Q3 2024 First Business Financial Services Inc Earnings Call
Speaker Change: Please stand by. We're about to begin.
Speaker Change: Good afternoon and welcome to the first business financial services third quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. After today's presentation, there will be an opportunity to ask questions.
Speaker Change: Please note, this event is being recorded.
Speaker Change: I would now like to turn the conference over to First Business Financial Services Inc. CEO, Cory Chambers, please go ahead. Good afternoon everyone. Today marks our first quarterly earnings call and we appreciate your time and interest in First Business Bank.
Speaker Change: Joining me today is our president and chief operating officer Dave Siler and our CFO Brian Spilman.
Speaker Change: Today we'll discuss our financial performance, operational highlights and strategic initiatives, followed by Q&A session.
Speaker Change: I'd like to direct you to our third quarter earnings release and investor presentation, which are available through our website at IR.FirstBusiness.Bank. We encourage you to review these alongside our other investor materials.
Speaker Change: Before we begin, please note this call may include forward-looking statements and the company's actual results may differ materially from those indicated in any forward-looking statements.
Speaker Change: In important factors that could cause actual results to differ materially from those indicated in the forward-looking statements are listed in earnings release.
Speaker Change: And on the company's most recent and your report, Form 10K, as may be supplemented from time to time in the company's other filings with SEC, all of which are expressly incorporated herein by reference.
Speaker Change: There you can also find information related to any non-gap financial measures we discuss on today's call, including reconfiliations of such measures.
Speaker Change: We are pleased to report a very solid third quarter. Our operating model did what we built it to do and produced strong loan and deposit growth.
Speaker Change: A stable, net interest margin and outstanding asset quality, all of which contributed to healthy earnings on both a pre-tax pre-provision basis and at the bottom line. Most importantly, we saw continued growth and tangible book value per share.
Speaker Change: There are some moving parts in the financials that Brian will walk through in a moment.
Speaker Change: Since this is our first earnings call, we wanted to take a few minutes to walk you through our model and our strategic plan, which is the driving force behind the consistent results we've been able to produce.
Speaker Change: I'll review our plan at the end of our remarks before opening it up to questions. Now I'll ask Dave Siler to spend a few minutes on the activity we saw in our markets and products during the quarter. Dave?
Dave Siler: Thanks, Corey. One reason we wanted to host an earnings call is to offer commentary on our markets and businesses and the dynamics driving our performance from a day-to-day business perspective.
Dave Siler: You saw in our press release that our loan and deposit growth has been solid. Loan balances grew approximately $286 million over the same period last year, up more than 10 percent, which is our long-term organic growth goal.
Dave Siler: Deposits grew $313 million, or nearly 12% from third quarter last year. This is a testament to our strong client relationships.
Dave Siler: We operate four distinct markets, South Central Wisconsin, Southeast Wisconsin, Northeast Wisconsin, and Kansas City. Each market operates under the guidance of a regional president.
Dave Siler: Consistent with our trends over the past several years, our south-central Wisconsin and southeast Wisconsin markets led the way with strong loan growth during the quarter.
Dave Siler: In our Kansas City market, we are excited to have a new regional president in place. Since he joined us in April this year, we have been able to hire two new bankers and we are already seeing loan growth in the market.
Dave Siler: We are also pleased to have an internal successor as our new market president in our Northeast Wisconsin region, which is headquartered in Appleton, Wisconsin.
Dave Siler: You can see our CNI and CRE breakouts in the earnings release and investor presentation. I want to take a minute to answer a question that I know we'll get.
Dave Siler: As an active CRE lender, we are often asked about asset quality in our office portfolio.
Dave Siler: We simply don't have any areas of concern there primarily due to the location of the properties, loan structures, and strength of the sponsors.
Dave Siler: On slide 36 of our investor presentation, you can see our office portfolio breakdown, and you'll see that we have no non-performing loans in the portfolio, and almost 90% of our office credits have recourse.
Dave Siler: The properties we lend against are predominantly in suburban locations in strong markets, which have not experienced the vacancy issues that have plagued large downtown metropolitan areas.
Dave Siler: As part of our CNI offerings, we have niche lending areas that operate nationally. The product offerings that make up this part of our business contribute to our loan portfolio's diversification in terms of credit type and geography, as well as to the diversification of our revenue streams.
Dave Siler: All these niche CNI lending areas have specialized bankers with deep expertise, and they utilize specialized platforms to manage the portfolios.
Dave Siler: I have a few comments on several niche areas that were notable this quarter.
Dave Siler: Our small-ticket vendor finance business continues to show nice growth at attractive spreads, and we recently hired two more experienced business developers.
Dave Siler: As previously disclosed, we continue to see weakness in the transportation sector of the equipment finance portfolio.
Dave Siler: We currently have 46 million of transportation loans in this portfolio, down from 61 million at the start of the year.
