XNAS:BKMU Bank Mutual Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

xQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2012

 

OR

 

¨Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File Number: 000-31207

 

BANK MUTUAL CORPORATION

(Exact name of registrant as specified in its charter) 

Wisconsin
39-2004336
(State or other jurisdiction of   (IRS Employer Identification No.)
incorporation or organization)    

 

4949 West Brown Deer Road
Milwaukee, Wisconsin  53223
(414) 354-1500
(Address, including Zip Code, and telephone number,
including area code, of registrant’s principal executive offices)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  x      No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)

 

Yes  x      No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

  

Large accelerated filer  ¨ Accelerated filer            x
Non-accelerated filer  ¨ Small reporting company   ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ¨      No x

 

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 46,326,484 shares, at May 8, 2012.

 

 
 

 

BANK MUTUAL CORPORATION

 

FORM 10-Q QUARTERLY REPORT

 

Table of Contents

 

Item   Page
     
PART I    
     
Item l. Financial Statements  
     
  Unaudited Condensed Consolidated Statements of Financial Condition  
  as of March 31, 2012, and December 31, 2011 3
     
  Unaudited Condensed Consolidated Statements of Income  
  for the three months ended March 31, 2012 and 2011 4
     
  Unaudited Condensed Consolidated Statements of Total Comprehensive  
  Income for the three months ended March 31, 2012 and 2011 5
     
  Unaudited Condensed Consolidated Statements of Equity  
  for the three months ended March 31, 2012 and 2011 6
     
  Unaudited Condensed Consolidated Statements of Cash Flows  
  for the three months ended March 31, 2012 and 2011 7
     
  Notes to Unaudited Condensed Consolidated Financial Statements 8
     
Item 2. Management's Discussion and Analysis of Financial  
  Condition and Results of Operations 30
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 45
     
Item 4. Controls and Procedures 49
     
PART II    
     
Item 1A. Risk Factors 50
     
Item 6. Exhibits 50
     
SIGNATURES 51

 

2
 

 

PART I

 

Item 1. Financial Statements

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Financial Condition

 

   March 31   December 31 
   2012   2011 
   (Dollars in thousands) 
Assets          
           
Cash and due from banks  $31,438   $52,306 
Interest-earning deposits   90,273    68,629 
Cash and cash equivalents   121,711    120,935 
Mortgage-related securities available-for-sale, at fair value   776,838    781,770 
Mortgage-related securities held-to-maturity, at amortized cost (fair value of $149,694 in 2012)   150,764     
Loans held-for-sale, net   22,877    19,192 
Loans receivable (net of allowance for loan losses of $25,241 in 2012 and $27,928 in 2011)   1,305,366    1,319,636 
Foreclosed properties and repossessed assets   22,176    24,724 
Mortgage servicing rights, net   8,039    7,401 
Other assets   202,414    224,826 
           
Total assets  $2,610,185   $2,498,484 
           
Liabilities and equity          
           
Liabilities:          
Deposit liabilities  $2,032,946   $2,021,663 
Borrowings   182,786    153,091 
Advance payments by borrowers for taxes and insurance   13,094    3,192 
Other liabilities   109,573    51,842 
Total liabilities   2,338,399    2,229,788 
Equity:          
Preferred stock–$0.01 par value:          
Authorized–20,000,000 shares in 2012 and 2011 Issued and outstanding–none in 2012 and 2011        
Common stock–$0.01 par value:          
Authorized–200,000,000 shares in 2012 and 2011 Issued–78,783,849 shares in 2012 and 2011 Outstanding–46,326,484 shares in 2012 and 46,228,984 in 2011   788    788 
Additional paid-in capital   489,082    490,159 
Retained earnings   141,485    140,793 
Accumulated other comprehensive loss   (3,069)   (5,379)
Treasury stock–32,457,365 shares in 2012 and 32,554,865 in 2011   (359,409)   (360,590)
Total shareholders’ equity   268,877    265,771 
Non-controlling interest in real estate partnership   2,909    2,925 
Total equity including non-controlling interest   271,786    268,696 
           
Total liabilities and equity  $2,610,185   $2,498,484 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

3
 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

 

   Three Months Ended
March 31
 
   2012   2011 
   (Dollars in thousands,
except per share data)
 
Interest income:          
Loans  $16,423   $17,873 
Mortgage-related securities   4,301    3,795 
Investment securities   12    1,344 
Interest-earning deposits   41    51 
Total interest income   20,777    23,063 
Interest expense:          
Deposit liabilities   4,055    5,469 
Borrowings   1,823    1,770 
Advance payments by borrowers for taxes and insurance   1    1 
Total interest expense   5,879    7,240 
Net interest income   14,898    15,823 
Provision for loan losses   51    3,180 
Net interest income after provision for loan losses   14,847    12,643 
Non-interest income:          
Service charges on deposits   1,559    1,468 
Brokerage and insurance commissions   581    614 
Loan related fees and servicing revenue, net   137    251 
Gain on loan sales activities, net   2,904    596 
Gain on investments, net       1,113 
Increase in cash surrender value of life insurance   527    545 
Other non-interest income   1,563    1,208 
Total non-interest income   7,271    5,795 
Non-interest expense:          
Compensation, payroll taxes, and other employee benefits   10,575    9,399 
Occupancy and equipment   2,954    2,998 
Federal insurance premiums   831    1,022 
Advertising and marketing   599    245 
Losses and expenses on foreclosed real estate, net   2,779    1,030 
Other non-interest expense   2,779    2,356 
Total non-interest expense   20,517    17,050 
Income before income taxes   1,601    1,388 
Income tax expense   462    361 
Net income before non-controlling interest   1,139    1,027 
Net loss attributable to non-controlling interest   16    13 
           
Net income  $1,155   $1,040 
           
Per share data:          
Earnings per share–basic  $0.03   $0.02 
Earnings per share–diluted  $0.03   $0.02 
Cash dividends per share paid  $0.01   $0.03 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

4
 

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Total Comprehensive Income

 

   Three Months Ended
March 31
 
   2012   2011 
   (Dollars in thousands,
except per share data)
 
         
Net income before non-controlling interest  $1,139   $1,027 
Other comprehensive income (loss), net of tax:          
Unrealized holding gains (losses) during the period:          
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $1,449 in 2012 and $331 in 2011   2,165    495 
Reclassification adjustment for realized gains on sales of securities available-for-sale, net of income taxes of $(446) in 2011       (667)
    2,165    (172)
Defined benefit pension plans:          
Amortization of prior period net loss included in net periodic pension cost, net of deferred income taxes of $97 in 2012   145     
Other pension-related adjustments, net of deferred income taxes of $(41) in 2011       (62)
    145    (62)
Total other comprehensive income (loss), net of tax   2,310    (234)
Total comprehensive income before non-controlling interest   3,449    793 
Comprehensive loss attributable to non-controlling interest   16    13 
           
Total comprehensive income  $3,465   $806 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

5
 

 

Bank Mutual Corporations and Subsidiaries

 Unaudited Condensed Consolidated Statements of Equity

 

               Accumulated       Non-Controlling     
       Additional       Other       Interest in     
   Common   Paid-In   Retained   Comprehensive   Treasury   Real Estate     
   Stock   Capital   Earnings   Income (Loss)   Stock   Partnership   Total 
   (Dollars in thousands, except per share data) 
                             
Balance at January 1, 2012  $788   $490,159   $140,793   $(5,379)  $(360,590)  $2,925   $268,696 
Net income           1,155                1,155 
Net loss attributable to non-controlling interest                       (16)   (16)
Other comprehensive income               2,310            2,310 
Issuance of management recognition plan shares       (1,181)           1,181         
Share based payments       104                    104 
Cash dividends ($0.01 per share)           (463)               (463)
                                    
Balance at March 31, 2012  $788   $489,082   $141,485   $(3,069)  $(359,409)  $2,909   $271,786 
                                    
Balance at January 1, 2011  $788   $494,377   $191,238   $(6,897)  $(366,553)  $2,925   $315,878 
Net income           1,040                1,040 
Net loss attributable to non-controlling interest                       (13)   (13)
Other comprehensive loss               (234)           (234)
Issuance of management recognition plan shares       (123)           123         
Exercise of stock options       (352)           485        133 
Share based payments       70                    70 
Cash dividends ($0.03 per share)           (1,372)               (1,372)
                                    
Balance at March 31, 2011  $788   $493,972   $190,906   $(7,131)  $(365,945)  $2,912   $315,502 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

6
 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

 

   Three months ended
March 31
 
   2012   2011 
   (Dollars in thousands) 
Operating activities:          
Net income  $1,155   $1,040 
Adjustments to reconcile net income to net cash from operating activities:          
Net provision for loan losses   51    3,180 
Net loss on foreclosed real estate   2,379    685 
Provision for depreciation   627    649 
Amortization of mortgage servicing rights   1,043    516 
Decrease in valuation allowance on MSRs   (321)   (6)
Net premium amortization on securities   1,048    530 
Loans originated for sale   (126,898)   (22,847)
Proceeds from loan sales   124,757    56,751 
Net gain on loan sales activities   (2,904)   (596)
Net gain on sale of investments       (1,113)
Other, net   (5,590)   (7,337)
Net cash provided (used) by operating activities   (4,653)   31,452 
Investing activities:          
Purchases of mortgage-related securities available-for-sale   (51,374)   (168,832)
Purchases of mortgage-related securities held-to-maturity   (84,602)    
Principal repayments on mortgage-related securities available-for-sale   58,873    27,875 
Proceeds from sale of investment securities       21,950 
Proceeds from redemption of FHLB of Chicago stock   18,417     
Net decrease (increase) in loans receivable   10,150    (9,060)
Proceeds from sale of foreclosed properties   4,238    677 
Net purchases of premises and equipment   (690)   (445)
Net cash used by investing activities   (44,988)   (127,835)
Financing activities:          
Net increase (decrease) in deposit liabilities   11,283    (60,314)
New long-term borrowings   30,000     
Repayments of borrowings   (305)   (272)
Net increase in advance payments by borrowers for taxes and insurance   9,902    9,251 
Cash dividends   (463)   (1,372)
Other, net       133 
Net cash provided (used) by financing activities   50,417    (52,574)
Increase (decrease) in cash and cash equivalents   776    (148,957)
Cash and cash equivalents at beginning of period   120,935    232,832 
Cash and cash equivalents at end of period  $121,711   $83,875 
           
Supplemental information:          
Cash paid in period for:          
Interest on deposit liabilities and borrowings  $5,873   $8,826 
Income taxes   2     
 Non-cash transactions:          
Loans  transferred to foreclosed properties and repossessed assets   5,777    6,722 
Due to brokers for securities purchases   66,162     

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

7

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

1.Basis of Presentation

 

The Unaudited Condensed Consolidated Financial Statements include the accounts of Bank Mutual Corporation (the “Company”), its wholly-owned subsidiary Bank Mutual (the “Bank”), and the Bank’s subsidiaries.

 

The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information, Rule 10-01 of Regulation S-X, and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by GAAP for complete financial information. However, in the opinion of management, all adjustments (consisting of normal recurring entries) necessary for a fair presentation of operations, cash flows, and financial position have been included in the accompanying financial statements. This report should be read in conjunction with the Company’s 2011 Annual Report on Form 10-K. Operating results for the three months ended March 31, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

 

In April 2011 the FASB issued new accounting guidance related to a creditor’s determination of whether a loan restructuring is a troubled debt restructuring. The new guidance was effective for the first interim period beginning on or after June 15, 2011, which was the third quarter of 2011 for the Company. The Company's adoption of this new guidance did not have a material impact on its financial condition, results of operations, or liquidity, although it did affect the matters that are disclosed in the financial statements.

 

During the second quarter of 2011 the FASB issued new accounting guidelines related to (i) accounting for repurchase agreements, (ii) certain fair value measurements of assets, liability, and instruments classified in shareholders’ equity, and (iii) presentation of net income, other comprehensive income, and total comprehensive income (certain aspects the adoption of which were deferred indefinitely in the fourth quarter of 2011). These new guidelines were effective for the first interim period beginning on or after December 15, 2011, which was the first quarter of 2012 for the Company. The Company's adoption of these guidelines did not have a material impact on its financial condition, results of operations, or liquidity. However, the new guidelines did affect the matters that are disclosed in the financial statements.

 

During the fourth quarter of 2011 the FASB issued new accounting guidelines related to (i) the determination of whether a parent should derecognize the in-substance real estate of a subsidiary that is in-substance real estate when the parent ceases to have a controlling financial interest in the subsidiary and (ii) the disclosure of both gross information and net information about instruments eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting agreement. Item (i) will be effective for interim and fiscal periods beginning on or after June 15, 2012, which for the Company will be the third quarter of 2012. Item (ii) will be effective for interim and fiscal periods beginning on or after January 1, 2013, which for the Company will be the first quarter of 2013. The Company's adoption of these guidelines is not expected to have a material impact on its financial condition, results of operations, or liquidity. However, the new guidelines may affect matters that will be disclosed in the financial statements.

