Good afternoon. Welcome to the First Business Financial Services 4th Quarter 2024 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to First Business Financial Services, Inc. CEO, Corey Chambers. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining us. We appreciate your time and your interest in First Business Bank. Joining me today is our President and Chief Operating Officer, Dave Seiler, and our CFO, Brian Spielman. Today, Today we'll discuss our financial performance along with some operational highlights, followed by a Q&A session. I'd like to direct you to our fourth quarter earnings release and investor presentation, which are available through our website at ir.firstbusiness.bank. We encourage you to review these alongside our other investor materials. Before we begin, please note this call may include forward-looking statements, and the company's actual results may differ materially from those indicated in any forward-looking statements. Important factors that could cause actual results to differ materially from those indicated in the forward-looking statements are listed in the earnings release and the company's most recent annual report on Form 10-K, and as may be supplemented from time to time in the company's other filings with the SEC, all of which are expressly incorporated herein by reference. There you can also find information related to any non-GAAP financial measures we discuss on today's call, including reconciliations of such measures. We are pleased to report an outstanding quarter. You'll see that we had some unusual items which boosted our reported earnings by about 28 cents. Even stripping that away, our earnings were excellent up 15 percent from the third quarter and 24 percent from q4 2023 our operating model continued to do what it's built to do it produced strong loan growth a strong and consistent net interest margin and thus strong revenue growth as well as positive operating leverage as a result we posted record earnings on both a pre-tax pre-provision basis in addition to the bottom line. Our priority is always to grow shareholder value, and we saw continued growth in tangible book value per share, which was up 23% annualized from the third quarter. Our efficiency ratio improved to its lowest level since fourth quarter of 2013. These results capped off a solid year, and at the end of the call, I'll cover how we performed overall for the first full year of our current five-year plan. Now, I'd like to pass it over to Dave to walk you through some of the business activity that drove our strong fourth quarter results.

Dave?

