FIRST BUSINESS FINANCIAL SERVICES, INC. annual report, FY2012

Full document

First Business Financial Services, Inc. — 2012 Form 10-K

Business and reporting period: The company is a Wisconsin bank holding company operating through First Business Bank and First Business Bank-Milwaukee, focused on commercial banking, asset-based lending, equipment finance, treasury management, and trust and investment services. This 10-K covers the year ended December 31, 2012; quarterly figures below include unaudited fourth-quarter results.

Financial performance and condition

  • Full-year earnings: Net income was $8.9 million, up 5.9% from $8.4 million in 2011; diluted EPS was $3.29 versus $3.23. The prior year included a substantial one-time Wisconsin tax benefit. The 2012 effective tax rate was 34.7%, compared with 29.0% in 2011.
  • Revenue and margins: Net interest income rose 6.8% to $37.9 million; non-interest income increased 23.2% to $8.7 million. Total top-line revenue was $46.6 million, up 9.5%. Net interest margin improved to 3.36% from 3.29%, as lower funding costs more than offset lower asset yields.
  • Expenses and credit costs: The provision for loan and lease losses was $4.2 million, essentially unchanged. Non-interest expense was $28.7 million, up from $26.4 million, mainly reflecting higher compensation, marketing, and foreclosed-property costs. The company reported record non-GAAP core earnings of $18.5 million, up 11.8%; this measure excludes credit costs and specified items and is not a GAAP earnings measure.
  • Fourth quarter: Net income was $2.5 million, versus $2.4 million in fourth-quarter 2011; diluted EPS was $0.86 versus $0.90. Net interest income was $9.4 million and the provision was $0.8 million. The filing provides no clearly labeled quarterly total-revenue figure.
  • Balance sheet and lending: Total assets grew 4.2% to $1.226 billion. Gross loans and leases rose 7.2% to $912.7 million; net loans and leases were $896.6 million. Commercial real estate accounted for 68.4% of gross loans, and commercial and industrial lending 28.1%.
  • Asset quality: Nonperforming assets fell to $15.7 million, or 1.28% of assets, from $24.0 million, or 2.04%. Nonaccrual loans were $14.1 million, or 1.55% of gross loans, compared with $21.8 million, or 2.56%. Net charge-offs declined to 0.35% of average loans from 0.74%. The allowance was $15.4 million, equal to 1.69% of gross loans and 109.05% of nonaccrual loans.
  • Deposits, liquidity, and debt: Deposits increased 3.9% to $1.092 billion. Brokered deposits were $374.4 million, or 34.3% of period-end deposits, down from 42.5%. Immediate on-balance-sheet liquidity was $241.4 million. Total borrowings fell to $22.7 million from $50.6 million; year-end stockholders’ equity was $99.5 million, or 8.1% of assets.
  • Cash flow: Operating activities generated $16.0 million; investing activities used $99.8 million, primarily for securities purchases and loan growth; financing activities provided $39.3 million, primarily from deposit growth and the equity offering. Cash and cash equivalents decreased $44.5 million to $85.6 million.
  • Capital: A December 2012 public offering of 1.265 million shares raised approximately $29.1 million gross and $27.1 million net. Proceeds were used to repay subordinated debt. The Banks were reported as well-capitalized; consolidated Tier 1 capital to risk-weighted assets was 10.54%.

Changes, outlook, and notable matters

  • Management said 2012’s priorities—asset-quality improvement, loan growth, in-market deposits, and fee income—made progress. Average in-market deposits increased 25.0% to $649.0 million and represented 61.8% of average deposits.
  • For 2013, management expects to pursue more significant loan and lease growth, continue improving asset quality, and expand organic business, particularly in Milwaukee and Northeast Wisconsin. It also expects ongoing market volatility to affect trust assets and fee income. No numerical earnings or revenue guidance was provided.
  • Credit quality improved overall, but management expects historically elevated impaired loans to persist and anticipates new additions to nonaccrual loans. Commercial real estate concentration, collateral values, and potential further foreclosed-property losses remain important risks.
  • Management identified funding and interest-rate risks, including reliance on brokered deposits and the possibility of margin pressure. Brokered deposits were 39.9% of First Business Bank deposits and 8.9% of Milwaukee bank deposits. Interest-rate sensitivity estimates vary by scenario; the filing’s model projects a 2.91% decline in next-12-month net interest income for an immediate 100-basis-point increase.
  • Basel III implementation in the United States was delayed and its final effects remained uncertain. The filing reported no material pending litigation and no significant subsequent events requiring adjustment. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.

Investor verification priorities

  1. Review loan-level and sector credit exposure, especially commercial real estate, construction and land development, troubled restructurings, and the adequacy of the $15.4 million allowance.
  2. Track brokered-deposit runoff, deposit pricing, and the $191.7 million of time deposits scheduled to mature in 2013, alongside the company’s liquidity sources.
  3. Assess the sustainability of earnings growth after the 2011 tax benefit, and whether higher compensation and other operating expenses support profitable growth.
  4. Verify the effects of the equity raise and subordinated-debt repayment on funding costs, capital composition, and future dilution; consider that diluted EPS was slightly lower in fourth-quarter 2012 year over year.
  5. Monitor realized and unrealized securities changes, interest-rate exposure, regulatory capital rule changes, and the execution of management’s 2013 growth plans.