First Business Reports First Quarter 2020 Financial Results

Record period-end loans and deposits, strong fee income, and prudent operating expense management temper COVID-19 related increase in loan loss provision

MADISON, Wis.--(BUSINESS WIRE)-- First Business Financial Services, Inc. (the “Company” or “First Business”) (Nasdaq:FBIZ) reported first quarter 2020 net income of $3.3 million, or diluted earnings per share of $0.38, highlighted by record period-end loans and deposits, strong private wealth management and swap fee income, and well-managed operating expenses. The quarter’s solid performance was impacted by a $3.2 million provision for loan and lease losses primarily due to the COVID-19 pandemic.

“Given the current environment, we are extremely proud of all of our people, their exceptional support of one another, and their dedication to providing proactive and uninterrupted service to our clients,” said Corey Chambas, President and Chief Executive Officer. “While we had solid fundamental operating performance in the first quarter, what is even more important now is how we were able to assist our small and mid-sized business clients with their need for Paycheck Protection Program loans. Our expertise and experience in SBA lending has proven to be invaluable to our clients as we help them navigate this important source of emergency funding in these extraordinary times.”

Summary results as of and for the quarter ended March 31, 2020:

• Robust liquidity position includes record in-market deposits of $1.383 billion, total deposits of $1.500 billion, and cash, short-term investments, and securities at their highest level since mid-2016 at $301.3 million at period end, as well as more than $200 million in Federal Home Loan Bank (“FHLB”) borrowing availability.
• Gross loans and leases receivable grew to a record $1.743 billion at period end, up 6.7% annualized during the first quarter of 2020 and 5.2% from March 31, 2019. Line of credit utilization during these same periods of comparison was relatively unchanged.
• The allowance for loan and lease losses increased $3.2 million, or 16.5%, compared to December 31, 2019 primarily due to an increase in the general and specific reserves driven by the COVID-19 pandemic. The allowance for loan and lease losses increased to 1.30% of total loans, compared to 1.14% and 1.23% in the linked and first quarter of 2019, respectively.
• Provision for loan and lease losses totaled $3.2 million in the first quarter of 2020, compared to $1.5 million in the linked quarter and $49,000 in the first quarter of 2019.
• Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, and non-accrual interest, totaled $722,000 in the first quarter of 2020, compared to $1.8 million in the linked quarter and $2.2 million in the first quarter of 2019.
• Private wealth management service fees grew to $2.1 million, while swap fees, loan fees, and service charges remained strong in the quarter, partially offsetting lower gains on the sale of SBA loans. Swap fee income totaled $1.7 million in the first quarter of 2020, compared to a record $2.3 million in the linked quarter and $473,000 in the first quarter of 2019.
• Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table included in the Non-GAAP Reconciliations at the end of this release, totaled $15.9 million in the first quarter of 2020, compared to $16.6 million in the linked quarter and $15.2 million in the first quarter of 2019.
• No tax credit activity was recognized during the first quarter of 2020 or the linked quarter, compared to $1.9 million in expense during the first quarter of 2019 due to the impairment of an in-market federal historic tax credit investment, which corresponded with the recognition of a $2.8 million tax credit.

COVID-19 Update

“First Business’s work to ensure business continuity and responsive client service included proactive engagement by relationship managers with our clients to address their needs in this challenging time, leveraging our comprehensive digital banking and service platforms, and enabling almost all of our employees to serve our clients remotely from the safety of their homes,” Chambas said.

Business Continuity Plan

During March 2020, management activated its previously developed Pandemic Preparedness Plan, taking the following actions to protect the health of employees and clients, while continuing to exceed client needs:

• Limited lobby hours.
• Increased, proactive communication with employees and clients via phone, video conferencing, email, and other digital tools, while prohibiting business travel.
• Transitioned over 90% of employees to remote work.

No furloughs or layoffs have been made to date, nor does management currently anticipate future employee furloughs or layoffs related to COVID-19.

Paycheck Protection Program

A team of nearly 60 employees, over 20% of the Company’s workforce, started accepting and processing applications for loans under the Paycheck Protection Program (“PPP”) on Friday, April 3, 2020, when the program was officially launched by the SBA and Treasury Department under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). As of April 22, 2020, the Company had received over 600 applications from existing clients, received conditional approval from the SBA in excess of $300 million, disbursed approximately $280 million in funds, and is expected to generate processing fee income of approximately $8.5 million. Management expects to fund these short-term loans through a combination of excess cash held at the Federal Reserve, short-term FHLB advances, and participation in the Federal Reserve’s Paycheck Protection Program Liquidity Facility (“PPPLF”).

