First Business Financial Services, Inc.

Hello and welcome to the First Business Financial Services Second Quarter 2026 Earnings Conference Call. After today's presentation, there will be an opportunity to ask questions. If you would like to ask a question, please press star 1 to raise your hand. To withdraw your question, press star 1 again. Please note this event is being recorded, and today's comments may contain forward-looking statements that are subject to risks and uncertainties. Thank you for joining us. We appreciate your time and your interest in First Business Bank.

Joining me today is our CFO, Brian Spielmann. We encourage you to review our earnings release and supplemental earnings call slides, which are available through our website at ir.firstbusiness.bank along with our other investor materials. Our team's outstanding execution drove our exceptional performance in the second quarter. We reported earnings per share of $1.84, which included a net benefit of 14 cents related to two one-time events. Excluding this benefit, EPS grew 18% from the first quarter and 26% from last year's second quarter. Pre-tax, pre-provision earnings grew to a record $19.8 million for the quarter and were up 15% for the first six months of 2026, reflecting strong contributions across the bank. We are very pleased with this performance. I'll cover the one-time events first. During the second quarter, we released the remaining $1.5 million of a deferred tax valuation allowance related to the changes in Wisconsin state law enacted in 2023. Brian will cover this in greater detail. This resulted in an 18-cent benefit to second quarter earnings per share and about a 9 percentage point decrease in the effective tax rate for the quarter. The second one-time item was $405,000 in SBA-related severance costs, which offset the tax-related EPS benefit by 4 cents. At the end of May, we exited our national out-of-footprint SBA 7a lending activities. You can see a summary of the financial impact of this decision on slide 5 of the earnings supplement. Over the past 10 years, we invested in expanding our SBA talent and capacity on a national basis. but we were ultimately unable to achieve the volume and profitability required to meet our internal targets for economic returns. This was primarily due to what we came to recognize as a mismatch between the industry standards for SBA underwriting and compliance and our own internal standards. We determined that building the national SBA volume at scale would require a level of underwriting flexibility that was inconsistent with our standards for credit quality. We struggled to build a sales team that consistently produced loan volume using our underwriting standards. We built a robust SBA loan closing and compliance operation that met the high standards we expect of all our lending activities, but which may have resulted in over processing the loans to ensure perfect compliance with SBA requirements. This drove up processing costs. You can see on slide five that outside of the one-time severance costs we recorded this quarter, this decision is immediately net positive to our earnings expectations. From a strategic perspective, it's particularly compelling given the capacity that is now freed up for management to prioritize more profitable growth opportunities. For example, We see significant opportunity to take share and grow relationships across our existing bank markets, particularly in Milwaukee and Kansas City. We also continue to prioritize hiring the best talent to accelerate growth in our higher yielding niche C&I lending businesses and our private wealth management business. And we continue to seek opportunities to increase fee income. This includes our participation in limited partnership investments, which Brian will discuss. Before moving on, I do want to note our SBA preferred lender status is unchanged and 7A and 504 lending will continue as needed to support clients within our bank markets. Moving to our operating results, our second quarter performance rounded out an outstanding first half of the year and positioned us to achieve our full year 10% growth goals. We focus on progress against our long-term strategic plan, which you can see on slide 17. Our first half performance was very strong. Revenue grew 11% over the first half of 2025, exceeding our 10% annual goal, even with the elimination of SBA gains on loan sales. Our first half efficiency ratio measured 59.31%, achieving our sub-60% long-term target. and tangible book value grew 15.2% over the prior year, surpassing our 10% growth goal. Our momentum is strong. Quality balance sheet growth was central to this success. Loans grew 10% annualized during the quarter, and I'll note that included the transfer of $23.7 million in SBA 7A loans from held for sale to loans and leases receivable as of June 30th. Excluding the transfer, loans grew an annualized 7.2%, which was in line with the expectations we communicated last quarter, given the extremely strong first quarter growth rate and above average payoffs. Payoffs in the quarter were approximately two times or $50 million above our quarterly average over the past two years. We saw broad growth in conventional loans across our bank markets with particular strength in our Southeast Wisconsin and Kansas City markets. Multifamily lending and