 

The Company describes all of its critical and/or significant accounting policies, judgments, and estimates in Note 1 of its Audited Consolidated Financial Statements contained in its 2011 Annual Report on Form 10-K. Particular attention should be paid to the Company’s allowance for losses on loans, which requires significant management judgments and/or estimates because of the inherent uncertainties surrounding this area and/or the subjective nature of the area. Information regarding the impact loss allowances have had on the Company's financial condition and results of operations for the three month periods ended March 31, 2012 and 2011, can be found in Note 3, “Loans Receivable,” below.

 

Significant judgments and/or estimates are also made in accounting for the Company’s net deferred income taxes and other-than-temporary impairment (“OTTI”) of its mortgage-related securities. Management evaluates the Company’s net deferred tax asset on an on-going basis to determine if a valuation allowance is required. In the judgment of management there was no need for a valuation allowance against the Company’s net deferred tax asset as of March 31, 2012. Information regarding the impact OTTI has had on the Company’s financial condition and results of operations for the three month periods ended March 31, 2012 and 2011, can be found in Note 2, “Securities Available-for-Sale,” below.

 

8

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

  

2.Mortgage-Related Securities Available-for-Sale and Held-to-Maturity

 

The amortized cost and fair value of mortgage-related securities available-for-sale and held-to-maturity are as follows:

  

   March 31, 2012 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Securities available-for-sale:                    
Federal Home Loan Mortgage Corporation  $496,732   $11,600       $508,332 
Federal National Mortgage Association   206,314    2,837        209,151 
Government National Mortgage Association   41    7        48 
Private-label CMOs   62,423    579   $(3,695)   59,307 
Total available-for-sale  $765,510   $15,023   $(3,695)  $776,838 
Securities held-to-maturity:                    
Federal National Mortgage Association  $150,764       $(1,070)  $149,694 
Total held-to-maturity  $150,764       $(1,070)  $149,694 

 

   December 31, 2011 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Securities available-for-sale:                    
Federal Home Loan Mortgage Corporation  $537,935   $11,009       $548,944 
Federal National Mortgage Association   167,601    2,476   $(57)   170,020 
Government National Mortgage Association   767    10        777 
Private-label CMOs   67,754    540   $(6,265)   62,029 
Total available-for-sale  $774,057   $14,035   $(6,322)  $781,770 

 

9

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

2.Mortgage-Related Securities Available-for-Sale and Held-to-Maturity (continued)

 

The following tables summarize mortgage-related available-for-sale and held-to-maturity securities by amount of time the securities have had a gross unrealized loss as of the dates indicated:

 

   March 31, 2012 
   Less Than 12 Months   Greater Than 12 Months         
   in an Unrealized Loss Position   in an Unrealized Loss Position   Gross   Total 
   Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Estimated
Fair
Value
 
Securities available-for-sale:                                        
Private-label CMOs              $(3,695)   17   $35,089   $(3,695)  $35,089 
Total available-for-sale              $(3,695)   17   $35,089   $(3,695)  $35,089 
Securities held-to-maturity:                                        
Federal National Mortgage Association  $(1,070)   16   $149,694               $(1,070)  $149,694 
Total held-to-maturity  $(1,070)   16   $149,694               $(1,070)  $149,694 

  

   December 31, 2011 
   Less Than 12 Months   Greater Than 12 Months         
   in an Unrealized Loss Position   in an Unrealized Loss Position   Gross   Total 
   Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Estimated
Fair
Value
 
Securities available-for-sale:                                        
Federal National Mortgage Association  $57    1   $9,603               $57   $9,603 
Private-label CMOs   1    1    448   $6,264    20   $40,523    6,265    40,971 
Total available-for-sale  $58    2   $10,051   $6,264    20   $40,523   $6,322   $50,574 

 

Certain of the Company’s available-for-sale and held-to-maturity securities that were in an unrealized loss position at March 31, 2012, and December 31, 2011, consisted of mortgage-related securities issued by government-sponsored entities. As of those dates, the Company believed that it was probable that it would receive all future contractual cash flows related to such securities. The Company did not intend to sell the securities and it is unlikely that it would be required to sell the securities before the recovery of their amortized cost. Accordingly, the Company determined that the unrealized loss on its mortgage-related securities issued by government-sponsored entities was temporary as of March 31, 2012, and December 31, 2011.

 

The Company also determined that the unrealized loss on its private-label collateralized mortgage obligations (“CMOs”) was temporary as of March 31, 2012, and December 31, 2011. The Company does not intend to sell these securities and it is unlikely that it will be required to sell these securities before the recovery of their amortized cost. The Company believes it is probable that it will receive all future contractual cash flows related to these securities. This determination was based on management’s judgment regarding the nature of the loan collateral that supports the securities, a review of the current ratings issued on the securities by various credit rating agencies, a review of the actual delinquency and/or default performance of the loan collateral that supports the securities, and recent trends in the fair market values of the securities. As of March 31, 2012, and December 31, 2011, the Company had private-label CMOs, with a fair value of $36,617 and $36,751 respectively, and unrealized losses of $3,233 and $5,357, respectively, that were rated less than investment grade. These private-label CMOs were analyzed using modeling techniques that considered the priority of cash flows in the CMO structure and various default and loss rate scenarios that management considered appropriate given the nature of the loan collateral.

 

Results of operations included gross realized gains on the sale of securities of zero and $1,113 for the three-month periods ended March 31, 2012 and 2011, respectively. None of these periods included gross realized losses on the sales of securities.

 

10

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

2.Mortgage-Related Securities Available-for-Sale and Held-to-Maturity (continued)

 

Mortgage-related securities available-for-sale with a fair value of approximately $77,393 and $91,731 at March 31, 2012, and December 31, 2011, respectively, were pledged to secure deposits, borrowings, and for other purposes as permitted or required by law.

 

3.Loans Receivable

 

The following table summarizes the components of loans receivable as of the dates indicated:

 

   March 31   December 31 
   2012   2011 
Permanent mortgage loans:          
One- to four-family  $496,116   $508,503 
Multi-family   251,591    247,040 
Commercial real estate   215,347    226,195 
Total permanent mortgages   963,054    981,738 
Construction and development loans:          
One- to four-family   14,444    16,263 
Multi-family   17,086    29,409 
Commercial real estate   32,429    19,907 
Land   14,651    16,429 
Total construction and development   78,610    82,008 
Total real estate mortgage loans   1,041,664    1,063,746 
Consumer loans:          
Fixed home equity   104,366    102,561 
Home equity lines of credit   83,562    86,540 
Student   15,161    15,711 
Home improvement   23,990    24,237 
Automobile   1,591    2,228 
Other consumer   8,766    7,177 
Total consumer loans   237,436    238,454 
Commercial business loans   87,596    87,715 
Total loans receivable   1,366,696    1,389,915 
Undisbursed loan proceeds   (35,544)   (41,859)
Allowance for loan losses   (25,241)   (27,928)
Unearned loan fees and discounts   (545)   (492)
Total loans receivable, net  $1,305,366   $1,319,636 

 

The Company’s first mortgage loans and home equity loans are primarily secured by properties that are located in the Company's local lending areas in Wisconsin, Illinois, Michigan, and Minnesota. Substantially all of the Company’s non-mortgage loans have also been made to borrowers in these same lending areas.

 

At March 31, 2012, and December 31, 2011, certain one- to four-family mortgage loans, multi-family mortgage loans, and home equity loans with aggregate carrying values of approximately $244,000 and $204,000 were pledged to secure advances from the FHLB of Chicago.

 

The unpaid principal balance of loans serviced for others was $1,111,176 and $1,102,126 at March 31, 2012, and December 31, 2011, respectively. These loans are not reflected in the consolidated financial statements.

 

11

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

The following tables summarize the activity in the allowance for loan losses by loan portfolio segment for the periods indicated. The tables also summarize the allowance for loan loss and loans receivable by the nature of the impairment evaluation, either individually or collectively, at the dates indicated (the loans receivable amounts in the table are net of undisbursed loan proceeds).

 

   March 31, 2012 
Allowance for loan losses:  One- to
Four-
Family
  

 

Multi-

Family

   Commercial
Real
Estate
   Construction
and
Development
  

 

 

Consumer

  

 

Commercial

Business

  

 

 

Total

 
Beginning balance  $3,201   $7,442   $9,467   $4,506   $1,214   $2,098   $27,928 
Provision   399    (178)   333    (169)   216    (550)   51 
Charge-offs   (377)   (697)   (2,245)   (102)   (278)   (10)   (3,709)
Recoveries       568    399        4        971 
Ending balance  $3,223   $7,135   $7,954   $4,235   $1,156   $1,538   $25,241 
Loss allowance individually evaluated for impairment  $452   $1,213   $305   $3,372   $281   $274   $5,897 
Loss allowance collectively evaluated for impairment  $2,771   $5,922   $7,649   $863   $875   $1,264   $19,344 
                                    
Loan receivable balances at the end of the period:                                   
Loans individually evaluated for impairment  $13,987   $21,252   $26,996   $19,777   $1,567   $3,148   $86,727 
Loans collectively evaluated for impairment   470,378    230,340    188,350    35,039    235,869    84,449    1,244,425 
Total loans receivable  $484,365   $251,592   $215,346   $54,816   $237,436   $87,597   $1,331,152 

  

   March 31, 2011 
Allowance for loan losses:  One- to
Four-
Family
  

 

Multi-

Family

   Commercial
Real
Estate
   Construction
and
Development
  

 

 

Consumer

  

 

Commercial

Business

  

 

 

Total

 
Beginning balance  $3,726   $9,265   $21,885   $10,141   $1,427   $1,541   $47,985 
Provision   (98)   1,747    286    996    (103)   352    3,180 
Charge-offs   (1,092)   (2,878)   (735)   (2,415)   (228)   (302)   (7,650)
Recoveries                   4    7    11 
Transfers       2,765    2,026    (4,791)            
    Ending balance  $2,536   $10,899   $23,462   $3,931   $1,100   $1,598   $43,526 
Loss allowance individually evaluated for impairment  $761   $5,561   $17,363   $2,628   $602   $383   $27,298 
Loss allowance collectively evaluated for impairment  $1,775   $5,338   $6,099   $1,303   $498   $1,215   $16,228 
                                    
Loan receivable balances at the end of the period:                                   
Loans individually evaluated for impairment  $20,683   $44,609   $56,863   $16,165   $1,724   $4,319   $144,363 
Loans collectively evaluated for impairment   512,735    196,242    193,098    35,073    236,081    49,176    1,222,405 
Total loans receivable  $533,418   $240,851   $249,961   $51,238   $237,805   $53,495   $1,366,768 

 

During the three months ended March 31, 2012 and 2011, the Company adjusted certain factors used to determine the allowance for loan losses on loans that are collectively evaluated for impairment. Management considered these adjustments necessary and prudent in light of recent trends in real estate values, economic conditions, and unemployment. The Company estimates that these adjustments, as well as overall changes in the balance of loans to which these factors were applied, resulted in decreases of $279 and $186 in the total allowances for loan losses during the three months ended March 31, 2012 and 2011, respectively. The transfers noted in the table were the result of the reclassification of certain construction loans to permanent loans as a result of the completion of construction.

 

12

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3.Loans Receivable (continued)

 

The following tables present information regarding impaired loans that have a related allowance for loan loss and those that do not as of the dates indicated (the loans receivable amounts in the table are net of undisbursed loan proceeds).

