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FBIZ > SEC Filings for FBIZ > Form 10-K on 7-Mar-2014All Recent SEC Filings

Show all filings for FIRST BUSINESS FINANCIAL SERVICES, INC.

Form 10-K for FIRST BUSINESS FINANCIAL SERVICES, INC.


7-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
When used in this report the words or phrases "may," "could," "should," "hope," "might," "believe," "expect," "plan," "assume," "intend," "estimate," "anticipate," "project," "likely," or similar expressions are intended to identify "forward-looking statements." Such statements are subject to risks and uncertainties, including, without limitation, changes in economic conditions in the market areas of FBB or FBB - Milwaukee, changes in policies by regulatory agencies, fluctuation in interest rates, demand for loans in the market areas of FBB or FBB - Milwaukee, borrowers defaulting in the repayment of loans and competition. These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our shareholders and potential investors. See Item 1A-Risk Factors for discussion relating to risk factors impacting us. Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors described within this Form 10-K could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods.
Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that, while our management believes such assumptions or bases are reasonable and are made in good faith, assumed facts or bases can vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, an expectation or belief is expressed as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements.
The following discussion and analysis is intended as a review of significant events and factors affecting the financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and the Selected Consolidated Financial Data presented in this Form 10-K.

OVERVIEW
We are a registered bank holding company incorporated under the laws of the State of Wisconsin and are engaged in the commercial banking business through our wholly-owned banking subsidiaries, FBB and FBB-Milwaukee. All of our operations are conducted through the Banks and certain subsidiaries of FBB. We operate as a business bank focusing on delivering a full line of commercial banking products and services tailored to meet the specific needs of small- and medium-sized businesses, business owners, executives, professionals and high net worth individuals. Products include commercial lending, asset-based lending, equipment financing, factoring, trust and investment services, treasury management services and a broad range of deposit products. We do not utilize a branch network to attract retail clients. Our operating philosophy is focused on local decision-making and local client service from each of our primary banking locations in Madison, Brookfield and Appleton, Wisconsin combined with the efficiency of centralized administrative functions such as support for information technology, loan and deposit operations, finance and accounting and human resources. We believe we have a unique niche business banking model and we consistently operate within this niche. This allows us to provide a great deal of expertise in offering financial solutions to our clients with an experienced staff who serve our clients on an ongoing basis.
Our 2013 strategic initiatives included, but were not limited to, maintaining strong asset quality as well as increasing full-service banking relationships with commercial and industrial clients in order to increase our in-market deposits, enhancing our loan and lease portfolio and growing our non-interest income. We have achieved success on all points of this strategic plan by posting record net income and record pre-tax adjusted earnings while continuing to grow the balance sheet, maintaining strong asset quality, and improving our overall operating efficiency. In 2014, we plan to continue to diligently focus on maintaining asset quality, increasing the number and volume of transaction accounts in an effort to support ongoing efforts to increase fee revenue associated with treasury management services and maintaining our efficiency ratio. We believe this strategy will create opportunities to capitalize on economic expansion as well as any current disruption to our competitors' businesses in our core Wisconsin markets. We continue to believe significant opportunity remains for this type of organic growth in our commercial business lines, particularly within our Milwaukee and Northeast Wisconsin markets.


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OPERATIONAL HIGHLIGHTS

Our total assets increased to $1.269 billion as of December 31, 2013, a 3.5% increase from $1.226 billion at December 31, 2012.

Net income for the year ended December 31, 2013 was a record $13.7 million, 54.0% higher than the previous record of $8.9 million earned for the year ended December 31, 2012.

Diluted earnings per common share were $3.49 for the year ended December 31, 2013 compared to $3.29 earned in the prior year.

Net interest margin was 3.54% for the year ended December 31, 2013, improving 18 basis points compared to the year ended December 31, 2012.

Top line revenue, which consists of net interest income and non-interest income, of $50.5 million for the year ended December 31, 2013 increased 8.5% compared to $46.6 million for the same period in 2012.

