Edgar Filing: First Business Financial Services, Inc.

e10vq

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 June 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)

(608) 238-8008

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 July 23, 2007 was 2,552,749 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 June 30, 2007 and December 31, 2006		2
Consolidated Statements of Income for the Three Months and Six Months Ended June 30, 2007 and 2006		3
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Six Months Ended June 30, 2007 and 2006		4
Consolidated Statements of Cash Flows for the Six Months Ended June 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		12

Item 3. Quantitative and Qualitative Disclosures about Market Risk		26

Item 4. Controls and Procedures		26

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		27

Item 1A. Risk Factors		27

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		27

Item 3. Defaults upon Senior Securities		27

Item 4. Submission of Matters to a Vote of Security Holders		27

Item 5. Other information		28

Item 6. Exhibits		28

SIGNATURES		28
Certification of Chief Executive Officer
Certification of Chief Financial Officer
Certification Pursuant to 18 U.S.C. Section 1350

PART I. Financial Information

Item 1. Financial Statements

First Business Financial Services, Inc.

Consolidated Balance Sheets


	June 30,			December 31,
	2007			2006
	(In Thousands, Except Share Data)
	(Unaudited)
Assets
Cash and due from banks	$	14,466		$	19,215
Short-term investments		76			246

Cash and cash equivalents		14,542			19,461
Securities available-for-sale, at fair value		90,166			100,008
Loans and leases receivable, net of allowance for loan and lease losses of $9,598 and $8,296, respectively		702,350			639,867
Leasehold improvements and equipment, net		1,106			1,051
Cash surrender value of bank-owned life insurance		14,399			13,469
Investment in Federal Home Loan Bank stock, at cost		2,313			2,024
Goodwill and other intangibles		2,801			2,817
Accrued interest receivable and other assets		11,623			9,626

Total assets	$	839,300		$	788,323


Liabilities and Stockholders’ Equity
Deposits	$	736,495			640,266
Securities sold under agreement to repurchase		—			451
Federal Home Loan Bank and other borrowings		45,721			92,519
Accrued interest payable and other liabilities		10,429			9,331

Total liabilities		792,645			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, 2,525,278 and 2,516,193 shares issued, 2,502,196 and 2,493,578 outstanding in 2007 and 2006, respectively		25			25
Additional paid-in capital		23,172			23,029
Retained earnings		25,369			24,237
Accumulated other comprehensive loss		(1,371	)		(1,005	)
Treasury stock (23,082 and 22,615 shares in 2007 and 2006, respectively), at cost		(540	)		(530	)

Total stockholders’ equity		46,655			45,756

Total liabilities and stockholders’ equity	$	839,300		$	788,323

See accompanying Notes to Unaudited Consolidated Financial Statements.

First Business Financial Services, Inc.

Consolidated Statements of Income (Unaudited)


	For the Three Months Ended					For the Six Months Ended,
	June 30,					June 30,
	2007		2006			2007		2006
			(In Thousands, Except Share Data)
Interest income:
Loans and leases	$	13,407	$	10,509		$	26,100	$	20,318
Securities income, taxable		1,044		982			2,130		1,948
Short-term investments		37		45			74		81

Total interest income		14,488		11,536			28,304		22,347


Interest expense:
Deposits		7,914		5,950			15,498		11,516
Notes payable and other borrowings		936		526			1,787		999
Junior subordinated debentures		—		254			—		502

Total interest expense		8,850		6,730			17,285		13,017


Net interest income		5,638		4,806			11,019		9,330
Provision for loan and lease losses		701		71			1,277		71

Net interest income after provision for loan and lease losses		4,937		4,735			9,742		9,259


Non-interest income:
Service charges on deposits		167		181			347		377
Credit, merchant and debit card fees		52		41			103		78
Loan fees		195		143			338		291
Increase in cash surrender value of bank-owned life insurance		177		146			340		298
Trust and investment services fee income		500		359			891		661
Change in fair value of interest rate swaps		—		(12	)		—		(171	)
Net cash settlement of interest rate swaps		—		44			—		18
Other		66		34			139		118

Total non-interest income		1,157		936			2,158		1,670


Non-interest expense:
Compensation		3,055		2,483			5,965		5,016
Occupancy		259		257			521		496
Equipment		115		125			237		247
Data processing		252		229			496		445
Marketing		248		213			528		420
Professional fees		308		334			763		582
Other		550		419			1,153		844

Total non-interest expense		4,787		4,060			9,663		8,050


Income before income tax expense		1,307		1,611			2,237		2,879
Income tax expense		448		532			780		943

Net income	$	859	$	1,079		$	1,457	$	1,936


Earnings per share:
Basic	$	0.35	$	0.44		$	0.59	$	0.79
Diluted		0.35		0.44			0.59		0.79
Dividends declared per share		0.065		0.06			0.13		0.12

See accompanying Notes to Unaudited Consolidated Financial Statements.

First Business Financial Services, Inc.

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Unaudited)


								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		—		—		1,936			—			—			1,936
Unrealized securities losses arising during the period		—		—		—			(1,036	)		—			(1,036	)
Unrealized derivatives gains arising during the period		—		—		—			10			—			10
Reclassification adjustment for realized loss on derivatives		—		—		—			65			—			65
Income tax effect		—		—		—			352			—			352

Comprehensive income															1,327
Share-based compensation – restricted shares		—		71		—			—			—			71
Cash dividends ($0.06 per share)		—		—		(296	)		—			—			(296	)
Treasury stock purchased (712 shares)		—		—		—			—			(17	)		(17	)
Stock options exercised (9,280 shares)		1		90		—			—			—			91

Balance at June 30, 2006	$	25	$	22,873	$	22,725		$	(2,078	)	$	(526	)	$	43,019


								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		—		—		1,457			—			—			1,457
Unrealized securities losses arising during the period		—		—		—			(563	)		—			(563	)
Unrealized derivative gains arising during the period		—		—		—			2			—			2
Reclassification adjustment for realized losses on derivatives		—		—		—			1			—			1
Income tax effect		—		—		—			194			—			194

Comprehensive income															1,091
Share-based compensation – restricted shares		—		143		—			—			—			143
Cash dividends ($0.13 per share)		—		—		(325	)		—			—			(325	)
Treasury stock purchased (467 shares)		—		—		—			—			(10	)		(10	)

Balance at June 30, 2007	$	25	$	23,172	$	25,369		$	(1,371	)	$	(540	)	$	46,655

See accompanying Notes to Unaudited Consolidated Financial Statements

First Business Financial Services, Inc.

