First Business Financial Services, Inc. — Q2 2018 Form 10-Q
Business and period: The Wisconsin bank holding company operates primarily through First Business Bank in Wisconsin and the greater Kansas City market. It focuses on commercial banking and related lending, equipment finance, trust, investment and treasury services. This unaudited report covers the quarter and six months ended June 30, 2018; balance-sheet comparisons are with December 31, 2017.
Financial performance
| Metric | Q2 2018 | Six months 2018 |
|---|---|---|
| Net income | $3.3 million, versus $1.9 million in Q2 2017 | $6.9 million, versus $5.3 million in 2017 |
| Diluted EPS | $0.38, versus $0.22 | $0.79, versus $0.61 |
| Net interest income | $16.9 million, up 9.4% year over year | $33.1 million, up 9.1% |
| Net interest margin | 3.77%, versus 3.64% | 3.71%, versus 3.58% |
| Top-line revenue | $20.9 million, up 3.4% | $41.8 million, up 6.7% |
| Provision for loan and lease losses | $2.6 million, versus $3.7 million | $5.1 million, versus $4.2 million |
| Non-interest expense | $14.5 million, up 1.7% | $28.4 million, up 2.1% |
Q2 annualized return on average assets was 0.70% and return on average equity was 7.59%, compared with 0.42% and 4.50%, respectively, a year earlier. For the six months, the measures were 0.74% and 8.22%, versus 0.59% and 6.38%. The reported efficiency ratio was 67.07% for Q2 and 67.27% for the first half; the six-month comparison was 68.03% in 2017.
Management attributed higher net interest income mainly to loan growth and improved yields as rates rose. Trust and investment fees rose 20.6% in Q2 and 18.5% for the first half. These gains were partly offset by lower SBA loan-sale gains, loan fees and other fee income. The lower first-half effective tax rate—16.9%, versus 26.2%—primarily reflected the reduction in the federal corporate tax rate; a state historic tax credit also reduced Q2 tax expense by $245,000.
Financial position, funding and credit
- Total assets were $1.900 billion, up 5.9% from year-end; net loans and leases were $1.574 billion, up 6.1%. Gross loans grew $93.4 million, with construction loans a major contributor.
- Deposits declined $56.6 million to $1.338 billion. FHLB advances and other borrowings rose $157.5 million to $365.4 million. Management said FHLB funding supported loan growth and accompanied a purposeful reduction in wholesale deposits.
- Cash and cash equivalents were $45.8 million, down from $52.5 million at year-end. First-half operating cash flow was $11.0 million; investing activities used $116.2 million, principally reflecting loan growth; financing activities provided $98.5 million, mainly from increased FHLB advances. Cash declined $6.7 million overall.
- Immediate on-balance-sheet liquidity was $271.5 million, compared with $401.1 million at year-end. Management said available liquidity exceeded the stated policy minimum and considered liquidity adequate.
- Stockholders’ equity was $173.7 million. The Bank remained “well capitalized”; its total capital ratio was 11.50%, common equity Tier 1 ratio 10.25%, and Tier 1 leverage ratio 10.15%. The company reported compliance with regulatory capital requirements.
- Non-accrual loans and leases increased to $31.1 million from $26.4 million; non-performing assets rose to $32.6 million from $27.5 million. Non-performing assets were 1.71% of total assets, versus 1.53% at year-end. The allowance was $20.9 million, or 1.31% of gross loans, versus $18.8 million, or 1.25%.
- Net charge-offs were $285,000 in Q2 and $2.9 million for the first half. Management cited losses on six impaired legacy SBA relationships as a principal driver of first-half provision expense. The allowance covered 67.32% of non-accrual loans, down from 71.10%.
Outlook, risks and unusual items
- No specific full-year earnings or revenue guidance was provided. Management expected loan and lease activity to replace normal amortization and support modest growth, and stated a goal of maintaining net interest margin at or above 3.50%. Its long-term efficiency-ratio goal was 58%–62%.
- Management expected deposit costs to continue rising amid rate increases and competition, and described growing in-market deposits as a strategic priority. It also cited potential variability in SBA loan-sale income and net interest margin.
- Credit risks include growth in non-accrual and non-performing assets, commercial real estate concentration (68.1% of loans), and possible additional charge-offs or provisions as workouts develop. The company noted that regulatory reviews could result in different loan classifications or required charge-offs.
- Other stated risks include economic deterioration, competition, interest-rate and market-price changes, ability to manage growth, regulatory or tax changes, fraud and cybersecurity, and SBA program compliance. Management reported no material change to the risks in its 2017 Form 10-K.
- The $196,000 first-half SBA recourse benefit contrasted with a $780,000 expense in the prior-year period; the reserve was $2.4 million at June 30. Q2 also included $329,000 of tax-credit investment impairment expense, partly offset by a $245,000 tax benefit. Securities had $1.9 million of first-half pretax unrealized losses in other comprehensive income; management reported no other-than-temporary impairment.
- Management reported no significant subsequent event requiring adjustment or disclosure. The Bank declared a $2.5 million dividend to the parent on July 25; year-to-date Bank dividend declarations were $7.5 million. Separately, shareholder dividends declared were $0.14 per share in Q2 and $0.28 per share for the first half.
Important facts for investors to verify
- Whether the increase in non-accrual loans and non-performing assets persists, and the adequacy of the allowance as the loan portfolio grows.
- How the company funds further loan growth, given lower deposits, higher FHLB borrowings and reduced on-balance-sheet liquidity.
- Whether rising deposit and borrowing costs continue to pressure net interest margin and earnings.
- Whether fee income, particularly SBA loan-sale gains, recovers as the SBA platform expands, and whether expense growth supports progress toward the efficiency-ratio goal.
- The effect of commercial real estate concentration, legacy SBA exposures and future credit-loss accounting implementation on asset quality, reserves and capital.