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**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549****FORM 10-K****ANNUAL REPORT PURSUANT TO****SECTION 13 OR 15(d) OF THE****SECURITIES EXCHANGE ACT OF 1934**For the fiscal year ended December 31, 2005Commission file number 0-51028**FIRST BUSINESS FINANCIAL SERVICES, INC.**        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 Registrant’s telephone number, including area codeSecurities registered pursuant to Section 12(g) of the Act:Common Stock, $0.01 par valueIndicate by check mark if the registrant is a well-knownseasoned issuer, as defined in Rule 405 of the SecuritiesAct.      Yes     X NoIndicate by check mark if the registrant is not required to filereports pursuant to Section 13 or 15(d) of theAct.      Yes     X NoIndicate by check mark whether the registrant (1) has filedall reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has beensubject to such filing requirements for the past90 days. XYes          NoIndicate by check mark if the disclosure of delinquent filerspursuant to Item 405 ofRegulation S-K isnot contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of thisFrom 10-K or anyamendment to thisForm 10-K.      Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, or a non- acceleratedfiler. See definition of “accelerated filer and largeaccelerated filer” inRule 12b-2 of theExchange Act. (Check one):      Large acceleratedfiler           Acceleratedfiler     X Non-acceleratedfilerIndicate by check mark whether the registrant is a shell company(as defined inRule 12b-2 of theAct).      Yes     X NoThe aggregate market value of the common equity held bynon-affiliates computed by reference to the average bid and askprice of such common equity, as of the last business day of theregistrant’s most recently completed second fiscal quarterwas approximately $52,545,000.As of March 15, 2006, 2,472,576 shares of common stockwere outstanding.**DOCUMENTS INCORPORATED BY REFERENCE**Part III – Portions of the Proxy Statement forthe Annual Meeting of Stockholders to be held on May 1,2006 are incorporated by reference into Part III hereof.

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**Table of Contents**       **Page No.**   ** PART I.**     ** Item 1.** Business  2  ** Item 1a.** Risk Factors  10  ** Item 1b.** Unresolved Staff Comments  13  ** Item 2.** Properties  13  ** Item 3.** Legal Proceedings  13  ** Item 4.** Submission of Matters to a Vote of    Security Holders  13  ** PART II.**     ** Item 5.** Market for Registrant’s Common    Equity and Related Stockholder Matters  14  ** Item 6.** Selected Financial Data  15  ** Item 7.** Management’s Discussion and    Analysis of Financial Condition and Results of Operations  16  ** Item 7a.** Quantitative and Qualitative    Disclosures About Market Risk  42  ** Item 8.** Financial Statements and Supplementary    Data  44  ** Item 9.** Changes in and Disagreements with    Accountants on Accounting and Financial Disclosure  79  ** Item 9A.** Controls and Procedures  79  ** Item 9B.** Other Information  80  ** PART III.**     ** Item 10.** Directors and Executive Officers of the    Registrant  81  ** Item 11.** Executive Compensation  81  ** Item 12.** Security Ownership of Certain    Beneficial Owners and Management and Related Stockholder    Matters  81  ** Item 13.** Certain Relationships and Related    Transactions  81  ** Item 14.** Principal Accountant Fees and    Services  81  ** PART IV**     ** Item 15.** Exhibits and Financial Statements    Schedules  81  ** Signatures**  82  2006 Incentive Bonus Program Consent of KPMG LLP Certification of CEO Certification of CFO Certification of CEO and CFO
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**PART I.****CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS**         This registration statement contains or incorporates byreference various forward-looking statements concerning theCorporation’s prospects that are based on the currentexpectations or beliefs of management. Forward-lookingstatements may also be made by the Corporation from time to timein other reports and documents as well as oral presentations.When used in written documents or oral statements, the words“anticipate,” “believe,”“estimate,” “expect,” “objective”and similar expressions and verbs in the future tense, areintended to identify forward-looking statements. The statementscontained herein and such future statements involve or mayinvolve certain assumptions, risks, and uncertainties, many ofwhich are beyond the Corporation’s control that could causethe Corporation’s actual results and performance to differmaterially from what is expected. In addition to the assumptionsand other factors referenced specifically in connection withsuch statements, the following factors could impact the businessand financial prospects of the Corporation: general economicconditions; legislative and regulatory initiatives; increasedcompetition and other effects of deregulation and consolidationof the financial services industry; monetary and fiscal policiesof the federal government; deposit flows; disintermediation; thecost of funds; general market rates of interest; interest ratesor investment returns on competing investments; demand for loanproducts; demand for financial services; changes in accountingpolicies or guidelines; general economic developments; acts ofterrorism and developments in the war on terrorism; and changesin the quality or composition of loan and investment portfolios.See also the factors regarding future operations discussed in**“Management’s Discussion and Analysis of FinancialCondition and Results of Operations”**, below.**Item 1. Business****General**         First Business Financial Services, Inc. (“FBFS” or“the Corporation”) is a registered bank holdingcompany incorporated under the laws of the State of Wisconsinand is engaged in the commercial banking business through itswholly-owned banking subsidiaries First Business Bank and FirstBusiness Bank – Milwaukee (referred to as “theBanks”). All of the operations of FBFS are conductedthrough its Banks and certain subsidiaries of First BusinessBank. The Corporation operates as a business bank focusing ondelivering products and services to small and medium sizebusinesses. The Corporation does not utilize its locations toattract retail customers. FBFS seeks to provide lending anddeposit products to local businesses and business executives. Tosupplement its business banking deposit base, the Corporationutilizes wholesale funding alternatives to fund a portion of theCorporation’s loan and lease portfolio.         First Business Bank (“FBB”) is a state bank that waschartered in 1909 under the name Kingston State Bank. In 1990,FBB relocated its home office to Madison, Wisconsin, opened abanking facility in University Research Park, and began focusingon providing high-quality banking services to small andmedium-sized businesses located in Madison and the surroundingarea. First Business Bank, through its single location, offers afull line of commercial banking products and services in thegreater Madison, Wisconsin area, tailored to meet the specificneeds of businesses, business owners, executives andprofessionals. FBB’s product lines include cash managementservices, commercial lending, commercial real estate lending andequipment leasing. FBB also offers trust and investment servicesthrough First Business Trust & Investments(“FBTI”), a division of FBB. The Corporation generallytargets businesses with sales between $2 million and$50 million located in the greater Madison area market. Fora more detailed discussion of loans and underwriting criteria ofthe Banks, see **“Lending Activities”**in thissection. In addition, FBB offers business owners and executivesprofessional and consumer services including a variety ofdeposit accounts, personal lines of credit and personal loans.         FBB has two wholly owned subsidiaries that are complementary tothe Corporation’s business banking services. First BusinessCapital Corp. (“FBCC”) is a wholly-owned subsidiary ofFBB operating as an asset-based commercial lending companyspecializing in providing secured lines of credit as well asterm loans on equipment and real estate assets primarily tomanufacturers and wholesale distribution companies locatedthroughout the United States. First Business Leasing, LLC(“FBL”) is a commercial leasing company specializingin the lease of general equipment to small and middle marketcompanies throughout the United States.
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         First Madison Investment Corp. (“FMIC”) and FMCCNevada Corp. (“FMCCNC”) are operating subsidiarieslocated in and formed under the laws of the state of Nevada.FMIC was organized for the purpose of managing a portion of theBank’s investment portfolio. FMIC invests in marketablesecurities and loans purchased from FBB. FMCCNC, a wholly-ownedsubsidiary of FBCC, invests in loans purchased from FBCC.         First Business Bank – Milwaukee (“FBB –Milwaukee”) is a state bank that was charter in 2000 inWisconsin. First Business Bank – Milwaukee also offersa wide range of commercial banking products and servicestailored to meet the specific needs of businesses, businessowners, executives and professionals in the greater Milwaukee,Wisconsin area through a single location in Brookfield,Wisconsin. Like FBB, FBB – Milwaukee’s productlines include cash management services, commercial lending andcommercial real estate lending for similar sized businesses asFBB. FBB – Milwaukee also offers trust and investmentservices through a trust service office agreement with FBB. Fora more detailed discussion of loans and underwriting criteria ofthe Banks, see **“Lending Activities”** in thissection. FBB – Milwaukee also offers business ownersand executives professional and consumer services which includea variety of deposit accounts, personal lines of credit, andpersonal loans.         In June 2000, FBFS purchased a 51% interest in The Business BancGroup Ltd. (“BBG”), a corporation formed to act as abank holding company owning all the stock of a Wisconsinchartered bank to be newly organized and headquartered inBrookfield, a suburb of Milwaukee, Wisconsin. In June 2004 allshares of BBG stock were successfully exchanged for FBFS stockpursuant to a conversion option. Subsequent to this transaction,BBG was dissolved. This transaction resulted in First BusinessBank – Milwaukee becoming a wholly-owned subsidiary ofthe Corporation.         In December 2001, FBFS formed FBFS Statutory Trust I(“Trust”), a statutory trust organized under the lawsof the State of Connecticut and a wholly-owned financingsubsidiary of FBFS. In December 2001, the Trust issued$10.0 million in aggregate liquidation amount of floatingrate trust preferred securities in a private placement offering.These securities mature 30 years after issuance and arecallable at face value after five years. In December 2003, theFinancial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 46, “Consolidation of VariableInterest Entities, an Interpretation of Accounting ResearchBulletin No. 51, Revised”(“FIN 46R”) to provide guidance on how toidentify a variable interest entity and determine when an entityneeds to be included in a company’s consolidated financialstatements. As a result of the adoption of FIN 46R in 2004,the Trust is no longer consolidated by FBFS. See **Note 11**to the consolidated financial statements.**Available Information**         The Corporation maintains a web site at www.fbfinancial.com.This and all of the Corporation’s filings under theExchange Act are available through that web site, free ofcharge, including copies of annual reports onForm 10-K,quarterly reports onForm 10-Q, currentreports onForm 8-K and anyamendments to those reports, on the date that the Corporationfiles those materials with, or furnishes them to, the Securitiesand Exchange Commission.**Employees**         At December 31, 2005, FBFS had 121 employees which include100 full-time equivalent employees. No employee is coveredby a collective bargaining agreement, and we believe ourrelationship with our employees to be excellent.**Supervision and Regulation**         Below is a brief description of certain laws and regulationsthat relate to the Corporation and the Banks. This narrativedoes not purport to be complete and is qualified in its entiretyby reference to applicable laws and regulations.**General**         The Banks are chartered in the State of Wisconsin and aresubject to regulation and supervision by the Division ofWisconsin Banking Review Board (the “Division”), andmore specifically the Wisconsin Department of FinancialInstitutions (“WDFI”), and are subject to periodicexaminations.
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Review of trust operations is included in the periodicexaminations. The Banks’ deposits are insured by the BankInsurance Fund (“BIF”). The BIF is administered by theFederal Deposit Insurance Corporation (“FDIC”), andtherefore the Banks are also subject to regulation by the FDIC.Periodic examinations of both Banks are also conducted by theFDIC. The Banks must file periodic reports with the FDICconcerning their activities and financial condition and mustobtain regulatory approval prior to entering into certaintransactions such as mergers with or acquisitions of otherdepository institutions and opening or acquiring branch offices.This regulatory structure gives the regulatory authoritiesextensive direction in connection with their supervisory andenforcement activities and examination policies, includingpolicies regarding the classification of assets and theestablishment of adequate loan and lease loss reserves.         Wisconsin banking laws restrict the payment of cash dividends bystate banks by providing that (i) dividends may be paidonly out of a bank’s undivided profits, and (ii) priorconsent of the Division is required for the payment of adividend which exceeds current year income if dividends declaredhave exceeded net profits in either of the two immediatelypreceding years. The various bank regulatory agencies haveauthority to prohibit a bank regulated by them from engaging inan unsafe or unsound practice; the payment of a dividend by abank could, depending upon the circumstances, be considered assuch. In the event that (i) the FDIC or the Division shouldincrease minimum required levels of capital; (ii) the totalassets of the Banks increase significantly; (iii) theincome of the Banks decrease significantly; or (iv) anycombination of the foregoing occurs, then the Boards ofDirectors of the Banks may decide or be required by the FDIC orthe Division to retain a greater portion of the Banks’earnings, thereby reducing dividends.         The Banks are subject to certain restrictions imposed by theFederal Reserve Act on any extensions of credit to their parentholding company, FBFS. Also included in this act arerestrictions on investments in stock or other securities of FBFSand on taking of such stock or securities as collateral forloans to any borrower. Under this act and regulations of theFederal Reserve Board, FBFS and its Banks are prohibited fromengaging in certain tie-in arrangements in connection with anyextension of credit or any property or service.**The Corporation**         FBFS is a financial holding company registered under the BankHolding Company Act of 1956, as amended (the “BHCA”),and is subject to regulation, supervision, and examination bythe Board of Governors of the Federal Reserve System (the“FRB”). The Corporation is required to file an annualreport with the FRB and such other reports as the FRB mayrequire. Prior approval must be obtained before the Corporationmay merge with or consolidate into another bank holding company,acquire substantially all the assets of any bank or bank holdingcompany, or acquire ownership or control of any voting shares ofany bank or bank holding company if after such acquisition itwould own or control, directly or indirectly, more than 5% ofthe voting shares of such bank or bank holding company.         In reviewing applications for such transactions, the FRBconsiders managerial, financial, capital and other factors,including financial performance of the bank or banks to beacquired under the Community Reinvestment Act of 1977, asamended (the “CRA”). Also, under the Riegle-NealInterstate Banking and Branching Efficiency Act of 1994, asamended, state laws governing interstate banking acquisitionssubject bank holding companies to some limitations in acquiringbanks outside of their home state without regard to local law.         The Gramm-Leach Bliley Act of 1999 (the “GLB”)eliminates many of the restrictions placed on the activities ofbank holding companies. Bank holding companies such as FBFS canexpand into a wide variety of financial services, includingsecurities activities, insurance, and merchant banking withoutthe prior approval of the FRB.         **Sarbanes-Oxley Act of 2002.** The Sarbanes-Oxley Act wasestablished to provide a comprehensive framework for themodernization and reform of the oversight of public companyauditing, to improve the quality and transparency of financialreporting by such companies, and to strengthen the independenceof auditors. The Act stemmed from the systemic and structuralweaknesses identified in the
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capital markets in the United States and perceptions that suchstructural weakness contributed to recent corporate scandals.The legislation’s significant reforms are listed below. nCreation of the    PCAOB – the Public Company Accounting Oversight Board.    The PCAOB is empowered to set auditing, quality control and    ethics standards, inspect public accounting firms, and institute    disciplinary actions for those firms. The PCAOB is subject to    oversight and review by the SEC and is funded by mandatory fees    assessed against all public companies. This legislation also    strengthened the Financial Accounting Standards Board by giving    it full financial independence from the accounting    industry.  nAuditor    independence was strengthened, among other things, by limiting    the scope of consulting services that auditors can offer their    public company audit clients.  nThe    responsibility of public company directors and senior managers    for the quality of financial reporting and disclosures made by    their companies was heightened.  nA number of    provisions to deter wrongdoing were contained in the    legislation. CEOs and CFOs have to certify that company    financial statements fairly present the company’s financial    condition and results of operations. If a restatement of    financial results stemmed from a misleading financial statement    resulting from “misconduct”, the CEO and CFO are    required to forfeit and return to the company any bonus, stock    or stock option compensation received within the twelve months    following the misleading financial report. Company officers and    directors are also prohibited from attempting to mislead or    coerce an auditor. The SEC is also empowered to bar certain    persons from serving as officers or directors of a public    company. The act also prohibits insider trading during pension    fund “blackout periods” and requires the SEC to adopt    rules requiring attorneys to report securities law violations as    well as imposing civil penalties for the benefit of harmed    investors.  nA range of new    corporate disclosures are also required. These requirements    include off-balance-sheet transactions and conflicts as well as    pro forma disclosures designed in ways that are not misleading    or are in accordance with SEC disclosure requirements.    Accelerated reporting requirements require that insider    transactions be reported by the end of the second business day    following the covered transaction and that annual reports filed    with the SEC include a statement by management asserting their    responsibility for creating and maintaining adequate controls    and assessing the effectiveness of those controls. The act    requires companies to disclose whether or not they have adopted    an ethics code for senior financial officers, and, if not, why    not. Companies must also disclose whether the audit committee    includes at least one “financial expert”, as defined    by the SEC in accordance with specified requirements. The SEC    will regularly and systematically review corporate filings.  nProvisions in    the legislation seek to limit and, at the same time, expose to    public view possible conflicts of interest affecting securities    analysts.  nA range of new    criminal penalties for fraud and other wrongful acts can be    brought against companies or their insiders.         Effective August 29, 2002, as prescribed bySections 302(a) and 906 (effective July 29, 2002) ofSarbanes-Oxley, a public company’s CEO and CFO are eachrequired to certify that the company’s quarterly and annualreports do not contain any untrue statements of a material factand that the financial statements, and other financialinformation included in each such report, fairly present in allmaterial respects the financial condition, results of operationsand cash flows of the company for the periods presented in thatreport.         Section 404 of Sarbanes-Oxley, which does not becomeeffective for the Corporation until the filing of its annualreport for the year ended December 31, 2007, requires thatthe CEO and CFO certify that they (i) are responsible forestablishing, maintaining, and regularly evaluating theeffectiveness of the Corporation’s internal controls;(ii) have made certain disclosures to theCorporation’s auditors and the audit committee of theCorporation’s board of directors (the “Board”)about the Corporation’s internal controls; and(iii) have included information in the Corporation’squarterly and annual reports about their evaluation and whetherthere have been significant changes in the Corporation’sinternal controls or in
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other factors that could significantly affect internal controlssubsequent to such evaluation. The Corporation intends to beprepared for timely compliance with these requirements.**The Banks**         As state-chartered BIF-insured banks, the Banks are subject toextensive regulation by the WDFI and the FDIC. Lendingactivities and other investments must comply with federalstatutory and regulatory requirements. This federal regulationestablishes a comprehensive framework of activities in which aninstitution can engage and is intended primarily for theprotection of the BIF, the FDIC, and depositors.         **Insurance of Deposits.** The Banks’ deposits areinsured up to $100,000 under the BIF of the FDIC. The FDICassigns institutions to a particular capital group based on thelevels of the Banks’ capital –“well-capitalized,” “adequatelycapitalized,” or “undercapitalized.” These threegroups are then divided into three subgroups reflecting varyinglevels of supervisory concern, ranging from those institutionsconsidered to be healthy to those that represent substantialsupervisory concern. The result is nine assessment riskclassifications, with well-capitalized, financially soundinstitutions paying lower rates than those paid byundercapitalized institutions that pose a risk to the insurancefund.         The Banks’ assessment rate depends on the capital categoryto which they are assigned. Assessment rates for depositinsurance currently range from 0 to 27 basis points. TheBanks are well capitalized. The supervisory subgroup to whichthe Banks are assigned by the FDIC is confidential and may notbe disclosed. The Banks’ rate of deposit insuranceassessments will depend upon the category or subcategory towhich the Banks are assigned. Any increase in insuranceassessments could have an adverse affect on the earnings of theBanks.         **Regulatory Capital Requirements.** The FRB monitors thecapital adequacy of the Banks since on a consolidated basis theyhave assets in excess of $500.0 million. A combination ofrisk-based and leverage ratios are determined by the FRB.Failure to meet these capital guidelines could result insupervisory or enforcement actions by the FRB. Under therisk-based capital guidelines, different categories of assets,including certain off-balance sheet items, such as loancommitments in excess of one year and letters of credit, areassigned different risk weights, with perceived credit risk ofthe asset in mind. These risk weighted assets are calculated byassigning risk-weights to corresponding asset balances todetermine the risk-weight of the entire asset base. Totalcapital, under this definition, is defined as the sum of“Tier 1” and “Tier 2” capitalelements, with Tier 2 capital being limited to 100% ofTier 1 capital. Tier 1 capital, with somerestrictions, includes common stockholders’ equity, anyperpetual preferred stock, qualifying trust preferredsecurities, and minority interests in any unconsolidatedsubsidiaries. Tier 2 capital, with certain restrictions,includes any perpetual preferred stock not included inTier 1 capital, subordinated debt, any trust preferredsecurities not qualifying as Tier 1 capital, specificmaturing capital instruments and the allowance for loan andlease losses (limited to 1.25% of risk-weighted assets). Theregulatory guidelines require a minimum total capital torisk-weighted assets of 8%, of which at least 4% must be in theform of Tier 1 capital. The FRB also has a leverage ratiorequirement which is defined as Tier 1 capital divided byaverage total consolidated assets. The minimum leverage ratiorequired is 3%. See **Note 12**to the ConsolidatedFinancial Statements for further discussion of regulatorycapital requirements and the Corporation and Banks’ capitalratios.         The Corporation and Banks’ actual capital amounts andratios are presented in the table below and reflect theBanks’ well-capitalized positions.
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                                  **Minimum Required to**      **Minimum Required for** **be Well Capitalized**    **Capital Adequacy** **Under FDIC**  **Actual** **Purposes** **Requirements**         **Amount** **Ratio** **Amount** **Ratio** **Amount** **Ratio**               (Dollars in Thousands)**As of December 31, 2005:**                            Total capital (to risk-weighted assets)                             Consolidated $62,234   10.43% $47,748   8.00%  N/A   N/A      First Business Bank  55,240   10.88   40,610   8.00  $50,763   10.00%     First Business Bank – Milwaukee  9,009   10.32   6,981   8.00   8,727   10.00     Tier 1 capital (to risk-weighted assets)                             Consolidated $50,461   8.45% $23,874   4.00%  N/A   N/A      First Business Bank  49,713   9.79   20,305   4.00  $30,458   6.00%     First Business Bank – Milwaukee  7,917   9.07   3,491   4.00   5,236   6.00     Tier 1 capital (to average assets)                             Consolidated $50,461   7.92% $25,486   4.00%  N/A   N/A      First Business Bank  49,713   9.14   21,746   4.00  $27,182   5.00%     First Business Bank – Milwaukee  7,917   8.21   3,858   4.00   4,823   5.00 **As of December 31, 2004:**                            Total capital (to risk-weighted assets)                             Consolidated $57,296   11.03% $41,550   8.00%  N/A   N/A      First Business Bank  48,611   10.75   36,164   8.00  $45,205   10.00%     First Business Bank – Milwaukee  8,185   12.45   5,259   8.00   6,574   10.00     Tier 1 capital (to risk-weighted assets)                             Consolidated $45,921   8.84% $20,775   4.00%  N/A   N/A      First Business Bank  43,323   9.58   18,082   4.00  $27,123   6.00%     First Business Bank – Milwaukee  7,360   11.20   2,629   4.00   3,944   6.00     Tier 1 capital (to average assets)                             Consolidated $45,921   8.21% $22,365   4.00%  N/A   N/A      First Business Bank  43,323   8.92   19,430   4.00  $24,287   5.00%     First Business Bank – Milwaukee  7,360   10.09   2,918   4.00   3,648   5.00          **Prompt Corrective Action.** The Banks are also subject tocapital adequacy requirements under the Federal DepositInsurance Corporation Improvement Act of 1991(“FDICIA”), whereby the Banks could be required toguarantee a capital restoration plan, should they become“undercapitalized” as defined by FDICIA. The maximumliability under such a guarantee would be the lesser of 5% ofthe Banks’ total assets at the time they becameundercapitalized or the amount necessary to bring the Banks intocompliance with the capital restoration plan. The Corporation isalso subject to the “source of strength doctrine” perthe FRB, which requires that holding companies serve as a sourceof “financial and managerial” strength to theirsubsidiary banks.         If banks fail to submit an acceptable restoration plan, they aretreated under the definition of “significantlyundercapitalized” and would thus be subject to a widerrange of regulatory requirements and restrictions. Suchrestrictions would include activities involving asset growth,acquisitions, branch establishment, establishment of new linesof business and also prohibitions on capital distributions,dividends and payment of management fees to control persons, ifsuch payments and distributions would cause undercapitalization.