Consolidated Statements of Cash Flows (Unaudited)


	For the Six Months Ended
	June 30,
	2007			2006
	(In Thousands)
Operating activities
Net income	$	1,457		$	1,936
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes, net		(740	)		(180	)
Provision for loan and lease losses		1,277			71
Depreciation, amortization and accretion, net		239			346
Share-based compensation		143			71
Change in fair value of interest rate swaps		—			171
Increase in cash surrender value of bank-owned life insurance		(340	)		(298	)
Origination of loans originated for sale		(1,340	)		(457	)
Sale of loans originated for sale		1,346			461
Gain on sale of loans originated for sale		(6	)		(4	)
(Increase) decrease in accrued interest receivable and other assets		(1,049	)		92
Increase (decrease) in accrued interest payable and other liabilities		1,088			(1,235	)

Net cash provided by operating activities		2,075			974

Investing activities
Proceeds from maturities of available-for-sale securities		10,244			9,660
Purchases of available-for-sale securities		(1,001	)		(14,936	)
Proceeds from sale of FHLB stock		—			771
Purchases of FHLB stock		(289	)		—
Net increase in loans and leases		(63,760	)		(9,359	)
Purchases of leasehold improvements and equipment, net		(256	)		(148	)
Purchase of bank-owned life insurance		(590	)		—

Net cash used in investing activities		(55,652	)		(14,012	)

Financing activities
Net increase in deposits		96,229			7,309
Net decrease in FHLB line of credit		(17,048	)		—
Repayment of FHLB advances		(5	)		(4	)
Proceeds from FHLB advances		—			7,000
Net decrease in short-term borrowed funds		(30,196	)		(4,291	)
Termination of interest rate swaps		—			(1,384	)
Exercise of stock options		—			91
Cash dividends paid		(312	)		(295	)
Purchase of treasury stock		(10	)		(17	)

Net cash provided by financing activities		48,658			8,409

Net decrease in cash and cash equivalents		(4,919	)		(4,629	)
Cash and cash equivalents at the beginning of the period		19,461			16,707

Cash and cash equivalents at the end of the period	$	14,542		$	12,078


Supplementary cash flow information
Interest paid on deposits and borrowings	$	16,194		$	12,885
Income taxes paid		1,783			1,616
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 six month periods ended June 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. Basic and diluted earnings per share for the three months ended June 30, 2006 as previously presented were $0.44 and $0.43, respectively compared to basic and diluted earnings per share of $0.44 and $0.44 as restated. Both basic and diluted earnings per share for the six months ended June 30, 2006 as previously presented were $0.78 compared to basic and diluted earnings per share of $0.79 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 June 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 June 30, 2007, State of Wisconsin tax years that remain open are 1997 and 1999 through 2006. Federal tax years that remain open are 2003 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. This option is available to all entities, including not-for-profit organizations. 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 425,772 common shares are currently authorized for awards under the Plans. 199,519 shares are available for future grants under the Plans as of June 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 six month period ended June 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 six months ended June 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 six months ended June 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		—			—
Forfeited		(2,500	)		25.00

Outstanding at June 30, 2007		163,668		$	21.92		6.09


Options exercisable at June 30, 2007		129,613		$	21.38

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 six months ended June 30, 2007, restricted share awards vested at a market price 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 six month period ending June 30, 2006. Restricted share activity for the six months ended June 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		9,085			21.53
Vested		(7,183	)		23.13
Forfeited		—			—

Nonvested balance as of June 30, 2007		47,027		$	22.77

As of June 30, 2007, there was approximately $912,000 of deferred compensation expense related to unvested shares which was expected to be recognized over four years. As of June 30, 2007, there were no restricted shares vested and not delivered. For the six months ended June 30, 2007 and 2006, share-based compensation expense included in net income totaled approximately $143,000 and $71,000, respectively.

Note 5 – Earnings Per Share.

Basic earnings per share for the three and six months ended June 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 June 30, 2007 and 2006, average anti-dilutive employee stock options totaled 132,200 and 65,250, respectively. For the six month periods ended June 30, 2007 and 2006, average anti-dilutive employee stock options totaled 132,200 and 65,250, respectively.


	For the Three Months				For the Six Months
	Ended June 30,				Ended June 30,
	2007		2006		2007		2006
Income available to common stockholders	$	858,532	$	1,079,025	$	1,457,164	$	1,935,678


Basic average shares		2,455,156		2,443,574		2,454,117		2,440,973
Dilutive effect of share-based awards		6,611		18,035		7,329		15,749

Dilutive average shares		2,461,767		2,461,609		2,461,446		2,456,722


Earnings per share:
Basic	$	0.35	$	0.44	$	0.59	$	0.79
Diluted	$	0.35	$	0.44	$	0.59	$	0.79

Note 6 – Securities.

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


	As of June 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	$	1,498	$	—	$	(20	)	$	1,478
Municipals		85		—		(1	)		84
Collateralized mortgage obligations		90,675		—		(2,071	)		88,604

	$	92,258	$	—	$	(2,092	)	$	90,166


	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 June 30, 2007 and December 31, 2006. At June 30, 2007 and December 31, 2006, the Corporation had 107 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 June 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	$	—	$	—	$	1,478	$	20	$	1,478	$	20
Municipals		—		—		84		1		84		1
Collateralized mortgage obligations		28,290		458		60,314		1,613		88,604		2,071

	$	28,290	$	458	$	61,876	$	1,634	$	90,166	$	2,092


	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 six months ended June 30, 2007 and 2006 and has therefore not realized any gains or losses on such transactions.

At June 30, 2007 and December 31, 2006, securities with a fair value of approximately $45.9 million and $35.4 million, respectively, were pledged to secure public deposits, securities sold under arrangements to repurchase, and FHLB advances.

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

Loans and leases receivable consisted of the following:


	June 30,		December 31,
	2007		2006
	(In Thousands)
First mortgage loans:
Commercial real estate	$	306,064	$	274,262
Construction		94,759		78,257
Multi-family		35,180		34,635
1-4 family		40,208		35,721

		476,211		422,875
Commercial business loans		189,953		176,701
Direct financing leases, net		23,532		23,203
Home equity loans		10,288		8,859
Credit card and other		12,143		16,712

		712,127		648,350

Less:
Allowance for loan and lease losses		9,598		8,296
Deferred loan fees		179		187

Loans and lease receivables, net	$	702,350	$	639,867

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


	Six
	Months Ended			Year Ended
	June 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		2			4
Commercial		23			—
Lease		—			—
Consumer		—			—

Total recoveries		25			4

Net recoveries (charge-offs)		25			4

Provision for loan and lease losses		1,277			1,519

Allowance at end of period	$	9,598		$	8,296


Allowance to gross loans and leases		1.35	%		1.28	%

Note 8 – Deposits.

Deposits consisted of the following:


	June 30, 2007					December 31, 2006
			Weighted					Weighted
	Balance		average rate			Balance		average rate
	(In Thousands)
Transaction accounts:
Demand deposits	$	45,808		0.00	%	$	45,171		0.00	%
Negotiable order of withdrawal (NOW) accounts		67,600		4.43			58,927		4.26

		113,408					104,098
Money market accounts		166,779		4.69			171,996		4.57
Certificates of deposit		456,308		4.91			364,172		4.63

	$	736,495				$	640,266

Note 9 – Borrowings.

