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 March 31, 2007

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 May 2, 2007 was 2,500,821 shares.

 

 

[This page intentionally left blank]

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

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006			2
Consolidated Statements of Income for the Three Months Ended March 31, 2007 and 2006			3
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Three Months Ended March 31, 2007 and 2006			4
Consolidated Statements of Cash Flows for the Three Months ended March 31, 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			23
Item 4. Controls and Procedures			23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			24
Item 1A. Risk Factors			24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			24
Item 3. Defaults upon Senior Securities			24
Item 4. Submission of Matters to Vote of Security Holders			24
Item 5. Other information			24
Item 6. Exhibits			24
SIGNATURES			25
Certification of the Chief Exexcutive Officer
Certification of the Senior Vice President and Chief Financial Officer
Section 1350 Certifications

PART I. Financial Information

Item 1. Financial Statements

First Business Financial Services, Inc.

		March 31,				December 31,
		2007				2006
		(In Thousands, Except Share Data)
		(Unaudited)
Assets
Cash and due from banks		$	16,311			$	19,215
Short-term investments			1,647				246
Cash and cash equivalents			17,958				19,461
Securities available-for-sale, at fair value			95,730				100,008
Loans and leases receivable, net of allowance for loan and lease losses of $8,896 and $8,296, respectively			656,760				639,867
Loans held for sale			308				—
Leasehold improvements and equipment, net			1,094				1,051
Cash surrender value of bank-owned life insurance			13,632				13,469
Investment in Federal Home Loan Bank stock, at cost			2,024				2,024
Goodwill and other intangibles			2,808				2,817
Accrued interest receivable and other assets			10,648				9,626
Total assets		$	800,962			$	788,323
Liabilities and Stockholders’ Equity
Deposits		$	693,123				640,266
Securities sold under agreement to repurchase			144				451
Federal Home Loan Bank and other borrowings			49,863				92,519
Accrued interest payable and other liabilities			11,194				9,331
Total liabilities			754,324				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 and outstanding			—				—
Common stock, $0.01 par value, 8,000,000 shares authorized, 2,521,203 and 2,516,193 shares issued, 2,498,171 and 2,493,578 outstanding in 2007 and 2006, respectively			25				25
Additional paid-in capital			23,098				23,029
Retained earnings			24,674				24,237
Accumulated other comprehensive loss			(620	)			(1,005	)
Treasury stock (23,032 and 22,615 shares in 2007 and 2006, respectively), at cost			(539	)			(530	)
Total stockholders’ equity			46,638				45,756
Total liabilities and stockholders’ equity		$	800,962			$	788,323

See accompanying Notes to Unaudited Consolidated Financial Statements.

First Business Financial Services, Inc.

		Three Months Ended
		March 31,
		2007				2006
		(In Thousands, Except Per Share Data)
Interest income:
Loans and leases		$	12,693			$	9,809
Securities income, taxable			1,086				966
Short-term investments			37				36
Total interest income			13,816				10,811
Interest expense:
Deposits			7,584				5,566
Notes payable and other borrowings			851				473
Junior subordinated debentures			—				248
Total interest expense			8,435				6,287
Net interest income			5,381				4,524
Provision for loan and lease losses			576				—
Net interest income after provision for loan and lease losses			4,805				4,524
Non-interest income:
Service charges on deposits			180				196
Credit, merchant and debit card fees			51				37
Loan fees			143				148
Increase in cash surrender value of bank-owned life insurance			163				152
Trust and investment services fee income			391				302
Change in fair value of interest rate swaps			—				(159	)
Net cash settlement of interest rate swaps			—				(26	)
Other			74				84
Total non-interest income			1,002				734
Non-interest expense:
Compensation			2,910				2,533
Occupancy			262				239
Equipment			122				122
Data processing			244				216
Marketing			280				207
Professional fees			455				248
Other			603				425
Total non-interest expense			4,876				3,990
Income before income tax expense			931				1,268
Income tax expense			332				411
Net income		$	599			$	857
Earnings per share:
Basic		$	0.24			$	0.35
Diluted		$	0.24			$	0.35
Dividends declared per share		$	0.065			$	0.06

See accompanying Notes to Unaudited Consolidated Financial Statements.