Dave Siler: This business stopped lending to the transportation sector in the first quarter of 2023, and the remaining transportation loans in the portfolio have an average remaining life of 35 months.
Dave Siler: Based on what we are seeing today, with low spot rates for trucking and depressed equipment values, we expect the credit impact of this portfolio to be in line with the past several quarters for the foreseeable future.
Dave Siler: The non-transportation portion of the equipment finance portfolio has performed better than our expectations.
Dave Siler: Our accounts receivable financing or factoring business also showed nice growth in Q3. We have been able to generate good activity through our business development officers, several referral channels, and pay-per-click marketing efforts.
Dave Siler: Our floor plan financing business, which finances the purchase of automobiles for larger, financially strong used car dealerships, has shown the strongest growth among our niche C&I lending areas year to date.
Dave Siler: The credit performance of this business has been outstanding since its inception in 2020.
Dave Siler: Our SBA team generated gain on sale revenue of $460,000 during the quarter, which although an increase over the two previous quarters, is still below our expectations.
Dave Siler: Although gain amounts can vary quarter over quarter, we expect gains to increase in future quarters.
Dave Siler: Reasons for our optimism include that we hired a new leader for this team in March of 2023 who has rebuilt our sales team, which now stands at eight business development officers.
Dave Siler: With this expanded team, we are seeing our pipelines improve. Additionally, our loan mix has changed and we are now closing more loans that have a construction component.
Dave Siler: These loans need to complete construction and fully fund before they are eligible for sale. We currently have over 19 million of closed loans in this category.
Dave Siler: One final note on our loan growth. The double digit growth we've been able to achieve is driven by our ability to main teams of quality bankers who outperform our competition by providing exceptional service and developing lasting relationships.
Dave Siler: Having the best teams allows us to maintain our underwriting standards and continue to grow faster than our competitors.
Dave Siler: It's highly competitive in our markets and we're winning clients who want the best partner to help them navigate the challenges and opportunities that lie ahead.
Dave Siler: This is also evident in our deposit activity. Over the past two quarters, we have been successful in managing down some of the higher priced deposits that we had due to individualized pricing in recent quarters.
Dave Siler: Despite that, we grew core deposits more than $193 million, or 9% from a year ago.
Dave Siler: Our pricing initiatives and commitment to high-quality growth have supported our goal to maintain a stable net interest margin in the range of 360 to 365 basis points.
Dave Siler: We've accomplished this in a period of intense competition, and we believe this speaks to the quality of our relationships.
Dave Siler: One more area I'd like to quickly draw your attention to is private wealth management.
Dave Siler: We grew private wealth assets under management and administration to $3.4 billion at the end of the quarter.
Dave Siler: This marked growth of 17% from the prior year, generating $3.3 million in fee income for the quarter, which was up 11% from the third quarter of last year.
Dave Siler: This business tends to fly under the radar of investors and analysts, but its importance to our model is certainly noteworthy.
Dave Siler: Private wealth management is a natural area of growth for us given our business-only banking model and the overlapping business and personal needs of our clients.
Dave Siler: We believe this is a differentiated strength of our company for both clients and investors alike. Currently, the majority of our private wealth relationships are in the South Central market, and we see meaningful opportunities to expand this business into our other geographic markets.
Speaker Change: I'll wrap up and reiterate Corey's message that our bankers are hard at work executing our strategic initiatives, motivated by incentives that are linked to our goals. They are delivering a superior client experience, driving loan and deposit growth, and upholding our asset quality.
Speaker Change: Now I'll hand it off to Brian.
Brian Spilman: Thanks, Dave. I'll go a little deeper into our financial highlights for the third quarter.
Brian Spilman: As Dave mentioned, our ability to produce net interest margin that is strong and stable compared to peers contributed to our solid performance.
Brian Spilman: In addition to successfully managing rates on both sides of the balance sheet, before and after the Fed's 50 basis point rate cut, we believe our differentiated match funding strategy and relatively neutral balance sheet sensitivity continues to set us apart in the industry.
Brian Spilman: I want to provide a little more detail on our Adjustment Interest Margin, which we also refer to as Core Margin.
Brian Spilman: We distinguish between NIM and core margin because we recognize the significant and recurring but variable amount of interest income from items like prepayment fees.
Brian Spilman: And that's the base loan fees, which we refer to as fees in lieu of interest.
Brian Spilman: by stripping these out from reported MIM.
Brian Spilman: We believe our core margin reflects more accurate representation of our client-facing loan and deposit rate changes.
Brian Spilman: Adjusted NIM for the third quarter is $351, compared to $347 in the late quarter.
Brian Spilman: This compares to reported NIMA 364 in the third quarter and 365 in the late quarter.
Brian Spilman: The majority of the adjusted NIM benefit in the quarter came from the loan portfolio.
Brian Spilman: Additionally, our ability to start reducing deposit rates helped offset some temporary short-term wholesale funding costs.
