UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended September 30, 2007

Commission file number 000-51028

FIRST BUSINESS FINANCIAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

Wisconsin		39-1576570
(State or jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
401 Charmany Drive Madison, WI		53719
(Address of Principal Executive Offices)		(Zip Code)

Telephone number

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ                      No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o           Accelerated filer o           Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o                      No þ

The number of shares outstanding of the registrant’s sole class of common stock, par value $0.01 per share, on October 19, 2007 was 2,548,213 shares.

 

 

FIRST BUSINESS FINANCIAL SERVICES, INC.
INDEX — FORM 10-Q

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006			2
Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2007 and 2006			3
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Nine Months Ended September 30, 2007 and 2006			4
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006			5
Notes to Unaudited Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			13
Item 3. Quantitative and Qualitative Disclosures about Market Risk			27
Item 4. Controls and Procedures			27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			28
Item 1A. Risk Factors			28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 3. Defaults upon Senior Securities			28
Item 4. Submission of Matters to a Vote of Security Holders			28
Item 5. Other information			29
Item 6. Exhibits			29
SIGNATURES			29
Certification of the Chief Executive Officer
Certification of the Senior VP and Chief Financial Officer
Certification of the CEO and Senior VP and CFO

PART I. Financial Information

Item 1. Financial Statements

First Business Financial Services, Inc.

		September 30,				December 31,
		2007				2006
		(In Thousands, Except Share Data)
		(Unaudited)
Assets
Cash and due from banks		$	13,786			$	19,215
Short-term investments			65				246
Cash and cash equivalents			13,851				19,461
Securities available-for-sale, at fair value			93,163				100,008
Loans and leases receivable, net of allowance for loan and lease losses of $10,196 and $8,296, respectively			748,563				639,867
Leasehold improvements and equipment, net			1,090				1,051
Cash surrender value of bank-owned life insurance			14,574				13,469
Investment in Federal Home Loan Bank stock, at cost			2,367				2,024
Goodwill and other intangibles			2,794				2,817
Accrued interest receivable and other assets			11,265				9,626
Total assets		$	887,667			$	788,323
Liabilities and Stockholders’ Equity
Deposits		$	749,914			$	640,266
Securities sold under agreement to repurchase			—				451
Federal Home Loan Bank and other borrowings			76,639				92,519
Accrued interest payable and other liabilities			12,649				9,331
Total liabilities			839,202				742,567
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $10 par value, 10,000 Series A shares and 10,000 Series B shares authorized, none issued or outstanding			—				—
Common stock, $0.01 par value, 8,000,000 shares authorized, 2,575,831 and 2,516,193 shares issued, 2,552,195 and 2,493,578 outstanding in 2007 and 2006, respectively			26				25
Additional paid-in capital			23,336				23,029
Retained earnings			26,088				24,237
Accumulated other comprehensive loss			(434	)			(1,005	)
Treasury stock (23,636 and 22,615 shares in 2007 and 2006, respectively), at cost			(551	)			(530	)
Total stockholders’ equity			48,465				45,756
Total liabilities and stockholders’ equity		$	887,667			$	788,323

See accompanying Notes to Unaudited Consolidated Financial Statements.

First Business Financial Services, Inc.

		For the Three Months Ended								For the Nine Months Ended,
		September 30,								September 30,
		2007				2006				2007				2006
						(In Thousands, Except Share Data)
Interest income:
Loans and leases		$	14,177			$	11,097			$	40,277			$	31,415
Securities income, taxable			1,032				1,026				3,162				2,974
Short-term investments			66				42				140				123
Total interest income			15,275				12,165				43,579				34,512
Interest expense:
Deposits			8,464				6,571				23,962				18,087
Notes payable and other borrowings			949				617				2,736				1,616
Junior subordinated debentures			—				260				—				762
Total interest expense			9,413				7,448				26,698				20,465
Net interest income			5,862				4,717				16,881				14,047
Provision for loan and lease losses			596				413				1,873				484
Net interest income after provision for loan and lease losses			5,266				4,304				15,008				13,563
Non-interest income:
Service charges on deposits			175				186				522				563
Credit, merchant and debit card fees			51				51				154				129
Loan fees			128				181				466				472
Increase in cash surrender value of bank-owned life insurance			175				154				515				452
Trust and investment services fee income			524				361				1,415				1,022
Change in fair value of interest rate swaps			—				(68	)			—				(239	)
Net cash settlement of interest rate swaps			—				74				—				92
Other			48				65				187				183
Total non-interest income			1,101				1,004				3,259				2,674
Non-interest expense:
Compensation			3,171				2,508				9,136				7,524
Occupancy			262				247				783				743
Equipment			130				117				367				364
Data processing			264				228				760				673
Marketing			260				237				788				657
Professional fees			291				331				1,054				913
Other			566				465				1,719				1,309
Total non-interest expense			4,944				4,133				14,607				12,183
Income before income tax expense			1,423				1,175				3,660				4,054
Income tax expense			538				309				1,318				1,252
Net income		$	885			$	866			$	2,342			$	2,802
Earnings per share:
Basic		$	0.36			$	0.35			$	0.95			$	1.15
Diluted			0.36				0.35				0.95				1.14
Dividends declared per share			0.065				0.06				0.195				0.18

See accompanying Notes to Unaudited Consolidated Financial Statements.