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         The following table sets forth the FDIC’s definition of thefive capital categories, in the absence of a specific capitaldirective.               **Total Capital to Risk** **Tier 1 Capital to**  **Category** **Weighted Assets** **Risk Weighted Assets** **Tier 1 Leverage Ratio**           Well capitalized  310%  36%  35%    Adequately capitalized  3 8%  34%  34%*    Undercapitalized  < 8%  < 4%  < 4%*    Significantly undercapitalized  < 6%  < 3%  <3%    Critically undercapitalized  Tangible assets to capital of 2%         *     3% if the Banks receive the highest rating under the uniform    system.         **Limitations on Dividends and Other Capital Distributions.**Federal and state regulations impose various restrictions orrequirements on state-chartered banks with respect to theirability to pay dividends or make various other distributions ofcapital. Generally, such laws restrict dividends to undividedprofits or profits earned during preceding periods. Also,FDIC-insured institutions may not pay dividends whileundercapitalized or if such a payment would causeundercapitalization. The FDIC also has authority to prohibit thepayment of dividends if such a payment constitutes an unsafe orunsound practice in light of the financial condition of aparticular bank. At December 31, 2005, subsidiaryunencumbered retained earnings of approximately $24,271,000could be transferred to the Corporation in the form of cashdividends without prior regulatory approval, subject to thecapital needs of each subsidiary.         **Liquidity.** The Banks are required by federal regulationto maintain sufficient liquidity to ensure safe and soundoperations. Management believes that its Banks have anacceptable liquidity percentage to match the balance of netwithdrawable deposits and short-term borrowings in light ofpresent economic conditions and deposit flows.         **Federal Reserve System.** The Banks are required tomaintain non-interest bearing reserves at specified levelsagainst their transaction accounts and non-personal timedeposits. As of December 31, 2005, the Banks were incompliance with these requirements. Because required reservesmust be maintained in the form of cash or non-interest bearingdeposits at the FRB, the effect of this requirement is to reducethe Banks’ interest-earning assets.         **Federal Home Loan Bank System.** The Banks are membersof the FHLB of Chicago. The FHLB serves as a central creditfacility for its members. The FHLB is funded primarily fromproceeds from the sale of obligations of the FHLB system. Itmakes loans to member banks in the form of FHLB advances. Alladvances from the FHLB are required to be fully collateralizedas determined by the FHLB.         As a member, each Bank is required to own shares of capitalstock in the FHLB in an amount equal to the greatest of $500, 1%of its aggregate unpaid residential mortgage loans, homepurchase contracts or similar obligations at the beginning ofeach year, or 20% of its outstanding advances. The FHLB alsoimposes various limitations on advances relating to the amountand type of collateral, the amount of advances and other items.At December 31, 2005, the Banks owned a total of$2.9 million in FHLB stock and were in compliance withtheir respective requirements. The Banks received combineddividends from the FHLB totaling $138,000 for fiscal 2005 ascompared to $146,000 for fiscal 2004.         Recently the FHLB announced the decision to discontinueredemptions of excess or “voluntary” stock by itsmembers. The FHLB believes this action will help ensure anadequate capital base as it continues serving housing financeneeds of its members. Voluntary stock is stock held by membersbeyond the amount required as a condition of membership or tosupport advance borrowings. As of December 31, 2005 theBanks held $400,000 of voluntary stock. In December 2005, theFHLB re-filed its Form 10 registration statement with theSEC. Registration with the SEC will increase costs and may haveother effects that are not possible to predict at this time.         **Restrictions on Transactions with Affiliates.** TheBanks’ loans to their own and the Corporation’sexecutive officers, directors and owners of greater than 10% ofany of their respective stock (so-called “insiders”)and any entities affiliated with such insiders are subject tothe conditions and limitations under Section 23A of theFederal Reserve Act and the Federal Reserve Bank’s
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Regulation O. Under these regulations, the amount of loansto any insider is limited to the same limit imposed in theloans-to-one borrowerlimits of the respective Banks. All loans to insiders must notexceed the Banks’ unimpaired capital and unimpairedsurplus. Loans to executive officers, other than loans for theeducation of the officers’ children and certain loanssecured by the officers’ residence, may not exceed thegreater of $25,000 or 2.5% of the Banks’ unimpaired capitaland unimpaired surplus, and may never exceed $100,000.Regulation O also requires that loans to insiders must beapproved in advance by a majority of the Board of Directors, atthe bank level. Such loans, in general, must be made onsubstantially the same terms as, and with credit underwritingprocedures no less stringent than those prevailing at the timefor, comparable transactions with other persons.         The Banks can make exceptions to the foregoing procedures ifthey offer extensions of credit that are widely available toemployees of the Banks and that do not give any preference toinsiders over other employees of the Banks.         **Community Reinvestment Act.** The Community ReinvestmentAct (“CRA”) requires each Bank to have a continuingand affirmative obligation in a safe and sound manner to helpmeet the credit needs of its entire community, including low andmoderate income neighborhoods. Federal regulators regularlyassess the Banks’ record of meeting the credit needs oftheir respective communities. Applications for additionalacquisitions would be affected by the evaluation of theBanks’ effectiveness in meeting its CRA requirements.         **Riegle Community Development and Regulatory Improvement Actof 1994.** Federal regulators have adopted guidelinesestablishing general standards relating to internal controls,information and internal audit systems, loan documentation,credit underwriting, interest rate risk, asset growth, assetquality, earnings and compensation, fees, and benefits. Theseguidelines require, in general, that appropriate systems andpractices are in place to identify and manage the risks andexposures specified by the guidelines. Such prohibitions includeexcessive compensation when amounts paid appear to beunreasonable or disproportionate to the services performed byexecutive officers, employees, directors or principalshareholders.         **USA PATRIOT Act of 2001.** The USA PATRIOT Act requiresbanks to establish anti-money laundering programs; to establishdue diligence policies, procedures, and controls with respect toprivate banking accounts and correspondent banking accountsinvolving foreign individuals and specific foreign banks; and toavoid establishing, maintaining, administering or managingcorrespondent accounts in the United States for or on behalf offoreign banks that maintain no presence in any country.Additionally, the USA PATRIOT Act encourages cooperation amongfinancial institutions, regulatory authorities, and lawenforcement with respect to individuals or organizations thatcould reasonably be suspected of engaging in terroristactivities. Federal regulators have begun proposing andimplementing regulations in efforts to interpret the USA PATRIOTAct. The Banks must comply with Section 326 of the Actwhich provides for minimum procedures in the verification ofidentification of new customers.         **Changing Regulatory Structure.** Regulation of theactivities of national and state banks and their holdingcompanies imposes a heavy burden on the banking industry. TheFRB, FDIC, and WDFI all have extensive authority to policeunsafe or unsound practices and violations of applicable lawsand regulations by depository institutions and their holdingcompanies. These agencies can assess civil monetary penalties,issue cease and desist or removal orders, seek injunctions, andpublicly disclose such actions. Moreover, the authority of theseagencies has expanded in recent years, and the agencies have notyet fully tested the limits of their powers.         The laws and regulations affecting banks and financial or bankholding companies have changed significantly in recent years,and there is reason to expect changes will continue in thefuture, although it is difficult to predict the outcome of thesechanges. From time to time, various bills are introduced in theUnited States Congress with respect to the regulation offinancial institutions. Certain of those proposals, if adopted,could significantly change the regulation of banks and thefinancial services industry.         **Monetary Policy.** The monetary policy of the FRB has asignificant effect on the operating results of financial or bankholding companies and their subsidiaries. Among the meansavailable to the FRB to affect the money supply are open markettransactions in U.S. government securities, changes in thediscount rate on member bank borrowings and changes in reserverequirements against member bank deposits. These means are usedin varying combinations to influence overall growth anddistribution of
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bank loans, investments and deposits, and their use may affectinterest rates charged on loans or paid on deposits.**Executive Officers of the Registrant**         The following contains certain information about the executiveofficers of FBFS. There are no family relationships between anydirectors or executive officers of FBFS.         Jerome J. Smith, age 61, has served as Chief ExecutiveOfficer and a Director of the Corporation since December, 1989.He served as President of the Corporation from December, 1989 toFebruary, 2005. He also served as President and Chief ExecutiveOfficer of First Business Bank from December, 1989 to July, 1999and as Chair of its Board of Directors from April, 2001 toDecember, 2003. Mr. Smith also serves as a Director andChairman of the Board of First Business Bank-Milwaukee.         Corey A. Chambas, age 43, has served as President and ChiefOperating Officer of the Corporation since February, 2005, andas a Director since July, 2002. He served as Executive VicePresident of the Corporation from July, 2002 to February, 2005.He has also served as Chief Executive Officer of First BusinessBank since July, 1999. He served as President of First BusinessBank from July, 1999 to February, 2005. He currently serves as aDirector of First Business Bank and other subsidiaries of theCorporation.         James F. Ropella, age 46, has served as Senior VicePresident and Chief Financial Officer of the Corporation sinceSeptember, 2000. Mr. Ropella also serves as the ChiefFinancial Officer of the subsidiaries of the Corporation.         Joan A. Burke, age 54, has served as President ofFirst Business Bank’s Trust Division since September,2001. Prior to that, from November, 1996 to May, 2001,Ms. Burke was the President, Chief Executive Officer andChairperson of the Board of Johnson Trust Company and certain ofits affiliates.         Mark J. Meloy, age 44, was elected Executive VicePresident of First Business Bank in September, 2004. He servedas President and Chief Executive Officer of First BusinessBank-Milwaukee from January, 2003 to October, 2004, and as aDirector from November, 2002 to October, 2004. From November,2002 to December 2002, he served as Executive Vice President andChief Operating Officer of First Business Bank-Milwaukee. FromApril 2000, to November, 2002 he served as Senior Vice Presidentand Senior Lending Officer at First Business Bank. He currentlyserves as a Director of First Business Leasing and FirstBusiness Capital Corp.         Michael J. Losenegger, age 48, was elected Presidentand a Director of First Business Bank in February, 2005. He hasserved as Chief Operating Officer of First Business Bank sinceSeptember, 2004. He served as Senior Vice President-BusinessDevelopment from February, 2003 to September, 2004. Prior tothat, from March, 1989 to January, 2003, Mr. Loseneggerserved as Assistant Vice President and Vice President and SeniorVice President of Lending at M&I Bank in Madison, Wisconsin.He currently serves as a Director of First Business Leasing andFirst Business Capital Corp.         Terry D. Taylor, age 37, was elected President and ChiefExecutive Officer of First Business Bank-Milwaukee in October,2004. Prior to that, he served as First Vice President and LoanOfficer from December, 2003 to October, 2004; as Vice Presidentand Loan Officer from December, 1999 to December, 2003; and asAssistant Vice President and Loan Officer from February, 1996 toDecember, 1999 at First Business Bank in Madison.         Charles H. Batson, age 52, joined the Corporation and waselected President and CEO of First Business Capital Corporationin January, 2006. Prior to joining the Corporation, fromFebruary 1986 to December, 2005, Mr. Batson served as VicePresident and Business Development Manager for Wells FargoBusiness Credit, Inc. He currently serves as a Director of FirstBusiness Capital Corp.**1a. Risk Factors**         The following risks and uncertainties should be carefully readand considered because they could materially and adverselyaffect our business, financial condition, results of operationsand prospects.         **Competition.** The Banks encounter strong competition inattracting both commercial loan and deposit clients. Suchcompetition includes banks, savings institutions, mortgagebanking companies, credit
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unions, finance companies, mutual funds, insurance companies,brokerage firms and investment banking firms. The Banks’market areas include branches of several commercial banks thatare substantially larger in terms of loans and deposits.Furthermore, tax exempt credit unions operate in most of theBanks’ market areas and aggressively price their productsand services to a large portion of the market. The Banks alsocompete with regional and national financial institutions, manyof which have greater liquidity, higher lending limits, greateraccess to capital, more established market recognition and moreresources and collective experience than the Banks. TheCorporation’s profitability depends upon the Banks’continued ability to successfully maintain and increase marketshare.         **Government Regulation and Monetary Policy.** TheCorporation’s businesses are subject to extensive state andfederal government supervision, regulation, and control.Existing state and federal banking laws subject the Corporationto substantial limitations with respect to loans, purchases ofsecurities, payment of dividends and many other aspects of theCorporation’s businesses. See **“Supervision andRegulation.”**There can be no assurance that futurelegislation or government policy will not adversely affect thebanking industry or the operations of the Corporation. Inaddition, economic and monetary policy of the Federal Reservemay increase the Corporation’s cost of doing business andaffect its ability to attract deposits and make loans.         **Key Personnel.** The Corporation’s success has beenand will be greatly influenced by its continuing ability toretain the services of its existing senior management and, as itexpands, to attract and retain additional qualified senior andmiddle management. The unexpected loss of services of any of thekey management personnel, or the inability to recruit and retainqualified personnel in the future, could have an adverse effecton the Corporation’s business and financial results.         **Technology.** The banking industry is undergoing rapidtechnological changes with frequent introductions of newtechnology-driven products and services. In addition to betterserving clients, the effective use of technology increasesefficiency and enables financial institutions to reduce costs.The Corporation’s future success will depend in part on itsability to address the needs of its clients by using technologyto provide products and services that will satisfy clientdemands for convenience as well as create additionalefficiencies in the Corporation’s operations. A number ofthe Corporation’s competitors have substantially greaterresources to invest in technological improvements. There can beno assurance that the Corporation will be able to implement newtechnology-driven products and services to its clients.         **Market Area.** One of the primary focal points of theBanks’ business development and marketing strategy isserving the needs of growing, small to medium-sized businesses.The origination of loans secured by real estate and businessassets of those businesses is the Banks’ primary businessand the principal source of profits. If client demand for suchloans decreases, the Banks’ income could be affectedbecause alternative investments, such as securities, typicallyearn less income than such loans. Client demand for these loanscould be reduced by a weaker economy, an increase inunemployment, a decrease in real estate values, or an increasein interest rates. Any factors that would adversely affectcommercial real estate values in Dane and Waukesha Counties inWisconsin and surrounding areas in general could be expected tohave a similar effect on the earnings and growth potential ofthe Corporation.         The principal factors that are used to attract deposit accountsand that distinguish one financial institution from anotherinclude rates of return, types of accounts, service fees, andconvenience of office locations, hours and other services. Theprimary factors in competing for commercial loans are interestrates, loan fee charges, loan structure and timeliness andquality of service to the borrower.         Most of the Banks’ loans are to businesses located in oradjacent to Dane and Waukesha Counties in Wisconsin. Any generaladverse change in the economic conditions prevailing in theseareas could reduce the Banks’ growth rate, impair theirability to collect loans or attract deposits, and generally havean adverse impact on the results of operations and financialcondition of the Corporation. If this region experienced adverseeconomic, political or business conditions, the Banks wouldlikely experience higher rates of loss and delinquency on theirloans than if their loans were geographically more diverse.         **Loan Portfolio Risk.** The Banks originate commercialmortgage, construction, multi-family, 1-4 family, commercial,asset-based, consumer loans, and leases, all of which areprimarily within their respective market areas. Such loansexpose a lender to greater credit risk than the home mortgageswhich form a greater part of the business of many commercialbanks, because the collateral securing these
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loans may not be sold as easily as residential real estate.These loans also have greater credit risk than residential realestate for the following reasons: nCommercial    mortgage loan repayment is dependent upon cash flow generation    sufficient to cover operating expenses and debt service.  nCommercial loan    repayment is dependent upon the successful operation of the    borrower’s business.  nConsumer loans    are collateralized, if at all, with assets that may not provide    an adequate source of payment of the loan due to depreciation,    damage or loss.         **Environmental Risk.** The Banks encounter certainenvironmental risks in their lending activities. Under federaland state law, lenders may become liable for costs of cleaningup hazardous materials found on secured properties. Certainstates may also impose liens with higher priorities than firstmortgages on properties to recover funds used in such efforts.The Banks attempt to control their exposure to environmentalrisks with respect to loans secured by larger properties bymonitoring available information on hazardous waste disposalsites and occasionally requiring environmental inspections ofsuch properties prior to closing the loan, as warranted. Noassurance can be given, however, that the value of propertiessecuring loans in the Banks’ portfolio will not beadversely affected by the presence of hazardous materials orthat future changes in federal or state laws will not increasethe Banks’ exposure to liability for environmental cleanup.         **Loan and Lease Loss Allowance Risk.** As lenders, the Banksare exposed to the risk that our loan and lease clients may notrepay their loans and leases according to their terms and thatthe collateral securing the payment of these loans and leasesmay be insufficient to assure repayment. The Banks mayexperience significant loan and lease losses which could have amaterial adverse impact on operating results. There is a riskthat various assumptions and judgments about the collectibilityof the loan and lease portfolios made by management could beformed from inaccurately assessed conditions leading to andrelated to such judgments and assumptions. Those assumptions andjudgments are based, in part, on assessment of the followingconditions: nCurrent economic    conditions and their estimated effects on specific borrowers;  nAn evaluation of    the existing relationships among loans and leases, potential    loan and lease losses and the present level of the allowance for    loan and lease losses;  nResults of    examinations of our loan and lease portfolios by regulatory    agencies;  nManagement’s    internal review of the loan and lease portfolios.         The Banks maintain an allowance for loan and lease losses tocover potential losses inherent in the loan and leaseportfolios. Additional loan and lease losses will likely occurin the future and may occur at a rate greater than thatexperienced to date. An analysis of the loan and leaseportfolios, historical loss experience and an evaluation ofgeneral economic conditions are all utilized in determining thesize of the allowance. Additional adjustments may be necessaryto allow for unexpected volatility or deterioration in the localor national economy. If material additions must be made to theallowance, this would materially decrease net income.Additionally, regulators periodically review the allowance forloan and lease losses or identify further loan or leasecharge-offs to be recognized based on judgments different fromthose of management. Any increase in the loan or lease allowanceor loan or lease charge-offs as required by regulatory agenciescould have a material adverse impact on net income.         **Interest Rate Risk.** The Corporation is subject tointerest rate risk. Changes in the interest rate environment mayreduce the Corporation’s profits. Net interest spreads areaffected by the difference between the maturities and repricingcharacteristics of interest-earning assets and interest-bearingliabilities. They are also affected by the proportion ofinterest-earning assets that are funded by interest-bearingliabilities. Loan volume and yield are affected by marketinterest rates on loans, and rising interest rates are generallyassociated with a lower volume of loan originations. There is noassurance that the Corporation can minimize its interest raterisk. In addition, a rise in the general level of interest ratesmay adversely affect the ability of certain borrowers to paytheir obligations if the reason for that rise in rates is not aresult of a general expansion of the economy. Accordingly,changes in levels of
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market interest rates could materially and adversely affect theCorporation’s net interest spread, asset quality, loanorigination volume and overall profitability.         **Trust Operations Risk.** The Corporation is subject totrust operations risk related to performance of fiduciaryresponsibilities. Clients may make claims and take legal actionpertaining to the Corporation’s performance of itsfiduciary responsibilities. Whether client claims and legalaction related to the Corporation’s performance of itsfiduciary responsibilities are founded or unfounded, if suchclaims and legal actions are not resolved in a manner favorableto the Corporation, they may result in significant financialliability and/or adversely affect the market perception of theCorporation and its products and services, as well as impactclient demand for those products and services. Any financialliability or reputation damage could have a material adverseeffect on the Corporation’s business, which, in turn, couldhave a material adverse effect on the Corporation’sfinancial condition and results of operations.**Item 1b. Unresolved Staff Comments**         None**Item 2. Properties**         At December 31, 2005, the Banks conducted business fromoffices located in Madison, Wisconsin at 401 Charmany Driveand in Brookfield, Wisconsin located at18500 W. Corporate Drive. The Banks lease theirfull-service offices and these leases expire in 2016 and 2010,respectively. FBB also conducts trust and investment businessfrom a limited purpose branch located at 3500 UniversityAvenue, Madison, Wisconsin. Office space is also leased inBurnsville, Minnesota under a short-term lease agreement whichhas a term of less than one year. See **Note 8**to theConsolidated Financial Statements for more information regardingthe premises and equipment. See **Note 14**to theConsolidated Financial Statements for more information regardingthe operating lease agreements.**Item 3. Legal Proceedings**         Management believes that no litigation is threatened or pendingin which the Corporation faces potential loss or exposure whichcould materially affect the Corporation’s consolidatedfinancial position, consolidated results of operations or cashflows. Since the Corporation’s subsidiaries act asdepositories of funds and trust agents, they could occasionallybe named as defendants in lawsuits involving claims to theownership of funds in particular accounts. This and otherlitigation is incidental to the Corporation’s business**Item 4. Submission of Matters to a Vote of SecurityHolders**         No matters were submitted to a vote of security holders duringthe fourth quarter of 2005.
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**PART II.****Item 5. Market for Registrant’s Common Equityand Related Stockholder Matters**         The common stock of the Corporation is traded on the NasdaqNational Market under the symbol “FBIZ”. AtMarch 15, 2006, there were approximately589 shareholders of record of FBFS common stock.         The following table presents the range of high and low closingsale prices of our common stock for each quarter within the twomost recent fiscal years, according to information available,and cash dividends declared for the years endedDecember 31, 2005 and 2004, respectively.                   **Dividend**  **High** **Low** **Declared**       **2005**                          1st Quarter $25.00  $24.50  $-     2nd Quarter  25.00   25.00   0.115     3rd Quarter  26.00   22.10   -     4th Quarter  29.73   23.70   0.06 **2004**                          1st Quarter $22.00  $21.00  $-     2nd Quarter  23.00   22.00   0.10     3rd Quarter  24.00   23.00   -     4th Quarter  25.00   24.00   0.11          The timing and amount of future dividends are at the discretionof the Board of Directors of the Corporation (the“Board”) and will depend upon the consolidatedearnings, financial condition, liquidity and capitalrequirements of the Corporation and its subsidiaries, the amountof cash dividends paid to the Corporation by its subsidiaries,applicable government regulations and policies and other factorsconsidered relevant by the Board. The Board anticipates it willcontinue to pay quarterly dividends in amounts determined basedon the above factors. Dividends are subject to restrictions tiedto the Banks’ earnings. See “Supervision andRegulation – The Banks – Limitations onDividends and Other Capital Distributions” under**Item 1 of Part I.**         The following transactions occurred during the quarter endedDecember 31, 2005 pursuant to the 1993 Equity IncentivePlan. On October 5, 2005, 11,552 shares of FBFS commonstock were sold for $100,040.32. On October 24, 2005,2,312 shares of common stock were sold for $20,021.92.These transactions were entered into pursuant to the exemptionprovided in Rule 701.         The following table summarizes repurchases made by theCorporation during the fourth quarter 2005.                       **Total Number** **Maximum**      **Of Shares** **Number that**      **Purchased as** **May Yet Be**  **Total Number** **Average** **Part of Publicly** **Purchased**  **Of Shares** **Price Paid** **Announced** **Under the****Period** **Purchased** **Per Share** **Plans or Programs** **Plans or Programs**             October 1 – 31, 2005  4,771  $25.17   None   None     November 1 – 30, 2005  -   -   -   -     December 1 – 31, 2005  -   -   -   - 
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**Item 6. Selected Consolidated Financial Data****Five Year Comparison of Selected Consolidated FinancialData**                       **At or For the Year Ended December 31,**     **2005** **2004** **2003** **2002** **2001**             (Dollars in Thousands, Except Per Share Data)**FOR THE YEAR:**                        Interest income $36,509  $28,136  $27,005  $27,643  $26,705     Interest expense  18,733   11,273   11,677   14,966   15,220                     Net interest income  17,776   16,863   15,328   12,677   11,485     Provision for loan and lease losses  400   (540)  200   3,614   1,940     Gain on sale of 50% owned joint venture*  973   -   -   -   -     Non-interest income  3,266   3,261   2,205   (1)  2,395     Written option income (expense)  -   7   1,361   (39)  (343)    Non-interest expense  14,403   13,148   11,432   10,525   8,544     Minority interest in (income) loss of consolidated subsidiary  -   (9)  (741)  787   338     Income tax expense (benefit)  2,455   3,255   873   (528)  965                     Net income (loss) $4,757  $4,259  $5,648  $(187) $2,426                     Yield on earning assets  6.22%  5.42%  5.65%  6.42%  7.82%    Cost of funds  3.59   2.49   2.77   3.94   5.14     Interest rate spread  2.62   2.93   2.88   2.47   2.68     Net interest margin  3.03   3.25   3.21   2.94   3.37     Return on average assets  0.78   0.79   1.14   (0.04)  0.69     Return on average equity  11.79   13.81   24.09   (0.87)  12.16                 **ENDING BALANCE SHEET:**                        Total assets $669,235  $562,951  $518,472  $480,061  $410,221     Securities  95,070   66,445   63,571   48,406   39,203     Loans and leases, net  532,716   469,938   433,105   409,227   351,579     Deposits  567,464   474,677   436,886   414,407   345,459     Borrowed funds  39,758   29,981   30,812   19,474   18,806     Junior subordinated debentures  10,310   10,310   -   -   -     Guaranteed trust preferred securities  -   -   10,000   10,000   10,000     Option liability  -   -   661   2,022   1,983     Minority interest in consolidated subsidiary  -   -   4,353   3,562   4,302     Stockholders’ equity  41,843   38,141   25,990   20,824   21,381                 **FINANCIAL CONDITION ANALYSIS:**                        Allowance for loan losses to year-end loans  1.25%  1.34%  1.55%  1.42%  1.55%    Allowance to non-accrual loans  438.64   281.83   423.57   192.69   383.54     Net (charge-offs) recoveries to average loans  (0.00)  0.02   0.17   (0.84)  (0.05)    Non-accrual loans to gross loans  0.29   0.47   0.37   0.73   0.40     Average equity to average assets  6.61   5.74   4.75   4.80   5.65                 **STOCKHOLDERS’ DATA:**                        Basic earnings (loss) per share $1.96  $1.89  $2.81  $(0.09) $1.23     Diluted earnings (loss) per share  1.93   1.83   2.02   (0.09)  1.18     Book value per share at end of period  17.18   15.81   12.86   10.49   10.80     Dividends declared per share  0.175   0.21   0.25   0.15   -     Dividend payout ratio  8.93%  11.09%  8.90%  N.M.   0.00%    Shares outstanding  2,435,008   2,412,409   2,021,033   1,985,466   1,979,927  *     See “Sale of m2” in Recent Developments in this    section and **Note 2**to the Consolidated Financial    Statements for further discussion.N.M. – Not Meaningful
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**Item 7. ****Management’s Discussion and Analysis of Financial    Condition and Results of Operations****Forward-Looking Statements**         When used in this report, and in any oral statements made withthe approval of an authorized executive officer, the words orphrases “may,” “could,” “should,”“hope,” “might,” “believe,”“expect,” “plan,” “assume,”“intend,” “estimate,”“anticipate,” “project,” “will likelyresult,” or similar expressions are intended to identify“forward-looking statements. “Such statements aresubject to risks and uncertainties, including, withoutlimitation, changes in economic conditions in the market area ofFirst Business Bank (“FBB”) or First BusinessBank – Milwaukee (“FBB –Milwaukee”),changes in policies by regulatory agencies,fluctuation in interest rates, demand for loans in the marketarea of FBB or FBB – Milwaukee, borrowers defaultingin the repayment of loans, competition, and the other risks setforth under **“Cautionary Factors,”**that couldcause actual results to differ materially from what FBFS hasanticipated or projected. These risk factors and uncertaintiesshould be carefully considered by potential investors. Investorsshould not place undue reliance on any such forward-lookingstatements, which speak only as of the date made. The factorsdescribed within thisForm 10-K couldaffect the financial performance of FBFS and could cause actualresults for future periods to differ materially from anyopinions or statements expressed with respect to future periods.         Where any such forward-looking statement includes a statement ofthe assumptions or bases underlying such forward-lookingstatement, FBFS cautions that, while its management believessuch assumptions or bases are reasonable and are made in goodfaith, assumed facts or bases almost always vary from actualresults, and the differences between assumed facts or bases andactual results can be material, depending on the circumstances.Where, in any forward-looking statement, an expectation orbelief is expressed as to future results, such expectation orbelief is expressed in good faith and believed to have areasonable basis, but there can be no assurance that thestatement of expectation or belief will result in, or beachieved or accomplished.         FBFS does not intend to update any forward-looking statements,whether written or oral, to reflect change. Furthermore, FBFSspecifically disclaims any obligation to publicly release theresult of any revisions which may be made to any forward-lookingstatements to reflect events or circumstances after the date ofsuch statements or to reflect the occurrence of anticipated orunanticipated events.         The following discussion and analysis is intended as a review ofsignificant factors affecting the financial condition andresults of operations of FBFS for the periods indicated. Thediscussion should be read in conjunction with the ConsolidatedFinancial Statements and the Notes thereto and the SelectedConsolidated Financial Data presented herein.**Overview**         The principal business of FBFS is conducted by FBB andFBB – Milwaukee and consists of a full range ofcommunity-based financial services focusing on small andmedium-sized businesses. Products include commercial lending,asset-based lending, leasing, trust and investment services anda broad range of deposit products. The profitability of FBFSdepends primarily on its net interest income, provision for loanand lease losses, non-interest income, and non-interestexpenses. Net interest income is the difference between theincome FBFS receives on its loans, leases and investmentsecurities, and its cost of funds, which consists of interestpaid on deposits and borrowings. The provision for loan andlease losses reflects the cost of credit risk in the loan andlease portfolio of FBFS. Non-interest income consists of servicecharges on deposit accounts, securities gains, loan and leasefees, trust fees, brokerage and investment income, changes infair value of interest rate swaps and other income. Non-interestexpenses include salaries and employee benefits, occupancy,equipment expenses, professional services, marketingexpenses,and other non-interest expenses.         Net interest income is dependent on the amounts of and yields oninterest-earning assets as compared to the amounts of and rateson interest-bearing liabilities. Net interest income issensitive to changes in market rates of interest and theasset/liability management procedures used by FBFS in respondingto such changes. The provision for loan and lease losses isdependent upon the credit quality of loans and leases andmanagement’s assessment of the collectibility of loans andleases under current economic conditions. Non-interest expensesare influenced by the growth of operations, with additional
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employees necessary to staff such growth. Growth in the numberof relationships directly affects such expenses as dataprocessing costs, supplies, postage, and other miscellaneousexpenses.         In the following discussion, as required by generally acceptedaccounting principles, FBFS’s interest income, interestexpense, provision for loan and lease losses, net interestincome, non-interest income, non-interest expense, income taxexpense, and all balance sheet items other thanshareholders’ equity include 100% of the amounts reportedby BBG for the periods and as of the dates stated, although FBFSowned only 51% of the outstanding shares of BBG stock as ofDecember 31, 2003. FBFS’s net income andstockholders’ equity are reported net of adjustment toreflect the 49% outstanding minority interests of BBG. Asof June 1, 2004, FBFS owned 100% of the shares of BBG. BBGwas subsequently dissolved and as a result First BusinessBank – Milwaukee became a direct wholly-ownedsubsidiary of FBFS. See **“Item 8 –Financial Statements and Supplementary Data.”****Recent Developments**         **Tax Audit.** Like the majority of financial institutionslocated in Wisconsin, First Business Bank transferred investmentsecurities and loans toout-of-state investmentsubsidiaries. FBB’s Nevada investment subsidiaries now holdand manage these assets. The investment subsidiaries have notfiled returns with, or paid income or franchise taxes to, theState of Wisconsin. The Wisconsin Department of Revenue (the“Department”) implemented a program to audit Wisconsinfinancial institutions which formed investment subsidiarieslocated outside of Wisconsin, and the Department has generallyindicated that it intends to assess income or franchise taxes onthe income of theout-of-state investmentsubsidiaries of Wisconsin financial institutions. FBB hasreceived a Notice of Audit from the Department that would coveryears 1999 through 2002 and would relate primarily to the issueof income of the Nevada subsidiaries. During 2004, theDepartment offered a blanket settlement agreement to most banksin Wisconsin having Nevada investment subsidiaries. TheDepartment has not issued an assessment to FBB, but theDepartment has stated that it intends to do so if the matter isnot settled.         Prior to the formation of the investment subsidiaries FBB soughtand obtained private letter rulings from the Departmentregarding the non-taxability of income generated by theinvestment subsidiaries in the State of Wisconsin. FBB believesit complied with Wisconsin law and the private rulings receivedfrom the Department. Should an assessment be forthcoming, FBBintends to defend its position vigorously through the normaladministrative appeals process in place at the Department andthrough other judicial channels should they become necessary.Although FBB will vigorously oppose any such assessment therecan be no assurance that the Department will not be successfulin whole or in part in its efforts to tax the income ofFBB’s Nevada investment subsidiary. FBB has accrued, as acomponent of current state income tax expense, an estimatedliability including interest which is the most likely amountwithin a range of probable settlement amounts. FBFS does notexpect the resolution of this matter to materially affect itsconsolidated results of operations and financial position beyondthe amounts accrued. Should the Department be wholly successfulin its efforts to tax the income of the Nevada investmentsubsidiaries then future cash flow would be negatively affectedby as much as $2.7 million.         **Sale of m2 Lease Funds, LLC.** On January 4, 2005, FBBsold its 50% equity interest in m2 Lease Funds, LLC(“m2”), in a cash sale. See **Note 2**“Sale of 50% Owned Joint Venture” in theConsolidated Financial Statements.         The primary function of m2 was to originate direct financingleases for its own account and to provide, on an agency basis,direct financing lease originations to First Business Leasing ona right of first refusal basis. m2 also originated and soldleases to non-affiliated banks.         In 2004 the Corporation’s equity in earnings of m2 was$124,000. The investment in m2 was accounted for under theequity method. The historical recognition of annual net incomewas immaterial to the overall performance of the Corporation. In2005, there was no material effect on the results of operationsdue to the sale of m2.         Historically, the Corporation has not received any cash flowfrom m2 until the sale in 2005 and therefore future cash flowand liquidity will not be affected by the sale.
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**Critical Accounting Policies and Estimates**         The preparation of financial statements in conformity withaccounting principles generally accepted in the United Statesrequires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenuesand expenses during the reporting period. By their nature,changes in these assumptions and estimates could significantlyaffect the financial position or results of operations for FBFS.Actual results could differ from those estimates. Please referto **Note 1**to the Consolidated Financial Statementsfor a discussion of the most significant accounting policiesfollowed by FBFS. Discussed below are certain policies that arecritical to FBFS. Management views critical accounting policiesto be those which are highly dependent on subjective or complexjudgments, estimates, and assumptions, and where changes inthose estimates and assumptions could have a significant impacton the financial statements.         **Allowance for Loan and Lease Losses.** The allowance forloan and lease losses represents management’s recognitionof the risks of extending credit and its evaluation of thequality of the loan and lease portfolio and as such, requiresthe use of judgment as well as other systematic objective andquantitative methods. The risks of extending credit and theaccuracy of management’s evaluation of the quality of theloan and lease portfolio are neither static nor mutuallyexclusive and could result in a material impact on theCorporation’s financial statements. Management couldover-estimate the quality of the loan and lease portfolioresulting in a lower allowance for loan and lease losses thannecessary, overstating net income and equity. Conversely,management could under-estimate the quality of the loan andlease portfolio, resulting in a higher allowance for loan andlease losses than necessary, understating net income and equity.The allowance for loan and lease losses is a valuation allowancefor probable incurred credit losses, increased by the provisionfor loan and lease losses and decreased by charge-offs, net ofrecoveries. Management estimates the allowance balance requiredand the related provision for loan and lease losses based onquarterly evaluations of the loan and lease portfolio, withparticular attention paid to loans and leases that have beenspecifically identified as needing additional managementanalysis because of the potential for further problems. Duringthese evaluations, consideration is also given to such factorsas the level and composition of impaired and othernon-performing loans and leases, historical loss experience,results of examinations by regulatory agencies, independent loanand lease reviews, the market value of collateral, the strengthand availabilities of guarantees, concentration of credits andother factors. Allocations of the allowance may be made forspecific loans or leases, but the entire allowance is availablefor any loan or lease that, in management’s judgment,should be charged off. Loan and lease losses are charged againstthe allowance when management believes that the uncollectibilityof a loan or lease balance is confirmed.         Historical loss rates for the various classifications and poolsof loans and leases may be adjusted by management from time totime for significant factors that, in management’sjudgment, reflect the effect of current conditions on lossrecognition. The loss rates used also consider the imprecisionin estimating losses on individual loans and leases or pools ofloans and leases.         Management also continues to pursue all practical and legalmethods of collection, repossession and disposal, and adheres tohigh underwriting standards in the origination process in orderto continue to maintain strong asset quality. Althoughmanagement believes that the allowance for loan and lease lossesis adequate based upon current evaluation of loan and leasedelinquencies, non-performing assets, charge-off trends,economic conditions and other factors, there can be no assurancethat future adjustments to the allowance will not be necessary.Should the quality of loans or leases deteriorate, then theallowance for loan and lease losses would be expected toincrease relative to total loans and leases. When loan or leasequality improves, then the allowance would be expected todecrease relative to total loans and leases.         **Income Taxes.** FBFS and its subsidiaries which are atleast 80% owned file a consolidated Federal income tax returnand separate state tax returns. Subsidiaries for whichFBFS’s interest is less than 80% file a separate Federaltax return from FBFS. Deferred income taxes are recognized forthe future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets andliabilities and their respective tax bases. The determination ofcurrent and deferred income taxes is based on complex analysesof many factors, including the interpretation of Federal andstate income tax laws, the difference between the tax andfinancial reporting basis of assets and liabilities
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(temporary differences), estimates of amounts currently due orowed, such as the timing of reversals of temporary differencesand current accounting standards. The Federal and state taxingauthorities who make assessments based on their determination oftax laws periodically review the Corporation’sinterpretation of Federal and state income tax laws. Taxliabilities could differ significantly from the estimates andinterpretations used in determining the current and deferredincome tax liabilities based on the completion of taxingauthority examinations. FBFS accrues through current income taxprovision amounts it deems probable of assessment related tofederal and state income tax expenses. Such accruals would bereduced when such taxes are paid or reduced by way of a creditto the current income tax provision when it is no longerprobable that such taxes will be paid. Deferred tax assets andliabilities are measured using enacted tax rates expected toapply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effectof a change in tax rates on deferred taxes is recognized inincome in the period that includes the enactment date. FBFS andits subsidiaries have State of Wisconsin net operating loss(“NOL”) carryforwards as of December 31, 2005 ofapproximately $27,500,000, which expire in years 2012 through2020.         FBFS has made its best estimates on valuation allowances neededfor deferred tax assets on certain net operating losscarryforwards and other temporary differences and has made itsbest estimate of the probable loss related to a state taxexposure matter (see **Note 15**to the consolidatedfinancial statements). These estimates are subject to changes.Changes in these estimates could adversely affect futureconsolidated results of operations. Through 2003, BBG, which wasconsolidated by FBFS for financial reporting, but not taxpurposes, had NOL carryforwards that were generated in 2000through 2002, the first three years of BBG’s existence.Realization of the net deferred tax assets related to such NOLsover time was dependent upon BBG generating sufficient taxableincome in future periods. Statement of Financial AccountingStandards (“SFAS”) No. 109, *Accounting forIncome Taxes,* requires establishment of a valuationallowance reserve for some portion or all of the NOLs if it ismore likely than not that sufficient taxable income will not begenerated in future periods to utilize the NOLs before theyexpire. A valuation allowance was established for the benefit ofNOLs accumulated through December 31, 2002. In 2003, therewas a reduction in the allowance of $1,206,000 against thedeferred income tax assets at the consolidated bank subsidiaryas FBFS determined the benefit of these NOL carryforwards to beprobable of realization in full based upon the profitability ofFBB – Milwaukee in 2003, its recovery in 2003 of$773,000 of the loans charged-off in 2002, the significantreduction in non-performing loans, the ability of FBFS to sellearning assets to FBB – Milwaukee, the achievement ofa growth in earning assets sufficient to forecast futureearnings more than sufficient to utilize the full NOL, and thelength of the remaining life of the NOL carryforwards whichrange from 10 to 12 years. FBB – Milwaukeecontinues to have taxable income in 2004 and 2005.         As noted elsewhere herein, in June 2004, BBG shareholderscompleted the exchange of their 49% minority ownership in BBG toFBFS for shares of FBFS. This event resulted in FBFS owning 100%of BBG shares. BBG was subsequently dissolved and as a result,FBB – Milwaukee became a direct wholly-ownedsubsidiary of FBFS. Since 2004, FBFS has filed a consolidatedFederal tax return with FBB – Milwaukee enabling theusage of FBB – Milwaukee’s NOL carryforwards tooffset consolidated taxable income, subject to certain IRSannual limitations. This event increases further the probabilitythat all of the benefits related to these NOL carryforwards willbe fully realized. FBFS will continue to evaluate theprobability of the usage of the NOL carryforwards and if in thefuture it is no longer deemed more likely than not that thebenefit of the NOL carryforwards will be realized, then avaluation allowance will be established through a charge toincome tax expense. At December 31, 2005, $1,694,000 of theBBG NOL remains unused.         **Valuation of Securities.** The Corporation’savailable-for-sale security portfolio is reported at fair value.The fair value of a security is determined based on quotedmarket prices. If quoted market prices are not available, fairvalue is determined based on quoted prices of similarinstruments. Available-for-sale securities are reviewedquarterly for possible other-than-temporary impairment. Thereview includes an analysis of the facts and circumstances ofeach individual investment such as the length of time the fairvalue has been below cost, the expectation for thatsecurity’s performance, the credit worthiness of the issuerand the Corporation’s intent and ability to hold thesecurity to maturity. A decline in value that is considered tobe other-than-temporary is recorded as a loss withinnon-interest income in the Consolidated Statements of Income.