Brian Spilman: I'll note that since we are generally interest rate neutral, we wouldn't expect to see a meaningful change in our margin due to the recent and anticipated rate cuts by the Fed.
Brian Spilman: Our long-term target for NIM is 360 to 365, so we are comfortable operating where we currently are. But especially we'll see some movement as we diligently work to fund our loan growth, core deposits in the current dynamic rate environment.
Brian Spilman: For more insight into our approach to interest rate risk management, we've added slide 14 in our investor presentation.
Brian Spilman: You'll see that we've outlined our strategy and the components of our current balance sheet positioning.
Speaker Change: I'm looking at income and expense.
Speaker Change: I point out that our diversified sources of fear have a built-in variability.
Speaker Change: I'll reiterate our longstanding position that we manage the positive long-term operating leverage, but we also manage the long-term growth in fee income.
Speaker Change: Quarter-to-quarter variances are generally smoothed over a longer horizon.
Speaker Change: There are a few moving parts to review this quarter.
Speaker Change: On non-interest income, as Dave discussed, SBA loan sale gains experienced growth and benefited from new leadership in the business that is beginning to deliver on production goals.
Speaker Change: We expect to see continued growth in these pipelines over time.
Speaker Change: Variability in slot fees and returns on SBIC mezzanine funds are expected and moved in opposite directions this quarter.
Speaker Change: Our slot fee income will continue to vary quarterly based on CRE activity, the rate environment, and client preference.
Speaker Change: SBIC mezzanine fee income is driven by interest income in the portfolio and unrealized and realized gains.
Speaker Change: Well, they experienced a stronger year in 2023 for Realized Games.
Speaker Change: 2024 was slower and more reliant on interest income only as the funds continued to invest in new companies.
Speaker Change: We believe realized gains will pick up again in 2025 as existing funds mature and we invest in new funds.
Speaker Change: Our overall decline in expenses during the quarter was mainly driven by two items.
Speaker Change: The first was our bonus and profit sharing accrual, which was adjusted down by approximately $400,000 to reflect updated four-year performance expectations in relation to our internal targets.
Speaker Change: In addition, the capital has a higher level of cost related to an internal software development project.
Speaker Change: This amounted to approximately $300,000.
Speaker Change: At a current expected level of incentives and after I didn't back these two adjustments.
Speaker Change: We anticipate overall compensation costs will stay at this approximate level for the rest of the year.
Speaker Change: We're pleased to report that we've produced positive operating leverage compared to the prior period, even after adjusting for these various compensation adjustments.
Speaker Change: Next, Texas.
Speaker Change: We utilize federal tax credit projects to improve the communities we serve and to lower our overall effective tax rate over time.
Speaker Change: The tax rate for the nine months ended September 30th, 2024 was 16.8% and in line with our expected full year 2024 effective tax rate of 16% to 18%.
Speaker Change: This is, of course, subject to change based on the timing of tax credit projects.
Speaker Change: The effective tax rate is down from 21.4% for the same period in 2023.
Speaker Change: to the benefit of Wisconsin's Small Business London Law.
Speaker Change: Given our tax credit pipeline and continued expectation of no Wisconsin state income tax liability, we believe our effective tax rate of 16% to 80% will continue in 2025.
Speaker Change: Thank you.
Speaker Change: I'm happy to report our bottom line profitability metrics show positive trends, reflecting our strong execution and efficient use of capital.
Speaker Change: return average tangible common equity expanded, and tangible book value per share grew by 9.7% annualized from the late quarter, and 12.5% from the prior quarter, in line with our 10% plus long-term goals.
Speaker Change: We also benefited from the issuance of $20 million in sub debt near the end of the quarter.
Speaker Change: which boosted Tier 2 capital and increased our total capital ratio by 15 basis points, all of us equal.
Speaker Change: Let's replace $15 million of subdebt we redeemed in the quarter to maintain full tier two capital treatment.
Speaker Change: We feel good about our capital levels and our stronger aims are generating capital to facilitate our expected organic growth.
Speaker Change: Now I'll hand it back over to Corey.
Corey: Thank you, Brian.
Corey: As promised, I want to report on our strategic plan for 2024 to 2028, which is well underway.
Corey: If you're new to FBIZ, understanding our strategic plan and the process that shapes it provides important insight into our success.
Corey: We take strategic planning very seriously. We operate a five-year plan and we spend a full year developing each plan. We kicked off our current plan in January of this year. You can see our strategies and the goals we use as a measure of success on slide seven and eight of our investor presentation.
Corey: Our overriding objective is to foster innovative and engaged team members who develop deep client relationships and deliver exceptional results for all stakeholders.
Corey: This isn't just lip service. We have specific strategies and tactics in place to accomplish this. These include initiatives to protect and strengthen our culture. While our culture has always been a strength and a differentiator,
Corey: Given the increasing geographic spread and remote nature of our team, we want to double down on our efforts.