Thanks, Corey. You saw in our press release that our loan and deposit growth was strong. Loan balances grew $264 million over the same period last year. That's off approximately 10%, which is our long-term growth goal. Total deposits grew 310 million or 11 percent from last year's fourth quarter. That included moderate growth of 57 million in core deposits which was supplemented by our continued use of wholesale deposits to execute our match funding strategy. The period end core deposit numbers are a point in time reflection so you can expect to see some variance there as clients move money around as part of their business activity such as paying out year-end bonuses or buying real estate and equipment. This is not unusual activity for our clients, especially at year-end. We have a consistent sticky base of core client deposits. Because we are a business-only bank, our account balances are larger than average. The strength and stability of these relationships is reflected in our Net Promoter Score. Updated scores were recently released, and First Business Bank earned a score of 70 from our clients, which is nearly three times the average score of 24 reported for the banking industry. This reflects our outstanding team and our recent employee engagement metrics validate this. This ability to attract and retain engaged employees who develop deep client relationships is critically important to our proven ability to achieve our growth goals. For the reasons I just stated, we managed to average core deposits for a period rather than ending balances. On average, our core deposits were up 13 percent year over year and over the last five years deposits have grown at a 12 compound annual rate over the past few quarters we further increased our focus on deposit relationship generation enhancing how we incent our bankers and adding new treasury management experts in our southeast and south central markets and we're seeing great results slide 19 in our investor presentation shows 11 year-over-year growth in treasury management fees which is an indicator that that we are adding new commercial relationships and we continue to expect 10% growth on an annual basis. Our pricing initiatives and commitment to high quality growth have supported our goal to maintain a stable net interest margin in the range of 360 to 365 basis points. And we continue to view this as an appropriate range looking ahead. As we look into 2025, we see opportunities for strong growth in several areas. Our Southeast Wisconsin and Kansas City markets should see continued improvement as we have grown our teams in both of these markets our floor plan finance team continues to show nice demand and extremely high client satisfaction results additionally our accounts receivable finance team has the strongest pipelines it has seen in several years our sba lending team is showing solid traction under its new leadership in 2023 we hired a new leader for this team and with the expanded team he's put in place we are seeing our pipelines improve. You can see the flow through to gains on SBA loan sales in fee income, which more than doubled compared to the third quarter and was up over three times from the fourth quarter of 2023. Since we've shifted our mix toward loans with a construction component, a greater portion of SBA loans in our pipeline need to complete construction and fully fund before they are eligible for sale. This can create variability in terms of the amount of loans available for sale in a given quarter. Additionally, our sell versus hold strategy for SBA loans, which is largely dependent on premium levels, may also impact our gains in a given quarter. However, on an annual basis, we expect 2025 to be stronger for production and gain on sale volume. That's a nice segue to total revenue. Revenue growth is a real highlight this quarter, and fee income in particular, which was up 13% compared to both last quarter and the prior year quarter. You can see the growth in fee income contribution over time on slide 12 of the investor presentation. We see this strong momentum as an outcome of our team's solid execution of our strategic plan that is focused on revenue diversification and 10% annual revenue growth. In the fourth quarter, we saw meaningful pickups in SBA gains and deposit service charges, as I just mentioned. Private wealth fees, which now comprise 43% of our fee income and represent an ever-growing annuity stream for our bank continued to expand due to our private wealth team's consistent growth. Swap fees were strong as clients utilized swaps to lower their interest rate risk. Income earned from SBIC fund investments continued to reflect the value of these relationships as well as the inherent variability in the timing of income recognition. Given the historically strong returns from these investments, we plan to continue investing in SBIC funds, fully investing our 5% of total capital allowed over time. The diversification we've built into our revenue profile provides a buffer against reliance on any one source. I'd like to talk briefly on asset quality. As we said last quarter, we are pleased with how our portfolio is performing and have no areas of particular concern. The tick-up in NPAs reflects what we believe to be a normalization from the unusually low level in recent years. We do continue to see isolated weakness in the transportation sector of the equipment finance portfolio. At December 31st, we had $41 million of transportation loans in the portfolio, down from $61 million at the start of the year. As a reminder, we stopped lending to the transportation sector in the first quarter of 2023 and the remaining transportation loans in the portfolio have an average remaining life of only 34 months. Based on what we are seeing today with continued low spot rates for trucking and depressed equipment values, we expect the credit impact of this portfolio to be in line with the past several quarters for this foreseeable future. The non-transportation portion of the equipment finance portfolio has performed better than our expectations. Of course, we're always looking closely at the migration in the portfolio. Our weighted average risk rating has barely moved. We continue to wait out the bankruptcy proceedings process for the $6.2 million ABL credit mentioned in previous quarters. We continue to expect full repayment on this credit, but unfortunately, it continues to inflate our otherwise healthy level of NPAs. We have one $6.9 million loan to a borrower in the equipment wholesale business that we moved to non-performing status during the quarter. This is a specific business situation and is not indicative of any trend. Looking at our accruing past due loans, there is a modest uptick related to one client whose payment was delayed and was paid in full in January, but missed the 1231 reporting date. Our asset quality measures continue to reflect the diversified and solid risk profile of our portfolio in 2024. I'll wrap up and reiterate that our bankers are hard at work executing our strategic initiatives. We see opportunity across our franchise and are executing to earn that business. We always say that the best team wins and our team is delivering. Now I'll hand it off to Brian.