Borrowings consisted of the following:


	June 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	$	—	$	12,776		5.43	%	$	33,751	$	13,875		5.12	%
FHLB advances		19,531		21,991		4.86			36,584		19,059		4.83
Junior subordinated debentures		—		—		0.00			—		9,915		12.52
Line of credit		5,190		2,525		7.12			1,635		3,167		6.82
Subordinated notes payable		21,000		21,000		7.77			21,000		6,929		7.58
Other		—		50		7.00			—		—		0.00

	$	45,721	$	58,342		6.13		$	92,970	$	52,945		6.82


Short-term borrowings	$	11,200						$	52,443
Long-term borrowings		34,521							40,527

	$	45,721						$	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 June 30, 2007, the Corporation had $5.2 million outstanding under its line of credit, and $21.0 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 that 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 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 June 30, 2007 was $859,000, down 20.4% from $1.1 million for the same time period in 2006. The principal factors contributing to this decline included a $701,000 provision for loan and lease losses during the second quarter of 2007 and an increase in non-interest expense of $727,000. Increases in expenses were partially offset by an increase in net interest income of $832,000 caused by volume increases associated with organic growth and increase in non-interest income of $221,000 primarily due to increased trust and investment service fee income. Basic earnings per share for the three months ended June 30, 2007 decreased to $0.35 from $0.44 for the same period in 2006. Diluted earnings per share for the three months ended June 30, 2007 decreased to $0.35 from $0.44 for the same period in 2006. The decrease is largely attributable to the decline in net income. The annualized returns on average assets and average return on equity are 0.42% and 7.31%, respectively, for the three month period ending June 30, 2007 compared to 0.64% and 10.10%, respectively for the same time period of 2006.

Net income for the six months ended June 30, 2007 was $1.5 million, down 24.7% from $1.9 million for the same time period in 2006. Similar to the three months ended June 30, 2007 results, the principal factors contributing to the decline in net income are related to the $1.3 million provision for loan and lease losses recorded and an increase in non-interest expense of $1.6 million. Positive factors offsetting the previously mentioned reductions of income include a $1.7 million increase in net interest income and $488,000 increase in non-interest income. Basic and diluted earnings per share decreased to $0.59 per share from $0.79 per share for the same time period in 2006 primarily due to the decline in net income. The annualized returns on average assets and average return on equity were 0.36% and 6.25%, respectively, for the six month period ending June 30, 2007 compared to 0.58% and 9.14%, 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 and based on the current pipeline and continued

investment in the infrastructure of our Corporation, we believe this level of 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 Six Months Ended
	June 30,							June 30,
	2007		2006		Change			2007		2006		Change
Net interest income	$	5,638	$	4,806		17.3	%	$	11,019	$	9,330		18.1	%
Non-interest income		1,157		936		23.6			2,158		1,670		29.2

Total top line revenue	$	6,795	$	5,742		18.3		$	13,177	$	11,000		19.8

Net Interest Income. Net interest income is dependent 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 six months ended June 30, 2007 compared to the same period of 2006.


	For the three months ended June 30, 2007												For the six months ended June 30, 2007
							Rate/												Rate/
	Rate			Volume			Volume			Net			Rate			Volume			Volume			Net
Interest-Earning Assets
Commercial real estate and other mortgage loans	$	158		$	1,905		$	46		$	2,109		$	604		$	3,339		$	161		$	4,104
Commercial loans		30			783			6			819			190			1,350			37			1,577
Leases		(107	)		102			(27	)		32			(63	)		171			(16	)		92
Consumer loans		(2	)		5			(1	)		2			(2	)		12			(1	)		9

Total loans and leases receivable		79			2,795			24			2,898			729			4,872			181			5,782
Mortgage-related securities		64			11			1			76			150			55			4			209
Investment securities		2			(15	)		(1	)		(14	)		6			(30	)		(3	)		(27	)
Other investments		(5	)		(5	)		2			(8	)		(4	)		(11	)		1			(14	)
Fed funds sold and other		1			(1	)		(1	)		(1	)		—			6			—			6
Short-term investments		3			(2	)		—			1			5			(4	)		—			1

Total net change in income on interest-earning assets		144			2,783			25			2,952			886			4,888			183			5,957

Interest-Bearing Liabilities
NOW accounts		21			204			8			233			94			370			33			497
Money market		43			273			7			323			268			645			55			968
Certificates – regular		322			936			91			1,349			723			1,575			179			2,479
Certificates – large		56			3			—			59			161			(103	)		(17	)		41

Total deposits		442			1,416			106			1,964			1,246			2,487			249			3,982
Junior subordinated debentures		—			(254	)		—			(254	)		—			(502	)		—			(502	)
FHLB advances		5			37			—			42			10			116			1			127
Other borrowings		39			290			39			368			134			429			98			661

Total net change in expense on interest-bearing liabilities		486			1,489			145			2,120			1,390			2,530			348			4,268

Net change in net interest income	$	(342	)	$	1,294		$	(120	)	$	832		$	(504	)	$	2,358		$	(165	)	$	1,689

Net interest income was $5.6 million for the three months ended June 30, 2007, up 17.3% from the same period in 2006. Net interest margin was 2.87% for the three months ended June 30, 2007 compared to 3.00% for the three months ended June 30, 2006. The yield on earning assets was 7.39% for the three months ended June 30, 2007 compared to 7.21% for the comparable period in 2006. The yield on interest-bearing liabilities was 4.92% and 4.64% for the three months ended June 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 $3.0 million, or 27.8%, to $13.4 million for the three months ended June 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 have increased 27.0%. The average balance of the commercial real estate and other mortgage loan portfolio was $468.0 million with a weighted average yield of 7.29% for the three months ended June 30, 2007 compared to an average balance of $361.0 million with a weighted average yield of 7.12% for the same three months of the prior year. The average balance of the commercial loan portfolio was $192.3 million with a weighted average yield of 9.26% for the three months ended June 30, 2007 compared to an average balance of $158.2 million with a weighted average yield of 9.18% for the same time period of the prior year. 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. The majority of our variable rate interest loan products are priced using a Prime index. Prime rates increased during the second quarter of 2006 increasing from approximately 7.75% at the beginning of the second quarter to 8.25% at the end of that quarter. There has been no change in Prime during the second quarter of 2007, as a result there has been little change to our loans and leases interest income relating to rate changes.

