-- Strong performance driven by robust loan growth, sustained deposit growth, and positive operating leverage --

First Business Financial Services, Inc. (the “Company,” the “Bank,” or “First Business Bank”) (Nasdaq:FBIZ) reported quarterly net income available to common shareholders of $8.1 million, or $0.98 diluted earnings per share. This compares to net income available to common shareholders of $8.8 million, or $1.05 per share, in the first quarter of 2023 and $11.0 million, or $1.29 per share, in the second quarter of 2022.

“First Business Bank’s focus on fundamentals drove outstanding core performance for the quarter, continuing our success in achieving our strategic objectives,” Chief Executive Officer Corey Chambas said. “Net interest income grew more than 17% from the second quarter of 2022, and we continued to expand in-market deposits, up 11.0% annualized from year end. Strong client activity also drove loan growth, which exceeded 20% annualized for the quarter, and capped off an outstanding first half, well above the Company’s mid-year loan growth expectations. The revenue expansion accompanying this growth contributed to excellent pre-tax, pre-provision earnings, a key measure we use to track ongoing earnings power. Our ability to execute on strategic priorities in a volatile first half of 2023 for the banking industry underscores the strength of our business model and reinforces our capacity to deliver for our stakeholders.”

“Exceptional loan growth is a testament to our team’s solid strategic planning and outstanding execution,” Chambas added. “We’ve thoughtfully built robust asset-generating business lines in response to client needs and our desire for balance sheet diversification and growth. That, along with our strategic focus on Treasury Management, has allowed us to grow both loans and deposits in excess of 10% over the last two years. We expect this growth rate to moderate as we manage to our long-term target of 10%.”

“We are pleased with the continuation of First Business Bank’s positive asset quality in the first half of 2023,” Chambas continued. “The increase in non-performing assets during the second quarter was the result of one default that occurred in our Asset-Based Lending (“ABL”) portfolio. While defaults and liquidations are not atypical for ABL loans, these loans are fully collateralized and therefore, as usual, we do not expect any loss. Further, we do not believe it to be reflective of portfolio or industry stress. Excluding this credit, non-performing assets totaled less than $5 million.”

Quarterly Highlights

• Robust Loan Growth. Loans grew $135.2 million, or 21.3% annualized, from the first quarter of 2023, reflecting broad-based expansion across the Company’s products and geographies in the second quarter. Similar expansion across the Company’s portfolios drove loan growth totaling $384.5 million, or 16.8%, from the second quarter of 2022.

• Continued Deposit Growth. Total deposits grew to $2.529 billion, increasing 8.4% annualized from the linked quarter and 35.3% from the second quarter of 2022. In-market deposits grew to a record $2.074 billion, up $19.0 million, or 3.7% annualized, from the linked quarter and 11.7% from the second quarter of 2022. Importantly, gross treasury management service charges grew to $1.4 million in the quarter, expanding 15% compared to the second quarter of 2022.

• Net Interest Income Expansion. Net interest income grew 3.9% from the linked quarter and 17.3% from the prior year quarter. Consistent execution of the Company’s strategy to drive diversified portfolio growth supported this outcome. Net interest margin of 3.81% declined five basis points from the linked quarter and increased 10 basis points compared to second quarter of 2022.

• Strong Pre-tax, Pre-Provision (“PTPP”) Income. PTPP income grew to $13.5 million, up 1.0% from the prior quarter and 24.2% from the second quarter of 2022. This performance reflects solid growth across the Company’s balance sheet and diversified sources of non-interest income, which outpaced non-interest expense expansion in support of the Company’s growth initiatives. PTPP adjusted return on average assets measured 1.72%, compared to 1.79% for the linked quarter and up from 1.60% for the second quarter of 2022.

• Tangible Book Value Growth. The Company’s strong earnings generation produced a 9.7% annualized increase in tangible book value per share compared to the linked quarter and 12.3% compared to the prior year quarter.

Quarterly Financial Results

Second Quarter 2023 Compared to First Quarter 2023

Net interest income increased $1.0 million, or 3.9%, to $27.7 million.