First Business Financial Services, Inc.

														Accumulated
						Additional								other
		Common				paid-in				Retained				comprehensive				Treasury
		Stock				capital				earnings				loss				stock				Total
		(In Thousands, Except Share Data)
Balance at December 31, 2005		$	24			$	22,712				21,085				(1,469	)		$	(509	)		$	41,843
Comprehensive income:
Net income			—				—				857				—				—				857
Unrealized securities losses arising during the period			—				—				—				(331	)			—				(331	)
Unrealized derivatives gains arising during the period			—				—				—				6				—				6
Reclassification adjustment for realized loss on derivatives			—				—				—				36				—				36
Income tax effect			—				—				—				111				—				111
Comprehensive income																							679
Share based compensation – restricted shares			—				31				—				—				—				31
Cash dividends ($0.06 per share)			—				—				(148	)			—				—				(148	)
Treasury stock purchased (712 shares)			—				—				—				—				(17	)			(17	)
Stock options exercised (9,280 shares)			1				90				—				—				—				91
Balance at March 31, 2006		$	25			$	22,833				21,794				(1,647	)		$	(526	)		$	42,479

														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			—				—				599				—				—				599
Unrealized securities gains arising during the period			—				—				—				589				—				589
Income tax effect			—				—				—				(204	)			—				(204	)
Comprehensive income																							984
Share based compensation – restricted shares			—				69				—				—				—				69
Cash dividends ($0.065 per share)			—				—				(162	)			—				—				(162	)
Treasury stock purchased (417 shares)			—				—				—				—				(9	)			(9	)
Balance at March 31, 2007		$	25			$	23,098			$	24,674			$	(620	)		$	(539	)		$	46,638

See accompanying Notes to Unaudited Consolidated Financial Statements

First Business Financial Services, Inc.

		For the Three Months Ended
		March 31,
		2007				2006
		(In Thousands)
Operating activities
Net income		$	599			$	857
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes, net			(569	)			313
Provision for loan and lease losses			576				—
Depreciation, amortization and accretion, net			120				171
Share-based compensation			69				31
Change in fair value of interest rate swaps			—				159
Increase in cash surrender value of bank-owned life insurance			(163	)			(152	)
Origination of loans originated for sale			(308	)			—
Increase in accrued interest receivable and other assets			(650	)			(62	)
Increase (decrease) in accrued expenses and other liabilities			1,863				(1,081	)
Net cash provided by operating activities			1,537				236
Investing activities
Proceeds from maturities of available-for-sale securities			4,850				4,591
Purchases of available-for-sale securities			—				(7,926	)
Net increase in loans and leases			(17,469	)			(1,016	)
Purchases of leasehold improvements and equipment, net			(144	)			(90	)
Net cash used in investing activities			(12,763	)			(4,441	)
Financing activities
Net increase in deposits			52,857				10,613
Net decrease in FHLB line of credit			(17,049	)			—
Repayment of FHLB advances			(2	)			(2	)
Proceeds from FHLB advances			—				7,000
Net decrease in short-term borrowed funds			(25,912	)			(14,336	)
Termination of interest rate swaps			—				(1,088	)
Exercise of stock options			—				91
Cash dividends			(162	)			(148	)
Purchase of treasury stock			(9	)			(17	)
Net cash provided by financing activities			9,723				2,113
Net decrease in cash and cash equivalents			(1,503	)			(2,092	)
Cash and cash equivalents at the beginning of the period			19,461				16,707
Cash and cash equivalents at the end of the period		$	17,958			$	14,615
Supplementary cash flow information
Interest paid on deposits and borrowings		$	7,455			$	5,910
Income taxes paid			5				416
Transfer to other real estate owned			664				—

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 FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. Refer to 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 month period ended March 31, 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. Management has deemed the impact of the disclosure error to be immaterial.