Interest expense increased $2.1 million, or 31.5%, to $8.9 million for the three months ended June 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, rate increases on deposits due to a rising rate environment 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 $657.9 million at June 30, 2007 with a weighted average cost of 4.81% compared to an average balance of $530.9 million with a weighted average cost of funds of 4.48% for the same time period of 2006. Typically our variable rate deposit liabilities, including NOW accounts and our money market accounts, are indexed to the 91 day Treasury Bill. The Treasury Bill rates in the second quarter of 2006 were increasing while they were decreasing in second quarter of 2007 resulting in an average rate for the respective periods being relatively similar. As a result, the change in interest expense for these deposits due to rate changes was minimal. The majority of the increase in the rate paid on deposits is the result of adding brokered certificates of deposit during the second quarter of 2007 at market rates that are higher than our existing deposit base. The interest rates on these 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 $61.1 million with a weighted average yield of 6.13% for the three months ended June 30, 2007 compared to $49.2 million, including junior subordinated debentures at June 30, 2006 with a weighted average yield of 6.34% for the three months ended June 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 2.87% for the three months ended June 30, 2007 compared to 3.00% for the comparable time period of 2006. Overall, interest rates impacting net interest margin were relatively stable during the second quarter of 2007; however, market rates increased from the same period of 2006. While average earning assets increased by approximately 22.6% and average interest-bearing liabilities increased by approximately 23.9%, the average yields of assets and liabilities did not grow as consistently. The average yield of the interest earning portfolio has increased 18 basis points while the yield on the interest-bearing liabilities has increased 28 basis points thus impacting the overall net interest income and creating margin compression. We continue to market price our assets and manage our gap position and duration of our liabilities to minimize the impact of a changing rate environment.

For the six months ended June 30, 2007, net interest income was $11.1 million, up 18.1% from the same period in 2006. Net interest margin was 2.86% compared to 2.92% for the same period in the prior year. The yield on earning assets was 7.35% for the six months ended June 30, 2007 compared to 7.00% for the six months ended June 30, 2006. The yield on interest bearing liabilities was 4.91% and 4.49% for the six months ended June 30, 2007 and 2006, respectively.

Interest income increased $6.0 million, or 26.6%, to $28.3 million for the six months ended June 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 have increased 24.4%. The average balance of the commercial real estate and other mortgage loan portfolio was $454.2 million with a weighted average yield of 7.30% for the six months ended June 30, 2007 compared to an average balance of $358.2 million with a weighted average yield of 6.96% for the six months ended June 30, 2006. The average balance of the commercial loan portfolio was $190.0 million with a weighted average yield of 9.13% for the six months ended June 30, 2007 compared to an average balance of $159.7 million with a weighted average yield of 8.89% for the same time period of the prior year. Similar to the explanation of second 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 $4.3 million, or 32.8%, to $17.3 million for the six months ended June 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, rate increases due to a rising rate environment 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 $646.0 million at June 30, 2007 with a weighted average cost of 4.80% compared to an average balance of $531.0 million with a weighted average cost of funds of 4.34% for the same time period of 2006. Average borrowings were $58.3 million at June 30, 2007 with a weighted average yield of 6.13% for the six months ended June 30, 2007 compared to $48.5 million, including junior subordinated debentures at June 30, 2006 with a weighted average yield of 6.18% 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 rate.

Net interest margin was 2.86% for the six months ended June 30, 2007 compared to 2.92% for the comparable period of 2006. As discussed above, interest rates have been relatively stable during the first six months of 2007; however, interest rates increased from the same period of 2006. Our net interest margin remained relatively stable primarily due to market-based pricing of asset 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 June 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⁾	$	467,957		$	8,534		7.29	%	$	360,951		$	6,425		7.12	%
Commercial loans⁽¹⁾		192,297			4,451		9.26			158,210			3,632		9.18
Leases		23,456			372		6.34			18,721			404		8.63
Consumer loans		3,102			50		6.45			2,831			48		6.78

Total loans and leases receivable⁽¹⁾		686,812			13,407		7.81			540,713			10,509		7.77
Mortgage-related securities⁽²⁾		92,115			1,030		4.47			91,083			954		4.19
Investment securities⁽²⁾		1,630			14		3.44			3,454			28		3.24
Federal Home Loan Bank stock		2,195			14		2.55			2,804			22		3.14
Fed funds sold and other		44			1		5.21			113			2		5.02
Short-term investments		1,715			22		5.13			1,864			21		4.51

Total interest-earning assets		784,511			14,488		7.39			640,031			11,536		7.21

Non-interest-earning assets		32,140								30,263

Total assets		816,651								670,294


Interest-Bearing Liabilities
NOW accounts		70,343			768		4.37			50,926			535		4.20
Money market		170,849			1,974		4.62			146,573			1,651		4.51
Certificates – regular		374,515			4,632		4.95			291,451			3,283		4.51
Certificates – large		42,213			540		5.12			41,967			481		4.58

Total deposits		657,920			7,914		4.81			530,917			5,950		4.48
Junior subordinated debentures		—			—		—			10,310			254		9.85
FHLB advances		22,581			277		4.91			19,552			235		4.81
Other borrowings		38,512			659		6.84			19,297			291		6.03

Total interest-bearing liabilities		719,013			8,850		4.92			580,076			6,730		4.64

Non-interest-bearing liabilities		50,667								47,498

Total liabilities		769,680								627,574
Stockholders’ equity		46,971								42,720

Total liabilities and stockholders’ equity	$	816,651							$	670,294

Net interest income/interest rate spread				$	5,638		2.47	%				$	4,806		2.57	%

Net interest-earning assets	$	65,498							$	59,955

Net interest margin							2.87	%							3.00	%

Average interest-earning assets to average interest-earning liabilities		109.11	%							110.34	%

Return on average assets		0.42	%							0.64	%

Return on average equity		7.31	%							10.10	%

Average equity to average assets		5.75	%							6.37	%

Non-interest expense to average assets		2.34	%							2.42	%


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

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


	For the Six Months Ended June 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⁾	$	454,119		$	16,566		7.30	%	$	358,166		$	12,462		6.96	%
Commercial loans⁽¹⁾		190,040			8,674		9.13			159,666			7,097		8.89
Leases		23,180			757		6.53			18,439			665		7.21
Consumer loans		3,167			103		6.50			2,820			94		6.67

Total loans and leases receivable⁽¹⁾		670,506			26,100		7.79			539,091			20,318		7.54
Mortgage-related securities⁽²⁾		94,028			2,100		4.47			91,373			1,891		4.14
Investment securities⁽²⁾		1,641			30		3.66			3,455			57		3.30
Federal Home Loan Bank stock		2,110			30		2.84			2,851			44		3.09
Fed funds sold and other		280			8		5.24			66			2		4.95
Short-term investments		1,492			36		4.83			1,665			35		4.20

Total interest-earning assets		770,057			28,304		7.35			638,501			22,347		7.00
Non-interest-earning assets		31,914								31,163

Total assets		801,971								669,664


Interest-Bearing Liabilities
NOW accounts		69,492			1,540		4.43			51,300			1,043		4.07
Money market		173,860			4,079		4.69			144,022			3,111		4.32
Certificates – regular		362,639			8,861		4.89			290,884			6,385		4.39
Certificates – large		40,035			1,018		5.09			44,762			977		4.37

