First Business Financial Services, Inc. — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021; comparisons are with the corresponding 2020 periods unless otherwise noted. The company provides commercial banking, specialty finance, private wealth management and bank consulting, primarily through First Business Bank, with operations focused on Wisconsin and the greater Kansas City area. Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Net interest income | $21.7 | $18.9 | $42.5 | $35.9 |
| Non-interest income | $6.3 | $6.3 | $13.5 | $12.7 |
| Net income | $8.2 | $3.3 | $18.0 | $6.6 |
| Diluted earnings per share | $0.95 | $0.38 | $2.08 | $0.77 |
| Net interest margin | 3.49% | 3.34% | 3.46% | 3.39% |
| Efficiency ratio | 64.17% | 61.22% | 63.18% | 64.36% |
- Top-line revenue, defined as net interest income plus non-interest income, rose 11.0% to $28.0 million in Q2 and 15.1% to $56.0 million in the first half. Higher average lending balances and loan fees supported net interest income; lower deposit costs also helped. Adjusted net interest margin was 3.20% in both 2021 periods, below 3.32% in the comparable periods.
- Provision for loan and lease losses was a benefit of $1.0 million in Q2 and $3.0 million for the first half, versus expenses of $5.5 million and $8.7 million, respectively, in 2020. Management cited improving historical loss experience, lower specific reserves and a significant loan recovery received in January 2021. Q2 net charge-offs were $2.3 million, including a $2.2 million legacy SBA loan charge-off.
- Non-interest expense was $18.2 million in Q2, little changed year over year, and $35.5 million for the first half, up 3.0%. Excluding specified discrete items, operating expense increased 16.2% in Q2 and 12.9% in the first half, mainly reflecting higher compensation, staffing, technology and marketing costs. Q2 efficiency worsened year over year; the first-half ratio improved.
- Annualized return on average assets/equity was 1.26%/15.09% for Q2 and 1.38%/16.75% for the first half, compared with 0.55%/6.70% and 0.58%/6.92%, respectively, in 2020.
Balance sheet, funding and cash flow
- Total assets were $2.866 billion at June 30, up $297.8 million from year-end 2020. Cash and cash equivalents were $390.0 million, including $365.4 million of short-term investments; management attributed much of the increase to PPP forgiveness proceeds and temporary funds from a client’s business sale.
- Gross loans and leases were $2.148 billion, nearly flat from year-end. Excluding net PPP loans, they increased $102.2 million, or 10.6% annualized, to $2.023 billion. Gross PPP loans were $123.8 million, down from $228.9 million at year-end.
- Deposits rose $305.2 million to $2.161 billion. In-market deposits were $2.016 billion; excluding temporary business-sale proceeds, they were $1.791 billion. Management said most of the temporary client funds left the balance sheet in July.
- FHLB advances and other borrowings were $420.1 million, and junior subordinated notes were $10.1 million. Stockholders’ equity was $221.5 million. The Bank remained “well capitalized”; its common equity tier 1 ratio was 9.89% and tier 1 leverage ratio was 9.18%. Consolidated tangible common equity to tangible assets was 7.33%.
- For the first half, operating cash flow was $15.0 million, investing cash flow was $15.9 million and financing cash flow was $302.2 million. Cash and cash equivalents increased $333.1 million to $390.0 million, largely from deposit growth. Immediate on-balance-sheet liquidity was $829.0 million, or $604.0 million excluding specified temporary business-sale proceeds and prior-year PPPLF availability.
- The quarterly dividend was $0.18 per share. Management reported a 18.9% payout ratio against Q2 diluted EPS.
Credit quality, outlook and risks
- Non-performing assets declined to $11.6 million, or 0.40% of assets, from $26.7 million, or 1.04%, at December 31, 2020. Non-accrual loans were 0.53% of gross loans. The allowance was $25.7 million, or 1.20% of gross loans (1.27% excluding net PPP loans), down from $28.5 million, or 1.33%, at year-end.
- COVID-related deferred loans totaled $20.5 million across five credits, versus $27.0 million at year-end. Two hospitality credits accounted for $19.8 million; management said they were accruing and current on payments and expected no losses. Hospitality, retail, entertainment and restaurant/food-service exposures totaled $195.5 million, or 9.6% of gross loans excluding net PPP loans.
- Management said it expects long-term average net interest margin of at least 3.50%, modest positive operating leverage annually and continued measured growth in specialized lending and private wealth. It noted quarterly margin and revenue volatility from loan fees, PPP activity, interest-rate changes and variable swap fees. No specific full-year earnings guidance was provided.
- Management identified continuing uncertainty around COVID-19 and its effects on borrowers and the economy, competition, borrower defaults, interest-rate and market movements, growth execution, regulation, cybersecurity/fraud and compliance with SBA requirements as risks. It also noted that further credit losses or provisions could arise as loan workouts and economic conditions evolve.
- Legal proceedings were described as ordinary-course matters with no material adverse effect anticipated. The company reported no material risk-factor changes from its 2020 Form 10-K and no significant subsequent events requiring disclosure. Disclosure controls were deemed effective as of June 30, 2021.
Most important facts for investors to verify
- How much of the reported deposit and liquidity growth remained after the temporary client business-sale funds departed in July, and how deposit growth and funding costs subsequently developed.
- Whether loan growth, PPP runoff and recognition of PPP processing fees affect recurring net interest income and margin; compare the reported 3.49% Q2 margin with the 3.20% adjusted margin.
- Credit performance of the two hospitality deferrals and the broader stressed-industry portfolio, along with changes in non-accrual loans, charge-offs and allowance adequacy.
- Whether lower provision expense and improved earnings are sustainable, given the large January recovery, reserve releases and the legacy SBA portfolio; also monitor the $830,000 SBA recourse reserve.
- Whether expense growth—particularly compensation and technology—translates into revenue growth and improved efficiency, and whether management’s margin and positive operating-leverage expectations are achieved.