Return on average assets and return on average equity for the year ended December 31, 2013 were 1.10% and 13.12% respectively, compared to 0.75% and 12.65% for 2012.

Pre-tax adjusted earnings, defined as pre-tax income excluding the effects of provision for loan and lease losses, other identifiable costs of credit and other discrete items unrelated to our primary business activities, increased 15.4% to a record level of $21.4 million for the year ended December 31, 2013 as compared to $18.5 million for the year ended December 31, 2012.

We recorded a negative $959,000 provision for loan and lease losses for the year ended December 31, 2013 as compared to an expense of $4.2 million for the year ended December 31, 2012.

Net loans and leases at December 31, 2013 increased $70.5 million, or 7.9%, to $967.1 million from $896.6 million as of December 31, 2012.

Non-performing assets were $16.2 million and 1.28% of total assets as of December 31, 2013, compared to $15.7 million and 1.28% as of December 31, 2012.

Net charge-offs as a percentage of average loans was 0.06% for the year ended December 31, 2013 compared to 0.35% for the year ended December 31, 2012.

Trust assets under management and administration as of December 31, 2013 were a record $959.0 million, an increase of $174.7 million, or 22%, from December 31, 2012.

Average in-market deposits of $712.3 million, or 64.4% of total deposits, for the year ended December 31, 2013 increased 9.8%, compared to $649.0 million, or 61.8% of total deposits, for the same period in 2012.

During the fourth quarter of 2013 we donated $1.3 million to the First Business Charitable Foundation ("the Foundation"), establishing an endowment for charitable giving in our markets.

                              RESULTS OF OPERATION

Top Line Revenue
Top line revenue is comprised of net interest income and non-interest income.
This measurement is also commonly referred to as operating revenue. In 2013, top
line revenue increased by approximately 8.5% from the prior year. The components
of top line revenue were as follows:

                               For the Year Ended December 31,
                                  2013              2012      Change
                                    (Dollars In Thousands)
Net interest income      $     42,105             $ 37,881    11.2  %
Non-interest income             8,442                8,699    (3.0 )
Total top line revenue   $     50,547             $ 46,580     8.5


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Pre-Tax Adjusted Earnings

Pre-tax adjusted earnings is comprised of our pre-tax income adding back (1) our provision for loan and leases losses, (2) other identifiable costs of credit and
(3) other discrete items that are unrelated to our primary business activities. In our judgment, the presentation of pre-tax adjusted earnings allows our management team, investors and analysts to better assess the growth of our business by removing the volatility that is associated with costs of credit and other discrete items and facilitates a more streamlined comparison of growth to our benchmark peers. Pre-tax adjusted earnings is a non-GAAP financial measure that does not represent and should not be considered as an alternative to net income derived in accordance with GAAP. Our pre-tax adjusted earnings metric improved by 15.4% when comparing the year ended December 31, 2013 to the year ended December 31, 2012.

                                                            For the Year Ended December 31,
                                                         2013               2012          Change
                                                                (Dollars in Thousands)
Net income before taxes                             $     21,135       $     13,676          54.5 %
Add back:
Provision for loan and lease losses                         (959 )            4,243            NM
Net (gain) loss on foreclosed properties                    (117 )              585            NM
Endowment to First Business Charitable Foundation          1,300                  -            NM
Pre-tax adjusted earnings                           $     21,359       $     18,504          15.4