First Business Financial Services, Inc.

														Accumulated
						Additional								other
		Common				paid-in				Retained				comprehensive				Treasury
		stock				capital				earnings				loss				stock				Total
						(In Thousands, Except Share Data)
Balance at December 31, 2005		$	24			$	22,712			$	21,085			$	(1,469	)		$	(509	)		$	41,843
Comprehensive income:
Net income			—				—				2,802				—				—				2,802
Unrealized securities losses arising during the period			—				—				—				(14	)			—				(14	)
Unrealized derivatives gains arising during the period			—				—				—				4				—				4
Reclassification adjustment for realized loss on derivatives			—				—				—				86				—				86
Income tax effect			—				—				—				2				—				2
Comprehensive income																							2,880
Share-based compensation — restricted shares			1				117				—				—				—				118
Cash dividends ($0.18 per share)			—				—				(446	)			—				—				(446	)
Treasury stock purchased (869 shares)			—				—				—				—				(21	)			(21	)
Stock options exercised (9,280 shares)			—				136				—				—				—				136
Balance at September 30, 2006		$	25			$	22,965			$	23,441			$	(1,391	)		$	(530	)		$	44,510

														Accumulated
						Additional								other
		Common				paid-in				Retained				comprehensive				Treasury
		stock				capital				earnings				loss				stock				Total
		(In Thousands, Except Share Data)
Balance at December 31, 2006		$	25			$	23,029			$	24,237			$	(1,005	)		$	(530	)		$	45,756
Comprehensive income:
Net income			—				—				2,342				—				—				2,342
Unrealized securities gains arising during the period			—				—				—				875				—				875
Unrealized derivative losses arising during the period			—				—				—				(4	)			—				(4	)
Reclassification adjustment for realized losses on derivatives			—				—				—				2				—				2
Income tax effect			—				—				—				(302	)			—				(302	)
Comprehensive income																							2,913
Share-based compensation — restricted shares			1				270				—				—				—				271
Cash dividends ($0.195 per share)			—				—				(491	)			—				—				(491	)
Treasury stock purchased (1,021 shares)			—								—				—				(21	)			(21	)
Stock options exercised (3,128 shares)			—				37				—				—				—				37
Balance at September 30, 2007		$	26			$	23,336			$	26,088			$	(434	)		$	(551	)		$	48,465

See accompanying Notes to Unaudited Consolidated Financial Statements

First Business Financial Services, Inc.

		For the Nine Months Ended
		September 30,
		2007				2006
		(In Thousands)
Operating activities
Net income		$	2,342			$	2,802
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes, net			(782	)			276
Provision for loan and lease losses			1,873				484
Depreciation, amortization and accretion, net			354				459
Share-based compensation			271				118
Change in fair value of interest rate swaps			—				239
Increase in cash surrender value of bank-owned life insurance			(515	)			(452	)
Origination of loans originated for sale			(1,340	)			(897	)
Sale of loans originated for sale			1,346				797
Gain on sale of loans originated for sale			(6	)			(6	)
Increase in accrued interest receivable and other assets			(938	)			(1,606	)
Increase (decrease) in accrued interest payable and other liabilities			3,071				(796	)
Net cash provided by operating activities			5,676				1,418
Investing activities
Proceeds from maturities of available-for-sale securities			16,488				16,630
Purchases of available-for-sale securities			(8,811	)			(19,971	)
Proceeds from sale of FHLB stock			—				771
Purchases of FHLB stock			(343	)			—
Net increase in loans and leases			(110,569	)			(44,647	)
Purchases of leasehold improvements and equipment, net			(319	)			(195	)
Purchase of bank-owned life insurance			(590	)			—
Net cash used in investing activities			(104,144	)			(47,412	)
Financing activities
Net increase in deposits			109,648				37,330
Net decrease in FHLB line of credit			(17,048	)			—
Repayment of FHLB advances			(7	)			(6	)
Proceeds from FHLB advances			15,000				7,000
Net decrease in short-term borrowed funds			(24,276	)			(497	)
Proceeds from subordinated notes payable			10,000				6,000
Termination of interest rate swaps			—				(1,384	)
Exercise of stock options			37				136
Cash dividends paid			(475	)			(443	)
Purchase of treasury stock			(21	)			(21	)
Net cash provided by financing activities			92,858				48,115
Net (decrease) increase in cash and cash equivalents			(5,610	)			2,121
Cash and cash equivalents at the beginning of the period			19,461				16,707
Cash and cash equivalents at the end of the period		$	13,851			$	18,828
Supplementary cash flow information
Interest paid on deposits and borrowings		$	24,726			$	19,407
Income taxes paid			1,885				2,851
Transfer to other real estate owned			660				—

See accompanying Notes to Unaudited Consolidated Financial Statements.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — Principles of Consolidation.

The unaudited consolidated financial statements include the accounts and results of First Business Financial Services, Inc. (FBFS or the Corporation), and its wholly-owned subsidiaries, First Business Bank, and First Business Bank — Milwaukee. All significant intercompany balances and transactions have been eliminated in consolidation.

