Classified in: Business, Covid-19 virus
Subjects: EARNINGS, Conference Call, Webcast

First Business Bank Reports Strong Second Quarter 2021 Net Income of $8.2 Million

First Business Financial Services, Inc. (the "Company", the "Bank", or "First Business Bank") (Nasdaq:FBIZ) reported net income of $8.2 million, or $0.95 diluted earnings per share, in the second quarter 2021. This compares to record net income of $9.7 million or $1.12 in the first quarter of 2021, and $3.3 million or $0.38 in the second quarter of 2020.

"First Business Bank again delivered strong financial performance in the second quarter, highlighted by continued double-digit annualized loan growth, further improvement in asset quality metrics, and diversified fee income," President and Chief Executive Officer Corey Chambas said. "Our active management of asset quality led to another significant reduction in non-performing assets as well as a provision benefit that positively impacted the bottom-line. Our NPAs as a percentage of total assets are at the lowest level since 2006 and, based on what we are seeing today, we believe there will be additional reductions in NPAs and release of reserves in the second half of 2021. Therefore, at this time, we believe there will be no meaningful provision for the second half of 2021, even though we expect double-digit organic loan growth to continue."

Quarterly Highlights

• Exceptional Loan Growth. Loans, excluding Paycheck Protection Program ("PPP") loans, grew $55.3 million, or 11.2% annualized, from the first quarter of 2021 and $286.0 million, or 16.5%, from the second quarter of 2020, as we continued to expand specialized lending offerings for commercial clients and focus on business development across products and geographies. This marks the fourth consecutive quarter of 10% or greater annualized loan growth, excluding PPP loans.
• Positive Asset Quality Trends. Non-performing assets ("NPAs") declined 39.0% to $11.6 million, marking the third consecutive quarterly reduction of more than 25%. NPAs made up 0.42% of total assets, excluding PPP loans, improving by 39 and 77 basis points from March 31, 2021 and June 30, 2020, respectively.
• Diversified Fee Income. Second quarter 2021 non-interest income continued to reflect the strength and diversity of our fee income sources and contributed meaningfully to top-line revenue. Private wealth management generated record revenue of $2.7 million on $2.564 billion in assets under management and administration for the period, while gains on the sale of Small Business Administration ("SBA") loans grew to $1.2 million.
• Robust Core Earnings and Top-Line Revenue. Our improved asset quality metrics, net interest margin stability, organic loan growth, and fee income generation produced strong net income of $8.2 million in the second quarter, up $4.9 million, or 147.8%, compared to the same period in 2020. Top-line revenue of $28.0 million was up $2.8 million, or 11.0% from the same period in 2020.
• PPP Update. Our participation in PPP has been a tremendous benefit to our clients. As of June 30, 2021, the Company had $123.8 million in gross PPP loans outstanding and deferred processing fees outstanding of $3.1 million to be recognized into income in future quarters. During the quarter, $2.5 million of processing fees were recognized.

Quarterly Financial Results

Second Quarter 2021 Compared to First Quarter 2021

Net interest income increased $789,000, or 3.8%, to $21.7 million.

• Net interest income reflected increases in average loans and leases, as well as in fees received in lieu of interest. Fees in lieu of interest, which can vary from quarter to quarter based on client-driven activity, totaled $3.5 million, compared to $3.1 million. Excluding fees in lieu of interest, net interest income increased $338,000, or 1.9%.
• Average loans and leases receivable, excluding net PPP loans in both periods of comparison, increased $53.5 million, or 11.0% annualized, to $1.994 billion.
• The yield on average interest-earning assets increased 3 basis points to 3.96% from 3.93%. Excluding average net PPP loans, the PPP loan interest income of $566,000, and the aforementioned fees in lieu of interest, the yield earned on average interest-earning assets decreased 5 basis points to 3.64% from 3.69%. The rate paid for average total bank funding decreased one basis point to 0.39% from 0.40%. Total bank funding is defined as total deposits plus Federal Home Loan Bank ("FHLB") advances, and Federal Reserve Discount Window advances.
• Net interest margin increased five basis points to 3.49% from 3.44%. Adjusted net interest margin, excluding fees in lieu of interest and other recurring but volatile components of net interest margin, was 3.20%, unchanged from the linked quarter.

The Company reported a net benefit to provision for loan and lease losses of $1.0 million, compared to a net benefit of $2.1 million in the first quarter.