NM = Not meaningful
Return on Average Assets and Return on Average Equity Return on average assets ("ROAA") was 1.10% for the year ended December 31, 2013 compared to 0.75% for the year ended December 31, 2012. The increase in ROAA was primarily due to the improvement in net income. Net income increased 54.0% year over year, primarily due to improved net interest income and negative provision for loan and lease losses, which reflects continued overall asset quality improvement. ROAA is a critical metric used by us to measure the profitability of our organization and how efficiently our assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures.
Return on average equity ("ROAE") for the year ended December 31, 2013 was 13.12% compared to 12.65% for the year ended December 31, 2012. ROAE increased as a result of improved net income outpacing the increase in our growth in average equity. In December 2012, we successfully raised $29.1 million through the issuance and sale of 1,265,000 common shares at $23.00 per share. The $27.1 million of net proceeds was used to immediately repay a portion of our outstanding subordinated debt and increased our overall equity levels. In spite of the increase in our average equity due to this, 2013's ROAE was greater than 2012. We view ROAE as an important measurement for monitoring profitability, and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses and minimizing our costs of credit.
Net Interest Income
Net interest income levels depend on the amounts of and yields on interest-earning assets as compared to the amounts of and rates paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management processes to prepare for and respond to such changes. The table on the next page shows our average balances, interest, average rates, net interest margin and the spread between combined average rates earned on our interest-earning assets and cost of interest-bearing liabilities for the periods indicated. The average balances are derived from average daily balances.


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                                                                    For the Year Ended December 31,
                                         2013                                     2012                                     2011
                                                      Average                                  Average                                  Average
                           Average                     yield/       Average                     yield/       Average                     yield/
                           balance       Interest       cost        balance       Interest       cost        balance       Interest       cost
                                                                         (Dollars In Thousands)
Interest-earning
assets
Commercial real
estate and other
mortgage loans(1)       $   633,605     $  32,021       5.05 %   $   583,594     $  31,667       5.43 %   $   608,665     $  33,192       5.45 %
Commercial and
industrial loans(1)         268,376        16,739       6.24 %       245,706        17,916       7.29 %       219,754        16,959       7.72 %
Direct financing
leases(1)                    17,413           844       4.85 %        15,873           888       5.59 %        16,974         1,039       6.12 %
Consumer and other
loans(1)                     16,446           634       3.86 %        16,899           654       3.87 %        18,591           742       3.99 %
Total loans and
leases receivable(1)        935,840        50,238       5.37 %       862,072        51,125       5.93 %       863,984        51,932       6.01 %
Mortgage-related
securities(2)               159,188         2,841       1.78 %       171,043         3,168       1.85 %       162,817         4,156       2.55 %
Other investment
securities(3)                33,990           474       1.39 %        17,532           249       1.42 %           410            10       2.36 %
FHLB stock                    1,402             4       0.29 %         1,537             4       0.28 %         2,367             2       0.10 %
Short-term
investments                  59,737           253       0.42 %        74,493           220       0.30 %        48,395           117       0.24 %
Total
interest-earning
assets                    1,190,157        53,810       4.52 %     1,126,677        54,766       4.86 %     1,077,973        56,217       5.22 %
Non-interest-earning
assets                       58,536                                   56,313                                   51,078
Total assets            $ 1,248,693                              $ 1,182,990                              $ 1,129,051
Interest-bearing
liabilities
Transaction accounts    $    62,578           126       0.20 %   $    34,180            94       0.28 %   $    25,389            70       0.28 %
Money market                450,558         2,398       0.53 %       395,259         3,023       0.76 %       300,652         2,971       0.99 %
Certificates of
deposit                      60,276           611       1.01 %        82,430           968       1.17 %        80,323         1,108       1.38 %
Brokered certificates
of deposit                  393,726         6,604       1.68 %       400,695         8,941       2.23 %       486,594        12,966       2.66 %
Total
interest-bearing
deposits                    967,138         9,739       1.01 %       912,564        13,026       1.43 %       892,958        17,115       1.92 %
FHLB advances                 6,471            13       0.19 %         2,034            32       1.59 %           656            38       5.83 %
Other borrowings             12,196           842       6.90 %        39,384         2,712       6.89 %        41,488         2,491       6.00 %
Junior subordinated
notes                        10,315         1,111      10.78 %        10,315         1,115      10.81 %        10,315         1,112      10.78 %
Total
interest-bearing
liabilities                 996,120        11,705       1.18 %       964,297        16,885       1.75 %       945,417        20,756       2.20 %
Non-interest-bearing
demand deposit
accounts                    138,920                                  137,117                                  112,899
Other
non-interest-bearing
liabilities                   8,909                                   11,019                                   10,674
Total liabilities         1,143,949                                1,112,433                                1,068,990
Stockholders' equity        104,744                                   70,557                                   60,061
Total liabilities and
stockholders' equity    $ 1,248,693                              $ 1,182,990                              $ 1,129,051
Net interest income                     $  42,105                                $  37,881                                $  35,461
Net interest spread                                     3.34 %                                   3.11 %                                   3.02 %
Net interest-earning
assets                  $   194,037                              $   162,380                                  132,556
Net interest margin                                     3.54 %                                   3.36 %                                   3.29 %
Average
interest-earning
assets to average
interest-bearing
liabilities                  119.48 %                                 116.84 %                                 114.02 %
Return on average
assets                         1.10 %                                   0.75 %                                   0.75 %
Return on average
equity                        13.12 %                                  12.65 %                                  14.03 %
Average equity to
average assets                 8.39 %                                   5.96 %                                   5.32 %
Non-interest expense
to average assets              2.43 %                                   2.42 %                                   2.34 %