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         The Corporation infrequently sells securities available forsale, having no sales in 2005, 2004 or 2003. The Corporationholds debt securities of the U.S. Government andcollateralized mortgage derivatives. The fair value of thesesecurities is affected mostly by changes in interest rates. Itis the Corporation’s intent and ability to hold securitieswith unrealized losses until maturity or until recovery of anyunrealized losses.         **Lease Residuals.** The Corporation leases machinery andequipment to clients under leases which qualify as directfinancing leases for financial reporting and as operating leasesfor income tax purposes. Under the direct financing method ofaccounting, the minimum lease payments to be received under thelease contract, together with the estimated unguaranteedresidual value (approximating 3 to 15% of the property cost ofthe related equipment), are recorded as lease receivables whenthe lease is signed and the lease property is delivered to theclient. Residual value is the estimated fair market value of theequipment on lease at lease termination. In estimating theequipment’s fair value, the Corporation relies onhistorical experience by equipment type and manufacturerpublished sources of used equipment prices, internal appraisalsand, where available, valuations by independent appraisers,adjusted for known trends. The Corporation’s estimates arereviewed regularly to ensure reasonableness; however, theamounts the Corporation will ultimately realize could differfrom the estimated amounts. Where residual amounts are estimatedto be other-than-temporarily impaired, the amount is reduced anda loss is recorded.         **Derivatives.** The Corporation uses derivative instruments,principally interest rate swaps, to protect against the risk ofadverse price or interest rate movements on the value of certainassets and liabilities and on future cash flows.         SFAS No. 133, *Accounting for Derivative Instrumentsand Hedging Activities,*as amended, requires all derivativeinstruments to be carried at fair value on the balance sheet.The accounting for the gain or loss due to changes in the fairvalue of the derivative instrument depends on whether thederivative instrument qualifies as a hedge. If the derivativeinstrument does not qualify as a hedge, the gains or losses arereported in earnings when they occur. However, if the derivativeinstrument qualifies as a hedge the accounting varies based onthe type of risk being hedged.         Derivative instruments designated in a hedge relationship tomitigate exposure to changes in the fair value of an asset,liability or firm commitment attributable to a particular risk,such as interest rate risk, are considered fair value hedgesunder SFAS No. 133. Derivative instruments designatedin a hedge relationship to mitigate exposure to variability inexpected future cash flows or other types of forecastedtransactions, are considered cash flow hedges. The Corporation,at the inception of the hedge, formally documents allrelationships between hedging instruments and hedged items, aswell as its risk management objective and strategy forundertaking each hedge transaction.         SFAS No. 133 requires that at the inception of eachhedge and at least quarterly thereafter, a formal assessment isperformed to determine whether changes in the fair values orcash flows of the derivative instruments have been highlyeffective in offsetting changes in the fair values or cash flowsof the hedged items and whether they are expected to be highlyeffective in the future. If it is determined that a derivativeinstrument has not been or will not continue to be highlyeffective, hedge accounting is discontinued. Thereafter, thederivative instrument would continue to be marked to market withchanges in fair value charged or credited to earnings.         For fair value hedges, gains or losses on derivative hedginginstruments are recorded in earnings. In addition, gains orlosses on the hedged item are recognized in earnings in the sameperiod and the same income statement line as the change in fairvalue of the derivative. Consequently, if gains or losses on thederivative hedging instrument and the related hedged item do notcompletely offset, the difference (i. e. the ineffective portionof the hedge) is recognized currently in earnings.         For cash flow hedges, the reporting of gains or losses onderivative hedging instruments depends on whether the gains orlosses are effective at offsetting the cash flows of the hedgeditem. The effective portion of the gain or loss is accumulatedin other comprehensive income and recognized in earnings duringthe period that the hedged forecasted transaction affectsearnings. The ineffective portion of the hedge is recognizedcurrently in earnings.
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         When available, the fair values of derivatives and the hedgedassets or liabilities are obtained from third party sources.Such fair values are based upon interest rates using discountedcash flow modeling techniques in the absence of market quotes.Therefore, management must make estimates regarding the amountand timing of cash flows, which are susceptible to significantchange in future periods based upon changes in interest rates.The assumptions used by management in the cash flow models arebased on yield curves, forward yield curves and impliedvolatilities observable in the cash and derivatives markets. Thepricing models are validated periodically by testing throughcomparison with other third parties.         At December 31, 2005, there are no fair value hedges andthere is one cash flow hedge. The interest rate swap designatedas a cash flow hedge has an unrealized loss fair value of$14,000 and $45,000 at December 31, 2005 and 2004,respectively.         **Goodwill and Other Intangible Assets.** Goodwill wasrecorded as a result of the acquisition of BBG on June 1,2004, the purchase price of which exceeded the fair value of thenet assets acquired. Goodwill is reviewed at least annually forimpairment. This review requires judgment. If goodwill isdetermined to be impaired, a reduction in value would beexpensed in the period in which it became impaired. See**Note 4**to the Consolidated Financial Statements forfurther discussion of goodwill and other intangibles.         Judgment is also used in the valuation of other intangibleassets consisting of a core deposit intangible and a client listfrom a purchased brokerage/investment business. Core depositintangibles were recorded for core deposits acquired in the BBGacquisition which was accounted for as a purchase businesscombination. The core deposit intangible assets were recordedusing the assumption that they provide a more favorable sourceof funding than wholesale borrowings. An intangible asset wasrecorded for the present value of the difference between theexpected interest to be incurred on these deposits and interestexpense that would be expected if these deposits were replacedby wholesale borrowings, over the expected lives of the coredeposits. The current estimate of the underlying lives of coredeposits is fifteen years and ten years for the client list. Ifit is determined that the deposits or the client list haveshorter lives, the assets will be adjusted and an expense willbe recorded for the amount that is impaired.**Results of Operations***Comparison of the Years Ended December 31, 2005 and2004*         **General.** Net income increased $498,000 to$4.8 million for the year ended December 31, 2005 from$4.3 million in the same period of 2004. The year endedDecember 31, 2005 included a gain on the sale of the 50%equity investment in a leasing joint venture, m2 Lease Funds,LLC (“m2”), of $973,000. In addition to the gain onsale of m2, interest income increased $8.4 million, trustand investment services fee income increased $313,000 and incometax expense decreased by $800,000. These components that causedan increase in net income were partially offset by increases ininterest expense of $7.5 million, an increase of $940,000in provision for loan and lease losses and an increase innon-interest expense of $1.3 million. The returns onaverage assets and average stockholders’ equity for theyear ended December 31, 2005 were .78% and 11.79%,respectively, as compared to .79% and 13.81%, respectively, forthe same period in 2004.         **Net Interest Income.** Net interest income increased$913,000, or 5.4%, to $17.8 million for the year endedDecember 31, 2005 from $16.9 million for the sameperiod in 2004. The improvement in net interest income was dueto an increase in average earning assets offset by a decrease innet interest margin. Net interest margin decreased to 3.03% forthe year ended December 31, 2005 from 3.25% in the sameperiod of 2004. The decrease in the net interest margin was theresult of the increase in yields paid on interest-bearingliabilities outpacing the increase in yields earned oninterest-bearing assets. This was also reflected in the decreasein the interest rate spread to 2.62% for the year endedDecember 31, 2005 from 2.93% for the same period in 2004.         Interest income on total interest-earning assets increased$8.4 million to $36.5 million for the year endedDecember 31, 2005 from $28.1 million for the sameperiod in 2004. In particular, interest income on loans andleases increased $7.3 million to $33.1 million as ofthe year ended December 31, 2005 from $25.9 millionfor the same period of 2004 due to an increase in average loansand leases outstanding of $42.9 million, or 9.5%,accompanied by an increase in average yields earned on loans and
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leases to 6.68% from 5.70% caused by the change in market rates.The average balance of loans and leases increased to$496.4 million for the year ended December 31, 2005from $453.5 million for the same period in 2004. Theincrease was driven largely by growth in mortgage loans whichincludes commercial real estate, construction, multi-family and1-4 family loans partially offset by decreases in the lease andconsumer loan categories. Total average mortgage loan growthamounted to $32.9 million, or 11.1%. Average commercialloans grew $13.8 million, or 10.7%, while average leasesdeclined by $3.4 million or 13.4%. The rate of growth incommercial real estate, construction and commercial loans haslargely been the result of attracting new clients in theBanks’ two principal markets.         Also contributing to the increase in income on interest earningassets was an increase in income on mortgage related securitiesof $1.1 million to $3.0 million for the year endedDecember 31, 2005 from $1.9 million for the sameperiod in 2004. Net purchases of roughly $30 million weremade as interest rates have become more attractive in thosesecurities as a result of rising mortgage rates. Averagebalances of mortgage related securities increased $25.2 million to $82.3 million for the year endedDecember 31, 2005 from $57.1 million for the sameperiod in 2004. These increases were accompanied by an increasein average yields on such securities to 3.71% in 2005 from 3.38%in 2004. It is the Corporation’s policy to diversify assetsand part of that diversification includes an investmentportfolio that is not less than 10.0% of total assets.         Interest expense on interest-bearing liabilities increased$7.5 million to $18.7 million for the year endedDecember 31, 2005 from $11.3 million for the sameperiod in 2004 primarily due to a $7.0 million increase ininterest expense on deposits with the weighted average rateincreasing to 3.44% from 2.34% for the same period in 2004. Theincrease in interest expense was largely due to rising rates ondeposits accompanied by an increase in average interest-bearingdeposits of $71.3 million or 17.3% to $483.3 millionfor the year ended December 31, 2005 from$411.9 million for the same period in 2004. This increasewas largely a result of growth in money market accounts acquiredprimarily within the local market and growth in averagecertificates of deposit primarily acquired through depositbrokers. Average money market deposits increased$39.5 million or 52.6% to $114.7 million for the yearended December 31, 2005 from $75.1 million in 2004.Average certificates of deposit increased $25.9 million or8.9% to $319.5 million for the year ended December 31,2005 from $293.6 million in 2004. These increases werepartially offset by a decrease in the average balance of FederalHome Loan Bank (“FHLB”) advances, used as anothersource of funding, of $11.4 million to $11.4 millionfor the year ended December 31, 2005 from$22.8 million for the same period in 2004, or 50.0%, withthe average cost of such advances increasing to 3.67% in 2005from 1.91% for 2004. The overall weighted average cost ofborrowings increased to 5.49% for the year endedDecember 31, 2005 from 3.99% for the same period in 2004.         The Banks’ strategies continue to focus on developingdeeper relationships through the sale of products and servicesthat meet clients’ needs accompanied by incentive programsthat encourage the growth of deposits. Specific depositinitiatives include service and retention calling programs,increased advertising and identification of high growthpotential individuals and businesses. Additionally, theBanks’ use of wholesale funding in the form of depositsgenerated through distribution channels other than theCorporation’s own bank locations allows the Banks to gatherfunds across a wider geographic base at pricing levelsconsidered attractive.         **Provision for Loan and Lease Losses.** The provision forloan and lease losses increased $940,000 to $400,000 for theyear ended December 31, 2005 compared to a negativeprovision of $540,000 for the same period in 2004. The primaryreason for the provision for loan and lease losses during 2005is the risk profile associated with the growth in the loan andlease portfolio. Charge-offs during the period wereinconsequential with net charge-offs totaling $2,000 during theyear ended December 31, 2005. In order to establish thelevels of the allowance for loan and lease losses, managementregularly reviews its historical charge-off migration analysisand an analysis of the current level and trend of severalfactors that management believes provides an indication oflosses in the loan and lease portfolio. These factors includedelinquencies, volume, average size, average risk rating,technical defaults, geographic concentrations, industryconcentrations, loans and leases on the management attentionlist, experience in the credit granting functions and changes inunderwriting standards.
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         **Non-Interest Income.** Non-interest income, consistingprimarily of deposit and loan related fees as well as feesearned for trust and investment services, changes in fair valueof derivatives and net cash settlements on interest rate swaps,increased $971,000, or 29.7%, to $4.2 million for the yearended December 31, 2005 from $3.3 million for the sameperiod in 2004. The primary contributor to this increase was thegain of $973,000 on the sale from the Corporation’s 50%owned joint venture, m2. See **Note 2**to theConsolidated Financial Statements as of and for the year endedDecember 31, 2005. In addition to this, there was a$313,000 increase in trust and investments services fee incomefrom FBB’s trust and investment services area due tosuccessful efforts to increase assets under management. Moneytransferred in from new and existing clients as well as marketappreciation contributed to the increase in trust assetsmanaged. In addition to this, there was an increase of $160,000in the income from bank-owned life insurance for the year endedDecember 31, 2005 as compared to the same period during2004 due to the purchase of additional bank-owned lifeinsurance. These increases were partially offset by decreases inservice charges on demand deposit accounts of $159,000 and adecrease in income related to derivatives of $265,000. Alsocontributing to the offset was a decrease in other non-interestincome of which $100,000 represents the Corporation’s 50%share of income attributable to m2 which was reported for theyear ended 2004.         **Non-Interest Expense.** Non-interest expense increased$1.3 million, or 9.5%, to $14.4 million for the yearended December 31, 2005 from $13.1 million in the sameperiod for 2004. A significant portion of this increase was dueto an increase of $567,000 in employee salaries and benefitsreflecting additions to staff or merit increases to$8.5 million from $7.9 million in the same period for2004. Professional and consulting fees increased $380,000 forthe year ended December 31, 2005 as compared to the sameperiod in 2004 due to additional fees associated with theCorporation’s process to register its common stock with theSecurities and Exchange Commission and increases in fees paid toDirectors. Marketing increased $109,000 as a result of loan,deposit, and general marketing campaigns. Data processingexpense increased $130,000 largely to keep pace with internalgrowth as well as overall technology in the industry. Otherexpenses increased $99,000 to $1.5 million for the yearended December 31, 2005 from $1.4 million for the sameperiod in 2004 largely due to impairment in the investment in acommunity housing project of $112,000.         **Minority Interest.** For the year ended December 31,2005 the consolidated financial statements included the accountsof FBFS and its wholly-owned subsidiaries. In 2004, theconsolidated financial statements also included the 51% share ofBBG prior to the acquisition of all of the minority interests inBBG shares effective June 1, 2004. Minority interest in netincome of consolidated subsidiary represents the 49% minorityownership interest in BBG prior to that date, which was $9,000.         **Income Taxes.** FBFS recorded income tax expense of$2.5 million for the year ended December 31, 2005,with an effective rate of 34.0%, as compared to$3.3 million for the same period in 2004, with an effectiverate of 43.3%. The higher than expected effective rate in 2004is the result of an accrual made in 2004 related to tax exposureassociated with the Wisconsin Department of Revenue (the“Department”) audits of Wisconsin financialinstitutions, like First Business Bank, which formed investmentsubsidiaries located outside of Wisconsin. See **Note 15**to the Consolidated Financial Statements.         Also contributing to the reduction in the effective tax rateduring the year ended December 31, 2005 was an increase inthe amount of non-taxable income from bank-owned life insuranceof $160,000 in comparison to the same period in 2004.*Comparison of Years Ended December 31, 2004 and 2003*         **General.** Net income decreased $1.4 million to$4.2 million in fiscal 2004 from $5.6 million in thesame period of 2003. 2003 included a non-cash gain of$1.3 million related to the change in fair value during2003 of the written option held by BBG’s minority interestshareholders. (See **Note 19**to the ConsolidatedFinancial Statements.) The decrease in net income is related toa $2.4 million increase in income tax expense principallyresulting from an increase in income before tax and a change inestimate for certain tax exposure items. In 2003, the lowereffective tax rate was attributable to the reversal of avaluation reserve against net deferred tax assets previouslyestablished for net operating losses incurred by BBG. Inaddition to this net increase from the prior year’s taxes,non-interest expense
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increased $1.7 million and non-interest income decreased$321,000. These components that caused a decrease in net incomewere partially offset by increases in net interest income of $1.6 million, a $740,000 reduction in the provision for loanand lease losses and a decrease in minority interest in netincome of consolidated subsidiary of $732,000. The returns onaverage assets and average stockholders’ equity for fiscal2004 were 0.79% and 13.81%, respectively, as compared to 1.14%and 24.09%, respectively, for the same period in 2003.         **Net Interest Income.** Net interest income increased$1.5 million, or 10. 0%, to $16.8 million for fiscal2004 from $15.3 million for the same period in 2003. Theimprovement in net interest income was due to an increase inaverage earning assets accompanied by an increased net interestmargin. Net interest margin increased from 3.21% in fiscal 2003to 3.25% in the same period of 2004. This was because thedecrease in yields paid on interest-bearing liabilities wasgreater than the decrease in yields earned on interest-bearingassets. This was also reflected in the increase in the interestrate spread from 2.88% in 2003 to 2.93% in 2004.         Interest income on total interest-earning assets increased$1.1 million to $28.1 million in fiscal 2004 from$27.0 million in 2003. In particular, interest income onloans and leases increased $640,000 to $25.9 million infiscal 2004 from $25.2 million in the same period of 2003due to an increase in average loans and leases outstanding of$30.1 million, or 7.1%, offset by a decrease in averageyields earned on loans and leases from 5.96% to 5.70% caused bya decline in market rates. Also contributing to the increase wasan increase in income on mortgage related securities of $610,000from $1.3 million in 2003 to $1.9 million in 2004.This increase was due to an increase in the average balance ofmortgage related securities of $13.6 million from$43.5 million in 2003 to $57.1 million in 2004accompanied by an increase in average yields on such securitiesfrom 3.03% in 2003 to 3.38% in 2004.         The average balance of loans increased in all categories. Totalaverage mortgage loan growth amounted to $17.9 million, or6.4%, which was driven largely by growth in commercial realestate and construction loans. Commercial loans grew$9.9 million, or 8.3%, while leases grew $1.5 millionor 6.2%. Consumer loans grew $848,000. The rate of growth incommercial real estate, construction and commercial loans haslargely been the result of attracting new clients in theBanks’ two principal markets. Existing borrowers aresuccessfully managing their businesses through the slowereconomic conditions and using cash flow to pay down loanbalances. The healthy cash flow of the underlying client basethat has resulted in such pay downs of loan balances hascontributed to the improvement in nonperforming loans.         The growth in the average balance of mortgage-related securitiesfrom 2003 to 2004 represented a replacement of investmentsecurities stemming from a drop in such securities from 2003 to2002, due to prepayments during that period, as mortgage ratesfell. It is the Corporation’s policy to diversify assetsand part of that diversification includes an investmentportfolio that is at least 10.0% of total assets. Asmortgage-related security prepayments increased during the priorperiod, the amortization of the premiums associated with thosesecurities was accelerated. This contributed to a lower yield inmortgage-related securities in 2003 as compared to 2004.         Interest expense on interest-bearing liabilities decreased$427,000 to $11.3 million in fiscal 2004 from$11.7 million in 2003 primarily due to a $331,000 decreasein interest expense on deposits with the weighted average ratedecreasing from 2.58% to 2.34%. The decrease in interest expensewas largely due to repricing opportunities on deposits whichwere partially offset by an increase in average interest-bearingdeposits of $26.1 million or 6.8% from $385.9 millionin 2003 to $412.0 million in 2004. This increase waslargely a result of growth in average certificates of deposit of$28.4 million from $224.4 million in 2003 to$252.8 million in 2004, primarily acquired through depositbrokers. The average balance of FHLB advances, used as anothersource of funding, increased $4.3 million from$18.5 million in 2003 to $22. 8 million in 2004, or23.1%, while the average cost of such advances declined to 1.91%in 2004 from 3.13% in 2003.         **Provision for Loan and Lease Losses.** The provision forloan and lease losses decreased $740,000 from $200,000 forfiscal 2003 to a negative provision of $540,000 for the sameperiod in 2004. The primary reason for the negative provisionwas a reduction in classified loan balances and a reduction inspecific reserves for impaired and substandard loans and leases.This net reduction is a result of an improvement of $829,000 inthe values of collateral versus carrying value of a loan to aninjection
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moldings manufacturer and two leases (one to a tool and diemanufacturer and the other to a metal stamping manufacturer),partially offset by a $165,000 increase in specific reserve on acommercial loan to a manufacturer of plastic injection moldings.Also contributing to the decrease in provision were netrecoveries in 2004 of $104,000 and a reduction in reservesallocated to impaired loans and leases. Contributing to thereduction in the allowance is management’s regular reviewof the loan and lease loss methodology including incorporatinghistorical charge-off migration analysis and an analysis of thecurrent level and trend of several factors that managementbelieves provides an indication of losses in the loan and leaseportfolio. These factors include delinquencies, volume, averagesize, average risk rating, technical defaults, geographicconcentrations, industry concentrations, loans and leases on themanagement attention list, experience in the credit grantingfunctions and changes in underwriting standards. This changeresulted in an overall reduction in the allowance for loan andlease reserve of $295,000. Offsetting the factors mentionedabove was the growth in the loan and lease portfolio requiring aprovision for loan and lease losses of $523,000.         **Non-Interest Income.** Non-interest income, consistingprimarily of deposit and loan related fees, fees earned fortrust and investment services and interest rate swap changes infair value and net cash settlements, decreased $298,000, or8.4%, to $3.3 million for fiscal 2004 from$3.6 million in the same period of 2003. The largestcontributor to this decrease was a $1.4 million decrease inincome relating to the year-end valuation of the conversionoptions issued in 2000 to the minority shareholders of BBG. Forfurther discussion of the written option, see **Note 19**to the Consolidated Financial Statements. Other contributingfactors included an increase in the gain recognized for thechange in fair value of interest rate swaps of $691,000partially offset by an increase in the net cash settlementexpense of interest rate swaps of $176,000. In addition to this,there was a $31,000 decrease in service charges on deposits dueto changes in interest rates. Offsetting these decreases was anincrease of $256,000 in trust and investment services fee incomefrom FBB’s trust services area due to successful efforts toincrease assets under management. Money transferred in from newand existing clients as well as market appreciation contributedto the increase in assets. Sales activity and account retentionwere positive in 2004. Another source of increased income was anincrease of $169,000 in loan fees stemming from loan growth andactivity. Non-interest income also increased $92,000 from 2003to 2004 due to income from the increase in cash surrender valueof bank owned life insurance. Equity in earnings of theBank’s 50% owned joint venture, m2, increased $46,000.Credit, merchant and debit card fees increased $8,000.         **Non-Interest Expense.** Non-interest expense increased$1.7 million, or 15. 0%, to $13.1 million in fiscal2004 from $11.4 million in the same period for 2003. Asignificant portion of this increase was due to an increase of$990,000 in employee salaries and benefits reflecting additionsto staff combined with annual merit increases. Other expensesincreased $169,000 from $1.2 million in 2003 to$1.4 million in 2004 largely due to computer softwareexpenses resulting from increased technology and informationprotection needs and also from increased recruitment expense asthe organization met increased staffing needs. Professional andconsulting fees increased $183,000 associated with theCorporation’s process to become a publicly registeredcompany and other fees associated with additional consultingnecessary due to regulatory changes such as Sarbanes-Oxley.Marketing increased $105,000 as a result of loan, deposit, andgeneral marketing campaigns. The remainder of the increase isattributable to increases in occupancy of $125,000, equipment of$63,000, and data processing of $80,000. These increases wereoffset by a decrease in collection fees of $73,000 associatedwith a return to a more acceptable level of delinquency andcharge-off activity in the loan and lease portfolio.         **Minority Interest.** The consolidated financialstatements for the year ended December 31, 2004 includedthe accounts of FBFS, its wholly-owned subsidiaries and its 51%share of BBG prior to the acquisition of all of the minorityinterests in BBG shares effective June 1, 2004. Minorityinterest in net income of consolidated subsidiary represents the49% minority ownership interest in BBG which was eliminated fromthe consolidated results of operations of FBFS. Net income forBBG for the first five months of 2004, until the minorityinterests were eliminated through the conversion option, was$19,000, $9,000 of which represents the minority interest in netincome of the consolidated subsidiary. For the year endedDecember 31, 2003, BBG reported net income of$1.1 million with minority interest of $741,000 eliminatedfrom the results of operations of FBFS.         **Income Taxes.** FBFS recorded income tax expense of$3.3 million for the year ended 2004, an effective rate of43.3%, as compared to $873,000 for the same period in 2003, aneffective rate of 13.4%.
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This represents an increase of $2.4 million principallyresulting from an increase in income before tax and a change inestimate for certain tax exposure items in 2004. The higher thanexpected effective rate in 2004 is a result of an accrual madein 2004 related to tax exposure items. The lower than expectedrate in 2003 was attributable to the reversal in 2003 of avaluation allowance against net deferred tax assets establishedin 2002 for net operating losses at BBG. For a discussion of thetax exposure items, see **“Income Taxes”**under**“Recent Developments”**in this section and**Note 15**to the Consolidated Financial Statements.
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**Net Interest Income Information**         **Average Interest-Earning Assets, Average Interest BearingLiabilities, Interest Rate Spread, and Net Interest Margin.**The following tables show the Corporation’s averagebalances, average rates, the spread between combined averagerates earned on the Corporation’s interest-earning assetsand interest-bearing liabilities and the net interest margin forthe years ended December 31, 2005, 2004 and 2003.                                        **Year Ended December 31,**     **2005** **2004** **2003**       **Average**   **Average**   **Average**  **Average**   **Yield/** **Average**   **Yield/** **Average**   **Yield/**  **Balance** **Interest** **Cost** **Balance** **Interest** **Cost** **Balance** **Interest** **Cost**                     (Dollars in Thousands)**Interest-Earning Assets**                                        Mortgage    loans(2) $328,959  $20,663   6.28% $296,078  $15,890   5.37% $278,181  $15,812   5.68%    Commercial loans  143,007   11,167   7.81   129,164   8,346   6.46   119,301   7,719   6.47     Leases  21,674   1,149   5.30   25,030   1,481   5.92   23,577   1,588   6.74     Consumer loans  2,727   163   5.98   3,206   144   4.49   2,358   102   4.33                                 Total loans and leases    receivable(1)  496,367   33,142   6.68   453,478   25,861   5.70   423,417   25,221   5.96     Mortgage-related    securities(2)  82,305   3,050   3.71   57,134   1,929   3.38   43,519   1,319   3.03     Investment    securities(2)  4,610   142   3.08   5,959   195   3.27   7,994   299   3.74     Federal Home Loan Bank stock  2,830   138   4.88   2,494   146   5.85   2,221   139   6.26     Fed funds sold and other  1,265   36   2.85   254   4   1.57   1,046   27   2.58     Interest bearing deposits  41   1   2.44   55   1   1.43   37   0   0.81                                  Total interest-earning assets  587,418   36,509   6.22   519,374   28,136   5.42   478,234   27,005   5.65     Non-interest-earning assets  22,866           17,844           15,753                                         Total assets $610,284          $537,218          $493,987                                     **Interest-Bearing Liabilities**                                        NOW accounts $49,114  $1,402   2.85  $43,233  $500   1.16  $45,516  $474   1.04     Money market  114,653   3,549   3.10   75,137   1,004   1.34   74,758   1,345   1.80     Certificates – regular  276,174   10,304   3.73   252,780   7,352   2.91   224,381   7,250   3.23     Certificates – large  43,360   1,387   3.20   40,827   782   1.92   41,267   900   2.18                                  Total deposits  483,301   16,642   3.44   411,977   9,638   2.34   385,922   9,969   2.58     Junior subordinated debentures  10,310   946   9.18   10,310   893   8.66   10,000   883   8.83     FHLB advances  11,427   419   3.67   22,807   436   1.91   18,529   580   3.13     Other borrowings  16,359   726   4.44   7,896   306   3.88   7,663   245   3.20                                  Total interest-bearing liabilities  521,397   18,733   3.59   452,990   11,273   2.49   422,114   11,677   2.77     Non-interest-bearing liabilities  48,518           51,613           44,699                                          Total liabilities  569,915           504,603           466,813             Minority interest in consolidated subsidiary  -           1,775           3,724             Stockholders’ equity  40,369           30,840           23,450                                          Total liabilities and Stockholders’ equity $610,284          $537,218          $493,987                                         Net interest income/interest rate spread     $17,776   2.62%     $16,863   2.93%     $15,328   2.88%                                Net interest-earning assets $66,021          $66,384          $56,120                                         Net interest margin          3.03%          3.25%          3.21%                                Ratio of average interest-earning assets to average    interest-earning liabilities  1.13           1.15           1.13                                         Return on average assets  0.78%          0.79%          1.14%                                        Return on average equity  11.79%          13.81%          24.09%                                        Average equity to average assets  6.61%          5.74%          4.75%                                        Non-interest expense to average assets  2.36%          2.45%          2.31%                                     (1)     The average balances of loans and leases include non-performing    loans and leases, interest of which is recognized on a cash    basis.(2)     Includes amortized cost basis of assets held and available for    sale.