Total deposits		646,026			15,498		4.80			530,968			11,516		4.34
Junior subordinated debentures		—			—		—			10,310			502		9.74
FHLB advances		21,991			534		4.86			17,156			407		4.74
Other borrowings		36,351			1,253		6.89			21,068			592		5.62

Total interest-bearing liabilities		704,368			17,285		4.91			579,502			13,017		4.49

Non-interest-bearing liabilities		50,989								47,786

Total liabilities		755,357								627,288
Stockholders’ equity		46,614								42,376

Total liabilities and stockholders’ equity	$	801,971							$	669,664


Net interest income/interest rate spread				$	11,019		2.44	%				$	9,330		2.51	%

Net interest-earning assets	$	65,689							$	58,999

Net interest margin							2.86	%							2.92	%

Average interest-earning assets to average interest-earning liabilities		109.33	%							110.18	%

Return on average assets		0.36	%							0.58	%

Return on average equity		6.25	%							9.14	%

Average equity to average assets		5.81	%							6.33	%

Non-interest expense to average assets		2.41	%							2.40	%


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

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

Non-Interest Income. Non-interest income, consisting primarily of fees earned for trust and investment services, deposit and loan related fees, changes in fair value of derivatives and income from bank-owned life insurance, increased $221,000, or 23.6%, to $1.2 million for the three months ended June 30, 2007

from $936,000 for the same period in 2006. Trust and investment services fee income increased $141,000, or 39.3%, to $500,000 for the three months ended June 30, 2007 compared to $359,000 for the same period in 2006. Fee income generated from trust assets under management increased $94,000 when comparing the three months ended June 30, 2007 and 2006, respectively. Trust assets under management increased approximately $98.9 million to $268.1 million at June 30, 2007 compared to $169.4 million at June 30, 2006, primarily due to successful sales efforts. Trust and investment service fee income also includes investment service commissions. As a result of increased activity of transactions processed for clients, investment service commissions increased approximately $47,000, or 57.8% when comparing the three months ended June 30, 2007 and 2006.

Non-interest income for the six months ended June 30, 2007 increased $488,000, or 29.2%, to $2.2 million from $1.7 million for the comparable period of 2006. Similar to the explanation for the second quarter activity, non-interest income increases are primarily due to increased trust and investment services fee income. Trust and investment service fee income increased $230,000, or 34.8%, to $891,000 for the six months ended June 30, 2007 from $661,000 for the six months ended June 30, 2006. This is primarily driven by a 58.4% increase in trust assets under management. In addition, non-interest income also increased due to the 2006 negative change in fair value of interest rate swaps and net cash settlement of interest rate swaps which decreased 2006 period revenue by approximately $153,000. A majority of our interest rate swaps were terminated during the first quarter of 2006, and the remaining interest rate swaps matured in subsequent periods. No new swaps were entered into during the last twelve months ending June 30, 2007.

Provision for Loan and Lease Losses. The provision for loan and lease losses totaled $701,000 and $71,000 for the three months ended June 30, 2007 and 2006, respectively. The provision for the six months ended June 30, 2007 and 2006 was $1.3 million and $71,000, respectively. The increase in the provision for loan and lease losses is primarily due to the increase of specific reserves required for impaired loans and increased inherent risk associated with a growing loan and lease portfolio among other factors prescribed by our allowance for loan and lease loss methodology. The provision for loan and lease losses is dependent upon the credit quality of loans and leases, the increased inherent risk associated with a growing portfolio, the risk inherent in specific loan types and management’s assessment of the collectibility of loans and leases under current economic conditions. There have been no material changes to our underwriting standards. In order to establish the level of the allowance for loan and lease losses, management regularly reviews its historical charge-off migration analysis and an analysis of the current level and trend of several factors that management believes provide an indication of losses in the loan and lease portfolio. These factors include delinquencies, volume, average size, average risk rating, technical defaults, geographic concentrations, industry concentrations, loans and leases on the management attention watch list, experience in the credit granting functions and changes in underwriting standards, and level of non-performing assets and related fair value of underlying collateral. Refer to Asset Quality for further information.

Non-Interest Expense. Non-interest expense increased $727,000, or 17.9%, to $4.8 million for the three months ended June 30, 2007 from $4.0 million for the comparable period of 2006, primarily due to an increase in compensation expense and other expense. In general, non-interest expenses are influenced by the growth of operations, with additional employees necessary to staff such growth. Compensation expense increased $572,000, or 23.0%, to $3.1 million from $2.5 million for the three months ended June 30, 2007 compared to the three months ended June 30, 2006. This increase is due to more full-time equivalent employees, higher compensation levels from normal annual salary reviews, additional compensation expense associated with share-based compensation awards, and increased healthcare costs. Other non-interest expense increased $131,000, or 31.2%, to $550,000 for the three months ended June 30, 2007 from $419,000 for the comparable period of 2006. This fluctuation is primarily caused by two factors. The first factor relates to the recognition of a loss of $47,000 for our investment in Aldine Capital Fund Limited Partnership which began operations during the third quarter of 2006. The second factor relates to donations and contributions of approximately $46,000 made to various not-for-profit organizations during the second quarter of 2007.

Non-interest expense increased $1.6 million, or 20.0%, to $9.7 million for the six months ended June 30, 2007 from $8.1 million for the comparable period of 2006, primarily due to an increase in compensation expense, marketing expense, professional fees, and other expenses. Compensation expense increased $949,000, or 18.9%, to $6.0 million for the six months ended June 30, 2007 compared to $5.1 million for the comparable period of 2006. As discussed earlier, the increase was due to more full-time equivalent employees, higher compensation levels from normal annual salary reviews, additional compensation expense associated with share-based compensation awards and increased healthcare costs. We continue to invest in additional people to provide for the future growth of our Corporation. From June 2006 to June 2007, we added 20 new positions. Of these 20 new positions, approximately 13 were for business development officers. The majority of the positions created are bonus eligible positions, which resulted in an increased bonus accrual. Salary expense is offset by the effects of the compensation differential associated with the retirement of our former Chief Executive Officer and recognition of a sizable signing bonus paid in 2006. We believe this investment in our people provides a strong foundation to meet our growth initiatives. Share-based compensation expense increased approximately $71,000 when comparing the six months ended June 30, 2007 to the six months ended June 30, 2006. We began issuing restricted share awards in 2006, and the increase in this expense represents the recognition of six months of expense relating to the 2006 awards that were granted sporadically throughout fiscal year 2006. Marketing expense increased $108,000, or 25.7%, to $528,000 for the six months ended June 30, 2007 from $420,000 in the comparable period of 2006. The increase is due to the timing of completion of planned advertising campaigns conducted during 2007 and 2006. Professional fees increased $181,000, or 31.1%, to $763,000 for the six months ended June 30, 2007 from $582,000 for the comparable period of 2006. The increase was attributable to increased audit fees, directors’ fees and use of third party consultants to assist us with a system upgrade. Other non-interest expense increased $309,000, or 36.6%, to $1.2 million for the six months ended June 30, 2007 from $844,000 for the comparable period in 2006. The increase was caused by several factors including the recognition of our portion of the loss associated with Aldine Capital Fund Limited Partnership (approximately $183,000), increased legal fees associated with defending our positions with certain loans and real estate owned (approximately $48,000), increased charitable donations (approximately $38,000), and increased training expenses (approximately $20,000). Our investment in Aldine Capital Fund Limited Partnership is accounted for under the equity method and the losses represent our pro-rata share of the costs associated with starting up a new private equity partnership.