Liquidity Sources

Management has reviewed all primary and secondary sources of liquidity in preparation for any unforeseen funding needs due to the COVID-19 pandemic and prioritized based on available capacity, term flexibility, and cost. As of March 31, 2020, the Company had the following sources of liquidity (excluding the Company’s ability to participate in the PPPLF):

In addition to the above primary sources of liquidity, as of March 31, 2020, the Company also had access to $53.5 million in federal funds lines with various correspondent banks and significant experience accessing the highly liquid brokered certificate of deposit market.

Capital Strength

The Company’s capital ratios continued to exceed the highest required regulatory benchmark levels.

• Total capital to risk-weighted assets was 11.74%, tier 1 capital to risk-weighted assets was 9.45%, tier 1 leverage capital to adjusted average assets was 9.33%, and common equity tier 1 capital to risk-weighted assets was 8.96%. Tangible common equity to tangible assets was 8.41%.
• Effective March 16, 2020, management suspended the Company’s current stock repurchase program due to the uncertainty surrounding the COVID-19 pandemic. As of March 16, 2020, the Company had repurchased 141,137 shares of its common stock at a weighted average price of 24.62 per share, for a total value of $3.5 million. The company has $1.5 million of buyback authority remaining as of March 16, 2020.
• As previously announced, during the first quarter of 2020, the Company’s Board of Directors declared a regular quarterly dividend of $0.165 per share. The dividend was paid on February 13, 2020 to stockholders of record at the close of business on February 3, 2020. Measured against first quarter 2020 diluted earnings per share of $0.38, the dividend represents a 43.4% payout ratio. The Board of Directors routinely considers dividend declarations as part of its normal course of business.

Deferral Requests

As of March 31, 2020, the Company had processed 64 deferral requests, representing $59.8 million in total outstanding loans. As of April 22, 2020, the Company had processed 267 deferral requests, representing $196.6 million in total outstanding loans. Management anticipates this activity will continue throughout the second quarter of 2020 and beyond.

Exposure to Stressed Industries

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

As of March 31, 2020, the Company had no meaningful direct exposure to the energy or airline industries and does not participate in shared national credits.

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

First Quarter 2020 Compared to Fourth Quarter 2019

Net interest income decreased $1.4 million, or 7.7%, to $17.1 million.

• Net interest income reflected a decrease in average loans and leases, net interest margin, and loan fees received in lieu of interest. Fees in lieu of interest, which can vary from quarter to quarter based on client-driven activity, totaled $722,000, compared to $1.8 million. Excluding fees in lieu of interest, net interest income decreased $339,000, or 2.0%.
• Net interest margin decreased 29 basis points to 3.44% from 3.73%. Excluding fees in lieu of interest, net interest margin decreased seven basis points to 3.30% from 3.37% primarily due to a decline in average loan yields following the Federal Open Market Committee’s (“FOMC”) decision to reduce the target federal funds interest rate 150 basis points during the first quarter of 2020, which more than offset the decline in the average rate paid on deposits. The average yield on loans and leases receivable decreased 51 basis points to 5.04% and the average rate paid on in-market deposits decreased 19 basis points to 0.96%, compared to the average decrease in the target federal funds interest rate of 42 basis points.
• The yield on variable-rate loans tied to LIBOR dropped in anticipation of the FOMC’s decision to decrease the target federal funds rate, while the reduction in deposit rates generally coincided with the timing of the actual federal funds rate decrease. Management believes this decrease in yield is temporary given our active balance sheet management, expected continued reduction in deposit costs, and improved loan mix driven by strong production in our higher yielding specialty finance business lines.
• Average loans and leases receivable decreased $10.6 million, or 2.4%, to $1.734 billion.

Non-interest income decreased $775,000, or 10.8% to $6.4 million.

• Private wealth management fee income increased $39,000, or 1.9% to $2.1 million. Trust assets under management and administration measured $1.664 billion at March 31, 2020, down $227.7 million, or 12.0%, due to the precipitous drop in equity prices in late March 2020.
• Commercial loan interest rate swap fee income decreased $586,000, or 25.8%, to $1.7 million compared to a record $2.3 million. Interest rate swaps continue to be an attractive product for the Company’s commercial borrowers, although associated fee income can vary from period to period based on client demand and the interest rate environment in any given quarter.
• Gains on sale of SBA loans decreased $200,000, or 43.0%, to $265,000 compared to $465,000. While there were interruptions to closings due to the COVID-19 pandemic, the Company’s pipeline continues to grow period over period and management believes the gain on sale of traditional SBA loans (i.e., SBA loans unrelated to the recently launched PPP) will increase at a measured pace over time, assuming uninterrupted access to the regular 7(a) loan program.

