First Business Financial Services, Inc. — Q1 2012 Form 10-Q
Business context and period: Wisconsin-based commercial bank holding company serving businesses, business owners, professionals and high-net-worth clients through First Business Bank and First Business Bank—Milwaukee. This unaudited filing covers the three months ended March 31, 2012; comparisons are with Q1 2011 unless otherwise stated.
Financial performance and position
| Metric | Q1 2012 / March 31, 2012 | Comparable period / prior year-end |
|---|---|---|
| Total revenue (net interest income plus non-interest income) | $10.8 million, up 6.1% | $10.2 million in Q1 2011 |
| Net interest income | $8.93 million, up 5.2% | $8.48 million in Q1 2011 |
| Net interest margin | 3.15% | 3.14% in Q1 2011 |
| Net income; diluted EPS | $2.21 million; $0.84 | $1.35 million; $0.52 in Q1 2011 |
| Provision for loan and lease losses | $504,000 | $1.40 million in Q1 2011 |
| Non-interest income / expense | $1.85 million / $6.83 million | $1.67 million / $6.76 million in Q1 2011 |
| Total assets | $1.162 billion | $1.177 billion at December 31, 2011 |
| Net loans and leases | $817.3 million | $836.7 million at December 31, 2011 |
| Deposits | $1.034 billion | $1.051 billion at December 31, 2011 |
| Cash and cash equivalents | $135.4 million | $130.1 million at December 31, 2011 |
| Non-performing assets | $22.8 million; 1.96% of assets | $24.0 million; 2.04% at December 31, 2011 |
| Allowance for loan and lease losses | $14.45 million; 1.74% of gross loans | $14.16 million; 1.66% at December 31, 2011 |
| Cash flow | $3.36 million operating; $18.40 million investing; $16.50 million financing outflow | Cash increased $5.26 million during Q1 |
Annualized return on average assets was 0.74%, versus 0.48% in Q1 2011; return on average equity was 13.43%, versus 9.62%. The company declared a $0.07 per-share dividend, unchanged from Q1 2011.
Total borrowings were $51.8 million at quarter-end, including $39.0 million of subordinated notes and $10.3 million of junior subordinated notes. Deposits included $415.2 million of brokered certificates of deposit, or 40.2% of total deposits. Management reported immediate on-balance-sheet liquidity of $271.9 million. The banks were categorized as well capitalized; consolidated total risk-based and Tier 1 risk-based capital ratios were 13.56% and 8.21%, respectively.
Material changes and management commentary
- Net income rose 63.8%, supported by lower loan-loss provision expense, higher net interest income and higher fee income. Management’s non-GAAP core earnings measure increased 19.5% to $4.12 million.
- Lower deposit costs lifted net interest income, as maturing brokered CDs were replaced at lower rates. Asset yields declined, notably due to lower-yielding reinvestments in mortgage securities; the elevated short-term investment balance also weighed on margin.
- Loans and leases contracted 2.3% from year-end. Management said new loan activity was not keeping pace with amortization, citing weak qualified demand and competition, and stated it would not relax underwriting standards to pursue growth. Commercial real estate remained about 68% of the portfolio.
- Non-accrual loans declined 7.2% from year-end to $20.2 million, and non-performing assets fell. However, non-accrual commercial and industrial loans increased to $5.6 million from $1.6 million at year-end. Management expected elevated impaired-loan levels to persist near term and warned further charge-offs or higher provisions could result from deteriorating facts or collateral values.
- Non-interest expense edged up 1.1%: higher compensation was partly offset by lower FDIC insurance and collateral liquidation costs. A $175,000 net loss on foreclosed properties included a $155,000 loss on sales and $20,000 impairment charge.
- In Q1 the company issued approximately $6.2 million of 7.5% fixed-rate subordinated debentures, maturing in 2022, to replace part of existing subordinated notes. It reported compliance with senior-line covenants.
Outlook, risks and other disclosures
Management’s 2012 priorities are improving asset quality, building commercial and industrial relationships and in-market deposits, growing fee income, and adding business-development staff as appropriate. It aims to reduce brokered-CD reliance and use excess liquidity for debt and deposit maturities, securities investment or loan growth. No numerical earnings or growth guidance was provided. Management said margin could improve if excess liquidity is redeployed into higher-yielding assets, but this depends on market and lending conditions.
Key risks identified include local economic conditions, interest-rate movements, loan demand and borrower defaults, competition, deposit gathering and brokered-funding availability, and regulatory actions. Securities are exposed to interest-rate and mortgage prepayment/extension risk. Management reported no material change in previously disclosed risk factors, no material change in interest-rate sensitivity since year-end, effective disclosure controls, and no material litigation expected to affect financial position, results or cash flows. No securities were considered other-than-temporarily impaired.
Important facts for investors to verify
- Whether lower loan demand and loan amortization continue to shrink the portfolio, and whether management can grow commercial and industrial lending without weakening underwriting.
- Credit migration and loss severity, particularly the rise in non-accrual commercial and industrial loans, construction exposure, collateral valuations, and reserve adequacy.
- Brokered-CD maturities, funding costs, in-market deposit growth and the company’s ability to maintain liquidity if brokered funding becomes less available.
- Whether lower deposit costs can be sustained and excess liquidity redeployed profitably enough to support net interest margin and earnings.
- The terms and capital treatment of the subordinated debentures, regulatory capital levels, dividend capacity and applicable restrictions.
- Cash flow and balance-sheet movements: operating cash flow was positive, while investing cash flow included an $18.1 million net decrease in loans and financing cash flow reflected lower deposits and debt transactions.