 

   March 31, 2012 
With an allowance recorded:  Loans
Receivable
Balance, Net
   Unpaid
Principal
Balance
   Related
Allowance
for Loss
   Average Loan
Receivable
Balance, Net
   Interest
Income
Recognized
 
One- to four-family  $3,521   $3,521   $452   $3,064   $16 
Multi-family   13,482    13,944    1,213    16,244     
Commercial real estate:                         
Office   685    688    82    1,580    5 
Retail/wholesale/mixed   787    805    186    2,004    1 
Industrial/warehouse   265    271    37    758     
Other               480     
Total commercial real estate   1,737    1,764    305    4,822    6 
Construction and development:                         
One- to four-family   275    283    90    138     
Multi-family               2,233     
Commercial real estate   2,602    2,670    949    1,377     
Land   1,805    1,817    2,333    2,399     
Total construction and development   4,682    4,770    3,372    6,147     
Consumer:                         
Home equity   323    323    234    368     
Student                    
Other   54    54    47    61     
Total consumer   377    377    281    429     
Commercial business:                         
Term loans   353    364    230    259    2 
Lines of credit   31    32    44    74    1 
Total commercial business   384    396    274    333    3 
Total with an allowance recorded  $24,183   $24,772   $5,897   $31,039   $25 
                          
With no allowance recorded:                         
One- to four-family  $9,603   $11,065       $10,934   $31 
Multi-family   6,579    7,103        5,239     
Commercial real estate:                         
Office   2,428    3,722        4,504    3 
Retail/wholesale/mixed   5,555    8,621        7,136    52 
Industrial/warehouse   1,087    1,321        809    7 
Other   3,314    4,489        1,791    37 
Total commercial real estate   12,384    18,153        14,240    99 
Construction and development:                         
One- to four-family   75    75        38     
Multi-family                    
Commercial real estate   2,741    2,779        1,371    3 
Land   698    833        1,228    3 
Total construction and development   3,514    3,687        2,637    6 
Consumer:                         
Home equity   976    976        1,010    7 
Student                    
Other   132    132        136     
Total consumer   1,108    1,108        1,146    7 
Commercial business:                         
Term loans   620    668        704    11 
Lines of credit   463    544        519    1 
Total commercial business   1,083    1,212        1,223    12 
Total with no allowance recorded  $34,271   $42,328       $35,419   $155 

 

13

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3.Loans Receivable (continued)

 

   December 31, 2011 
Impaired loans with an allowance recorded:  Loans
Receivable
Balance, Net
   Unpaid
Principal
Balance
   Related
Allowance
for Loss
   Average Loan
Receivable
Balance, Net
   Interest
Income
Recognized
 
One- to four-family  $2,606   $2,606   $364   $3,916   $51 
Multi-family   19,006    19,106    2,357    23,158    851 
Commercial real estate:                         
Office   2,474    2,474    746    7,917    30 
Retail/wholesale/mixed   3,220    3,225    570    16,931    78 
Industrial/warehouse   1,250    1,250    250    1,286     
Other   959    964    318    1,175    67 
Total commercial real estate   7,903    7,913    1,884    27,309    175 
Construction and development:                         
One- to four-family                    
Multi-family   4,466    4,488    678    4,482    248 
Commercial real estate   152    153    84    1,908    11 
Land   2,993    2,995    2,434    2,944    58 
Total construction and development   7,611    7,636    3,196    9,334    317 
Consumer:                         
Home equity   413    413    327    446     
Student                    
Other   67    67    49    126     
Total consumer   480    480    376    572     
Commercial business:                         
Term loans   Term loans   164    165    83    690    15 
Lines of credit   117    117    45    324    5 
Total commercial business   281    282    128    1,014    20 
Total with an allowance recorded  $37,887   $38,023   $8,305   $65,303   $1,414 
                          
Impaired loans with no allowance recorded:                         
One- to four-family  $12,262   $13,645       $12,382   $264 
Multi-family   3,899    4,413        7,117    306 
Commercial real estate:                         
Office   6,580    8,520        2,937    375 
Retail/wholesale/mixed   8,716    15,318        7,797    712 
Industrial/warehouse   530    754        1,146    25 
Other   268    1,044        673    9 
Total commercial real estate   16,094    25,636        12,553    1,121 
Construction and development:                         
One- to four-family                    
Multi-family               20     
Commercial real estate               2,459     
Land   1,757    1,967        3,219    28 
Total construction and development   1,757    1,967        5,698    28 
Consumer:                         
Home equity   1,044    1,044        962    43 
Student                    
Other   140    140        110    4 
Total consumer   1,184    1,184        1,072    47 
Commercial business:                         
Term loans   787    896        825    44 
Lines of credit   574    699        268    40 
Total commercial business   1,361    1,595        1,094    84 
Total with no allowance recorded  $36,557   $48,440       $39,915   $1,850 

 

14

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3.Loans Receivable (continued)

 

The following tables present information relating to the Company’s internal risk ratings of its loans receivable as of the dates indicated (all amounts in the tables are net of undisbursed loan proceeds):

 

   March 31, 2012 
   Pass   Watch   Special
Mention
   Substandard   Total 
One- to four-family  $469,247   $899   $232   $13,987   $484,365 
Multi-family   191,656    30,961    7,723    21,252    251,592 
Commercial real estate:                         
Office   34,962    2,286    18,389    3,645    59,282 
Retail/wholesale/mixed use   52,685    7,373    22,031    14,303    96,392 
Industrial/warehouse   25,734    6,449        5,371    37,554 
Other   18,395    46        3,677    22,118 
Total commercial real estate   131,776    16,154    40,420    26,996    215,346 
Construction and development:                         
One- to four-family   7,668            350    8,018 
Multi-family   5,573            11,513    17,086 
Commercial real estate   9,086    633        5,343    15,062 
Land   8,887    3,048    144    2,571    14,650 
Total construction/development   31,214    3,681    144    19,777    54,816 
Consumer:                         
Home equity   210,571            1,347    211,918 
Student   15,161                15,161 
Other   10,137            220    10,357 
Total consumer   235,869            1,567    237,436 
Commercial business:                         
Term loans   55,714    1,648    158    1,718    59,238 
Lines of credit   22,761    3,774    394    1,430    28,359 
Total commercial business   78,475    5,422    552    3,148    87,597 
Total  $1,138,237   $57,117   $49,071   $86,727   $1,331,152 

 

15

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3.Loans Receivable (continued)

 

   December 31, 2011 
   Pass   Watch   Special
Mention
   Substandard   Total 
One- to four-family  $482,271   $4,044   $141   $16,075   $502,531 
Multi-family   196,231    18,123    8,357    24,108    246,819 
Commercial real estate:                         
Office   49,324    1,853    20,405    9,054    80,636 
Retail/wholesale/mixed use   50,108    9,376    19,870    19,849    99,203 
Industrial/warehouse   24,431    3,237    2,230    5,698    35,596 
Other   4,897    1,318    181    2,405    8,801 
Total commercial real estate   128,760    15,784    42,686    37,006    224,236 
Construction and development:                         
One- to four-family   7,704                7,704 
Multi-family   4,503            14,347    18,850 
Commercial real estate   4,411            908    5,319 
Land   11,125    299    184    4,820    16,428 
Total construction/development   27,743    299    184    20,075    48,301 
Consumer:                         
Home equity   211,834            1,505    213,339 
Student   15,711                15,711 
Other   9,214            190    9,404 
Total consumer   236,759            1,695    238,454 
Commercial business:                         
Term loans   35,433    1,342        2,823    39,598 
Lines of credit   44,291    1,729    252    1,845    48,117 
Total commercial business   79,724    3,071    252    4,668    87,715 
Total  $1,151,488   $41,321   $51,620   $103,627   $1,348,056 

 

Loans rated “pass” or “watch” are generally current on contractual loan and principal payments and comply with other contractual loan terms. Pass loans generally have no noticeable credit deficiencies or potential weaknesses. Loans rated watch, however, will typically exhibit early signs of credit deficiencies or potential weaknesses that deserve management’s close attention. Loans rated “special mention” do not currently expose the Company to a sufficient degree of risk to warrant a lower rating, but possess clear trends in credit deficiencies or potential weaknesses that deserve management’s close attention. The allowance for loan losses on loans rated pass, watch, or special mention is typically evaluated collectively for impairment using a homogenous pool approach. This approach utilizes quantitative factors developed by management from its assessment of historical loss experience, qualitative factors, and other considerations.

 

Loans rated “substandard” involve a distinct possibility that the Company could sustain some loss if deficiencies associated with the loan are not corrected. Loans rated “doubtful” indicate that full collection is highly questionable or improbable. The Company did not have any loans that were rated doubtful at March 31, 2012, or December 31, 2011. Loans rated substandard or doubtful that are also considered in management’s judgment to be impaired are generally analyzed individually to determine an appropriate allowance for loan loss. A loan rated “loss” is considered uncollectible, even if a partial recovery could be expected in the future. The Company generally charges off loans that are rated as a loss. As such, the Company did not have any loans that were rated loss at March 31, 2012, or December 31, 2011.

 

16

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3.Loans Receivable (continued)

 

The following tables contain information relating to the past due and non-accrual status of the Company’s loans receivable as of the dates indicated (all amounts in the table are net of undisbursed loan proceeds):

 

   March 31, 2012 
   Past Due Status           Total 
   30-59
Days
   60-89
Days
   > 90
Days
   Total
Past Due
   Total
Current
   Total
Loans
   Non-
Accrual
 
One- to four-family  $6,842   $2,024   $10,804   $19,670   $464,695   $484,365   $13,124 
Multi-family   697    509    9,230    10,436    241,157    251,592    20,061 
Commercial real estate:                                   
Office   322        2,254    2,576    56,706    59,282    3,113 
Retail/wholesale/mixed   2,973    339    811    4,123    92,269    96,392    6,342 
Industrial/warehouse   27    2,225    426    2,678    34,875    37,554    1,352 
Other           2,399    2,399    19,719    22,118    3,314 
Total commercial real estate   3,322    2,564    5,890    11,776    203,569    215,346    14,121 
Construction and development:                                   
One- to four-family                   8,018    8,018    350 
Multi-family                   17,086    17,086     
Commercial real estate           5,179    5,179    9,883    15,062    5,343 
Land   94    87    538    719    13,931    14,650    2,503 
Total construction   94    87    5,717    5,898    48,918    54,816    8,196 
Consumer:                                   
Home equity   1,290    128    1,299    2,716    209,202    211,918    1,299 
Student   312    224    562    1,098    14,063    15,161     
Other   42    71    186    299    10,058    10,357    186 
Total consumer   1,644    423    2,047    4,113    233,323    237,436    1,485 
Commercial business:                                   
Term loans   166    65    664    896    58,343    59,238    974 
Lines of credit   96    146    168    409    27,949    28,359    493 
Total commercial   262    211    832    1,305    86,292    87,597    1,467 
Total  $12,861   $5,818   $34,520   $53,198   $1,277,954   $1,331,152   $58,454 

 

17

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3.Loans Receivable (continued)

 

   December 31, 2011 
   Past Due Status           Total 
   30-59
Days
   60-89
Days
   > 90
Days
   Total
Past Due
   Total
Current
   Total
Loans
   Non-
Accrual
 
One- to four-family  $10,713   $2,491   $12,890    26,094   $476,437   $502,531   $14,868 
Multi-family   7,692        9,949    17,640    229,179    246,819    22,905 
Commercial real estate:                                   
Office   745        3,743    4,488    76,147    80,636    9,054 
Retail/wholesale/mixed   695    154    7,214    8,063    91,139    99,203    11,936 
Industrial/warehouse   2,230        1,474    3,704    31,892    35,596    1,780 
Other           560    560    8,241    8,801    1,227 
Total commercial real estate   3,670    154    12,991    16,815    207,419    224,236    23,997 
Construction and development:                                   
One- to four-family                   7,704    7,704     
Multi-family       4,466        4,466    14,384    18,850    4,466 
Commercial real estate                   5,319    5,319    152 
Land   238    1,046    3,310    4,594    11,834    16,428    4,750 
Total construction   238    5,512    3,310    9,060    39,241    48,301    9,368 
Consumer:                                   
Home equity   1,172    439    1,457    3,067    210,271    213,339    1,457 
Student   396    310    696    1,403    14,309    15,711     
Other   137    64    202    404    9,000    9,404    207 
Total consumer   1,705    813    2,355    4,874    233,580    238,454    1,664 
Commercial business:                                   
Term loans   86    169    412    668    38,930    39,598    951 
Lines of credit   58        608    665    47,452    48,117    691 
Total commercial   144    169    1,020    1,333    86,382    87,715    1,642 
Total  $24,162   $9,139   $42,515   $75,816   $1,272,238   $1,348,056   $74,444 

 

As of March 31, 2012, and December 31, 2011, $562 and $696 in student loans, respectively, were 90-days past due, but remained on accrual status. No other loans 90-days past due were in accrual status as of either date.

 

The Company classifies a loan modification as a troubled debt restructuring (“TDR”) when it has granted a borrower experiencing financial difficulties a concession that it would otherwise not consider. Loan modifications that result in insignificant delays in the receipt of payments (generally six months or less) are not considered TDRs under the Company’s TDR policy. TDRs are relatively insignificant and/or infrequent in the Company and generally consist of loans placed in interest-only status for a short period of time or payment forbearance for greater than six months. There was one one- to four-family mortgage loan with a balance of $95 added to TDRs during the three months ended March 31, 2012. TDRs are evaluated for impairment and appropriate credit losses are recorded in accordance with the Company’s accounting policies. There were no loans that had a payment default in the three months ended March 31, 2012, that were restructured within the preceding 12 months.