owner-occupied CRE were strong and picked up pace while investor CRE declined. Asset-based lending continued to benefit from new leadership and a growing sales team. Portfolio balances grew 19% annualized during the quarter and were up 48% annualized year to date. Loans, including the transfer from held for sale, were up $212 million or an annualized 12.6% in the first half of 2026. This is ahead of our target pace and positions us to achieve 10% annual growth for the full year. We do continue to see elevated prepayment fees compared to our historical experience. Prepayment fees totaled $1.3 million up from $642,000 in the first quarter and above our 12-quarter average of $562,000. We expect this will slow in the second half of the year, but third quarter will likely remain elevated. Recent payoff activity has largely reflected client-driven events, including property sales or refinancings in the secondary market and M&A activity involving commercial clients. Our clients and our markets continue to be strong and steady, and they like doing business with us. Our Net Promoter Score reflects the strength of our relationship model. You can see this on slide 17. Looking ahead, we expect to drive continued loan growth as we grow our team. We are opportunistic recruiters and we attract and retain producers with proven track records of growth. Our talent is a differentiator for first business in any economic landscape. Growing our team also continues to benefit our funding profile. Core deposit growth outpaced loan growth in the quarter, increasing 12% annualized following our robust 18% growth in the first quarter. Growth came from several areas with our Kansas City market and asset-based lending team leading the way. Our focus on hiring the best treasury management talent and maintaining a disciplined approach to business development continues to pay off. Like our outlook for loan growth, we expect deposit growth to be approximately 10% on an annual basis. I'll also highlight fee income for the quarter, which grew 18% year over year, even with the absence of SBA gain on sale revenue. Private wealth again generated record revenues and provides annuity-like support for our revenue growth and diversification goals. You can see more on our fee income trends on slide 11. Over the past year, the private wealth team has added $508 million in assets under management and administration. of which approximately 70% is new client dollars. Our South Central Wisconsin and Kansas City markets were the largest contributors to this growth. On credit, we were pleased to see non-performing assets decline during the quarter and our overall asset quality remains stable. You can see this on slide 13. We continue to expect progress towards resolving our largest two non-performing assets later this year. Before handing it off to Brian, I'll reiterate our commitment to four key objectives. Prioritizing high-quality relationship-based growth, diversifying our revenue streams, maintaining long-term positive operating leverage, and preserving a culture that attracts and keeps the highest quality talent. We believe consistent execution of these growth strategies will continue to support strong shareholder returns. Now I'll hand it off to Brian.

Thanks, Dave. I'll cover the economics of the SBA decision first. Our SBA 7A strategy had been to sell 75% of our loan production and retain 25% on balance sheet. Effective June 30th, we have moved all help for sale balances on balance sheet, and any new production is expected to be retained on balance sheet and serviced through the life of the loans. We currently have about $15 million in process that should fund by the end of 2026. Using our historical SBA spread of 4.9% and an assumption of 75% of $15 million for incremental loans held on balance sheet, we estimate approximately $140,000 in incremental net interest income and $20,000 in incremental servicing income per quarter by 2027. This helps offset the loss of approximately $500,000 and average quarterly SBA gain on sale revenue. On the expense side, salaries and benefits for the limited positions averaged about $650,000 per quarter. This brings the net pre-tax income benefit to approximately $310,000 per quarter in 2027, or about 3 cents per share after tax. That should equate to about 30 to 50 basis points of improvement in our efficiency ratio, all else equal. And now on to our normal financial review. Second quarter net interest margin increased 22 basis points to 378 from 356 in the first quarter. You can see a breakdown of this on slide eight of our earnings supplement. Recall that first quarter net interest margin included a five basis point impact of fewer accrual days in the quarter, putting it at 361 or 17 basis points lower than Q2 for comparative purposes. The 17 basis point difference primarily reflects the deployment of excess cash held at the Fed during the first quarter into loan growth during the second quarter and an increase in prepayment fees. This contributed to a 24 basis point increase in earning asset yields, while the rate paid on average total bank funding increased just two basis points. As Dave mentioned, elevated loan payoffs and related prepayment fees provided a meaningful lift to net interest margin this quarter. Fees in lieu of interest contributed 37 basis points to margin compared to 