• The increase in net interest income was driven by an increase in both average loans and leases receivable and fees in lieu of interest, partially offset by a decrease in net interest margin. Average loans and leases receivable increased $102.0 million, or 16.4% annualized, to $2.583 billion. Fees in lieu of interest, which vary from quarter to quarter based on client-driven activity, totaled $936,000, compared to $651,000 in the prior quarter. Excluding fees in lieu of interest, net interest income increased $757,000, or 11.6% annualized.
• The yield on average interest-earning assets increased 38 basis points to 6.47% from 6.09%. Excluding fees in lieu of interest, the yield earned on average interest-earning assets increased 36 basis points to 6.35% from 5.99%. The daily average effective federal funds rate increased 48 basis points compared to the linked quarter, which equates to an average adjusted interest-earning asset beta of 73.9% for the three months ended June 30, 2023, compared to 47.0% in the linked quarter. The cumulative adjusted interest earning asset beta since December 31, 2021 was 57.2%. The change in yield of the respective interest-earning asset or the rate paid on interest-bearing liability compared to the change in short-term market rates is commonly referred to as a beta.
• The rate paid for average interest-bearing, in-market deposits increased 47 basis points to 3.25% from 2.78% due to the acceleration of exception pricing and the shift of client balances from non-interest bearing deposits to certificates of deposit and interest bearing demand deposit accounts. Similarly, the rate paid for average total bank funding increased 48 basis points to 2.78% from 2.30%. Total bank funding is defined as total deposits plus Federal Home Loan Bank (“FHLB”) advances. The total bank funding beta was 98.9% for the three months ended June 30, 2023, compared to 73.3% in the linked quarter. The cumulative bank funding beta since December 31, 2021 was 49.9%.
• Net interest margin was 3.81%, down 5 basis points compared to 3.86% in the linked quarter. Adjusted net interest margin¹ was 3.63%, down 11 basis points compared to 3.74% in the linked quarter. The decline in net interest margin was due to an increase in the rate paid on total bank funding, partially offset by an increase in the yield on average adjusted interest earning assets.
• The Bank anticipates deposit betas may continue to rise and net interest margin may continue to decline at a gradual pace in coming quarters as the Federal Open Market Committee approaches a terminal federal funds rate. Based on current trends, we believe our net interest margin should stabilize meaningfully above our strategic plan goal of 3.50%.

The Bank reported a provision expense of $2.2 million, compared to $1.6 million in the first quarter of 2023. The second quarter provision expense included $1.2 million due to exceptional loan growth and $1.1 million of additional specific reserves. The increase in specific reserves was related to the equipment finance and SBA loan portfolios.

Non-interest income decreased $1.0 million, or 12.3%, to $7.4 million.

• Private Wealth and Retirement assets (“Private Wealth”) fee income increased $239,000, or 9.0% to $2.9 million. Private Wealth assets under management and administration measured $2.907 billion at June 30, 2023, up $103.0 million from the prior quarter.
• Commercial loan swap fee income increased $420,000, or 75.4%, to $977,000. Swap fee income varies from period to period based on loan activity and the interest rate environment.
• Other fee income decreased $1.8 million to $1.4 million, compared to $3.2 million in the prior quarter. The decrease was primarily due to higher returns on the Company’s investments in mezzanine funds in the first quarter. Income from mezzanine funds was $389,000 in the second quarter, compared to $2.4 million in the linked quarter. Income from mezzanine funds varies from period to period based on changes in the value of underlying investments.

Non-interest expense increased $264,000, or 1.2%, to $22.0 million, while operating expense decreased $87,000, or 0.4%, to $21.7 million.

