Detailed Narrative
Strategic Exit from National SBA 7(a) Lending
First Business Financial Services announced its exit from national out-of-footprint SBA 7(a) lending activities at the end of May. This decision was driven by an inability to achieve internal volume and profitability targets due to a mismatch between industry underwriting standards and the bank's credit quality requirements, leading to high processing costs. The move is expected to be immediately net positive to earnings expectations, freeing up management capacity to focus on more profitable growth opportunities within existing bank markets and higher-yielding niche C&I lending.
Strong Balance Sheet Growth and Asset Quality
The bank achieved strong balance sheet growth, with loans increasing 10% annualized during the quarter, or 7.2% excluding the transfer of $23.7 million in SBA 7(a) loans from held-for-sale. Year-to-date, loans were up 12.6% annualized, positioning the bank to meet its 10% annual growth target. Core deposit growth outpaced loan growth, rising 12% annualized in Q2, following 18% growth in Q1. Asset quality remained stable, with nonperforming assets declining during the quarter, and management expects to resolve its two largest nonperforming assets later in the year.
Diversified Fee Income and Private Wealth Momentum
Fee income grew 18% year-over-year in Q2, even with the absence of SBA gain on sale revenue. Private Wealth was a significant contributor, generating record revenues and increasing $509,000 or nearly 14% year-over-year. The Private Wealth team added $508 million in assets under management and administration over the past year, with approximately 70% from new client dollars. Growth in income from limited partnership investments also contributed to strong fee revenue, reaching $796,000 for the quarter.
Net Interest Margin Dynamics and Prepayment Fees
Net interest margin (NIM) increased 22 basis points to 3.78% in Q2 from 3.56% in Q1. The Q1 NIM, adjusted for fewer accrual days, was 3.61%. The improvement was primarily driven by the deployment of excess cash into loan growth and an increase in prepayment fees. Prepayment fees totaled $1.3 million in Q2, up from $642,000 in Q1, contributing 37 basis points to NIM. Management expects prepayment fees to remain elevated in Q3 but slow in H2, and targets a full-year NIM of 3.60% to 3.65%.
Expense Management and Operating Leverage
Total compensation expense decreased by $79,000 from Q1, benefiting from SBA-related cost savings, though partially offset by increased annual cash bonus accruals and SBA severance costs. On an operating basis, noninterest expense declined almost 1% to $26.9 million. The bank achieved operating leverage of 6.2% compared to the linked quarter and 6.4% compared to the prior year quarter, supporting a strong efficiency ratio of 59.31% for the first half of the year. Management aims for annual expense growth modestly below 10% annual revenue growth.
Capital Position and Deployment Strategy
The bank maintains a strong capital position, with its CET1 ratio exceeding the 9.5% internal target and total capital ratio above the 12% internal target. This provides flexibility for capital deployment, with the primary priority being investment in the business to support organic growth. Share repurchases, under the $5 million authorization, remain an attractive tool to return capital and enhance shareholder value when prudent growth opportunities do not fully utilize excess capital.