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, there was $1.4 million of unrecognized tax benefits. Approximately $983,000 of the unrecognized tax benefit would impact the effective tax rate if recognized. At this time, there is no unrecognized tax benefit that is 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 March 31, 2007, State of Wisconsin tax years that remain open are 1997 and 1999 through 2006. Federal tax years that remain open are 2003-2006.

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 and 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 is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157, Fair Value Measurements. The Corporation has not adopted the provisions of SFAS 159 and is currently evaluating the impact of adopting this standard.

Note 3 – Share-Based Compensation.

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 months ended March 31, 2007 and 2006, except with respect to restricted stock awards. 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 three months ended March 31, 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 three month period ending March 31, 2006.

Equity Incentive Plans.

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 417,397 common shares are currently authorized for awards under the Plans. 202,969 shares were available for future grants under the Plans as of March 31, 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 three month period ended March 31, 2007. The Corporation expects that a majority of the outstanding stock options will fully vest. Stock option activity for the three months ended March 31, 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			(1,875	)			25.00
Outstanding at end of period			164,293			$	21.93				6.34
Options exercisable at March 31, 2007			129,925			$	21.51				6.03

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. Restricted share activity for the three months ended March 31, 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			5,010				21.81
Vested			(7,058	)			23.13
Forfeited			—				—
Nonvested balance as of March 31, 2007			43,077			$	22.92

As of March 31, 2007, there was approximately $900,000 of deferred compensation expense related to unvested restricted share awards which is expected to be recognized over four years. As of March 31, 2007, there were no restricted shares vested and not delivered. For the three months ended March 31, 2007 and 2006, share-based compensation expense included in net income totaled approximately $69,000 and $31,000, respectively.

Note 4 – Earnings Per Share.

Basic earnings per share for the three months ended March 31, 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 March 31, 2007 and 2006, average anti-dilutive employee stock options totaled 132,825 and 74,250, respectively.

		For the Three Months
		Ended March 31,
		2007				2006
Income available to common stockholders		$	598,632			$	856,653
Basic average shares			2,453,068				2,438,344
Dilutive effect of share-based awards			8,354				15,411
Dilutive average shares			2,461,422				2,453,755
Earnings per share:
Basic		$	0.24			$	0.35
Diluted		$	0.24			$	0.35

Note 5 – Securities.

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

		As of March 31, 2007
						Gross				Gross
		Amortized				unrealized				unrealized				Estimated
Securities available-for-sale		cost				holding gains				holding losses				fair value
		(In Thousands)
U.S. Government corporations and agencies		$	1,498			$	—			$	(22	)		$	1,476
Municipals			185				—				(2	)			183
Collateralized mortgage obligations			94,987				185				(1,101	)			94,071
		$	96,670			$	185			$	(1,125	)		$	95,730

		As of December 31, 2006
						Gross				Gross
		Amortized				unrealized				unrealized				Estimated
Securities available-for-sale		cost				holding gains				holding losses				fair value
		(In Thousands)
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 March 31, 2007 and December 31, 2006. At March 31, 2007 and December 31, 2006, the Corporation had 94 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 March 31, 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		$	—				—			$	1,476			$	(22	)		$	1,476			$	(22	)
Municipals			—				—				183				(2	)			183				(2	)
Collateralized mortgage obligations			6,373				(31	)			63,778				(1,070	)			70,151				(1,101	)
		$	6,373				(31	)		$	65,437			$	(1,094	)		$	71,810			$	(1,125	)

		As of December 31, 2006
		Less than 12 months								12 months or longer								Total
						Unrealized								Unrealized								Unrealized
		Fair Value				loss				Fair Value				loss				Fair value				loss
		(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 three months ended March 31, 2007 and 2006 and has therefore not realized any gains or losses on such transactions.

