FIRST BUSINESS FINANCIAL SERVICES, INC. quarterly report, Q2 FY2022

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First Business Financial Services, Inc. — Q2 2022 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2022. First Business is a Wisconsin-based commercial bank holding company, operating primarily through First Business Bank in Wisconsin and the Kansas City metropolitan area, with commercial banking, specialized lending, private wealth and bank consulting businesses. Amounts below are in U.S. dollars.

Financial performance and condition

  • Quarterly earnings: Net income was $11.2 million; net income available to common shareholders was $11.0 million, or diluted EPS of $1.29, compared with $8.2 million and $0.95 a year earlier. Annualized ROA was 1.61% and return on average common equity was 18.79%, versus 1.26% and 15.09%.
  • Six-month earnings: Net income was $19.9 million and common earnings were $19.6 million, or diluted EPS of $2.31, compared with $18.0 million and $2.08 in the prior-year period. Six-month ROA was 1.46%; return on average common equity was 16.74%.
  • Revenue and margin: Q2 net interest income rose 9.3% to $23.7 million; non-interest income increased 8.7% to $6.9 million. Combined top-line revenue was $30.5 million, up 9.1%. Net interest margin improved to 3.71% from 3.49%; adjusted margin was 3.45% versus 3.20%. For the first half, top-line revenue rose 5.9% to $59.3 million and net interest margin was 3.55% versus 3.46%.
  • Costs and credit provision: Q2 non-interest expense increased 7.0% to $19.5 million; first-half expense increased 7.8% to $38.3 million. Provision for loan and lease losses was a benefit of $3.7 million in Q2 and $4.6 million for the first half, compared with benefits of $1.0 million and $3.0 million, respectively, in 2021.
  • Cash flow: For the six months, operating activities provided $16.8 million, investing activities used $79.4 million, and financing activities provided $101.0 million. Cash and cash equivalents ended at $95.5 million, up from $57.1 million at year-end 2021.
  • Balance sheet and liquidity: Total assets were $2.777 billion, up 4.7% from December 31, 2021. Net loans and leases were $2.266 billion, up from $2.215 billion. Deposits declined $88.6 million to $1.869 billion; FHLB advances and other borrowings rose $193.2 million to $596.6 million. Management reported immediate on-balance-sheet liquidity of $413.0 million and said available liquidity exceeded policy minimums.
  • Credit quality: Non-performing assets were $5.7 million, or 0.21% of assets, versus $6.5 million and 0.25% at year-end. The allowance was $24.1 million, or 1.05% of gross loans, compared with $24.3 million and 1.09%. Approximately 99.0% of loans and leases were current, versus 99.8% at year-end.
  • Capital: The Bank remained “well capitalized.” At June 30, its total risk-based capital ratio was 11.25%, CET1 was 10.32%, and Tier 1 leverage was 10.15%. The holding company’s corresponding ratios were 11.56%, 8.90%, and 9.19%.

Material changes and notable items

  • Loan growth and higher earning-asset yields supported net interest income and margins; management cited a low deposit beta in the rising-rate environment. Average loans excluding PPP loans increased 14.0% year over year for the first half.
  • PPP balances and associated fee income continued to run off, reducing a source of prior-period revenue. Management’s PPP-adjusted comparisons showed Q2 top-line revenue up 22.0% and adjusted pre-tax, pre-provision earnings up 53.8% year over year; these are non-GAAP measures.
  • The loan-loss benefit included a $4.1 million recovery on a legacy SBA relationship previously charged off in 2020. This unusual recovery materially affected the quarter’s provision result.
  • Available-for-sale securities had $19.9 million of gross unrealized losses at June 30, largely attributed to higher interest rates. The company recorded $19.7 million of pre-tax unrealized securities losses in first-half other comprehensive income; management reported no other-than-temporary impairment and expected recovery of amortized cost.
  • The company issued $20.0 million of 3.50% subordinated debt, redeemed $9.1 million of 6.00% subordinated notes, and redeemed $10.1 million of junior subordinated notes. It also issued $12.5 million of Series A preferred stock ($12.0 million net proceeds), carrying a 7.0% fixed dividend through March 2027 and a floating rate thereafter.
  • Common equity was affected by securities-related accumulated other comprehensive losses. The company repurchased shares under a $5 million program; it reported approximately $1.0 million repurchased through June 30 under the program.

Outlook, risks and contingencies

  • Management expects long-term average net interest margin of at least 3.50%, while noting quarterly volatility from loan fees, non-accrual interest collections and short-term deposit inflows. It described the balance sheet as asset-sensitive and positioned to benefit from rising short-term rates.
  • Management expects a 2022 effective tax rate of approximately 23%, subject to quarterly reassessment. No specific full-year earnings or revenue guidance is provided in the supplied filing text.
  • Management expects continued loan growth and annual net growth in in-market deposits, but deposits may fluctuate with client cash needs, seasonality and competition. Wholesale funding increased; the company said it remained within liquidity-policy limits and had adequate liquidity.
  • Key risks include economic weakness, inflation, supply-chain and labor pressures, borrower defaults, interest-rate and market-price changes, competition, growth execution, cybersecurity and fraud, regulatory or tax changes, and maintaining SBA-guarantee compliance. Commercial real estate represented 65.2% of loans excluding PPP at quarter-end.
  • The company reported no significant subsequent events, no material changes to previously disclosed risk factors or contractual obligations, and no expected material loss from pending legal proceedings. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.

Important facts for investors to verify

  • Whether reported earnings and provision benefits are sustainable without the $4.1 million legacy SBA recovery and other volatile or nonrecurring items.
  • How net interest margin, deposit pricing and funding costs respond to further rate changes, particularly as FHLB borrowings have risen and deposits have declined.
  • Whether loan growth, delinquency trends and the allowance remain adequate as economic conditions change, with attention to commercial real estate concentration.
  • The effect of securities unrealized losses on accumulated other comprehensive income, capital and potential liquidity if securities sales become necessary.
  • Future progress on deposit gathering, liquidity and capital, including preferred dividends, share repurchases, and the terms and use of new debt and preferred-stock proceeds.