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**Rate/Volume Analysis**         The Corporation’s net interest income between periods isderived from the interaction of changes in the volume of andrates earned or paid on interest-earning assets andinterest-bearing liabilities. The dollar volume of loans, leasesand investments compared to the dollar volume of deposits andborrowings, combined with the interest rate spread, produces thechanges in net interest income between periods. The followingtables show the relative contribution of the changes in averagevolume and average interest rates on changes in net interestincome for the years ended December 31, 2005, 2004, and2003. Information is provided with respect to (i) theeffect on interest income attributable to changes in rate(changes in rate multiplied by prior volume), (ii) theeffect on interest income attributable to changes in volume(changes in volume multiplied by prior rate) and (iii) thechanges in rate/volume (changes in rate multiplied by changes involume).                                   **Increase (Decrease) for the Year Ended December 31,**     **2005 Compared To 2004** **2004 Compared To 2003**         **Rate/**     **Rate/**    **Rate** **Volume** **Volume** **Net** **Rate** **Volume** **Volume** **Net**                   (In Thousands)**Interest-Earning Assets**                                    Mortgage loans $2,706  $1,765  $301  $4,772  $(881) $1,017  $(57) $79     Commercial loans  1,741   894   187   2,822   (10)  638   (1)  627     Leases  (154)  (199)  21   (332)  (193)  98   (12)  (107)    Consumer loans  48   (22)  (7)  19   4   37   1   42                              Total loans and leases receivable  4,341   2,438   502   7,281   (1,080)  1,790   (69)  641     Mortgage-related securities  188   850   83   1,121   150   413   47   610     Investment securities  (12)  (44)  3   (53)  (38)  (76)  10   (104)    Other investments  (25)  20   (3)  (8)  (9)  17   (1)  7     Fed funds sold  3   16   13   32   (11)  (20)  8   (23)    Interest bearing deposits  -   -   -   -   -   -   -   -                              Total net change in income on interest-earning assets  4,495   3,280   598   8,373   (988)  2,124   (5)  1,131                           **Interest-Bearing Liabilities**                                    NOW accounts  733   68   100   902   53   (24)  (3)  26     Money market  1,322   528   695   2,545   (346)  7   (2)  (341)    Certificates – regular  2,080   680   192   2,952   (724)  918   (92)  102     Certificates – large  523   49   33   605   (109)  (10)  1   (118)                             Total deposits  4,658   1,325   1,020   7,004   (1,126)  891   (96)  (331)    Junior subordinated debentures  53   -   -   53   -   -   -   -     Guaranteed trust preferred securities  -   -   -   -   (16)  27   (1)  10     FHLB advances  401   (218)  (200)  (17)  (226)  134   (52)  (144)    Other borrowings  44   328   48   420   52   7   2   61                              Total net change in expense on interest-bearing liabilities  5,157   1,435   868   7,460   (1,316)  1,059   (147)  (404)                             Net change in net interest income $(662) $1,845  $(270) $913  $328  $1,065  $142  $1,535                          
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**Financial Condition***December 31, 2005*         **General.** The total assets of FBFS increased$106.2 million, or 18.9%, to $669.2 million atDecember 31, 2005 from $563.0 million atDecember 31, 2004. This increase was funded primarily bynet increases in deposits of $92.8 million. This growth isgenerally invested in securities and loans and leases receivable.         **Securities.** Securities available-for-sale increased$28.7 million to $95. 1 million at December 31,2005 from $66.4 at December 31, 2004 as a net result ofpurchases of $56.8 million net of maturities of$26.5 million during the year. Mortgage-related securitiesconsisted largely of agency-backed mortgage-derivativesecurities in the form of REMICS.         **Loans and Leases Receivable.** Total net loans and leasesincreased $62.8 million to $532.7 million atDecember 31, 2005 from $469.9 million atDecember 31, 2004. The activity in the loan and leaseportfolio consisted of originations of $201.6 million andpurchases of $20.3 million offset by principal repaymentsof $158.0 million, sales of $998,000 and an increase in theallowance for loan and lease losses of $398,000. Deferred loanfees declined from $310,000 to $241,000 from December 31,2004 to December 31, 2005. The primary reason for thedecrease in deferred loan fees was a decrease in loansoriginated in the Corporation’s asset-based lendingsubsidiary from the prior year ended December 31, 2004 tothe year ended December 31, 2005 accompanied by increasedpayoff activity in the prior year as compared to the year endedDecember 31, 2005. The increased payoff activity in theprior period resulted in accelerated deferred loan feeamortization for those loans that were paid off.         **Non-performing Assets.** Non-performing assets consists ofnon-accrual loans and leases of $1.5 million as ofDecember 31, 2005, or 0.23% of total assets, as compared to$2.9 million, or 0.52% of total assets, as ofDecember 31, 2004. This represents a decrease of$1.4 million in non-performing assets largely due to thereceipt of payment in full for a non-accrual lease which had acarrying value of $1.1 million as of December 31,2004, and the sale of foreclosed property that had a carryingvalue of $665,000. An immaterial gain was recognized on the saleof the property. Partially offsetting this decrease is anincrease in non-accrual loans primarily due to two loans, one toa plumbing, heating and air conditioning company with a netcarrying value totaling $200,000 and the second to a wholesalefood broker with a net carrying value totaling $462,000 as ofDecember 30, 2005.**Lending Activities**         **General.** At December 31, 2005, net loans and leasestotaled $532.7 million, representing approximately 79.6% of$669.2 million in total assets at that date. Approximately$348.4 million or 64.6% of the Banks’ gross loans andleases, at December 31, 2005 were secured by first orsecond-liens on real estate. An additional $8.2 million ofhome equity and second mortgage loans which are classified asconsumer loans are also secured by real estate.         While the Banks endeavor to make commercial, industrial,commercial real estate and consumer loans, the majority of theBanks’ loans are commercial real estate loans secured byproperties located primarily in Dane and Waukesha counties andsurrounding communities in Wisconsin. In order to increase theyield, minimize interest rate sensitivity, and diversify therisk of their portfolios, the Banks also originate construction,multi-family, commercial, industrial and consumer loans.         Non-real estate loans originated by the Banks consist of avariety of commercial and asset-based loans and leases as wellas a small amount of consumer loans. At December 31, 2005,the Banks’ gross loans and leases included$169.5 million of commercial loans and leases, or 31.4% ofthe total, and $13.6 million of consumer loans, or 2.5% ofthe total.
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         **Loan Portfolio Composition.** The following table presentsinformation concerning the composition of the Banks’consolidated loans and leases held for investment at the datesindicated.                                           **December 31,**     **2005** **2004** **2003** **2002** **2001**               **Percent**   **Percent**   **Percent**   **Percent**   **Percent**  **Amount** **of Total** **Amount** **of Total** **Amount** **of Total** **Amount** **of Total** **Amount** **of Total**                       (Dollars in Thousands)    Mortgage loans:                                            Commercial real estate $249,133   46.16% $215,605   45.25% $210,708   47.86% $195,634   47.13% $147,870   41.41%    Construction  50,619   9.38   41,910   8.80   38,621   8.77   35,858   8.64   30,808   8.63     Multi-family  22,115   4.10   17,786   3.73   19,005   4.32   18,327   4.42   15,394   4.31     1-4 family  26,513   4.91   22,814   4.79   17,070   3.88   11,796   2.84   12,551   3.51                                    Total mortgage loans  348,380   64.55   298,115   62.57   285,404   64.83   261,615   63.02   206,623   57.86                                    Commercial loans and leases:                                            Commercial  102,482   18.99   93,041   19.53   87,012   19.77   86,883   20.93   92,747   25.97     Asset-based  49,206   9.12   43,441   9.12   32,254   7.33   34,844   8.39   22,681   6.35     Direct financing leases, net  17,852   3.31   25,583   5.37   22,955   5.21   22,658   5.46   21,920   6.14                                    Total commercial loans and leases  169,540   31.41   162,065   34.01   142,221   32.31   144,385   34.78   137,348   38.46                                    Consumer loans:                                            Home equity and second mortgage  8,231   1.53   5,563   1.17   5,558   1.26   3,734   0.90   3,488   0.98     Credit card  560   0.10   580   0.12   605   0.14   663   0.16   637   0.18     Personal  860   0.16   884   0.19   1,834   0.42   1,225   0.30   1,974   0.55     Other  12,159   2.25   9,279   1.95   4,600   1.04   3,480   0.84   7,032   1.97                                    Total consumer loans  21,810   4.04   16,306   3.42   12,597   2.86   9,102   2.19   13,131   3.68                                    Gross loans and leases receivable  539,730   100.00%  476,486   100.00%  440,222   100.00%  415,102   100.00%  357,102   100.00%    Contras to loans and leases:                                            Allowance for loan and lease losses  (6,773)      (6,375)      (6,811)      (5,875)      (5,523)        Deferred loan fees  (241)      (310)      (306)      -       -                                        Loan and lease receivables, net $532,716      $469,801      $433,105      $409,227      $351,579                                             The following table shows the scheduled contractual maturitiesof the Banks’ consolidated gross loans and leases held forinvestment, as well as the dollar amount of such loans andleases which are scheduled to mature after one year which havefixed or adjustable interest rates, as of December 31, 2005.                              **Asset-based** **Consumer**  **Commercial Real** **Commercial** **Construction and** **and Lease** **and 1-4**  **Estate Loans** **Loans** **Multi-family** **Receivables** **Family**             (In Thousands)    Amounts due:                        In one year or less $48,009  $65,452  $35,380  $27,943  $31,238      After one year through five years  160,815   29,907   31,809   33,403   16,899      After five years  40,309   7,123   5,545   5,711   186                   $249,133  $102,482  $72,734  $67,058  $48,323                     Interest rate terms on amounts due after one year:                        Fixed $159,613  $27,591  $20,243  $15,143  $12,162                     Adjustable $41,511  $9,439  $17,111  $23,971  $4,922                          **Commercial Real Estate and Construction Loans.** The Banksoriginate commercial real estate loans which have fixed oradjustable rates and terms of generally up to five years and
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amortizations of twenty years on existing commercial real estateand twenty-five years on new construction. Loans secured bycommercial real estate consist of commercial owner-occupiedproperties as well as investment properties. AtDecember 31, 2005, the Banks had $249.1 million ofloans secured by commercial real estate. This represented 46.2%of the Banks’ gross loans and leases. Approximately$105.1 million of the commercial real estate loans areowner-occupied properties which represents 30.2% of all loanssecured by real estate.         The Banks originate loans to construct commercial properties. AtDecember 31, 2005, construction loans amounted to$50.6 million, or 9.4% of the Banks’ gross loans andleases. The Banks’ construction loans generally have termsof six to twelve months with adjustable interest rates and feeswhich are due at the time of origination. Loan proceeds aredisbursed in increments as construction progresses and asinspections by title companies’ warrant.         **Multi-family Loans.** The Banks also originate multi-familyloans that amounted to $22.1 million at December 31,2005, or 4.1% of gross loans and leases. These loans areprimarily secured by apartment buildings and are mainly locatedin Dane County.         **1-4 Family Loans.** The Banks have a small amount of1 – 4 family loans which totaled $26.5 million atDecember 31, 2005 or 4.9% of gross loans and leases. Theseloans are primarily secured by single family homes and held forinvestment by clients.         **Commercial Loans.** At December 31, 2005, commercialloans amounted to $102.5 million or 19.0% of gross loansand leases. The Banks’ commercial loan portfolio iscomprised of loans for a variety of purposes and generally issecured by inventory, accounts receivable, equipment, machineryand other corporate assets. Commercial loans generally haveterms of five years or less and interest rates that float inaccordance with a designated published index or fixed rates withtypical amortization of four to seven years. Most accountsreceivable advances do not exceed 65% of receivables less than90 days past due from invoices; however this may beincreased to 75% if the Banks receive a borrower’scertificate and accounts receivable aging on a quarterly or morefrequent basis. Advances on raw material and finished goodsinventory generally do not exceed 50% and advances on machineryand equipment typically do not exceed 65% of net book value.Advances on new equipment and new vehicles generally do notexceed 80% of cost. Substantially all of such loans are securedand backed by personal guarantees of the owners of the borrowingbusiness.         **Asset-Based Loans.** Asset-based loans are originatedthrough FBCC, the asset based lending subsidiary, and aretypically secured by accounts receivable, inventories, equipmentand/or real estate. The asset-based loans secured by accountsreceivable and inventories amounted to $49.2 million as ofDecember 31, 2005. This represented 9.1% of gross loans andleases. Because asset-based borrowers are usually highlyleveraged, such loans have higher interest rates and feesaccompanied by close monitoring of assets. The receivableadvance rate is determined by a number of factors includingconcentrations of business with clients, amount of dilution andthe credit quality of the client base. The controls includedominion over all cash receipts of the borrowers either througha lockbox collection service or cash collateral account. Theaccounts receivable borrowing bases are updated daily.Eligibility of accounts receivable and inventories is based onrestrictive requirements designed to exclude low-quality ordisputed receivables and low-quality, slow moving or obsoleteinventories. FBCC monitors adherence to these requirements byupdating the borrowing base daily and conducting periodicon-site audits of allborrowers including assessing the quality of the collateral, anddetermining the financial operating trends of those borrowers.Asset-based loans secured by real estate amounted to$9.4 million as of December 31, 2005.         **Leases.** Leases are originated through FBL (the“Leasing Company”) and amounted to $17.9 millionas of December 31, 2005 and represented 3.3% of gross loansand leases. Such leases are generally secured by equipment andmachinery located principally in Wisconsin. While$6.8 million or 38.1% of the leases are to printingbusinesses, this does not constitute a concentration whencompared to the loan and lease portfolio as a whole. Leases aretypically originated with a fixed rate and a term of seven yearsor less. It is customary in the leasing industry to provide 100%financing, however, the Leasing Company will, fromtime-to-time, require adown payment or lease deposit to provide a credit enhancement.All equipment leases must have an additional insured endorsementand a loss payable
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clause in the interest of the Leasing Company and must carrysufficient physical damage and liability insurance.         The Leasing Company leases machinery and equipment to clientsunder leases which qualify as direct financing leases forfinancial reporting and as operating leases for income taxpurposes. Under the direct financing method of accounting, theminimum lease payments to be received under the lease contract,together with the estimated unguaranteed residual value(approximating 3 to 15% of the property cost of the relatedequipment), are recorded as lease receivables when the lease issigned and the lease property is delivered to the client. Theexcess of the minimum lease payments and residual values overthe cost of the equipment is recorded as unearned lease income.Unearned lease income is recognized over the term of the leaseon a basis which results in an approximate level rate of returnon the unrecovered lease investment. Lease payments are recordedwhen due under the lease contract. Residual value is theestimated fair market value of the equipment on lease at leasetermination. In estimating the equipment’s fair value, theLeasing Company relies on historical experience by equipmenttype and manufacturer, published sources of used equipmentpricing, internal appraisals and, where available, valuations byindependent appraisers, adjusted for known trends. The LeasingCompany’s estimates are reviewed continuously to ensurereasonableness; however, the amounts the Leasing Company willultimately realize could differ from the estimated amounts. Themajority of the equipment is leased to businesses in theprinting, (38.1%), manufacturing (27.4%) and construction(10.6%) industries as of December 31, 2005.         **Consumer Loans.** The Banks originate a small amount ofconsumer loans. Such loans amounted to $21.8 million atDecember 31, 2005 and consist of home equity and secondmortgages and credit card and other personal loans forprofessional and executive clients of the Banks. Generally, themaximum loan to value on home equity loans is 80% with proof ofproperty value required and annual personal financial statementsafter the initial loan application. The maximum loan to value onnew automobiles and trucks is 80%. These loans represented 4.0%of the Banks’ gross loans and leases at December 31,2005.         **Net Fee Income from Lending Activities.** Loan and leaseorigination and commitment fees and certain direct loan andlease origination costs are deferred and the net amounts areamortized as an adjustment to the related loan and lease yields.         The Banks also receive other fees and charges relating toexisting loans, which include prepayment penalties, loanmonitoring fees, late charges and fees collected in connectionwith loan modifications.         **Loan and Lease Delinquencies.** Loans and leases are placedon non-accrual status when, in the judgment of management, theprobability of collection of interest is deemed to beinsufficient to warrant further accrual. Previously accrued butunpaid interest is deducted from interest income at that time.As a matter of policy, the Banks do not accrue interest on loansor leases past due beyond 90 days.         The following table sets forth information relating todelinquent loans and leases at the dates indicated.                                            **December 31,**     **2005** **2004** **2003** **2002** **2001**               **% of**   **% of**   **% of**   **% of**   **% of**    **Gross**   **Gross**   **Gross**   **Gross**   **Gross**    **Loans and**   **Loans and**   **Loans and**   **Loans and**   **Loans and****Days Past Due** **Balance** **Leases** **Balance** **Leases** **Balance** **Leases** **Balance** **Leases** **Balance** **Leases**                       (Dollars in Thousands)    30 to 59 days $389   0.07% $230   0.05% $96   0.02% $514   0.12% $-   0.00%    60 to 89 days  99   0.02   2   0.00   -   0.00   230   0.06   -   0.00     90 days and over  721   0.13   -   0.00   14   0.00   -   0.00   -   0.00                                     Total $1,209   0.22% $232   0.06% $110   0.02% $744   0.18% $-   0.00%                                        **Non-performing Assets and Impaired Loans and Leases.**Non-performing assets consists of non-accrual loans and leasesof $1.5 million as of December 31, 2005, or 0.23% oftotal assets, as compared to $2.9 million, or 0.52% oftotal assets, as of December 31, 2004. This represents adecrease of $1.4 million in non-performing assets. Thedecrease was largely due to the receipt of payment in full
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for a non-accrual lease which had a carrying value of$1.1 million as of December 31, 2004 and the sale offoreclosed property that had a carrying value of $665,000. Thesedecreases were partially offset by an increase in non-accrualloans of $758,000 primarily due to two loans, one to a plumbing,heating and air conditioning company with a net carrying valueof $200,000 and the second to a wholesale food broker with a netcarrying value of $462,000 as of December 31, 2005. It isanticipated that through successful liquidation of assetscollateralizing the loan to the wholesale food broker the Bankwill be made substantially whole. As of December 31, 2005,the Corporation does not anticipate any loss from eitherborrower.                        **Year Ended December 31,**     **2005** **2004** **2003** **2002** **2001**             (Dollars in Thousands)    Non-accrual loans $1,454  $696  $891  $3,049  $1,440     Non-accrual leases  90   1,566   717   -   -                      Total non-accrual loans and leases  1,544   2,262   1,608   3,049   1,440     Foreclosed properties and repossessed assets, net  -   665   708   -   -                     Total non-performing assets $1,544  $2,927  $2,316  $3,049  $1,440                     Performing troubled debt restructurings $-  $-  $-  $-  $-                     Total non-accrual loans and leases to total loans and leases  0.29%  0.47%  0.37%  0.73%  0.40%    Total non-performing assets to total assets  0.23   0.52   0.45   0.64   0.35     Allowance for loan and lease losses to total loans and leases  1.25   1.34   1.55   1.42   1.55     Allowance for loan and lease losses to non-accrual loans and    leases  438.64   281.83   423.57   192.69   383.54          A loan or lease is considered impaired if, based upon currentinformation and events, it is probable that we will be unable tocollect the scheduled payments of principal and interest whendue according to the contractual terms of the loan or leaseagreement. Certain homogeneous loans, including residentialmortgage and consumer loans, are collectively evaluated forimpairment, and therefore, do not have individual credit riskratings and are excluded from impaired loans. Impaired loansinclude all nonaccrual loans as well as certain accruing loansjudged to have higher risk of noncompliance with the presentcontractual repayment schedule for both interest and principal.Once a loan has been determined to be impaired, it is measuredto establish the amount of the impairment. While impaired loansexhibit weaknesses that inhibit repayment in compliance with theoriginal note terms, the measurement of impairment may notalways result in an allowance for loan loss for every impairedloan. The amount in the allowance for loan losses for impairedloans is based on the present value of expected future cashflows discounted at the loan’s effective interest rate,except that collateral-dependent loans may be measured forimpairment based on the fair value of the collateral, net ofcost to sell.         Information about impaired loans at or for the years endedDecember 31, 2005, 2004 and 2003 is as follows:                **As of December 31,**     **2005** **2004** **2003**         (In Thousands)    Impaired loans and leases with impairment reserves required $1,544  $2,262  $2,100     Less:                 Impairment reserve (included in allowance for loan and lease    losses)  399   470   935               Net impaired loans and leases $1,145  $1,792  $1,165               Average impaired loans and leases $2,192  $2,112  $2,408     Interest income attributable to impaired loans and leases  112   177   367     Interest income recognized on impaired loans and leases  65   85   45 
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         The amount of foregone interest for the years endedDecember 31, 2005, 2004 and 2003 was $47,000, $92,000 and$322,000, respectively.         **Allowance for Loan and LeaseLosses.**  Management regularly reviews and revisesits methodology to provide greater precision in its assessmentof risks in the loan and lease portfolio and related evaluationof adequate allowance for loan and lease losses by incorporatinghistorical charge-off migration analysis and an analysis of thecurrent level and trend of factors felt indicative of loan andlease quality. The historical charge-off migration analysisutilizes the most recent five years of net charge-offs andtraces the migration of the risk rating from origination throughcharge-off. The historical percentage of the amounts charged-offfor each risk rating, for each subsidiary is averaged for thefive year period giving greater weight in the calculation to therecent years. These percentages are then applied to the currentloan and lease portfolio for this portion of the Allowance forLoan and Lease Losses. The other factors consider the risksinherent in the mix of the portfolio reflective of the weightingtoward commercial and commercial real estate lending. The loanand lease portfolio is examined for any material concentrationsand additional reserves have been established in an amount that,based on the experience of senior management, is adequate tocover concentration risk. These reserves are increased on a prorata basis as the loan and lease portfolio grows. As a result ofthis review process, the improved historical trends innon-performing loans and charge-offs, and the improvement incollateral value of three loans and leases, the provisiondecreased $740,000 from $200,000 in 2003 to a negative $540,000in 2004 and resulted in the allowance for loan and lease lossesas a percent of total loans to decrease from 1.55% to 1.34%. Therelative improvement in the collateral value versus the carryingvalue was primarily due to updated appraisals from vendors thathave experience in valuing the type of collateral combined withthe continuation of payments which further reduced the carryingvalue of the loan and leases. As of December 31, 2005, theallowance for loan and lease losses has increased $398,000 dueto increased loan volume offset by a decrease in non-accrualloans and leases. The evaluation process focuses on severalfactors including, but not limited to, management’s ongoingreview and risk rating of the portfolio, with particularattention paid to loans and leases identified by management asimpaired and to potential impaired loans and leases based uponhistorical trends and ratios, the fair value of the underlyingcollateral, historical losses, changes in the size of theportfolio, trends in the level of delinquencies, concentrationsof loans and leases to specific borrowers or industries andother factors which could affect potential credit losses.         To determine the level and composition of the allowance for loanand lease losses the portfolio is broken out by categories andrisk ratings. Impaired loans and leases and potential impairedloans and leases are evaluated for a specific reserve based uponthe estimated value of the underlying collateral forcollateral-dependent loans, or alternatively, the present valueof expected cash flows. Historical trends of the identifiedfactors are applied to each category of loans that have not beenspecifically evaluated for the purpose of establishing thegeneral reserve.         The Corporation reviews its methodology and periodically adjustsits allocation percentages based upon historical results. Withinthe specific categories certain loans or leases have beenidentified for specific reserve allocations as well as the wholecategory of that loan type or lease being reviewed for a generalreserve based on the foregoing analysis of trends and overallbalance growth within that category.         Foreclosed properties are recorded at the lower of cost or fairvalue. If, at the time of foreclosure, the fair value less costto sell is lower than the carrying value of the loan, thedifference, if any, is charged to the allowance for loan lossesprior to transfer to foreclosed property. The fair value isprimarily based on appraisals, discounted cash flow analysis(the majority of which is based on current occupancy and leaserates) and verifiable offers to purchase. After foreclosure,valuation allowances or future write-downs to fair value lesscosts to sell are charged directly to expense.
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         A summary of the activity in the allowance for loan and leaselosses follows:                        **Year Ended December 31,**     **2005** **2004** **2003** **2002** **2001**             (Dollars in Thousands)    Allowance at beginning of year $6,375  $6,811  $5,875  $5,523  $3,743     Charge-offs:                         Mortgage  -   -   -   -   (48)     Commercial  -   (25)  (37)  (2,876)  (128)     Lease  -   -   -   (480)  -      Consumer  (10)  (6)  -   (2)  -                     Total charge-offs  (10)  (31)  (37)  (3,358)  (176)    Recoveries:                         Mortgage  4   9   -   96   -      Commercial  4   4   773   -   16      Lease  -   122   -   -   -      Consumer  -   -   -   -   -                     Total recoveries  8   135   773   96   16      Net recoveries (charge-offs)  (2)  104   736   (3,262)  (160)    Provision  400   (540)  200   3,614   1,940                     Allowance at end of year $6,773  $6,375  $6,811  $5,875  $5,523                     Net recoveries (charge-offs) to average loans  (0.00)%  0.02%  0.17%  (0.84)%  (0.05)%         Loan charge-offs were $10,000 and $31,000 for the year endedDecember 31, 2005 and for the year ended December 31,2004, respectively. Recoveries for the year endedDecember 31, 2005 were $8,000 and were $135,000 for theyear ended December 31, 2004.         The table below shows the Corporation’s allocation of theallowance for loan and lease losses by loan and lease lossreserve category at the dates indicated.                                            **December 31,**     **2005** **2004** **2003** **2002** **2001**             **Allowance** **Percent of** **Allowance** **Percent of** **Allowance** **Percent of** **Allowance** **Percent of** **Allowance** **Percent of**  **for Loan** **Allowance** **for Loan** **Allowance** **for Loan** **Allowance** **for Loan** **Allowance** **for Loan** **Allowance**  **and Lease** **to Total** **and Lease** **to Total** **and Lease** **to Total** **and Lease** **to Total** **and Lease** **to Total**  **Losses** **Allowance** **Losses** **Allowance** **Losses** **Allowance** **Losses** **Allowance** **Losses** **Allowance**                       (Dollars in Thousands)    Commercial real estate $2,777   41.01% $2,787   43.72% $1,709   25.09% $1,151   19.59% $1,216   22.02%    Construction  554   8.17   461   7.23   314   4.61   189   3.22   159   2.88     Multi-family  231   3.41   187   2.93   135   1.98   134   2.28   62   1.12     1-4 family  292   4.30   311   4.88   166   2.44   71   1.21   69   1.25     Commercial  2,415   35.65   2,061   32.33   2,662   39.08   3,401   57.89   2,647   47.93     Lease receivables  268   3.96   445   6.98   887   13.02   281   4.78   392   7.10     Consumer and other  237   3.50   123   1.93   193   2.83   122   2.08   64   1.16     Unallocated  -   0.00   -   0.00   745   10.94   526   8.95   914   16.55                                     Total $6,773   100.00% $6,375   100.00% $6,811   100.00% $5,875   100.00% $5,523   100.00%                                        Although management believes the allowance for loan and leaselosses is adequate based on the current level of loandelinquencies, non-performing assets, trends in charge-offs,economic conditions and other factors as of December 31,2005, there can be no assurance that future adjustments to theallowance will not be necessary. Management adheres to highunderwriting standards in order to maintain strong asset qualityand continues to pursue practical and legal methods ofcollection, repossession and disposal of any such troubledassets.
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         **Securities.** The Banks’ Boards of Directors(“Boards”) review and approve the investment policy onan annual basis. Management, as authorized by the Boards,implements this policy. The Boards review investment activity ona monthly basis.         Investment objectives are formed to meet liquidity requirementsand generate a favorable return on investments withoutcompromising other business objectives and levels of interestrate risk and credit risk. Consideration is also given toinvestment portfolio concentrations. Federal and state charteredbanks are allowed to invest in various types of assets,including U.S. Treasury obligations, securities of variousfederal agencies, state and municipal obligations,mortgage-related securities, certain time deposits of insuredfinancial institutions, repurchase agreements, loans of federalfunds, and, subject to certain limits, corporate debt and equitysecurities, commercial paper and mutual funds. TheCorporation’s investment policy provides that it will notengage in any practice that the Federal Financial InstitutionsExamination Council considers an unsuitable investment practice.         The Banks’ investment policies allow participation inhedging strategies or the use of financial futures, options orforward commitments or interest rate swaps with prior Boardapproval. The Banks utilize derivative instruments in the courseof their asset/liability management. These derivativeinstruments are primarily interest rate swap agreements whichare used to protect against the risk of adverse price orinterest rate movements on the value of certain assets andliabilities and on future cash flows.         Securities are classified as available-for-sale,held-to-maturity andtrading. Available-for-sale securities are carried at fairvalue, with the unrealized gains and losses, net of tax,reported as a separate component of stockholder’s equity.There were no securities designated asheld-to-maturity ortrading as of December 31, 2005.         The Corporation’s investment securities includeU.S. government obligations and securities of variousfederal agencies as well as a small amount of money marketinvestments and corporate stock.         The Corporation also purchases mortgage-related securities, inparticular, agency-backed mortgage-derivative securities tosupplement loan production and to provide collateral forborrowings. Management believes that certain mortgage-derivativesecurities represent attractive alternative investments due tothe wide variety of maturity and repayment options available anddue to the limited credit risk associated with such investments.Mortgage-derivative securities include real estate mortgageinvestment conduits (“REMICS”) which are securitiesderived by reallocating cash flows from mortgage pass-throughsecurities or from pools of mortgage loans held by a trust. TheCorporation invests in mortgage-related securities which areinsured or guaranteed by FHLMC, FNMA, or GNMA, which are backedby FHLMC, FNMA, and GNMA mortgage-backed securities. Of thetotal available-for-sale mortgage-derivative securities atDecember 31, 2005, $52,316,000, $22,610,000, and$13,668,000 were insured or guaranteed by FHLMC, FNMA, and GNMA,respectively. The Corporation has noheld-to-maturitymortgage-derivative securities at December 31, 2005.         Mortgage-related securities are subject to inherent risks basedupon the future performance of the underlying collateral,mortgage loans, for these securities. Among the risks areprepayment risk, extension risk, and interest rate risk. Shouldgeneral interest rates decline, the mortgage-related securitiesportfolio would be subject to prepayments caused by borrowersseeking lower financing rates. A decline in interest rates couldalso cause a decline in interest income on adjustable-ratemortgage-related securities. Conversely, an increase in generalinterest rates could cause the mortgage-related securitiesportfolio to be subject to a longer term to maturity caused byborrowers being less likely to prepay their loans. Such a rateincrease could also cause the fair value of the mortgage-relatedsecurities portfolio to decline.         The Corporation has mortgage-backed securitiesavailable-for-sale at December 31, 2005 with a fair valueof $3,184,000. Of these securities, $1,452,000 are insured orguaranteed by FHLMC, $491,000 are insured or guaranteed by FNMAand $1,241,000 are insured by FHLB.         At December 31, 2005, $29,700,000 million of theCorporation’s mortgage-related securities were pledged tosecure various obligations of the Corporation.