At March 31, 2007 and December 31, 2006, securities with a fair value of approximately $33.6 million and $35.4 million, respectively, were pledged to secure public deposits, securities sold under arrangements to repurchase, and FHLB advances.

Note 6 – Loans and Allowance for Loan and Lease Losses.

Loan and lease receivables consisted of the following:

		March 31,				December 31,
		2007				2006
		(In Thousands)
First mortgage loans:
Commercial real estate		$	293,128			$	274,262
Construction			80,478				78,257
Multi-family			34,188				34,635
1-4 family			33,817				35,721
			441,611				422,875
Commercial business loans			174,825				176,701
Direct financing leases, net			23,335				23,203
Home equity loans			9,899				8,859
Credit card and other			16,169				16,712
			665,839				648,350
Less:
Allowance for loan and lease losses			8,896				8,296
Deferred loan fees			183				187
Loans and lease receivables, net		$	656,760			$	639,867

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

		Three
		Months Ended				Year Ended
		March 31,				December 31,
		2007				2006
		(In Thousands)
Allowance at beginning of period		$	8,296			$	6,773
Charge-offs:
Mortgage			—				—
Commercial			—				—
Lease			—				—
Consumer			—				—
Total charge-offs			—				—
Recoveries:
Mortgage			1				4
Commercial			23				—
Lease			—				—
Consumer			—				—
Total recoveries			24				4
Net recoveries (charge-offs)			24				4
Provision for loan and lease losses			576				1,519
Allowance at end of period		$	8,896			$	8,296
Allowance to gross loans and leases			1.34	%			1.28	%

Note 7 – Deposits.

Deposits consisted of the following:

		March 31, 2007								December 31, 2006
						Weighted								Weighted
		Balance				Average Rate				Balance				Average Rate
		(In Thousands)
Transaction accounts:
Demand deposits		$	41,411				0.00	%		$	45,171				0.00	%
Negotiable order of withdrawal (NOW) accounts			74,071				4.50				58,927				4.26
			115,482								104,098
Money market accounts			180,907				4.76				171,996				4.57
Certificates of deposit			396,734				4.85				364,172				4.63
		$	693,123							$	640,266

Note 8 – Borrowings.

Borrowings consisted of the following:

		March 31, 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		$	6,994			$	11,254				5.40	%		$	33,751			$	13,875				5.12	%
FHLB advances			19,534				21,394				4.81				36,584				19,059				4.83
Junior subordinated debentures			—				—				0.00				—				9,915				12.52
Line of credit			2,205				1,906				7.14				1,635				3,167				6.82
Subordinated notes payable			21,000				21,000				7.77				21,000				6,929				7.58
Other			274				6				7.00				—				—				0.00
		$	50,007			$	55,560				6.13			$	92,970			$	52,945				6.82
Short-term borrowings		$	15,209											$	52,443
Long-term borrowings			34,798												40,527
		$	50,007											$	92,970

During the first quarter of 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 March 31, 2007, the Corporation has $2.2 million outstanding under its line of credit, and $21.0 million of subordinated notes payable are 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 uncertainities, 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” will be 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 discussed in our annual Report on Form 10-K and factors regarding future operations discussed below.

Overview

First Business Financial Services, Inc. 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.

Recent Developments/Financial Highlights

	•		Net income for the three months ended March 31, 2007 decreased $258,000 over the comparable prior year period. The decrease in net income is primarily driven by an increase in the provision for loan and lease losses and an increase in compensation expenses, partially offset by increased net interest income.
	•		Net loans and leases receivable increased $16.9 million or 2.6% from $639.9 million at December 31, 2006 to $656.8 million at March 31, 2007.
	•		Deposits increased $52.9 million or 8.3% from $640.3 million at December 31, 2006 to $693.1 million at March 31, 2007. Of the $52.9 million increase, $26.5 million was due to growth of local deposits.
	•		On March 15, 2007, the Board of Directors approved a cash dividend on its common stock of $0.065 per share. The cash dividend is payable on April 16, 2007 to shareholders of record at the close of business on April 1, 2007.