 

18

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

4.Mortgage Servicing Rights

 

The following table presents the activity in the Company’s mortgage servicing rights (“MSRs”) for the periods indicated:

 

   Three Months Ended March 31 
   2012   2011 
MSRs at beginning of the period  $8,269   $7,775 
Additions   1,360    603 
Amortization   (1,043)   (516)
MSRs at end of period   8,586    7,862 
Valuation allowance at end of period   (547)    
MSRs at end of the period, net  $8,039   $7,862 

 

The following table shows the estimated future amortization expense for MSRs for the periods indicated:

 

       Amount 
Estimate for nine months ended December 31:   2012   $982 
Estimate for years ended December 31:   2013    1,276 
    2014    1,243 
    2015    1,216 
    2016    1,179 
    2017    997 
    Thereafter    1,146 
    Total   $8,039 

 

The projections of amortization expense shown above for MSRs are based on existing asset balances and the existing interest rate environment as of March 31, 2012. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates, and market conditions.

 

5. Other Assets

 

The following table summarizes the components of other assets as of the dates indicated:

 

   March 31   December 31 
   2012   2011 
Accrued interest:          
Loans receivable  $3,471   $4,664 
Mortgage-related securities   1,972    1,851 
Interest-earning deposits   16    6 
Total accrued interest   5,459    6,521 
Premises and equipment, net   50,486    50,423 
Federal Home Loan Bank stock, at cost   27,675    46,092 
Bank owned life insurance   57,104    56,604 
Prepaid FDIC insurance premiums   4,879    5,673 
Deferred tax asset, net   35,288    37,493 
Prepaid and other assets   21,523    22,020 
Total other assets  $202,414   $224,826 

 

19

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

6.Deposit Liabilities

 

The following table summarizes the components of deposit liabilities as of the dates indicated:

 

   March 31   December 31 
   2012   2011 
Checking accounts:          
Non-interest-bearing  $125,135   $112,211 
Interest-bearing   236,413    229,990 
Total checking accounts   361,548    342,201 
Money market accounts   425,997    432,248 
Savings accounts   217,633    204,263 
Certificates of deposit:          
Due within one year   725,846    709,362 
After one but within two years   224,161    250,613 
After two but within three years   60,917    61,291 
After three but within four years   10,279    13,301 
After four but within five years   6,565    8,384 
Total certificates of deposits   1,027,768    1,042,951 
Total deposit liabilities  $2,032,946   $2,021,663 

 

7.Borrowings

 

The following table summarizes borrowings as of the dates indicated:

 

   March 31, 2012   December 31, 2011 
       Weighted-       Weighted- 
       Average       Average 
   Amount   Rate   Amount   Rate 
Federal Home Loan Bank advances maturing in:                    
2012  $100,000    4.52%  $100,000    4.52%
2013   229    4.17    233    4.17 
2014                

2015 

   7,500    0.83         
2016   7,500    1.07         
2017 and thereafter   67,557    4.23    52,858    5.00 
Total borrowings  $182,786    4.12%  $153,091    4.69%

 

All of the Company’s advances from the Federal Home Loan Bank (“FHLB”) of Chicago are subject to prepayment penalties if voluntarily repaid by the Company prior to stated maturity.

 

The Company is required to maintain certain unencumbered mortgage loans and certain mortgage-related securities as collateral against its outstanding advances from the FHLB of Chicago. Total advances from the FHLB of Chicago are limited to the lesser of: (i) 35% of the Bank’s total assets; (ii) twenty times the capital stock of the FHLB of Chicago that is owned by the Bank; or (iii) the total of 60% of the book value of certain multi-family mortgage loans, 75% of the book value of one- to four-family mortgage loans, and 95% of certain mortgage-related securities.

 

20

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

7.  Borrowings (continued)

 

At March 31, 2012 and December 31, 2011, the Company had lines of credit with two financial institutions that totaled $10,000 as of both dates. There were no amounts outstanding on these lines of credits as of either of the dates.

 

8.  Shareholders' Equity

 

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory actions and possible additional discretionary actions by regulators, that, if undertaken, could have a direct material effect on the Bank’s and the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

Quantitative measures established by federal regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total capital and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to adjusted assets (as all of these terms are defined in the applicable regulations). Management believes, as of March 31, 2012, that the Bank met or exceeded all capital adequacy requirements to which it is subject. The Company is not aware of any conditions or events which would change the Bank’s status from “well capitalized.”

 

The following table presents the Bank’s actual and required regulatory capital amounts and ratios as of the dates indicated:

 

           To Be Well 
       Required   Capitalized Under 
       For Capital   Prompt Corrective 
   Actual   Adequacy Purposes   Action Provisions 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of March 31, 2012:                              
Total capital
(to risk-weighted assets)
  $256,872    18.31%  $112,259    8.00%  $140,324    10.00%
Tier 1 capital
(to risk-weighted assets)
   239,236    17.05    56,130    4.00    84,195    6.00 
Tier 1 capital
(to adjusted total assets)
   239,236    9.29    103,053    4.00    128,816    5.00 
                               
As of December 31, 2011:                              
Total capital
(to risk-weighted assets)
  $253,815    18.34%  $110,714    8.00%  $138,392    10.00%
Tier 1 capital
(to risk-weighted assets)
   236,516    17.09    55,354    4.00    83,035    6.00 
Tier 1 capital
(to adjusted total assets)
   236,516    9.59    98,601    4.00    123,252    5.00 

 

21

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

  

9.  Earnings Per Share

 

The following table summarizes the computation of basic and diluted earnings per share for the periods indicated:

 

   Three Months Ended
 March 31
 
   2012   2011 
Basic earnings per share:        
Net income  $1,155   $1,040 
Weighted average shares outstanding   46,184,264    45,734,674 
Vested MRP shares for period   1,604    1,745 
Basic shares outstanding   46,185,868    45,736,419 
Basic earnings per share  $0.03   $0.02 
           
Diluted Earnings Per Share:          
Net income  $1,155   $1,040 
Weighted average shares outstanding used in basic earnings per share   46,185,868    45,736,419 
Net dilutive effect of:          
Stock option shares       126,633 
Unvested MRP shares   6,696     
Diluted shares outstanding   46,192,564    45,863,052 
Diluted earnings per share  $0.03   $0.02 

 

The Company had stock options for 2,685,000 shares outstanding as of March 31, 2012, and for 2,391,000 shares as of March 31, 2011, that were not included in the computation of diluted earnings per share because they were anti-dilutive. These shares had weighted average exercise prices of $8.51 and $9.50 per share as of those dates, respectively.

 

10.  Employee Benefit Plans

 

The Company has a discretionary, defined contribution savings plan (the “Savings Plan”). The Savings Plan is qualified under Sections 401 and 401(k) of the Internal Revenue Code and provides employees meeting certain minimum age and service requirements the ability to make contributions to the Savings Plan on a pretax basis. The Company then matches a percentage of the employee’s contributions. Matching contributions made by the Company were $48 and $40 during the three months ended March 31, 2012 and 2011, respectively.

 

The Company also has a defined benefit pension plan covering employees meeting certain minimum age and service requirements and a non-qualified supplemental pension plan for certain qualifying employees. The supplemental pension plan is funded through a "rabbi trust" arrangement. The benefits are generally based on years of service and the employee’s average annual compensation for five consecutive calendar years in the last ten calendar years that produces the highest average. The Company’s funding policy for the qualified plan is to contribute annually the amount necessary to satisfy the requirements of the Employee Retirement Income Security Act of 1974.

  

22

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

10. Employee Benefit Plans (continued)

 

The following table summarizes the qualified plan’s net periodic benefit cost for the periods indicated:

 

   Three Months Ended 
   March 31 
   2012   2011 
Service cost  $725   $626 
Interest cost   564    569 
Expected return on plan assets   (756)   (650)
Amortization of unrecognized prior service cost   440    216 
Net periodic benefit cost  $973   $761 

 

The net periodic benefit cost for the Company’s supplemental plan was $8 and $6 for the three months ended March 31, 2012 and 2011, respectively. The amount in 2012 consisted of interest cost of $6, and amortization of net loss from earlier periods of $2. The amount for 2011 consisted solely of interest cost.

 

The amount of the 2012 contribution will be determined based on a number of factors, including the results of the Actuarial Valuation Report as of January 1, 2012. As of March 31, 2012, the amount of the 2012 contribution was unknown. No contribution is necessary for the supplemental pension plan.

 

11.  Stock-Based Benefit Plans

 

In 2001 the Company’s shareholders approved the 2001 Stock Incentive Plan (the “2001 Plan”), which provided for stock option awards of up to 4,150,122 shares. The 2001 Plan also provided for restricted stock ("MRP") awards of up to 1,226,977 shares. The 2001 Plan has expired, no further awards may be granted under the 2001 Plan, and no options or unvested MRP awards remain outstanding under the 2001 Plan.

 

In 2004 the Company’s shareholders approved the 2004 Stock Incentive Plan (the “2004 Plan”), which provided for stock option awards of up to 4,106,362 shares. Options granted under the 2004 Plan vest over five years and have expiration terms of ten years. The 2004 Plan also provided for MRP awards of up to 1,642,521 shares. MRP shares awarded under the 2004 Plan vest over five years. As of March 31, 2012, 520,221 MRP shares and options for 631,632 shares remain eligible for award under the 2004 Plan.

 

MRP grants are amortized to compensation expense as the Company’s employees and directors become vested in the granted shares. The amount amortized to expense was $46 and $30 for the three month periods ended March 31, 2012 and 2011 respectively. Outstanding non-vested MRP grants had a fair value of $566 and an unamortized cost of $511 at March 31, 2012. The cost of these shares is expected to be recognized over a weighted-average period of 2.0 years.

 

During the three months ended March 31, 2012 and 2011, the Company recorded stock option compensation expense of $58 and $40, respectively. As of March 31, 2012, there was $851 in total unrecognized stock option compensation expense related to non-vested options. This cost is expected to be recognized over a weighted-average period of 2.0 years.

 

23

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

  

11. Stock-Based Benefit Plans (continued)

 

The following table summarizes the activity in the Company’s stock options during the periods indicated:

 

   Three months ended
March 31
 
   2012   2011 
   Stock
Options
   Weighted
Average
Exercise
Price
   Stock
Options
   Weighted
Average
Exercise
Price
 
Outstanding at beginning of period   2,382,500   $9.4637    2,462,464   $9.0184 
Granted   402,500    3.3900    421,000    5.0251 
Exercised           (39,439)   3.2056 
Forfeited   (100,000)   10.6730    (4,000)   10.6730 
Outstanding at end of period   2,685,000   $8.5082    2,840,025   $8.5049 

 

The following table provides additional information regarding the Company’s outstanding options as of March 31, 2012.

 

   Remaining   Non-Vested Options   Vested Options 
   Contractual
Life in Years
   Stock
Options
   Intrinsic
Value
   Stock
Options
   Intrinsic
Value
 
Exercise Price:                         
$10.6730   2.1            1,600,000     
$12.2340   4.3            50,000     
$11.1600   6.1    12,800        19,200     
$12.0250   6.4    20,000        30,000     
$7.2200   8.1    40,000        10,000     
$4.7400   8.7    56,000        14,000     
$5.0500   8.8    310,400        77,600     
$4.3000   9.0    20,000        5,000     
$3.7200   9.3    17,500   $6         
$3.3900   9.8    402,500    262         
Total        879,200   $268    1,805,800     
Weighted average remaining contractual life        9.1 years        2.7 years     
Weighted average exercise price       $4.5731        $10.4195      

 

The intrinsic value of options exercised during the three months ended March 31, 2011, was $38. There were no options exercised during the three months ended March 31, 2012. The weighted average grant date fair value of non-vested options at March 31, 2012, was $1.06 per share. During the three months ended March 31, 2012, options for 402,500 shares were granted, options for 82,600 shares became vested, and there were no forfeitures of non-vested options shares.

 

The Company uses the Black-Scholes option-pricing model to estimate the fair value of granted options. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. However, the Company's stock options have characteristics significantly different from traded options and changes in the subjective input assumptions can materially affect the fair value estimate. Option valuation models such as Black-Scholes require the input of highly subjective assumptions including the expected stock price volatility, which is computed using five-years of actual price activity in the Company’s stock. The Company uses historical data of employee behavior as a basis to estimate the expected life of the options, as well as forfeitures due to employee terminations. The Company also uses its actual dividend yield at the time of the grant, as well as actual U.S. Treasury yields in effect at the time of the grant to estimate the risk-free rate. The following weighted-average assumptions were used to value 402,500 options granted during the three month period ended

 

24

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

  

11.  Stock-Based Benefit Plans (continued)

 

March 31, 2012: risk free rate of 1.50%, dividend yield of 1.18%, expected stock volatility of 25%, and expected term to exercise of 7.5 years. These options had a weighted-average value of $0.86 per option using these assumptions. The following weighted-average assumptions were used to value 421,000 options granted during the three month period ended March 31, 2011: risk free rate of 2.06%, dividend yield of 2.04%, expected stock volatility of 25%, and expected term to exercise of 7.5 years.

