First Business Financial Services, Inc. — Q1 2022 Form 10-Q
Business context and period: The Wisconsin-based bank holding company provides commercial banking, specialized lending, private wealth management and bank consulting, primarily in Wisconsin and the greater Kansas City area. This unaudited report covers the three months ended March 31, 2022; balance-sheet comparisons are against December 31, 2021.
Financial results and position
- Earnings: Net income was $8.7 million, down 10.9% from $9.7 million a year earlier; diluted EPS was $1.02 versus $1.12. Annualized ROA was 1.30% (1.51% in Q1 2021) and ROE was 14.47% (18.48%).
- Revenue and costs: Net interest income rose 2.7% to $21.4 million; non-interest income rose 2.7% to $7.4 million. Total top-line revenue was $28.8 million, up 2.7%. Non-interest expense increased 8.6% to $18.8 million, including compensation expense up 7.8% and professional fees up 35.1%. Income before tax was $10.8 million versus $12.8 million.
- Credit provision and margin: The loan-loss provision was a benefit of $855,000, compared with a $2.1 million benefit in Q1 2021. Net interest margin was 3.39%, down from 3.44%; management’s adjusted NIM was 3.24%, versus 3.20% (3.28% excluding accelerated debt-cost amortization). The efficiency ratio increased to 65.55% from 62.19%.
- Cash flows: Operating activities provided $2.1 million, versus $6.8 million. Investing activities used $40.1 million, versus $79.5 million; financing activities provided $76.5 million, versus $74.6 million. Cash and cash equivalents increased $38.5 million to $95.6 million.
- Balance sheet and funding: Assets were $2.724 billion, up $71.2 million from year-end. Gross loans and leases were $2.253 billion; deposits were $2.024 billion, up $65.8 million. Total liabilities were $2.479 billion and stockholders’ equity was $245.1 million. FHLB advances and other borrowings totaled $414.5 million; junior subordinated notes were redeemed in the quarter.
- Liquidity and capital: Management reported immediate on-balance-sheet liquidity of $638.9 million and wholesale funds of $373.7 million, or 15.7% of total bank funding. The Bank remained “well capitalized”; its CET1 ratio was 10.14% and leverage ratio 9.95%. Consolidated CET1 was 8.81%.
- Credit quality: Non-performing assets were $5.7 million, or 0.21% of assets, down from $6.5 million and 0.25% at year-end. Non-accrual loans were 0.25% of gross loans; 99.9% of the portfolio was current. The allowance was $23.7 million, or 1.05% of gross loans, versus $24.3 million and 1.09% at year-end.
- Comprehensive income: Other comprehensive loss was $6.4 million, largely reflecting $12.5 million of pre-tax unrealized available-for-sale securities losses, partly offset by swap gains and tax effects. Accumulated other comprehensive loss increased to $7.9 million from $1.5 million at year-end.
Changes versus the prior comparable period
- Reported earnings and returns declined, while revenue grew modestly; higher operating costs and a smaller provision benefit weighed on results.
- PPP-related interest and fee income fell materially: PPP fee income was $249,000 versus $2.2 million, and average PPP loans, net of deferred fees, were $20.9 million versus $242.2 million.
- Management’s adjusted pre-tax, pre-provision earnings were $9.9 million, down 6.4%. Excluding PPP effects, the measure was $9.6 million, up 23.5%; these are non-GAAP measures.
- Average loans and leases increased 2.8% year over year; excluding net PPP loans, average balances rose 14.6%. Private wealth fees increased 18.0%, while SBA loan-sale gains and swap fees declined.
Outlook, commentary, risks and unusual items
- Management said the balance sheet was asset-sensitive and positioned to benefit from rising short-term rates. It targets a long-term average NIM of at least 3.50%; this is a management objective, not formal quarterly earnings guidance.
- Management expects a 2022 effective tax rate of 23%–24%, excluding discrete items, and expects to continue investing in staff and growth initiatives. It cited specialized lending, in-market deposit growth and private wealth expansion as priorities.
- The company issued $20.0 million of 3.50% subordinated debt and $12.5 million liquidation preference of 7.0% fixed-to-floating Series A preferred stock. It used proceeds in part to redeem approximately $10.1 million of junior subordinated notes and planned to redeem a further $9.1 million of subordinated notes in Q2 2022. The preferred stock becomes floating-rate after March 15, 2027.
- A $5 million common-stock repurchase authorization runs through March 4, 2023; 4,502 shares were repurchased under the program in March for approximately $148,000. Additional first-quarter repurchases included shares surrendered for tax withholding.
- Key risks include rate and market-value movements, inflation and economic conditions, credit deterioration, CRE concentration (65.8% of loans excluding net PPP loans), competition, growth execution, cybersecurity/fraud, regulatory changes and compliance with SBA requirements. Management said it did not expect pending ordinary-course legal proceedings to have a material adverse effect.
- Management attributed securities losses primarily to the interest-rate environment and said it did not intend to sell the affected securities and did not expect to be required to do so. It recorded no other-than-temporary impairment. The allowance remains subject to estimation uncertainty and potential charge-offs or regulatory review.
- The company expects to adopt CECL on January 1, 2023; implementation work was ongoing. Management reported no material changes to previously disclosed risk factors and no material changes in contractual obligations or off-balance-sheet arrangements.
Investor verification priorities
- Check whether loan growth, deposit growth and the stated asset-sensitive positioning translated into subsequent NIM and earnings performance.
- Track the size and composition of CRE exposure, criticized loans, non-accruals, charge-offs and the allowance as CECL adoption approaches.
- Assess the duration and potential capital impact of securities unrealized losses, and verify liquidity and funding mix as rates and deposit conditions change.
- Confirm completion and costs of the planned $9.1 million debt redemption, and monitor preferred dividends, subordinated debt terms and capital ratios.
- Reconcile reported earnings with management’s non-GAAP adjusted measures, including the effects of PPP runoff and one-time accelerated debt-cost amortization.
- Review subsequent filings for repurchase activity, CECL implementation impacts, and any material legal, SBA recourse or other contingency developments.