Corey: Some things we are doing to promote a strong, inclusive, and solutions-oriented culture include sharing departmental best practices for leading remote and hybrid work teams and providing additional manager training on how to model and coach to our culture.
Corey: We measure our progress through anonymous third-party surveys to determine employee engagement, manager effectiveness, and belonging scores, and we expect exceptional results.
Corey: This goes hand in hand with our continued focus on future ready talent.
Corey: We need to retain and continuously invest in the development of our top-notch team and we want to attract the best talent around to enable our ambitious organic growth plans. To do this, we are focused on the future, asking ourselves what does the workplace of the future require for success?
Corey: AI training is an example of something we're doing to improve our workplace preparedness for tomorrow. Employee education and training have always been a focus, but we believe the pace of change of technology advancement will make this even more critical, and enabling our employees to effectively use AI tools can be a competitive advantage.
Corey: Of course, we are in the business of banking, so a big focus for us is growing core deposits.
Speaker Change: Those of you familiar with FBIZ know we have a unique approach to funding. We don't operate a consumer business or branches. Instead, we develop deep business and private wealth relationships, drawing in deposits that are extremely sticky.
Speaker Change: as was proven in 2023 with our success in deposit retention and growth following the bank failures of early 2023.
Speaker Change: We aim to continue growing client-sourced deposits through a company-wide focus, adding treasury management talent, and by utilizing incentive programs to reward deposit growth more than loan growth.
Speaker Change: Improving operational efficiency and excellence is another important goal for us.
Speaker Change: Digital transformation and technology utilization are priorities and we are leveraging our talent by using robotic process automation and AI to enhance our productivity and client experience. As an example, we think robotic process automation is a game changer in terms of efficiently scaling for future growth.
Speaker Change: Recently, we brought our RPA efforts in-house by hiring our own team, including a manager and two developers.
Speaker Change: In addition, we have recently implemented automated financial statement spreading software to improve credit analysis efficiency.
Speaker Change: We believe these strategies will help us achieve our financial goals.
Speaker Change: We aim to produce tangible book value growth of 10% or more per year, along with return on average tangible common equity of 15% or more by 2028.
Speaker Change: We believe this will deliver on our ultimate goal to generate total shareholder returns that exceed our peer group median, a target we overachieved for the five years ended 2023.
Speaker Change: I want to note that our growth model works because of our deeply knowledgeable business experts who truly understand our clients' business needs.
Speaker Change: This allows us to form deep, long-term relationships with these clients, which is evidenced by our Net Promoter Score of 78, which is over twice the industry average. As a result of these relationships, the average tenure of our 50 largest depositors is approximately 15 years.
Speaker Change: Thank you.
Speaker Change: I'll offer a related anecdote. These banker-client relationships are deep in more ways than you might realize. You probably saw our 8K in late September announcing the completion of a $20 million sub-debt placement with certain accredited investors.
Speaker Change: Finally, I'll reiterate that our match funding strategy and growth model are doing the work they were designed to do, bringing stability to the areas where it is needed, like net interest margin, and bringing growth in key areas, including loans, deposits, and top line revenue.
Speaker Change: We have long been a 10% per year grower and we intend to continue that trend. I want to thank you for taking time to join us today. We're happy to take your questions now.
Speaker Change: That concludes today's prepared remarks and we will now open the floor for your questions. If you would like to ask a question, simply press star 1 on your telephone keypad. If at any point you find your question has been answered, you may remove yourself from the queue by pressing star 2.
Speaker Change: Once again, that is star 1 to ask a question and star 2 to remove yourself. We will pause for just a moment to allow our questions to queue.
Speaker Change: We'll hear first from Jeff Rulis with DA Davidson. Please go ahead.
Jeff Rulis: Thanks. Good afternoon, guys.
Jeff Rulis: Hey, Jeff. Nice work on the call so far. Question on the margin. Brian, do you have a September average for the margin?
Brian Spilman: No, we don't have that. We don't disclose that.
Jeff Rulis: I guess the follow-on is looking at the cost of funds, slide 45, still increasing but showed some deceleration. I guess any visibility on the peak there and the opportunity that you see on funding costs?
Jeff Rulis: Bye for now.
Brian Spilman: Yeah, I think we've been proactive in our efforts to reduce deposit costs. Like I said, we did some before the 50-base point rate cut and did more after, and we'll continue to evaluate those rates as we get closer to presumably another rate cut.
Speaker Change: And we think given our relationships, we have opportunity to continue moving those down and line with the asset side of our balance sheet. And then given the neutrality of our balance sheet, feel pretty comfortable continuing to operate in that 360 to 365 range.
Speaker Change: the customers that you approached was that more so the exception price folks that sort of understood that as you on the way up you adjusted and and and now re-approaching them or was it pretty broad-based in terms of lowering?