Thanks Dave. I'll go a little deeper into our financial highlights for the fourth quarter. To start, let's cover the tax and recourse benefits that boost our reported net income. The table on the front page of the earnings release breaks out these items at a high level. The first is the update to our SBA recourse reserve estimate, which was large for the quarter, but basically net to zero for the full year. The fourth quarter change in estimate amounted to about $686,000, or seven cents on UPS. As of year-end, the SBA recourse reserve outstanding to $645,000. This one-time change is not indicative of future expectations and we believe the recourse provision run rate will remain consistent with the past several quarters going forward. The bigger item is the income tax adjustment resulting from the semi-annual review of our state-deferred tax asset valuation allowance related to the 2023 Wisconsin commercial loan income exemption. This rule, which significantly reduces FBB's state income tax, allows financial institutions to exclude from their income any interest, fees, and penalties from commercial loans of $5 million or less provided to Wisconsin residents for business or agricultural purposes. Fourth quarter review included adjustments to our 10-year state taxable income forecast based on the 2023 actual tax return, as well as updates on other variables. As a result of this analysis, we reversed about half of the DTA valuation allowance that was established in 2023 when the law change was enacted. As you saw in the release, this amounted to about 21 cents of EPS for the quarter. As Dave mentioned, our ability to produce net interest margin that is strong and stable compared to peers contributed to our solid performance. Fourth quarter margin of 377 benefited from high fees earned in lieu of interest that grew 1.4 million dollars from the linked quarter. Fees in lieu of interest refers to the significant and recurring but variable amount of interest income we earn from items like prepayment fees and asset-based loan fees. They contributed 27 basis points to the reported margin for the fourth quarter compared to 12 basis points in the third quarter and 14 basis points in the fourth quarter of 2023, which are more typical levels. Excluding these fees, our adjusted NIM was 348 for the fourth quarter compared to 350 in the late quarter. Margin remained strong and consistent due to our successful management of rates on both sides of the balance sheet before and after the feds rate cuts in the third and fourth quarters we continue to see our differentiator match funding strategy and relatively neutral balance sheet sensitivity set us apart in the industry they've covered fee income and the great activity we're seeing there just a few additional notes ongoing variability in swap fees and returns on sbic funds are expected our swap fee income will continue to vary quarterly based on cre activity the rate environment and client preference sbic fee income is driven by an interest income in the portfolio and unrealized and realized gains while they experienced a strong year in 2023 for realized gains 2024 was slower and more reliant on interest income only as the funds continued to invest in new companies we saw an uptick in q4 and expect realized gains will pick up again in 2025 as the existing funds mature our expenses had some moving parts this quarter. Total expenses were up modestly, about $45,000 compared to the third quarter. This includes two offsetting items, a $687,000 SBA recourse reserve release and about $500,000 in costs related to a change in credit card vendors. We don't expect any additional future expenses related to this conversion. We believe compensation expense for Q4 is a decent starting point for looking at a 2025 run rate. From that starting point, we expect we'll see a pickup due to vacancies for existing positions we expect to fill throughout the year, anticipated new hires, the new year reset on Social Security, and merit increases of approximately 3.5%, which is lower than the previous two years. When we think about expenses, our primary objective is achieving annual positive operating leverage, expense growth at some level below revenue growth, which is targeted at 10% or above. We're able to pull levers to manage this on a long-term basis. On slide 15 of the investment presentation, you can see our historic success in not only achieving this goal, but far outperforming our peers. Next, taxes. As I mentioned, the fourth quarter saw a significant change in estimated state taxes, which brought our effective tax rate down to 5.8%. Excluding the evaluation allowance adjustment, our effective tax rate would have been 16.7% for the quarter, compared to 18.3% in the late quarter. Looking ahead, we expect to continue utilizing federal tax credit projects to improve the communities we serve and to maintain a lower overall effective tax rate over time. We believe our effective tax rate will be between 16% and 18% in 2025. Finally, we feel good about our capital levels, and our strong earnings are generating capital to facilitate our expected organic growth. With CET1 above 9% as of year-end, we will balance asset growth with the potential use of our share buyback program to optimize long-term sharehold return. And now I'll hand it back over to Corey.