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         The table below sets forth information regarding the amortizedcost and fair values of the Corporation’s investments andmortgage-related securities at the dates indicated.                           **December 31,**     **2005** **2004** **2003**         **Amortized** **Fair** **Amortized** **Fair** **Amortized** **Fair**  **Cost** **Value** **Cost** **Value** **Cost** **Value**               (In Thousands)**Securities available-for-sale**                            FHLB stock $2,898  $2,898  $2,761  $2,761  $2,302  $2,302     U.S. Treasury securities and obligations of the    U.S. Government corporations and agencies  3,264   3,184   3,275   3,253   8,095   8,152     Municipals  275   272   -   -   -   -     Collateralized mortgage obligations  90,601   88,599   60,873   60,381   53,569   53,050     Other  117   117   50   50   67   67                      $97,155  $95,070  $66,959  $66,445  $64,033  $63,571                             The following table sets forth the maturity and weighted averageyield characteristics of the Corporation’s debt securitiesat December 31, 2005, classified by term maturity. Thebalances are reflective of fair value.                               **One to Five Years** **Five to Ten Years** **Over Ten Years**               **Weighted**   **Weighted**   **Weighted**      **Average**   **Average**   **Average**    **Balance** **Yield** **Balance** **Yield** **Balance** **Yield** **Total**                 (Dollars in Thousands)**Available for sale**                                U.S. Government corporations and agencies $3,184   3.05% $-   0.00% $-   0.00% $3,184     Collateralized mortgage obligations  267   6.11   20,720   3.61   67,705   4.10   88,692                         $3,451   3.46% $20,720   3.61% $67,705   3.44% $91,876                                **Derivative Activities.** The Corporation uses derivativeinstruments, principally interest rate swaps, to protect againstthe risk of adverse price or interest rate movements on thevalue of certain assets and liabilities and on future cashflows. For further discussion on the Corporation’s interestrate risk management activities and use of derivatives, seemanagement’s discussion of critical accounting policies in**Item 8**and **Note 1**to the ConsolidatedFinancial Statements.         **Deposits.** As of December 31, 2005, depositsincreased $92.8 million to $567.5 million from$474.7 million at December 31, 2004. The increaseduring the year ended December 31, 2005 was largelyattributable to an increase in money market accounts of$50.1 million accompanied by an increase of$27.8 million in certificates of deposit and an increase of$14.9 million in transaction accounts, respectively. Theweighted average cost of deposits increased to 3.44% atDecember 31, 2005 from 2.34% at December 31, 2004.         Deposits are a major source of the Banks’ funds for lendingand other investment activities. A variety of accounts aredesigned to attract both short and long-term deposits. Theseaccounts include time deposits, money market and demanddeposits. The Banks’ deposits are obtained primarily fromDane and Waukesha Counties. At December 31, 2005,$279.6 million of the Corporation’s time deposits werecomprised of brokered certificates of deposit with$57.2 million maturing in three months or less,$27.8 million maturing in over three to six months,$20.7 million in over six to twelve months and$173.9 million maturing in over twelve months. The Banksenter into agreements with certain brokers
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who provide funds for a specified fee. The Banks’ liquiditypolicy limits the amount of brokered deposits to 75% of totaldeposits.         Deposit terms offered by the Banks vary according to minimumbalance required, the time period the funds must remain ondeposit, U.S. Treasury securities offerings and theinterest rates charged on other sources of funds, among otherfactors. In determining the characteristics of deposit accounts,consideration is given to profitability of the Banks, matchingterms of the deposits with loan and lease products, theattractiveness to clients and the rates offered by theBanks’ competitors.         The following table sets forth the amount and maturities of theBanks’ certificates of deposit at December 31, 2005.                           **Over Six**        **Over Three** **Months**        **Months** **Through**      **Three Months** **Through** **Twelve** **Over Twelve**  **Interest Rate** **and Less** **Six Months** **Months** **Months** **Total**             (In Thousands)    0.00% to 1.99% $20  $-  $-  $-  $20     2.00% to 2.99%  8,627   6,054   8,125   238   23,044     3.00% to 3.99%  56,822   3,025   11,544   36,665   118,056     4.00% and greater  12,189   21,034   15,369   145,582   194,174                   $77,658  $40,113  $35,038  $182,485  $335,294                          At December 31, 2005, time deposits included$50.9 million of certificates of deposit in denominationsgreater than or equal to $100,000. Of these certificates,$26.9 million are scheduled to mature in three months orless, $11.9 million in greater than three through sixmonths, $9.4 million in greater than six through twelvemonths and $2.7 million in greater than twelve months.         **Borrowings.** The Corporation had borrowings of$39.0 million as of December 31, 2005, largelyconsisting of FHLB advances of $12.5 million which had aweighted average rate of 3.67% and Fed funds purchased andsecurities sold under agreement to repurchase of$19.5 million and had a weighted average rate of 3.45%. TheCorporation also had a $2.8 million line of credit with aweighted average rate of 5.39%, a $5.0 million subordinatednote payable which carried a weighted average rate of 5.75% andjunior subordinated debentures of $10.3 million with aweighted average rate of 9.18%. Borrowings increased$9.7 million during the year ended December 31, 2005.The increase in Fed funds purchased of $18.7 million waspartially offset by the maturity of FHLB advances. AtDecember 31, 2004, FHLB advances were $23.8 millionwith a weighted average rate of 1.91%. Fed funds purchased andsecurities sold under agreement to repurchase totaled $678,000and had a weighted average rate of 2.20%. The Corporation’sline of credit of $500,000 had a weighted average rate of 3.76%,the subordinated note payable carried a weighted average rate of4.62% and junior subordinated debentures of $10.3 millionhad a weighted average rate of 8.67%.         The Banks obtain advances from the Federal Home Loan Bank(“FHLB”). Such advances are made pursuant to severaldifferent credit programs, each of which has its own interestrate and maturity. The FHLB may prescribe acceptable uses forthese advances as well as limitations on the size of theadvances and repayment provisions. The Banks pledge a portion oftheir 1-4 family loans, commercial loans, and mortgage-relatedsecurities as collateral.         The Banks may also enter into repurchase agreements withselected clients. Repurchase agreements are accounted for asborrowings by the Banks and are secured by mortgage-relatedsecurities.         The Corporation has a short-term line of credit to fundshort-term cash flow needs. The interest rate is based on theLondon Interbank Offer Rate (“LIBOR”) plus a spread of1.75% with an embedded floor of 3.75% and is payable monthly.The final maturity of the credit line is April 30, 2006.The Corporation also has a subordinated note payable with aninterest rate based on LIBOR plus 2.35% subject to a floorof 4.25% which matures on December 31, 2011. See**Note 11**to the Corporation’s ConsolidatedFinancial Statements for more information on borrowings.
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         The following table sets forth the outstanding balances,weighted average balances and weighted average interest ratesfor the Corporation’s borrowings (short-term and long-term)as indicated.                                        **December 31,**     **2005** **2004** **2003**       **Weighted** **Weighted**   **Weighted** **Weighted**   **Weighted** **Weighted**    **Average** **Average**   **Average** **Average**   **Average** **Average**  **Balance** **Balance** **Rate** **Balance** **Balance** **Rate** **Balance** **Balance** **Rate**                     (Dollars in Thousands)    Fed funds purchased and securities sold under agreement                                         to repurchase $19,463  $9,021   3.45% $678  $2,231   2.20% $5,965  $2,663   1.08%    FHLB advances  12,545   11,427   3.67   23,803   22,807   1.91   19,837   18,519   3.13     Junior subordinated debentures  10,310   10,310   9.18   10,310   10,310   8.67   -   -   0.00     Guaranteed trust preferred securities  -   -   0.00   -   -   0.00   10,000   10,000   8.83     Line of credit  2,750   2,338   5.39   500   665   3.76   10   10   3.75     Subordinated note payable  5,000   5,000   5.75   5,000   5,000   4.62   5,000   5,000   4.25                               $50,068  $38,096   5.49% $40,291  $41,013   3.99% $40,812  $36,192   3.15%                                Short-term borrowings $22,222          $23,434          $23,758             Long-term borrowings (due beyond one year)  27,846           16,857           17,054                                              The following table sets forth maximum amounts outstanding atmonth-end for specific types of borrowings for the periodsindicated.               **December 31,**     **2005** **2004** **2003**         (In Thousands)    Maximum month-end balance:                FHLB advances $23,503  $32,309  $33,917     Fed funds purchased and securities sold under agreement to    repurchase  25,127   7,271   12,524          **Stockholders’ Equity.** As of December 31, 2005,stockholders’ equity was $41.8 million or 6.3% oftotal assets. Stockholders’ equity increased$3.7 million during the year ended December 31, 2005primarily as a result of comprehensive income of$4.0 million, which includes net income of$4.8 million partially offset by an increase in accumulatedother comprehensive loss of $792,000. Stock options exercisedtotaled $286,000. These increases were partially offset bytreasury stock purchases of $125,000 and cash dividends of$424,000. As of December 31, 2004, stockholders’equity totaled $38.1 million or 6.8% of total assets.**Non-bank Subsidiaries**         **First Madison Investment Corporation.** FMIC is anoperating subsidiary of First Business Bank that wasincorporated in the State of Nevada in 1993. FMIC was organizedfor the purpose of managing a portion of the Bank’sinvestment portfolio. FMIC invests in marketable securities andalso invests in commercial real estate, multi-family, commercialand some 1-4 family loans in the form of loan participationswith FBB retaining servicing and charging a servicing fee of..25%. As an operating subsidiary, FMIC’s results ofoperations are consolidated with FBB’s for financial andregulatory purposes. FBB’s investment in FMIC amounted to$171.5 million at December 31, 2005. FMIC had netincome of $5.1 million for the year ended December 31,2004. This compares to a total investment of $147.3 millionat December 31, 2004 and net income of $4.2 millionfor the year ended December 31, 2004.         **First Business Capital Corp.** FBCC is a wholly-ownedsubsidiary of First Business Bank formed in 1995 andheadquartered in Madison, Wisconsin. FBCC is a commerciallending company designed to meet the needs of growing, highlyleveraged manufacturers and wholesale distribution businessesand specializes in providing secured lines of credit as well asterm loans on equipment and real estate assets. FBB’sinvestment in FBCC at December 31, 2005 was$8.4 million and net income for the year endedDecember 31, 2005 was $1.5 million. This compares to atotal investment of $6.9 million and net income of$1.0 million, respectively, at and for the year endedDecember 31, 2004.
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         FMCC Nevada Corp. (“FMCCNC”) is a wholly-ownedsubsidiary of FBCC incorporated in the state of Nevada in 2000.FMCCNC invests in asset based loans in the form of loanparticipations with FBCC retaining servicing. FBCC’s totalinvestment in FMCCNC at December 31, 2005 was$18.9 million. FMCCNC had net income of $1.0 millionfor the year ended December 31 2005. This compares to atotal investment of $17.9 million and net income of$742,000, respectively, at and for the year endedDecember 31, 2004.         **First Business Leasing, LLC.** FBL, headquartered inMadison, Wisconsin, was formed in 1998 for the purpose ofpurchasing leases from m2 Lease Funds, LLC (“m2”) andto originate leases. Until its sale on January 4, 2005, FBBhad a 50% equity interest in m2, which is a commercial financejoint venture specializing in the lease of general equipment tosmall and medium-sized companies nationwide. FBB’s totalinvestment in FBL at December 31, 2004 was$3.2 million and net income was $155,000 for the year endedDecember 31, 2005. This compares to a total investment of$3.0 million and net income of $614,000, respectively, atand for the year ended December 31, 2004.**Liquidity and Capital Resources**         During the years ended December 31, 2005, 2004 and 2003,the Banks did not make dividend payments to the Corporation. TheBanks are subject to certain regulatory limitations regardingtheir ability to pay dividends to the Corporation. Managementbelieves that the Corporation will not be adversely affected bythese dividend limitations and that any future projecteddividends from the Banks will be sufficient to meet theCorporation’s liquidity needs. The Corporation’sprincipal liquidity requirements at December 31, 2005 arethe repayment of a short-term borrowing of $2.8 million andinterest payments due on subordinated debentures and the juniorsubordinated debentures during 2006. The Corporation expects tomeet its liquidity needs through existing cash flow sources, itsbank line of credit and/ or dividends received from the Banks.The Corporation and its subsidiaries continue to have a strongcapital base and the Corporation’s regulatory capitalratios continue to be significantly above the defined minimumregulatory ratios. See **Note 12**in Notes toConsolidated Financial Statements for the Corporation’scomparative capital ratios and the capital ratios of its Banks.         FBFS manages its liquidity to ensure that funds are available toeach of its Banks to satisfy the cash flow requirements ofdepositors and borrowers and to ensure the Corporation’sown cash requirements are met. The Banks maintain liquidity byobtaining funds from several sources.         The Banks’ primary sources of funds are principal andinterest repayments on loans receivable and mortgage-relatedsecurities, FHLB advances, deposits and other borrowings such asfederal funds and Federal Home Loan Bank advances. Thescheduled repayments of loans and the repayments ofmortgage-related securities are a predictable source of funds.Deposit flows and loan repayments, however, are greatlyinfluenced by general interest rates, economic conditions andcompetition.         Brokered deposits are used by the Banks, which allows them togather funds across a larger geographic base at price levelsconsidered attractive. Access to such deposits allows theflexibility to not pursue single service deposit relationshipsin markets that have experienced some unprofitable pricinglevels. Brokered deposits account for $279.6 million ofdeposits as of December 31, 2005. Brokered deposits areutilized to support asset growth and are generally a lower costsource of funds when compared to the interest rates that wouldneed to be offered in the local markets to generate a sufficientlevel of funds. In addition, the administrative costs associatedwith brokered deposits are considerably less than theadministrative costs that would be incurred to administer asimilar level of local deposits. Although local market depositsare expected to increase as new client relationships areestablished and as existing clients increase the balances intheir deposit accounts, the usage of brokered deposits willlikely remain. In order to provide for ongoing liquidity andfunding, all of the brokered deposits are certificates ofdeposit that do not allow for withdrawal, at the option of thedepositor, before the stated maturity. In the event that thereis a disruption in the availability of brokered deposits atmaturity, the Banks have managed the maturity structure so thatat least 90 days of maturities would be funded throughother means, including but not limited to advances from theFederal Home Loan Bank, replacement with higher cost localmarket deposits or cash flow from borrower repayments andsecurity maturities.         The Banks are required by federal regulators to maintain levelsof liquid investments in qualified U.S. Government andagency securities and other investments which are sufficient toensure the safety
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and soundness of operations. The regulatory requirements forliquidity are discussed in **Item 1** under**“Supervision and Regulation.”**         During the year ended December 31, 2005, operatingactivities resulted in a net cash inflow of $2.6 million.Operating cash flows for the year ended December 31, 2005included earnings of $4.8 million. Net cash provided fromfinancing activities of $102.3 million, which included anincrease in deposits of $92.8 million, was partially offsetby net cash outflows of $97.0 million in loan originationand investment activities. During the year endedDecember 31, 2004, operating activities resulted in a netcash inflow of $4.3 million. Operating cash flows for thefiscal year included earnings of $4.3 million. Net cashprovided from financing activities of $36.7 million, whichincluded an increase in deposits of $37.8 million, wasoffset by net cash outflows of $44.8 million in loanorigination and investment activities.**Off-balance Sheet Arrangements**         As of December 31, 2005 the Corporation had outstandingcommitments to originate $168.8 million of loans andcommitments to extend funds to or on behalf of clients pursuantto standby letters of credit of $19.0 million. Commitmentsto extend funds typically have a term of less than one year;however the Banks have $48.4 million of commitments whichextend beyond one year. See **Note 16**to theConsolidated Financial Statements. No losses are expected as aresult of these funding commitments. The Banks also utilizeinterest rate swaps for the purposes of interest rate riskmanagement. Such instruments are discussed in **Note 18**to the Consolidated Financial Statements. Managementbelieves adequate capital and liquidity are available fromvarious sources to fund projected commitments.**Contractual Obligations**         The following table summarizes the Corporation’scontractual cash obligations and other commitments atDecember 31, 2005 and December 31, 2004, respectively.                       **Payment Due by Period**       **Less than**   **More than****Contractual Obligations** **Total** **1 Year** **1-3 Years** **4-5 Years** **5 Years**             (Dollars in Thousands)    Operating lease obligations $5,371  $581  $1,158  $1,158  $2,474     Fed funds purchased and securities repurchase agreements  19,463   19,463   -   -   -     Time deposits  335,294   152,808   130,203   52,283   -     Line of Credit  2,750   2,750   -   -   -     Subordinated debt  5,000   -   -   -   5,000     Junior subordinated debentures  10,310   -   -   -   10,310     FHLB advances  12,545   9   1,020   11,022   494                     Total contractual obligations $390,733  $175,612  $132,381  $64,462  $18,278                                        **Payment Due by Period**       **Less than**   **More than****Contractual Obligations** **Total** **1 Year** **1-3 Years** **4-5 Years** **5 Years**             (Dollars in Thousands)    Operating lease obligations $5,768  $569  $1,122  $1,122  $2,955     Securities repurchase agreements  678   678   -   -   -     Time deposits  307,501   201,734   72,921   1,970   30,876     Subordinated debt  5,000   -   -   -   5,000     Junior subordinated debentures  10,310   -   -   -   10,310     FHLB advances  23,803   22,259   19   1,021   504                     Total contractual obligations $353,060  $225,240  $74,062  $4,113  $49,645                 
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**Item 7a. Quantitative and Qualitative DisclosuresAbout Market Risk**         Interest rate risk, or market risk, arises from exposure of theCorporation’s financial position to changes in interestrates. It is the Corporation’s strategy to reduce theimpact of interest rate risk on net interest margin bymaintaining a favorable match between the maturities andrepricing dates of interest-earning assets and interest-bearingliabilities. This strategy is monitored by the respectiveBanks’ Asset/ Liability Management Committees, inaccordance with policies approved by the respective Banks’Boards. These committees meet regularly to review thesensitivity of the Corporation’s assets and liabilities tochanges in interest rates, liquidity needs and sources, andpricing and funding strategies.         The Corporation uses two techniques to measure interest raterisk. The first is simulation of earnings. The balance sheet ismodeled as an ongoing entity whereby future growth, pricing, andfunding assumptions are implemented. These assumptions aremodeled under different rate scenarios that include asimultaneous, instant and sustained change in interest rates.         The following table illustrates the potential impact of changingrates on the Corporation’s net interest margin for the nexttwelve months, as of December 31, 2005.                       **Change in interest rates in basis points**     **-200** **-100** **0** **+100** **+200**               Impact on net interest income  5.65%  2.85%  -   - 2.76%  - 5.60%         The second measurement technique used is static gap analysis.This technique measures the difference between the amount ofinterest-earning assets maturing and/or repricing and the amountof interest-bearing liabilities and interest rate swaps maturingand/or repricing in specified time periods. A significantrepricing gap could result in a large impact on net interestmargin during periods of changing interest rates.
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         The following table illustrates the Corporation’s staticgap position as of December 31, 2005, which is well withinpolicy parameters.                         **Estimated maturity or repricing at December 31, 2005**     **Within** **3 - 12** **1 - 5** **After**    **3 Months** **Months** **Years** **5 Years** **Total**             (In Thousands)**Assets:**                         Investment securities $7,455  $14,990  $62,310  $12,071  $96,826      Commercial loans  124,840   6,629   28,166   2,379   162,012      Real estate loans  131,235   36,336   148,802   40,515   356,888      Lease receivables  1,464   4,395   11,996   0   17,855      Consumer loans  1,095   234   92   118   1,538                       Total Earning Assets $266,089  $62,583  $251,365  $55,082  $635,119                  **Liabilities:**     Interest-bearing checking $46,962  $-  $-  $-  $46,962      Money market accounts  138,442   0   0   0   138,442      Time deposits under $100,000  57,550   48,807   179,894   0   286,250      Time deposits $100,000 and over  28,678   17,793   2,574   0   49,045      Securities sold under agreements to repurchase  713   0   0   0   713      Federal Home Loan Bank advances  2   7   12,043   493   12,545      Short term borrowings  21,500   0   0   0   21,500      Long term debt  15,310   0   0   0   15,310      Interest rate swaps  746   (128)  (618)  0   0                       Total Interest-bearing Liabilities $309,902  $66,478  $193,892  $493  $570,767                      Interest rate gap $(43,814) $(3,895) $57,473  $54,589  $64,353                      Cumulative interest rate gap $(43,814) $(47,709) $9,764  $64,353                          Cumulative interest rate gap to total earning assets  -7.68%  -8.36%  1.71%  11.27%                    
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**Item 8.****Financial Statements and Supplementary Data****INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF FIRST BUSINESSFINANCIAL SERVICES****The following financial statements are included in thisreport onForm 10-K:**     **Consolidated Financial Statements** **Page**       Consolidated Balance Sheets as of December 31, 2005 and 2004  45     Consolidated Statements of Income for the Years Ended    December 31, 2005, 2004, and 2003  46     Consolidated Statements of Changes in Stockholders’ Equity    and Comprehensive Income for the Years Ended December 31,    2005, 2004, and 2003  47     Consolidated Statements of Cash Flows for the Years Ended    December 31, 2005, 2004, and 2003  48     Notes to Consolidated Financial Statements  49     Report of Independent Registered Public Accounting Firm  78 
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**Consolidated Balance Sheets**             **December 31,** **December 31,**  **2005** **2004**       (In Thousands, Except Share Data)**Assets**            Cash and due from banks $16,568  $8,644     Interest-bearing deposits  8   27             Cash and cash equivalents  16,576   8,671     Securities available-for-sale, at fair value  95,070   66,445     Loans and leases receivable, net:             Held for sale  -   137      Held for investment  532,716   469,801     Leasehold improvements and equipment, net  1,155   1,247     Foreclosed properties  -   665     Cash surrender value of bank-owned life insurance  12,856   7,441     Goodwill and other intangibles  2,852   2,896     Accrued interest receivable and other assets  8,010   5,648              Total assets $669,235  $562,951         **Liabilities and Stockholders’ Equity**            Deposits $567,464  $474,677     Securities sold under agreement to repurchase  713   678     Federal Home Loan Bank and other borrowings  39,045   29,303     Junior subordinated debentures  10,310   10,310     Other liabilities  9,860   9,842           627,392   524,810            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, $.01 par value, 8,000,000 shares    authorized, 2,456,754 and 2,429,182 shares issued,    2,435,008 and 2,412,409 outstanding in 2005 and 2004,    respectively  24   24     Additional paid-in capital  22,712   22,426     Retained earnings  21,085   16,752     Accumulated other comprehensive loss  (1,469)  (677)    Treasury stock (21,746 and 16,773 shares in 2005 and 2004,    respectively), at cost  (509)  (384)             Total stockholders’ equity  41,843   38,141              Total liabilities and stockholders’ equity $669,235  $562,951        See accompanying Notes to Consolidated Unaudited FinancialStatements.
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**Consolidated Statements of Income**                **Years Ended December 31,**     **2005** **2004** **2003**         (In Thousands, Except Per  **Share Data)****Interest and dividend income:**                Loans and leases $33,142  $25,861  $25,221     Securities income:                Taxable  3,161   2,124   1,618     Federal funds sold, FHLB dividends and other  206   151   166                Total interest and dividend income  36,509   28,136   27,005 **Interest expense:**                Deposits  16,642   9,638   9,969     Notes payable and other borrowings  1,145   742   825     Junior subordinated debentures  946   893   883                Total interest expense  18,733   11,273   11,677                Net interest income  17,776   16,863   15,328     Provision for loan and lease losses  400   (540)  200                Net interest income after provision for loan and lease losses  17,376   17,403   15,128           **Non-interest income:**                Service charges on deposits  845   1,004   1,035     Credit, merchant and debit card fees  157   145   137     Loan fees  626   600   431     Gain on sale of 50% owned joint venture  973   -   -     Increase in cash surrender value of bank-owned life insurance  415   255   163     Trust and investment services fee income  1,045   732   476     Change in fair value of interest rate swaps  1   976   285     Net cash settlement of interest rate swaps  (119)  (829)  (653)    Written option income  -   7   1,361     Other  296   378   331                Total non-interest income  4,239   3,268   3,566           **Non-interest expense:**                Compensation  8,502   7,935   6,945     Occupancy  943   894   769     Equipment  439   518   455     Data processing  802   672   592     Marketing  797   688   583     Professional fees  1,401   1,021   837     Other  1,519   1,420   1,251                Total non-interest expense  14,403   13,148   11,432     Minority interest in net income of consolidated subsidiary  –   (9)  (741)              Income before income tax expense  7,212   7,514   6,521     Income tax expense  2,455   3,255   873                Net income $4,757  $4,259  $5,648               Earnings per share:                Basic $1.96  $1.89  $2.81     Diluted  1.93   1.83   2.02     Dividends declared  0.175   0.21   0.25 See accompanying Notes to Consolidated Financial Statements.
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**Consolidated Statements of Changes in Stockholders’Equity and Comprehensive Income**                                   **Accumulated**        **Additional**   **other**      **Common** **paid-in** **Retained** **comprehensive** **Treasury**    **stock** **capital** **earnings** **income (loss)** **stock** **Total**               (Dollars in thousands, except share data)    Balance at January 1, 2003 $20  $13,864  $7,856  $(885) $(31) $20,824     Comprehensive income:                            Net income $-  $-  $5,648  $-  $-  $5,648      Unrealized securities losses arising during the year net of    minority interest  -   -   -   (1,178)  -   (1,178)     Unrealized derivatives losses arising during the year  -   -   -   (169)  -   (169)     Reclassification adjustment for realized loss on derivatives  -   -   -   963   -   963      Income tax effect  -   -   -   166   -   166                          Comprehensive income                      5,430     Cash dividends ($0.25 per share)  -   -   (504)  -   -   (504)    Treasury stock purchased (200 shares)  -   -   -   -   (4)  (4)    Stock options exercised (35,767 shares)  -   244   -   -   -   244                        Balance at December 31, 2003 $20  $14,108  $13,000  $(1,103) $(35) $25,990                         Comprehensive income:                            Net income $-  $-  $4,259  $-  $-  $4,259      Unrealized securities losses arising during the year  -   -   -   (70)  -   (70)     Unrealized derivatives gains arising during the year  -   -   -   4   -   4      Reclassification adjustment for realized loss on derivatives  -   -   -   540   -   540      Income tax effect  -   -   -   (48)  -   (48)                         Comprehensive income                      4,685     Cash dividends ($0.21 per share)  -   -   (507)  -   -   (507)    Treasury stock purchased (15,173 shares)  -   -   -   -   (349)  (349)    Issuance of shares for BBG option exercise (336,205 shares)  3   7,730   -   -   -   7,733     Stock options exercised (70,344 shares)  1   588   -   -   -   589                        Balance at December 31, 2004 $24  $22,426  $16,752  $(677) $(384) $38,141                         Comprehensive income:                            Net income $-  $-  $4,757  $-  $-  $4,757      Unrealized securities losses arising during the year  -   -   -   (1,571)  -   (1,571)     Unrealized derivatives gains arising during the year  -   -   -   13   -   13      Reclassification adjustment for realized loss on derivatives  -   -   -   235   -   235      Income tax effect  -   -   -   531   -   531                          Comprehensive income                      3,965     Cash dividends ($0.175 per share)  -   -   (424)  -   -   (424)    Treasury stock purchased (4,973 shares)  -   -   -   -   (125)  (125)    Stock options exercised (27,572 shares)  -   286   -   -   -   286                        Balance at December 31, 2005 $24  $22,712  $21,085  $(1,469) $(509) $41,843                    See accompanying Notes to Consolidated Financial Statements
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**Consolidated Statement of Cash Flows**               **Years Ended December 31,**     **2005** **2004** **2003**         (In Thousands)**Operating Activities**                Net income $4,757  $4,259  $5,648     Adjustments to reconcile net income to net cash provided by    operating activities:                Deferred income taxes  (3,824)  2,594   1,291     Benefit of net operating loss carryforwards  -   -   (105)    Reduction of beginning of year valuation allowance  -   -   (1,206)    Provision for loan and lease losses  400   (540)  200     Depreciation, amortization and accretion, net  959   1,181   1,013     Change in fair value of interest rate swaps  1   (976)  (285)    Written option income  -   (7)  (1,361)    Increase in cash surrender value of bank-owned life insurance  (415)  (255)  (163)    Gain on sale of loans originated for sale  (6)  (16)  (18)    Origination of loans originated for sale  (861)  (4,434)  (3,382)    Sale of loans originated for sale  998   4,297   3,400     Gain on sale of 50% owned joint venture  (973)  -   -     Minority interest in net income of consolidated subsidiaries  -   9   741     (Increase) decrease in accrued interest receivable and other    assets  (825)  2,739   11     Increase (decrease) in accrued expenses and other liabilities  2,417   (4,597)  1,348               Net cash provided by operating activities  2,628   4,254   7,132           **Investing activities**                Proceeds from maturities of available-for-sale securities  26,528   15,550   52,591     Proceeds from sale of 50% owned joint venture  2,082   -   -     Purchases of available-for-sale securities  (56,794)  (18,364)  (69,427)    Net increase in loans and leases  (63,308)  (36,184)  (25,075)    Increase in other investments  (206)  (458)  (167)    Purchases of leasehold improvements and equipment, net  (327)  (304)  (76)    Purchase of bank-owned life insurance  (5,000)  (5,000)  -               Net cash used in investing activities  (97,025)  (44,760)  (42,154)          **Financing activities**                Net increase in deposits  92,788   37,791   22,479     Net increase (decrease) in FHLB line of credit  (11,259)  3,967   5,892     Net increase (decrease) in short-term borrowed funds  21,036   (4,798)  5,445     Minority interest investment in subsidiaries  -   19   91     Exercise of stock options  286   589   245     Cash dividends  (424)  (507)  (504)    Purchase of treasury stock  (125)  (349)  (4)              Net cash provided by financing activities  102,302   36,712   33,644               Net increase (decrease) in cash and cash equivalents  7,905   (3,794)  (1,378)    Cash and cash equivalents at beginning of period  8,671   12,465   13,843               Cash and cash equivalents at end of period $16,576  $8,671  $12,465           **Supplementary cash flow information**                Cash paid or credited to accounts:                Interest on deposits and borrowings $15,907  $11,691  $12,936     Income taxes  5,347   701   60     Non-cash transactions:                Loans transferred to foreclosed properties  -   -   708     Deconsolidation of trust preferred securities  -   10,310   -     Acquisition of minority shares of BBG:                Increase in common stock and paid-in capital  -   7,733   -     Elimination of minority interest  -   (4,392)  -     Settlement of written option liability  -   (654)  -     Increase in goodwill and other intangible assets  -   (2,689)  -     Other  -   2   - See accompanying Notes to Consolidated Financial Statements.