Note 2 — Basis of Presentation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The Corporation has not changed its significant accounting and reporting policies from those disclosed in the Corporation’s Form 10-K for the year ended December 31, 2006 with the exception of the adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. Refer to Note 3 — Recent Accounting Changes for the impacts of the adoption of this interpretation. There have been no significant changes in the methods or assumptions used in accounting policies requiring material estimates and assumptions.

In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the unaudited consolidated financial statements have been included. The results of operations for the three and nine month periods ended September 30, 2007 are not necessarily indicative of results that may be expected for any other interim period or the entire fiscal year ending December 31, 2007. Certain amounts in prior periods have been reclassified to conform to the current presentation. Weighted average common and diluted shares outstanding and the dilutive effect of stock options have been modified from prior year presentation to account for a correction of an error in applying the treasury stock method. Both basic and diluted earnings per share for the three months ended September 30, 2006 were unchanged and basic and diluted earnings per share for the nine months ended September 30, 2006 as previously presented were $1.13 and 1.13, respectively compared to basic and diluted earnings per share of $1.15 and 1.14, respectively as restated. Management has quantitatively and qualitatively deemed the impact of the disclosure error to be immaterial.

Note 3 — Recent Accounting Changes.

Accounting for Uncertainty in Income Taxes. The Corporation adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, there were no adjustments to the liabilities for unrecognized tax benefits. At the date of adoption, the Corporation had $1.4 million of unrecognized tax benefits. Approximately $983,000 of the unrecognized tax benefit would impact the effective tax rate if recognized. As of September 30, 2007, there was no unrecognized tax benefit that was expected to significantly increase or decrease within the next twelve months. The Corporation recognizes accrued interest relating to unrecognized tax benefits in income tax expense and penalties in other non-interest expense. As of January 1, 2007, the Corporation had accrued $91,000 of interest related to the unrecognized tax benefit. As of September 30, 2007, State of Wisconsin tax years that remain open are 1997 and 1999 through 2006. Federal tax years that remain open are 2004 through 2006.

Fair Value Option for Financial Assets and Financial Liabilities. In February 2007, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 159, The Fair Value Option for Financial Assets and Liabilities — Including an Amendment of SFAS No. 115 (SFAS No. 159). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for sale and trading securities.

The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments.

SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption was permitted as of the beginning of the previous fiscal year provided that the entity make that choice in the first 120 days of that fiscal year and also elected to apply the provisions of SFAS No. 157, Fair Value Measurements. The Corporation has not early adopted the provisions of SFAS No. 159 and is currently evaluating the impact of adopting this standard.

Note 4 — Share-Based Compensation.

The Corporation adopted an equity incentive plan in 1993 as amended in 1995, an equity incentive plan in 2001 and the 2006 Equity Incentive Plan (the Plans). The Plans are administered by the Compensation Committee of the Board of Directors of FBFS and provide for the grant of equity ownership opportunities through incentive stock options, nonqualified stock options (stock options) and restricted stock (unvested shares). A maximum of 426,147 common shares are currently authorized for awards under the Plans. 152,094 shares are available for future grants under the Plans as of September 30, 2007. Shares covered by awards that expire, terminate or lapse will again be available for the grant of awards under the Plans. The Corporation may issue new shares and shares from treasury for shares delivered under the Plans.

Stock Options

Stock options may be granted to senior executives and other employees under the Plans. Options generally have an exercise price that is equal to the fair value of the common shares on the date the option is granted. Options granted under the Plans are subject to graded vesting, generally ranging from four to eight years, and have a contractual term of 10 years. For any new awards issued, compensation expense is recognized over the requisite service period for the entire award on a straight-line basis. There were no stock options granted during the nine month period ended September 30, 2007. No stock options have been granted since the Corporation met the definition of a public entity and no stock options have been modified, repurchased or cancelled. Therefore, no stock-based compensation was recognized in the consolidated statement of income for the three and nine months ended September 30, 2007 and 2006, except with respect to restricted stock awards. The Corporation expects that a majority of the outstanding stock options will fully vest. Stock option activity for the nine months ended September 30, 2007 was as follows:

										Weighted
										Average
										Remaining
						Weighted				Contractual
		Options				Average Price				Life (Years)
Outstanding at December 31, 2006			166,168			$	21.97				6.68
Granted			—				—
Exercised			(3,128	)			11.91
Forfeited			(2,500	)			25.00
Outstanding at end of period			160,540				22.16				6.09
Options exercisable at September 30, 2007			126,887				21.61				5.67

Restricted Shares

Under the 2001 and 2006 Equity Incentive Plans, participants may be granted restricted shares, subject to forfeiture upon the occurrence of certain events until dates specified in the participant’s award agreement. While the restricted shares are subject to forfeiture, the participant may exercise full voting rights and will receive all dividends and other distributions paid with respect to the restricted shares. The restricted shares granted under this plan are subject to graded vesting. For awards with graded vesting, compensation expense is recognized over the requisite service period of four years for the entire award on a straight-line basis. Upon vesting of restricted stock awards, the benefits of tax deductions in excess of recognized compensation expense is recognized as a financing cash flow activity. For the nine months ended September 30, 2007, restricted share awards vested at a date at which the market price was lower than the market value on the date of grant; therefore, there is no excess tax benefit reflected in the consolidated statements of cash flows for the period. There were no vesting events during the nine month period ending September 30, 2006. Restricted share activity for the nine months ended September 30, 2007 was as follows:

						Weighted
		Number of				Average
		Restricted				Grant-Date
		Shares				Fair Value
Nonvested balance as of December 31, 2006			45,125			$	23.08
Granted			56,885				20.29
Vested			(10,024	)			23.18
Forfeited			(375	)			23.20
Nonvested balance as of September 30, 2007			91,611				21.33

As of September 30, 2007, there was approximately $1.7 million of deferred compensation expense related to unvested shares which is expected to be recognized over four years. As of September 30, 2007, there were no restricted shares vested and not delivered. For the nine months ended September 30, 2007 and 2006, share-based compensation expense included in net income totaled approximately $271,000 and $118,000, respectively.

Note 5 — Earnings Per Share.

Basic earnings per share for the three and nine months ended September 30, 2007 and 2006 have been determined by dividing net income for the respective periods by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding plus the effect of dilutive securities. The effect of dilutive securities is computed using the treasury stock method. For the three month periods ended September 30, 2007 and 2006, average anti-dilutive employee stock options totaled 132,200 and 65,250, respectively. For the nine month periods ended September 30, 2007 and 2006, average anti-dilutive employee stock options totaled 132,200 and 65,250, respectively.

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
		2007				2006				2007				2006
Income available to common stockholders		$	885,021			$	866,302			$	2,342,185			$	2,801,980
Basic average shares			2,457,885				2,447,122				2,455,005				2,443,045
Dilutive effect of share-based awards			2,970				15,948				6,004				16,009
Dilutive average shares			2,460,855				2,463,070				2,461,009				2,459,054
Earnings per share:
Basic		$	0.36			$	0.35			$	0.95			$	1.15
Diluted		$	0.36			$	0.35			$	0.95			$	1.14

Note 6 — Securities.

The amortized cost and estimated fair values of securities available-for-sale were as follows:

		As of September 30, 2007
						Gross				Gross
		Amortized				unrealized				unrealized				Estimated
		cost				holding gains				holding losses				fair value
		(In Thousands)
Securities available-for-sale
U.S. Government corporations and agencies		$	1,499			$	—			$	(10	)		$	1,489
Municipals			85				—				—				85
Collateralized mortgage obligations			92,233				138				(782	)			91,589
		$	93,817			$	138			$	(792	)		$	93,163

		As of December 31, 2006
						Gross				Gross
		Amortized				unrealized				unrealized				Estimated
		cost				holding gains				holding losses				fair value
		(In Thousands)
Securities available-for-sale
U.S. Government corporations and agencies		$	1,497			$	—			$	(30	)		$	1,467
Municipals			185				—				(3	)			182
Collateralized mortgage obligations			99,855				85				(1,581	)			98,359
		$	101,537			$	85			$	(1,614	)		$	100,008

The table below shows the Corporation’s gross unrealized losses and fair value of investments, aggregated by investment category and length of time that individual investments have been in a continuous unrealized loss position at September 30, 2007 and December 31, 2006. At September 30, 2007 and December 31, 2006, the Corporation had 98 and 105 securities that were in an unrealized loss position, respectively. Such securities have declined in value due to current interest rate environments and not credit quality and do not presently represent realized losses. The Corporation has the ability to and anticipates that these securities, which have been in a continuous loss position but are not other-than-temporarily impaired, will be kept in the portfolio until the unrealized loss is recovered. If held until maturity, it is anticipated that the investments will be realized with no loss. If the Corporation determines that any of the above securities are deemed other-than-temporarily impaired, the impairment loss will be recognized in the income statement.

A summary of unrealized loss information for investment securities, categorized by security type follows:

		As of September 30, 2007
		Less than 12 months								12 months or longer								Total
						Unrealized								Unrealized								Unrealized
		Fair value				losses				Fair value				losses				Fair value				losses
		(In Thousands)
U.S. Government corporations and agencies		$	—			$	—			$	1,489			$	10			$	1,489			$	10
Collateralized mortgage obligations			12,445				42				54,428				740				66,873				782
		$	12,445			$	42			$	55,917			$	750			$	68,362			$	792

		As of December 31, 2006
		Less than 12 months								12 months or longer								Total
						Unrealized								Unrealized								Unrealized
		Fair value				losses				Fair value				losses				Fair value				losses
		(In Thousands)
U.S. Government corporations and agencies		$	—			$	—			$	1,467			$	30			$	1,467			$	30
Municipals			—				—				182				3				182				3
Collateralized mortgage obligations			14,451				107				69,021				1,474				83,472				1,581
		$	14,451			$	107			$	70,670			$	1,507			$	85,121			$	1,614

The Corporation has not sold any available-for-sale securities during the nine months ended September 30, 2007 and 2006 and has therefore not realized any gains or losses on such transactions.

At September 30, 2007 and December 31, 2006, securities with a fair value of approximately $66.1 million and $35.4 million, respectively, were pledged to secure public deposits, securities sold under arrangements to repurchase, and Federal Home Loan Bank (FHLB) advances.

Note 7 — Loans, Leases and Allowance for Loan and Lease Losses.