Speaker Change: It was a combination of both. There was a broad-based approach across the whole portfolio, and then also a little bit more surgical approach on the exception-rated individually-priced clients that we know we have strong relationships with and can have those conversations.
Speaker Change: Got it. Thanks a quick one on the on the expense side. I think you you've talked about the comp line reverting in the other portion that Is there any offset in that?
Speaker Change: And it looked like the...
Speaker Change: SBA recourse provision. Any thought on that? Maybe lowering going forward? Is that a pretty good run rate?
Speaker Change: Yeah, I think that's more of a non-recurring one-off that's just tied to some methodology that we have in place for our SBA lending, and we don't expect that to be a recurring at that level.
Speaker Change: Thanks for tuning in. I'm your host, Scott. We'll see you next time.
Speaker Change: Okay, and then just the last one, Corey, looking at slide 15.
Speaker Change: you talk about some of those strategic initiatives. I guess, if you could, which of those are maybe easier acquired than built out, if you handpick any ones that jump out to you?
Speaker Change: What slide are you on, Joe?
Corey: Slide 15 of the initiatives going forward in terms of.
Corey: Yeah, what are you thinking?
Speaker Change: Yeah, yeah, I would say well one that's well in motion is a robotic process automation because We mentioned that we brought the team in-house To do that, but we were already working on that prior with an outsource consultant. So we've been
Speaker Change: You know playing in this space for about a year plus now, so we have Think it's three bots in place and in two different areas. So that one is
Speaker Change: All right.
Speaker Change: I don't want to say easier, but it's already in motion. And so it's just a function of.
Speaker Change: continuing to find the highest and best paybacks on those.
Speaker Change: and tick them off with, it's really been great internally.
Speaker Change: The staff has embraced it, and I believe our treasury management team came to our
Speaker Change: Our technology folks and said we have like 12 use cases or something like that. And we're like, well,
Speaker Change: we only have one team let's uh we get we we gotta parse this out uh in an orderly fashion so so that one i feel really good about um at the
Speaker Change: The C&I lending, that just continues to go. That's been a role that we've been on, and it's always a challenge with our model on deposits, but we keep doing it year after year. So that will be forever a focus of ours.
Speaker Change: Okay. Thanks, Corey. I'll step back.
Speaker Change: Thank you.
Speaker Change: Next, we'll hear from Daniel Kameo with
Speaker Change: Hey guys, good afternoon.
Daniel Kameo: Yeah, maybe just one on the lending side. I know you guys reiterated your double-digit loan growth guidance, but just curious if you had any insight on kind of where you're seeing specific demand right now and kind of
Speaker Change: how we're thinking about what the mix could look like as we go into the next few quarters.
Speaker Change: I'll probably kick that over to Dave, Danny, but I guess big picture I would say, you know, mix probably more of the same as what we've seen, but specific between different pieces of what we do. Dave, do you want to touch on that?
Dave Siler: Sure. I think, you know, if you think about our niche CNI businesses, I think we've seen really nice demand and pipelines in our accounts receivable finance area.
Dave Siler: We had a fair amount of real estate growth, CRE growth, this quarter. A lot of that, I believe, was from construction loans funding up.
Dave Siler: We haven't added as many new CRE loans, I'd say, in the past six months due to interest rates. So, you know, if I would guess, I would say C&I might outpace CRE loans, you know, in the coming quarters.
Dave Siler: And, in terms of markets, we still see really nice growth in our southeast Wisconsin market, which is headquartered in Milwaukee, and I'd expect that to continue.
Speaker Change: Great, thanks for all that color Dave and Corey. And then maybe just to follow up on the credit side, you know, you guys did a good job of laying out the pressure on the over the road trucking, but the, or the transportation, but the.
Speaker Change: Just curious how you're thinking about overall net charge-offs in the next few quarters. I think you said similar pressure from the transportation side, but curious how you think that translates in terms of overall net charge-offs near-term.
Speaker Change: Yeah, I think it probably stays the same as to what we've been seeing lately. As we mentioned a few quarters ago, we knew as that
Speaker Change: transportation piece, our methodology is time-based in terms of reserving for those, so we were building the reserve for a while and then it started to flow through to
Speaker Change: to the charge-offs eventually when it hit a certain point in time. And that's how we've been seeing that for the last couple quarters.
Speaker Change: Okay great and I apologize if this was in the release or if you mentioned it but the specific reserves that you called out what were those related to?
Speaker Change: Equipment Finance, Small Ticket, Transportation Portfolio, and maybe a little bit of SBA but it's primarily Equipment Finance, Small Ticket.
Speaker Change: Okay. All right. Got it.
Speaker Change: All right, that's all I had. Thanks for taking my questions.
Speaker Change: Thanks, James.
Speaker Change: Next, we'll hear from Nathan Race with Piper Sandler. Please go ahead. Hey guys, good afternoon and thanks for hosting the call.
