First Business Reports Record Quarterly Net Income of $6.6 Million

— Robust Commercial Loan and In-Market Deposit Growth, Combined with Reduction in Credit Costs Contribute to Strong Quarterly Results —

MADISON, Wis.–(BUSINESS WIRE)–First Business Financial Services, Inc. (the “Company” or “First Business”) (Nasdaq:FBIZ) reported second quarter 2019 net income of $6.6 million, primarily driven by exceptional loan and deposit growth, strong fee income, stable operating expenses, and a reduction in credit costs.

Summary results for the quarter ended June 30, 2019 include:

• Net income increased to a record $6.6 million, compared to $5.9 million for the linked quarter and $3.3 million for the second quarter of 2018.
• Diluted earnings per common share were $0.75, compared to $0.67 and $0.38 for the linked and prior year quarters, respectively.
• Annualized return on average assets and annualized return on average equity measured 1.30% and 14.09%, respectively, compared to 1.20% and 13.67% for the linked quarter and 0.70% and 7.59% for the second quarter of 2018.
• Net interest margin was 3.52%, compared to 3.79% for the linked quarter and 3.77% for the second quarter of 2018.
• Net interest income was $16.9 million, decreasing by $902,000 from the linked quarter and by $79,000 from the second quarter of 2018.
• Top line revenue, the sum of net interest income and non-interest income, totaled a record $22.7 million, compared to $22.4 million for the linked quarter and $20.9 million for the second quarter of 2018.
• Provision for loan and lease losses was a benefit of $784,000, compared to expenses of $49,000 and $2.6 million for the linked and prior year quarters, respectively.
• SBA recourse provision was $113,000, compared to $481,000 for the linked quarter and $99,000 for the second quarter of 2018.
• Efficiency ratio measured 67.41%, compared to 68.04% for the linked quarter and 67.07% for the second quarter of 2018.
• Relationship-based historic tax credit programs contributed $446,000, or $0.05 per share, compared to $846,000, or $0.10 per share, in the linked quarter and no contribution in the second quarter of 2018.
• Record period-end gross loans and leases receivable of $1.720 billion grew 15.3% annualized during the second quarter of 2019 and 7.8% from June 30, 2018.
• Non-performing assets were $28.5 million and 1.38% of total assets, compared to $26.1 million and 1.30% at March 31, 2019 and $32.6 million and 1.71% at June 30, 2018.
• Record period-end in-market deposits of $1.290 billion increased 16.4% annualized during the second quarter of 2019 and 22.1% from June 30, 2018.

“Our record quarterly results highlight the strength of our core operations and the Company’s continued forward progress and successful execution on both short-term initiatives and long-term strategies,” said Corey Chambas, President and Chief Executive Officer. “We are excited about the exceptional growth we have been able to achieve on both sides of the balance sheet. Combined with the ongoing success of our trust and investments team, as well as our other fee income sources, we believe the recurring positive operating leverage created by this growth will continue to generate long-term value for our shareholders.”

Results of Operations

Net interest income of $16.9 million decreased by $902,000, or 5.1%, compared to the linked quarter and $79,000, or 0.5%, compared to the second quarter of 2018. The decrease compared to the linked and prior year quarters was principally due to net interest margin compression and a decrease in loan fees received in lieu of interest, partially offset by an increase in average loans and leases outstanding. Fees collected in lieu of interest, defined as prepayment fees, asset-based loan fees, and non-accrual interest, returned to a more normalized level of $1.2 million in the second quarter of 2019, compared to the above average $2.2 million in the linked quarter and $1.4 million in the prior year quarter. Excluding fees collected in lieu of interest, net interest income increased $155,000, or 1.0%, compared to the linked quarter and $182,000, or 1.2%, compared to the second quarter of 2018. Average gross loans and leases of $1.694 billion increased by $49.8 million, or 12.1% annualized, from the linked quarter and $125.1 million, or 8.0%, compared to the second quarter of 2018.

The yield on average loans and leases was 5.64% for the second quarter of 2019, down from 5.89% in the linked quarter and up from 5.42% in the prior year quarter. The yield in the linked quarter benefited primarily from above average fees collected in lieu of interest. Excluding fees collected in lieu of interest, the yield on average loans and leases improved to 5.37%, up from 5.35% and 5.05% in the linked and prior year quarter.