Loans and leases receivable consisted of the following:

		September 30,				December 31,
		2007				2006
		(In Thousands)
First mortgage loans:
Commercial real estate		$	322,808			$	274,262
Construction			97,400				78,257
Multi-family			35,202				34,635
1-4 family			48,158				35,721
			503,568				422,875
Commercial and industrial loans			208,974				176,701
Direct financing leases, net			26,138				23,203
Home equity loans			9,874				8,859
Credit card and other			10,321				16,712
			758,875				648,350
Less:
Allowance for loan and lease losses			10,196				8,296
Deferred loan fees			116				187
Loans and lease receivables, net		$	748,563			$	639,867

An analysis of the allowance for loan and lease losses is presented below:

		Nine
		Months Ended				Year Ended
		September 30,				December 31,
		2007				2006
		(In Thousands)
Allowance at beginning of period		$	8,296			$	6,773
Charge-offs:
Commercial real estate and other mortgage			—				—
Commercial			—				—
Lease			—				—
Consumer			—				—
Total charge-offs			—				—
Recoveries:
Commercial real estate and other mortgage			4				4
Commercial			23				—
Lease			—				—
Consumer			—				—
Total recoveries			27				4
Net recoveries			27				4
Provision for loan and lease losses			1,873				1,519
Allowance at end of period		$	10,196			$	8,296
Allowance to gross loans and leases			1.34	%			1.28	%

Note 8 — Deposits.

Deposits consisted of the following:

		September 30, 2007								December 31, 2006
						Weighted								Weighted
		Balance				average rate				Balance				average rate
		(In Thousands)
Transaction accounts:
Demand deposits		$	43,641				0.00	%		$	45,171				0.00	%
Negotiable order of withdrawal (NOW) accounts			63,821				4.41				58,927				4.26
			107,462								104,098
Money market accounts			166,752				4.66				171,996				4.57
Certificates of deposit			475,700				4.97				364,172				4.63
		$	749,914							$	640,266

Note 9 — Borrowings.

Borrowings consisted of the following:

		September 30, 2007												December 31, 2006
						Weighted				Weighted								Weighted				Weighted
						average				average								average				average
		Balance				balance				rate				Balance				balance				rate
		(In Thousands)
Fed funds purchased and securities sold under agreements to repurchase		$	11,100			$	11,704				5.43	%		$	33,751			$	13,875				5.12	%
FHLB advances			34,529				22,827				4.87				36,584				19,059				4.83
Junior subordinated debentures			—				—				—				—				9,915				12.52
Line of credit			10				3,406				7.16				1,635				3,167				6.82
Subordinated notes payable			31,000				21,147				7.83				21,000				6,929				7.58
Other			—				33				7.00				—				—				—
		$	76,639			$	59,117				6.17			$	92,970			$	52,945				6.82
Short-term borrowings		$	27,120											$	52,443
Long-term borrowings			49,519												40,527
		$	76,639											$	92,970

During 2007, the Corporation increased its line of credit to $7.5 million and amended a subordinated loan agreement to provide for an additional $10 million of subordinated debt for a total of $31 million available. As of September 30, 2007, the Corporation had $10,000 outstanding under its line of credit, and $31.0 million of subordinated notes payable was outstanding.

Item 2. — Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

You should read the following discussion together with the Corporation’s Unaudited Consolidated Financial Statements and related Notes to Unaudited Consolidated Financial Statements, which are included elsewhere in this Report. The following discussion contains forward-looking statements that reflect plans, estimates and beliefs. When used in written documents or oral statements, the words “anticipate,” “believe,” “estimate,” “expect,” “objective” and similar expressions and verbs in the future tense are intended to identify forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks, and uncertainties, many of which are beyond the Corporation’s control, which could cause actual results to differ materially from those discussed in the forward-looking statements.

Unless otherwise indicated or unless the context requires otherwise, all references in this Report to “First Business Financial Services”, the “Corporation”, “FBFS”, “we”, “us”, “our”, or similar references mean First Business Financial Services, Inc. together with our subsidiaries. “First Business Bank” or “First Business Bank — Milwaukee” or the “Banks” are used to refer to our subsidiaries, First Business Bank and First Business Bank — Milwaukee, alone.

Cautionary Factors

Forward-looking statements may also be made by the Corporation from time to time in other reports and documents as well as oral presentations. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Corporation: general economic conditions; legislative and regulatory initiatives; increased competition and other effects of deregulation and consolidation of the financial services industry; monetary and fiscal policies of the federal government; deposit flows; disintermediation; the cost and availability of funds; general market rates of interest; interest rates or investment returns on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; general economic developments; acts of terrorism and developments in the war on terrorism; and changes in the quality or composition of loan and investment portfolios. See also Item 1A. Risk Factors in our annual Report on Form 10-K and factors regarding future operations discussed below.

Overview

FBFS is a registered bank holding company incorporated under the laws of the State of Wisconsin and is engaged in the commercial banking business through its wholly-owned banking subsidiaries, First Business Bank and First Business Bank — Milwaukee. All of the operations of FBFS are conducted through its Banks and certain subsidiaries of First Business Bank. The Corporation operates 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. The Corporation does not utilize its locations to attract retail customers.