Speaker Change: I appreciate that you guys are still expecting to maintain the margin within the provided range. But just given the magnitude of the Fed rate cut last, I think it's a good idea to look at that. Thank you. Thank you.
Speaker Change: month and just, you know, the outlook for at least a couple more rate, excuse me, rate cuts.
Speaker Change: before your end. Just curious how you're thinking about the near-term margin trajectory, just going back to the earlier question around deposit cost reductions and what you have repricing on the in the loan portfolio.
Speaker Change: Yeah, I think I'll just reiterate I think we we believe we're we're comfortable and confident our ability to match the asset repricing side of the balance sheet on our existing book of business. The qualifier statement we've always been making is the competition and deposit growth.
Speaker Change: We know we value deposit volume, I'll say, more than we do the rate.
Speaker Change: if it's competitive. And so we'll continue to grow the balance sheet on the deposit side. And so that's where I think we'll see the pressure, if any, that would cause us to come out of that 360 to 365 range temporarily. Over the long term, we think given the match funding, we still have the ability.
Speaker Change: to manage to that along with the specialty finance C&I, higher C&I lending percentage of our loan portfolio.
Speaker Change: Okay, that's helpful. Thanks for that, Ryan.
Speaker Change: Just think about operating leverage.
Speaker Change: for next year you know obviously you guys are on pace to post pretty strong growth in pre-tax pre-provision areas this this year just curious how you're thinking about kind of the magnitude of the increase in
Speaker Change: pre-tax preprovisioned earnings next year with hopefully, you know, some moderation in upward deposit cost pressures, if not relief.
Speaker Change: Yeah we think about it in terms of our balance sheet growth again just kind of reiterating on the margin side of our ability to stabilize that and be stable there.
Speaker Change: We feel confident we can grow 10%.
Speaker Change: And then so if we're growing balance sheet 10%, revenue 10%, and driving some modest positive operating leverage, we feel confident in our ability to continue to drive that PPNR.
Speaker Change: at a similar rate.
Speaker Change: Yeah, and Nate, as you know, the biggest thing on the expense side is Tom.
Speaker Change: And, fortunately, a lot of the technology initiatives that we've been putting in place for the last several years
Speaker Change: across the company allow us to not have to add 10% headcount when we're growing 10% top line revenue.
Speaker Change: And I don't know what the exact numbers are, but they're well less than that. It's like 5% or so in terms of headcount. Maybe up only like 10 from a year ago. Yeah, so being able to add, we'll still be adding people, but not at a 10% clip. So if we can do that and wage increases aren't, you know, they've
Speaker Change: mitigated back down to reasonable numbers and so you know that's really the key in
Speaker Change: and generating that positive operating leverage, which we think is a real differentiator for us in terms of profitability and driving continued improvement and bottom line and in our efficiency ratio.
Speaker Change: One thing that I would add on that, in terms of the revenue side, we are seeing a little bit of a softer fee income year as we've spoken to, and so we have
Speaker Change: We're feeling very confident about our SBA pipelines, like we said, as well as what has typically been our recurring but variable items in SBIC, MES fund income. We're optimistic about that as they start to realize gains in the portfolio, and that's a strategy of ours to expand some of that, too.
Speaker Change: expand some of that investment as well. So we feel like some of these recurring, but historically variable fee income lines will begin to pick up and start to stabilize and show some more consistency, which we think really adds value to our PPE and our story.
Speaker Change: Yeah, for sure. That's helpful. Speaking of fee income, I was surprised that wealth management fees came down a little bit versus 2Q despite AUM increasing quarter over quarter.
Speaker Change: I think, Holly, you can shed on that and just kind of how you're thinking about wealth management growth into next year, assuming, you know, relatively stable equity markets.
Speaker Change: Yep, Q2 had some, I'll say, annual fees in there, some tax processing related fees that we'll typically see around that time of year, and so it wasn't unexpected to us that that came down a little bit, but to your point, strong asset center management growth in the quarter, which we feel will be realized here with a pickup in fee income in the fourth quarter and going forward.
Speaker Change: Yeah, it's been made in there, that.
Speaker Change: That one, obviously, you'd think there's just a lockstep correlation between assets under management and fee levels.
Speaker Change: And it's not, and a little bit of that is, if you smooth it out and you looked at a longer time period, it would be. But quarter to quarter, it's not because there's a little bit of lag in how we charge.
Speaker Change: And so quarter end.
Speaker Change: asset levels are the basis for fee income for the next quarter. So depending upon where you were the previous quarter can affect that current quarter being down compared to where you ended at the end of the quarter. So those two things can get off in a quarter but they will smooth out over a couple quarter time period.
Speaker Change: Thank you.
Speaker Change: Got it. That makes sense. I appreciate all the color. Thanks, guys. Yeah. You bet. Thanks, Dave.