Income Taxes. Income tax expense was $448,000 for the three months ended June 30, 2007, with an effective rate of 34.3% compared to $532,000 with an effective rate of 33.0% for the three months ended June 30, 2006. The primary reason for the increase in the effective tax rate is due to increased state income tax expense as a result of related uncertain tax liabilities and a decline in the level of tax credits.

Income tax expense was $780,000 for the six months ended June 30, 2007, with an effective rate of 34.9% compared to $943,000 with an effective rate of 32.8% for the six months ended June 30, 2006. Similar to the explanation provided for the quarter ended June 30, 2007, the increase in the effective tax rate is due to increased state income tax expense as a result of related uncertain tax liabilities and a decline in the level of tax credits.

Financial Condition

General. The total assets of the Corporation increased $50.8 million, or 6.4%, to $839.1 million at June 30, 2007 from $788.3 million at December 31, 2006, primarily in the loan and lease portfolio. Loan growth was funded by an overall net increase in the liabilities of $50.9 million and reduction of the investment portfolio of $9.8 million. The allowance for loan and lease losses was 1.35% at June 30, 2007 of gross loans and leases compared to 1.28% at December 31, 2006.

Securities. Securities available-for-sale decreased $9.8 million to $90.1 million at June 30, 2007 from $100.0 million at December 31, 2006. Principal pay-downs received from our collateralized mortgage obligation portfolio were used to fund loan and lease growth. Our available-for-sale investment portfolio primarily consists of collateralized mortgage obligations and is used to provide a source of liquidity while maximizing the earnings potential of the Banks’ assets. We purchase investment securities intended to protect our net interest margin while maintaining an acceptable risk profile.

While collateralized mortgage obligations present prepayment risk and extension risk, the overall credit risk associated with these investments is minimal as approximately 41.6% of the obligations we hold were issued by government agencies and 58.4% of the obligations we hold were issued by government sponsored agencies. The estimated pre-payment streams associated with this portfolio allow us to better match our short-term liabilities. There were no sales of securities during the three and six months ended June 30, 2007 and 2006.

The average balance of our available-for-sale portfolio for the three months ended June 30, 2007 was $93.7 million, with an average yield of 4.45%, compared to an average balance of $94.5 million, with an average yield of 4.15% for the same period last year. The average balance of our available-for-sale portfolio for the six months ended June 30, 2007 was $95.7 million, with an average yield of 4.45%, compared to an average balance of $94.8 million, with an average yield of 4.11% for the same six months of last year.

Loans and Leases Receivable. Loans and lease receivables, net of allowance for loan and lease losses increased $62.5 million, or 9.8%, to $702.4 million at June 30, 2007 from $639.9 million at December 31, 2006. The Banks principally originate commercial business loans and commercial real estate loans. The overall mix of the loan and lease portfolio at June 30, 2007 remains relatively consistent with the mix at December 31, 2006 with a concentration in commercial real estate mortgage loans. Growth in the loan and lease portfolio is attributable to successful sales efforts by the expanded sales team to extend credit to established and new client relationships, including production from our new loan production office located in the Northeast region of Wisconsin. Approximately 27% of our loan and lease portfolio growth has been generated by this location. Our pipeline of potential new business remains strong, and we expect continued growth in the loan and lease portfolio.

Allowance for loan loss as a percentage of gross loans was 1.35% as of June 30, 2007 compared to 1.28% at December 31, 2006. Non-accrual loans increased to 0.45% of total loans at June 30, 2007 from 0.17% of total loans and leases at December 31, 2006. Increased amount of non-accrual loans, increased specific reserves needed for impaired loans, increased levels of loans on our management attention watch lists and increased inherent risk due to a growing portfolio has resulted in an increased loan loss provision during the six month period ending June 30, 2007. Management believes the allowance for loan losses is adequate at June 30, 2007. Our non-performing assets as a percentage of total assets were 0.46% which is lower than our peer group median. Refer to the Asset Quality section for more information.

Deposits. As of June 30, 2007, deposits increased $96.2 million to $736.5 million from $640.3 million at December 31, 2006. The increase during the six months ended June 30, 2007 was primarily attributable to an increase of brokered certificates of deposit. Brokered certificates of deposit represented $406.1 million of total deposits at June 30, 2007 compared to $323.4 million of total deposits at June 30, 2006. We experienced a significant amount of growth in our loan and lease portfolio during the second quarter of 2007 — approximately $45.7 million of the $62.4 million year-to-date growth occurred during this time. This growth was primarily funded through the attainment of brokered certificates of deposit. Brokered deposits are utilized to support asset growth and are generally a lower cost source of funds when compared to the interest rates on deposits with similar terms that would need to be offered in the local markets to generate a sufficient level of funds. The increase in brokered certificates of deposits is also affected by the completion of an initiative to obtain brokered certificates to fund the growth we experienced during the fourth quarter of 2006. This growth was temporarily funded by federal funds purchased and other short-term FHLB advances while the Corporation orderly obtained brokered certificates of deposit from the market. The attainment of the appropriate level of brokered certificates of deposits was completed in January of 2007. At that time, the funds obtained were used to pay down the federal funds purchased.

Borrowings. The Corporation had borrowings of $45.7 million as of June 30, 2007 compared to $93.0 million as of December 31, 2006, a decrease of $46.8 million, or 50.6%. We use borrowings to offset variability of deposit flows and as a temporary funding source for the growth of our balance sheet. As discussed above, the primary reason for the decrease of borrowings was caused by the repayment of short-term borrowings, including federal funds purchased, upon the attainment of the level of brokered certificates of deposit needed to repay short-term borrowings and fund the asset growth of our balance sheet.

Asset Quality

Non-performing Assets. Non-performing assets consisted of non-accrual loans and leases of $3.8 million and foreclosed property of $660,000 as of June 30, 2007. This represented approximately 0.46% of total assets as of June 30, 2007, compared to $1.1 million, or 0.14% of total assets, as of December 31, 2006. The increase in non-accrual loans is a function of the addition of four unrelated relationships where the contractual principal and interest payments have gone 90 days past due. The primary growth in non-accrual loans is related to loans with principal source of repayment from the sale of real estate. The real estate markets in our primary business areas have slowed. Adding to the increase in non-accrual loans is one commercial credit experiencing significant cash flow problems. In addition, non-performing assets have increased due to the addition of one foreclosed property, with a carrying value of $660,000, during the first quarter of 2007. Currently, First Business Bank does not expect a loss on this property.