The yield on average interest-earning assets was 5.29% for the second quarter of 2019, compared to 5.48% in the linked quarter and 5.01% in the prior year quarter. Excluding fees collected in lieu of interest, the yield on average earning assets improved to 5.05%, up from 5.01% and 4.69% in the linked and prior year quarters, respectively.

The Company’s cost of average interest-bearing liabilities increased to 2.19% for the second quarter of 2019 from 2.11% and 1.52% in the linked and prior year quarters, respectively. Average interest-bearing deposit costs for the second quarter of 2019 increased to 2.01%, up from 1.93% and 1.17% in the linked and prior year quarters, respectively.

Net interest margin measured 3.52% for the second quarter of 2019, compared to 3.79% in the linked quarter and 3.77% in the second quarter of 2018. The decrease compared to both the linked and prior year quarters was principally due to the rate paid on average interest-bearing liabilities increasing more than the yield on average interest-earning assets, combined with the aforementioned above average fees collected in lieu of interest. Excluding fees collected in lieu of interest, net interest margin measured 3.28% for the second quarter of 2019, compared to 3.32% in the linked quarter and 3.46% in the second quarter of 2018. Despite this trend of downward pressure, management expects the execution of its strategies will allow the Company to maintain a net interest margin at or above its target of 3.50%, including fees collected in lieu of interest.

The Company recorded a provision for loan and lease loss benefit of $784,000 in the second quarter of 2019, compared to an expense of $49,000 in the linked quarter and $2.6 million in the second quarter of 2018. The decrease in provision for the second quarter of 2019 was principally driven by a net reduction in specific reserves due to improved collateral values, net reduction in historic loss rates, and decrease in net charge-offs, partially offset by an increase in provision related to the aforementioned loan growth. Net recoveries were $154,000 in the second quarter of 2019, compared to net charge-offs of $25,000 in the linked quarter and $285,000 in the prior year quarter.

While it was not a source of provision for loan and lease losses during the second quarter of 2019, the legacy on-balance sheet SBA portfolio, defined as SBA loans originated prior to 2017, has been a source of elevated non-performing assets. Total performing on-balance sheet legacy loans were $23.4 million at June 30, 2019, down from $24.4 million and $37.0 million at March 31, 2019 and June 30, 2018, respectively. As of June 30, 2019, total on-balance sheet legacy loans were $40.3 million, compared to $39.3 million and $46.0 million at March 31, 2019 and June 30, 2018, respectively. Legacy on-balance sheet SBA loans increased during the second quarter of 2019 primarily due to repurchase activity resulting in a $2.5 million net increase in sold loans previously identified as impaired.

Non-interest income totaled $5.8 million, or 25.6% of total revenue, in the second quarter of 2019, compared to $4.6 million, or 20.7% of total revenue, in the linked quarter and $4.0 million, or 19.0% of total revenue, in the prior year quarter. The increase in non-interest income was marked by strong trust and investment service fees, fee income related to the Company’s commercial loan interest rate swap transactions, and other fee income.

Trust and investment services fee income, which remained the Company’s largest source of non-interest income, totaled $2.1 million in the second quarter of 2019, compared to $1.9 million in the linked quarter and $2.0 million in the prior year quarter. Strong markets, successful business development, and client retention efforts propelled trust assets under management and administration to a record $1.755 billion at June 30, 2019, up $23.1 million, or 5.3% annualized, from the linked quarter and $109.6 million, or 6.7%, from June 30, 2018. Management expects new business development efforts to remain strong throughout 2019 and beyond as the Company continues to expand the private wealth management business outside its more mature Wisconsin markets.

Commercial loan interest rate swap fee income totaled $1.1 million in the second quarter of 2019, compared to $473,000 in the linked quarter and $70,000 in the second quarter of 2018. Interest rate swaps continue to be an attractive product for the Bank’s commercial borrowers, though associated fee income can be variable, period to period, based on client demand and the interest rate environment in any given quarter.

Other fee income totaled $1.1 million in the second quarter of 2019, compared to $805,000 in the linked quarter and $542,000 in the prior year quarter. The increase is primarily due to $501,000 in gains recognized on end-of-term buyout agreements related to the Company’s equipment financing business line.

Gains on sale of SBA loans totaled $297,000 in the second quarter of 2019, compared to $242,000 in the linked quarter and $274,000 in the second quarter of 2018.

