First Business Financial Services 2026 Q2 Earnings Call

Please go ahead. Good morning, everyone.

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 $0.14 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 $0.18 benefit to second quarter earnings per share and about a nine 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 $0.04. At the end of May, we exited our national out-of-footprint SBA 7 lending activities. You can see a summary of the financial impact of this decision on slide five of the earnings supplement. Over the past 10 years, we invested in expanding our SBA talent and capacity on a national basis.

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 5 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. 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 7 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. 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 7 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 7 strategy had been to sell 75% of our loan production and retain 25% on balance sheet. Effective June 30th, we have moved all held 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, which 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 in average quarterly SBA gain on sale revenue.

On the expense side, salaries and benefits for the limited positions averaged $650,000 per quarter. This brings the net pre-tax income benefit to approximately $310,000 per quarter in 2027, or about $0.03 per share after tax. That should equate to about 30-50 basis points of improvement in our efficiency ratio, all else equal. 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.