  

12.  Financial Instruments with Off-Balance Sheet Risk

 

Off-balance sheet financial instruments or obligations whose contract amounts represent credit and/or interest rate are summarized in the following table as of the dates indicated:

 

   March 31   December 31 
   2012   2011 
Unused consumer lines of credit  $153,302   $151,807 
Unused commercial lines of credit   42,111    43,518 
Commitments to extend credit:          
Fixed rate   49,138    23,793 
Adjustable rate   13,070    17,197 
Undisbursed commercial loans   532    870 
Standby letters of credit   1,605    410 

 

The Company sells substantially all of its long-term, fixed-rate, one- to four-family loan originations in the secondary market. The Company uses derivative instruments to manage interest rate risk associated with these activities. Specifically, the Company enters into interest rate lock commitments (“IRLCs”) with borrowers, which are considered to be derivative instruments. The Company manages its exposure to interest rate risk in IRLCs (as well as interest rate risk in its loans held-for-sale) by entering into forward commitments to sell loans to the Federal National Mortgage Association (“Fannie Mae”). Commitments to sell loans expose the Company to interest rate risk if market rates of interest decrease during the commitment period. Such forward commitments are considered to be derivative instruments. These derivatives are not designated as accounting hedges as specified in GAAP. As such, changes in the fair value of the derivative instruments are recognized currently through earnings.

 

As of March 31, 2012, and December 31, 2011, net unrealized gains of $426 and $243, respectively, were recognized in net gain on loan sales activities on the derivative instruments specified in the previous paragraph. These amounts were exclusive of net unrealized gains of $330 and $507 on loans held-for-sale as of those dates, respectively, which were also included in net gain on loan sales activities.

 

The following table summarizes the Company’s derivative assets and liabilities as of the dates indicated:

 

   March 31, 2012   December 31, 2011 
   Notional
Amount
   Fair Value   Notional
Amount
   Fair Value 
Interest rate lock commitments  $58,970   $1,092   $52,699   $1,012 
Forward commitments   74,209    (666)   62,025    (769)
   Net unrealized gain       $426        $243 

 

The unrealized gains shown in the above table were included as a component of other assets as of the dates indicated. The unrealized losses were included in other liabilities as of the dates indicated.

 

25

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

  

13.  Fair Value Measurements

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing its financial assets and liabilities, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company primarily applies the market approach for recurring fair value measurements and endeavors to utilize the best available information. Accordingly, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company is able to classify fair value balances based on the observability of those inputs. Accounting guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1), the next highest priority to prices based on models, methodologies, and/or management judgments that rely on direct or indirect observable inputs (Level 2), and the lowest priority to prices derived from models, methodologies, and/or management judgments that rely on significant unobservable inputs (Level 3). There were no transfers of assets or liabilities between categories of the fair value hierarchy during the three months ended March 31, 2012.

 

The methods and assumptions used by the Company in estimating the fair value of its financial instruments, whether or not such fair values are recognized in the consolidated financial statements, are summarized below:

 

Cash and Cash Equivalents The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate those assets’ fair values. The Company considers the fair value of cash and cash equivalents to be Level 1 in the fair value hierarchy.

 

Mortgage-Related Securities Available-for-Sale and Held to Maturity Fair values for these securities are based on price estimates obtained from a third-party independent pricing service. This service utilizes pricing models that vary by asset class and incorporate available trade, bid, ask, and other market information of comparable instruments. For structured securities, such as CMOs, the pricing models include cash flow estimates that consider the impact of loan performance data, including, but not limited to, expectations relating to loan prepayments, default rates, and loss severities. Management has reviewed the pricing methodology used by its pricing service to verify that prices are determined in accordance with the fair value guidance specified in GAAP. The Company considers the fair value of mortgage-related securities to be Level 2 in the fair value hierarchy.

 

Loans Held-for-Sale The fair value of loans held-for-sale is based on the current market price for securities collateralized by similar loans. The Company considers the fair value of loans held for sale to be Level 2 in the fair value hierarchy.

 

Loans Receivable Loans receivable are segregated by type such as one- to four-family, multi-family, and commercial real estate mortgage loans, consumer loans, and commercial business loans. The fair value of each type is calculated by discounting scheduled cash flows through the expected maturity of the loans using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan type. The estimated maturity is based on the Company’s historical experience with prepayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. The Company considers the fair value of loans receivable to be Level 3 in the fair value hierarchy.

 

Mortgage Servicing Rights The Company estimates the fair market value of MSRs for those loans that are sold with servicing rights retained. For valuation purposes, the related loans are stratified into pools by product type and, within product type, by contractual interest rates. The fair value of the MSR pools is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing cost, and other factors. The Company considers the fair value of MSRs to be Level 3 in the fair value hierarchy.

 

26

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

  

13.  Fair Value Measurements (continued)

 

The following table summarizes the significant inputs utilized by the Company to estimate the fair value of its MSRs as of March 31, 2012:

 

   Weighted-
Average
   Range 
Loan size  $126   2 – $417 
Contractual interest rate   4.39%   2.00% – 7.75% 
Constant prepayment rate (“CPR”)   15.94%   9.36% – 21.46% 
Remaining maturity in months   265    48 – 423 
Servicing fee   0.25%    
Annual servicing cost per loan (not in thousands)  $82.68     
Annual ancillary income per loan (not in thousands)  $63.72     
Discount rate   3.59%   3.125% – 3.875% 

 

MSR pools with an amortized cost basis greater than fair value are carried at fair value in the Company’s financial statements. Pools determined to be impaired at March 31, 2012, had an amortized cost basis of $4,334 and a fair value of $3,787 as of that date. Accordingly, the Company recorded a valuation allowance of $547 as of March 31, 2012, as well as a corresponding gain of $321 during the three month period then ended, which was equal to the change in the valuation allowance during that period. Pools determined to be impaired at December 31, 2011, had an amortized cost basis of $6,812 and a fair value of $5,944 as of that date. Accordingly, the Company recorded a valuation allowance of $868 as of December 31, 2011, as well as a corresponding loss of $862 during the twelve month period then ended, which was equal to the change in the valuation allowance during that period. The company recorded a gain of $6 during the three month period ended March 31, 2011.

 

Federal Home Loan Bank Stock FHLB of Chicago stock is carried at cost, which is its redeemable (fair) value, since the market for this stock is restricted. The Company considers the fair value of FHLB of Chicago stock to be Level 2 in the fair value hierarchy.

 

Accrued Interest Receivable and Payable The carrying values of accrued interest receivable and payable approximate their fair value. The Company considers the fair value of accrued interest receivable and payable to be Level 2 in the fair value hierarchy.

 

Deposit Liabilities and Advance Payments by Borrowers for Taxes and Insurance Fair value for demand deposits equal book value. The Company considers the fair value of demand deposits to be Level 2 in the fair value hierarchy. Fair values for certificates of deposits are estimated using a discounted cash flow calculation that applies current market borrowing interest rates to a schedule of aggregated expected monthly maturities on deposits. The Company considers the fair value of certificates of deposit to be Level 3 in the fair value hierarchy. The advance payments by borrowers for taxes and insurance are equal to their carrying amounts at the reporting date. The Company considers the fair value of advance payment by borrowers to be Level 2 in the fair value hierarchy.

 

Borrowings The fair value of long-term borrowings is estimated using discounted cash flow calculations with the discount rates equal to interest rates currently being offered for borrowings with similar terms and maturities. The carrying value on short-term borrowings approximates fair value. The Company considers the fair value of borrowings to be Level 2 in the fair value hierarchy.

 

Off-Balance Sheet Financial Instruments Off-balance sheet financial instruments consist of commitments to extend credit, IRLCs, and forward commitments to sell loans. Commitments to extend credit that are not IRLCs generally carry variable rates of interest. As such, the fair value of these instruments is not material. The Company considers the fair value of these instruments to be Level 2 in the fair value hierarchy. The carrying value of IRLCs and forward commitments to sell loans, which is equal to their fair value, is the difference between the current market prices for securities collateralized by similar loans and the notional amounts of the IRLCs and forward commitments. The Company considers the fair value of IRLCs and forward commitments to sell loans to be Level 2 in the fair value hierarchy.

 

27

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

13.  Fair Value Measurements (continued)

 

The carrying values and fair values of the Company’s financial instruments are presented in the following table as of the indicated dates.

 

   March 31
2012
   December 31
2011
 
   Carrying
Value
   Fair 
Value
   Carrying
Value
   Fair 
Value
 
Cash and cash equivalents  $121,711   $121,711   $120,935   $120,935 
Securities available-for-sale   776,838    776,838    781,770    781,770 
Securities held-to-maturity   150,764    149,694         
Loans held-for-sale   22,877    22,877    19,192    19,192 
Loans receivable, net   1,305,366    1,271,555    1,319,636    1,284,651 
Mortgage servicing rights, net   8,039    10,106    7,401    7,577 
Federal Home Loan Bank stock   27,675    27,675    46,092    46,092 
Accrued interest receivable   5,459    5,459    6,521    6,521 
Deposit liabilities   2,032,946    1,967,149    2,021,663    1,968,842 
Borrowings   182,786    194,237    153,091    167,418 
Advance payments by borrowers   13,094    13,094    3,192    3,192 
Accrued interest payable   756    756    750    750 
Unrealized gain (loss) on off-balance-sheet items:                    
 Interest rate lock commitments on loans   1,092    1,092    1,012    1,012 
 Forward commitments to sell loans   (666)   (666)   (769)   (769)

 

Certain financial instruments and all nonfinancial instruments are excluded from the table, above. Accordingly, the aggregate fair value of amounts presented in the table does not represent the underlying value of the Company and is not particularly relevant to predicting the Company’s future earnings or cash flows. Furthermore, because the fair value estimates in the table are estimated under Levels 2 or 3 of the fair value hierarchy, the fair value estimates presented in the table cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.

 

The following table segregates by fair value hierarchy (i.e., Level 1, 2, or 3) all of the Company's assets and liabilities that were accounted for at fair value on a recurring basis as of the dates indicated:

 

   At March 31, 2012 
   Level 1   Level 2   Level 3   Total 
Loans held-for-sale      $22,877       $22,877 
Mortgage-related securities available-for-sale       776,838        776,838 

 

   At December 31, 2011 
   Level 1   Level 2   Level 3   Total 
Loans held-for-sale      $19,192       $19,192 
Mortgage-related securities available-for-sale       781,770        781,770 

 

28

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

March 31, 2012

 

(Dollars in Thousands, Except Share and Per Share Amounts)

  

13.  Fair Value Measurements (continued)

 

Impaired Loans For non-accrual loans greater than an established threshold and individually evaluated for impairment and all renegotiated loans, impairment is measured based on: (i) the fair value of the loan or the fair value of the collateral less estimated selling costs (collectively the “collateral value method”) or (ii) the present value of the estimated cash flows discounted at the loan’s original effective interest rate (the “discounted cash flow method”). The resulting valuation allowance, if any, is a component of the allowance for loan losses. The discounted cash flow method is a fair value measure. For the collateral value method, the Company generally obtains appraisals on a periodic basis to support the fair value of collateral underlying the loans. Appraisals are performed by independent certified and/or licensed appraisers that have been reviewed by the Company and incorporate information such as recent sales prices for comparable properties, costs of construction, and net operating income of the property or business. Selling costs are generally estimated at 10%. Appraised values may be further discounted based on management judgment regarding changes in market conditions and other factors since the time of the appraisal. A significant unobservable input in using net operating income to estimate fair value is the capitalization rate. At March 31, 2012, the range of capitalization rates utilized to determine the fair value of the underlying collateral on certain loans was 7% to 13%. The Company considers these fair values to be Level 3 in the fair value hierarchy. For those loans individually evaluated for impairment using the collateral value method, a valuation allowance of $5,897 was recorded for loans with a recorded investment of $86,727 at March 31, 2012. These amounts were $8,305 and $103,627 at December 31, 2011, respectively. Provision for loan losses related to these loans was $156 during the three month period ended March 31, 2012, and $1,257 during the twelve month period ended December 31, 2011. Provision for loan losses related to impaired loans at March 31, 2011 was $2,245 for the three months ended March 31, 2011.