• The decrease in the provision for loan and lease losses was primarily due to a $1.7 million reduction in the general reserve from improving historical loss rates and a $1.5 million decrease in specific reserves. These decreases were partially offset by $2.3 million in net charge-offs and a $498,000 increase in the general reserve due to loan growth. Net charge-offs for the quarter principally consisted of a $2.2 million charge-off of one previously identified and partially reserved for legacy SBA loan.

Non-interest income decreased $874,000, or 12.1%, to $6.3 million.

• Private wealth management fee income increased $337,000, or 14.0% to $2.7 million. Private wealth and trust assets under management and administration measured a record $2.564 billion at June 30, 2021, up $177.8 million, or 29.8% annualized, primarily due to growth from new and existing clients and increased equity market values.
• Gains on sale of SBA loans increased $125,000, or 11.6%, to $1.2 million. Management believes the gain on sale of traditional SBA loans (i.e., SBA loans unrelated to PPP loans), while variable based on timing of closings, will continue to increase annually at a measured pace.
• During the second quarter there was no commercial loan interest rate swap fee income, compared to total swap fees of $684,000 in the first quarter. Swap fee income can vary from period to period based on client demand and the interest rate environment in any given quarter.
• Other fee income decreased $729,000 to $835,000, compared to $1.6 million in the first quarter, which reflected higher than typical returns in the first three months of 2021 from the Company's investments in mezzanine funds.

Non-interest expense increased $854,000, or 4.9%, to $18.2 million. Operating expense increased $483,000, or 2.8%, to $17.9 million.

• Compensation expense increased $598,000, or 4.7%, to $13.3 million, primarily due to a $415,000 true up of the Company's performance-based incentive compensation accrual to reflect the strong earnings results through the first half of 2021.
• SBA recourse provision for estimated losses in the outstanding guaranteed portion of SBA loans sold totaled $245,000, compared to a net benefit of $130,000 in the linked quarter.
• Other non-interest expense decreased $228,000 to $176,000. The decrease was principally due to a reduction in the credit valuation adjustment ("CVA") related to the commercial loan interest rate swap program and a reduction in the loan servicing valuation adjustment related to the Bank's SBA portfolio.

Total period-end loans and leases receivable, excluding net PPP loans in both periods of comparison, increased $55.3 million, or 11.2% annualized, to $2.023 billion.

• Commercial and industrial ("C&I") loans, excluding net PPP loans, increased $58.0 million, or 44.8% annualized, led by First Business Bank's specialized lending commercial business lines. While we believe this level of above average growth is not sustainable, management believes the timely prior-period investments in producers for specialized lending, such as dealer floorplan financing, small-ticket equipment vendor financing, and accounts receivable financing, have positioned C&I lending to increase throughout the current economic cycle.
• Commercial real estate ("CRE") loans were unchanged at $1.392 billion, as growth from non-owner occupied CRE was offset by payoffs and paydowns in the remaining categories.

Total period-end in-market deposits increased $279.0 million to $2.016 billion, or 64.2% annualized, and the average rate paid decreased one basis point to 0.15%.

• A significant portion of the large increase in deposits was due to the proceeds of a commercial client's business sale late in the second quarter, the majority of which was moved off the balance sheet in early July. Excluding this temporary deposit, total period-end in-market deposits increased $54.0 million to $1.791 billion, or 12.4% annualized.
• Excluding the temporary deposit described above, non-interest bearing transaction and money market accounts increased $52.4 million and $53.1 million, respectively, while interest-bearing transaction accounts and certificates of deposits decreased $49.8 million and $1.7 million, respectively.

Period-end wholesale funding, including FHLB advances, Federal Reserve Discount Window advances, brokered deposit, and deposits gathered through internet deposit listing services, decreased $49.0 million to $532.3 million.

• Wholesale deposits decreased $21.0 million to $144.5 million, due to contractual runoff. The average rate paid on wholesale deposits decreased 2 basis points to 0.74% and the weighted average original maturity of brokered certificates of deposit decreased to 3.5 years from 3.9 years.
• FHLB advances decreased $28.0 million to $387.8 million. The average rate paid on FHLB advances decreased nine basis points to 1.27% and the weighted average original maturity increased to 6.1 years from 5.7 years.

Non-performing assets decreased $7.4 million, or 39.0%, to $11.6 million, or 0.40% of total assets, compared to $19.0 million, or 0.73% of total assets. The reduction in non-performing assets was principally due to loan payoffs and charge-offs. Excluding net PPP loans, non-performing assets were 0.42% of total assets as of June 30, 2021, compared to 0.81% as of March 31, 2021.

The allowance for loan and lease losses decreased $3.3 million, or 11.4%, as an increase in the general reserve from loan growth was more than offset by a decrease in the historical loss rate and reduction in specific reserves.