Results of Operations

General. Net income for the three months ended September 30, 2007 was $885,000, up 2.19% from $866,000 for the same time period in 2006. The principal factors contributing to this increase included an increase in net interest income of $1.1 million caused by volume increases associated with organic growth of our Corporation and increased non-interest income of $97,000 primarily due to increased trust and investment service fee income. Negative factors impacting the increase in net income include an increase in the loan and lease loss provision of $183,000 which is primarily due to additional reserves required for increased inherent risk associated with a growing portfolio. There was also an additional $811,000 of non-interest expenses primarily due to increases in compensation expense. Both basic and diluted earnings per share for the three months ended September 30, 2007 increased to $0.36 from $0.35 for the same period in 2006. The increase is attributable to the increase in net income.

The annualized returns on average assets and average return on equity are 0.41% and 7.45%, respectively, for the three month period ended September 30, 2007 compared to 0.50% and 7.97%, respectively for the same time period of 2006.

Net income for the nine months ended September 30, 2007 was $2.3 million, down 16.4% from $2.8 million for the same time period in 2006. The principal factors contributing to the decline in net income are related to an increase in the provision for loan and lease losses of $1.4 million and an increase in non-interest expense of $2.4 million. Positive factors offsetting the previously mentioned reductions of income include a $2.8 million increase in net interest income and $585,000 increase in non-interest income. Basic earnings per share decreased to $0.95 from $1.15 from the same period of 2006. Diluted earnings per share decreased to $0.95 from $1.14 for the same period in 2006. The decline in earnings per share is directly related to the 16.4% decline in net income. The annualized returns on average assets and average return on equity were 0.38% and 6.65%, respectively, for the nine month period ended September 30, 2007 compared to 0.55% and 8.74%, respectively, for the same time period of 2006.

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. We use this measurement to monitor our revenue growth and as one half of the performance measurements used for our non-equity incentive plans. The growth in top line revenue exceeds our target of 12.5% growth over the prior year. Based on the current pipeline and continued investment in the infrastructure of our Corporation, we believe our target growth can be sustained through the remainder of the year. The components of top line revenue were as follows:

		For the Three Months Ended												For the Nine Months Ended
		September 30,												September 30,
		2007				2006				Change				2007				2006				Change
		(In Thousands)
Net interest income		$	5,862			$	4,717				24.3	%		$	16,881			$	14,047				20.2	%
Non-interest income			1,101				1,004				9.7				3,259				2,674				21.9
Total top line revenue		$	6,963			$	5,721				21.7			$	20,140			$	16,721				20.4

Net Interest Income. Net interest income depends on the amounts of and yields on interest-earning assets as compared to the amounts of and rates on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the asset/liability management procedures used by management in responding to such changes. The table below presents the change in net interest income resulting from change in the volume of interest-earning assets or interest-bearing liabilities and change in interest rates for the three and nine months ended September 30, 2007 compared to the same period of 2006.

		For the three months ended September 30, 2007																For the nine months ended September 30, 2007
										Rate/																Rate/
		Rate				Volume				Volume				Net				Rate				Volume				Volume				Net
		(In Thousands)
Interest-Earning Assets
Commercial real estate and other mortgage loans		$	177			$	2,156			$	55			$	2,388			$	783			$	5,488			$	221			$	6,492
Commercial and industrial loans			(139	)			812				(30	)			643				49				2,161				10				2,220
Leases			(45	)			108				(16	)			47				(109	)			279				(31	)			139
Consumer loans			(1	)			3				—				2				(4	)			15				—				11
Total loans and leases receivable			(8	)			3,079				9				3,080				719				7,943				200				8,862
Mortgage-related securities			58				(37	)			(2	)			19				208				19				1				228
Investment securities			4				(14	)			(2	)			(12	)			10				(44	)			(5	)			(39	)
Other investments			(7	)			2				(1	)			(6	)			(11	)			(11	)			2				(20	)
Fed funds sold and other			—				—				28				28				—				39				(5	)			34
Short-term investments			1				—				—				1				6				(4	)			—				2
Total net change in income on interest-earning assets			48				3,030				32				3,110				932				7,942				193				9,067
Interest-Bearing Liabilities
NOW accounts			(12	)			190				(4	)			174				82				560				29				671
Money market			(77	)			173				(7	)			89				195				829				33				1,057
Certificates – regular			216				1,215				73				1,504				943				2,776				261				3,980
Certificates – large			21				101				4				126				182				(14	)			(1	)			167
Total deposits			148				1,679				66				1,893				1,402				4,151				322				5,875
Junior subordinated debentures			—				(260	)			—				(260	)			—				(762	)			—				(762	)
FHLB advances			2				59				1				62				12				174				3				189
Other borrowings			48				197				25				270				182				631				118				931
Total net change in expense on interest-bearing liabilities			198				1,675				92				1,965				1,596				4,194				443				6,233
Net change in net interest income		$	(150	)		$	1,355			$	(60	)		$	1,145			$	(664	)		$	3,748			$	(250	)		$	2,834

Net interest income was $5.9 million for the three months ended September 30, 2007, up 24.3% from the same period in 2006. Net interest margin was 2.86% for the three months ended September 30, 2007 compared to 2.84% for the three months ended September 30, 2006. The yield on earning assets was 7.44% for the three months ended September 30, 2007 compared to 7.33% for the comparable period in 2006. The yield on interest-bearing liabilities was 5.01% and 4.94% for the three months ended September 30, 2007 and 2006, respectively. The improvement in net interest income is primarily attributable to favorable volume increases due to organic growth.