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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****Note 1**** – Summary of Significant Accounting Policies and    Nature of Operations**         **Nature of Operations.** The accounting and reportingpractices of First Business Financial Services (“FBFS”or the “Corporation”), its wholly-owned subsidiaries,First Business Bank (“FBB”) and First BusinessBank – Milwaukee (“FBB –Milwaukee”) have been prepared in accordance withU.S. generally accepted accounting principles. FirstBusiness Bank and First Business Bank – Milwaukee aresometimes referred to together as the “Banks”. TheBanks operate as commercial banking institutions in the Madisonand Milwaukee, Wisconsin markets and provide a full range offinancial services to businesses and business owners. The Banksare subject to competition from other financial institutions andservice providers and are also subject to state and federalregulations. FBB has the following subsidiaries: First BusinessCapital Corp. (“FBCC”), First Madison Investment Corp.(“FMIC”), and First Business Leasing, LLC. FBCC has awholly-owned subsidiary, FMCC Nevada Corp. (“FMCCNC”).FMIC and FMCCNC are located in and were formed under the laws ofthe state of Nevada. Significant intercompany accounts andtransactions have been eliminated. On January 4, 2005, FBBsold its 50% interest in m2 Lease Funds, LLC (“m2”),in a cash sale to the owner of the other 50% interest. See**Note 2** for additional information regarding the sale.         **Basis of Financial Statement Presentation.** Theconsolidated financial statements include the accounts of FBFS,and its wholly-owned subsidiaries. All significant intercompanybalances and transactions have been eliminated in consolidation.         Management of the Corporation is required to make estimates andassumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements as well as reportedamounts of revenues and expenses during the reporting period.Actual results could differ significantly from those estimates.Material estimates that could experience significant changes inthe near-term include the allowance for loan and lease losses,the value of foreclosed property, lease residuals, and the valueof property under operating leases.         **Cash and Cash Equivalents.** The Corporation considersfederal funds sold and interest-bearing deposits that haveoriginal maturities of three months or less to be cashequivalents.         **Securities Available-for-Sale.** The Corporation classifiesits investment and mortgage-related securities asavailable-for-sale,held-to-maturity andtrading. Debt securities that the Corporation has the intent andability to hold to maturity are classified asheld-to-maturity andare stated at amortized cost. Debt and equity securities boughtexpressly for the purpose of selling in the near term areclassified as trading securities and are measured at fair valuewith unrealized gains and losses reported in earnings. Debt andequity securities not classified asheld-to-maturity or astrading are classified as available-for-sale. Available-for-salesecurities are measured at fair value with unrealized gains andlosses reported as a separate component of stockholders’equity, net of tax. Realized gains and losses, and declines invalue judged to be other than temporary, are included in“securities gains, net” in the consolidated statementsof income as a component of non-interest income. The cost ofsecurities sold is based on the specific identification method.The Corporation had noheld-to-maturity ortrading securities at December 31, 2005 and 2004.         Discounts and premiums on investment and mortgage-backedsecurities are accreted and amortized into interest income usingthe effective yield method over the period to maturity orearlier call date.         When it is determined securities are other than temporarilyimpaired, an impairment loss is recorded in earnings and a newcost basis is established for the impaired security. AtDecember 31, 2005 and 2004, no securities were deemed to beother than temporarily impaired.         **Federal Home Loan Bank Stock.** The Corporation ownsshares in the Federal Home Loan Bank (“FHLB”) asrequired for membership. FHLB stock is carried at cost whichapproximates its fair value because the shares can be resold toother member banks at their carrying amount of $100 pershare par amount. In October 2005, the FHLB announced that itwould indefinitely defer members’ rights to tender theirexcess stock to the FHLB for redemption. The FHLB stock isperiodically evaluated for impairment. Should the stock beimpaired, it would be written down to its estimated fair value.
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         **Loans and Leases.** Loans and leases that management hasthe intent and ability to hold for the foreseeable future ormaturity are reported at their outstanding principal balancewith adjustments for charge-offs, the allowance for loan andlease losses, deferred fees or costs on originated loans andleases, and unamortized premiums or discounts on any purchasedloans. Loans originated or purchased and intended for sale inthe secondary market are carried at the lower of cost orestimated market value in the aggregate. Unrealized losses arerecognized through a valuation allowance by a charge to othernon-interest income. Gains and losses on the sale of loans areincluded in other non-interest income.         **Net Investment in Direct Financing Leases.** Directfinancing lease agreements are accounted for by combining theminimum lease payments to be received under the lease contracttogether with the estimated unguaranteed residual value(approximating 3% to 15% of the cost of the related equipment)and recorded as lease receivables when the lease is signed andthe leased property delivered to the customer. The excess of theminimum lease payments and residual values over the cost of theequipment is recorded as unearned lease income. Unearned leaseincome is recognized over the term of the lease on a basis whichresults in an approximate level rate of return on theunrecovered lease investment. Lease payments are recorded whendue under the lease contract. Residual values are established atlease inception equal to the estimated value to be received fromthe equipment following termination of the initial lease andsuch estimated value considers all relevant information andcircumstances regarding the equipment. In estimating theequipment’s fair value at lease termination, theCorporation relies on internally or externally preparedappraisals, published sources of used equipment prices, andhistorical experience adjusted for known industry and economictrends. The Corporation’s estimates are periodicallyreviewed to ensure reasonableness, however the amounts theCorporation will ultimately realize could differ from theestimated amounts. When there is other than temporary impairmentin the Corporation’s carrying amount of the unguaranteedresidual value, the carrying value is reduced and charged tonon-interest expense.         **Operating Leases.** Machinery and equipment are leased toclients under operating leases and are recorded at cost. Suchleases provide that equipment is depreciated over the estimateduseful life or term of the lease, if shorter. The carrying valueof the leased equipment is periodically evaluated forimpairment. Impairment loss, if any, would be charged to expensein the period it becomes evident. Rental income is recorded onthe straight-line accrual basis as other non-interest income.         **Interest on Loans.** Interest on loans is accrued andcredited to income on a daily basis based on the unpaidprincipal balance and is calculated using the effective interestmethod. Per policy, a loan is placed in a non-accrual statuswhen it becomes 90 days past due or more or the likelihoodof collecting interest is doubtful unless the loan is wellcollateralized and in the process of collection. A loan may beplaced on non-accrual status prior to being 90 days pastdue if the collectibility of interest is doubtful. A loan isdetermined to be past due if the borrower fails to meet acontractual payment and will continue to be considered past dueuntil all contractual payments are received. When a loan isplaced on non-accrual, interest accrual is discontinued andpreviously accrued but uncollected interest is deducted frominterest income and the payments on non-accrual loans areapplied to interest on a cash basis. If collectibility of theprincipal is in doubt, payments received are applied to reduceloan principal. As soon as it is determined that the principalof a non-accrual loan is uncollectible, the portion of thecarrying balance that exceeds the value of the underlyingcollateral is charged off.. Loans are returned to accrual statuswhen they are brought current in terms of both principal andaccrued interest due, have performed in accordance withcontractual terms for a reasonable period of time, and when theultimate collectibility of total contractual principal andinterest is no longer doubtful.         **Loan and Lease Origination Fees.** Loan and leaseorigination fees as well as certain direct origination costs aredeferred and amortized as an adjustment to loan yields over thestated term of the loan or lease. Loans that result from arefinance or restructure, other than a troubled debtrestructure, where terms are at least as favorable to theCorporation as the terms for comparable loans to other borrowerswith similar collection risks and result in an essentially newloan, are accounted for as a new loan. Any unamortized net fees,costs, or penalties are recognized when the new loan isoriginated. Unamortized net loan fees or costs for loans thatresult from a refinance or restructure with only minormodifications to the original loan contract are carried forwardas a part of the net investment in the new loan. For troubleddebt restructurings, as defined by Statement of FinancialAccounting Standards (SFAS) No. 15, *Accounting byDebtors and Creditors for Troubled Debt Restructurings,* allfees received in
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connection with a modification of terms are applied as areduction of the loan; and related costs including direct loanorigination costs are charged to expense as incurred.         **Foreclosed Properties and Repossessed Assets.** Real estateacquired by foreclosure or by deed in lieu of foreclosure andother repossessed assets are carried at the lower of cost orfair value with estimated selling expenses deducted. Costsrelating to the development and improvement of the property arecapitalized while holding period costs are charged to expense.Valuations are periodically performed by management andindependent third parties and an allowance for loss isestablished by a charge to expense if the carrying value of aproperty exceeds its fair value less estimated costs to sell.         **Allowance for Loan and Lease Losses.** The allowance forloan and lease losses is maintained at a level that managementdeems adequate to absorb probable and estimable losses inherentin the loan and lease portfolios. Such inherent losses stem fromthe size and current risk characteristics of the loan and leaseportfolio, an assessment of individual impaired and otherproblem loans and leases, actual loss experience, estimated fairvalue of underlying collateral, adverse situations that mayaffect the borrower’s ability to repay, and currentgeographic or industry-specific current economic events. Someimpaired and other loans have risk characteristics that areunique to an individual borrower and the inherent loss must beestimated on a loan-by-loan basis. Other impaired and problemloans and leases may have risk characteristics similar to otherloans and leases and bear similar inherent risk of loss. Suchloans and leases are aggregated with historical statisticsapplied to determine inherent risk of loss.         The determination of the estimate of loss is reliant uponhistorical experience, information about the ability of theindividual debtor to pay, and appraisal of loan collateral inlight of current economic conditions. An estimate of loss is anapproximation of what portion of all amounts receivable,according to the contractual terms of that receivable, is deemeduncollectible. Determination of the allowance is inherentlysubjective because it requires estimation of amounts and timingof expected future cash flows on impaired loans, estimation oflosses on types of loans based on historical losses, andconsideration of current economic trends, both local andnational. Based on management’s periodic review using allpreviously mentioned pertinent factors, a provision for loan andlease losses is charged to expense. Loan and lease losses arecharged against the allowance and recoveries are credited to theallowance.         The allowance for loan and lease losses contains specificallowances established for expected losses on impaired loans andleases. Impaired loans and leases are defined as loans andleases for which, based on current information and events, it isprobable that the Corporation will be unable to collectscheduled principal and interest payments according to thecontractual terms of the loan or lease agreement. Loans andleases subject to impairment are defined as non-accrual andrestructured loans and leases exclusive of smaller homogeneousloans such as home equity, installment and1-4 family residentialloans.         The fair value of impaired loans and leases is determined basedon the present value of expected future cash flows discounted atthe loan’s effective interest rate (the contractualinterest rate adjusted for any net deferred loan fees or costs,premium, or discount existing at the origination or acquisitionof the loan), the market price of the loan, or the fair value ofthe underlying collateral less costs to sell, if the loan iscollateral dependent. A loan or lease is collateral dependent ifrepayment is expected to be provided solely by the underlyingcollateral. Estimated costs to sell are discounted if thosecosts are expected to reduce the cash flows available to repaythe loan or lease. A loan’s effective interest rate maychange over the life of the loan based on subsequent changes inrates or indices or may be fixed at the rate in effect at thedate the loan was determined to be impaired.         Subsequent to the initial impairment, any significant change inthe amount or timing of an impaired loan or lease’s futurecash flows will result in a reassessment of the valuationallowance to determine if an adjustment is necessary.Measurements based on observable market value or fair value ofthe collateral may change over time and require a reassessmentof the valuation allowance if there is a significant change ineither measurement base. Any increase in the present value ofexpected future cash flows attributable to the passage of timeis recorded as interest income accrued on the net carryingamount of the loan or lease at the effective interest rate usedto discount the impaired loan or lease’s estimated futurecash flows. Any change in present value attributable to changesin the amount or timing of expected future cash flows isrecorded as loan loss expense in the same manner in whichimpairment was initially recognized or as a reduction of loanloss expense that otherwise would be reported. Where
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the level of loan or lease impairment is measured usingobservable market price or fair value of collateral, any changein the observable market price of an impaired loan or lease orfair value of the collateral of an impaired collateral-dependentloan or lease is recorded as loan loss expense in the samemanner in which impairment was initially recognized. Anyincrease in the observable market value of the impaired loan orlease or fair value of the collateral in an impairedcollateral-dependent loan or lease is recorded as a reduction inthe amount of loan loss expense that otherwise would be reported.         No income has been recognized for impaired loans or leases,where the measurement of impairment is based on the presentvalue of future cash flows discounted at the loan’seffective interest rate, since such loans or leases have notexperienced any increases in present values.         **Derivative Instruments.** The Corporation uses derivativeinstruments to protect against the risk of adverse price orinterest rate movements on the value of certain assets andliabilities and on future cash flows. Derivative instrumentsrepresent contracts between parties that usually require littleor no initial net investment and result in one party deliveringcash to the other party based on a notional amount and anunderlying as specified in the contract. A notional amountrepresents the number of units of a specific item, such ascurrency units. An underlying represents a variable, such as aninterest rate. The amount of cash delivered from one party tothe other is determined based on the interaction of the notionalamount of the contract with the underlying.         Market risk is the risk of loss arising from an adverse changein interest rates, exchange rates or equity prices. TheCorporation’s primary market risk is interest rate risk.Management uses derivative instruments to protect against therisk of interest rate movements on the value of certain assetsand liabilities and on future cash flows. These instrumentsinclude interest rate swaps, interest rate options and interestrate caps and floors with indices that relate to the pricing ofspecific assets and liabilities. The nature and volume of thederivative instruments used to manage interest rate risk dependon the level and type of assets and liabilities on the balancesheet and the risk management strategies for the current andanticipated rate environments.         Credit risk occurs when a counter party to a derivative contractwith an unrealized gain fails to perform according to the termsof the agreement. Credit risk is managed by limiting thecounterparties to highly rated dealers, applying uniform creditstandards to all activities with credit risk and monitoring thesize and the maturity structure of the derivative portfolio.         SFAS No. 133, *Accounting for Derivative Instrumentsand Hedging Activities,* requires all derivative instrumentsto be carried at fair value on the balance sheet. The accountingfor the gain or loss due to changes in the fair value of thederivative instrument depends on whether the derivativeinstrument qualifies as a hedge. If the derivative instrumentdoes not qualify as a hedge, the gains or losses are reported inearnings when they occur. However, if the derivative instrumentqualifies as a hedge the accounting varies based on the type ofrisk being hedged.         For fair value hedges, gains or losses on derivative hedginginstruments are recorded in earnings. In addition, gains orlosses on the hedged item are recognized in earnings in the sameperiod and the same income statement line as the change in fairvalue of the derivative. Consequently, if gains or losses on thederivative hedging instrument and the related hedged item do notcompletely offset, the difference (i.e. the ineffective portionof the hedge) is recognized currently in earnings.         For cash flow hedges, the reporting of gains or losses onderivative hedging instruments depends on whether the gains orlosses are effective at offsetting the cash flows of the hedgeditem. The effective portion of the gain or loss is accumulatedin other comprehensive income and recognized in earnings duringthe period that the hedged forecasted transaction affectsearnings.         **Goodwill and Other Intangible Assets.** The excess of thecost of the acquisition of BBG over the fair value of the netassets acquired consists primarily of goodwill and core depositintangibles. Core deposit intangibles have estimated finitelives and are amortized on an accelerated basis to expense overa period of 15 years. The Corporation reviews long-livedassets and certain identifiable intangibles for impairment atleast annually, or whenever events or changes in circumstancesindicate that the carrying amount of an asset may not berecoverable, in which case an impairment charge would berecorded.         Goodwill is not amortized but is subject to impairment tests onat least an annual basis. Any impairment of goodwill will berecognized as an expense in the period of impairment. TheCorporation
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completes its annual goodwill impairment test as of June 1each year and no impairment has been recognized. Note 5includes a summary of the Corporation’s goodwill and coredeposit intangible.         **Leasehold Improvements and Equipment.** The cost ofcapitalized leasehold improvements is amortized on thestraight-line method over the lesser of the term of therespective lease or estimated economic life. Equipment is statedat cost less accumulated depreciation and amortization which iscalculated by the straight-line method over the estimated usefullives of three to ten years. Maintenance and repair costs arecharged to expense as incurred. Improvements which extend theuseful life are capitalized and depreciated over the remaininguseful life of the assets.         **Other Investments.** The Corporation owns certain equityinvestments in other corporate organizations which are notconsolidated because the Corporation does not own more than a50% interest or exercise control over the organization.Investments in corporations representing at least a 20% interestare generally accounted for using the equity method andinvestments in corporations representing less than 20% interestare generally accounted for at cost. Investments in limitedpartnerships representing from at least a 3% up to a 50%interest in the investee are generally accounted for using theequity method and investments in limited partnershipsrepresenting less than 3% are generally accounted for at cost.All of these investments are periodically evaluated forimpairment. Should an investment be impaired, it would bewritten down to its estimated fair value. The equity investmentsare reported in other assets and the income and expense fromsuch investments, if any, is reported in non-interest income andnon-interest expense.         **Bank-Owned Life Insurance.** Bank-owned life insurance(“BOLI”) is reported at the amount that would berealized if the life insurance policies were surrendered on thebalance sheet date. BOLI policies owned by the Banks arepurchased with the objective to fund certain future employeebenefit costs with the death benefit proceeds. The cashsurrender value of such policies is recorded in “Cashsurrender value of life insurance” on the ConsolidatedBalance Sheets and changes in the value are recorded innon-interest income. The total death benefit of all of the BOLIpolicies is $40,536,000. There are no restrictions on the use ofBOLI proceeds and as of December 31, 2005, there were noloans against the cash surrender value of the BOLI policies.         **Advertising Costs.** All advertising costs incurred by theCorporation are expensed in the period in which they areincurred.         **Income Taxes.** Deferred income tax assets and liabilitiesare computed annually for temporary differences in timingbetween the financial statement and tax basis of assets andliabilities that result in taxable or deductible amounts in thefuture based on enacted tax law and rates applicable to periodsin which the differences are expected to affect taxable income.The ultimate realization of deferred tax assets is dependentupon the generation of future taxable income during the periodsin which those temporary differences become deductible.Management considers the scheduled reversals of deferred taxliabilities, appropriate tax planning strategies, projectedfuture taxable income, and projections for future taxable incomeover the period which the deferred tax assets are deductible.When necessary, valuation allowances are established to reducedeferred tax assets to the realizable amount. Managementbelieves it is more likely than not that the Corporation willrealize the benefits of these deductible differences, net of theexisting valuation allowances.         Income tax expense represents the tax payable or tax refundablefor a period, adjusted by the applicable change in deferred taxassets and liabilities for that period. The Corporation and itssubsidiaries file a consolidated Federal income tax return andseparate state income tax returns. FBFS accrues through currentincome tax provision amounts it deems probable of assessmentrelated to federal and state income tax expenses. Such accrualswould be reduced when such taxes are paid or reduced by way of acredit to the current income tax provision when it is no longerprobable that such taxes will be paid. Tax sharing agreementsallocate taxes to each entity for the settlement of intercompanytaxes.         **Earnings Per Share.** Basic earnings per share(“EPS”) is computed by dividing net income by theweighted average number of common shares outstanding for theperiod. The basic EPS computation excludes the dilutive effectof all common stock equivalents. Common stock equivalents areall potential common shares which could be issued if securitiesor other contracts to issue common stock were exercised orconverted into common stock. Diluted EPS is computed by dividingadjusted net income by the weighted average number of commonshares outstanding plus all common stock
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equivalents. These common stock equivalents are computed basedon the treasury stock method using the average market price forthe period. Some stock options are anti-dilutive and aretherefore not included in the calculation of diluted earningsper share.         **Segments and Related Information.** The Corporation isrequired to report each operating segment based on materialitythresholds of ten percent or more of certain amounts, such asrevenue. Additionally, the Corporation is required to reportseparate operating segments until the revenue attributable tosuch segments is at least 75 percent of total consolidatedrevenue. The Corporation provides a broad range of financialservices to individuals and companies in south central andsoutheastern Wisconsin. These services include demand, time, andsavings products, the sale of certain non-deposit financialproducts, and commercial and retail lending, leasing and trustservices. While the Corporation’s chief decision-makermonitors the revenue streams of the various products andservices, operations are managed and financial performance isevaluated on a corporate-wide basis. Since theCorporation’s business units have similar basiccharacteristics in the nature of the products, productionprocesses, and type or class of customer for products orservices, and do not meet materiality thresholds based on therequirements of reportable segments, these business units areconsidered one operating segment.         **Defined Contribution Plan.** The Corporation has acontributory 401(k) defined contribution plan coveringsubstantially all employees. A matching contribution of up to 3%of salary is provided. The Corporation may also makediscretionary contributions up to an additional 6% of salary.         **Proforma Employee Stock Option Information.** The followingtable illustrates what the Corporation’s net income andearnings per share would have been had compensation cost for theCorporation’s employee stock option plans been determinedbased on the fair value at the date of grant for awards underthe stock option plans. As allowed under SFAS No. 123,*Accounting for Stock-Based Compensation*andSFAS No. 148, *Accounting for Stock-BasedCompensation – Transition and Disclosure –an amendment of SFAS 123,*the Corporation accounts forstock-based compensation cost under the intrinsic value methodof Accounting Principles Board Opinion No. 2*5*,*Accounting for Stock Issued to Employees*(APB Opinion25), and related Interpretations, under which no compensationcost has been recognized for any periods presented, except withrespect to restricted stock awards. Compensation expense foremployee stock options is not recognized if the exercise priceof the option equals or exceeds the fair value of the stock onthe date of grant as such options would have no intrinsic valueat the date of grant.                **Year Ended December 31,**     **2005** **2004** **2003**         **(Dollars in Thousands, Except Per Share Data)**    Net Income                 As reported $4,757  $4,259  $5,648      Compensation expense under the fair value method, net of tax    benefit  201   130   67      Pro forma  4,556   4,129   5,581     Earnings Per Share – Basic                 As reported  1.96   1.89   2.81      Compensation expense under the fair value method, net of tax    benefit  0.08   0.05   0.04      Pro forma  1.88   1.84   2.77     Earnings Per Share – Diluted                 As reported  1.93   1.83   2.02      Compensation expense under the fair value method, net of tax    benefit  0.06   0.02   0.02      Pro forma  1.87   1.81   2.00          The fair value of each option granted is estimated using theminimum value method on the grant date using the Black-Scholesoption-pricing model which considers the risk free rate ofreturn based upon 10 year treasury obligations, a10 year expected life and dividends, if any are declared,but does not consider expected volatility. Option holders have10 years in which to exercise their options and must
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exercise vested options upon employment termination.Compensation amounts are amortized over the vesting period ofthe options in accordance with the vesting terms of the stockoptions agreements. The per share weighted average fair value ofstock options granted during 2005, 2004 and 2003 was $8.18,$7.56 and $7.24, respectively.For purposes of providing the pro forma disclosures requiredunder SFAS No. 123, the fair value of stock optionsgranted in 2005, 2004, and 2003 was estimated at the date ofgrant using a Black-Scholes option pricing model, which wasoriginally developed for use in estimating the fair value oftraded options that have different characteristics from theCorporation’s employee stock options. The model is alsosensitive to changes in the subjective assumptions that canmaterially affect the fair value estimate. As a result,management believes the Black-Scholes model may not necessarilyprovide a reliable single measure of the fair value of employeestockThe table below discusses the weighted average fair values foroptions granted during the years ended December 31, 2005,2004, and 2003.               **Year Ended December 31,**     **2005** **2004** **2003**           Expected dividend yield  0.92%   0.00%   0.00%     Risk free interest rate  4.13-4.21%   4.07%/4.19%   4.41%/3.98%     Expected lives  10 years   10 years   10 years **Reclassifications.** Certain accounts have beenreclassified to conform to 2005 presentations.**Recent Accounting Changes.****Other-Than-Temporary Impairment and Its Application toCertain Investments.** In June 2005, the FASB decided not toprovide additional guidance on the meaning ofother-than-temporary impairment, and directed the staff to issueproposed FASB Staff Position (“FSP”) Emerging IssuesTask Force (“EITF”)03-1-a, ImplementationGuidance for the Application of Paragraph 16 of EITF IssueNo. 03-1, asfinal. The final FSP will supercede EITF IssueNo. 03-1, TheMeaning of Other-Than-Temporary Impairment and Its Applicationto Certain Investments, and EITF TopicNo. D-44,Recognition of Other-Than-Temporary Impairment upon the PlannedSale of a Security Whose Cost Exceeds Fair Value. The final FSP(retitled FSPFAS 115-1, TheMeaning of Other-Than-Temporary Impairment and Its Applicationto Certain Investments) will replace the guidance set forth inparagraphs 10-18of EITF Issue 03-1with references to existing other-than-temporary impairmentguidance, such as SFAS No. 115, Accounting for CertainInvestments in Debt and Equity Securities, SEC Staff AccountingBulletin No. 59, Accounting for Noncurrent MarketableEquity Securities, and APB Opinion No. 18, The EquityMethod of Accounting for Investments in Common Stock. FSPFAS 115-1 willcodify the guidance set forth in EITF TopicD-44 and clarify thatan investor should recognize an impairment loss no later thanwhen the impairment is deemed other than temporary, even if adecision to sell has not been made. The provisions of FSPFAS 115-1 wereeffective for other-than-temporary impairment analysis conductedin periods beginning after September 15, 2005. Adoption ofthis FSP had no effect on the Corporation’sshareholders’ equity or results of operations.**Accounting for Certain Loans or Debt Securities Acquired in aTransfer.** In December 2003, the AICPA’s AccountingStandards Executive Committee issued Statement of Position(“SOP”) 03-3,*Accounting for Certain Loans or Debt Securities Acquired in aTransfer.* SOP 03-3 addresses accounting for differencesbetween contractual cash flows and cash flows expected to becollected from an investor’s initial investment in loans ordebt securities acquired in a transfer if those differences areattributable, at least in part, to credit quality. Theprovisions of this SOP are effective for loans acquired infiscal years beginning after December 15, 2004. TheCorporation adopted the SOP on January 1, 2005. Adoption ofthe SOP had no effect on the Corporation’s results ofoperations or financial position.**Accounting for Changes and Error Corrections.** In May2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections*which replaces the AccountingPrinciples Board (“APB”) opinion No. 20,*Accounting Changes,*and FASB No. 3, *ReportingChanges in Interim Financial Statements.*SFAS No. 154 requires retrospective application toprior period’s financial statements of voluntary changes inaccounting principle and changes required by new accountingstandards when the
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standard does not include specific transition provisions, unlessit is impracticable to do so. SFAS No. 154 iseffective for accounting changes and corrections of errors infiscal years beginning after December 15, 2005. Theadoption of SFAS No. 154 is not expected to impact theCorporation’s consolidated financial statements.         **Stock Options.** On December 16, 2004, the FASB issuedSFAS No. 123 (revised 2004), which is a revision ofSFAS No. 123, *Accounting for Stock-basedCompensation.* SFAS No. 123(R) supersedes APBOpinion No. 25, *Accounting for Stock Issued toEmployees,* and amends SFAS No. 95, *Statement ofCash Flows.* SFAS No. 123(R), which is effectivefor FBFS beginning January 1, 2006, requires a publicentity to measure the cost of employee services received inexchange for an award of equity instruments based on the fairvalue at the grant date. The cost is then recognized over theperiod during which an employee is required to provide servicein exchange for the award – the requisite serviceperiod (usually the vesting period). This statement eliminatesthe alternative to APB Opinion No. 25’s intrinsicvalue method of accounting that was provided inStatement 123 as originally issued.         Accordingly, the adoption of SFAS No. 123(R)’sfair value method will have future impact on the results ofoperations, although it will have no impact on the overallfinancial position at December 31, 2005. Adoption ofSFAS No. 123(R) will result in additional before taxcompensation expense of approximately $310,000 for optionsoutstanding at December 31, 2005 which are expected to vestin 2006.         **Note 2 – Sale of 50% Owned Joint Venture.**On January 4, 2005, FBB sold its 50% interest in m2 LeaseFunds, LLC (“m2”), in a cash sale to the owner of theother 50% interest. In this individually negotiated transaction,cash proceeds from the sale were $2.1 million and resultedin an approximate before tax gain of $973,000. OnJanuary 18, 2005, all secured loans from FBB to m2 werepaid in full. FBB no longer holds any equity interest in m2 andhas no continuing involvement with m2.         **Note 3 – Acquisition of MinorityShares.**  On June 1, 2004, minorityshareholders of BBG exercised their option to exchange theirshares of common stock of BBG representing 49% of theoutstanding shares of BBG common stock for 1.63 shares ofcommon stock of the Corporation per BBG share. The transactionresulted in the Corporation issuing 336,205 shares of itscommon stock. Subsequent to this transaction, BBG was dissolvedand as a result, the Corporation owns 100% of First BusinessBank – Milwaukee. The approximate fair value of theCorporation’s shares issued was $7,733,000. The fair valueof the FBFS shares was based on known recent trades.         The transaction was accounted for as a purchase. The purchaseprice was allocated to tangible and intangible assets of BBGbased upon the fair value of those assets to the extent of the49% of BBG’s common stock acquired and historical cost tothe extent of the 51% of BBG’s common stock already ownedby FBFS. All earnings of First Business Bank –Milwaukee are included in consolidated earnings fromJune 1, 2004.         As a result of the transaction, the remaining liability for theBBG conversion option (see **Note 20**) of $654,000 wassettled, a core deposit intangible of $145,000 was recorded,loans and investments, other assets and liabilities wererecorded at their pro rata fair values and the residual of$2,689,000 was allocated to goodwill.         Had BBG been consolidated for all years presented in theconsolidated statements of income, consolidated net earningswould have been approximately $3,884,000 in 2004 and $6,216,000in 2003. Diluted earnings per share would have been $1.68 in2004 and $2.92 in 2003.         **Note 4 – Goodwill and IntangibleAssets.**  Goodwill is not amortized. Goodwill aswell as other intangible assets are subject to impairment testson at least an annual basis. No impairment loss
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was necessary in 2005 or 2004. At December 31, 2005,goodwill was $2,689,000. The change in the carrying amount ofgoodwill was as follows:                **Year Ended December 31,**     **2005** **2004** **2003**         (In Thousands)    Balance at beginning of year $2,689  $-  $-      Goodwill acquired  -   2,689   -               Balance at end of period $2,689  $2,689  $-           The Corporation has other intangible assets that are amortizedconsisting of core deposit intangibles and other intangibles,consisting of a purchased customer list from purchasedbrokerage/investment business.Changes in the gross carrying amount, accumulated amortizationand net book value of core deposits and other intangibles wereas follows:               **Year Ended December 31,**     **2005** **2004** **2003**         (In Thousands)    Core deposit intangibles:                Gross carrying amount $145  $145  $-     Accumulated amortization  (54)  (22)  -               Net book value $91  $123  $-               Additions during the year $-  $145  $-     Amortization during the period  (32)  (22)  -     Other intangibles:                Gross carrying amount $120  $120  $120     Accumulated amortization  (48)  (36)  (24)              Net book value $72  $84  $96               Additions during the year $-  $-  $-     Amortization during the period  (12)  (12)  (12)Estimated amortization expense of core deposit and otherintangibles for fiscal years 2006 through 2010 are as follows:$36,000, $30,000, $25,000, $22,000 and $19,000.**Note 5 – Cash and Due From Banks.**Reserves in the form of deposits with the Federal Reserve Bankand vault cash totaling approximately $597,000 and $527,000 weremaintained to satisfy federal regulatory requirements as ofDecember 31, 2005 and 2004, respectively. These amounts areincluded in cash and due from banks in the Consolidated BalanceSheets.