(1) The average balances of loans and leases include non-performing loans and leases. Interest income related to non-performing loans and leases is recognized when collected.

(2) Includes amortized cost basis of assets available for sale.

(3) Yields on tax-exempt municipal obligations are not presented on a tax-equivalent basis in this table.


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The following table provides information with respect to (1) the change in interest income attributable to changes in rate (changes in rate multiplied by prior volume), (2) the change in interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (3) the change in rate/volume (changes in rate multiplied by changes in volume) for the year ended December 31, 2013 compared to the year ended December 31, 2012 and for the year ended December 31, 2012 compared to the year ended December 31, 2011.

                              Rate/Volume Analysis

                                              Increase (Decrease) for the Year Ended December 31,
                                     2013 compared to 2012                           2012 compared to 2011
                                                   Rate/                                           Rate/
                            Rate       Volume      Volume       Net        Rate        Volume      Volume       Net
                                                                 (In Thousands)
Interest-earning
assets
Commercial real estate
and other mortgage
loans                    $ (2,173 )   $ 2,714     $ (187 )   $   354     $  (165 )   $ (1,367 )   $    7     $ (1,525 )
Commercial and
industrial loans           (2,591 )     1,653       (239 )    (1,177 )      (935 )      2,003       (111 )        957
Direct financing
leases                       (119 )        86        (11 )       (44 )       (89 )        (67 )        5         (151 )
Consumer and other
loans                          (3 )       (18 )        1         (20 )       (23 )        (68 )        3          (88 )
Total loans and leases
receivable                 (4,886 )     4,435       (436 )      (887 )    (1,212 )        501        (96 )       (807 )
Mortgage-related
securities                   (117 )      (220 )       10        (327 )    (1,140 )        210        (58 )       (988 )
Other investment
securities                     (5 )       234         (4 )       225          (4 )        418       (175 )        239
FHLB Stock                      -           -          -           -           4           (1 )       (1 )          2
Short-term investments         94         (44 )      (17 )        33          26           63         14          103
Total net change in
income on
interest-earning
assets                     (4,914 )     4,405       (447 )      (956 )    (2,326 )      1,191       (316 )     (1,451 )
Interest-bearing
liabilities
Transaction accounts          (25 )        78        (21 )        32           -           24          -           24
Money market                 (919 )       423       (129 )      (625 )      (672 )        935       (211 )         52
Certificates of
deposit                      (132 )      (260 )       35        (357 )      (165 )         29         (4 )       (140 )
Brokered certificates
of deposit                 (2,220 )      (156 )       39      (2,337 )    (2,108 )     (2,289 )      372       (4,025 )
Total deposits             (3,296 )        85        (76 )    (3,287 )    (2,945 )     (1,301 )      157       (4,089 )
FHLB advances                 (28 )        70        (61 )       (19 )       (28 )         80        (58 )         (6 )
Other borrowings                4      (1,872 )       (2 )    (1,870 )       366         (126 )      (19 )        221
Junior subordinated
notes                           -           -         (4 )        (4 )         3            -          -            3
Total net change in
expense on
interest-bearing
liabilities                (3,320 )    (1,717 )     (143 )    (5,180 )    (2,604 )     (1,347 )       80       (3,871 )
Net change in net
interest income          $ (1,594 )   $ 6,122     $ (304 )   $ 4,224     $   278     $  2,538     $ (396 )   $  2,420