Interest income increased $3.1 million, or 25.6%, to $15.3 million for the three months ended September 30, 2007 compared to the same time period of the prior year primarily due to volume increases in the commercial real estate and other mortgage and commercial loan portfolios. Average loans and leases receivable increased 28.2%. The average balance of the commercial real estate and other mortgage loan portfolio was $494.0 million with a weighted average yield of 7.51% for the three months ended September 30, 2007 compared to an average balance of $376.2 million with a weighted average yield of 7.33% for the same three months of the prior year. Yields on our commercial real estate and other mortgage loan portfolio increased 18 basis points. The majority of loans in this portfolio are fixed rate in nature and are minimally impacted during a volatile interest rate market. The average balance of the commercial and industrial loan portfolio was $203.1 million with a weighted average yield of 8.84% for the three months ended September 30, 2007 compared to an average balance of $167.7 million with a weighted average yield of 9.18% for the same time period of the prior year.

The yields on our commercial and industrial loan portfolio dropped 34 basis points from the same time period one year ago. This basis point decline is partially attributable to the 50 basis point decline in the Prime rate during the month of September 2007 coupled with continued pressures to competitively price our commercial loans. Overall growth in the loan portfolio is partially attributable to the loan production office located in Oshkosh, Wisconsin which serves the Northeast region of Wisconsin coupled with the addition of new business development officers in the Madison and Milwaukee, Wisconsin markets. Yields on commercial loans also reflect the recognition of prepayment fees received on certain of our asset based lending loans.

Interest expense increased $2.0 million, or 26.4%, to $9.4 million for the three months ended September 30, 2007 compared to the same time period of 2006. The increase in interest expense was caused by increased average deposit liability balances needed to fund asset growth and the need to competitively price deposit products to attract local deposits. Shortfalls in attracting local deposits are supplemented with brokered deposits. Average deposit balances, including brokered deposits, were approximately $690.9 million at September 30, 2007 with a weighted average cost of 4.90% compared to an average balance of $549.9 million with a weighted average cost of funds of 4.79% for the same time period of 2006. Historically, our variable rate deposit liabilities, including NOW accounts and our money market accounts, were indexed to the 91 day Treasury Bill (T-Bill). Given the significant volatility in T-Bill rates during September 2007, management made the decision to change our pricing index to the Federal Funds rate. This change allowed us to continue to competitively price our products while protecting our in-market deposits and maintaining adequate liquidity within the institution. T-Bill rates were significantly lower for the three months ended September 30, 2007 when compared to the same period of 2006. However, due to our change in pricing methodology during this quarter and the relative stability of the federal funds rate during three months ended September 30, 2007, our NOW account and money market deposit yields do not reflect a large rate impact due to the declining rate environment. Rather, the majority of the increase in the interest expense on deposits is the result of adding additional brokered certificates of deposit during the third quarter of 2007 at market rates that are higher than our existing deposit base. Although overall LIBOR and Federal Funds interest rates were declining during the third quarter of 2007, brokered deposit rates did not fall as quickly due to significant demand for liquidity throughout the financial service industry as a result of liquidity issues amongst larger financial institutions that were impacted by the challenges of the sub-prime market. Interest rates on brokered deposits are fixed; however, purchases of brokered certificates are structured to match the repricing and maturity of the interest-earning asset portfolio.

Average borrowings were $60.6 million with a weighted average yield of 6.26% for the three months ended September 30, 2007 compared to $53.7 million, including junior subordinated debentures at September 30, 2006 with a weighted average yield of 6.52% for the three months ended September 30, 2006. $10.3 million of junior subordinated debentures were repaid during the fourth quarter of 2006. The decrease in the yield for borrowings is directly related to the repayment of the junior subordinated debt in 2006 replaced with subordinated notes payable at a lower rate.

Net interest margin was 2.86% for the three months ended September 30, 2007 compared to 2.84% for the comparable time period of 2006. Our net interest margin remained relatively stable primarily due to market-based pricing of assets and liabilities as well as managing the composition and duration of our interest-bearing liabilities to limit the exposure to changing rates. In addition, the change of the index of which we price our variable rate deposit products from the 91 day Treasury Bill to the Federal Funds index allows us to significantly mitigate basis risk or repricing mismatch inherent in our portfolios without implementing complicated hedging strategies to protect net interest margin in changing rate environments.

For the nine months ended September 30, 2007, net interest income was $16.9 million, up 20.2% from the same period in 2006. Net interest margin was 2.86% compared to 2.89% for the same period in the prior year. The yield on earning assets was 7.38% for the nine months ended September 30, 2007 compared to 7.11% for the nine months ended September 30, 2006. The yield on interest bearing liabilities was 4.94% and 4.64% for the nine months ended September 30, 2007 and 2006, respectively.

