First Business 2019 Net Income Increases 43% to a Record $23.3 Million

First Business Financial Services, Inc. (the “Company” or “First Business”) (Nasdaq:FBIZ) reported strong fourth quarter and record full year 2019 net income as the Company continued to execute on key initiatives, resulting in an increase in top line revenue, reduction in the level of non-performing assets, improvement in operating efficiency, and strong in-market deposit growth.

Summary results for the year ended December 31, 2019:

• Record net income of $23.3 million increased by $7.0 million, or 43.1%, compared to $16.3 million in 2018.
• Diluted earnings per common share measured $2.68 compared to $1.86 in 2018.
• Return on average assets and return on average equity measured 1.14% and 12.55%, respectively, compared to 0.86% and 9.41%, respectively, in 2018.
• Net interest margin was 3.61% compared to 3.72% in 2018.
• Top line revenue, the sum of net interest income and non-interest income, totaled $93.3 million, an increase of 9.1% compared to $85.5 million in 2018.
• Provision for loan and lease losses was $2.1 million compared to $5.5 million in 2018.
• SBA recourse provision was $188,000 compared to $1.9 million in 2018.
• Efficiency ratio improved to 66.59%, down from 67.77% in 2018.

Summary results as of and for the quarter ended December 31, 2019:

• Net income totaled $5.8 million compared to $5.1 million for the linked quarter and $4.1 million for the fourth quarter of 2018.
• Diluted earnings per common share measured $0.67 compared to $0.59 and $0.46 for the linked and prior year quarters, respectively.
• Annualized return on average assets and annualized return on average equity measured 1.09% and 11.93%, respectively, compared to 0.97% and 10.68%, respectively, for the linked quarter and 0.83% and 9.06%, respectively, for the fourth quarter of 2018.
• Net interest margin was 3.73% compared to 3.40% for the linked quarter and 3.69% for the fourth quarter of 2018.
• Top line revenue totaled $25.7 million compared to $22.6 million for the linked quarter and $21.8 million for the fourth quarter of 2018.
• Provision for loan and lease losses was $1.5 million compared to $1.3 million and $983,000 for the linked and prior year quarters, respectively.
• SBA recourse provision was $21,000 compared to a benefit of $427,000 for the linked quarter and expense of $1.8 million for the fourth quarter of 2018.
• Efficiency ratio improved to 64.77% from 66.41% for the linked quarter and 66.95% for the fourth quarter of 2018.
• Average gross loans and leases of $1.744 billion increased by $12.9 million, or 3.0% annualized, from the linked quarter and $127.1 million, or 7.9%, compared to the fourth quarter of 2018. Period-end gross loans and leases receivable of $1.715 billion decreased $5.9 million during the fourth quarter of 2019 and increased $97.0 million, or 6.0%, from $1.618 billion at December 31, 2018.
• Non-performing assets were $23.5 million, or 1.12% of total assets, compared to $25.7 million, or 1.23%, at September 30, 2019 and $27.8 million, or 1.42%, at December 31, 2018.
• Average in-market deposits of $1.350 billion increased $52.1 million, or 16.0% annualized, during the fourth quarter of 2019 and $207.8 million, or 18.2%, from December 31, 2018. Record period-end in-market deposits of $1.379 billion increased $57.9 million, or 17.5% annualized, during the fourth quarter of 2019 and $199.5 million, or 16.9%, from December 31, 2018.

“We are extremely pleased to report record earnings for 2019. Through the efforts of our talented team of bankers, we achieved strong loan growth and outstanding in-market deposit growth, while also continuing to improve our operating efficiency,” said Corey Chambas, President and Chief Executive Officer. “Our investments in people and infrastructure are driving these significantly improved quarterly and annual results,” Chambas added.

Fourth Quarter 2019 Results of Operations

Net interest income of $18.5 million increased by $1.7 million, or 10.1%, compared to the linked quarter and $1.4 million, or 7.9%, compared to the fourth quarter of 2018. Net interest income reflected an increase in net interest margin, higher average loans and leases outstanding, and an increase in loan fees received in lieu of interest. Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, and non-accrual interest, which can be variable from quarter to quarter, totaled $1.8 million, compared to $1.1 million for the linked quarter and $1.4 million for the fourth quarter of 2018. Fourth quarter 2019 net interest income included $67,000 of one-time interest expense related to exercising the call options on brokered deposits. Third quarter 2019 net interest income included $261,000 and $47,000 of one-time interest expense related to exercising the call options on subordinated debt and brokered deposits, respectively. Excluding these one-time interest expense items and fees collected in lieu of interest in all periods of comparison, net interest income increased $713,000, or 4.5%, compared to the linked quarter and $1.0 million, or 6.5%, compared to the fourth quarter of 2018.

