First Business Financial Services, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited consolidated results. The company operates commercial banking and related financial services through banks in Wisconsin and Kansas, serving businesses, business owners, professionals and high-net-worth individuals.
Financial performance and position
- Profit and revenue: Net income was $4.55 million, up 8.5% from $4.19 million in Q1 2015. Diluted EPS rose to $0.52 from $0.48. Net interest income increased 4.1% to $15.54 million; non-interest income increased 19.4% to $4.59 million. Total top-line revenue was $20.13 million, up 7.2%.
- Margins and returns: Net interest margin declined 20 basis points year over year to 3.59%, mainly reflecting lower purchase-accounting accretion; excluding that effect, margin improved four basis points to 3.51%. Return on average assets was 1.00%, unchanged; return on average equity was 11.68%, versus 11.98%. The efficiency ratio was 62.44%, essentially unchanged from 62.47%.
- Expenses and credit costs: Non-interest expense increased 8.2% to $12.70 million, primarily due to compensation. Provision for loan and lease losses declined to $525,000 from $684,000. Net charge-offs were $157,000, or 0.04% of annualized average gross loans and leases, compared with $319,000, or 0.10%, a year earlier.
- Assets and lending: Total assets were $1.790 billion, up 0.5% from year-end 2015. Gross loans and leases were $1.451 billion, up from $1.435 billion; net loans and leases, including loans held for sale, were approximately $1.434 billion. Commercial real estate represented about 64% of loans. Construction and land development loans grew 12.1% in the quarter.
- Credit quality: Non-accrual loans and leases fell to $17.9 million from $22.3 million at year-end; non-performing assets were $19.5 million, or 1.09% of assets, versus $24.0 million, or 1.35%. The allowance was $16.7 million, or 1.15% of gross loans and leases. Substandard loans and leases increased to $33.9 million from $26.8 million.
- Deposits, debt and liquidity: Deposits were $1.582 billion, up $4.4 million from year-end. Wholesale deposits were $476.0 million, or 30.1% of deposits. The filing reports $45.0 million of total borrowings across its borrowing categories, including $10.0 million of junior subordinated notes; it states the company was in compliance with senior-line covenants. Immediate on-balance-sheet liquidity was $321.0 million, down from $331.5 million.
- Cash flow: Operating activities provided $9.8 million; investing activities used $22.2 million, mainly reflecting net loan growth; financing activities provided $3.7 million. Cash and cash equivalents declined $8.7 million to $104.9 million.
- Capital and shareholder returns: The company and its banking subsidiaries were characterized as well capitalized. Consolidated common equity Tier 1, Tier 1 risk-based and total capital ratios were 8.37%, 8.96% and 11.24%, respectively. The quarterly dividend declared was $0.12 per share, versus $0.11 a year earlier.
Material changes and management commentary
- Revenue growth reflected loan growth and stronger SBA production. SBA loan-sale gains increased to $1.38 million from $505,000; trust and investment fees also rose.
- Average loan yields and overall earning-asset yields were lower year over year, partly because Alterra purchase-accounting accretion diminished. Higher wholesale-deposit costs also weighed on margin.
- Compensation expense rose 13.8%; full-time-equivalent employees increased to 255 from 212. Management expected continued investment in business-development and operational staff during 2016.
- Management expected loan activity to exceed normal amortization and support further growth, while stating it would maintain underwriting standards. It anticipated managing funding to support a stable net interest margin, but provided no numerical earnings or margin guidance.
- Direct energy-sector exposure declined to $7.6 million, or 0.53% of gross loans and leases; $5.8 million remained non-performing. Management considered the portfolio adequately collateralized, with reserves equal to 8.25% of its carrying value.
Risks, contingencies and unusual items
- Key disclosed risks include credit deterioration, economic weakness, competition, interest-rate and market-price changes, growth execution, regulatory or tax changes, and system or network-security failures. The company noted that CRE concentration and periodic credit volatility warrant monitoring.
- Management said it could not rule out further charge-offs or increased provision if credit facts change. It also noted that regulators may require different loan classifications or charge-offs.
- Unrealized securities losses were attributed primarily to interest-rate conditions; management expected recovery of amortized cost and recorded no other-than-temporary impairment. The filing reports no material change in market-risk sensitivity since year-end.
- Management believed ordinary-course legal proceedings would not materially affect financial position, results or cash flows. No significant subsequent events requiring adjustment or disclosure were reported through issuance.
- New accounting standards adopted in Q1 had no material impact. Adoption of debt-issuance-cost guidance reclassified approximately $0.8 million as a deduction from debt.
Important facts for investors to verify
- Whether loan growth, particularly CRE and construction lending, remains consistent with underwriting discipline and adequate risk-adjusted returns.
- Trends in substandard loans, non-accrual balances, troubled debt restructurings, energy-sector credits and allowance adequacy.
- Whether deposit mix and wholesale-funding costs pressure net interest margin as purchase-accounting accretion continues to decline.
- Whether increased staffing and other operating costs are matched by sustained revenue growth and operating leverage.
- Liquidity and capital headroom, including wholesale-deposit maturity coverage, borrowing capacity, regulatory requirements and dividend capacity.