First Business Financial Services, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. The company is a Wisconsin-based bank holding company serving businesses and individuals through banks in Wisconsin and Kansas City. Comparisons are affected by the November 2014 acquisition of Alterra Bank. Dollar figures below are in millions unless otherwise noted.
Financial results and condition
- Q3 results: Net income was $4.4 million, up 23% from $3.6 million; diluted EPS was $0.50 versus $0.45. Net interest income rose 33.6% to $14.6 million, and non-interest income rose 66.8% to $4.1 million. Provision for loan and lease losses was $0.3 million, compared with a $0.1 million provision release a year earlier.
- Nine-month results: Net income was $12.4 million, up from $10.4 million; diluted EPS was $1.43 versus $1.31. Net interest income increased 34.4% to $43.7 million and non-interest income increased 69.2% to $12.1 million. Provision expense was $1.5 million versus none in 2014.
- Margins and returns: Net interest margin was 3.61% in Q3, up 17 basis points year over year, and 3.67% for nine months, up 16 basis points. Nine-month ROAA declined to 0.98% from 1.07%; ROAE declined to 11.55% from 12.13%. The efficiency ratio increased to 64.2% for nine months from 59.6%.
- Balance sheet at September 30: Assets were $1.744 billion, up 7.0% from year-end 2014. Gross loans and leases were $1.381 billion, up from $1.282 billion; deposits were $1.539 billion, up from $1.438 billion. Stockholders’ equity was $148.0 million.
- Credit quality: Non-accrual loans were $9.7 million, or 0.70% of gross loans, versus $9.8 million and 0.76% at year-end. Non-performing assets were 0.65% of assets, down from 0.70%. The allowance was $15.4 million, or 1.11% of gross loans. Performing troubled debt restructurings increased to $7.9 million from $2.0 million.
- Debt and capital: Borrowings were approximately $46.7 million, including $10.3 million of junior subordinated notes; deposits remained the primary funding source. The company reported compliance with debt covenants and regulatory capital requirements. Consolidated total capital and common equity Tier 1 ratios were 11.29% and 8.34%, respectively.
- Liquidity and cash flow: Immediate on-balance-sheet liquidity was $334.7 million. For the nine months, operating cash flow was $12.1 million, investing cash outflow was $93.5 million (largely loan growth), and financing cash inflow was $100.8 million, primarily from deposit growth. Cash and cash equivalents ended at $122.7 million. Dividends declared were $0.33 per share for the nine-month period.
Material changes and management commentary
- Management attributed much of the growth in revenue and assets to Alterra. Alterra contributed $4.7 million of pre-tax income in the first nine months, including $2.2 million of net purchase-accounting accretion/amortization in net interest income.
- Loan-sale gains were a notable new income source: $2.3 million from SBA loans and $0.6 million from residential mortgage loans during the first nine months. Management describes its SBA strategy as a relationship-building approach, typically selling the guaranteed portion while retaining the unguaranteed portion and broader client relationship.
- Expenses grew faster than revenue in percentage terms, with nine-month non-interest expense up 50.9%. Management cited acquisition-related costs, staffing, technology initiatives, and expanded marketing. It expects continued investment and says the efficiency ratio will remain moderately above its 60% target.
- Management expects continued organic momentum and loan growth, while prioritizing in-market deposit growth and transaction accounts. It provided no specific earnings or revenue guidance. It noted that purchase-accounting accretion may trend lower and fluctuate with loan prepayments.
Risks, contingencies, and unusual items
- Key disclosed risks include credit deterioration, economic weakness, competition, interest-rate and market movements, managing growth, regulatory or tax changes, and technology or cybersecurity failures. Management reported no material change to previously disclosed risk factors.
- Commercial real estate represented approximately 64% of loans. Management noted that loan growth, competition, future charge-offs, and provisions may vary; further charge-offs or higher provisions could arise if credit conditions or loan-specific facts change.
- Wholesale deposits were $476.6 million, or 31.0% of deposits, within the company’s stated 30%–40% operating range. Management cited possible disruption in wholesale funding as a liquidity risk, while reporting available liquidity above policy minimums.
- Interest-rate swaps had $27.1 million aggregate notional with both borrowers and dealer counterparties; they were not designated as accounting hedges. Management said their fair-value changes had an insignificant income-statement effect.
- No significant subsequent events requiring adjustment or disclosure were reported. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. Disclosure controls were reported effective.
Important facts for investors to verify
- How much of reported earnings growth is sustainable after Alterra-related purchase-accounting accretion and loan-sale gains.
- Whether expense growth moderates and the efficiency ratio moves toward management’s 60% target.
- Loan growth, CRE concentration, troubled debt restructurings, non-accrual trends, and adequacy of the allowance as the portfolio expands.
- Deposit mix and cost, wholesale-funding dependence, and the company’s ability to maintain liquidity while funding loan growth.
- Capital and dividend capacity as regulatory capital buffers phase in and the company continues investing in growth.