First Business Financial Services, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; financial statements are unaudited. The Wisconsin bank holding company operates commercial banks and related services, primarily serving businesses and professionals in Wisconsin.
Financial performance and condition
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $9.1 million | $8.2 million | $26.6 million | $23.7 million |
| Non-interest income | $1.7 million | $1.7 million | $5.1 million | $5.0 million |
| Net income | $2.2 million | $969,000 | $6.0 million | $343,000 |
| Diluted EPS | $0.83 | $0.38 | $2.32 | $0.14 |
| Net interest margin | 3.40% | 3.12% | 3.31% | 3.03% |
| Provision for loan and lease losses | $435,000 | $2.0 million | $3.3 million | $4.4 million |
| Non-interest expense | $6.8 million | $6.4 million | $20.1 million | $22.1 million |
- Top-line revenue, defined by the company as net interest income plus non-interest income, rose 10.5% year over year to $31.7 million for the first nine months. Management attributed higher net interest income mainly to lower deposit funding costs.
- Net income in the first nine months of 2010 included a $2.7 million goodwill impairment charge. Excluding it, 2010 net income was $3.0 million and diluted EPS was $1.20; management reported 2011 year-to-date net income was $3.0 million higher on that adjusted comparison.
- Q3 annualized return on average assets and equity was 0.78% and 14.02%, respectively; nine-month figures were 0.72% and 13.67%. Management’s comparable 2010 figures excluding goodwill impairment were 0.37% and 7.22%.
- Cash and cash equivalents were $80.5 million at September 30, up from $50.8 million at year-end. Nine-month operating cash flow was $12.8 million; investing activities used $5.4 million and financing activities provided $22.2 million.
- Total assets were $1.136 billion, up from $1.107 billion at year-end. Net loans and leases were $846.7 million, down from $860.9 million; deposits were $1.013 billion, up from $988.3 million. Stockholders’ equity was $61.8 million.
- Borrowings included $39.5 million of FHLB and other borrowings and $10.3 million of junior subordinated notes. In September, the company renewed $31 million of subordinated debt, maturing May 2017, at LIBOR plus 4.75%, subject to a 7.00% floor. It reported compliance with senior-line debt covenants.
- Immediate on-balance-sheet liquidity was $208.2 million. Brokered deposits were $482.8 million, or 47.7% of deposits, versus $499.1 million, or 50.5%, at year-end. The Banks reported liquidity sufficient for approximately 20 months of brokered-deposit maturities.
- Consolidated regulatory capital ratios included total capital to risk-weighted assets of 12.66%, Tier 1 risk-based capital of 7.60%, and Tier 1 leverage of 6.21%. The Banks were reported as well capitalized.
Material changes and asset quality
- Net interest margin improved 28 basis points year over year for both the quarter and nine-month period. The decline in funding costs more than offset lower yields on earning assets; management cited approximately 65 basis points of investment-yield decline due to reinvestment in a low-rate environment.
- Non-performing assets were $29.1 million, compared with $40.2 million at December 31, 2010; non-accrual loans and leases fell to $27.0 million from $38.4 million. Non-accrual loans were 3.14% of gross loans, down from 4.37%.
- Gross loans and leases were $861.5 million. The allowance was $14.1 million, or 1.64% of gross loans, versus $16.3 million, or 1.85%, at year-end. Nine-month net charge-offs were $5.4 million, compared with $2.8 million in 2010; construction and land development represented about one-third of year-to-date charge-offs.
- Management cited successful loan payoffs, principal collections and workouts, but said economic conditions and collateral values remain challenging, particularly for vacant land and development projects. It warned that further charge-offs or higher provisions may be needed if conditions worsen.
- Year-to-date non-interest expense fell 9.0%, chiefly because 2010 included the goodwill impairment and because FDIC insurance and collateral liquidation costs declined. Q3 compensation and marketing expenses increased.
Outlook, risks and contingencies
- Management expected net interest margin to remain stable at the then-current level for the remainder of 2011, while noting uncertainty from competitive pricing, customer demand, asset-liability decisions and the yield curve. It expected continued market volatility to affect trust assets and related fees.
- The company said loan growth would likely remain below its historical rates as new lending was offset by amortization. It intended to grow in-market deposits and reduce brokered-deposit reliance, but expected brokered funding to remain part of its funding strategy.
- Key stated risks include local economic conditions, borrower defaults, interest-rate changes, competition, regulatory changes, loan demand, and continued weakness in real estate collateral. The company disclaimed an obligation to update forward-looking statements.
- A Wisconsin tax assessment involving investment subsidiaries was settled in June 2011 under confidential terms; the settlement did not create a materially different liability from the amount previously accrued. Management said existing legal proceedings were not expected to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
- The company said disclosure controls were effective and reported no material quarterly change in internal control over financial reporting. No formal earnings guidance was provided.
Important facts for investors to verify
- Reconcile the filing’s differing descriptions of the decline in non-performing assets: reported balances of $40.2 million and $29.1 million imply a decrease of about 27.6%, while one passage states 38.2%.
- Assess whether lower provisions and improving non-accrual balances are sustainable given higher year-to-date net charge-offs and ongoing land-development collateral risks.
- Monitor brokered deposits, their maturities and pricing, along with the company’s ability to attract local deposits and maintain stated liquidity coverage.
- Review the subordinated-debt renewal terms, future debt-service needs, and capital and dividend constraints, including the company’s stated intention to consult regulators before declaring dividends.
- Evaluate the sensitivity of net interest margin and securities values to rates, prepayments and reinvestment yields, and track the effect of compensation and marketing expense increases.