As discussed in the results of operations, we recorded a provision for loan and lease losses of $701,000 for the three months ended June 30, 2007 compared to $71,000 provision for the three months ended June 30, 2006. For the six month period ended June 30, 2007, we recorded a provision for loan and lease loss of $1.3 million compared to $71,000 for the comparable period of the prior year. The primary drivers of the increased provision are an increased amount of specific reserves required for impaired loans and increased inherent risk associated with a growing portfolio. There have been no significant changes to our underwriting standards. Through proactive loan and lease portfolio monitoring, management has identified weakening of key performance indicators based upon our clients’ financial statements which has elevated the number and amount of loans on management attention watch lists. In addition, there is an increase in non-accrual loans and leases with no specific concentration of any particular industry identified. Non-accrual loans and leases are considered an indicator of potential future losses.

The Corporation’s non-accrual loans and leases consisted of the following at June 30, 2007 and December 31, 2006, respectively.


	June 30,			December 31,
	2007			2006
Non-accrual loans	$	3,181		$	1,109
Non-accrual leases		—			—

Total non-accrual loans and leases		3,181			1,109
Foreclosed properties and repossessed assets		660			—

Total non-performing assets	$	3,841		$	1,109

Performing troubled debt restructurings	$	—		$	—


Total non-accrual loans and leases to total loans and leases		0.45	%		0.17	%
Total non-performing assets to total assets		0.46			0.14
Allowance for loan and lease losses to total loans and leases		1.35			1.28
Allowance for loan and lease losses to non-accrual loans and leases		301.73			748.06

The following represents information regarding the Corporation’s impaired loans:


	As of and for		As of and for
	the Six Months		the Year
	ended		Ended
	June 30,		December 31,
	2007		2006
Impaired loans and leases with no impairment reserves required	$	1,050	$	683
Impaired loans and leases with impairment reserves required		2,136		1,404

Total impaired loans and leases		3,186		2,087
Less:
Impairment reserve (included in allowance for loan and lease loss)		1,369		863

Net impaired loans and leases	$	1,817	$	1,224

Average impaired loans and leases	$	2,710	$	1,444


Foregone interest income attributable to impaired loans and leases	$	188	$	210
Interest income recognized on impaired loans and leases		27		217

Net foregone interest income on impaired loans and leases	$	161	$	(7	)

A summary of the activity in the allowance for loan and lease losses follows:


	For the Three Months Ended						For the Six Months
	June 30,						Ended June 30,
	2007			2006			2007			2006
				(In Thousands)
Allowance at beginning of period	$	8,896		$	6,774			8,296		$	6,773

Recoveries:
Commercial real estate and other mortgage		1			1			2			2
Commercial		—			—			23			—

Total recoveries		1			1			25			2
Provision for loan and lease loss		701			71			1,277			71

Allowance at end of period	$	9,598		$	6,846			9,598		$	6,846

Allowance to average loans and leases		1.40	%		1.27	%		1.43	%		1.27	%

There were no charge-offs in the loan portfolio for the three and six months ended June 30, 2007 or June 30, 2006.

Liquidity and Capital Resources

During the three and six months ended June 30, 2007 and the year ended December 31, 2006, the Banks did not make dividend payments to the Corporation. The Banks are subject to certain regulatory limitations regarding their ability to pay dividends to the Corporation. Management believes that the Corporation will not be adversely affected by these dividend limitations. The Corporation’s principal liquidity requirements at June 30, 2007 are the repayment of interest payments due on subordinated debentures. The Corporation expects to meet its liquidity needs through existing cash flow sources, its line of credit in the amount of $7.5 million of which $5.2 million is outstanding on June 30, 2007 and through any future dividends received from the Banks. The Corporation and its subsidiaries continue to have a strong capital base and the Corporation’s regulatory capital ratios continue to be above the defined minimum regulatory ratios. In addition to the capital instruments on the June 30, 2007 balance sheet the Corporation has the option through September 2007 to draw up to an additional $10.0 million of subordinated debt in order to manage its capital position.

We manage our liquidity to ensure that funds are available to each of our Banks to satisfy the cash flow requirements of depositors and borrowers and to ensure the Corporation’s own cash requirements are met. The Banks maintain liquidity by obtaining funds from several sources.

The Banks’ primary sources of funds are principal and interest repayments on loans receivable and mortgage-related securities, deposits and other borrowings such as federal funds and Federal Home Loan Bank advances. The scheduled repayments of loans and the repayments of mortgage-related securities are a predictable source of funds. Deposit flows and loan prepayments, however, are greatly influenced by general interest rates, economic conditions and competition.

Brokered deposits are used by the Banks, which allows them to gather funds across a larger geographic base at price levels considered attractive. Access to such deposits allows the flexibility to not pursue single service deposit relationships in markets that have experienced some unprofitable pricing levels. There were $406.1 million of outstanding brokered deposits at June 30, 2007 compared to $325.9 million of deposits as of December 31, 2006. In addition, the administrative costs associated with brokered deposits are considerably less than the administrative costs that would be incurred to administer a similar level of local deposits. Although local market deposits are expected to increase as new client relationships are established and as marketing efforts are made to increase the balances in existing clients’ deposit accounts, we will likely continue to use brokered deposits. In order to provide for ongoing liquidity and funding, all of the brokered deposits are certificates of deposit that do not allow for withdrawal, at the option of the depositor, before the stated maturity. In the event that there is a disruption in the availability of brokered deposits at maturity, the Banks have managed the maturity structure so that at least 90 days of maturities would be funded through other means, including but not limited to advances from the Federal Home Loan Bank, replacement with higher cost local market deposits or cash flow from borrower repayments and security maturities.

The Banks are required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. Management believes that its Banks have an acceptable liquidity percentage to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows.

Under Federal law and regulation, the Corporation and the Banks are required to meet certain Tier 1 and risk-based capital requirements. Tier 1 capital generally consists of stockholders’ equity plus certain qualifying debentures and other specified items less intangible assets such as goodwill. Risk-based capital requirements presently address credit risk related to both recorded and off-balance sheet commitments and obligations.

As of June 30, 2007, the most recent notification from the Federal Deposit Insurance Corporation and the State of Wisconsin Department of Financial Institutions (DFI) categorized the Banks as well capitalized under the regulatory framework for prompt corrective action.

In addition, the Banks exceeded minimum net worth requirement of 6.0% as required by the State of Wisconsin at December 31, 2006.