Thank you, Brian. I want to provide a brief update on our progress against our strategic plan for 2024 through 2028, which is now one full year in. As you know, we kicked off our current five-year plan last January and we're very happy with our results to date. You can see our strategies and the goals we used to measure the success on slides seven and eight of our investor presentation. We are far exceeding our 10% plus target on tangible book value growth. Our full year 2024 return on average tangible common equity was strong at 15.4%. It was 14.6% after excluding the effect of this quarter's unusual items, marching toward our goal of 15% plus. Total Total revenue growth for 2024 was 6.6%. This reflected strong growth in net interest income of 10.3%, which was offset by lower levels of SBIC and SWAP-C income throughout the year. As Dave and Brian laid out, we believe the momentum we saw in the fourth quarter positions us nicely to achieve our targeted 10% revenue growth in 2025. While not a specific target, we aim for positive operating leverage on an annual basis. it allows us to achieve our efficiency goals. For full year 2024, we reported an efficiency ratio of 60.61%, very nearly approaching our five-year plan target of less than 60% by 2028. Finally, Dave mentioned our updated net promoter score and employee engagement metrics. It bears repeating that we are very proud of this. More importantly, the relative measure compared to our banking industry peers shows that we are an outlier by a long shot and in the right way. This is a testament to our culture and our team. We can't say it enough, the best team wins. I beat this drum quarter after quarter. Our strategic plan goes hand in hand with maintaining our entrepreneurial culture and it matters. The strategies we put in place to achieve our financial goals are working and we will continue to execute regardless of what the economy brings us in 2025 and beyond. We believe this will deliver on our ultimate goal to generate top-tier total shareholder returns, a goal we've overachieved on again in 2024. I want to thank you for taking time to join us today. We're happy to take your questions now.

Thank you, sir. Ladies and gentlemen, if you would like to ask a question, please press star followed by one on your touchtone phone. You will then hear a three-tone prompt acknowledging your request. And should you wish to decline from the polling process, please press star followed by two. If you're using a speakerphone, you will need to lift the handset first before pressing any keys. Please go ahead and press star one now if you do have any questions. First, we will hear from Daniel Tomeo at Raymond James. Please go ahead.

Thank you. Good afternoon, everybody. um maybe starting on the loan growth so um i think i heard you guys reiterate the the 10 annual loan growth guidance um just kind of within that i'm looking at the the cni bucket which was down a bit in the fourth quarter so maybe you could give a little color around that and then um your thoughts on you know within that 10 growth next year where cni fits and kind of what the mix you're looking at or you're expecting is next year this year yeah uh danny i would say next year we think c and i will be the the bigger portion uh cre is still a little slower as it has

been um we you know we continued to fund up some things this last year that were projects multi-family projects things like that that were in the construction phase and that that still flowed through to last year, but that activity slowed throughout the year. So I think that's going to continue to be the case, given the rate environment and cost environment. And we would expect that CNI would have a higher percentage of the growth, faster growth.

Okay. And any color on the fourth quarter decline well we had um you know in the fourth quarter we had some asset-based lending uh loans pay off so we went down a little bit there um that's probably the only unusual you know or atypical item that i can think of off the top got it okay so just a little bit of volatility um and then maybe on the other side um on the funding side um just you know you talked about your ability to continue to grow core deposits and then kind of fill the gap with the wholesale. But, you know, curious where you see opportunities to grow core deposits and where maybe in your mind that that wholesale versus core mix ends up longer term.

Why don't I start on the mix and then Dave to talk about growing the core. I would say on the mix it's really dependent on the other side of our balance sheet because we're going to use wholesale to match fund and that's you know so that's always going to be a part of what we do because as you know we don't like taking interest rate risk we like a match funded balance sheet so we'll we'll always be um using some of that um you know it probably in the same proportion that we've we've been doing over the last several years where it's you know 70 to 80 percent of our funding is is in market deposits and you know 20 to 30 is is uh wholesale so that we can match on the balance sheet they want you to talk about initiatives relative to that right well it's a

little bit in terms of growing our core deposits it's it's really doing what we have been doing over the last five years i mean if you look over the last five years we've grown our core deposits It's at a 12% annual rate, and we do that by, you know, having treasury management folks that are sales-oriented, I think, than you'll find in other organizations, and it's just adding new relationships. And one of the things we look at when we kind of check to see that we're adding new relationships is our treasury management fee income. That grew 11% for us in 2024 and nearly 11% annual rate over the last five years. So, I mean, we just feel confident that, you know, we just stay focused on it and add the people we need. And we've also, in the company, put the right incentives around. It's very attractive for bankers to bring in deposits.

And, Danny, we've added salespeople on that side, on the Treasury management side, and we also did something I think is pretty unusual in banking, is to take a really successful commercial lender, and that person flipped over to the Treasury management side to lead one of our Treasury management teams and is focused on TM. You know, as you know, most banks treat Treasury as more like order takers, and they don't have sales-oriented people with the same kind of new business development goals and activities, expectations that they do on the lending side, but we do. So, you know, we just have a different mindset about it, and we continue to work on adding talent because it's all about the people and the talent. Great.