Results of Operations

Comparison of Three Months Ended March 31, 2007 and 2006

General. Net income for the three months ended March 31, 2007 was $599,000, down 30.1% from $857,000 for the same time period in 2006. The principal factors contributing to this decline included a $576,000 provision for loan and lease losses during the first quarter of 2007 and an increase in non-interest expense of $886,000. Such declines were partially offset by an increase in net interest income of $857,000 caused by an increase in average earning assets at a stable margin for its comparable period. Basic and diluted earnings per share for the three months ended March 31, 2007 decreased to $0.24 from $0.35 for the same period in 2006, which decrease is largely attributable to the decline in net income.

The annualized returns on average assets and average return on equity were 0.30% and 5.18%, respectively, for the three month period ending March 31, 2007 compared to 0.51% and 8.16%, respectively, for the three month period ending March 31, 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 plan. The components of top line revenue are as follows:

		For the Three Months Ended March 31,
		2007				2006				Change
Net interest income		$	5,381			$	4,524				18.9	%
Non-interest income			1,002				734				36.5
Total top line revenue		$	6,383			$	5,258				21.4

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 months ended March 31, 2007 compared to the same period of 2006.

		For the Three Months Ended March 31, 2007
		Rate				Volume				Rate/Volume				Net
						(In Thousands)
Interest-Earning Assets
Mortgage loans		$	448			$	1,440			$	108			$	1,996
Commercial loans			159				572				26				757
Leases			44				68				12				124
Consumer loans			—				7				—				7
Total loans and leases receivable			651				2,087				146				2,884
Mortgage-related securities			85				44				4				133
Investment securities			5				(15	)			(3	)			(13	)
Other investments			—				(7	)			1				(6	)
Fed funds sold and other			—				—				7				7
Short-term investments			2				(2	)			—				—
Total net change in income on interest-earning assets			743				2,107				155				3,005
Interest-bearing liabilities
NOW accounts			73				167				24				264
Money market			223				366				56				645
Certificates – regular			399				645				83				1,127
Certificates – large			105				(102	)			(21	)			(18	)
Total deposits			800				1,076				142				2,018
Junior subordinated debentures			—				(248	)			—				(248	)
FHLB advances			5				79				1				85
Other borrowings			96				149				48				293
Total net change in expense on interest-bearing liabilities			901				1,056				191				2,148
Net change in net interest income		$	(158	)		$	1,051			$	(36	)		$	857

Net interest income was $5.4 million for the three months ended March 31, 2007, up 18.9% from the same period in 2006. Net interest margin remained stable at 2.85% for the three months ended March 31, 2007 compared to 2.84% for the three months ended March 31, 2006.

The yield on earning assets was 7.32% for the first three months of 2007 compared 6.79% for the first three months of 2006. The yield on interest bearing liabilities was 4.89% and 4.34% for the three months ended March 31, 2007 and 2006, respectively. The improvement in net interest income is primarily attributable to favorable volume increases due to organic growth.

As indicated in the rate volume table above, interest income increased $3.0 million, or 27.8%, to $13.8 million for the three months ended March 31, 2007 compared to the same time period of the prior year primarily due to volume increases in the mortgage and commercial loan portfolios. The mortgage loan portfolio primarily consists of commercial real estate, 1-4 family and multi-family loans. The average balance of the mortgage loan portfolio was $440.1 million with a weighted average yield of 7.30% at March 31, 2007 compared to an average balance of $355.3 million with a weighted average yield of 6.80% at March 31, 2006. The average balance of the commercial loan portfolio was $187.8 million with a weighted average yield of 9.0% compared to an average balance of $161.2 million with a weighted average yield of 8.60% for the same time period of the prior year. Growth in the loan portfolio is attributable to the loan production office located in the Northeast Region of Wisconsin coupled with the addition of new business development officers whose primary focus remains on generating new business for the Banks.

