cash equivalents ended at $111.0 million. Management reported $549.2 million of readily accessible liquidity, up from $529.5 million at year-end.
- Capital: The Bank remained “well capitalized” under regulatory standards. At September 30, its total risk-based capital ratio was 11.49%, common equity Tier 1 was 10.57%, and Tier 1 leverage was 10.42%.
Material changes and management commentary
- Q3 net income available to common shareholders increased 15% year over year; nine-month net income available to common shareholders increased 11%. Net interest income growth reflected higher asset yields and loan growth, partly offset by higher deposit and borrowing costs.
- Management attributed stronger margins chiefly to rising rates and a relatively low deposit beta. It said margin expansion may slow as deposit costs respond to further rate increases. The company ended the quarter positioned to benefit from rising short-term rates and expects to maintain a long-term average net interest margin of at least 3.50%.
- Gross loans and leases grew 5.4% on an annualized basis from year-end; growth excluding PPP loans was 7.0%. Commercial real estate represented 63.8% of loans excluding PPP loans, a significant portfolio concentration.
- Period-end in-market deposits were nearly flat versus year-end, while wholesale deposits increased substantially. Wholesale funds were $536.1 million, or 21.8% of total bank funding, compared with $398.4 million and 17.1% at year-end. Management expects deposit balances to fluctuate and intends to continue building in-market relationships while using wholesale funding as needed.
- Available-for-sale securities had $29.9 million of gross unrealized losses at quarter-end, principally attributed to higher interest rates. The company recorded no other-than-temporary impairment and said it did not expect to need to sell the securities. Nine-month other comprehensive loss was $15.1 million, largely reflecting securities marks, partly offset by gains on interest-rate hedges.
- Compensation expense rose 11% in Q3, reflecting hiring, market pay increases and incentive accruals; management expected continued upward compensation pressure. Private wealth and trust assets under management and administration declined from year-end, primarily reflecting lower market values.
Outlook, risks and unusual items
- Management expected the 2022 effective tax rate to be below 22.5%, citing tax-credit investments; the nine-month rate was 22.6% and included a $155,000 low-income-housing tax credit benefit.
- The company planned to adopt CECL on January 1, 2023. It was validating and refining its model, and said the adoption impact could not yet be reasonably estimated.
- Key disclosed risks include economic deterioration, inflation and labor pressures, borrower defaults, interest-rate and market changes, competition, growth execution, cyber or fraud events, regulatory changes, and compliance with SBA requirements. Management noted that additional charge-offs or provisions could arise if credit conditions or workout facts change.
- The company issued $20 million of 3.50% subordinated notes and $12.5 million liquidation preference of 7% Series A preferred stock in March 2022, using proceeds in part to refinance or redeem older obligations. It also authorized a $5 million share-repurchase program through March 2023; approximately $2.4 million had been repurchased by September 30.
- The company maintained a $763,000 reserve for potential recourse on sold SBA loans. Management did not anticipate material losses from pending legal proceedings. No significant subsequent events requiring adjustment or disclosure were reported through issuance of the financial statements.
Important facts for investors to verify
- Whether margin growth persists as deposit costs and wholesale funding needs rise, and how management’s long-term 3.50% margin expectation develops.
- Credit performance and reserve adequacy, particularly within the CRE-concentrated portfolio, alongside the effect of CECL adoption in 2023.
- The scale and duration of unrealized securities losses, and whether liquidity or capital needs could require sales of marked securities.
- Deposit mix, wholesale funding concentration, maturities, and the company’s ability to grow in-market deposits economically.
- Whether fee income from mezzanine investments, swaps, SBA loan sales and private wealth remains durable, given market sensitivity and period-to-period variability.