• Compensation expense was $15.1 million, reflecting a decrease of $779,000, or 4.9%, from the linked quarter primarily due to 401(k) employer match and payroll taxes paid in the prior quarter on the annual cash bonus payout. Average full-time equivalents (FTEs) for the first quarter of 2023 were 341, up from 340 in the linked quarter.
• Professional fees were $1.2 million, decreasing $103,000, or 7.7%, from the linked quarter primarily due to expenses related to an office relocation in the prior quarter.
• Data processing expense was $1.1 million, increasing $186,000, or 21.3%, from the linked quarter primarily due to the recurring, annual expense related to tax processing on behalf of the Bank’s Private Wealth clients.
• Marketing expenses were $779,000, increasing $151,000, or 24.0%, from the linked quarter primarily due to seasonal increases in client entertainment and sponsorships.
• FDIC insurance expense was $580,000, increasing $186,000, or 47.2%, from the linked quarter primarily due to an increase in the assessment rate and the assessable base.
• Other non-interest expense increased $577,000, or 113.1%, to $1.1 million from the linked quarter primarily due to a $359,000 increase in SBA recourse provision, a loss on disposal of fixed assets, and an increase in travel expenses related to normal business development activities.

Income tax expense decreased $286,000, or 10.2%, to $2.5 million. The effective tax rate was 23.2% for the three months ended June 30, 2023, compared to 23.8% for the linked quarter. Both quarters benefited from low-income housing tax credits. Based on expected earnings and future tax credit investments, the Company expects to report an effective tax rate between 21% and 22% for 2023.

Total period-end loans and leases receivable increased $135.2 million, or 21.3% annualized, to $2.675 billion. Management does not believe this level of loan growth is sustainable and expects growth to moderate in subsequent quarters. Additionally, management expects to evaluate loan sale strategies as a means of adding to and further diversifying fee income. The average rate earned on average loans and leases receivable was 6.86%, up 44 basis points from 6.42% in the prior quarter.

• Commercial Real Estate (“CRE”) loans increased by $62.6 million, or 16.4% annualized, to $1.592 billion. The increase was primarily due to an increase in non-owner occupied CRE loans.
• Commercial & Industrial (“C&I”) loans increased $73.6 million, or 30.4% annualized, to $1.037 billion. The increase was due to growth across the majority of the Bank’s C&I products and geographies.

Total period-end in-market deposits increased $19.0 million, or 3.7% annualized, to $2.074 billion, compared to $2.055 billion. The average rate paid was 2.56%, up 47 basis points from 2.09% in the prior quarter.

• Growth in interest-bearing transaction accounts, driven in part by client movement into extended insurance products, was partially offset by a decrease in non-interest bearing transaction accounts, money market accounts, and certificates of deposit.

Period-end wholesale funding, including FHLB advances, brokered deposits, and deposits gathered through internet deposit listing services, increased $61.2 million to $790.8 million.

• Wholesale deposits increased $33.0 million to $455.1 million, compared to $422.1 million as the Bank continued to replace FHLB advances with wholesale deposits consistent with the Company’s long-held philosophy to manage interest rate risk by utilizing the most efficient and cost-effective source of wholesale funds to match-fund fixed-rate loans. The average rate paid on wholesale deposits increased three basis points to 4.24% and the weighted average original maturity increased to 3.7 years from 1.8 years.
• FHLB advances decreased $28.2 million to $335.7 million. The average rate paid on FHLB advances increased 20 basis points to 2.67% and the weighted average original maturity increased to 5.2 years from 4.7 years.

Non-performing assets increased $12.3 million to $15.8 million, or 0.48% of total assets, up from 0.11% in the prior quarter. The increase was primarily due to the default of one $10.9 million fully collateralized ABL credit, for which the Company expects full repayment. Excluding this credit, non-performing assets totaled $4.9 million, or 0.15% of total assets.

The allowance for credit losses, including unfunded credit commitments reserve, increased $2.1 million, or 7.8%, primarily driven by loan growth and an increase in specific reserves. The allowance for credit losses, including unfunded credit commitment reserves, as a percent of total gross loans and leases was 1.11% compared to 1.08% in the prior quarter.

Second Quarter 2023 Compared to Second Quarter 2022

Net interest income increased $4.1 million, or 17.3%, to $27.7 million.