• The allowance for loan and lease losses as a percent of total gross loans and leases was 1.20% compared to 1.29% as of March 31, 2021.
• Excluding net PPP loans, the allowance for loan and leases losses as a percent of total gross loans and leases was 1.27%, compared to 1.47% as of March 31, 2021.

Second Quarter 2021 Compared to Second Quarter 2020

Net interest income increased $2.8 million, or 14.6%, to $21.7 million.

• The increase in net interest income reflects an increase in average gross loans and leases and an increase in fees collected in lieu of interest. Fees in lieu of interest, which can vary from quarter to quarter, totaled $3.5 million compared to $2.3 million. Excluding fees in lieu of interest and interest income from PPP loans, net interest income increased $1.5 million, or 9.7%. Excluding net PPP loans, average gross loans and leases increased $263.9 million, or 15.3%.
• The yield on average interest-earning assets measured 3.96% compared to 4.03%. Excluding fees collected in lieu of interest, PPP loan interest income and net PPP loans, the yield on average interest-earning assets was 3.64%, compared to 3.96%. The decline in yields was primarily due to the decrease in LIBOR and Prime rates and related impact on variable-rate loans, in addition to the renewal of fixed-rate loans and reinvestment of security cash flows at historically low interest rates. The rate paid for average total bank funding decreased 22 basis points to 0.39% from 0.61%.
• Net interest margin increased 15 basis points to 3.49% from 3.34%. Adjusted net interest margin decreased 12 basis points to 3.20% from 3.32%.

The Company reported a net benefit to provision for loan and lease losses of $1.0 million, compared to a $5.5 million expense in the second quarter of 2020.

Non-interest income was $6.3 million for both periods.

• Gains on sale of SBA loans increased $629,000, or 109.6%, to $1.2 million as a result of the Company's rebuilt SBA business line.
• Private wealth management fee income increased $620,000, or 29.2%, to $2.7 million. Private wealth and trust assets under management and administration measured a record $2.564 billion at June 30, 2021, up $691.0 million, or 36.9%.
• During the second quarter there was no commercial loan interest rate swap fee income, compared to total swap fees of $1.7 million for the year-ago quarter.
• Other fee income increased $149,000, or 21.7%, to $835,000 compared to $686,000.

Non-interest expense decreased $159,000, or 0.9%, to $18.2 million. Operating expense increased $2.5 million, or 16.2%, to $17.9 million.

• Compensation expense increased $2.5 million, or 22.8%, to $13.3 million. The increase reflects new hires and an increase in the Company's performance-based incentive compensation accrual based on estimated full year 2021 results, compared to a second quarter 2020 reduction to the same accrual due to COVID-19 pandemic uncertainty. Average full-time equivalent employees increased to 312, up 11.0% for the quarter ended June 30, 2021, compared to 281 for the quarter ended June 30, 2020.
• In the second quarter of 2020, the Company recognized $1.7 million in expense due to the impairment of federal historic tax credit investments, which corresponded with the recognition of a $2.5 million in tax credits during the quarter. No federal historic tax credit investments were recognized in the second quarter of 2021.
• Other non-interest expense decreased $369,000, or 67.7%, to $176,000. The decrease was principally due to a reduction in the credit valuation adjustment ("CVA") related to the commercial loan interest rate swap program and a decrease in business travel expense.

Total period-end loans and leases receivable, excluding net PPP loans in both periods of comparison, increased $286.0 million, or 16.5%, to $2.023 billion.

• C&I loans, excluding net PPP loans, increased $113.5 million, or 24.6%.
• CRE loans increased $169.8 million, or 13.9%, driven by an increase across most CRE categories with the majority in the non-owner occupied and multi-family portfolios.

Total period-end in-market deposits increased $395.6 million, or 24.4%, to $2.016 billion and the average rate paid decreased 18 basis points to 0.15%.

• Excluding the temporary deposit from a client's business sale, total period-end in-market deposits increased $170.6 million to $1.791 billion, or 10.5%.
• Excluding the temporary deposit described above, transaction and money market accounts increased $214.0 million and $28.4 million, respectively, while certificates of deposits decreased $71.8 million.

Period-end wholesale funding increased $31.5 million to $532.3 million.

