First Business Financial Services, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; comparisons are primarily with fiscal 2018. This is an annual filing, not a standalone fourth-quarter report. The company is a Wisconsin-based commercial bank holding company focused on business banking, specialty finance, private wealth, and bank consulting, principally serving Wisconsin and the Kansas City area.
Financial performance and condition
| Metric | 2019 | 2018 / change |
|---|---|---|
| Total assets at year-end | $2.097 billion | $1.966 billion; up 6.6% |
| Gross loans and leases at year-end | $1.715 billion | $1.619 billion; up 6.0% |
| Deposits at year-end | $1.530 billion | $1.455 billion; up $75.1 million |
| Net income | $23.3 million | $16.3 million; up 43.1% |
| Diluted earnings per share | $2.68 | $1.86 |
| Net interest income | $69.9 million | $67.3 million; up 3.7% |
| Net interest margin | 3.61% | 3.72%; down 11 basis points |
| Non-interest income | $23.4 million | $18.2 million; up 28.9% |
| Provision for loan and lease losses | $2.1 million | $5.5 million |
| Non-interest expense | $66.7 million | $62.4 million; up 6.9% |
| Return on average assets / equity | 1.14% / 12.55% | 0.86% / 9.41% |
| Stockholders’ equity at year-end | $194.2 million | $180.7 million |
Revenue, defined as net interest income plus non-interest income, rose 9.1% to $93.3 million. Higher average loan balances, loan yields and fees supported net interest income, while higher deposit costs and other funding costs compressed margin. Fee growth included commercial swap fees of $4.2 million, up $2.5 million, and private wealth fees of $8.2 million, up 5.8%. The efficiency ratio improved to 66.59% from 67.77%.
Cash flow: Operating activities provided $29.0 million; investing activities used $131.5 million, primarily reflecting loan growth and securities purchases; financing activities provided $83.1 million, including deposit growth and increased FHLB advances. Cash and cash equivalents ended the year at $67.1 million, down from $86.5 million.
Credit quality: Non-performing loans and leases were $20.6 million, or 1.20% of gross loans, versus $25.3 million, or 1.56%, in 2018. Non-performing assets were $23.5 million, or 1.12% of assets, versus $27.8 million, or 1.42%. The allowance was $19.5 million, equal to 1.14% of gross loans and 94.70% of non-accrual loans. Commercial real estate represented 67.3% of gross loans.
Funding, liquidity and capital: In-market deposits increased 16.9% to $1.379 billion, while wholesale deposits declined. Total borrowings were $329.4 million at year-end, including $295.0 million of FHLB advances and $23.7 million of subordinated notes. Management reported immediate on-balance-sheet liquidity of $438.2 million. The Bank was well-capitalized; its common equity Tier 1 ratio was 10.74%, and its total capital ratio was 11.79%. The company reported equity equal to 9.3% of total assets.
Material changes and unusual items
- Net income increased substantially, aided by higher revenue and a lower credit-loss provision; net charge-offs fell to 0.18% of average loans from 0.24%.
- Non-interest income growth reflected unusually strong swap fee revenue, including $2.1 million from three large commercial real estate transactions, and higher returns on mezzanine fund investments and equipment finance buyout gains.
- Compensation expense rose 12.2% to $42.0 million, reflecting hiring, pay increases, benefit costs and incentives. Full-time equivalent employees increased 5.1% to 288.
- Income tax expense was $1.2 million and the effective tax rate was 4.8%, with federal historic tax credits of $5.2 million reducing tax expense. Tax-credit investment impairment expense was $4.1 million; management said the impairments were more than offset by a reduction in income tax expense.
- The company issued $15 million of 5.50% subordinated notes in August 2019 and used the proceeds to redeem $15 million of 6.50% notes. The refinancing generated one-time interest expense effects.
- Adoption of lease accounting brought $8.8 million of lease liabilities and an $8.5 million right-of-use asset onto the balance sheet, with a $687,000 retained-earnings adjustment. A $299,000 right-of-use asset impairment related to vacated, subleased office space.
- Dividends declared were $0.60 per share, versus $0.56 in 2018. The company repurchased $7.2 million of shares during 2019 and had a separate $5 million repurchase authorization through September 2020.
Outlook, risks and contingencies
Management described a five-year strategy centered on talent, operating efficiency and technology, deposit growth, and optimizing business-line performance. It expects to continue investing in people and technology, attract additional in-market deposits, and pursue loan growth. Management stated it believes it can maintain net interest margin of 3.50% or better and expects modest positive operating leverage; these are expectations, not formal earnings guidance. Management also expected SBA loan-sale gains to increase at a measured pace, while acknowledging fee income can vary.
- Credit exposure is concentrated in commercial real estate, with sensitivity to property values, borrower cash flows and regional economic conditions. Commercial and industrial borrowers may also be leveraged or reliant on business-asset collateral.
- Legacy SBA loans have contributed to prior credit losses. The company’s SBA Preferred Lender status, secondary-market sales, and compliance with SBA requirements are important to this business. The SBA recourse reserve was $1.3 million at year-end.
- Interest-rate changes can affect loan yields, deposit and borrowing costs, borrower repayment capacity, and securities values. The company also disclosed exposure to the transition away from LIBOR, then expected after 2021.
- Funding depends on deposits and wholesale sources, including FHLB advances. Although wholesale funding declined as in-market deposits grew, funding costs and deposit competition remain risks.
- CECL adoption was deferred to January 2023 for the company; the expected-loss model may increase the allowance and requires significant implementation work.
- Other identified risks include economic weakness in the company’s markets, competition, cybersecurity and third-party service disruptions, regulatory and compliance costs, and potential volatility in private wealth fees from market movements.
- Outstanding commitments included $555.4 million to extend credit and $8.9 million in standby letters of credit. Management said it did not expect losses from these commitments. The filing reports no pending litigation expected to materially affect the company.
The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management and the auditor concluded internal controls were effective as of December 31, 2019.
Important facts for investors to verify
- Whether the improvement in earnings persists after unusually strong swap fees, historic tax credits, and other variable or non-recurring items.
- Current CRE concentration, collateral values, non-performing exposures and reserve adequacy, particularly in commercial and industrial and legacy SBA portfolios.
- Deposit retention, funding mix and costs, FHLB borrowing levels, and the company’s ability to sustain its stated margin objective.
- Capital and liquidity capacity after dividends and repurchases, and any regulatory or other limits on distributions from the Bank to the holding company.
- CECL implementation assumptions and expected effect, as well as progress in replacing LIBOR in contracts and related systems.
- Quarterly results and disclosures for subsequent developments; the filing’s annual figures do not by themselves establish a forward earnings trend.