The following table summarizes the Corporation and Banks’ capital ratios and the ratios required by their federal regulators at June 30, 2007 and December 31, 2006, respectively:


											Minimum Required to be
											Well Capitalized Under
						Minimum Required for					Prompt Corrective Action
	Actual					Capital Adequacy Purposes					Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio
						(In Thousands)
As of June 30, 2007

Total capital (to risk-weighted assets) Consolidated	$	75,824		9.80	%	$	61,866		8.00	%		N/A		N/A
First Business Bank		69,210		10.14			54,582		8.00		$	68,228		10.00	%
First Business Bank – Milwaukee		9,900		11.05			7,168		8.00			8,960		10.00

Tier 1 capital (to risk-weighted assets) Consolidated	$	45,226		5.85	%	$	30,933		4.00	%		N/A		N/A
First Business Bank		62,025		9.09			27,291		4.00		$	40,937		6.00	%
First Business Bank – Milwaukee		8,764		9.78			3,584		4.00			5,376		6.00

Tier 1 capital (to average assets) Consolidated	$	45,226		5.55	%	$	32,603		4.00	%		N/A		N/A
First Business Bank		62,025		8.77			28,292		4.00		$	35,365		5.00	%
First Business Bank – Milwaukee		8,764		7.84			4,470		4.00			5,588		5.00	%


											Minimum Required to be
											Well Capitalized Under
						Minimum Required for					Prompt Corrective Action
	Actual					Capital Adequacy Purposes					Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio
						(In Thousands)
As of December 31, 2006

Total capital (to risk-weighted assets) Consolidated	$	73,241		10.40	%	$	56,360		8.00	%		N/A		N/A
First Business Bank		64,443		10.49			49,144		8.00		$	61,430		10.00	%
First Business Bank – Milwaukee		10,205		11.31			7,218		8.00			9,022		10.00

Tier 1 capital (to risk-weighted assets) Consolidated	$	43,944		6.24	%	$	28,180		4.00	%		N/A		N/A
First Business Bank		57,838		9.42			24,572		4.00		$	36,858		6.00	%
First Business Bank – Milwaukee		9,070		10.05			3,609		4.00			5,413		6.00	%

Tier 1 capital (to average assets) Consolidated	$	43,944		5.99	%	$	29,331		4.00	%		N/A		N/A
First Business Bank		57,838		9.22			25,086		4.00		$	31,358		5.00	%
First Business Bank – Milwaukee		9,070		8.50			4,269		4.00			5,336		5.00

Contractual Obligations and Off-balance Sheet Arrangements

There have been no significant changes to the Corporation’s contractual obligations and off-balance arrangements disclosed in our Form 10-K at December 31, 2006 with the exception of a new lease agreement signed for our loan production office located in the Northeast Region of Wisconsin. The lease begins upon completion of construction of the facility, which is expected during the fourth quarter of 2007, and provides for annual expense of $124,000 on a straight-line basis incorporating rental escalation clauses. As discussed in Note 2 of the Notes to Unaudited Consolidated Financial Statements, we have adopted the provisions of FASB interpretation No. 48, Accounting for Uncertainty in Income Taxes and upon adoption have a liability associated with our uncertain tax positions of approximately $1.4 million recorded in our consolidated financial statements. At this time, there is no unrecognized tax benefit that is expected to significantly increase or decrease within the next twelve months. Management continues to believe there is adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.

Item 3. – Quantitative and Qualitative Disclosures about Market Risk

Interest rate risk, or market risk, arises from exposure of our financial position to changes in interest rates. It is our strategy to reduce the impact of interest rate risk on net interest margin by maintaining a favorable match between the maturities and repricing dates of interest-earning assets and interest-bearing liabilities. This strategy is monitored by the Banks’ respective Asset/Liability Management Committees, in accordance with policies approved by the Banks’ respective Board of Directors. These committees meet regularly to review the sensitivity of our assets and liabilities to changes in interest rates, liquidity needs and sources, and pricing and funding strategies.

We use two techniques to measure interest rate risk. The first is simulation of earnings. The balance sheet is modeled as an ongoing entity whereby future growth, pricing, and funding assumptions are implemented. These assumptions are modeled under different rate scenarios.

The second measurement technique used is static gap analysis. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. A positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature in a time frame and a negative gap indicates the opposite. In addition to the gap position, other determinants of net interest income are the shape of the yield curve, general rate levels, reinvestment spreads, balance sheet growth and mix, and interest rate spreads. We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity and/or repricing characteristics based on market conditions.

The process of asset and liability management requires management to make a number of assumptions as to when an asset or liability will reprice or mature. Management believes that its assumptions approximate actual experience and considers them reasonable, although the actual amortization and repayment of assets and liabilities may vary substantially. The Corporation’s economic sensitivity to change in rates at June 30, 2007 has not changed materially since December 31, 2006.

Item 4. – Controls and Procedures

In accordance with Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Form 10-Q, the Corporation’s management evaluated, with the participation of the Corporation’s Chief Executive Officer along with its Senior Vice President and Chief Financial Officer, the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the Corporation’s Chief Executive Officer and the Corporation’s Senior Vice President and Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures were effective as of the end of the period covered by this Form 10-Q.

There was no change in the Corporation’s internal control over financial reporting that occurred during the quarter ended June 30, 2007 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.

Part II. Other Information

Item 1. – Legal Proceedings

From time to time, the Corporation and its subsidiaries are engaged in legal proceedings in the ordinary course of their respective businesses. Management believes that any liability arising from any such proceedings currently existing or threatened will not have a material adverse effect on the Corporation’s financial position, results of operations, and cash flows.

Item 1A. – Risk Factors

There have been no material changes to risk factors as previously disclosed in Item 1A. to Part 1 of the Corporation’s Form 10-K filed on March 15, 2007.

Item 2. – Unregistered Sales of Equity Securities and Use of Proceeds

	(a)		None.

	(b)		None.

	(c)		Issuer Purchases of Equity Securities

Total Number of

Maximum Number

Shares Purchased

that May Yet be

as Part of Publicly

Purchased Under

Total Number of

Average Price Paid

Announced Plans

the Plans or

Period

Shares Purchased

Per Share

or Programs

Programs

April 1 – 30, 2007

22.00

—

N/A

May 1 – 30, 2007

—

N/A

June 1 – 30, 2007

—

N/A

Item 3. – Defaults Upon Senior Securities

Not applicable.

Item 4. – Submission of Matters to a Vote of Security Holders

The following matters were submitted to a vote during the annual meeting held May 7, 2007:


	Number of Shares
	For		Against		Abstained		Withheld		Non-Votes
Election of Directors for a three-year term expiring in 2010:
Jan A. Eddy		1,884,438		—		—		18,037		—
John M. Silseth		1,886,919		—		—		15,556		—
Dean W. Voeks		1,876,468		—		—		26,007		—

Item 5. – Other Information.

None.

Item 6. – Exhibits.

(31.1) Certification of the Chief Executive Officer.
(31.2) Certification of the Senior Vice President and Chief Financial Officer.

(32) Certification of the Chief Executive Officer and Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. paragraph 1350.

Signatures

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



		FIRST BUSINESS FINANCIAL SERVICES, INC.

		By:		/s/ Corey A. Chambas

				Corey A. Chambas
				Chief Executive Officer

				July 26, 2007

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