26 basis points in the first quarter and our historical average of 20 basis points. Looking ahead, we continue to target net interest margin of 360 to 365 for the year. We also continue to expect 10% growth in fee income for the year and our 17% year-to-date growth over last year's first half supports this expectation. Note that compared to the linked quarter, Second quarter fee income declined by just $206,000 despite swap fees decreasing $466,000 and the elimination of SBA loan sale gains, which totaled $592,000 in the link quarter. The modest link quarter decline in total fee income highlights the resiliency of our diversified revenue base. Private wealth helped offset pressure from lower swap fees and the elimination of SBA loan sale gains, increasing $380,000 from the first quarter including approximately $247,000 of seasonal tax processing fees. Private wealth fees grew $509,000 or nearly 14% on a year-over-year basis, showing this business's strength as an off-balance sheet capital-free revenue generator. Our strong fee revenue also reflected growth in income from limited partnership investments, which is reported in other non-interest income. These fees grew to $796,000 for Q2 and totaled $1.1 million for the first half of 2026. This compares to $1.2 million for the full year 2025. We continue to look to optimize our limited partnership investment strategy and we expect returns to grow over time as the portfolio investments mature. Looking at expenses, we had some moving parts related to compensation. Total compensation expense decreased by $79,000 from Q1. This included several large items. Salaries and benefits declined, mainly due to one month of SBA-related cost savings amounting to about $217,000. You can see our outlook for SBA-related cost savings on slide five of the earnings supplement. Payroll taxes were also lowered by $593,000 following the annual cash bonus payouts in the first quarter. These declines were almost fully offset by a $446,000 increase in annual cash bonus accruals compared to the first quarter, along with $405,000 in one-time severance costs related to the SBA exit. Other non-interest expense included a $552,000 impairment on historic tax credit investments, which has been more than offset by related tax benefits recognized in the current and prior periods. In addition, data processing expenses increased $212,000 due to annual tax processing costs associated with our private wealth clients. On an operating basis, non-interest expense declined $189,000, or almost 1%, to $26.9 million. Excluding SBA severance expense and the impairment on tax credit investments, our second quarter expense level was largely aligned with the first quarter. We expect the ongoing run rate to trend modestly lower through the remainder of 2026, as SBA-related personnel savings are fully realized, while continuing to selectively reinvest a portion of those savings into revenue-producing talent in our existing bank markets, nationwide niche C&I businesses, and private wealth. I'll remind you that our primary expense management objective is achieving annual positive operating leverage. That is, annual expense growth at some level modestly below our targeted level of 10% annual revenue growth. We achieved operating leverage of 6.2% compared to the linked quarter and 6.4% compared to the prior year quarter, which supported a very strong efficiency ratio. On a year-to-date basis, operating leverage was 2.4%. The effective tax rate was 7.2% for the second quarter, reflecting the benefit of this quarter's $1.5 million deferred tax asset valuation allowance reversal. Excluding this one-time benefit, our effective tax rate was 15.9%. For background, in 2023, Wisconsin enacted a law which excluded small business lending interest from state tax. In the fourth quarter of 2023, we established a deferred tax valuation allowance of approximately $3.2 million based on forecast estimates and preliminary state guidance. In the fourth quarter of 2024, we released $1.7 million of this allowance due to improved guidance from the state. This quarter, we released the remaining $1.5 million due to historical and forecasted Wisconsin taxable income. For the full year 2026, we now expect our effective tax rate to be approximately 13% to 15%, reflecting the benefit of this quarter's deferred tax asset valuation allowance reversal. After that discrete item, we expect the effective tax rate to normalize to approximately 15% to 17% for the second half of 2026 and in 2027. Finally, our strong earnings continue to generate capital. As shown on slide 15, our CET1 ratio at June 30th exceeded our 9.5% internal target, and our total capital ratio remained above our 12% internal target. Maintaining capital levels above our internal targets provides flexibility in how we deploy excess capital. Our priority remains investing in the business to support organic growth, which we believe creates the greatest long-term value for shareholders. At the same time, we evaluate other capital management alternatives, including our common stock dividend and our $5 million share repurchase authorization. When prudent growth opportunities do not fully utilize our excess capital, share repurchases remain an attractive tool to return capital to shareholders and enhance shareholder value. And now I'll hand it back over to Dave.