• Wholesale deposits increased $54.7 million to $144.5 million mainly due to adding non-maturity brokered deposits at a favorable rate compared to alternative funding sources. Excluding these deposits, wholesale deposits decreased as the existing portfolio runoff was replaced by in-market deposits and lower cost FHLB advances to match-fund long-term fixed rate loans and fund loan growth. The average rate paid on brokered certificates of deposit decreased 168 basis points to 0.74% and the weighted average original maturity decreased to 3.5 years from 4.6 years.
• FHLB advances decreased $23.2 million to $387.8 million. The average rate paid on FHLB advances increased 2 basis points to 1.27% and the weighted average original maturity increased to 6.1 years from 5.3 years.

Non-performing assets decreased to $11.6 million, or 0.40% of total assets, compared to $25.5 million, or 1.03% of total assets. Excluding net PPP loans, non-performing assets were 0.42% of total assets as of June 30, 2021 compared to 1.19% one year prior.

The allowance for loan and lease losses decreased $1.8 million to $25.7 million compared to $27.5 million.

• The allowance for loan and lease losses as a percent of total gross loans and leases was 1.20% compared to 1.33%.
• Excluding net PPP loans, the allowance for loan and leases losses as a percent of total gross loans and leases was 1.27% as of June 30, 2021 compared to 1.57% one year prior.

COVID-19 Update

On March 11, 2020, the World Health Organization declared COVID-19, the disease caused by the novel coronavirus, a pandemic as a result of the global spread of the coronavirus illness. In response to the outbreak, federal and state authorities in the U.S. introduced various measures to try to limit or slow the spread of the virus, including travel restrictions, nonessential business closures, stay-at-home orders, and strict social distancing. The Company activated its Pandemic Preparedness Plan to protect the health of employees and clients, which included temporarily limiting lobby hours and transitioning the vast majority of the Company's workforce to remote work. The Company did not incur any significant disruptions to its business activities during this time of transition and extended remote work.

The second half of 2020 saw improvements in economic trends, but continued waves of new cases of COVID-19 created continued uncertainty in the economic environment. However, at the end of the fourth quarter of 2020 and into the first quarter of 2021, the rollout of new vaccines and the ratification of two additional stimulus laws resulted in lower infection rates and significant improvement in the outlook of the economy. In the second quarter of 2021, the Company communicated return to office plans to employees. Based on the national and local guidelines, the Company developed a phased-in approach for returning to the office. Under this phased-in approach, offices opened in early June 2021. The return to office included enhanced safety protocols and processes to provide the best working environment possible for employees.

Paycheck Protection Program

As of June 30, 2021, the Company had $123.8 million in gross PPP loans outstanding and deferred processing fees outstanding of $3.1 million. The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. During the three and six months ended June 30, 2021, the Company recognized $2.5 million and $4.8 million, respectively, of processing fees in loans and leases interest income in the unaudited Consolidated Statements of Income. The SBA provides a guaranty to the lender of 100% of principal and interest, unless the lender violated an obligation under the agreement. Since loan losses are expected to immaterial, if at all due to the government guarantee, management excluded the PPP loans from the allowance for loan and lease losses calculation. These short-term loans were funded primarily through a combination of excess cash held at the Federal Reserve and from an increase in in-market deposits.

Deferral Requests

The Company provided loan modifications deferring payments for certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Company's loan modification program. Excluding gross PPP loans, as of June 30, 2021, the Company had five deferred loans outstanding of $20.5 million, or 1.0% of gross loans and leases, compared to $323.2 million, or 18.6% of gross loans and leases as of June 30, 2020. Of the $20.5 million of deferred loans outstanding, $19.8 million relates to two hospitality credits that went on deferral during the second quarter of 2021 and are both accruing and current on payments. Management believes there will be no losses associated with these two credits.

The following tables represent a breakdown of the deferred loan balances by industry segment and collateral type:

Exposure to Stressed Industries

Certain industries have been and are expected to be particularly impacted by social distancing, quarantines, and the economic impact of the COVID-19 pandemic, such as the following:

As of June 30, 2021, the Company had no meaningful direct exposure to the energy sector, airline industry or retail consumer, and does not participate in Shared National Credits.

Because of the uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our clients and prospects, and on the national and local economies as a whole, there can be no assurances as to how the crisis may ultimately affect the Company's loan portfolio.

About First Business Financial Services, Inc.

First Business Financial Services, Inc., (Nasdaq: FBIZ) is the parent company of First Business Bank. First Business Bank specializes in Business Banking, including Commercial Banking and Specialized Lending, Private Wealth, and Bank Consulting services, and through its refined focus, delivers unmatched expertise, accessibility, and responsiveness. Specialized Lending solutions are delivered through First Business Bank's wholly owned subsidiary First Business Specialty Finance, LLC. For additional information, visit www.firstbusiness.bank.

