First Business Financial Services, Inc. — Q1 2019 Form 10-Q
Business context and reporting period
First Business Financial Services is a Wisconsin-based bank holding company operating through First Business Bank, primarily serving businesses, business owners, professionals, and high-net-worth individuals in Wisconsin and the greater Kansas City market. This unaudited filing covers the three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018. Amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Q1 2019 | Comparable / prior period |
|---|---|---|
| Net interest income | $17.8 | $16.2 in Q1 2018; up 9.6% |
| Non-interest income | $4.6 | $4.7 in Q1 2018; down 0.6% |
| Top-line revenue | $22.4 | $20.9 in Q1 2018; up 7.3% |
| Provision for loan and lease losses | $0.05 | $2.5 in Q1 2018 |
| Non-interest expense | $17.7 | $13.9 in Q1 2018; up 27.6% |
| Income before tax | $4.6 | $4.5 in Q1 2018 |
| Income tax benefit / expense | $(1.3) benefit | $0.8 expense in Q1 2018 |
| Net income; diluted EPS | $5.9; $0.67 | $3.6; $0.42 in Q1 2018 |
| Net interest margin | 3.79% | 3.65% in Q1 2018 |
| Efficiency ratio | 68.04% | 67.45% in Q1 2018 |
Annualized return on average assets was 1.20% versus 0.78%; return on average equity was 13.67% versus 8.88%. The reported efficiency ratio is a non-GAAP measure. Management attributes higher earnings primarily to stronger net interest income and lower loan-loss provision, together with a tax-credit-related benefit, partly offset by higher operating costs.
- Balance sheet: Total assets were $2.006 billion, up $39.2 million from year-end. Net loans and leases were $1.636 billion, up $39.0 million; gross loans and leases were $1.658 billion. Securities totaled $192.7 million.
- Funding and debt: Deposits increased $46.4 million to $1.502 billion. FHLB advances and other borrowings declined $29.0 million to $270.0 million; junior subordinated notes were $10.0 million. The average rate on interest-bearing deposits rose to 1.93% from 0.95% in Q1 2018.
- Capital and liquidity: Stockholders’ equity was $185.1 million. The Bank remained well capitalized; its total capital ratio was 11.83%, common equity Tier 1 ratio 10.58%, and leverage ratio 10.28%. Immediate on-balance-sheet liquidity was $393.4 million. Management reported liquidity above policy minimums.
- Cash flows: Operating activities provided $10.7 million; investing used $55.5 million, primarily reflecting loan growth and securities purchases; financing provided $14.6 million, including deposit growth partly offset by lower FHLB advances. Cash and cash equivalents declined $30.2 million to $56.3 million.
- Credit quality: Non-accrual loans and leases were $23.5 million, or 1.42% of gross loans, down from $25.3 million and 1.56% at year-end. Non-performing assets were $26.1 million, or 1.30% of assets. The allowance was $20.4 million, 1.23% of gross loans, versus 1.26% at year-end. Q1 net charge-offs were $25,000, compared with $2.6 million in Q1 2018.
Material changes versus the prior comparable period
- Net interest income rose $1.6 million, driven by loan growth, higher asset yields, and $2.2 million of fees collected in lieu of interest, versus $1.0 million in Q1 2018. Deposit and borrowing costs also increased materially, limiting the benefit.
- Non-interest expense increased $3.8 million. Compensation rose $1.1 million, reflecting merit increases and additional producers; staffing grew to 278 from 256. A $2.0 million tax-credit investment impairment and a $0.5 million SBA recourse provision also contributed.
- The provision for loan losses fell to $49,000 from $2.5 million, as lower historical loss rates and reduced net charge-offs more than offset a provision associated with loan growth.
- The income tax benefit reflected recognition of approximately $2.8 million of historic tax credits alongside the impairment of the related investment. The filing reports an increase in unrealized gains on available-for-sale securities amid declining rates.
- Adoption of lease accounting in Q1 added an $8.2 million right-of-use asset and $8.5 million lease liability at quarter-end, following an $8.8 million liability and $8.5 million asset at adoption; retained earnings increased $0.7 million from the cumulative-effect adjustment.
Outlook, commentary, risks, and contingencies
- No specific full-year earnings forecast is provided. Management expects to maintain net interest margin at 3.50% or better, while noting quarterly volatility from loan fees, non-accrual collections, and deposit inflows. It targets a long-term efficiency ratio of 58%–62% and expects to continue investing in production and support staff.
- Management expects a 2019 effective tax rate of 20%–22%, excluding discrete items, and intends to pursue additional in-market historic tax-credit opportunities. Tax credits and related investment impairments can make reported quarterly earnings uneven.
- Management expects loan activity to replace normal amortization and support future growth, while stating it will not relax underwriting standards to pursue volume. Commercial real estate represented 68.0% of gross loans, creating concentration exposure. Loan growth and asset-based lending fees, including fees collected in lieu of interest, may be variable.
- Funding costs, competition for deposits, interest-rate movements, and reliance on wholesale funding remain relevant risks. The company’s stated operating ranges are 25%–40% wholesale funds to total bank funding and 60%–75% in-market deposits to total bank funding.
- The SBA recourse reserve was $3.3 million; the company recorded a $481,000 provision in Q1. Future reserve changes may cause expense volatility. Management also identifies credit deterioration, economic conditions, regulatory and tax changes, fraud or cybersecurity events, and the ability to manage growth as risks.
- Management does not expect ordinary-course legal proceedings to have a material adverse effect. It reported no material changes to previously disclosed risk factors, no significant subsequent events requiring adjustment, and effective disclosure controls. The company plans to adopt the expected-credit-loss standard in Q1 2020 and is evaluating its impact.
Important facts for investors to verify
- Whether the $2.8 million historic tax credit and related $2.0 million investment impairment are discrete items and how their timing affects future earnings and tax rates.
- Whether loan-fee income, especially fees collected in lieu of interest, is sustainable; reported Q1 margin benefited from an unusually higher level of these fees.
- Trends in deposit pricing and the ability to fund loan growth while maintaining the targeted mix of in-market deposits and wholesale funding.
- Developments in commercial real estate and commercial-and-industrial credit quality, including non-accrual balances, troubled restructurings, allowance adequacy, and the SBA recourse reserve.
- Progress toward management’s long-term efficiency-ratio target as compensation and other growth investments continue.