Non-interest expense was $17.5 million for the second quarter of 2019, compared to $17.7 million for the linked quarter and $14.5 million in the second quarter of 2018. Operating expense, as defined in the Efficiency Ratio table included in the Non-GAAP Reconciliations at the end of this release, totaled $15.3 million in the second quarter of 2019, $15.2 million in the linked quarter, and $14.0 million in the second quarter of 2018.

The Company’s second quarter of 2019 efficiency ratio was 67.41%, compared to 68.04% for the linked quarter and 67.07% for the prior year quarter. Compensation expense for the three months ended June 30, 2019 was $10.5 million, an increase of $338,000 compared to the linked quarter and $1.4 million compared to the prior year quarter. The increase in compensation expense compared to both the linked and prior year quarters reflects an increase in employees, as well as an increase in incentive compensation tied to individual and Company performance. Full-time equivalent employees were 275 at June 30, 2019, compared to 274 at December 31, 2018 and 265 at June 30, 2018. The producers hired over the past 18 months are now generating new business, and as a result, management believes operating revenue will continue to increase at a greater rate than operating expense, generating positive operating leverage and moving the efficiency ratio back toward the Company’s long-term operating goal of 58%-62%.

Non-interest expense includes SBA recourse provision for estimated losses in the outstanding guaranteed portion of SBA loans sold. SBA recourse provision totaled $113,000 in the second quarter of 2019, $481,000 in the linked quarter, and $99,000 in the prior year quarter. The total recourse reserve balance was $2.1 million, or 2.7% of total sold SBA loans outstanding, at June 30, 2019, compared to $3.3 million, or 4.0%, in the linked quarter, and $2.4 million, or 2.7%, in the prior year quarter. Total sold legacy SBA loans at June 30, 2019 were $52.7 million, compared to $58.2 million and $77.5 million at March 31, 2019 and June 30, 2018, respectively. Total performing sold legacy SBA loans were $44.4 million at June 30, 2019, down from $45.7 million and $65.5 million at March 31, 2019 and June 30, 2018, respectively. Changes to SBA recourse reserves may be a source of non-interest expense volatility in future quarters, though the magnitude of this volatility should diminish over time as the outstanding balance of sold legacy SBA loans continues to decline.

During the second quarter of 2019, the Company recognized $2.0 million in expense due to the impairment of relationship-based federal historic tax credit investments, which corresponded with the recognition of a $2.4 million in tax credits during the quarter. The Company’s relationship-based historic tax credit program contributed $446,000, $0.05 per share, to second quarter 2019 earnings, compared to $846,000, or $0.10 per share, in the linked quarter. Second quarter 2018 earnings did not benefit from historic tax credit investments. The second quarter 2019 effective tax rate, excluding these discrete items, was 22.8%. For 2019, the Company expects to report an effective tax rate of 21%-23%, excluding discrete items. Management intends to continue actively pursuing relationship-based tax credit opportunities throughout 2019 and beyond.

Balance Sheet

Period-end, gross loans and leases receivable totaled a record $1.720 billion at June 30, 2019, increasing $63.3 million, or 15.3% annualized, from March 31, 2019 and increasing $125.0 million, or 7.8%, from June 30, 2018. The Company’s emphasis on growing its commercial and industrial (“C&I”) portfolio continued, with balances increasing $44.2 million, or 38.0% annualized, compared to the linked quarter and $62.9 million, or 14.1%, compared to June 30, 2018. While we are seeing significant loan growth opportunities in our primary geographic areas, management remains committed to maintaining its strong underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio.

“The First Business team has generated exceptional loan growth through the first six months of the year,” said Chambas. “Due to the investments made in business development officers and niche business lines over the last couple of years, we are seeing above average loan growth across the Company, with C&I lending serving as the driving force of late.” Chambas added, “While we do not expect to sustain a 15% growth rate in 2019, we are confident in our ability to continue producing quality loans and believe high single-digit growth in 2019 and beyond is achievable and sustainable with the outstanding team we have in place.”

Period-end, in-market deposits increased to $1.290 billion, or 71.6% of total bank funding at June 30, 2019, compared to $1.239 billion, or 70.9%, at March 31, 2019 and $1.056 billion, or 62.9%, at June 30, 2018. Total bank funding is defined as total deposits plus FHLB advances. Transaction accounts and money market accounts were the largest contributors to in-market deposit growth during the quarter, increasing $53.8 million and $17.0 million compared to the linked quarter, respectively. The increase compared to the linked quarter was partially offset by a $20.0 million reduction in certificates of deposit.

