Business context and reporting period
First Business Financial Services, Inc. (Nasdaq: FBIZ) filed this unaudited Form 10-Q for the quarter ended March 31, 2020. It operates a commercial bank primarily in Wisconsin and the greater Kansas City area, serving businesses and individuals, with commercial lending, specialty finance, private wealth management and bank consulting businesses. Unless otherwise noted, financial amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q1 2020 | Comparable period / prior date |
|---|---|---|
| Net interest income | $17.1 million | $17.8 million in Q1 2019 |
| Provision for loan and lease losses | $3.2 million | $49,000 in Q1 2019 |
| Non-interest income | $6.4 million | $4.6 million in Q1 2019 |
| Non-interest expense | $16.1 million | $17.7 million in Q1 2019 |
| Net income / diluted EPS | $3.3 million / $0.38 | $5.9 million / $0.67 in Q1 2019 |
| Net interest margin | 3.44% | 3.79% in Q1 2019 |
| Efficiency ratio | 67.74% | 68.04% in Q1 2019 |
| Assets | $2.196 billion | $2.097 billion at Dec. 31, 2019 |
| Gross loans and leases | $1.744 billion | $1.715 billion at Dec. 31, 2019 |
| Deposits | $1.500 billion | $1.530 billion at Dec. 31, 2019 |
| FHLB advances and other borrowings | $412.9 million | $319.4 million at Dec. 31, 2019 |
Top-line revenue, defined as net interest income plus non-interest income, rose 4.8% year over year to $23.5 million. Commercial loan swap fees increased to $1.7 million from $473,000, helping lift non-interest income. Net interest income fell 4.0%, largely reflecting lower asset yields and fewer fees collected in lieu of interest. Excluding those fees, net interest income increased 5.1% year over year.
Operating cash flow was $1.2 million; investing cash flow was negative $33.7 million, including net loan growth and an $8.0 million purchase of bank-owned life insurance; financing cash flow was positive $60.4 million, mainly from increased FHLB advances. Cash and cash equivalents ended the quarter at $95.0 million, up from $67.1 million at year-end.
The allowance for loan and lease losses increased to $22.7 million, or 1.30% of gross loans, from $19.5 million, or 1.14%, at year-end. Non-accrual loans were $27.9 million, equal to 1.60% of gross loans, versus $20.6 million and 1.20% at year-end. Non-performing assets totaled $29.6 million, or 1.35% of assets, compared with $23.5 million and 1.12%.
At March 31, the company reported stockholders’ equity of $195.7 million. Regulatory capital ratios included consolidated total capital of 11.74%, Tier 1 capital of 9.45%, common equity Tier 1 of 8.96% and Tier 1 leverage of 9.33%; the Bank remained classified as well capitalized. Management reported immediate on-balance-sheet liquidity of $341.1 million and total available liquidity sources of approximately $457.8 million, excluding access to the Federal Reserve’s PPP Liquidity Facility. The filing also reports $53.5 million of federal funds lines.
Material changes and unusual items
- Net income fell 44% year over year, chiefly as the company increased credit-loss provisioning in response to COVID-19 uncertainty. Management attributed $3.1 million of the first-quarter provision to the increased perceived risk; the reported provision was $3.2 million.
- Net interest margin declined 35 basis points year over year. Lower interest rates reduced loan yields, while lower funding costs partly offset that pressure.
- Non-interest income rose 38.3%, primarily on higher commercial loan swap fees and stronger mezzanine fund returns. Private wealth fees increased 9.6%, though assets under management and administration fell 12.0% from year-end to $1.664 billion following the late-March market decline.
- Non-interest expense declined 9.0%, but the comparison includes a $2.0 million tax-credit investment impairment in Q1 2019 versus $113,000 in Q1 2020. The prior-year impairment was associated with recognition of a $2.8 million tax credit, contributing to a $1.3 million tax benefit in Q1 2019; Q1 2020 tax expense was $858,000.
- Non-performing assets increased, primarily due to a newly impaired $5.0 million commercial relationship and repurchase of $2.0 million of impaired legacy SBA loans. The company recorded $46,000 of net recoveries in Q1 2020.
- Deposits declined $30.3 million from year-end, while borrowings increased $93.5 million. Management cited shifts from money-market accounts into transaction accounts and use of FHLB advances as funding sources.
Outlook, management commentary and risks
Management stated it believes it can achieve a net interest margin of at least 3.50% on average, while noting expected second-quarter volatility from PPP loans and variability in loan fees. This is not full-year earnings guidance; the filing provides no clear quantified full-year revenue or profit forecast. Management expects a modest reduction in private wealth fee income in Q2 due to lower market values at the end of March.
As of April 22, 2020, the company had processed 267 COVID-related loan modifications covering $196.6 million of loans, up from 64 agreements covering $59.8 million at March 31. Separately, by April 22 it had received more than 600 PPP applications, obtained conditional SBA approval for more than $300 million, disbursed approximately $280 million and expected about $8.5 million in processing fees. These are post-quarter-end figures and are not Q1 results.
The company identified $171.2 million, or 9.8% of gross loans and leases, in retail, hospitality, entertainment, and restaurant and food-service exposures. Management said the pandemic’s duration and ultimate effect on borrowers and the economy are uncertain. Other stated risks include rising defaults, weaker collateral values, funding and market volatility, cybersecurity risks from remote work, and possible securities impairments. The company suspended stock repurchases effective March 16; management reported no COVID-related furloughs or layoffs and did not then anticipate them.
Management reported no significant legal proceedings expected to materially affect financial position, results or cash flows. It also stated that the company and Bank exceeded regulatory capital minimums, and that the Bank complied with its liquidity policy. The board declared a regular $0.165-per-share quarterly dividend, paid February 13; the filing notes that future dividends remain subject to regulatory and capital considerations.
Most important facts for investors to verify
- Whether COVID-19-related borrower stress leads to further deterioration in credit quality, provisions, charge-offs or non-performing assets, particularly in the identified stressed industries.
- How the 267 reported loan modifications perform after deferral periods, and whether their balances or terms change.
- Whether PPP conditional approvals, disbursements and expected processing fees were finalized and recognized, and how PPP funding affects liquidity and margin.
- Whether deposits stabilize and increased reliance on FHLB advances and other wholesale funding remains manageable in cost, maturity and concentration.
- Whether management’s at-least-3.50% average margin expectation is achieved amid low rates and PPP-related volatility, and whether private wealth fees recover after market declines.
- Capital, liquidity and dividend capacity if pandemic conditions worsen; stock repurchases were suspended, and management may take additional capital actions.