Interest expense increased $2.1 million, or 34.2%, to $8.4 million for the three months ended March 31, 2007 compared to the same time period of 2006. The increase in interest expense is caused by increased average interest-bearing 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 supplemented with brokered deposits. Average deposit balances, including brokered deposits, were approximately $634.0 million at March 31, 2007 with a weighted average cost of 4.78% compared to an average balance of $531.0 million with a weighted average cost of funds of 4.19% for the same time period of 2006. Average borrowings were $55.6 million at March 31, 2007 with a weighted average yield of 6.13% compared to $47.9 million, including junior subordinated debentures at March 31, 2006 with a weighted average yield of 6.02%. $10.3 million of junior subordinated debentures were repaid during the fourth quarter of 2006.

Net interest margin remained stable at 2.85% for the three months ended March 31, 2007 compared to 2.84% for the comparable time period of 2006. Interest rates have been relatively stable during the first quarter of 2007; however, market rates increased from the same period of 2006. Our net interest margin has remained stable primarily due to the 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 March 31,
		2007												2006
		Average								Average				Average								Average
		Balance				Interest				Yield/Cost				Balance				Interest				Yield/Cost
										(In Thousands)
Interest-Earning Assets
Mortgage loans		$	440,127			$	8,032				7.30	%		$	355,337			$	6,036				6.80	%
Commercial loans			187,758				4,223				9.00				161,150				3,466				8.60
Leases			22,900				385				6.72				18,154				261				5.75
Consumer loans			3,234				53				6.56				2,809				46				6.51
Total loans and leases receivable(1)			654,019				12,693				7.76				537,450				9,809				7.30
Mortgage-related securities(2)			95,963				1,070				4.46				91,667				937				4.09
Investment securities(2)			1,651				16				3.88				3,457				29				3.36
Federal Home Loan Bank stock			2,024				16				3.16				2,898				22				3.04
Fed funds sold and other			519				7				5.39				19				—				4.71
Short-term investments			1,266				14				4.42				1,463				14				3.83
Total interest-earning assets			755,442			$	13,816				7.32				636,954			$	10,811				6.79
Non-interest-earning assets			31,675												32,074
Total assets		$	787,117											$	669,028
Interest-Bearing Liabilities
NOW accounts		$	68,632			$	772				4.50			$	51,678			$	508				3.93
Money market			176,905				2,105				4.76				141,442				1,460				4.13
Certificates – regular			350,631				4,229				4.82				290,310				3,102				4.27
Certificates – large			37,832				478				5.05				47,588				496				4.17
Total deposits			634,000				7,584				4.78				531,018				5,566				4.19
Junior subordinated debentures			—				—				—				10,310				248				9.62
FHLB advances			21,394				257				4.81				14,732				172				4.67
Other borrowings			34,166				594				6.95				22,858				301				5.27
Total interest-bearing liabilities			689,560			$	8,435				4.89				578,918			$	6,287				4.34
Non-interest-bearing liabilities			51,303												48,081
Total liabilities			740,863												626,999
Stockholders’ equity			46,254												42,029
Total liabilities and stockholders’ equity		$	787,117											$	669,028
Net interest income/interest rate spread						$	5,381				2.43	%						$	4,524				2.45	%
Net interest-earning assets		$	65,882											$	58,036
Net interest margin											2.85	%											2.84	%
Ratio of average interest-earning assets to average interest-earning liabilities			109.55	%											110.02	%
Return on average assets			0.30	%											0.51	%
Return on average equity			5.18	%											8.16	%
Average equity to average assets			5.88	%											6.28	%
Non-interest expense to average assets			2.41	%											2.39	%