Business context and reporting period
First Business Financial Services, Inc. is a Wisconsin bank holding company operating primarily through First Business Bank in Wisconsin and the Kansas City metropolitan area. It focuses on commercial banking, specialty finance, private wealth management and bank consulting. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2021; comparisons are with the corresponding 2020 periods or December 31, 2020, as applicable. Amounts below are in millions unless noted.
Financial performance and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net interest income | $21.2 | $18.6 | $63.7 | $54.6 |
| Non-interest income | $7.0 | $7.4 | $20.5 | $20.1 |
| Net income | $9.2 | $4.3 | $27.2 | $10.9 |
| Diluted EPS | $1.07 | $0.50 | $3.15 | $1.27 |
- Revenue and profitability: Top-line revenue, defined as net interest income plus non-interest income, was $28.2 million for Q3, up 8.5%; nine-month revenue was $84.3 million, up 12.8%. Annualized Q3 return on average assets and equity were 1.41% and 16.39%, respectively, versus 0.68% and 8.58% a year earlier.
- Margins: Net interest margin was 3.45% for Q3 and 3.46% for the nine months, versus 3.14% and 3.30%. Adjusted net interest margin, excluding certain volatile items, was 3.22% and 3.21%, versus 3.24% and 3.29%.
- Credit costs: The provision for loan and lease losses was a benefit of $2.3 million in Q3 and $5.3 million for the nine months, compared with expenses of $3.8 million and $12.5 million in 2020. The Q3 benefit reflected recoveries and reductions in general and specific reserves.
- Expenses: Non-interest expense rose 10.3% to $18.5 million in Q3 and 5.4% to $54.0 million for the nine months. Compensation increased 12.6% and 16.5%, respectively. The efficiency ratio was 65.68% in Q3 versus 64.16%; nine-month ratio improved to 64.02% from 64.29%.
- Cash flow: For the nine months, operating cash flow was $24.8 million, investing cash flow was $14.5 million and financing cash flow was $14.5 million. Cash and cash equivalents increased $53.7 million to $110.6 million.
- Balance sheet and funding: Total assets were $2.584 billion, up $16.6 million from year-end 2020. Deposits were $1.904 billion, up $48.8 million; FHLB advances and other borrowings were $394.1 million, down $25.1 million, plus $10.1 million of junior subordinated notes. Net loans and leases were $2.099 billion, down $18.8 million, primarily reflecting PPP forgiveness; excluding net PPP loans, net loans increased $142.1 million.
- Liquidity and capital: Immediate on-balance-sheet liquidity was $535.3 million, compared with $640.2 million at year-end. The Bank remained well capitalized. Consolidated total capital, Tier 1, common equity Tier 1 and leverage ratios were 11.14%, 9.14%, 8.73% and 8.69%, respectively. Tangible common equity to tangible assets was 8.28%.
- Credit quality: Non-performing assets were $7.6 million, or 0.29% of assets, compared with $26.7 million, or 1.04%, at year-end. The allowance was $24.7 million, or 1.16% of gross loans, versus $28.5 million and 1.33%. Excluding net PPP loans, allowance coverage was 1.20% versus 1.48%.
Material changes versus comparable periods
- Earnings increased substantially, supported by higher net interest income, lower funding costs, stronger loan-fee income and a reversal from loan-loss provision expense to benefit. Management also cited recovery of previously impaired credits and improved credit conditions.
- Average loans excluding net PPP loans grew 12.5% in Q3 year over year and 13.2% for the nine months. Period-end in-market deposits increased $146.6 million from year-end, while PPP loans declined to $65.9 million from $228.9 million.
- Private wealth and trust assets under management and administration reached $2.694 billion, up $445.2 million from year-end. Nine-month private wealth fees increased 23.6%.
- Commercial loan swap fees were highly variable: none were recorded in Q3 2021 versus $2.4 million in Q3 2020; nine-month fees fell to $0.7 million from $5.8 million. Other non-interest income increased, including returns from mezzanine investments and bank consulting services.
- Non-accrual loans fell to $7.4 million from $26.6 million at year-end. The allowance reduction reflected recoveries, improving historical loss factors and releases of specific reserves, partly offset by reserve needs associated with loan growth.
Outlook, commentary and risks
- No formal earnings guidance was provided. Management said it expects near-term net interest margin to be slightly below its long-term target of at least 3.50%, citing excess liquidity and the interest-rate environment. It expects to manage funding costs and pursue in-market deposit growth.
- Management expects specialized lending volume to continue increasing in 2021 and 2022, and described goals to expand commercial banking and private wealth businesses. It also expects positive operating leverage annually excluding non-recurring PPP effects, while investing in staff, technology and business development.
- Five COVID-related deferred loans totaling $24.1 million remained outstanding; $23.5 million related to three hospitality credits with principal deferrals that were current on interest. Management said it believed there would be no losses on those three credits. Separately, stressed-industry exposure was $189.8 million, or 9.2% of gross loans excluding net PPP loans, including retail, hospitality, entertainment and restaurants/food service.
- Management cautioned that COVID-19’s duration and portfolio effects remain uncertain. The filing also identifies risks from economic conditions, borrower defaults, interest-rate and market changes, competition, growth execution, regulation, cybersecurity and maintaining SBA guarantees.
- PPP loans outstanding were $65.9 million and are 100% SBA-guaranteed subject to compliance with program requirements. PPP fee income was $1.7 million for Q3 and $6.4 million for the nine months.
- Other notable items: $3.4 million of loan charge-offs and $4.9 million of recoveries for the nine months; unrealized securities losses of $3.0 million before tax in other comprehensive income; $4.3 million of stock repurchases since program adoption, with $0.7 million of authority remaining; and a quarterly dividend of $0.18 per share. Management reported no significant subsequent events, no material changes to previously disclosed risk factors, and no expected material loss from pending legal proceedings.
Important facts for investors to verify
- Whether improving credit metrics and the large provision benefit are sustainable, particularly given the lower allowance and ongoing commercial real estate concentration.
- Performance and repayment status of the three hospitality deferral credits, the remaining $24.1 million of deferred loans, and exposures to other stressed industries.
- Underlying earnings and margin trends excluding PPP income, loan fees in lieu of interest, swap fees and reserve releases; these items can be volatile.
- Loan growth, deposit mix and funding costs, including reliance on FHLB advances and wholesale funding and the effect of excess liquidity on margins.
- Execution of stated growth and operating-efficiency plans, rising compensation and technology expenses, and the effect of variable private wealth and SBA revenues.
- Capital, liquidity and dividend capacity, as well as future credit-reserve needs and the transition from LIBOR-linked instruments.