Non-interest expense decreased $627,000, or 3.7%, to $16.1 million. Operating expense decreased $752,000, or 4.5%, to $15.9 million.

• Compensation expense increased $22,000, or 0.2%, to $11.1 million. The increase in compensation reflects annual merit increases partially offset by a decrease in the Company’s performance-based incentive compensation accrual based on estimated full year 2020 results in light of the economic impact of the COVID-19 pandemic.
• Professional fee expense decreased $138,000, or 14.4%, to $819,000, primarily due to lower audit and consulting fees.
• Marketing expense decreased $149,000, or 24.4%, to $461,000, due to temporary postponement of various marketing plans due to the COVID-19 pandemic.
• FDIC insurance expense increased $162,000 to $208,000. The Company received an assessment credit of $458,000 in 2019, $143,000 in the linked quarter and $315,000 in the third quarter of 2019, as the Deposit Insurance Fund (“DIF”) reached 1.38%, exceeding the statutorily required minimum ratio of 1.35% and requiring the FDIC to distribute assessment credits to small banks for their portion of their assessments that contributed to the growth in the reserve ratio.
• Other non-interest expense decreased $764,000, or 48.4%, to $816,000. The linked quarter included a one-time right-of-use impairment of $299,000 from vacating and subleasing unused office space in our Kansas City market. The decline also included a decrease in business travel and training costs due to the Company’s adherence to COVID-19 stay-at-home orders.

Total period-end loans and leases receivable increased $28.8 million, or 6.7% annualized, to $1.743 billion.

• Commercial and industrial (“C&I”) loans increased $16.5 million, or 13.2% annualized. This includes a $8.7 million, or 136.8% annualized, increase in purchased receivables from the Company’s nationwide accounts receivable financing division, First Business Growth Funding.
• Commercial real estate loans increased $6.3 million, or 2.2% annualized, driven primarily by an increase in construction loans.

Total period-end in-market deposits increased $4.4 million, or 1.3% annualized, to $1.383 billion.

• Transaction accounts increased $77.2 million and money market accounts decreased $64.5 million as clients started to favor the safety and soundness of the Company’s full FDIC insured reciprocal deposit product over interest rate.
• Similarly, certificates of deposits decreased $8.3 million as client preferences continued to shift towards more liquid products.
• Total period-end in-market deposits represent 73.2% of total bank funding compared to 75.5%. Total bank funding is defined as total deposits plus FHLB advances.

Period-end wholesale funding, including FHLB advances, brokered certificates of deposit, and deposits gathered through internet deposit listing services, increased $58.9 million to $505.3 million.

• Brokered certificates of deposit decreased $34.6 million to $116.8 million, as the existing portfolio runs off and is replaced as needed by lower cost FHLB advances to match fund long-term fixed-rate loans. The average rate paid on brokered certificates of deposit increased 16 basis points to 2.57% and the weighted average original maturity decreased to 4.8 years from 5.3 years.
• FHLB advances increased $93.5 million to $388.5 million. The average rate paid on FHLB advances decreased 18 basis points to 1.91% and the weighted average original maturity increased to 5.9 years from 5.4 years. The Company extended maturities during the first quarter of 2020 by entering into pay-fixed swaps, with terms to pay fixed rates and receive 3-month LIBOR, to partially pre-fund the Company’s loan originations with historically low cost funding.

Non-performing assets increased $6.0 million to $29.6 million, or 1.35% of total assets, compared to $23.5 million, or 1.12% of total assets.

• The increase in non-performing assets was principally due to the impairment of one $5.0 million commercial relationship and the repurchase of $2.0 million of impaired legacy SBA loans.
• The increase in non-performing assets was partially offset by a $1.3 million decrease in foreclosed properties, net of impairment, principally due to the sale of one legacy SBA property.

The allowance for loan and lease losses increased 16.5% primarily due to an increase in the general and specific reserve driven by the COVID-19 pandemic.

• The Company recorded a provision for loan and lease losses of $3.2 million compared to $1.5 million. As a result of the anticipated effects of the COVID-19 pandemic, the Company increased the allowance for loan and lease losses by $3.1 million during the first quarter of 2020.
• The allowance for loan and lease losses as a percent of total gross loans and leases was 1.30% compared to 1.14%.
• Net recoveries were $46,000 compared to net charge-offs of $2.1 million.

First Quarter 2020 Compared to First Quarter 2019

Net interest income decreased $704,000, or 4%, to $17.1 million.

