First Business Financial Services, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; balance-sheet comparisons are to December 31, 2012. The company is a Wisconsin bank holding company serving businesses and individuals through its Wisconsin bank subsidiaries and trust and investment services.
Financial performance and condition
- Q2 results: Net income was $3.13 million, versus $1.57 million a year earlier; diluted EPS was $0.80 versus $0.60. Top-line revenue, defined as net interest income plus non-interest income, increased 7.4% to $12.37 million.
- First-half results: Net income was $6.38 million versus $3.78 million; diluted EPS was $1.62 versus $1.44. Top-line revenue rose 10.1% to $24.55 million.
- Interest income and margins: Net interest income increased 6.1% in Q2 to $10.19 million and 10.2% for the first half to $20.42 million. Net interest margin was 3.46% in Q2, down from 3.49%; first-half margin was 3.50%, up from 3.32%. Lower funding costs and reduced subordinated borrowing costs helped, while lower loan yields offset some of the benefit.
- Other income and expenses: Non-interest income rose 14.2% in Q2 to $2.17 million, led by trust and investment fees. Non-interest expense rose 5.0% to $7.49 million, including higher compensation, data processing, marketing, and other expense; lower FDIC insurance expense partly offset the increases. First-half provision for loan and lease losses was $0.13 million, down from $2.55 million.
- Balance sheet at June 30: Total assets were $1.276 billion, up 4.1% from year-end. Net loans and leases were $932.7 million, up 4.0%; deposits were $1.143 billion, up $50.7 million; stockholders’ equity was $103.2 million.
- Funding and liquidity: Cash and cash equivalents were $106.6 million. Management-defined immediate on-balance-sheet liquidity was $306.6 million. Brokered certificates of deposit totaled $452.0 million, or 39.5% of deposits, compared with 34.3% at year-end. Borrowings included $11.9 million of FHLB and other borrowings and $10.3 million of junior subordinated notes. The company reported compliance with its senior credit-line covenants.
- Cash flow, first half: Operating activities provided $5.9 million, investing activities used $34.3 million, and financing activities provided $49.4 million. Cash and cash equivalents increased $21.0 million to $106.6 million.
- Asset quality: Nonperforming assets were $11.8 million, or 0.93% of assets, versus $15.7 million and 1.28% at year-end. Nonaccrual loans and leases declined to $11.2 million from $14.1 million. The allowance was $15.2 million, or 1.60% of gross loans, versus 1.69% at year-end; first-half net charge-offs were $0.33 million.
- Capital and comprehensive income: The company and banks reported meeting applicable capital requirements; both banks were categorized as well capitalized. First-half comprehensive income was $4.52 million, including a $3.01 million pretax unrealized securities loss recorded in other comprehensive income.
Material changes and unusual items
- Loan growth and stronger fee income supported higher revenue, while lower deposit and borrowing costs supported net interest income. Falling loan and securities yields remain a countervailing pressure.
- Asset-quality measures improved and the provision for credit losses was substantially lower than in 2012. Management attributed the allowance change partly to improved credit trends and a reduction in subjective reserve factors.
- In May, the company repurchased a participated portion of a loan for $1.5 million cash, versus $3.2 million aggregate principal, to control the workout. It is recorded as a nonperforming troubled debt restructuring; management reported sufficient collateral value at June 30.
- Higher “other” expense included an adjustment to the carrying value of an investment in a limited partnership after the fund reached preferred return thresholds. The filing does not provide a clear amount for this adjustment.
- Higher market interest rates reduced the fair value of available-for-sale securities. Management reported no securities sales or other-than-temporary impairment and said it did not expect to be required to sell securities in loss positions.
Outlook, risks, and contingencies
The filing provides no numerical earnings or revenue guidance. Management expects loan and lease originations to exceed normal amortization and to support further growth, while stating it will maintain underwriting standards. It intends to pursue more in-market deposits and reduce reliance on brokered deposits, but expects brokered funding and short-term FHLB advances may continue to support growth and manage funding needs. Management also expects trust fees to remain exposed to market volatility and credit-card fee income to become insignificant as the portfolio-sale transition is completed.
Key risks include borrower defaults and further credit deterioration, commercial real estate concentration, competition and pressure on loan yields, interest-rate-driven securities valuation changes, and dependence on brokered deposits. The company noted that regulators may require different loan classifications or charge-offs than management’s estimates. It reported no material change to previously disclosed risk factors, no significant change in contractual obligations, and no legal proceedings expected to have a material adverse effect. Disclosure controls were assessed as effective at quarter-end.
Important facts for investors to verify
- Whether improving nonaccrual and nonperforming asset trends continue, and whether the allowance remains adequate as loans grow.
- How loan yields, deposit costs, and net interest margin respond to competition and changes in interest rates.
- Whether brokered deposits continue to rise and how the company progresses toward its stated goal of reducing dependence on them.
- The scale and recurrence of the limited-partnership valuation expense and other higher operating costs.
- The effect of further rate changes on securities values, accumulated other comprehensive income, and liquidity.
- Developments in the repurchased troubled debt restructuring and other credit workouts.