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**Note 6 – Securities**The amortized cost and estimated fair values of securitiesavailable-for-sale are as follows (in thousands):                   **As of December 31, 2005**       **Gross** **Gross**      **unrealized** **unrealized**    **Amortized** **holding** **holding** **Estimated**  **Cost** **gains** **losses** **fair value****Securities available-for-sale**          (In Thousands)    FHLB stock $2,898  $-  $-  $2,898     U.S. Government corporations and agencies  3,264   -   (80)  3,184     Municipals  275   -   (3)  272     Collateralized mortgage obligations  90,601   2   (2,004)  88,599     Other  117   -   -   117                $97,155  $2  $(2,087) $95,070                                 **As of December 31, 2004**       **Gross** **Gross**      **unrealized** **unrealized**    **Amortized** **holding** **holding** **Estimated**  **Cost** **gains** **losses** **fair value****Securities available-for-sale**          (In Thousands)    FHLB stock $2,761  $-  $-  $2,761     U.S. Treasury securities and obligations of the    U.S. Government corporations and Agencies  3,275   -   (22)  3,253     Collateralized mortgage obligations  60,873   41   (533)  60,381     Other  50   -   -   50                $66,959  $41  $(555) $66,445                       The Corporation has not sold any available-for-sale securitiesfor any of the periods shown.         Securities with carrying values aggregating approximately$29,700,000 and $39,895,000 were pledged to secure publicdeposits, securities sold under agreement to repurchase,negative market values in excess of thresholds established withcounterparties and borrowings at December 31, 2005 and2004, respectively.         Unrealized holding gains and losses, net of tax effect, includedin accumulated other comprehensive income at December 31,2005 and 2004 were ($1,365,000) and ($338,000), respectively.         The amortized cost and estimated fair value of securitiesavailable-for-sale by contractual maturity at December 31,2005 are shown below (in thousands). Actual maturities maydiffer from contractual maturities because issuers have theright to call or prepay obligations with or without call orprepayment penalties.           **Amortized** **Estimated**  **Cost** **fair value**       (In Thousands)    Due in one year or less $4,015  $3,996     Due in one year through five years  2,803   2,742     Due in five through ten years  21,325   20,769     Due in over ten years  69,012   67,563          $97,155  $95,070        
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         The table below shows the Corporation’s gross unrealizedlosses and fair value of investments, aggregated by investmentcategory and length of time that individual investments havebeen in a continuous unrealized loss position atDecember 31, 2005. Such securities have declined in valuedue to current interest rate environments and not credit qualityand do not presently represent realized losses. The Corporationhas the ability and intent to and anticipates that thesesecurities, which have been in a continuous loss position butare not other-than-temporarily impaired, will be kept in theCorporation’s portfolio until maturity or until theunrealized loss is recovered. If held until maturity, it isanticipated that the investments will regain their value. If theCorporation determines that any of the above investments aredeemed to be other-than-temporarily impaired, the impairmentloss will be recognized in the consolidated statement of income.                           **As of December 31, 2005**     **Less than 12 Months** **12 months or longer** **Total**         **Fair Value** **Unrealized Loss** **Fair Value** **Unrealized Loss** **Fair Value** **Unrealized Loss**               (In Thousands)    U.S. Government corporations and agencies $1,452  $43  $1,732  $37  $3,184  $80     Municipals  272   3   -   -   272   3     Collateralized mortgage obligations  34,073   606   53,269   1,398   87,342   2,004                      $35,797  $652  $55,001  $1,435  $90,798  $2,087                    **Note 7 – ****Loan and Lease Receivables and Allowance for Loan and Lease    Losses**Loan and lease receivables consist of the following (inthousands):           **As of December 31,**     **2005** **2004**       (In thousands)    First mortgage loans:            Commercial real estate $249,133  $215,605     Construction  50,619   41,910     Multi-family  22,115   17,786     1-4 family  26,513   22,814           348,380   298,115      Commercial business loans  151,688   136,482     Direct financing leases, net  17,852   25,583     Second mortgage loans  8,231   5,563     Credit card and other  13,579   10,743           539,730   476,486     Less:            Allowance for loan and lease losses  6,773   6,375     Deferred loan fees  241   310          $532,716  $469,801        Certain of the Corporation’s executive officers, directors,and their related interests are loan clients of the Banks. As ofDecember 31, 2005 and 2004, loans aggregating approximately$17,069,000 and $14,019,000, respectively, were outstanding tosuch parties. New loans granted during 2005 and 2004 wereapproximately $7,794,000 and $6,582,000 and loan repayments wereapproximately $4,744 000 and $6,999,000, respectively. Theseloans were made in the ordinary course of business and onsubstantially the same terms as those prevailing for comparabletransactions with other clients. None of these loans wereconsidered impaired.
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         A summary of the activity in the allowance for loan and leaselosses follows:                **Year Ended December 31,**     **2005** **2004** **2003**         (In Thousands)    Allowance at beginning of period $6,375  $6,811  $5,875     Charge-offs:                 Mortgage      -   -      Commercial  -   (25)  (37)     Lease  -   -   -      Consumer  (10)  (6)  -               Total charge-offs  (10)  (31)  (37)    Recoveries:                 Mortgage  4   9   -      Commercial  4   4   773      Lease  -   122   -      Consumer  - -   - -   - -               Total recoveries  8   135   773      Net recoveries (charge-offs)  (2)  104   736     Provision  400   (540)  200               Allowance at end of period $6,773  $6,375  $6,811               Allowance to gross loans and leases  1.25%  1.34%  1.55%The Corporation’s non-accrual loans and leases consist ofthe following at December 31, 2005, 2004 and 2003,respectively.                **Year Ended December 31,**     **2005** **2004** **2003**         (Dollars in Thousands)    Non-accrual loans $1,454  $696  $891     Non-accrual leases  90   1,566   717                Total non-accrual loans and leases  1,544   2,262   1,608     Foreclosed properties and repossessed assets, net  -   665   708               Total non-performing assets $1,544  $2,927  $2,316               Performing troubled debt restructurings $-  $-  $-               Total non-accrual loans and leases to total loans and leases  0.29%  0.47%  0.37%    Total non-performing assets to total assets  0.23   0.52   0.45     Allowance for loan and lease losses to total loans and leases  1.25   1.34   1.55     Allowance for loan and lease losses to non-accrual loans and    leases  438.64   281.83   423.57 
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The following represents information regarding theCorporation’s impaired loans:                **As of December 31,**     **2005** **2004** **2003**         (In Thousands)    Impaired loans and leases with impairment reserves required $1,544  $2,262  $2,100     Less:                 Impairment reserve (included in allowance for loan and lease    losses)  399   470   935               Net impaired loans and leases $1,145  $1,792  $1,165               Average impaired loans and leases $2,192  $2,112  $2,408     Interest income attributable to impaired loans and leases  112   177   367     Interest income recognized on impaired loans and leases  65   85   45 The Corporation’s net investment in direct financing leasesconsists of the following:            **December 31,**     **2005** **2004**       (Dollars in Thousands)    Minimum lease payments receivable $15,063  $21,437     Estimated unguaranteed residual values of leased property  4,993   7,713     Initial direct costs  363   409      Less unearned lease and residual income  (2,568)  (3,976)           Investment in commercial direct financing leases $17,852  $25,583        There were no impairments of residual value of leased propertyduring 2005 and 2004.The Corporation leases equipment under direct financing leasesexpiring in various future years. Some of these leases providefor additional rents, based on use in excess of a stipulatedminimum number of hours, and generally allow the lessees topurchase the equipment for fair value at the end of the leaseterm. Future aggregate maturities of minimum lease payments tobe received are as follows:         2006 $5,425     2007  3,437     2008  2,462     2009  1,834     2010  1,228     Thereafter  677       $15,063     **Note 8 – Leasehold Improvements andEquipment**         A summary of leasehold improvements and equipment atDecember 31, 2005 and 2004 is as follows:            **At December 31,**     **2005** **2004**       (In Thousands)    Leasehold improvements $762  $754     Furniture and equipment  2,035   2,088     Purchases in progress  60   -           2,857   2,842      Less: accumulated depreciation  (1,702)  (1,595)         $1,155  $1,247        
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**Note 9 – Other Assets**         Included in other assets is the Corporation’s 50% equityinterest of $1,319,442 at December 31, 2004, in acommercial finance leasing joint venture, m2 Lease Funds, LLC,(“m2”) which specializes in the leasing of generalequipment to small and middle market companies. m2 had totalassets of $27,888,000 and total liabilities of $25,249,000 atDecember 31, 2004. Net income of m2 for the years endedDecember 31, 2004 and 2003 was $484,000 and $364,000,respectively. m2 originates certain commercial leases and sellsthem to FBB as well as to non-affiliated banks. Origination feespaid to m2 by FBB approximated $320,000 and $292,000 in fiscal2004 and 2003, respectively. m2 had loans from FBB of$13.4 million at December 31, 2004. AtDecember 31, 2004, FBB had sold, without recourse,$8.4 million of those loans to non-affiliated banksreducing its outstanding loans from FBB to $5.0 million.Such loans are included in the total liabilities of m2. Allloans from FBB to m2 were paid in full on January 18, 2005.See **Note 2.**         Also reported in other assets is an equity investment of $57,000and $37,000 in CapVest Fund, LP as of December 31, 2005 and2004, respectively. As of December 31, 2005 the Corporationhas an additional commitment to provide funds of $43,000. TheCorporation has two tax-preferred limited partnership equityinvestments, Porchlight Inc., a community housing limitedpartnership and Chapel Valley Senior Housing, LP, in the amountsof $100,000 and $59,000, respectively, as of December 31,2005. As of December 31, 2004, investments in these twoentities were $212,000 and $89,000, respectively. TheCorporation is not the general partner, does not havecontrolling ownership, and is not the primary variable interestholder in any of these limited partnerships.         In addition to these other investments, accrued interestreceivable and other assets includes accrued interest receivableof $2,697,000, net deferred tax assets of $2,045,000 and otherassets of $3,052,000 as of December 31, 2005. As ofDecember 31, 2004, these amounts were accrued interestreceivable of $1,745,000, net deferred tax assets of $0 andother assets of $2,329,000.**Note 10 – Deposits**         Deposits are summarized as follows (dollars in thousands):                   **December 31,**     **2005** **2004**         **Weighted**   **Weighted**  **Balance** **Average Rate** **Balance** **Average Rate**           (Dollars in Thousands)    Transaction accounts:                    Demand deposits $46,766   0.00% $40,835   0.00%    Negotiable order of withdrawal (“NOW”) accounts  46,962   2.85   38,017   1.16                 93,728       78,852         Money market accounts  138,442   3.10   88,324   2.27     Certificates of deposit  335,294   3.95   307,501   2.78                $567,464      $474,677                           A summary of annual maturities of certificates of depositoutstanding at December 31, 2004 follows (in thousands):**Matures During the Year Ended December 31**         2006 $152,809     2007  64,866     2008  65,337     2009  11,187     2010  41,095       $335,294     
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         Deposits include approximately $50,929,000 and $36,981,000 ofcertificates of deposit, including brokered deposits, which aredenominated in amounts of $100,000 or more at December 31,2005 and 2004, respectively. Included in certificates of depositwere brokered deposits of $279.6 million and$257.5 million at December 31, 2005 and 2004,respectively.**Note 11 – Borrowed Funds**         The composition of borrowed funds at December 31, 2005 and2004 is as follows:                           **December 31,**     **2005** **2004**         **Weighted** **Weighted**   **Weighted** **Weighted**    **Average** **Average**   **Average** **Average**  **Balance** **Balance** **Rate** **Balance** **Balance** **Rate**               (Dollars in Thousands)    Fed funds purchased and securities sold under agreement to    repurchase $19,463  $9,021   3.45% $678  $2,231   2.20%    FHLB advances  12,545   11,427   3.67   23,803   22,807   1.91     Junior subordinated debentures  10,310   10,310   9.18   10,310   10,310   8.67     Line of credit  2,750   2,338   5.39   500   665   3.76     Subordinated note payable  5,000   5,000   5.75   5,000   5,000   4.62                      $50,068  $38,096   5.49% $40,291  $41,013   3.99%                       Short-term borrowings $22,222          $23,434             Long-term borrowings (due beyond one year)  27,846           16,857                              $50,068          $40,291                                     The maximum outstanding of fed funds purchased and securitiesrepurchase agreements was $25,127,000 and $7,271,000 for theyears ended December 31, 2005 and 2004, respectively.         The Corporation has a $34,677,000 FHLB line of credit availablefor advances which is collateralized by mortgage-relatedsecurities, unencumbered first mortgage loans and secured smallbusiness loans as noted below. At December 31, 2005 and2004, open line advances totaled $0 and $10,750,000,respectively. Open line advances have an interest rate based onthe overnight investment rate at the FHLB plus 45 basispoints. The rate at December 31, 2005 and 2004 was 4.41%and 2.47%, respectively. Long-term FHLB advances bear fixedinterest rates which range from 4.50% to 6.06% and 1.24% to7.37% at December 31, 2005 and 2004, respectively, and aresubject to a prepayment fee if they are repaid prior tomaturity. None of the Corporation’s FHLB advances arecallable.         The Corporation is required to maintain, as collateral,mortgage-related securities and unencumbered first mortgageloans and secured small business loans in its portfolioaggregating at least the amount of outstanding advances from theFHLB. Loans totaling approximately $18,069,000 and $27,114,000and mortgage-related securities totaling approximately$27,627,000 and $37,626,000 were pledged as collateral for FHLBadvances at December 31, 2005 and 2004, respectively.
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         Scheduled repayments of long-term FHLB advancesDecember 31, 2005 are as follows (in thousands):**Matures during Year Ended December 31,**         2006 $9     2007  10     2008  1,010     2009  11     2010  11,011     Thereafter  494       $12,545              As of December 31, 2005, the Corporation has an unsecuredbank line of credit of $5.0 million with an interest ratebased on one-month LIBOR (London Inter Bank Offer Rate) plus1.75% subject to a floor of 3.75% per year. TheCorporation is in compliance with all covenants as ofDecember 31, 2005. The line of credit matures onApril 30, 2006 and had a rate of 6.06% and 4.06% atDecember 31, 2005 and 2004, respectively. The balanceoutstanding was $2,750,000 and $500,000 at December 31,2005 and 2004, respectively.         The Corporation also has a $5.0 million subordinated notepayable to a bank with an interest rate based on one-month LIBORplus 2.35%, subject to a floor of 4.25%. The note matures onDecember 31, 2011 and had a 6.66% interest rate atDecember 31, 2005.         In December 2001, FBFS Statutory Trust I (the“Trust”), a Connecticut business trust wholly owned bythe Corporation, completed the sale of $10.0 million ofthree-month LIBOR plus 3.60% preferred securities (the“Preferred Securities”), with a maximum rate of 12.5%.The rate at December 31, 2005 was 8.10%. The Trust alsoissued common securities of $300,000. The Trust used theproceeds from the offering to purchase $10.3 million of3 month LIBOR plus 3.60% Junior Subordinated Debentures(the “Debentures”) of the Corporation. The incomeeffects of the Debentures are the sole assets of the Trust andare consolidated in the financial statements of the Corporation,the Preferred Securities are classified in the liability sectionof the consolidated balance sheets and the dividends paid on thePreferred Securities are classified as interest expense in theconsolidated statements of income. The Corporation fully andunconditionally guarantees the obligations of the trusts on asubordinated basis. The Corporation capitalized the debtissuance costs in 2001 of approximately $312,000, which areincluded in other assets, and are amortizing over the life ofthe Debentures.         The Preferred Securities are mandatorily redeemable upon thematurity of the Debentures on December 18, 2031. TheCorporation has the right to redeem the Debentures at anyinterest payment date within 120 days following theoccurrence of a special event at the special redemption price.Special events are limited to 1) a change in capitaltreatment resulting in the inability of the Corporation toinclude the Debentures in Tier 1 capital, 2) a changein laws or regulations that could require the Trust to registeras an investment company under The Investment Company Act of1940, as amended and 3) a change in laws or regulationsthat would a) require the Trust to pay income tax withrespect to income received on the Debentures or b) prohibitthe Corporation from deducting the interest payable by theCorporation on the Debentures or c) result in greater thana de minimis amount of taxes for the Trust.         The special redemption price is 107.5% of the principal amountof the Debenture if the redemption date is beforeDecember 18, 2006 or 100% of the principal if theredemption occurs on December 18, 2006 or later.         The Corporation has the right to redeem the Debentures quarterlyon or after December 18, 2006.         The Preferred Securities qualify under the risk-based capitalguidelines as Tier 1 capital for regulatory purposes. TheCorporation used the proceeds from the sale of the Debenturesfor general corporate purposes.
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**Note 12 – Stockholders’ Equity**         The Corporation and Banks are subject to various regulatorycapital requirements administered by the Federal and State ofWisconsin banking agencies. Failure to meet minimum capitalrequirements can result in certain mandatory, and possiblyadditional discretionary actions on the part of regulators, thatif undertaken, could have a direct material effect on theBanks’ assets, liabilities, and certain off-balance sheetitems as calculated under regulatory accounting practices. TheCorporation and the Banks’ capital amounts andclassification are also subject to qualitative judgments by theregulators about components, risk weightings and other factors.         Qualitative measures established by regulation to ensure capitaladequacy require the Corporation and the Bank to maintainminimum amounts and ratios of total and Tier 1 capital toand risk-weighed assets and of Tier 1 capital to averageassets. Management believes, as of December 31, 2005, thatthe Corporation and the Banks meet all applicable capitaladequacy requirements.         As of December 31, 2005 and 2004, the most recentnotification from the Federal Deposit Insurance Corporation andthe state of Wisconsin Department of Financial Institutions(DFI) categorized the Banks as well capitalized under theregulatory framework for prompt corrective action. Thequalification results in lower assessment of FDIC premiums,among other benefits.         In addition, the Banks met the minimum net worth requirement of6.0% as required by the State of Wisconsin at December 31,2005 and 2004.         The following table summarizes the Corporation and Banks’capital ratios and the ratios required by its federal regulatorsat December 31, 2005 and 2004, respectively:                                **Minimum** **Minimum**      **Required for** **Required to be**      **Capital** **Well Capitalized**    **Adequacy** **Under FDIC**  **Actual** **Purposes** **Requirements**         **Amount** **Ratio** **Amount** **Ratio** **Amount** **Ratio**               (Dollars in Thousands)**As of December 31, 2005:**                            Total capital                             (to risk-weighted assets)                             Consolidated $62,234   10.43% $47,748   8.00%  N/A   N/A      First Business Bank  55,240   10.88   40,610   8.00  $50,763   10.00%     First Business Bank – Milwaukee  9,009   10.32   6,981   8.00   8,727   10.00     Tier 1 capital                             (to risk-weighted assets)                             Consolidated $50,461   8.45% $23,874   4.00%  N/A   N/A      First Business Bank  49,713   9.79   20,305   4.00  $30,458   6.00%     First Business Bank – Milwaukee  7,917   9.07   3,491   4.00   5,236   6.00     Tier 1 capital                             (to average assets)                             Consolidated $50,461   7.92% $25,486   4.00%  N/A   N/A      First Business Bank  49,713   9.14   21,746   4.00  $27,182   5.00%     First Business Bank – Milwaukee  7,917   8.21   3,858   4.00   4,823   5.00 **As of December 31, 2004:**                            Total capital                             (to risk-weighted assets)                             Consolidated $57,296   11.03% $41,550   8.00%  N/A   N/A      First Business Bank  48,611   10.75   36,164   8.00  $45,205   10.00%     First Business Bank – Milwaukee  8,185   12.45   5,259   8.00   6,574   10.00     Tier 1 capital                             (to risk-weighted assets)                             Consolidated $45,921   8.84% $20,775   4.00%  N/A   N/A      First Business Bank  43,323   9.58   18,082   4.00  $27,123   6.00%     First Business Bank – Milwaukee  7,360   11.20   2,629   4.00   3,944   6.00 
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                                **Minimum** **Minimum**      **Required for** **Required to be**      **Capital** **Well Capitalized**    **Adequacy** **Under FDIC**  **Actual** **Purposes** **Requirements**         **Amount** **Ratio** **Amount** **Ratio** **Amount** **Ratio**               (Dollars in Thousands)    Tier 1 capital                             (to average assets)                             Consolidated $45,921   8.21% $22,365   4.00%  N/A   N/A      First Business Bank  43,323   8.92   19,430   4.00  $24,287   5.00%     First Business Bank – Milwaukee  7,360   10.09   2,918   4.00   3,648   5.00          The following table reconciles stockholders’ equity tofederal regulatory capital at December 31, 2005 and 2004,respectively (in thousands):            December 31,     **2005** **2004**         Stockholders’ equity of the Corporation $41,843  $38,141     Unrealized and accumulated gains and losses on specific items,    minority interest in qualifying trust preferred securities and    other disallowed goodwill and intangible assets  8,618   7,780            Tier 1 Capital  50,461   45,921      Plus: Allowable general valuation allowances and subordinated    debt  11,773   11,375            Risk-based capital $62,234  $57,296                 The Banks may not declare or pay cash dividends if suchdeclaration and payment would violate Federal and/or stateregulatory requirements. Unlike the Banks, the Corporation isnot subject to these regulatory restrictions on the payment ofdividends to its stockholders, the source of which, however, maydepend upon dividends from the Banks. At December 31, 2005,subsidiary net assets of approximately $24,271,000 could betransferred to the Corporation in the form of cash dividendswithout prior regulatory approval, subject to the capital needsof each subsidiary.**Note 13 –****Employee Benefit Plans**         The Corporation maintains a contributory 401(k) definedcontribution plan covering substantially all employees. TheCorporation matches 100% of amounts contributed by eachparticipating employee up to 3% of the employee’scompensation. The Corporation made a matching contribution of 3%to all eligible employees in 2005, 2004, and 2003. TheCorporation may also contribute additional amounts at itsdiscretion. Discretionary contributions of 3.8%, 4.2% and 4.0%were made in fiscal 2005, 2004 and 2003. Plan expense totaledapproximately $344,000, $327,000 and $266,000 in 2005, 2004 and2003, respectively.         The Corporation has a deferred compensation plan covering twoofficers under which it provides contributions to supplementtheir retirement. Under the terms of the agreements, benefits tobe received are generally payable within six months of the dateof the termination of employment with the Corporation. Theexpense associated with this plan in 2005, 2004, and 2003 was$283,000, $290,000 and $183,000, respectively. The present valueof future payments under the plan of $1,881,000 and $1,598,000at December 31 2005 and 2004 is included in otherliabilities. One of the agreements provides for contributions tosupplement health insurance costs. The expense associated withthis portion of the plan in 2005, 2004 and 2003 was $36,000,$1,000 and $5,000, respectively. The present value of futurepayments related to post retirement health insurance costs of$75,000 and $39,000 at December 31, 2005 and 2004 isincluded in other liabilities.         The Corporation owns life insurance policies on the lives ofthese two officers, which have cash surrender values ofapproximately $1,261,000 and $1,165,000 as of December 31,2005 and 2004, respectively and death benefits of $4,773,000 and$4,698,000, respectively. The remaining balance of the
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cash surrender value of bank-owned life insurance of $11,595,000and $6,276,000 as of December 31, 2005 and 2004,respectively, is related to policies on a number of otherofficers of the Banks.**Note 14 –****Leases**         The Corporation and First Business Bank occupy space under anoperating lease agreement that expires on March 31, 2016.Rent expense was approximately $752,000, $647,000 and $518,000for 2005, 2004 and 2003, respectively. First BusinessBank – Milwaukee occupies office space under anoperating lease agreement that expires in November 2010.Additional space was added to the lease in 2005. Rent expensewas approximately $140,000, $134,000 and $133,000 for fiscal2005, 2004 and 2003, respectively. Included in the rent expensewas contingent rent of approximately $237,000, $212,000, and$208,000 for 2005, 2004 and 2003, respectively. The leaseagreements include both fixed rent increases as well ascontingent rent increases. The fixed rent increases are accruedon a straight-line basis. The contingent rent increases areexpensed as incurred.         Future minimum lease payments for each of the five succeedingyears and thereafter are as follows (in thousands):           2006 $581      2007  579      2008  579      2009  579      2010  579     Thereafter  2,474       $5,371     **Note 15 – Income Taxes**         Income tax expense applicable to income for the years endedDecember 31, 2005, 2004 and 2003 consists of the following:                **Year Ended December 31,**     **2005** **2004** **2003**         (In Thousands)    Current:                 Federal $6,005  $(369) $870      State  274   1,030   23              6,279   661   893      Deferred:                 Federal  (3,780)  2,317   1,305      State  (44)  277   (14)             (3,824)  2,594   1,291      Benefit of NOL carryforwards of consolidated subsidiary:                 Federal  -   -   (84)     State  -   -   (21)             -   -   (105)     Reduction of beginning of year valuation allowance applicable to    consolidated subsidiary:                 Federal  -   -   (1,046)     State  -   -   (160)             -   -   (1,206)     Total income tax expense $2,455  $3,255  $873           
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         Deferred income tax assets and liabilities reflect the net taxeffects of temporary differences between the carrying amounts ofassets and liabilities for financial reporting purposes.         The significant components of the Corporation’s deferredtax assets and liabilities are as follows:            **At December 31,**     **2005** **2004**       (In Thousands)    Deferred tax assets:            Allowance for loan and lease losses $2,452  $2,274     Deferred compensation  737   627     Unrealized loss on securities  720   176     Unrealized losses on interest rate swaps  432   572     Federal and state net operating loss carryforwards  2,008   2,598     Alternative minimum tax credit carryforwards  -   771     Low income housing credit carryforwards  -   80     Other  583   483           6,932   7,581     Valuation allowance  (672)  (638)            Total deferred tax assets  6,260   6,943     Deferred tax liabilities:            Leasing and fixed asset activities  3,943   9,015     Other  272   238             Total deferred tax liabilities  4,215   9,253            Net deferred tax asset (liability) $2,045  $(2,310)                The tax effects of unrealized gains and losses on derivativeinstruments and unrealized gains and losses on securities arecomponents of other comprehensive income. A reconciliation ofthe change in net deferred tax assets to deferred tax expensefollows:           **At December 31,**     **2005** **2004**       (In Thousands)    Change in net deferred tax assets (liabilities) $4,355  $(2,561)    Deferred taxes allocated to OCI  (531)  48     Other adjustments  -   (81)           Deferred income tax benefit (expense) $3,824  $(2,594)                Net deferred tax assets and liabilities are included in otherassets and other liabilities, respectively, in the consolidatedbalance sheets.         First Business Financial Services, Inc. and its wholly ownedsubsidiaries have state net operating loss carryforwards ofapproximately $27,500,000 and $35,900,000 at December 31,2005 and 2004, respectively, which can be used to offset theirfuture state taxable income. The carry forwards expire between2012 and 2020. A valuation allowance has been established forthe future benefits attributable to certain of the state netoperating losses.         Included in deferred tax assets is a benefit for separate returnFederal and state net operating loss carryforwards for theBusiness Banc Group, Inc and its subsidiary prior to the 2004transaction. See **Note 3 – Acquisition ofMinority Shares.** As a result of the 2004 transaction, FBFSobtained 100% ownership of BBG and its subsidiary enabling aconsolidated Federal tax return to be filed in 2004. The losscarry forward of approximately $1,694,000 is subject to certainlimitations. It is expected the loss will be utilized within thecarry forward period based on projected consolidated taxableearnings of First Business Financial Services, Inc. and itssubsidiaries and the projected stand alone taxable income ofFirst Business Bank – Milwaukee and appropriate taxplanning strategies.
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         Realization of the deferred tax asset over time is dependentupon the Corporation generating sufficient taxable earnings infuture periods. In determining that realizing the deferred taxwas more likely than not, the Corporation gave consideration toa number of factors including its recent earnings history, itsexpected earnings in the future, appropriate tax planningstrategies and expiration dates associated with operating losscarry forwards.         The provision for income taxes differs from that computed at thefederal statutory corporate tax rate as follows:               **Year Ended December 31,**     **2005** **2004** **2003**         (In Thousands)    Income before minority interest in net income of consolidated    subsidiary and income tax expense $7,212  $7,523  $7,262               Tax expense at statutory federal rate of 34% applied to income    before minority interest in net income of consolidated    subsidiary and income tax expense $2,452  $2,558  $2,469     State income tax, net of Federal effect  152   863   (3)    Low income housing tax credits  (80)  (80)  (80)    Bank-owned life insurance  (141)  (86)  (26)    Written option income  -   (2)  (462)    Reduction in beginning of year valuation allowance applicable to    consolidated subsidiary  -   -   (1,206)    Other  72   2   181               Total income tax expense $2,455  $3,255  $873               Effective tax rate  34.04%  43.32%  12.02%                   The valuation allowance is established against certain statedeferred tax assets for those entities which have state netoperating loss carry forwards in which management believes thatit is more likely than not that the state deferred tax assetswill not be realized.         Like the majority of financial institutions located inWisconsin, First Business Bank transferred investment securitiesand loans toout-of-state investmentsubsidiaries. The Bank’s Nevada investment subsidiaries nowhold and manage these assets. The investment subsidiaries havenot filed returns with, or paid income or franchise taxes to,the State of Wisconsin. The Wisconsin Department of Revenue (the“Department”) recently implemented a program to auditWisconsin financial institutions which formed investmentsubsidiaries located outside of Wisconsin, and the Departmenthas generally indicated that it intends to assess income orfranchise taxes on the income of theout-of-state investmentsubsidiaries of Wisconsin financial institutions. FBB hasreceived a Notice of Audit from the Department that would coveryears 1999 through 2002 and would relate primarily to the issueof income of the Nevada subsidiaries. During 2004, theDepartment offered a blanket settlement agreement to most banksin Wisconsin having Nevada investment subsidiaries. TheDepartment has not issued an assessment to the bank, but theDepartment has stated that it intends to do so if the matter isnot settled.         Prior to the formation of the investment subsidiaries the Banksought and obtained private letter rulings from the Departmentregarding the non-taxability of the investment subsidiaries inthe State of Wisconsin. The Bank believes that it complied withWisconsin law and the private rulings received from theDepartment. Should an assessment be forthcoming, the Bankintends to defend its position vigorously through the normaladministrative appeals process in place at the Department andthrough other judicial channels should they become necessary.Although the Bank will vigorously oppose any such assessmentthere can be no assurance that the Department will not besuccessful in whole or in part in its efforts to tax the incomeof the Bank’s Nevada investment subsidiary. In 2005 and2004, the Bank accrued, as a component of current state taxexpense, an estimated liability including interest which is themost likely amount within a range of probable settlementamounts. FBFS does not expect the resolution of this matter tomaterially affect its consolidated results of operations andfinancial position beyond the
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amounts accrued. Should the Department be wholly successful inits efforts to tax the income of the Nevada subsidiary thenfuture cash flow would be negatively affected by as much as$2.7 million.**Note 16 –****Commitments, Contingencies, and Financial Instruments with    Off-Balance Sheet Risk**         The Banks are party to financial instruments with off-balancesheet risk in the normal course of business to meet thefinancing needs of clients. These financial instruments includecommitments to extend credit and standby letters of credit andinvolve, to varying degrees, elements of credit and interestrate risk in excess of the amounts recognized in theconsolidated financial statements. The contract amounts reflectthe extent of involvement the Banks have in these particularclasses of financial instruments.         In the event of non-performance, the Banks’ exposure tocredit loss for commitments to extend credit and standby lettersof credit is represented by the contractual amount of theseinstruments. The Banks use the same credit policies in makingcommitments and conditional obligations as they do forinstruments reflected in the consolidated financial statements.An accrual for credit losses on financial instruments withoff-balance sheet risk would be recorded separate from anyvaluation account related to any such recognized financialinstrument. As of December 31, 2005 and 2004, there were noaccrued credit losses for financial instruments with off-balancesheet risk.         Financial instruments whose contract amounts represent potentialcredit risk at December 31, 2005 and 2004, respectively,are as follows:           **December 31,**     **2005** **2004**       (Dollars in  **Thousands)**    Commitments to extend credit, primarily commercial loans $168,798  $139,784     Standby letters of credit  18,969   12,876          Commitments to extend credit are agreements to lend to acustomer as long as there is no violation of any condition inthe contract. Commitments generally have fixed expiration datesor other termination clauses and may have a fixed interest rateor a rate which varies with the prime rate or other marketindices and may require payment of a fee. Since some commitmentsexpire without being drawn upon, the total commitment amounts donot necessarily represent future cash requirements of the Banks.The Banks evaluate the creditworthiness of each customer on acase-by-case basis and generally extend credit only on a securedbasis. Collateral obtained varies but consists primarily ofaccounts receivable, inventory, equipment, securities, lifeinsurance or income-producing commercial properties. There isgenerally no market for commercial loan commitments, the fairvalue of which would approximate the present value of any feesexpected to be received as a result of the commitment. These arenot considered to be material to the financial statements.         Standby letters of credit are conditional commitments issued bythe Banks to guarantee the performance of a customer to a thirdparty. Standby letters of credit, collateralized by accountsreceivable, inventory, and income-producing commercialproperties, expire primarily within one year. The credit riskinvolved in issuing letters of credit is essentially the same asthat involved in extending loan facilities to clients. The fairvalue of standby letters of credit is recorded as a liabilitywhen the standby letter of credit is issued. The fair value hasbeen estimated to approximate the fees received by the Banks forissuance. The fees are recorded into income and the fair valueof the guarantee is decreased ratably over the term of thestandby letter of credit.         Management has estimated that there is no probable loss expectedfrom the funding of loan commitments or stand-by letters ofcredit at December 31, 2005 and 2004.         In the normal course of business, various legal proceedingsinvolving the Corporation are pending. Management, based uponadvice from legal counsel, does not anticipate any significantlosses as a result of these actions. Management believes thatany liability arising from any such proceedings currentlyexisting or threatened will not have a material adverse effecton the Corporation’s financial position, results ofoperations, and cash flows.