• Net interest income reflected a decrease in net interest margin and a decrease in loan fees received in lieu of interest, partially offset by higher average loans and leases outstanding. Fees in lieu of interest totaled $722,000, compared to $2.2 million. Excluding fees in lieu of interest, net interest income increased $796,000, or 5.1%.
• Net interest margin decreased 35 basis points to 3.44% from 3.79%. Excluding fees collected in lieu of interest, net interest margin decreased two basis points to 3.30% from 3.32%.
• The average yield on loans and leases receivable decreased 85 basis points to 5.04% and the average rate paid on in-market deposits decreased 51 basis points to 0.96%, compared to an average decrease in the target federal funds interest rate of 207 basis points.
• Average loans and leases receivable increased $89.3 million, or 5.4%, to $1.734 billion.

Non-interest income increased $1.8 million, or 38.3%, to $6.4 million.

• Private wealth management fee income increased $185,000, or 9.6% to $2.1 million. Trust assets under management and administration measured $1.664 billion at March 31, 2020, down $67.5 million, or 3.9%, due to the precipitous drop in equity prices in late March 2020.
• Commercial loan interest rate swap fee income totaled $1.7 million compared to $473,000.
• Other fee income increased $252,000, or 31.3%, to $1.1 million compared to $805,000. Returns on the investment in mezzanine funds were $462,000 compared to $232,000. In addition, fee income from the Company’s newly established bank consulting division, First Business Consulting Services, totaled $63,000 compared to $10,000.

Non-interest expense decreased $1.6 million, or 9.0%, to $16.1 million. Operating expense increased $661,000, or 4.3%, to $15.9 million.

• Compensation expense increased $887,000, or 8.7%, to $11.1 million. The increase in compensation reflects annual merit increases and an increase in staff as average full-time equivalent employees were 286 for the quarter ended March 31, 2020, compared to 277 for the quarter ended March 31, 2019.
• Professional fee expense decreased $391,000, or 32.3%, to $819,000. The decrease was primarily due to decrease in consulting and recruiting expense.
• No tax credit activity was recognized during the first quarter of 2020 compared to $1.9 million in expense during the first quarter of 2019 due to the impairment of an in-market federal historic tax credit investment, which corresponded with the recognition of a $2.8 million tax credit.

Total period-end loans and leases receivable increased $86.8 million, or 5.2%, to $1.743 billion.

• Commercial and industrial loans increased $53.6 million, or 11.5%. This includes a $17.6 million, or 108.4% increase in purchased receivables from the Company’s nationwide accounts receivable financing division, First Business Growth Funding.
• Commercial real estate loans increased $33.5 million, or 3.0%, driven primarily by an increase in multi-family and non-owner occupied real estate.

Total period-end in-market deposits increased $143.8 million, or 11.6%, to $1.383 billion.

• Transaction and money market accounts increased $152.0 million, and $30.3 million, respectively.
• Certificates of deposits decreased $38.6 million as client preferences continued to shift towards more liquid products.
• Total period-end in-market deposits represent 73.2% of total Bank funding compared to 70.9%.

Period-end wholesale funding decreased $2.4 million, or 0.5%, to $505.3 million.

• Brokered certificates of deposit decreased $145.4 million, or 55.4%, to $116.8 million as the existing portfolio runs off and is replaced as needed by lower cost FHLB advances to match fund long-term fixed-rate loans. The average rate paid on brokered certificates of deposit increased 41 basis points to 2.57% and the weighted average original maturity was 4.8 years in both periods.
• FHLB advances increased $143.0 million, or 58.2%, to $388.5 million. The average rate paid on FHLB advances decreased 25 basis points to 1.91% and the weighted average original maturity increased to 5.9 years from 3.9 years.

Non-performing assets increased $3.5 million to $29.6 million, or 1.35% of total assets, compared to $26.1 million or 1.30%. The reasons for the increase in non-performing assets compared to the prior year quarter are consistent with the explanations discussed above with respect to the linked quarter.

The allowance for loan and lease losses increased 11.2% due to an increase in the general and specific reserve driven by the COVID-19 pandemic.

• The Company recorded a provision for loan and lease losses of $3.2 million compared to $49,000.
• The allowance for loan and lease losses as a percent of total gross loans and leases was 1.30% compared to 1.23%.
• Net recoveries were $46,000 compared to net charge-offs of $25,000.

About First Business Financial Services, Inc.

First Business Financial Services, Inc. (Nasdaq:FBIZ) is a Wisconsin-based bank holding company focused on the unique needs of businesses, business executives, and high net worth individuals. First Business offers commercial banking, specialty finance, and private wealth management solutions, and because of its niche focus, is able to provide its clients with unmatched expertise, accessibility, and responsiveness. For additional information, visit www.firstbusiness.com or call 608-238-8008.

This release may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect First Business’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 Corporation’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, 2019 and other filings with the Securities and Exchange Commission.