 

Foreclosed Properties Foreclosed properties acquired through, or in lieu of, loan foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. In determining fair value, the Company generally obtains appraisals to support the fair value of foreclosed properties, as described in the previous paragraph. In certain instances, the Company may also use the selling list price, less estimated costs to sell, as the fair value of foreclosed properties. In such instances, the list price is generally less than the appraised value. The Company considers these fair values to be Level 3 in the fair value hierarchy. As of March 31, 2012, $20,871 in foreclosed properties were valued at collateral value compared to $22,655 at December 31, 2011. Losses of $2,078 and $4,639 related to these foreclosed properties were recorded during the three months ended March 31, 2012, and the twelve months ended December 31, 2011, respectively. Losses on foreclosed properties valued at collateral value at March 31, 2011 were $707 for the three months ended March 31, 2011. The following table summarizes foreclosed properties and repossessed assets as of the dates indicated:

 

   March 31   December 31 
   2012   2011 
One- to four-family  $5,065   $6,557 
Multi-family   619    1,162 
Commercial real estate   12,159    13,115 
Land   4,333    3,890 
   $22,176   $24,724 

 

29
 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement

 

This report contains or incorporates by reference various forward-looking statements concerning the Company's prospects that are based on the current expectations and beliefs of management. Forward-looking statements may contain, and are intended to be identified by, words such as “anticipate,” “believe,” “estimate,” “expect,” “objective,” “projection,” “intend,” and similar expressions or use of verbs in the future tense any discussions of periods after the date on which this report is filed are also forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks, and uncertainties, many of which are beyond the Company's control, that could cause the Company's actual results and performance to differ materially from what is stated or expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company: general economic conditions, including instability in credit, lending, and financial markets; declines in the real estate market, which could further affect both collateral values and loan activity; continuing relatively high unemployment and other factors which could affect borrowers’ ability to repay their loans; negative developments affecting particular borrowers, which could further adversely impact loan repayments and collection; legislative and regulatory initiatives and changes, including action taken, or that may be taken, in response to difficulties in financial markets and/or which could negatively affect the right of creditors; monetary and fiscal policies of the federal government; the effects of further regulation and consolidation within the financial services industry, including substantial changes under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the transfer of regulatory authority from the Office of Thrift Supervision (“OTS”) to the Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve Board (“FRB”); regulators’ increasing expectations for financial institutions’ capital levels and restrictions imposed on institutions, as to payments of dividends or otherwise, to maintain or achieve those levels, including the possible effect of the memoranda of understanding mentioned in this report; pending and/or potential rulemaking or other actions by the Consumer Financial Protection Bureau (“CFPB”); potential regulatory or other actions affecting the Company or the Bank; potential adverse publicity relating to any such action or other developments affecting the Company or the Bank; potential changes in the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), which could impact the home mortgage market; increased competition and/or disintermediation within the financial services industry; changes in tax rates, deductions and/or policies; potential further changes in Federal Deposit Insurance Corporation (“FDIC”) premiums and other governmental assessments; changes in deposit flows; changes in the cost of funds; fluctuations in general market rates of interest and/or yields or rates on competing loans, investments, and sources of funds; demand for loan or deposit products; illiquidity of financial markets and other negative developments affecting particular investment and mortgage-related securities, which could adversely impact the fair value of and/or cash flows from such securities; changes in customers’ demand for other financial services; the Company’s potential inability to carry out business plans or strategies; changes in accounting policies or guidelines; natural disasters, acts of terrorism, or developments in the war on terrorism; the risk of failures in computer or other technology systems or data maintenance, or breaches of security relating to such systems; and the factors discussed in the Company’s filings with the Securities and Exchange Commission, particularly under Part I, Item 1A, “Risk Factors,” of the Company’s 2011 Annual Report on Form 10-K.

 

Results of Operations

 

Overview The Company’s net income was $1.2 million or $0.03 per diluted share for the three months ended March 31, 2012, compared to $1.0 million or $0.02 per diluted share during the same period in 2011. The improvement in net income between these periods was principally due to lower provision for loan losses and higher gains on sales of loans. These developments were partially offset by higher net losses and expenses on foreclosed real estate, higher compensation-related costs, lower gains on sales of investments, and lower net interest income. The following paragraphs describe these changes in greater detail, along with other matters affecting the Company’s results of operations during the three month periods ended March 31, 2012 and 2011.

 

30
 

 

Net Interest Income Net interest income decreased by $925,000 or 5.8% during the three months ended March 31, 2012, compared to the same period in 2011. This decrease was primarily attributable to a 17 basis point decline in the Company’s net interest margin, from 2.82% in the first quarter of 2011 to 2.65% in the same quarter of 2012. This decrease was primarily the result of a lower interest rate environment in 2012 compared to 2011, which reduced the return on the Company’s earning assets more than the cost of its funding sources. This development was offset somewhat by the favorable impact of a modestly better mix in the Company’s average earning assets and average interest-bearing liabilities. The Company’s average loans and mortgage-related securities (which generally have higher yields) increased between the quarterly periods relative to its lower-yielding earning assets, such as investment securities and overnight investments, which decreased between the periods. Furthermore, the Company’s average core deposits (which consist of checking, savings, and money market accounts, and generally have a lower interest cost) increased between the quarterly periods, whereas its average certificates of deposit (which generally have a higher interest cost) decreased between the periods.

 

31
 

 

The following table presents certain details regarding the Company's average balance sheet and net interest income for the periods indicated. The tables present the average yield on interest-earning assets and the average cost of interest-bearing liabilities. The yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. The average balances are derived from daily balances over the periods indicated. Interest income includes fees, which are considered adjustments to yields. Net interest spread is the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin is derived by dividing net interest income by average interest-earning assets. No tax equivalent adjustments were made since the Company does not have any tax exempt investments.

 

   Three Months Ended March 31 
   2012   2011 
       Interest   Average       Interest   Average 
   Average   Earned/   Yield/   Average   Earned/   Yield/ 
   Balance   Paid   Rate   Balance   Paid   Rate 
   (Dollars in thousands) 
Assets:                              
Interest-earning assets:                              
Loans receivable (1)  $1,373,303   $16,423    4.78%  $1,366,298   $17,873    5.23%
Mortgage-related securities   753,149    4,301    2.28    511,898    3,795    2.97 
Investment securities (2)   36,782    12    0.13    255,500    1,344    2.10 
Interest-earning deposits   84,222    41    0.19    106,775    51    0.19 
Total interest-earning assets   2,247,456    20,777    3.70    2,240,471    23,063    4.12 
Non-interest-earning assets   223,571              305,881           
Total average assets  $2,471,027             $2,546,352           
                               
Liabilities and equity:                              
Interest-bearing liabilities:                              
Regular savings deposits  $207,620    15    0.03   $207,132    22    0.04 
Money market accounts   421,812    198    0.19    394,276    534    0.54 
Interest-bearing demand accounts   214,540    12    0.02    193,668    23    0.05 
Certificates of deposit   1,033,150    3,830    1.48    1,084,636    4,890    1.80 
Total deposit liabilities   1,877,122    4,055    0.86    1,879,712    5,469    1.16 
Advance payments by borrowers for taxes and insurance   8,490    1    0.05    7,722    1    0.05 
Borrowings   158,668    1,823    4.60    146,508    1,770    4.83 
Total interest-bearing liabilities   2,044,280    5,879    1.15    2,033,942    7,240    1.42 
Non-interest-bearing liabilities:                              
Non-interest-bearing deposits   117,487              102,631           
Other non-interest-bearing liabilities   41,607              96,375           
Total non-interest-bearing liabilities   159,091              199,006           
Total liabilities   2,203,371              2,232,948           
Total equity   267,656              313,404           
Total average liabilities and equity  $2,471,027             $2,546,352           
Net interest income and net interest rate spread       $14,898    2.55%       $15,823    2.70%
Net interest margin             2.65%             2.82%
Average interest-earning assets to average interest-bearing liabilities   1.10x             1.10x          

  

(1)For the purposes of these computations, non-accruing loans and loans held-for-sale are included in loans receivable.
(2)The carrying value and earnings on stock in the FHLB of Chicago is included in investment securities.

 

32
 

 

The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to the change attributable to change in volume (change in volume multiplied by prior rate), the change attributable to change in rate (change in rate multiplied by prior volume), and the net change. The change attributable to the combined impact of volume and rate has been allocated proportionately to the change due to volume and the change due to rate.

 

   Three Months Ended March 31, 2012
Compared to March 31, 2011
 
   Increase (Decrease) 
   Volume   Rate   Net 
   (Dollars in thousands) 
Interest-earning assets:               
Loans receivable  $95   $(1,545)  $(1,450)
Mortgage-related securities   1,526    (1,020)   506 
Investment securities   (634)   (698)   (1,332)
Interest-earning deposits   (11)   1    (10)
Total interest-earning assets   976    (3,262)   (2,286)
Interest-bearing liabilities:               
Savings accounts   (2)   (5)   (7)
Money market accounts   35    (371)   (336)
Interest-bearing demand accounts   3    (14)   (11)
Certificates of deposit   (223)   (837)   (1,060)
Total deposit liabilities   (187)   (1,227)   (1,414)
Advance payments by borrowers for taxes  and insurance            
Borrowings   143    (90)   53 
Total interest-bearing liabilities   (44)   (1,317)   (1,361)
Net change in net interest income  $1,020   $(1,945)  $(925)

 

Provision for Loan Losses The Company’s provision for loan losses was $51,000 in the first quarter of 2012 compared to $3.2 million in the same quarter last year. During the first quarter of 2012 the Company recorded additional loss provisions of $1.2 million against a number of smaller multi-family, commercial real estate, and business loan relationships, as well as residential and consumer loans. This development was substantially offset by a $568,000 cash recovery related to a large loan relationship that had been charged off in a prior period. In addition, the Company recorded $334,000 in loss recoveries from two non-performing loans that aggregated $4.0 million that paid off during the period. Finally, the Company reduced its allowance for loan losses modestly during the quarter to reflect improved credit quality in its loan portfolio, attributable to lower levels of delinquent and classified loans.

 

During the first quarter of 2011, the Company recorded a $903,000 loss on a $3.6 million loan relationship and a $569,000 loss on an $8.3 million loan relationship. These loans were principally secured by multi-family buildings. Remaining losses during this period were related to smaller commercial real estate and business loan relationships and, to a lesser extent, consumer and one- to four-family mortgage loans.

 

Although the Company’s provision for loan losses was substantially lower in the first quarter of 2012 than it has been in recent periods, its loan portfolio continues to be impacted by slow economic growth, persistent unemployment, and depressed real estate values. These conditions have been particularly challenging for borrowers whose loans are secured by commercial real estate, multi-family real estate, and land. Although the Company’s level of non-performing loans and credit-related losses remain elevated compared to historical levels, it was successful in the first quarter of 2012 at further reducing the overall level of non-performing loans. This favorable development has contributed to a lower level of provision for loan loss in the first quarter of 2012 relative to recent periods. However, management cannot provide any assurance that this trend will continue. For additional discussion related to the Company’s non-performing loans, non-performing assets, classified assets, and allowance for loan losses, refer to “Financial Condition—Asset Quality,” below.

 

33
 

 

 

Non-Interest Income Total non-interest income increased by $1.5 million or 25.5% during the three months ended March 31, 2012, compared to the same period in 2011. Significant reasons for this increase are discussed in the following paragraphs.

 

Service charges on deposits increased by $91,000 or 6.2% during the three months ended March 31, 2012, compared to the same quarter in 2011. Management attributes these improvements to an increase in the Company’s average core deposit accounts, consisting of checking, savings, and money market accounts, which increased by $63.8 million or 7.1% during the three months ended March 31, 2012, compared to the same period in 2011. In addition, enhancements in recent periods to the Company’s commercial deposit products and services resulted in increased fee revenue during the quarter, particularly related to treasury management services.

 

Brokerage and insurance commissions were $581,000 during the first quarter of 2012, a $33,000 or 5.4% decline from the same period in the previous year. Increased competitive pressure in the market for tax-deferred annuities in recent periods has resulted in lower profit margins on the sales of these financial products.

 

Net loan-related fees and servicing revenue was $137,000 during the three months ended March 31, 2012, compared to $251,000 in the same period of the previous year. The following table presents the components of net loan-related fees and servicing revenue for the periods indicated:

 

   Three months ended
March 31
 
   2012   2011 
   (Dollars in thousands) 
Gross servicing fees  $693   $681 
Mortgage servicing rights amortization   (1,043)   (516)
Mortgage servicing rights valuation (loss) recovery   321    6 
Loan servicing revenue, net   (29)   171 
Other loan fee income   166    80 
Loan-related fees and servicing revenue, net  $137   $251 

 

Amortization of MSRs increased in first quarter of 2012 compared to the first quarter of 2011 due to lower market interest rates for one- to four-family mortgage loans, which resulted in increased loan prepayments and faster amortization of the MSRs relative to the 2011 period. Net loan-related fees and servicing revenue is also impacted by changes in the valuation allowance that is established against MSRs. The change in this allowance is recorded as a recovery or loss, as the case may be, in the period in which the change occurs. Although market interest rates were lower for most of the first quarter, such rates increased near the end of the quarter. This increase resulted in lower prepayment expectations as of March 31, 2012, which resulted in a $321,000 decrease in the valuation allowance as of that date. As of March 31, 2012, the Company had a valuation allowance of $547,000 against MSRs with a gross book value of $8.6 million. As of the same date the Company serviced $1.1 billion in loans for third-party investors compared to a similar amount one year ago.