• The increase in net interest income primarily reflects an increase in average gross loans and leases and net interest margin expansion, partially offset by lower fees in lieu of interest. Fees in lieu of interest decreased from $1.9 million to $936,000, primarily due to a decrease in non-accrual interest recovery and loan fee amortization related to Paycheck Protection Program loans. Excluding fees in lieu of interest, net interest income increased $5.0 million, or 23.0%.
• The yield on average interest-earning assets measured 6.47% compared to 4.24%. Excluding fees in lieu of interest, the yield on average interest-earning assets measured 6.35%, compared to 3.95%. This increase in yield was primarily due to the increase in short-term market rates and the reinvestment of cash flows from the securities and fixed rate loan portfolios in a rising rate environment. The daily average effective federal funds rate increased 422 basis points compared to the prior year quarter, which equates to an average adjusted interest-earning asset beta of 56.9% for the three months ended June 30, 2023, compared to the prior year period.
• The rate paid for average interest-bearing in-market deposits increased 296 basis points to 3.25% from 0.29%. The rate paid for average total bank funding increased 232 basis points to 2.78% from 0.46%. The total bank funding beta was 55.0% for the three months ended June 30, 2023, compared to the prior year period.
• Net interest margin increased 10 basis points to 3.81% from 3.71%. Adjusted net interest margin increased 19 basis points to 3.63% from 3.44%.

The Company reported a provision expense of $2.2 million, compared to a provision benefit of $3.7 million in the second quarter of 2022, primarily due to loan growth and an increase in specific reserves. The prior year quarter benefited from net recoveries of $4.2 million.

Non-interest income of $7.4 million increased by $502,000, or 7.3%, from $6.9 million in the prior year period.

• Private Wealth fee income increased $41,000, or 1.4%, to $2.9 million. Private Wealth assets under management and administration measured $2.907 billion at June 30, 2023, up $353.4 million, or 13.8%.
• Gain on sale of SBA loans decreased $507,000, or 53.3%, to $444,000. The decrease was driven by lower premiums and a decrease in loan originations compared to prior year quarter. In addition, the Company elected to hold a higher number of SBA loans on its balance sheet in the current interest rate environment.
• Service charges on deposits decreased $275,000, or 26.4%, to $766,000, driven by an increase in the earnings credit rate commensurate with the rising rate environment.
• Loan fees of $905,000 increased by $208,000, or 29.8%, primarily due to an increase in C&I lending activity.
• Other fee income increased $574,000, or 66.7%, to $1.4 million, mainly due to higher returns on the Company’s investments in mezzanine funds and a gain on customer lease restructuring. Income from mezzanine funds was $389,000 in the second quarter, compared to $115,000 in the prior year quarter. Income on mezzanine funds varies from period to period based on changes in the value of underlying investments.

Non-interest expense increased $2.6 million, or 13.2%, to $22.0 million. Operating expense increased $2.0 million, or 10.2%, to $21.7 million.

• Compensation expense increased $1.1 million, or 7.9%, to $15.1 million. The increase in compensation expense was mainly due to an increase in average FTEs, annual merit increases and promotions, and an increase in incentive compensation due to outstanding production. Average FTEs increased 6% to 341 in the second quarter of 2023, compared to 321 in the second quarter of 2022, as a result of expanded hiring efforts that have successfully driven growth while maintaining positive operating leverage.
• FDIC insurance increased $284,000, or 95.9%, to $580,000, primarily due to an increase in the assessment rate and the assessable base.
• Marketing expense increased $109,000, or 16.3%, to $779,000, primarily due to an increase in business development efforts and advertising projects commensurate with our expanded sales force.
• Equipment expense increased $120,000, or 51.1%, to $355,000, primarily due to equipment needs for an increasing workforce and increased depreciation expense related to new office locations.

Total period-end loans and leases receivable increased $384.5 million, or 16.8%, to $2.675 billion.

• C&I loans increased $281.8 million, or 37.3% to $1.037 billion, due to growth across all categories and geographies.
• CRE loans increased $103.3 million, or 6.9%, to $1.592 billion, due to increases in most CRE categories and geographies.

