First Business Financial Services, Inc. — Q1 2017 Form 10-Q
Business context and period. The company is a Wisconsin-based bank holding company serving small and midsize businesses, business owners, professionals, and high-net-worth clients through banks in Wisconsin and Kansas. This unaudited filing covers the three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. Amounts are in U.S. dollars.
Financial performance and position
- Revenue and earnings: Net interest income was $14.9 million, down 4.2%; non-interest income was $4.1 million, down 11.6%. Combined top-line revenue was $19.0 million, down 5.9%. Net income was $3.4 million versus $4.6 million, and diluted EPS was $0.39 versus $0.52.
- Margins and returns: Net interest margin declined 8 basis points to 3.51%. Annualized return on average assets was 0.77% versus 1.00%, and return on average equity was 8.31% versus 11.70%. The efficiency ratio rose to 70.85% from 62.44%.
- Income drivers: SBA loan sale gains fell to $360,000 from $1.4 million as production was deliberately slowed. Trust and investment services fees increased 28% to $1.6 million, a record. Non-interest expense rose 6.8% to $13.6 million, including higher compensation, professional fees, software, and other costs.
- Credit costs and asset quality: Provision for loan and lease losses was $572,000 versus $525,000. Net recoveries were $182,000, compared with net charge-offs of $157,000 in Q1 2016. Non-accrual loans increased to $37.5 million from $25.2 million at year-end; non-performing assets rose to $39.0 million, or 2.17% of assets, from $26.7 million, or 1.50%. The allowance was $21.7 million, 1.46% of gross loans.
- Balance sheet: Total assets were $1.801 billion at March 31, up 1.1% from year-end. Net loans and leases were $1.459 billion, up 2.1%; gross loans and leases grew $30.3 million during the quarter. Commercial real estate represented approximately 65% of loans.
- Funding and liquidity: Deposits declined $46.1 million, or 3.0%, to $1.493 billion. FHLB advances and other borrowings increased to $121.8 million from $59.7 million; management attributed funding changes partly to replacing maturing wholesale deposits with FHLB advances. Cash and cash equivalents were $60.9 million, down from $77.5 million. Reported immediate on-balance-sheet liquidity was $476.3 million.
- Cash flow: Operating activities provided $4.9 million, investing activities used $36.4 million, and financing activities provided $14.9 million. Net cash decreased $16.6 million in the quarter.
- Capital and shareholder returns: The company reported that it and its banks remained “well capitalized.” Consolidated ratios included 11.55% total capital to risk-weighted assets and 9.16% Tier 1 capital. The quarterly dividend declared was $0.13 per share, up from $0.12.
Material changes and management outlook
- Profitability weakened year over year as lower loan yields and reduced SBA sale gains outweighed higher trust fees and lower interest expense. Management cited competitive loan pricing, a shift toward lower-yielding conventional commercial lending, and higher average non-accrual loans as headwinds.
- Management expects modest loan growth and aims to maintain net interest margin at 3.50% or better. Its long-term efficiency-ratio goal is 58%–62%; it said charter consolidation and a core system conversion are expected to support capacity and efficiency, with potential to contribute to earnings growth in 2018 and beyond. These are management expectations, not formal earnings guidance.
- The company slowed SBA production while investing in personnel, infrastructure, and processes, and expects to resume high-quality production as that work progresses. It will discontinue secondary-market residential mortgage originations effective May 1, 2017, citing limited scale, inefficiency, compliance risk, and minimal revenue contribution.
- Consolidation of the three bank charters into one was approved by the boards and regulators and was expected to take effect in Q2 2017. Management also cited a core system conversion; the filing does not provide a specific completion date.
- Credit deterioration was concentrated in three borrower relationships, including a $6.7 million commercial and industrial loan and two SBA-related relationships. Management said the affected impaired loans did not require additional specific reserves or charge-offs at quarter-end because of collateral positions, but noted that further charge-offs or provisions may be needed if circumstances change.
- The SBA recourse reserve was $1.665 million at quarter-end; the quarter included a $6,000 provision. Management did not expect ordinary-course legal proceedings to have a material adverse effect. No material changes to previously disclosed risk factors or contractual obligations were reported.
Important facts for investors to verify
- Whether the elevated non-accrual and non-performing asset levels stabilize, and how the three identified borrower relationships perform.
- Whether the allowance remains adequate as impaired loans increase; the allowance-to-non-accrual-loan ratio fell to 57.75% from 83.00% at year-end.
- Whether net interest margin holds at or above management’s 3.50% target amid competitive loan pricing, rate changes, and funding-mix shifts.
- Whether SBA platform investments translate into renewed production and gains, and whether the charter consolidation and core system conversion proceed as planned and within expected costs.
- How the deposit decline, wholesale funding reliance, and higher FHLB borrowing affect funding costs and liquidity; confirm reported liquidity and capital figures against subsequent filings.