First Business Financial Services, Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. This is an annual filing, not a standalone fourth-quarter report; quarterly figures below are included where reported. The company is a Wisconsin bank holding company serving small and midsize businesses and related clients through banks in Wisconsin and the Kansas City area, plus specialized lending, SBA, equipment finance, trust, and treasury-management businesses.
Financial results and condition
| Metric | 2015 | 2014 |
|---|---|---|
| Total assets at year-end | $1.783 billion | $1.629 billion |
| Gross loans and leases at year-end | $1.435 billion | $1.282 billion |
| Deposits at year-end | $1.577 billion | $1.438 billion |
| Net interest income | $58.6 million | $46.1 million |
| Non-interest income | $17.0 million | $10.1 million |
| Net income | $16.5 million | $14.1 million |
| Diluted earnings per share | $1.90 | $1.75 |
| Net interest margin | 3.66% | 3.56% |
| Return on average assets / equity | 0.97% / 11.36% | 1.04% / 11.78% |
| Efficiency ratio (company-defined, non-GAAP) | 62.75% | 60.06% |
Net interest income after a $3.4 million loan-loss provision was $55.3 million. Non-interest expense was $47.4 million, up 40.3%; income tax expense was $8.4 million and the effective tax rate was 33.7%. Fourth-quarter 2015 net income was $4.1 million, or $0.47 per diluted share; quarterly provision was $1.9 million.
Operating cash flow was $23.2 million; investing activities used $149.6 million, principally reflecting loan growth; financing activities provided $136.7 million, mainly from deposit growth. Cash and cash equivalents ended the year at $113.6 million. Total stockholders’ equity was $150.8 million, or 8.5% of assets. Year-end deposits were $1.577 billion; borrowings were $35.2 million and junior subordinated notes were $10.3 million. The company reported regulatory capital ratios above applicable minimums and the banks were considered well-capitalized.
Immediate on-balance-sheet liquidity was $331.5 million. Wholesale deposits were $487.5 million, or 30.9% of deposits, within the company’s stated 30%–40% operating range. The annual dividend declared was $0.44 per share. The 2015 figures reflect a two-for-one stock split completed in August.
Changes from the prior period
- Net income reached a record and rose 16.8%; total assets increased 9.4% and net loans and leases increased 11.9%.
- Top-line revenue, defined by the company as net interest income plus non-interest income, rose 34.5%. A full year of Alterra results was the primary factor; Alterra had been acquired on November 1, 2014, so 2014 included only two months.
- Non-interest income grew 68.4%, including $4.0 million of SBA loan-sale gains versus $0.3 million in 2014. Trust and investment fees rose 11.7% to $5.0 million.
- Non-interest expense rose 40.3%, driven chiefly by the full-year Alterra contribution, increased staffing, professional fees, and investment in technology and marketing. The efficiency ratio increased to 62.75%.
- Asset quality weakened: non-performing loans rose to $22.3 million from $9.8 million, and non-performing assets reached $24.0 million, or 1.34% of assets, versus $11.5 million, or 0.70%. Net charge-offs were 0.10% of average loans, compared with 0.08%.
- The allowance was $16.3 million, or 1.14% of gross loans; coverage of non-accrual loans fell to 73.17% from 146.33%. Management refined its reserve methodology during the year; it said the change had no significant effect.
Outlook, commentary, and risks
Management provided no quantified earnings or growth guidance. Its 2016 priorities include organic loan growth, maintaining underwriting standards and historically low charge-offs, building transaction-account deposits and fee income, expanding the SBA platform, and investing in staff and technology. It will also consider acquisitions opportunistically. Management noted that strategic spending weighed on near-term operating leverage.
- Credit concentration merits attention: commercial real estate was $905.5 million, 63.1% of gross loans; construction and land-development loans were 11.2%. Non-performing assets increased substantially, including energy-sector exposure.
- Direct energy exposure was $10.0 million, or 0.70% of gross loans; $7.8 million was non-performing at year-end. The filing says $1.8 million of non-performing energy exposure was paid off in January 2016. Continued weakness in oil and gas prices could affect the remaining credits.
- Interest-rate and funding risks include potential margin pressure, competition for deposits, and reliance on wholesale deposits. Management’s rate-sensitivity simulation estimated net interest income would rise 2.30% with a 100-basis-point increase and fall 2.82% with a 50-basis-point decrease, subject to stated modeling assumptions.
- Other material risks include regional economic concentration, borrower and collateral deterioration, SBA program or secondary-market changes, regulatory and capital requirements, cyber and third-party technology risks, and the ability to manage growth and acquisition integration.
- The company recorded $719,000 of pre-tax unrealized securities losses in other comprehensive income, attributed primarily to higher longer-term rates; it reported no securities as other-than-temporarily impaired. Goodwill was $10.7 million, with no impairment recorded.
- Off-balance-sheet commitments included $512.6 million to extend credit and $18.6 million in standby letters of credit. Management did not expect losses from these commitments. The filing reports no litigation expected to materially affect the company.
KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management and the auditor concluded controls were effective at year-end. The filing also notes that Edward Sloane was appointed CFO in January 2016, with James Ropella continuing as principal financial officer on an interim basis during the transition.
Investor verification priorities
- Review the drivers, status, collateral, and subsequent collections for the increased non-accrual loans, particularly the energy-related relationship and the January 2016 payoff.
- Assess reserve adequacy and coverage in light of rising non-performing loans, the change in reserve methodology, and the CRE and construction concentration.
- Separate organic growth from the full-year contribution of Alterra when evaluating revenue, earnings, and expense trends.
- Monitor the sustainability of SBA loan-sale gains, servicing income, and purchase-accounting accretion, which management expects to trend lower and may be volatile.
- Track deposit mix, wholesale-funding reliance, liquidity coverage, debt costs, regulatory capital buffers, and the capacity to maintain dividends while funding growth.