“In-market deposit growth of 22.1% over the past 12 months is another example of how successful execution and investments in people, product, and technology have been paying off for First Business,” Chambas commented. “We are growing our in-market deposit base through strategic deposit campaigns and traditional lower-cost treasury management efforts, which are proving to be attractive to growing numbers of businesses, business executives, and high net worth individuals. Importantly, we have achieved this above average growth while maintaining pricing discipline and limiting our deposit rates to those at or below our alternative sources of wholesale funding.”

Period-end wholesale funding was $512.9 million at June 30, 2019, including FHLB advances of $273.5 million, brokered certificates of deposit of $238.9 million, and deposits gathered through internet deposit listing services of $498,000, compared to period-end wholesale funding of $507.7 million at March 31, 2019 and $622.4 million at June 30, 2018.

Consistent with the Company’s longstanding funding strategy to manage risk and use the most efficient and cost-effective source of wholesale funds, management intends to maintain a ratio of in-market deposits to total bank funding sources in line with the Company’s target range of 60%-75%. Management recently updated this range from the previously disclosed 60%-70% to reflect a reduced need for on-balance sheet wholesale funding to match-fund long-term, fixed rate loans due to greater client demand for interest rate swaps, which results in a floating rate loan on our balance sheet.

Asset Quality

Non-performing assets were $28.5 million, or 1.38% of total assets, at June 30, 2019, compared to $26.1 million, or 1.30% of total assets, and $32.6 million, or 1.71% of total assets, at the end of the linked quarter and second quarter of 2018, respectively. The increase from the linked quarter was primarily due to legacy SBA loan repurchase activity resulting in a $2.5 million net increase in sold loans previously identified as impaired.

Capital Strength

As of June 30, 2019, total capital to risk-weighted assets was 11.92%, tier 1 capital to risk-weighted assets was 9.60%, tier 1 leverage capital to adjusted average assets was 9.36%, and common equity tier 1 capital to risk-weighted assets was 9.09%. In addition, as of June 30, 2019, tangible common equity to tangible assets was 8.59%.

Share Repurchases

As of July 24, 2019, the Company had purchased 217,688 shares of its common stock, since the adoption of its previously disclosed stock repurchase program, at a weighted average price of $22.31 per share, for a total value of $4.9 million. The company has $100,000 of buyback authority remaining under the program as of July 24, 2019.

Quarterly Dividend

As previously announced, during the second quarter of 2019, the Company’s Board of Directors declared a regular quarterly dividend of $0.15 per share. The dividend was paid on May 16, 2019 to stockholders of record at the close of business on May 6, 2019. Measured against second quarter 2019 diluted earnings per share of $0.75, the dividend represents a 20.0% payout ratio. The Board of Directors routinely considers dividend declarations as part of its normal course of business.

About First Business Financial Services, Inc.

First Business Financial Services, Inc. (Nasdaq:FBIZ) is a Wisconsin-based bank holding company focused on the unique needs of businesses, business executives, and high net worth individuals. First Business offers commercial banking, specialty finance, and private wealth management solutions, and because of its niche focus, is able to provide its clients with unmatched expertise, accessibility, and responsiveness. For additional information, visit www.firstbusiness.com or call 608-238-8008.

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

• Competitive pressures among depository and other financial institutions nationally and in our markets.
• Adverse changes in the economy or business conditions, either nationally or in our markets.
• Increases in defaults by borrowers and other delinquencies.
• Our ability to manage growth effectively, including the successful expansion of our client service, administrative infrastructure, and internal management systems.
• Fluctuations in interest rates and market prices.
• Changes in legislative or regulatory requirements applicable to us and our subsidiaries.
• Changes in tax requirements, including tax rate changes, new tax laws, and revised tax law interpretations.
• Fraud, including client and system failure or breaches of our network security, including our internet banking activities.
• Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portion of SBA loans.

For further information about the factors that could affect the Company’s future results, please see the Company’s annual report on Form 10-K for the year ended December 31, 2018 and other filings with the Securities and Exchange Commission.

SELECTED FINANCIAL CONDITION DATA

STATEMENTS OF INCOME

Contacts

First Business Financial Services, Inc.

Edward G. Sloane, Jr.

Chief Financial Officer

608-232-5970

[email protected]

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