This release may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect First Business Bank's current views with respect to future events and financial performance. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results, or other developments. Forward-looking statements are based on management's expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Those statements are based on general assumptions and are subject to various risks, uncertainties, and other factors that may cause actual results to differ materially from the views, beliefs, and projections expressed in such statements. Such statements are subject to risks and uncertainties, including among other things:

• Adverse changes in the economy or business conditions, either nationally or in our markets, including, without limitation, the adverse effects of the COVID-19 pandemic on the global, national, and local economy.
• The effect of the COVID-19 pandemic on the Company's credit quality, revenue, and business operations.
• Competitive pressures among depository and other financial institutions nationally and in our markets.
• Increases in defaults by borrowers and other delinquencies.
• Our ability to manage growth effectively, including the successful expansion of our client service, administrative infrastructure, and internal management systems.
• Fluctuations in interest rates and market prices.
• Changes in legislative or regulatory requirements applicable to us and our subsidiaries.
• Changes in tax requirements, including tax rate changes, new tax laws, and revised tax law interpretations.
• Fraud, including client and system failure or breaches of our network security, including our internet banking activities.
• Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portion of SBA loans.

For further information about the factors that could affect the Company's future results, please see the Company's annual report on Form 10-K for the year ended December 31, 2020 and other filings with the Securities and Exchange Commission.

SELECTED FINANCIAL CONDITION DATA

STATEMENTS OF INCOME

NET INTEREST INCOME ANALYSIS

NET INTEREST INCOME ANALYSIS

PROVISION FOR LOAN AND LEASE LOSS COMPOSITION

PERFORMANCE RATIOS

ASSET QUALITY RATIOS

ASSET QUALITY RATIOS - EXCLUDING NET PPP LOANS

NET CHARGE-OFFS (RECOVERIES)

CAPITAL RATIOS

LOAN AND LEASE RECEIVABLE COMPOSITION

LEGACY SBA 7(a) AND EXPRESS LOAN COMPOSITION ⁽¹⁾

DEPOSIT COMPOSITION

TRUST ASSETS COMPOSITION

NON-GAAP RECONCILIATIONS

Certain financial information provided in this release is determined by methods other than in accordance with generally accepted accounting principles (United States) ("GAAP"). Although the Company's management believes that these non-GAAP financial measures provide a greater understanding of its business, these measures are not necessarily comparable to similar measures that may be presented by other companies.

TANGIBLE BOOK VALUE

"Tangible book value per share" is a non-GAAP measure representing tangible common equity divided by total common shares outstanding. "Tangible common equity" itself is a non-GAAP measure representing common stockholders' equity reduced by intangible assets, if any. The Company's management believes that this measure is important to many investors in the marketplace who are interested in period-to-period changes in book value per common share exclusive of changes in intangible assets. The information provided below reconciles tangible book value per share and tangible common equity to their most comparable GAAP measures.

TANGIBLE COMMON EQUITY TO TANGIBLE ASSETS

"Tangible common equity to tangible assets" is defined as the ratio of common stockholders' equity reduced by intangible assets, if any, divided by total assets reduced by intangible assets, if any. The Company's management believes that this measure is important to many investors in the marketplace who are interested in the relative changes from period to period in common equity and total assets, each exclusive of changes in intangible assets. The information below reconciles tangible common equity and tangible assets to their most comparable GAAP measures.

EFFICIENCY RATIO & PRE-TAX, PRE-PROVISION ADJUSTED EARNINGS

"Efficiency ratio" is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse provision, impairment of tax credit investments, losses or gains on foreclosed properties, amortization of other intangible assets and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized gains or losses on securities, if any. "Pre-tax, pre-provision adjusted earnings" is defined as operating revenue less operating expense. In the judgment of the Company's management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Company's operating expenses in relation to its core operating revenue by removing the volatility that is associated with certain one-time items and other discrete items. The information provided below reconciles the efficiency ratio and pre-tax, pre-provision adjusted earnings to its most comparable GAAP measure.

ADJUSTED NET INTEREST MARGIN

"Adjusted Net Interest Margin" is a non-GAAP measure representing net interest income excluding the fees in lieu of interest and other recurring but volatile components of net interest margin divided by average interest-earning assets less average net PPP loans, if any, and other recurring but volatile components of average interest-earning assets. Fees in lieu of interest are defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization. In the judgment of the Company's management, the adjustments made to net interest income allow investors and analysts to better assess the Company's net interest income in relation to its core client-facing loan and deposit rate changes by removing the volatility that is associated with these recurring but volatile components. The information provided below reconciles the net interest margin to its most comparable GAAP measure.

 

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