Business context and reporting period
First Business Financial Services, Inc. is a Wisconsin bank holding company operating commercial banks in the Madison and Milwaukee markets, with related lending, equipment-finance, and trust and investment services businesses. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2013. Comparisons below are to the same 2012 periods or, for balance-sheet items, December 31, 2012.
Financial performance and position
- Revenue and earnings: Third-quarter top-line revenue—net interest income plus non-interest income—rose 5.4% to $12.8 million. Net income increased to $3.6 million from $2.6 million. For the first nine months, revenue rose 8.5% to $37.4 million and net income increased to $10.0 million from $6.4 million.
- Per-share results: Third-quarter diluted EPS was $0.91, versus $0.99; nine-month diluted EPS was $2.54, versus $2.43. The company attributed period comparability in EPS partly to its December 2012 stock offering, which increased shares outstanding. Dividends declared were $0.14 per share for Q3 and $0.42 year to date, twice the respective 2012 amounts.
- Interest income and margins: Net interest income increased 7.9% to $10.7 million in Q3 and 9.4% to $31.1 million year to date. Net interest margin improved to 3.56% from 3.50% in Q3 and to 3.52% from 3.38% year to date. Lower funding costs and reduced borrowings helped, while yields on loans and leases declined.
- Credit costs and operating expenses: Provision for loan and lease losses was $0.1 million in Q3 and $0.2 million year to date, versus $0.9 million and $3.4 million in 2012. Non-interest expense fell 1.4% to $7.1 million in Q3 but rose 2.8% to $21.8 million year to date, including higher compensation and business-support costs.
- Cash flow: For the first nine months, operating activities provided $11.3 million, investing activities used $34.9 million, and financing activities provided $34.1 million. Cash and cash equivalents increased $10.5 million to $96.1 million.
- Balance sheet and funding: Total assets were $1.265 billion, up 3.2% from year-end 2012. Net loans and leases rose 5.0% to $941.2 million; deposits increased 3.3% to $1.128 billion. Borrowings were $11.9 million, with an additional $10.3 million of junior subordinated notes. Stockholders’ equity was $106.1 million.
- Liquidity and capital: Management reported immediate on-balance-sheet liquidity of $277.9 million. Brokered deposits were $414.3 million, or 36.7% of total deposits; the Banks’ operating goal was 50% or less, with a policy limit of 75%. The Banks were reported well capitalized; at September 30, First Business Bank’s total risk-based capital ratio was 12.84% and First Business Bank–Milwaukee’s was 14.09%.
Material changes and asset quality
- Non-accrual loans and leases fell to $9.7 million from $14.1 million at year-end; non-performing assets declined to $10.3 million from $15.7 million. Non-performing assets were 0.82% of total assets, compared with 1.28%.
- The allowance for loan and lease losses was $15.2 million, or 1.59% of gross loans and leases, down from 1.69%. Net charge-offs for the first nine months were $0.5 million, compared with $2.8 million in 2012. Management said improving credit metrics and lower charge-offs contributed to the lower provision and allowance ratio.
- Gross loans and leases grew approximately $44.7 million. Commercial real estate remained the largest portfolio segment, at about 67% of loans and leases; commercial and industrial loans grew 7.7% from year-end.
- Available-for-sale securities declined to $186.2 million from $200.6 million. Rising longer-term rates produced $3.5 million of pretax unrealized losses in other comprehensive income for the first nine months. The company reported no securities as other-than-temporarily impaired.
- Trust and investment services fees increased 27.3% year to date, supported by higher assets under management. In contrast, loan-fee income declined 20.8%; the prior-year period included loan-administration fees that did not recur to the same extent.
Outlook, commentary, and risks
The company gave no specific earnings or full-year numerical guidance. Management said it expected new loan and lease activity to exceed normal amortization and support further portfolio growth, while emphasizing that it would maintain underwriting standards amid competition. It intended to keep building in-market deposit relationships and limit reliance on brokered certificates of deposit, while using excess liquidity to fund growth, repay maturing debt, allow brokered deposits to run off, or invest.
Management expected asset-quality improvement to continue, but cautioned that further reductions in non-accrual loans may be slower and could be uneven. Additional provisions or charge-offs remain possible as problem credits are worked out. Key risks cited include local economic conditions, interest-rate changes, loan demand, borrower defaults, competition, regulatory actions, and market volatility affecting securities values and trust-fee income. The company also noted that actual results may differ from estimates, including estimates for the allowance, foreclosed properties, securities, and taxes.
A $3.2 million loan participation was repurchased in May 2013 for $1.5 million to manage the workout directly; it was classified as a nonperforming troubled debt restructuring. Management reported compliance with debt covenants, effective disclosure controls, and no material change in previously disclosed risk factors or contractual obligations. It stated that ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether improved credit quality persists and whether the $15.2 million allowance remains adequate as loans grow and problem credits are resolved.
- The composition, maturity profile, and cost of deposits—particularly the $414.3 million of brokered deposits—and the company’s progress toward its in-market funding goals.
- Whether net interest margin can be sustained as loan yields and securities reinvestment rates respond to competition and interest-rate movements.
- The extent to which lower provisions, reduced FDIC and credit-workout costs, and higher trust fees are repeatable, versus one-time or timing-related effects.
- The impact of securities valuation changes on comprehensive income and equity, given the reported rate-related unrealized losses.
- Capital and dividend capacity, including regulatory constraints on bank-to-holding-company distributions and the effect of the prior equity offering on per-share returns.