Net interest margin measured 3.73% for the fourth quarter of 2019, compared to 3.40% in the linked quarter and 3.69% in the fourth quarter of 2018. Net interest margin reflected a decrease in the rate paid on average interest-bearing liabilities, combined with the aforementioned increase in loan fees in lieu of interest. Excluding fees collected in lieu of interest and one-time interest expense related to exercising the call options on subordinated debt and brokered deposits, net interest margin measured 3.38% for the fourth quarter of 2019, compared to 3.25% in the linked quarter and 3.39% in the fourth quarter of 2018. This improvement in net interest margin compared to the linked quarter is primarily due to the reduction in the rate paid on deposits following the Federal Reserve’s third and final rate cut of 2019, which more than offset the decline in variable loan rates. Management expects the execution of its strategies will allow the Company to maintain a net interest margin, including fees collected in lieu of interest, at or above its target of 3.50%.

The Company recorded a provision for loan and lease losses of $1.5 million in the fourth quarter of 2019, compared to $1.3 million and $983,000 in the linked quarter and prior year quarter, respectively. The increase in provision for the fourth quarter of 2019 was in large part due to increases in specific reserves related to previously impaired legacy SBA relationships. Net charge-offs were $2.1 million in the fourth quarter of 2019, compared to $998,000 in the linked quarter and $1.0 million in the prior year quarter. The increase in net charge-offs was related to existing impaired legacy SBA loans and offset by a reduction in the previously established specific reserves.

Non-interest income totaled $7.2 million, or 28.0% of total revenue, for the fourth quarter of 2019, surpassing the Company’s goal of 25% of total revenue, compared to $5.8 million, or 25.7% of total revenue, in the linked quarter and $4.6 million, or 21.4% of total revenue, in the prior year quarter.

Trust and investment services fee income totaled $2.1 million in the current and linked quarters compared to $1.9 million in the prior year quarter. Trust assets under management and administration measured a record $1.892 billion at December 31, 2019, up $91.7 million, or 20.4% annualized, from the linked quarter and up $261.9 million, or 16.1%, from December 31, 2018. Management expects new business development efforts to remain strong in 2020 and beyond as the Company continues to expand its private wealth management business outside its Madison, Wisconsin, market.

Commercial loan interest rate swap fee income totaled a record $2.3 million in the fourth quarter of 2019, compared to $374,000 in the linked quarter and $662,000 in the fourth quarter of 2018. The above average swap fee income in the quarter was primarily due to one large commercial real estate transaction which generated a $1.1 million fee. Interest rate swaps continue to be an attractive product for the Company’s commercial borrowers, although associated fee income can be variable from period to period based on client demand and the interest rate environment in any given quarter.

Gains on sale of SBA loans totaled $465,000 in the fourth quarter of 2019, an increase of $11,000, or 9.7% annualized, compared to $454,000 in the linked quarter and an increase of $198,000, or 74.2%, compared to $267,000 in the fourth quarter of 2018. Based on the Company’s enhanced business development team and growing pipeline of new business, management believes the gain on sale of SBA loans will continue to increase at a measured pace moving forward.

Other fee income totaled $1.2 million in the fourth quarter of 2019, a decrease of $488,000, or 29.2%, compared to $1.7 million in the linked quarter and an increase of $560,000, or 89.5%, compared to $626,000 in the fourth quarter of 2018. Returns on the investment in mezzanine funds were $241,000 in the fourth quarter of 2019, compared to $770,000 in the linked quarter and $100,000 in the prior year quarter. The increase compared to the prior year quarter was also due to a $207,000 gain from the sale of a state tax credit and increased fee income from our newly established division, First Business Consulting Services, which provides investment portfolio administrative and asset/liability management services.

Non-interest expense was $16.8 million for the fourth quarter of 2019, compared to $14.7 million for the linked quarter and $18.2 million in the fourth quarter of 2018. 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 $16.6 million in the fourth quarter of 2019, compared to $15.0 million in the linked quarter and $14.6 million in the prior year quarter.

Compensation expense for the three months ended December 31, 2019 was $11.0 million, an increase of $706,000 compared to the linked and prior year quarters and an increase of $1.6 million compared to the prior year quarter. The increase in compensation expense from the linked quarter reflects a $606,000 increase in the Company’s performance-based incentive compensation accrual based on actual full year 2019 results. Full-time equivalent employees (“FTE”) were 288 at December 31, 2019, compared to 281 at September 30, 2019 and 274 at December 31, 2018. The year-over-year increase in FTEs consists of eight net new production positions and six net new support positions.

Professional fee expense for the three months ended December 31, 2019 was $957,000, an increase of $206,000 compared to the linked quarter and $78,000 compared to the prior year quarter. The increase compared to the linked quarter was due to an increase in audit and consulting fees.

Other non-interest expense for the three months ended December 31, 2019 was $1.6 million, an increase of $683,000 compared to the linked quarter and $770,000 compared to the prior year quarter. The increase in other non-interest expense compared to both the linked and prior year quarters was principally due to a one-time right-of-use impairment of $299,000 from vacating and subleasing unused office space in our Kansas City market. The Company also experienced an increase in business travel and training costs consistent with the increase in FTEs referenced above.