 

The valuation of MSRs, as well as the periodic amortization of MSRs, is significantly influenced by the level of market interest rates and loan prepayments. If interest rates decrease and/or prepayment expectations increase, the Company could potentially record charges to earnings related to increases in the valuation allowance on its MSRs. In addition, amortization expense could increase due to likely increases in loan prepayment activity. Alternatively, if market interest rates for one- to four-family loans increase and/or actual or expected loan prepayment expectations decrease in future periods, the Company could recover all or a portion of previously established allowance on MSRs, as well as record reduced levels of MSR amortization expense.

 

34
 

 

Gains on sales of loans were $2.9 million in the first quarter of 2012 compared to $596,000 in the same quarter last year. The Company typically sells most fixed-rate, one- to four-family mortgage loans that it originates in the secondary market. During the three months ended March 31, 2012, sales of these loans were $123.0 million compared to $57.6 million during the same period in the previous year. Management attributes this increase to lower market interest rates for one- to four-family mortgage loans, which encouraged borrowers to refinance higher-rate loans into lower-rate loans during the period. Although market interest rates for one- to four-family mortgage loans remain relatively low, management is not certain that gains on sales of loans can be sustained at the level experienced in the first quarter for the remainder of 2012 or at levels comparable to the prior year.

 

The Company recorded $1.1 million in net gains on sales of investments in the first quarter of 2011. In that period the Company sold a $20.8 million investment in a mutual fund that management did not expect would perform well in future periods. The Company did not sell any investments during the first quarter of 2012.

 

Other non-interest income was $1.6 million and $1.2 million during the three months ended March 31, 2012 and 2011, respectively. The increase in the 2012 period was due primarily to an increase in the fair value of assets held in trust for certain non-qualifying employee benefit plans, due to the effects of lower interest rates and improved equity markets.

 

Non-Interest Expense Total non-interest expense increased by $3.5 million or 20.3% during the three months ended March 31, 2012, compared to the same period in 2011. This increase was primarily attributable to an increase in net losses and expenses on foreclosed properties, which were $2.8 million during the first quarter of 2012 compared to $1.0 million in the same quarter last year. The Company has experienced elevated losses and expenses on foreclosed real estate in recent periods due to depressed real estate values and slow economic growth. If these conditions persist, losses on foreclosed real estate could remain elevated in the near term. The following paragraphs discuss additional components of the Company’s non-interest expense and the primary reasons for their changes during the first quarter of 2012 compared to the first quarter of 2011.

 

Compensation-related expenses increased by $1.2 million or 12.5% in the first quarter of 2012 compared to the same quarter in 2011. This increase was due primarily to the hiring of additional commercial relationship managers and other key personnel in recent periods, as well as normal annual merit increases. Also contributing was an increase in expenses related to stock-based compensation, certain non-qualifying employee benefit plans, and the defined-benefit pension plan. The later development was principally caused by a decline in the interest rate used to determine the present value of the pension obligation.

 

Federal deposit insurance premiums declined by $191,000 or 18.7% during the first three months of 2012 compared to the same period in 2011. In the second quarter of 2011 the FDIC implemented a new rule that changed the deposit insurance assessment base from an insured institution’s domestic deposits (minus certain allowable exclusions) to an insured institution’s average consolidated assets (minus average tangible equity and certain other adjustments). This rule change resulted in lower FDIC deposit insurance costs for the Company.

 

Advertising and marketing-related expenses increased by $354,000 or over 140% during the three months ended March 31, 2012, compared to the same period in the prior year. This increase was caused by increased television advertising during the first quarter of the year. Management does not expect advertising and marketing-related expenses during the remaining quarters of 2012 to be as high as they were in the first quarter, although this will depend on future management decisions and there can be no assurances.

 

35
 

 

Other non-interest expense increased by $423,000 or 18.0% during the three months ended March 31, 2012, compared to the same period in 2011. These increases were primarily the result of legal, consulting, and accounting fees related to loan workout efforts and related professional services.

 

Income Tax Expense Income tax expense was $462,000 and $361,000 during the three months ended March 31, 2012 and 2011, respectively. The Company’s effective tax rates (“ETR”) during these periods was 28.9% and 26.0%, respectively. These ETRs are lower than typical for the Company because non-taxable revenue, such as earnings from bank-owned life insurance (“BOLI”), comprised a substantial portion of pre-tax earnings during these periods.

 

Like many Wisconsin financial institutions, the Company has non-Wisconsin subsidiaries that hold and manage investment assets and loans, the income from which has not been subject to Wisconsin tax prior to 2009. The Wisconsin Department of Revenue (the “Department”) has instituted an audit program specifically aimed at financial institutions’ out-of-state investment subsidiaries. The Department has asserted the position that some or all of the income of the out-of-state subsidiaries in years prior to 2009 was taxable in Wisconsin. In 2010 the Department’s auditor issued a Notice of Proposed Audit Report to the Company which proposes to tax all of the income of its out-of-state investment subsidiaries for all periods that are still open under the statute of limitations, which includes tax years back to 1997. This is a preliminary determination made by the auditor and does not represent a formal assessment. The Company’s outside legal counsel has met with representatives of the Department to discuss, and object to, the auditor’s proposed adjustments. The Department has requested further information to support the Company’s position, which the Company is in the process of providing.

 

Management continues to believe that the Company has reported income and paid Wisconsin taxes in prior periods in accordance with applicable legal requirements and the Department’s long-standing interpretations of them and that the Company’s position will prevail in discussions with the Department, court proceedings, or other actions that may occur. Ultimately, however, an adverse resolution of these matters could result in additional Wisconsin tax obligations for prior periods, which could have a substantial negative impact on the Company’s earnings in the period such resolution is reached. The Company may also incur further costs in the future to address and defend these issues.

 

Financial Condition

 

Overview The Company’s total assets increased by $111.7 million or 4.5% during the three months ended March 31, 2012. During the period the Company’s held-to-maturity securities increased by $150.8 million. This development was partially offset by an $18.4 million decrease in the Company’s investment in the common stock of the FHLB of Chicago, which is included in other assets, and a $14.3 million decrease in period-end loans receivable. Also during the period, the Company’s borrowings from the FHLB of Chicago increased by $29.7 million, deposit liabilities increased by $11.3 million, escrow deposits increased by $9.9 million, and other liabilities increased by $57.7 million. The latter development was primarily the result of an increase in amounts due to securities brokers for held-to-maturity securities that were purchased in March, but were not delivered until April. The Company’s total shareholders’ equity increased from $265.8 million at December 31, 2011, to $268.9 million at March 31, 2012. Non-performing assets decreased from $99.9 million or 4.0% of total assets at December 31, 2011, to $81.2 million or 3.1% at March 31, 2012. The following paragraphs describe these changes in greater detail, as well as other changes in the Company’s financial condition during the three months ended March 31, 2012.

 

Mortgage-Related Securities Available-for-Sale The Company’s portfolio of securities available-for-sale decreased by $4.9 million or 0.6% during the three months ended March 31, 2012. This decrease was principally caused by security repayments that exceeded the Company’s purchase of new securities during the period. The Company purchased $51.4 million of CMOs issued by government-sponsored entities during the three months ended March 31, 2012.

 

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Changes in the fair value of the Company’s available-for-sale securities are recorded through accumulated other comprehensive loss (net of deferred income taxes), which is a component of shareholders’ equity. The fair value adjustment on the Company’s available-for-sale securities was a net unrealized gain of $11.3 million at March 31, 2012, compared to a net unrealized gain of $7.7 million at December 31, 2011.

 

The Company maintains an investment in private-label CMOs that were purchased from 2004 to 2006 and are secured by prime residential mortgage loans. The securities were all rated “triple-A” by various credit rating agencies at the time of their purchase. However, most of the securities in the portfolio have been downgraded since their purchase. The following table presents the credit ratings, carrying values, and unrealized gains (losses) of the Company’s private-label CMO portfolio as of the dates indicated (in instances of split-ratings, each security has been classified according to its lowest rating):

 

   March 31, 2012   December 31, 2011 
   Carrying
Value
   Unrealized
Gain (Loss),
Net
   Carrying
Value
   Unrealized
Gain (Loss),
Net
 
   (Dollars in thousands) 
Credit rating:                    
AAA/Aaa  $4,482   $176   $5,386   $210 
AA/Aa   2,041    59    2,512    58 
A   7,003    57    6,951    (271)
BBB/Baa   9,164    (175)   10,428    (366)
Less than investment grade   36,617    (3,233)   36,751    (5,357)
Total private-label CMOs  $59,307   $(3,116)  $62,028   $(5,726)

 

As of March 31, 2012, management has determined that none of the Company’s private-label CMOs were other-than-temporarily impaired. The Company does not intend to sell these securities and it is unlikely it would be required to sell them before the recovery of their amortized cost. However, collection is subject to numerous factors outside of the Company’s control and a future determination of OTTI could result in significant losses being recorded through earnings in future periods.

 

Mortgage-Related Securities Held-to-Maturity During the three months ended March 31, 2012, the Company purchased $150.8 million in held-to-maturity securities, including $66.2 million in securities purchased in March that were not delivered until April, as previously noted. These purchases consisted of mortgage-related securities issued and guaranteed by Fannie Mae and backed by multi-family residential loans. The Company funded the purchase of these securities with $150.7 million in term advances from the FHLB of Chicago, $30.0 million of which were drawn in March and $120.7 million of which were not drawn until April. The securities have a weighted-average life of 7.6 years and yield of 2.30%. The securities also have call protection in the form of yield-maintenance fees that discourage early prepayment of the underlying loans. The term advances have a weighted-average life of 5.4 years and cost of 1.45%. The purpose of this transaction was to supplement growth in the Company’s earning assets. The Company classified these securities as held-to-maturity because it has the ability and intent to hold them until they mature.

 

Loans Receivable Loans receivable declined by $14.3 million or 1.1% during the three months ended March 31, 2012. This decrease was caused by loan repayments and foreclosures that exceeded originations during the period. Despite the decrease in the Company’s loan portfolio, total loans originated for portfolio increased by $18.6 million or 25.9% in the first quarter of 2012 compared to the same quarter in 2011. A substantial portion of this increase came from an increase in the origination of multi-family mortgage loans. Management has noted increased demand for these types of loans in recent periods, which it believes is most likely a response to a general decline in the level of home ownership in recent periods. In addition, consumer loan originations, which consisted principally of home equity lines of credit, increased during the quarter due to more competitive pricing and increased marketing efforts for these types of loans.

 

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Originations of commercial business loans also increased by $1.4 million or 11.5% during the first quarter of 2012 compared to the same quarter in 2011. Management attributes this increase to recent efforts to improve the Company’s share of the mid-tier commercial banking market (defined as business entities with sales revenues of $5 to $100 million), which was a new market segment for the Company in 2011. In the past year-and-a-half the Company has added experienced leaders to its senior management team and hired a number of commercial relationship managers experienced in managing and selling financial services to the mid-tier commercial banking market. In the near term the Company expects to add additional professionals capable of serving this market segment, although there can be no assurances as to the extent or timing of such staff additions or the impact on operating results.

 

The following table sets forth the Company’s mortgage, consumer, and commercial loan originations for portfolio during the periods indicated:

 

   Three months ended 
   March 31 
   2012   2011 
   (Dollars in thousands) 
Mortgage loans:          
One- to four-family (1)  $22,578   $21,058 
Multi-family   21,095    5,564 
Commercial real estate   6,021    9,014 
Construction and development loans   2,187    7,292 
Total mortgage loans   51,881    42,928 
Consumer loans   25,056    16,821 
Commercial business loans   13,467    12,078 
Total loans originated for portfolio  $90,404   $71,827 

 

(1)Excludes $126.9 million and $22.8 million in loans originated for sale during the three months ended March 31, 2012 and 2011, respectively.

