First Business Financial Services, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. The company is a Wisconsin-based commercial bank holding company serving businesses, business owners and individuals, primarily through First Business Bank. Unless stated otherwise, amounts below are in millions.
Financial performance and position
| Metric | Q2 2023 | Comparable period / balance |
|---|---|---|
| Net interest income | $27.7 | $23.7 in Q2 2022 |
| Net interest margin | 3.81% | 3.71% in Q2 2022; adjusted NIM was 3.63% vs. 3.44% |
| Non-interest income | $7.4 | $6.9 in Q2 2022 |
| Non-interest expense | $22.0 | $19.5 in Q2 2022 |
| Provision for credit losses | $2.2 expense | $3.7 benefit in Q2 2022 |
| Net income / common EPS | $8.3 / $0.98 | $11.2 / $1.29 in Q2 2022 |
| Annualized ROAA / ROACE | 1.04% / 12.58% | 1.61% / 18.79% in Q2 2022 |
Top-line revenue (net interest income plus non-interest income) rose 15.0% year over year to $35.1 million. Higher loan yields and average loan balances supported net interest income, but much higher deposit costs and credit-loss expense, along with increased operating costs, weighed on reported earnings. Management-reported adjusted pre-tax, pre-provision earnings increased 24.2% to $13.5 million; this is a non-GAAP measure.
- Balance sheet at June 30: Total assets were $3.266 billion, up 9.7% from year-end 2022. Gross loans and leases were $2.674 billion, up $231.2 million; deposits were $2.529 billion, up $360.6 million. Stockholders’ equity was $272.6 million.
- Credit: Allowance for credit losses, including unfunded commitment reserves, was $29.7 million, or 1.11% of gross loans, versus $24.2 million and 0.99% at year-end. Non-performing assets increased to $15.8 million (0.48% of assets) from $3.8 million (0.13%).
- Funding and liquidity: Cash and cash equivalents totaled $112.8 million. The company reported $563.5 million of readily available liquidity and $1.626 billion of total liquidity, including contingent sources. Wholesale funds were $790.8 million, 27.6% of total bank funding. Net uninsured deposits after collateral were $829.7 million, 32.8% of deposits.
- Borrowings and capital: FHLB advances and other borrowings were $370.1 million, down from $456.8 million at year-end. The Bank remained “well capitalized”; its CET1 ratio was 9.82%, total capital ratio 10.73%, and Tier 1 leverage ratio 9.93%.
- Cash flow, six months: Operating activities provided $22.5 million; investing activities used $279.2 million, mainly for loan growth and securities purchases; financing activities provided $266.8 million, mainly from deposit growth, partly offset by FHLB repayments. Cash and cash equivalents increased $10.1 million.
Material changes versus prior periods
- For the first six months, net income available to common shareholders fell to $16.9 million from $19.6 million; diluted EPS was $2.02 versus $2.31. Net interest income rose 20.8%, while non-interest expense rose 14.4% and credit-loss provision shifted from a $4.6 million benefit to a $3.8 million expense.
- Average loan yields rose with market rates, but deposit costs also increased sharply. Q2 average interest-bearing deposit cost was 3.42%, versus 0.31% a year earlier. Management noted rising deposit betas and anticipated gradual NIM pressure in coming quarters.
- Loan growth was concentrated in commercial and industrial lending. Management said the recent pace was not sustainable and expected growth to moderate, including C&I growth to lower double-digit levels in subsequent quarters.
- Non-performing loans rose to $15.7 million, largely because of one $10.9 million Asset-Based Lending default. Management said the loan was fully collateralized and did not view it as indicative of broader portfolio or industry stress.
Outlook, risks and unusual items
- Management expects 2023 effective tax rate of 21%–22%, subject to quarterly reassessment. It believes NIM should stabilize meaningfully above its 3.50% strategic-plan goal, while cautioning that deposit betas may rise and NIM may gradually decline.
- Management expects positive annual operating leverage and continued focus on revenue growth, expense control, process improvement and automation. It also expects to assess loan-sale strategies to diversify fee income.
- In 2023 the company adopted CECL (ASC 326), recording an $1.8 million increase in the allowance and unfunded-commitment reserve and a $1.4 million reduction to retained earnings, net of related tax effects. The company reported no securities credit-loss provision; unrealized securities losses were attributed to market factors, principally interest rates.
- Key stated risks include interest-rate and liquidity sensitivity, withdrawals of uninsured deposits, dependence on wholesale funding, borrower defaults, economic conditions, potential higher FDIC assessments, regulatory changes, and cybersecurity or fraud risks. The filing says existing legal proceedings are not expected to have a material adverse effect.
- The company repurchased approximately $2.0 million of shares under its $5.0 million authorization through June 30. It reported no significant subsequent events requiring disclosure and stated that disclosure controls were effective.
Important facts for investors to verify
- Whether the $10.9 million ABL default remains fully collateralized and whether additional loans migrate to non-performing status or require specific reserves.
- Deposit retention, mix and pricing—particularly uninsured deposits, wholesale funding, and the $414.5 million of certificates of deposit scheduled to mature in 2023.
- Whether deposit-cost increases outpace asset-yield repricing, and how actual NIM compares with management’s outlook.
- Whether rapid loan growth moderates as expected while credit quality, allowance coverage and liquidity remain adequate.
- How FDIC assessment changes, securities values and other rate-sensitive items affect earnings, capital and available liquidity.