Interest income increased $9.1 million, or 26.2%, to $43.8 million for the nine months ended September 30, 2007 compared to the same time period of the prior year. As shown in the rate/volume table, $7.9 million of the $9.1 million increase in interest income is attributable to favorable volume increases in our loans and leases portfolio. Average loans and leases receivable have increased 25.7%. The average balance of the commercial real estate and other mortgage loan portfolio was $467.5 million with a weighted average yield of 7.37% for the nine months ended September 30, 2007 compared to an average balance of $364.3 million with a weighted average yield of 7.08% for the nine months ended September 30, 2006. The average balance of the commercial and industrial loan portfolio was $194.4 million with a weighted average yield of 9.03% for the nine months ended September 30, 2007 compared to an average balance of $162.4 million with a weighted average yield of 8.99% for the same time period of the prior year. Similar to the explanation of third quarter activity, growth in the loan portfolio is partially attributable to the loan production office located in Oshkosh, Wisconsin which serves the Northeast region of Wisconsin coupled with the addition of new business development officers in the Madison and Milwaukee, Wisconsin markets.

Interest expense increased $6.2 million, or 30.4%, to $26.7 million for the nine months ended September 30, 2007 compared to the same time period of 2006. The increase in interest expense was primarily caused by increased average deposit liability balances needed to fund asset growth and the need to competitively price deposit products to attract local deposits. Shortfalls in attracting local deposits are offset with brokered deposits. Average deposit balances, including brokered deposits, were approximately $661.1 million at September 30, 2007 with a weighted average cost of 4.83% compared to an average balance of $537.4 million with a weighted average cost of funds of 4.49% for the same time period of 2006. Average borrowings were $59.1 million at September 30, 2007 with a weighted average yield of 6.17% for the nine months ended September 30, 2007 compared to $50.3 million, including junior subordinated debentures at September 30, 2006 with a weighted average yield of 6.31% for the same time period of the prior year. $10.3 million of junior subordinated debentures were repaid during the fourth quarter of 2006. The decrease in the yield for borrowings is a direct result of the repayment of junior subordinated debentures during 2006 with subordinated notes payable at a lower interest rate.

Net interest margin was 2.86% for the nine months ended September 30, 2007 compared to 2.89% for the comparable period of 2006. Our net interest margin remained relatively stable primarily due to market-based pricing of assets and liabilities as well as managing the composition and duration of our interest-bearing liabilities to limit the exposure to changing rates.

Average Interest-Earning Assets, Average Interest-Bearing Liabilities and Interest Rate Spread. The tables on the following pages show the Corporation’s average balances, interest, average rates, net interest margin and the spread between the combined average rates earned on interest-earning assets and average cost of interest-bearing liabilities for the periods indicated. The average balances are derived from average daily balances.

		For the Three Months Ended September 30,
		2007												2006
		Average								Average				Average								Average
		balance				Interest				yield/cost				balance				Interest				yield/cost
										(In Thousands)
Interest-Earning Assets
Commercial real estate and other mortgage loans(1)		$	493,953			$	9,279				7.51	%		$	376,230			$	6,891				7.33	%
Commercial and industrial loans(1)			203,071				4,490				8.84				167,696				3,847				9.18
Leases			23,935				361				6.03				17,818				314				7.05
Consumer loans			2,949				47				6.38				2,740				45				6.57
Total loans and leases receivable(1)			723,908				14,177				7.83				564,484				11,097				7.86
Mortgage-related securities(2)			89,048				1,016				4.56				92,487				997				4.31
Investment securities(2)			1,701				16				3.76				3,409				28				3.29
Federal Home Loan Bank stock			2,328				16				2.75				2,127				22				4.14
Fed funds sold and other			2,104				28				5.32				—				—				0.00
Short-term investments			1,760				22				5.00				1,755				21				4.79
Total interest-earning assets			820,849				15,275				7.44				664,262				12,165				7.33
Non-interest-earning assets			32,947												30,807
Total assets			853,796												695,069
Interest-Bearing Liabilities
NOW accounts			65,806				717				4.36	%			48,755				543				4.45	%
Money market			170,170				1,960				4.61				155,794				1,871				4.80
Certificates – regular			404,661				5,139				5.08				303,267				3,635				4.79
Certificates – large			50,217				648				5.16				42,095				522				4.96
Total deposits			690,854				8,464				4.90				549,911				6,571				4.79
Junior subordinated debentures			—				—				—				10,310				260				10.09
FHLB advances			24,471				300				4.90				19,605				238				4.86
Other borrowings			36,171				649				7.18				23,816				379				6.37
Total interest-bearing liabilities			751,496				9,413				5.01				603,642				7,448				4.94
Non-interest-bearing liabilities			54,757												47,944
Total liabilities			806,253												651,586
Stockholders’ equity			47,543												43,483
Total liabilities and stockholders’ equity		$	853,796											$	695,069
Net interest income/interest rate spread						$	5,862				2.43	%						$	4,717				2.39	%
Net interest-earning assets		$	69,353											$	60,620
Net interest margin											2.86	%											2.84	%
Average interest-earning assets to average interest-bearing liabilities			109.23	%											110.00	%
Return on average assets			0.41												0.50
Return on average equity			7.45												7.97
Average equity to average assets			5.57												6.26
Non-interest expense to average assets			2.32												2.38