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**Note 17 –****Fair Value of Financial Instruments**         Disclosure of fair value information about financialinstruments, for which it is practicable to estimate that value,is required whether or not recognized in the consolidatedbalance sheets. In cases where quoted market prices are notavailable, fair values are based on estimates using presentvalue or other valuation techniques. Those techniques aresignificantly affected by the assumptions used, including thediscount rate and estimates of future cash flows. In thatregard, the derived fair value estimates cannot be substantiatedby comparison to independent markets and, in many cases, couldnot be realized in immediate settlement of the instruments.Certain financial instruments and all non-financial instrumentsare excluded from the disclosure requirements. Accordingly, theaggregate fair value amounts presented do not necessarilyrepresent the underlying value of the Corporation.         The carrying amounts reported for cash and cash equivalents,interest bearing deposits, federal funds sold, federal fundspurchased, accrued interest receivable and accrued interestpayable approximate fair value because of their short-termnature and because they do not present unanticipated creditconcerns.         **Securities:** The fair value of securities is estimatedbased on bid prices published in financial newspapers or bidquotations received from securities dealers.         **Loans and Leases:** Fair values are estimated forportfolios of loans with similar financial characteristics. Thefair value of performing loans is calculated by discountingscheduled cash flows through the estimated maturity usingestimated market discount rates that reflect the credit andinterest rate risk inherent in the loan. The estimate ofmaturity is based on the Banks’ historical experience withrepayments for each loan classification, modified, as required,by an estimate of the effect of current economic and lendingconditions.         **Federal Home Loan Bank stock:** The carrying amount ofFHLB stock equals its fair value because the shares can beresold to other member banks at their carrying amount of$100 per share par amount.         **Cash surrender value of life insurance:** The carryingamount of the cash surrender value of life insuranceapproximates its fair value.         **Deposits:** The fair value of deposits with no statedmaturity, such as demand deposits and money market accounts, isequal to the amount payable on demand. The fair value of timedeposits is based on the discounted value of contractual cashflows. The discount rate is estimated using the rates offeredfor deposits of similar remaining maturities.         The fair value estimates do not include the benefit that resultsfrom the low cost funding provided by deposit liabilitiescompared to borrowing funds in the market.         **Securities sold under agreement to repurchase:** Securitiessold under agreement to repurchase reprice frequently, and assuch, fair value approximates the carrying value.         **Borrowed funds:** Rates currently available to theCorporation and Banks for debt with similar terms and remainingmaturities are used to estimate fair value of existing debt.         **Junior subordinated debentures:** Junior subordinateddebentures reprice frequently, and as such, fair valueapproximates the carrying value.         **Financial instruments with off-balance sheet risks:** Thefair value of the Corporation’s off-balance sheetinstruments is based on quoted market prices and fees currentlycharged to enter into similar agreements, taking into accountthe remaining terms of the agreements and the credit standing ofthe related counter party.         Commitments to extend credit and standby letters of credit aregenerally not marketable. Furthermore, interest rates on anyamounts drawn under such commitments would generally beestablished at market rates at the time of the draw. Fair valuewould principally derive from the present value of fees receivedfor those products.         **Interest rate swaps:** The fair value of interest rateswaps is based on the amount the Banks would pay or receive toterminate the contract.
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         **Limitations:** Fair value estimates are made at a discretepoint in time, based on relevant market information andinformation about the financial instrument. These estimates donot reflect any premium or discount that could result fromoffering for sale at one time the Corporation’s entireholding of a particular financial instrument. Because no marketexists for a significant portion of the Corporation’sfinancial instruments, fair value estimates are based onjudgments regarding future expected loss experience, currenteconomic conditions, risk characteristics of various financialinstruments, and other factors. These estimates are subjectivein nature and involve uncertainties and matters of significantjudgment and, therefore, cannot be determined with precision.Changes in assumptions could significantly affect the estimates.         Fair value estimates are based on existing balance sheetfinancial instruments without attempting to estimate the valueof anticipated future business and the value of assets andliabilities that are not considered financial instruments. Inaddition, the tax ramifications related to the realization ofthe unrealized gains and losses can have a significant effect onfair value estimates and have not been considered in theestimates.         Fair value estimates, methods, and assumptions used by theCorporation to estimate fair value for its financial instrumentsare set forth below.                   **December 31,**     **2005** **2004**       **Carrying**   **Carrying**    **Amount** **Fair Value** **Amount** **Fair Value**           (In Thousands)    Financial assets:                    Cash and cash equivalents $16,576  $16,576  $8,671  $8,671     Securities available-for-sale  92,172   92,172   63,685   63,685     Loans and lease receivables  532,716   530,002   469,801   475,903     Loans held for sale  -   -   137   137     Federal Home Loan Bank stock  2,898   2,898   2,760   2,760     Cash surrender value of life insurance  12,856   12,856   7,441   7,441     Accrued interest receivable  2,697   2,697   1,745   1,745     Financial liabilities:                    Deposits  567,464   563,860   474,677   475,650     Securities sold under agreement to repurchase  713   713   678   678     Federal Home Loan Bank and other borrowings  39,045   38,819   29,303   29,413     Junior subordinated debentures  10,310   10,310   10,310   10,310     Interest rate swaps  1,542   1,542   1,147   1,147     Accrued interest payable  2,943   2,943   2,209   2,209     Off-balance sheet items:                    Standby letters of credit  49   49   32   32     Commitments to extend credit  -   *   -   *  *     Amounts not material**Note 18 – Derivative and HedgingActivities**         Derivative gains and losses reclassified from accumulated othercomprehensive income to current period earnings are included inthe line item in which the hedged cash flows are recorded. AtDecember 31, 2005, 2004 and 2003 accumulated othercomprehensive income included unrealized after tax losses of$8,000, $27,000 and $808,000 respectively, related toderivatives used to hedge funding cash flows. The estimatedamount of loss expected to be classified into earnings fromaccumulated other comprehensive income due to net expenses oncash flow hedges within the next twelve months is $5,000.
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         The unrealized holding gains and losses, net of tax effect,included in other comprehensive income at December 31, 2005and 2004, was ($104,000) and ($339,000), respectively.         No derivatives were terminated prior to maturity during 2005,2004, or 2003.         The interest rate swap agreements consist of the following:                                    **As of December 31,**     **2005** **2004**       **Notional** **Maturity** **Fixed** **Variable** **Notional** **Maturity** **Fixed** **Variable**  **Amount** **Date** **Rate** **Rate** **Amount** **Date** **Rate** **Rate**                   (In Thousands)**Cash Flow Hedge:**                                     Pay-fixed interest rate swap $789   April, 2009   5.24%  3.97% $960   April, 2009   5.24%  2.25% **Other Derivatives:**                                     Pay-fixed interest rate swap  10,000   October, 2006   3.94   4.08   10,000   October, 2006   3.94   2.25      Pay-fixed interest rate swap  10,000   November, 2006   3.75   4.12   10,000   November, 2006   3.75   2.25      Pay-fixed interest rate swap  10,000   December, 2006   4.94   4.50   10,000   December, 2006   4.94   2.51      Callable receive-fixed interest rate swap  10,000   January, 2010   4.25   4.44   10,000   January, 2010   4.25   2.48      Callable receive-fixed interest rate swap  10,000   February, 2010   4.35   4.39   10,000   February, 2010   4.35   2.42      Callable receive-fixed interest rate swap  10,000   February, 2010   4.10   4.42   -       -   -      Callable receive-fixed interest rate swap  10,000   November, 2010   4.00   4.41   10,000   November, 2010   4.00   2.42      Pay-fixed interest rate swap  4,742   June, 2011   5.49   4.20   4,823   June, 2011   5.49   2.26                            $75,531              $65,783                                               At December 31, 2005 and 2004, the fair value of theinterest rate swaps designated as cash flow hedges representedunrealized losses of $14,000 and $45,000, respectively. Therewere no unrealized gains on interest rate swaps which qualify ascash flow hedges as of December 31, 2005, 2004 and 2003. AtDecember 31, 2005, the fair value of other derivativesincluded in other assets and other liabilities totaled $40,000and $1,141,000, respectively. At December 31, 2004, thefair value of derivatives included in other liabilities totaled$1,102,000.         As required by SFAS No. 133, the Corporation isamortizing to non-interest income over the remaining term of theswap the market loss of the interest rate swap that no longerqualifies for cash flow hedge accounting because upon adoptionof FIN 46R, the Corporation did not redesignate a newhedging relationship. At December 31, 2005 and 2004, thebalance of the unamortized loss, net of tax effect, on theinterest rate swap included in accumulated other comprehensiveincome is $96,000 and $312,000, respectively.         **Note 19 – Written Option.** FBFS was afounding shareholder in the newly formed bank holding company,BBG, which owned 100% of the stock of the chartered bank,FBB – Milwaukee. FBB – Milwaukee beganoperations in June, 2000. At the inception of BBG, FBFSpurchased 51% of the common stock issued by BBG at $25 pershare. Minority shareholders purchased the remaining 49% of thestock originally issued by BBG at $24.90 per share and paid$.10 per share to FBFS for a written option acquired fromFBFS. FBFS contributed capital of $5.3 million and minorityshareholders contributed capital of $5.0 million. Thewritten options sold to the BBG minority shareholders enabledthe shareholders to exchange their shares of BBG common stockfor shares of FBFS common stock. The written options were dualindexed and were exercisable based upon the ratio of the BBGbook value per share to the FBFS book value per share.Therefore, at inception, if the options had been exercisable,BBG shares would have been convertible into shares of FBFS basedupon the number of FBFS shares at book value that could bepurchased for $24.90. There was no established public market foreither FBFS or BBG shares at the time of this transaction,however shares of FBFS were privately traded. The writtenoptions were dual indexed such that the monetary value of theoptions increased in relation to the increases in the fairvalue, per share, of FBFS’ common stock as compared toFBFS’ book value per share and decreased in relation to theincreases in the fair value, per share, of BBG’s commonstock as compared to BBG’s book value per share.
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         201,880 options were issued having a fair value of approximately$1,938,000. The fair value of the written options was reportedas a derivative liability with a corresponding amount less thecash received of $21,000 for the purchase of the option,reported as an expense in 2000. Subsequent to the initialrecording, the changes in fair value of the options have beenrecorded on the consolidated statements of income as expense orincome.         The options to convert BBG shares into FBFS shares were writtento become exercisable on April 1, 2003, contingent upon BBGhaving had at least $1.00 of annual net income beginning in 2002based upon audited financial statements prepared in accordancewith generally accepted accounting principles. The writtenoptions could only be exercised by tendering the related BBGshares to FBFS, there was no established public market for theBBG stock or the options and the options had no cash netsettlement value.         In November, 2002, the written option was modified to eliminatethe contingency of BBG having at least $1.00 of annual netincome and to make the initial exercise date April 1, 2004.This modification affected the valuation of the option to theextent that the projected exchange ratio would be based on dataas of December 2003 instead of December 2002. In 2003, BBG hadnet income in excess of $1.00 and thus the options would havebecome and did become exercisable on April 1, 2004notwithstanding the modification. At this first date that theoptions were exercisable both indexes, the book value per shareof FBFS and the book value per share of BBG, of this dualindexed option were known. The valuation reflected thisinformation even though BBG shareholders were not obligated toexercise their options. The options became exercisable onApril 1, 2004 for a 60 day period occurring then andeach subsequent year after audited financial statements wereavailable and remained exercisable indefinitely. Allshareholders of BBG exercised their options and tendered all BBGshares in 2004.         Income (expense) reported in other non-interest income relatedto the written options was $7,000 in 2004 and $1,361,000 in2003. Reported in other liabilities at December 31, 2003 isthe fair value of the written options of $661,000. The fairvalue of the written options was $654,000 on the date theoptions were exercised and that amount was considered to besettled as a result of FBFS’ acquisition of BBG.         For purposes of diluted earnings per share, FBFS considered thewritten options in determining diluted earnings per share in2003 and 2004 until settlement occurred on June 1, 2004.See **Note 22.****Note 20 –****Stock Options**         The Corporation adopted an incentive stock option plan in 1993as amended in 1995, and an incentive stock option plan in 2001.The plans authorized the granting of options to acquire sharesof the Corporation at the fair value of the Corporation’sstock on the date of the grant. These options must be exercisedwithin 10 years. The options granted under the 1993 planvest over eight years and the options granted under the 2001plan vest over four years. At December 31, 2005,33,779 shares were available for future grants.         The following table represents a summary of stock optionsactivity for all periods.                           **Year Ended December 31,**     **2005** **2004** **2003**           **Weighted**   **Weighted**   **Weighted**    **Average**   **Average**   **Average**  **Options** **Price** **Options** **Price** **Options** **Price**                 Outstanding at beginning of year  228,654  $19.62   219,739  $15.01   172,956  $9.96     Granted  15,750   25.00   83,059   22.44   85,100   22.00     Exercised  (27,572)  10.37   (70,344)  8.36   (35,767)  6.85     Forfeited  (15,300)  22.98   (3,800)  22.44   (2,550)  20.18                        Outstanding at end of year  201,532  $21.05   228,654  $19.62   219,739  $15.01                        Options exercisable at year end  101,772       90,531       117,611                        
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         The following table represents outstanding stock options andexercisable stock options at the respective ranges of exerciseprices at December 31, 2005.                       **Options Outstanding** **Exercisable**    **Options**    **Weighted**        **Average** **Weighted**   **Weighted**    **Remaining** **Average**   **Average**    **Contractual** **Exercise**   **Exercise****Range of Exercise Prices** **Shares** **Life (Years)** **Price** **Shares** **Price**               9.09  12,214   1  $9.09   12,214  $9.09     11.91  5,228   2   11.91   5,228   11.91     19.38  7,624   5   19.38   5,337   19.38     19.00  16,532   6   19.00   16,532   19.00     22.00  75,700   7   22.00   37,852   22.00     22.39  68,484   9   22.62   24,609   20.40     25.00  15,750   9   25.00   .   .                    201,532           101,772                              Concurrent with organization of BBG, 29,000 stock options weregranted to employees of BBG. These stock options when vestedwould enable the holder to exercise the options to acquire BBGcommon shares which would also include an option to exchangethose shares for shares of FBFS common stock. See WrittenOption** – Note 19.** The exercise price wasset at $25 per share with $.10 per share allocated tothe Conversion Option.         17,750 of these options were forfeited prior toDecember 31, 2003. 7,750 of these were exercised in 2003.An additional 6,125 options were granted in 2004. OnJune 1, 2004, in connection with the acquisition by FBFS ofthe 49% of minority interest in BBG, 9,625 BBG employee stockoptions were converted into 15,689 FBFS options.**Note 21 – ****Condensed Parent Only Financial Information**         The following represents the unconsolidated financialinformation of the Corporation:**Condensed Balance Sheets**            **December 31,**     **2005** **2004**       (In Thousands)**Assets**            Cash and cash equivalents $67  $486     Investments in subsidiaries, at equity  60,274   54,557     Leasehold and equipment, net  724   811     Other  389   926             Total assets $61,454  $56,780         **Liabilities and Stockholders’ Equity**            Borrowed funds $7,750  $5,500     Junior subordinated debentures  10,310   10,310     Other liabilities  1,551   2,829             Total liabilities  19,611   18,639     Stockholders’ equity  41,843   38,141            Total liabilities and stockholders’ equity $61,454  $56,780        
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**Condensed Statements of Income**                **For the Year Ended December 31,**     **2005** **2004** **2003**         (In Thousands)    Interest income $-  $-  $10     Interest expense  1,360   1,149   1,099                Net interest expense  (1,360)  (1,149)  (1,089)    Consulting and rental income from subsidiaries  1,941   2,009   1,771     Written option income  -   7   1,361     Other  139   21   7              720   888   2,050     Non-interest expense  3,747   3,241   2,619               Loss before tax expense and equity in undistributed net income    of subsidiaries  (3,027)  (2,353)  (569)    Income tax benefit  (1,058)  (757)  (654)              Income (loss) before equity in undistributed net income of    subsidiaries  (1,969)  (1,596)  85     Equity in undistributed net income of subsidiaries  6,726   5,855   5,563                Net income $4,757  $4,259  $5,648           **Condensed Statement of Cash Flows**                  **December 31,**    **2005** **2004** **2003**         (In Thousands)**Operating Activities**                Net Income $4,757  $4,259  $5,648     Adjustments to reconcile net income to net cash provided by    operations:                Equity in undistributed earnings of subsidiaries  (6,726)  (5,855)  (5,563)    Change in fair value of interest rate swaps  (285)  (361)  -     Decrease in liabilities  (360)  (550)  (1,606)    Other, net  208   910   (603)               Net cash used in operating activities  (2,406)  (1,597)  (2,124)**Investing Activities**                Payments for investment in and advances to subsidiaries  -   (2,729)  (78)    Change in loans, net  -   -   458                Net cash (used in) provided by investing activities  -   (2,729)  380 **Financing Activities**                Acquisition of minority shares of BBG  -   3,341   -     Exercise of stock options  286   589   245     Proceeds from advances and other borrowed funds  3,250   990   -     Repayment from advances and other borrowed funds  (1,000)  (500)  -     Purchase of treasury stock  (125)  (349)  (4)    Dividends paid  (424)  (241)  (504)    Proceeds from dissolution of BBG  -   382   -                Net cash provided by (used in) financing activities  1,987   4,212   (263)              Decrease in cash and cash equivalents  (419)  (114)  (2,007)    Cash and cash equivalents at beginning of year  486   600   2,607               Cash and cash equivalents at end of year $67  $486  $600           
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**Note 22 – Earnings per Share**         The computation of earnings per share for fiscal years 2005,2004, and 2003, respectively, is as follows:                **December 31,**     **2005** **2004** **2003**           Numerator: $4,757,217  $4,258,804  $5,648,445                Net income                 Numerator for basic earnings per share – income    available to common stockholders  4,757,217   4,258,804   5,648,445               Income for option liability  -   (7,000)  (1,361,000)     Numerator for diluted earnings per share – income    available to common stockholders  4,757,217   4,251,804   4,287,445               Denominator:                 Denominator for basic earnings per share –    weighted-average common shares outstanding  2,422,631   2,249,927   2,011,797               Effect of dilutive securities:                 Employee stock options  41,813   54,670   74,256      BBG employee stock options  -   1,820   10,030      Option liability  -   12,248   30,974                Denominator for diluted earnings per share – adjusted    weighted-average common shares and assumed conversions  2,464,444   2,318,665   2,127,057               Basic earnings per share $1.96  $1.89  $2.81     Diluted earnings per share  1.93   1.83   2.02 **Note 23 – Condensed Quarterly Earnings(unaudited)**                                    **2005** **2004**       **First** **Second** **Third** **Fourth** **First** **Second** **Third** **Fourth**  **Quarter** **Quarter** **Quarter** **Quarter** **Quarter** **Quarter** **Quarter** **Quarter**                   (In thousands, except per share data)    Interest income $7,956  $8,863  $9,376  $10,314  $6,568  $6,795  $7,048  $7,725     Interest expense  3,693   4,365   5,041   5,635   2,598   2,488   2,982   3,205                              Net interest income  4,263   4,498   4,335   4,679   3,970   4,307   4,066   4,520     Provision for loan losses  65   -   53   282   -   -   (834)  294     Gain on sale of 50% owned joint venture  973   -   -   -   -   -   -   -     Other non-interest income  736   1,120   616   793   76   1,790   406   995     Non-interest expense  3,575   3,746   3,550   3,532   3,260   3,111   3,314   3,462     Minority interest in net income of consolidated subsidiary  -   -   -   -   (6)  (3)  -   -                              Income before income taxes  2,332   1,872   1,348   1,658   780   2,983   1,992   1,759     Income taxes  807   649   432   566   305   1,060   1,275   615     Net income $1,525  $1,223  $916  $1,092  $475  $1,923  $717  $1,144                              Per share data:                                    Basic earnings $0.63  $0.51  $0.38  $0.45  $0.23  $0.89  $0.30  $0.47     Diluted earnings  0.62   0.50   0.37   0.44   0.22   0.85   0.29   0.47     Dividends  -   0.115   -   0.06   -   0.10   -   0.11     Stock price ranges – high  25.00   25.00   26.00   29.73   22.00   23.00   24.00   25.00                               – low  24.50   25.00   22.10   23.70   21.00   22.00   23.00   24.00 
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Report of Independent Registered Public Accounting FirmThe Board of Directors and StockholdersFirst Business Financial Services, Inc.         We have audited the accompanying consolidated balance sheets ofFirst Business Financial Services, Inc. and subsidiaries as ofDecember 31, 2005 and 2004, and the related consolidatedstatements of income, changes in stockholders’ equity andcomprehensive income, and cash flows for each of the years inthe three-year period ended December 31, 2005. Theseconsolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express anopinion on these consolidated financial statements based on ouraudits.         We conducted our audits in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing theaccounting principles used and significant estimates made bymanagement, as well as evaluating the overall financialstatement presentation. We believe that our audits provide areasonable basis for our opinion.         In our opinion, the consolidated financial statements referredto above present fairly, in all material respects, the financialposition of First Business Financial Services, Inc. andsubsidiaries as of December 31, 2005 and 2004, and theresults of their operations and their cash flows for each of theyears in the three-year period ended December 31, 2005, inconformity with U.S. generally accepted accountingprinciples./s/ KPMG LLPMilwaukee, WisconsinMarch 15, 2006
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**Item 9. Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**         None.**Item 9A. Controls and Procedures**         **Evaluation of Disclosure Controls and Procedures.** FBFSmaintains disclosure controls and procedures as required underRule 13a-15promulgated under the Securities Exchange Act of 1934, asamended (the “Exchange Act”), that are designed toensure that information required to be disclosed in our ExchangeAct reports is recorded, processed, summarized and reportedwithin the time periods in the SEC’s rules and forms, andthat such information is accumulated and communicated to theCorporation’s management, including its Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosures.         At December 31, 2004, March 31, 2005 and June 30,2005, FBFS’s management carried out an evaluation, underthe supervision and with the participation of FBFS’s ChiefExecutive Officer and Chief Financial Officer, of theeffectiveness of its disclosure controls and procedures. Basedon those evaluations, FBFS’s management initially concludedthat as of December 31, 2004, March 31, 2005 andJune 30, 2005, such disclosure controls and procedures wereeffective. However, on November 8, 2005, management and theAudit Committee of the Board of Directors of FBFS concluded thatFBFS had a material weakness in its internal control overfinancial reporting as described below. Because of this materialweakness in its internal control over financial reporting(described below) which impacted the financial statements forthe first two quarters of 2005 and as of and for the years endedDecember 31, 2004, 2003, and 2002, management concludedthat FBFS’s disclosure controls and procedures were noteffective as of December 31, 2004, March 31, 2005,June 30, 2005 or September 30, 2005. Managementidentified the following material weakness in internal controlover financial reporting as of December 31, 2004,March 31, 2005, June 30, 2005 and September 30,2005:         As of the aforementioned period-ends, FBFS had ineffectivepolicies and procedures relating to the accounting for certainderivative financial instruments under Statement of FinancialAccounting Standards No. 133, *Accounting for DerivativeInstruments and Hedging Activities(“SFAS 133”).* Specifically, FBFS’spolicies and procedures did not provide for sufficient testingand verification of the criteria for the “short cut”method to ensure proper application of the provisions ofSFAS No. 133 at inception for certain derivativefinancial instruments and did not provide for periodic timelyreview of the proper accounting for certain derivative financialinstruments for periods subsequent to inception. In addition,FBFS did not have personnel possessing sufficient technicalexpertise related to the application of the provisions ofSFAS No. 133, or with a sufficient understanding ofderivative instruments. This material weakness has resulted inthe restatement of the Company’s financial statements forthe first two quarters of 2005 and for the years endedDecember 31, 2004, 2003 and 2002 and the restatement offinancial information for the year ended December 31, 2001and each of the quarters in 2004.         **Changes in Internal Control over Financial Reporting.**FBFS continually assesses the adequacy of its internal controlover financial reporting and enhances its controls in responseto internal control assessments and internal and external auditand regulatory recommendations.         Since November 8, 2005, we have implemented severalimportant changes in our internal control over financialreporting related to our accounting for derivatives. Theseactions include: nEnhancing risk    management policies and procedures related to reviewing    derivative transactions;  nReviewing    policies and procedures related to the initiation and subsequent    review of hedge strategies; and  nChanging    policies and procedures to limit the Corporation’s use of    the “short cut” method.         These actions have significantly improved our internal controlover financial reporting. The Corporation has not entered intoany derivative transactions during the fourth quarter endingDecember 31, 2005. Management believes that we have fullyremediated the material weakness referred to above as ofDecember 31, 2005.
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         Additionally, as part of management’s continual assessmentof internal controls over financial reporting the method bywhich the Corporation administers the internal audit functionwas restructured during the fourth quarter. The audit committeeapproved outsourcing the internal audit function to a qualifiedpublic accounting firm to provide for expanded resourcesavailable to management. The internal audit function continuesto report directly to the CEO and the Chair of the auditcommittee.**Item 9B. Other Information**         On March 15, 2006 the Board of Directors approved the 2006Incentive Bonus Program that is attached as Exhibit 10.8.Two performance criteria weighted equally will be used asmeasurements in the program as follows: Top Line Growth definedas net interest income plus fee income and Cash Flow Growthdefined as net income after tax, before loan loss provision,after actual net charge offs.
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**PART III.****Item 10. Directors and Executive Officers of theRegistrant** (a)  *Directors of the Registrant.* Information with respect to    the Directors of the registrant , included in the definitive    Proxy Statement for the Annual Meeting of the Stockholders to be    held on May 1, 2006 under the captions “Board of    Directors” and “Section 16(a) Beneficial    Ownership Reporting Compliance” is incorporated herein by    reference. (b)  *Executive Officers of the Registrant.* The information is    presented in **Item 1**of this document. (c)  *Code of Ethics.* The Corporation has adopted a code of    ethics applicable to all employees, including the principal    executive and principal accounting officer of the Corporation.    The FBFS Code of Ethics is posted on the Corporation’s    website at www.fbfinancial.com**Item 11. Executive Compensation**         Information with respect to compensation for our directors andofficers included in the definitive Proxy Statement for theAnnual Meeting to be held on May 1, 2006 under the captions“Director Compensation” and “ExecutiveCompensation” is incorporated herein by reference.**Item 12. Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters**         Information with respect to security ownership of certainbeneficial owners and management, including securitiesauthorized for issuance under equity compensation plans,included in the definitive Proxy Statement for the AnnualMeeting of the Stockholders to be held on May 1, 2006 underthe captions “Principal Shareholders”, “ExecutiveCompensation” and “Section 16(a) BeneficialOwnership Reporting Compliance” is incorporated herein byreference.**Item 13. Certain Relationships and RelatedTransactions**         The Corporation’s executive officers and directors andtheir associates have been, and the Corporation anticipates willcontinue to be, clients of the Corporation’s subsidiaryBanks in the ordinary course of business, which has includedmaintaining deposit accounts and trust and other fiduciaryaccounts and obtaining loans. Specifically, the Banks,principally FBB, have granted various types of loans to theCorporation’s executive officers and directors and entitiescontrolled by them. As of December 31, 2005, the loans(i) were consistent with similar practices in the bankingindustry generally, (ii) were made in the ordinary courseof business and on substantially the same terms, includinginterest rates and collateral, as those prevailing the time forcomparable transactions with the Banks’ other clients,(iii) did not involve more than the normal risk ofcollectibility or present other unfavorable features, and(iv) were subject to and made in accordance withRegulation O as promulgated by the Federal Reserve Board.**Item 14. Principal Accountant Fees and Services**         Information with respect to principal accounting fees andservices included in the definitive Proxy Statement for theAnnual Meeting of the Stockholders to be held on May 1,2006 under the caption “Independent Registered PublicAccounting Firm” is incorporated herein by reference.**ITEM IV****Item 15. Exhibits and Financial StatementsSchedules**         The consolidated financial statements listed on the Indexincluded under **“Item 8 – FinancialStatements and Supplementary Data”** are filed as a partof this Form 10-K.All financial statement schedules have been included in theconsolidated financial statements or are either not applicableor not significant.         **Exhibits.** See Exhibit Index.
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**Signatures**         Pursuant to the requirements of Section 12 of theSecurities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned,thereunto duly authorized. **FIRST BUSINESS FINANCIAL SERVICES, INC.**      By: /s/ Jerome J. Smith       Jerome J. Smith     Director and Chief Executive Officer      March 15, 2006
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       **Exhibit No.** **Exhibit Name**   3.1      Amended and Restated Articles of Incorporation of First Business    Financial Services, Inc.     *  3.2      Amended and Restated Bylaws of First Business Financial    Services, Inc.     *  4      Pursuant to Item 601(b)(4)(iii) of Regulation S-K, the    Registrant agrees to furnish to the Securities and Exchange    Commission, upon request, any instrument defining the rights of    holders of long-term debt not being registered that is not filed    as an exhibit to this Registration Statement on Form 10. No    such instrument authorizes securities in excess of 10% of the    total assets of the Registrant    10.1      2001 Equity Incentive Plan     *  10.2      Form of Stock Option Agreement     *  10.3      Employment Agreement dated June 23, 1995 between the    Registrant and Jerome J. Smith, as amended, June 25, 2004     *  10.4      Employment Agreement amended and restated September 21,    2004 between First Business Bank and Corey Chambas     *  10.5      Restated Employment Agreement dated December 14, 2005    between the Registrant and Jerome J. Smith (previously filed as    Exhibit 10.1 and incorporated by reference in the 8-K    filed on December 16, 2005)    10.6      Employment and Repayment Agreement between First Business    Capital Corp. and Charles H. Batson, dated December 14,    2005 and amended February 6, 2006 (previously filed as    Exhibits 10.1 and 10.2 and incorporated by reference in    the 8-Ks filed on December 20, 2005 and    February 10, 2006)    10.7      Form of Restricted Stock Agreement (previously filed as    Exhibit 10.1 and incorporated by reference in the 8-K    filed on February 7, 2006 )    10.8      2006 Incentive Bonus Program    21      Subsidiaries of the Registrant     *  23      Consent of KPMG LLP    31.1      Certification of the Chief Executive Officer    31.2      Certification of the Senior Vice President and Chief Financial    Officer    32      Certification of the Chief Executive Officer and Senior Vice    President and Chief Financial Officer pursuant to 18 U.S.C.    Section 1350    99      Proxy Statement for the Annual Meeting of the Stockholders (to    be filed with the SEC under Regulation 14A within    120 days after December 31, 2005; except to the extend    specifically incorporated by reference, the Proxy Statement for    the Annual Meeting of the Stockholders shall not be deemed to be    filed with the SEC as part of this Annual Report on    Form 10-K)   *All exhibits previously filed and incorporated by reference inthe Amended Registration Statement on Form 10 filedApril 28, 2005.
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