Well, it sounds like you guys are set up for another good year. Thank you. Thanks.

Thank you. Next question will be from Jeff Rulis at DA Davidson. Please go ahead.

Thanks. Good afternoon. I wanted to ask you about your outlook on the kind of loan yield repricing, you know, some headwinds there. I want to, if you think about kind of maturities and what's sort of upcoming? Do you get back to sort of neutral by quarter or maybe new production begins to lift that average loan yield? Any thoughts there?

Well, we like to think about it more in our 360 to 365 margin, but specific to the earning asset yield, I would say we have some reinvestment opportunity left to improve that as well as with our C&I lending mix improving too that came down a little bit as we talked about the abl payoffs and amortization there we think that mix of cni business improves as well in 25 driving those those yields higher and offsetting any remaining uh downward pressure from the short-term market rates on the floating side of the balance sheet and and just jumping in there um jeff and and again anything that's going to be fixed rate that's maturing we're going to be match funding it again so those those uh

those yields correlate and they're moving together. So the repricing there would be repricing down the fixed rates on the deposit side, match-funded deposit side, if we have something ballooning and we're rewriting that.

Got it. So if we kind of slam that together in the 348 core, your expectations ahead, I appreciate the 360, 365 guide, and I guess if the fees in lieu are 10 to 15, I guess the expectation is that pretty stable margin, or are you optimistic that maybe you've been through some of the rate cut impact, and I guess the expectation on the core margin relative to 348, what would that be?

Yeah, we like stable. We think stable is possible and any rate environment we strive for. And so we think it's a good place to be. And that's where we're operating towards, along with your point around the fees and Lua, that's because on average, you know, we've historically on average had about 15 basis points of contribution from the fees and Lua of interest.

Those were elevated, obviously, in Q4, but expect that to continue. okay and brian want to have you just confirming the he said the tax rate was was 16 16 to 18 uh or one one six yeah one six i wrote that 16.7 um and then if we're thinking about kind of your guides of loan growth and asset growth and operating leverage feel safe to say the expense implied rate is kind of high, single digit, mid to high, just some margin of improvement Is that fair? That's fair.

Okay.

Last one, if I could squeeze it in there.

Just the non-accrual increase in the quarter, outside of the one loan you had identified, could you just review that again with the pieces that came in? um in the fourth quarter yeah the the largest one was a a single c and i relationship in the wholesale uh equipment industry um that uh we've evaluated and reserved for everything appropriately the specific reserve for that um and that was that was the biggest biggest chunk of the increase was that one c and i c and i loan in the wholesale equipment industry

and uh and the remainder so that we you got the balance of that but the remainder of the increase in it was um other equipment finance or um trying to get yes someone else i'll take it of the small ticket yep correct got it okay thank you thank you next question will be from Damon Del Monte at KBW.

Please go ahead.

Hey, good afternoon, guys. Hope everybody's doing well today. Just to kind of follow up on the last questions on credit, just curious as how you guys are looking at the reserve level right now. Is there any concern that the remaining the remaining maturities in the transportation book that there could be a need to build reserve levels a little bit. So just kind of curious, trying to back into kind of the outlook for the provision, you know, given potential charge-off volatility that would require maybe some additional reserving.

Yep. As a 1231, we think radically reserved, in particular in the small ticket space where we have a more of a methodical process around past dues where the charges we are having on a quarterly basis we are reserved for there's a kind of an in and out within the reserve as we're going through that process and so we think that the run rates you're seeing on the equipment finance side are going to continue as we keep working through that portfolio but but the reserve is built appropriately to um to absorb those as we go forward and so the The rate that we're at right now around that 120 all in, including the unfunded, the pickup there from the prior quarter was more towards that specific reserve on the one CNI loan that we added this quarter.

Got it. Okay. Okay, great. And then maybe help us think a little bit about fee income. I think the commentary was that, you know, gains from the SBIC investments were lower this year, but you would expect to pick up here in 25. So, you know, can you give a ballpark on what you might expect for that benefit to fee income going forward?