Exceptional operating revenue resulted in a reduction in the Company’s fourth quarter 2019 efficiency ratio to 64.77%, compared to 66.41% for the linked quarter and 66.95% for the prior year quarter. The increase in operating revenue was principally attributable to the improvement in net interest margin and above average fee income generated by the Company’s commercial loan interest rate swap program. This increase in operating revenue was partially offset by the increase in incentive compensation expense related to the Company’s strong full year 2019 performance.

Balance Sheet

Period-end gross loans and leases receivable totaled $1.715 billion at December 31, 2019, decreasing $5.9 million from September 30, 2019 and increasing $97.0 million, or 6.0%, from December 31, 2018. Average gross loans and leases receivable totaled $1.744 billion at December 31, 2019, increasing $12.9 million, or 3.0% annualized, from September 30, 2019 and increasing $127.1 million, or 7.9%, from December 31, 2018. The decrease in period-end loans and leases receivable compared to the linked quarter was primarily due to above average prepayments, which generated the substantial increase in fees collected in lieu of interest during the quarter.

“Commercial loan production was very strong this year, however, our loan payoff activity was elevated, particularly in the second half of the year, which tempered our year-over-year ending loan growth,” said Chambas. “We don’t believe these above average payoffs were due to any ongoing trend as they occurred across multiple loan types, geographies, and business lines. We remain optimistic about our team’s ability to grow loans in line with the high single-digit levels our average loan balances grew this year.”

Period-end in-market deposits increased to a record $1.379 billion, or 75.5% of total bank funding at December 31, 2019, compared to $1.321 billion, or 72.7%, at September 30, 2019 and $1.179 billion, or 68.2%, at December 31, 2018. Total bank funding is defined as total deposits plus FHLB advances. The largest contributors to in-market deposit growth in 2019 were transaction accounts and money markets, increasing $57.1 million and $158.4 million, respectively, compared to the prior year quarter. Importantly, this above average growth was achieved while maintaining pricing discipline and setting deposit rates below the alternative sources of wholesale funding. The rate paid on average in-market deposits was 1.14% for the fourth quarter of 2019, compared to 1.47% in the linked quarter and 1.27% in the prior year quarter.

“It was an extraordinary year at First Business for in-market deposit growth,” said Chambas. “In 2019, not only did we grow deposits to record levels and more than fully fund our net loan growth for the year, but we did so while maintaining a strong net interest margin amid a very turbulent and uncertain interest rate environment. We remain focused on retaining and growing these relationships further in 2020 to continue supporting our expectations of above market loan growth.”

Period-end wholesale funding was $446.5 million at December 31, 2019, including FHLB advances of $295.0 million, brokered certificates of deposit of $150.5 million, and deposits gathered through internet deposit listing services of $1.0 million, compared to period-end wholesale funding of $496.4 million at September 30, 2019 and $550.4 million at December 31, 2018. The rate paid on average wholesale funding was 2.21% for the fourth quarter of 2019, compared to 2.25% in the linked quarter and 2.18% in the prior year quarter. The rate paid on average wholesale funding is greater than the cost of in-market deposits and changes more gradually because the portfolio includes longer original maturities as the Company match-funds its longer-term fixed rate loans to mitigate interest rates risk. The weighted average original maturity for wholesale funds as of December 31, 2019 and September 30, 2019 was 5.3 years, compared to 4.2 years at December 31, 2018.

Asset Quality

Non-performing assets were $23.5 million, or 1.12% of total assets, at December 31, 2019, compared to $25.7 million, or 1.23% of total assets, and $27.8 million, or 1.42% of total assets, at the end of the linked quarter and fourth quarter of 2018, respectively. The decrease from the linked quarter was primarily due to current quarter charge-offs of $2.2 million, the majority of which related to legacy SBA relationships previously classified as impaired for which we were fully reserved, as well as payments received on non-performing loans.

Capital Strength

The Company’s capital ratios continued to exceed the highest required regulatory benchmark levels. As of December 31, 2019, total capital to risk-weighted assets was 12.01%, tier 1 capital to risk-weighted assets was 9.77%, tier 1 leverage capital to adjusted average assets was 9.27%, and common equity tier 1 capital to risk-weighted assets was 9.27%. In addition, as of December 31, 2019, tangible common equity to tangible assets was 8.74%.

Share Repurchases

As of January 17, 2020, the Company had repurchased 98,356 shares of its common stock at a weighted average price of $24.78 per share, for a total value of $2.4 million. Under the previously disclosed stock repurchase program approved by its Board of Directors on September 20, 2019 and ending on September 30, 2020, the company has $2.6 million of buyback authority remaining as of January 17, 2020.

Quarterly Dividend

As previously announced, during the fourth quarter of 2019, the Company’s Board of Directors declared a regular quarterly dividend of $0.15 per share. The dividend was paid on November 14, 2019 to stockholders of record at the close of business on November 4, 2019. Measured against fourth quarter 2019 diluted earnings per share of $0.67, the dividend represents a 22.4% payout ratio. The Board of Directors routinely considers dividend declarations as part of its normal course of business.

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:

• Competitive pressures among depository and other financial institutions nationally and in our markets.
• Adverse changes in the economy or business conditions, either nationally or 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, 2018 and other filings with the Securities and Exchange Commission.