Total period-end in-market deposits increased $216.7 million, or 11.7%, to $2.074 billion, and the average rate paid increased 236 basis points to 2.56%. The increase in in-market deposits was principally due to a $252.4 million and $179.3 million increase in interest bearing transaction accounts and certificates of deposits, respectively. This increase was partially offset by a $125.2 million and $89.7 million decrease in non-interest bearing deposit accounts and money market accounts, respectively.

Period-end wholesale funding increased $224.4 million to $790.8 million.

• Wholesale deposits increased $442.8 million to $455.1 million, as the Bank utilized more wholesale deposits in lieu of FHLB advances to build excess liquidity and to match-fund fixed rate assets. The average rate paid on brokered certificates of deposit increased 126 basis points to 4.24% and the weighted average original maturity decreased to 3.7 years from 4.8 years.
• FHLB advances decreased $218.4 million to $335.7 million. The average rate paid on FHLB advances increased 119 basis points to 2.67% and the weighted average original maturity increased to 5.2 years from 3.2 years.

Non-performing assets increased to $15.8 million, or 0.48% of total assets, compared to $5.7 million, or 0.21% of total assets.

The allowance for credit losses, including unfunded commitment reserves, increased $5.6 million to $29.7 million, compared to $24.1 million. The allowance for credit losses as a percent of total gross loans and leases was 1.11%, compared to the allowance for loan losses of 1.05% under the incurred loss model.

Share Repurchase Program Update

As previously announced, effective January 27, 2023, the Company’s Board of Directors authorized the repurchase by the Company of shares of its common stock with a maximum aggregate purchase price of $5.0 million, effective January 31, 2023 through January 31, 2024. As of June 30, 2023, the Company had repurchased a total of 65,112 shares for approximately $2.0 million at an average cost of $30.72 per share. The Company expects to continue its pause of the repurchase program, instead allocating capital to support continued exceptional balance sheet growth.

Investor Presentation

The Company has prepared investor presentation materials that management intends to use from time to time in discussions about the Company’s operations and performance. The presentation will be available for viewing in the Investor Relations section of the Company’s website at firstbusiness.bank and will also be furnished to the U.S. Securities and Exchange Commission on July 28, 2023.

About First Business Bank

First Business Bank specializes in Business Banking, including Commercial Banking and Specialty Finance, Private Wealth, and Bank Consulting services, and through its refined focus delivers unmatched expertise, accessibility, and responsiveness. Specialty Finance solutions are delivered through First Business Bank’s wholly owned subsidiary First Business Specialty Finance, LLC. First Business Bank is a wholly owned subsidiary of First Business Financial Services, Inc. (Nasdaq: FBIZ). For additional information, visit firstbusiness.bank.

This release may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect First Business Bank’s current views with respect to future events and financial performance. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results, or other developments. Forward-looking statements are based on management’s expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Those statements are based on general assumptions and are subject to various risks, uncertainties, and other factors that may cause actual results to differ materially from the views, beliefs, and projections expressed in such statements. Such statements are subject to risks and uncertainties, including among other things:

• Adverse changes in the economy or business conditions, either nationally or in our markets including, without limitation, inflation, supply chain issues, labor shortages, or any future public health epidemics.
• Competitive pressures among depository and other financial institutions nationally and in the Company’s markets.
• Increases in defaults by borrowers and other delinquencies.
• Management’s 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 the Company and its 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 the Company’s internet banking activities.
• Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portion of SBA loans.
• Recent volatility in the banking sector may result in new legislation, regulations or policy changes that could subject the Corporation and the Bank to increased government regulation and supervision.
• The proportion of the Corporation’s deposit account balances that exceed FDIC insurance limits may expose the Bank to enhanced liquidity risk.
• The Corporation may be subject to increases in FDIC insurance assessments as a result of the recent bank failures.

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, 2022 and other filings with the Securities and Exchange Commission.

SELECTED FINANCIAL CONDITION DATA

STATEMENTS OF INCOME

NET INTEREST INCOME ANALYSIS