Speaker Change: Our next question will come from the
Speaker Change: Hey, good afternoon guys. Hope you're all doing well today
Speaker Change: A lot of good questions have been...
Speaker Change: Great. A lot of good questions have been asked and answered, but I'm just kind of curious on the outlook for the reserve level. Corey, your comments, I believe it was Corey, about how you kind of build the reserves for the transportation sector and anticipation of them eventually
Speaker Change: being charged off down the road. So as we look at the reserve at, you know, call it 116 this quarter, like how much padding do you have built in there? Like what would be a more normalized reserve level once you've kind of worked through those problem loans?
Speaker Change: Yeah, thanks, Damon. You know, our take on that is that we have
Speaker Change: some elevated small ticket finance reserves, like you said, that we feel a little taper and moderate over time, along with then some credit normalization at some point, right? So we're really operating under an environment that where we're reserved now is a good place to be, and absent any broader macro events that would flow through the quantitative components of the model, that'll kind of stay.
Speaker Change: In that
Speaker Change: in that area for the foreseeable future.
Speaker Change: Got it. Okay, that's helpful. Thank you. And then with regards to expenses...
Speaker Change: as it relates to the investments in the AI training and the robotic process optimization. Is that kind of an ongoing expense that you guys deal with every quarter or is there kind of an upfront cost to get it going and then you don't really have to continue to invest in that?
Speaker Change: So that's that's a good question and part of what we were talking about and what happened in this quarter Is that that decrease in compensation was it's we have a much larger
Speaker Change: software development project going on related to a loan origination system and so that's what's causing that increase in capitalized expense.
Speaker Change: But going forward as we finish that project because we have our software developers on staff, our RPA developers on staff, we'll continue to have modules that we'll add to, maintenance that we'll do, so we'll continue to capitalize these compensation expenses through the software development. And so we'll have...
Speaker Change: Instead of an outsourced software development licensing cost, we'll have just a slight, moderate increase in computer software amortization over time as we continue to build out those systems and get the benefits of the operating efficiency.
Speaker Change: Okay. Thank you. Bye-bye.
Speaker Change: Just to put a finer point on that, Damon, besides a little bit of additional capitalization, which was unique to this quarter, it's really a run rate thing. It's baked in. Those folks were on staff and will continue to be.
Speaker Change: Got it. Okay. Great. I appreciate that color. That's all that I had.
Speaker Change: Thanks, Damon.
Speaker Change: Once again, ladies and gentlemen, it is star one if you would like to signal for a question. We'll hear now from Brian Martin with Jamie. Please go ahead.
Brian Martin: Hey, good afternoon, guys.
Brian Martin: Bye. Bye.
Brian Martin: Hey Brian, I guess just one back to the margin, I guess as you guys think about, you know, kind of right now you're kind of at the upper end of the range, just kind of the, you know, the sub debt, it was there, it was done this quarter and then as far as just kind of maybe what could take
Brian Martin: You know, I guess my thought was maybe you guys are looking to shift maybe to a little bit more of a liability-sensitive balance sheet, but I guess is that not something you guys are looking to do, just equivalent where we're at in the cycle, or is just staying neutral and, you know, kind of what you've outlined in terms of kind of the range, how to best think about it?
Speaker Change: Yeah, I think your first point about being at the higher end of the range is accurate. We got there a little faster than we thought we would, and again, there's probably some base points there from competitive pressures that still stay within that range. But I would say we don't really...
Speaker Change: Try not to think about or bet on rates and so we like the neutrality of that because
Speaker Change: Who's to say right that there could be a pause or a right hike and so
Speaker Change: We try to stay neutral, we try to stay in a position where we can.
Speaker Change: Maintain a stable margin. And so I think I have a 930 because some various
Speaker Change: variable funding that came on. We have a slight asset sense of the balance sheet. That'll flip to liability sense throughout the rest of the year as we get closer to what the markets think is another rate cut. And so we like the ability of staying really balanced.
Speaker Change: so they can be nimble, and we really just value the stability of the value of net-inspired stability.
Speaker Change: Gotcha. And as far as what could actually take it above or below that range, I mean, I think you said the competitive side on
Speaker Change: on the deposits could drift a bit below the lower end of the range, and as far as on the flip side, I guess if you're going to get outside the range on the upside, what do you see the potential there if you move outside the band? The upside would be our C&I lending mix, and so some of those niche areas such as asset-based lending.
Speaker Change: You know, a softer economy presents more opportunities for asset-based lending, and those are much higher yields.
Speaker Change: opportunities for more prepayment fees, asset-based loan fees, so...
Speaker Change: If we have more outsized opportunity there, I see that as an opportunity to increase margin. And that goes for some of the other bid share areas in our C&I business as well.
Speaker Change: Okay, and those niches today are, you know, low 20s in terms of percentage-wise what they are of the total. Is that kind of where you want to maintain them, or is that something you're looking to kind of shift up or shift down from where we're at?