Net interest income increased by $4.2 million, or 11.2%, for the year ended December 31, 2013 compared to the same period in 2012. The increase in net interest income during the year was primarily attributable to favorable rate variances from lower cost brokered certificates of deposit, lower cost money market deposits and favorable volume-related variances due to the paydown of other borrowings, partially offset by an overall unfavorable variance affiliated with the decline in interest income on the loan and lease portfolio. The yield on average earning assets for the year ended December 31, 2013 was 4.52% compared to 4.86% for the year ended December 31, 2012. The decline in the yield on average earning assets was related to the overall decline in the yield on the loan and lease portfolio which declined 56 basis points to 5.37% for the year ended December 31, 2013 from 5.93% for the year ended December 31, 2012. A significant portion of the commercial real estate portfolio is comprised of fixed rate loans with terms generally up to five years. As these loans reached their maturity in 2013 and 2012 they were renewed at current market rates, which were generally lower than the original rate of the loan, and subject to competitive pricing pressures. As a result, the overall yield on the commercial real estate portfolio continued to decline in 2013. The marketplace for commercial and industrial loans also continues to be subject to competitive pressures, contributing to the decline in yield on this portfolio. Irregular prepayment activity and the associated fees collected in lieu of interest partially offset the decline in yields. Growth within the overall loan


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and lease portfolio has partially offset the decline in interest income caused by the declining yields on the loan and lease portfolio.
Over the course of 2013, we were successful in reducing the average balance of excess cash held in our account at the Federal Reserve Bank. Excess cash was utilized to fund loan and lease growth, invest in agency and other investment securities, increase our holdings of commercial paper, and repay maturing brokered certificates of deposit. The average balance of the short-term investment portfolio was $59.7 million with a yield of 0.42% for the year ended December 31, 2013 as compared to the $74.5 million with a yield of 0.30% for the year ended December 31, 2012. As we strive to reduce on-balance-sheet liquidity to target levels, we may on occasion use other sources available to us to fund asset growth. Other sources may include temporary use of FHLB short-term advances and orderly issuance of long-term brokered certificates of deposit designed to mitigate interest rate risk as we provide fixed rate loan alternatives to our clients. The improvement in yield in our short-term investments was related to the purchase in 2013 of additional commercial paper and brokered certificates of deposits from other issuers with yields in excess of the target fed funds rate.
The overall weighted average rate paid on interest-bearing liabilities was 1.18% for the year ended December 31, 2013, a decrease of 57 basis points from 1.75% for the year ended December 31, 2012. The decrease in the overall rate on the interest-bearing liabilities was primarily caused by the replacement of certain maturing certificates of deposit, principally brokered certificates of deposit, at lower current market rates, lower rates paid on our money market accounts and favorable volume-related variances due to paydown of other borrowings. The continued low rate environment combined with the maturity structure of our brokered certificates of deposit provided us the opportunity to be able to manage our liability structure in both maturity terms and rate to deliver an enhanced net interest margin during 2013 relative to 2012. Further, our continued success of attracting in-market deposits through new business relationships and increased client deposit balances contributed to the overall decline in our cost of funds. Average in-market client deposits - comprised of all transaction accounts, money market accounts, and non-brokered certificates of deposit - increased 9.8% to $712.3 million for the year ended December 31, 2013 from $649.0 million for the year ended December 31, 2012. Correspondingly, we also continued to reduce our overall reliance on higher-cost brokered certificates of deposit by $7.0 million, or 1.7%, lowering average balances to $393.7 million for the year ended December 31, 2013 from $400.7 million for the year ended December 31, 2012 . Applying the net proceeds of our December 2012 common stock offering to repay approximately $27.1 million of our subordinated . . .

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