Yeah, so kind of sticking with the 10% mantra, we think that 10% holds true for all parts of revenue. Same with fee income while we were down this year. We think that that Q4 place of about $8 million is a good place to start in 2025. We like the components that are going into that total $8 million and they'll be, you know, puts and takes throughout the year, but that's a great place to be. And we think year over year, we can grow that 10% along with our other revenue items.

Okay, great. That's all that I had. Everything else was asked and answered. So thank you very much. Thanks, Danny.

Or, sorry.

As a reminder, ladies and gentlemen, if you have a question, please press star followed by one on your telephone keypad next we will hear from nathan race at piper sandler please go ahead hey guys good afternoon thanks for taking the question um yeah i've seen a nice uh funding uh beta in the quarter i think he kind of shook out around 32 percent when i look at your total cost of interest uh bearing liabilities you know just curious if the fed remains on hold over the course of this year kind of where you see your funding uh phases shaking out over the next uh few quarters here well i think on the variable side of the balance sheet we have good opportunity and we are

relatively matched in terms of we think about our sulfur products and our prime asset products we also then have our our sulfur indexed liability accounts they're many non-managed deposits we feel our ability to maintain um maintain those where our betas are consistent on the liability side with the asset side and that gets back to our our kind of message of of adjusted interest interest margin neutrality.

Okay, got it. And then, you know, just curious, you know, in terms of how you guys are thinking about capital deployment this year, you know, Corey, you mentioned, you know, sharing purchases may be an ongoing consideration, but just curious if it's just mostly going to be kind of orientated towards organic growth, if you see, you know, room or opportunities to increase the common going forward as well.

Sure. Yeah, first and foremost, for us is always toward growth. We think if we can do our 10% balance sheet growth deploying the capital in that regard, that's going to be the best return for our shareholders is growing loans and the balance sheet and using the capital for that. We always look at our dividends. We've had But dividend increases, you know, for a lot of years since we, 12 years, I think, since the great financial crisis where we held it steady through there. We didn't cut. We held it steady and then have grown consistently since on an annual basis. So that's, you know, that's been our pattern. And I think over the last five years, the CAGR on dividend growth is double digits as well. We're the double-digit people, I guess. And so, you know, that's something we'll always look at. And then if we, you know, keep doing really well, like we did this last quarter, you know, then we'll be generating capital in addition to those needs beyond growth and beyond the dividend. And then we can be opportunistic on buybacks should that be, you know, should that make sense. And you might recollect that we put a buyback in place about a year ago, and that one, that's perpetual. So it's not one that, you know, is rolling off on an annual basis. That's what we had done in the past. So it's always out there for us, and we'll constantly be monitoring it.

Okay, that's really helpful. If I could just ask one more. I mean, you're tracking kind of ahead of your target plan on the efficiency ratio, you know, come out of the fourth quarter. And you guys have always been kind of forward thinkers and early adopters on some technology So just curious, based on some of those technology investments, kind of where you see the efficiency ratio, you know, trend over the next couple of years, just given the strong operating leverage outlook that we've already discussed.

Yeah, I would say it's a march downward. We had our board meeting this morning, and that's a graph that we have in there. And it's been a pretty steady march downward because we've had positive operating leverage for the last six years in a row. So if you keep generating positive operating leverage, you're going to keep driving that down incrementally. We're always going to be investing in technology, people, et cetera, as a growth company. But that's a key thing we keep our eye on in terms of management is positive operating leverage. So yeah, that's going to continue to grind down. I don't think given who we are and what we do as our growth orientation, We're never going to be super, super low on efficiency ratio, but the math just makes causes it to go down if you have positive operating leverage every year.

Right. That's helpful. I appreciate all the color. Thanks, guys. Yep. Thanks.

Thank you. And at this time, gentlemen, we have no other questions registered. Please proceed.

Thanks for joining the call today. We appreciate everyone taking the time to get an update on the company, how we're doing, and we're looking forward to speaking to you again next quarter as we move forward in 2025. Thank you.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we ask that you please disconnect your lines. Have yourselves a good