Speaker Change: Yeah, Brian, we're about 25% which was that had been our goal in our last strategic plan to move that
Speaker Change: from 16 at the beginning of that plan to 25, and we got there, and we're kind of stabilized there right now. We'd like to see that inch up a little bit more. That would be great. But it's a little bit of taking what the market gives you. We're not going to ever stretch on credit in any of the segments that we do. As you know, we like to play in the higher credit quality
Speaker Change: end of the spectrum for any of those business lines. So, as I think we mentioned, ABL, SFA's lending has been soft as banks have not been squeezing deals out over the last couple of years.
Speaker Change: that's one of the places where we get a little bit more accounts receivable finance the receivables factoring business that's that's a place that that we get a little higher yields to so you know that that would be where we could see a little bit more
Speaker Change: Gotcha. Okay, so that's helpful. And then maybe I just missed what you guys said on the compensation line, but the compensation line, I heard the, you know, what had dropped through this quarter was, is your expectation for 4Q that it was stable towards that or it's going to return to where it was in terms of the fourth quarter outlook?
Speaker Change: Yeah, so we had the two adjustments in Q3, the total of $700,000. So you add those back, and we feel like that's a good place, a good run rate for Q4 to jump off of. Okay. So that's around 16, Brian? Is that what that, is that ballpark what that was?
Brian: Yeah, ballpark, I think we're 15.2 plus 700,000, I think, if you go back.
Speaker Change: Okay, and then just remind me, kind of with your business model and the hiring and whatnot, I mean, just a normal, you know, as we kind of look into 25 in terms of what to expect in terms of growth and that comp line, you know, what's kind of a normal, you know, as far as budgeting goes? How do you guys think about that, you know, given the model?
Speaker Change: Yeah, I would say if if we look back recent recent history, I think Brian you'd find that we've
Speaker Change: added maybe 5% in a headcount number.
Speaker Change: And then our annual merit increases that we do at year end, they were inflated in the last couple of years with inflation, but historically those have been in the 3%, 3.5% kind of range.
Speaker Change: And then we, there's, you know, some other.
Speaker Change: adjustments, but if you think about something like that, if it is 5%, another three, three and a half, and another half a percent or something of adjustments that have to happen through the year, market adjustments, those kinds of things, you know, that puts you in the higher single digits, mid to high single digit range.
Speaker Change: And I think that's where, that's where we feel.
Speaker Change: Very confident in our ability to drive operating leverage because if we can deliver the 10% plus growth which we have Pretty consistently as you know That that gives us that gap to the high single digits on the comp side, which is the biggest piece of of expenses
Speaker Change: Gotcha. Nope. Okay. That makes sense. And then just the last one for me was the, you talked about some of the volatility on those fee income lines and just kind of the outlook near term and then a little bit longer term, you know, it sounds like the MES funds, which is, you know, a pretty decent component and swings around a little bit.
Speaker Change: Your expectation is that
Speaker Change: You know, 23 was low, 24 was high, and then 20, yeah, I guess 23 was low, 24, 24 was low, 23 was high, and
Speaker Change: the outlook for next year is probably somewhere in between if you get some recovery, is that?
Speaker Change: how to think about you know what 25 looks like in terms of
Speaker Change: Those fees that, you know, by quarter are available annually, can you think about them?
Speaker Change: C25 from the SPIC fee income being a lot similar to 23. We're just seeing a lot of opportunities for realizations in the portfolio based on where they are in their life cycle.
Speaker Change: And feel good about where that's at.
Speaker Change: Yeah, this quarter was probably one of the lowest points we've had ever.
Speaker Change: So, no adjustments.
Speaker Change: You know, they changed, as you might remember, Brian, previous to this year, there was revaluations on their portfolio, which would then flow through only twice a year. This year that started to be monthly, excuse me, quarterly, they would look at valuations. So that smoothed that out a little bit, but there just really wasn't any of that. It was basically just...
Speaker Change: you know, the interest income on the coupon that they earn this quarter. So that was probably a low point.
Speaker Change: Gotcha. Yeah, the outlook seems pretty positive with both SBA and the MES coming back next year and so at least the stage looks to be set for some pretty good momentum. So that's all I had guys, so thanks for hosting the call and congrats on putting it together.
Speaker Change: Thank you, Brian. I appreciate it.
Speaker Change: And as there are no further questions in queue at this time, I'd like to turn the floor back over to Corey Chambis for any additional or closing comments.
Corey Chambis: That concludes our Q&A session. We appreciate your time and interest in First Business Bank, and we look forward to sharing our progress next quarter. Thank you and have a great weekend.
Speaker Change: Thank you. Once again, ladies and gentlemen, that will conclude today's call. Thank you for your participation. You may disconnect at this time.
Speaker Change: Good-bye.
Speaker Change: [music]