 

Foreclosed Properties and Repossessed Assets The Company’s foreclosed properties and repossessed assets decreased to $22.2 million at March 31, 2012, from $24.7 million at December 31, 2011. This decrease was caused by the sales of foreclosed real estate, as well as continued charge-offs on foreclosed properties. These developments were partially offset by foreclosures related to a number of smaller commercial real estate mortgage loans and, to a lesser extent, one- to four-family mortgage loans. Management expects foreclosed properties and repossessed assets to remain elevated in the near term as the Company continues to work out its non-performing loans.

 

Mortgage Servicing Rights The carrying value of the Company’s MSRs was $8.0 million at March 31, 2012, and $7.4 million at December 31, 2011, net of valuation allowances of $547,000 and $868,000 as of such dates, respectively. As of both March 31, 2012, and December 31, 2011, the Company serviced $1.1 billion in loans for third-party investors.

 

Other Assets As a condition of membership in the FHLB of Chicago, the Company holds shares of the common stock of the FHLB of Chicago, which is included as a component of other assets. The Company’s investment in the common stock of the FHLB of Chicago declined from $46.1 million at December 31, 2011, to $27.7 million at March 31, 2012. The FHLB of Chicago redeemed $18.4 million of excess common stock held by the Company in accordance with a redemption plan it announced in December 2011. Under this plan, the FHLB of Chicago has stated that it intends to redeem additional excess common stock in quarterly increments through the end of 2013. However, the amount and timing of these redemptions, if any, depend on many factors outside the control of the Company and the FHLB of Chicago. As of March 31, 2012, Company owned approximately $12.5 million more in FHLB of Chicago common stock than it would otherwise be required to own under minimum guidelines established by the FHLB of Chicago.

 

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As of March 31, 2012, and December 31, 2011, the Company’s net deferred tax asset, which is included as component of other assets, was $35.3 million and $37.5 million, respectively. Management evaluates this asset on an on-going basis to determine if a valuation allowance is required. Management determined that no valuation allowance was required as of these dates. The evaluation of the net deferred tax asset requires significant management judgment based on positive and negative evidence. Such evidence includes the Company’s cumulative three-year net loss, the nature of the components of such cumulative loss, recent trends in earnings, expectations for the Company’s future earnings, the duration of federal and state net operating loss carryforward periods, and other factors. There can be no assurance that future events, such as adverse operating results, court decisions, regulatory actions or interpretations, changes in tax rates and laws, or changes in positions of federal and state taxing authorities will not differ from management’s current assessments. The impact of these matters could be significant to the consolidated financial conditions, results of operations, and capital of the Company.

 

Deposit Liabilities Deposit liabilities increased by $11.3 million or 0.6% during the three months ended March 31, 2012. Core deposits, consisting of checking, savings and money market accounts, increased by $26.5 million or 2.7% during the period while certificates of deposits declined by $15.2 million or 1.5%. The Company continues to closely manage the rates it offers on certificates of deposit to control is overall liquidity position, which has resulted in a decline in certificates of deposit in recent periods.

 

Borrowings Borrowings, which consist of advances from the FHLB of Chicago, increased by $29.7 million or 19.4% during the three months ended March 31, 2012. As previously noted, in March the Company borrowed $30.0 million in term advances from the FHLB of Chicago to fund the purchase of held-to-maturity securities. The following table presents the Company’s FHLB of Chicago advances by contractual maturities as March 31, 2012.

 

   Amount   Rate 
   (Dollars in thousands) 
FHLB advances maturing in:          
2012  $100,000    4.52%
2013   229    4.17 
2014        
2015   7,500    0.83 
2016   7,500    1.07 
2017 and thereafter   67,557    4.23 
Total FHLB advances  $182,786    4.12%

 

The above table excludes the $120.7 million in FHLB of Chicago advances drawn in April. These advances have term maturities ranging from three to nine years, a weighted-average maturity of 5.7 years, and a weighted-average cost of 1.51%.

 

The Company’s advances from the FHLB of Chicago are subject to significant prepayment penalties if repaid by the Company prior to their stated maturity. Management believes that additional funds are available to be borrowed from the FHLB of Chicago or other sources in the future to fund maturing advances, loan originations, security purchases, and other corporate purposes, if needed or desirable. However, there can be no assurances of the future availability of borrowings or any particular level of future borrowings.

 

Advance Payments by Borrowers for Taxes and Insurance Advance payments by borrowers for taxes and insurance (i.e., escrow deposits) were $13.1 million at March 31, 2012, compared to $3.2 million at December 31, 2011. Escrow deposits typically increase during the course of the calendar year until real estate tax obligations are paid, generally in December of each year or January of the following year.

 

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Other Liabilities The Company’s other liabilities increased to $109.6 million at March 31, 2012, from $51.1 million at December 31, 2011. This increase was principally caused by amounts due to securities brokers for $66.2 million in securities purchased in March that were not delivered until April, as previously described.

 

Shareholders' Equity The Company’s shareholders’ equity increased from $265.8 million at December 31, 2011, to $268.9 million at March 31, 2012. This increase was caused by net income during the period, as well as lower accumulated other comprehensive loss due to an increase in the fair value of available-for-sale securities. These developments were partially offset by the payment of a regular cash dividend to shareholders of $0.01 per share during the quarter. This dividend payment represented a dividend payout ratio of 40.1% of net income. The book value per share of the Company’s common stock was $5.80 at March 31, 2012, compared to $5.75 at December 31, 2011.

 

On May 7, 2012, the Company’s board of directors announced that it had declared a $0.01 per share dividend payable on June 1, 2012, to shareholders of record on May 18, 2012. During the three months ended March 31, 2012, the Company did not repurchase any shares of its common stock. For additional discussion relating to the Company’s ability to pay dividends or repurchase shares of its common stock, refer to “Liquidity and Capital Resources—Capital Resources,” below.

 

Asset Quality The following table summarizes non-performing loans and assets as of the dates indicated:

 

   At March 31   At December 31 
   2012   2011 
   (Dollars in thousands) 
 Non-accrual mortgage loans:          
One- to four-family  $13,124   $14,868 
Multi-family   20,061    22,905 
Commercial real estate   14,121    23,997 
Construction and development   8,196    9,368 
Total non-accrual mortgage loans   55,502    71,138 
Non-accrual consumer loans:          
Secured by real estate   1,299    1,457 
Other consumer loans   186    207 
Total non-accrual consumer loans   1,485    1,664 
Non-accrual commercial business loans   1,467    1,642 
Total non-accrual loans   58,454    74,444 
Accruing loans delinquent 90 days or more (1)   562    696 
Total non-performing loans   59,016    75,140 
Foreclosed properties and repossessed assets   22,176    24,724 
Total non-performing assets  $81,192   $99,864 
           
Non-performing loans to loans receivable, net   4.52%   5.69%
Non-performing assets to total assets   3.11%   4.00%
Interest income that would have been recognized if non-accrual loans had been current (2)  $1,033   $4,535 
Interest income on non-accrual loans included in interest income (2)  $180   $1,850 

 

(1)Consists of student loans that are guaranteed under programs sponsored by the U.S. government.
(2)Amounts shown are for the three months ended March 31, 2012, and the twelve months ended December 31, 2011, respectively.

 

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Although the Company’s non-performing loans have declined in recent periods, such loans remain high by historical standards due to weak economic conditions and high unemployment. These developments have strained the financial condition of many borrowers and have resulted in higher levels of loan delinquencies. As a result, many properties securing the Company’s loans have experienced increased vacancy rates, reduced lease rates, and/or delays in unit sales, as well as lower real estate values. The Company’s non-performing loans were $59.0 million or 4.52% of loans receivable as of March 31, 2012, compared to $75.1 million or 5.69% of loans receivable as of December 31, 2011. Non-performing assets, which includes non-performing loans, were $81.2 million or 3.11% of total assets and $99.9 million or 4.00% of total assets as of these same dates, respectively. The decline in non-performing loans during the three months ended March 31, 2012, was primarily attributable to three loans that aggregated $5.3 million that were paid off, one loan for $2.5 million that was returned to performing status due to the improved condition of the borrower, and two loans that aggregated $2.2 million that were transferred to foreclosed real estate. All of these loans were secured by commercial and multi-family real estate. In addition, non-performing one- to four-family loans declined by $1.7 million or 11.7% during the three months ended March 31, 2012.

 

As of March 31, 2012, non-performing loans included $23.8 million in loans that were current on all contractual principal and interest payments, but which management determined should be classified as non-performing in light of underlying difficulties with the properties that secure the loans, as well as an increasingly strict regulatory environment. In most cases, interest income is no longer being accrued on these loans and periodic payments are being applied against the recorded investment in the loan.

 

In addition to non-performing assets, at March 31, 2012, management was closely monitoring $49.1 million in additional loans that were classified as “special mention” and $27.7 million that were adversely classified as “substandard” in accordance with the Company’s internal risk rating policy. These amounts compared to $51.2 million and $28.5 million, respectively, as of December 31, 2011. These loans are primarily secured by commercial real estate, multi-family real estate, land, and certain commercial business assets. Although these loans were performing in accordance with their contractual terms, management deemed their classification prudent in light of deterioration in the financial strength of the borrowers and/or the performance of the collateral, including an assessment of occupancy rates, lease rates, unit sales, and/or estimated changes in the value of the collateral.

 

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A summary of the allowance for loan losses is shown below for the periods indicated:

 

   Three months ended March 31 
   2012   2011 
   (Dollars in thousands) 
Balance at the beginning of the period  $27,928   $47,985 
Provision for loan losses:          
One- to four-family   399    (98)
Multi-family   (178)   1,747 
Commercial real estate   333    286 
Construction and development   (169)   996 
Consumer loans   216    (103)
Commercial business loans   (550)   352 
     Total provision for loan losses   51    3,180 
Charge-offs:          
One- to four-family   (377)   (1,092)
Multi-family   (697)   (2,878)
Commercial real estate   (2,245)   (735)
Construction and development   (102)   (2,415)
Consumer loans   (278)   (228)
Commercial business loans   (10)   (302)
Total charge-offs   (3,709)   (7,650)
Recoveries:          
One- to four-family        
Multi-family   568     
Commercial real estate   399     
Construction and development        
Consumer loans   4    4 
Commercial business loans       7 
Total recoveries   971    11 
Net charge-offs   (2,738)   (7,639)
Balance at the end of the period  $25,241   $43,526 

  

   March 31   December 31 
   2012   2011 
Allowance as a percent of total loans   1.93%   2.12%
Allowance as a percent of non-performing loans   42.77%   37.17%
Net charge-offs to average loans (1)   0.80%   1.96%

 

(1)The rate for the three months ended March 31, 2012, is annualized.

 

The Company’s allowance for loan losses was $25.2 million or 1.93% of total loans at March 31, 2012, compared to $27.9 million or 2.12% of total loans at December 31, 2011. As a percent of non-performing loans, the Company’s allowance for loan losses was 42.77% at March 31, 2012, compared to 37.17% at December 31, 2011. The decrease in the allowance was principally caused by $2.7 million in net charge-offs during the period. Most notably, the Company charged off $1.5 million related to two loan relationships that aggregated $4.6 million on which management commenced foreclosure proceedings during the period. These loans are secured by a multi-tenant office showroom and multi-tenant retail center. Most of the allowances related to these two loan relationships had been established in previous periods. Additions to the allowance for loan losses during the period, which consisted of $1.2 million in provision for loan losses, were substantially offset by loan loss recoveries, as previously described. In addition, The Company reduced its allowance for loan losses modestly during the quarter to reflect improved credit quality in its loan portfolio, attributable to lower levels of delinquent and classified loans, as previously described.

 

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The allowance for loan losses has been determined in accordance with GAAP. Management is responsible for the timely and periodic determination of the amount of the allowance required. Future provisions for loan losses will continue to be based upon management’s assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions, and other relevant factors. To the best of management’s knowledge, all known and inherent losses have been provided for in the allowance for loan losses.

 

Refer to “Operating Results—Provision for Loan Losses,” above, for additional discussion.

 

Liquidity and Capital Resources

 

Liquidity The term "liquidity" refers to the Company’s ability to generate cash flow to fund loan originations, loan purchases, deposit withdrawals, and operating expenses. The Company’s primary sources of funds are deposit liabilities, scheduled payments, prepayments, and maturities of loans and securities available-for-sale, sales of one- to four-family loans in the secondary market, sales of securities available-for-sale, borrowings from the FHLB of Chicago, and cash flow provided by the Company’s operations. Historically, these sources of funds have been adequate to maintain liquidity, with the Company borrowing correspondingly more in periods in which its operations generate less cash.

 

Scheduled payments and maturities of loans and securities available-for-sale are relatively predictable sources of funds. However, cash flows from customer deposits, calls of investment securities, and prepayments of loans and mortgage-related securities are strongly influenced by interest rates, general and local economic conditions, and competition in the marketplace. These factors increase the variability of cash flows from these sources of funds.

 

The Company is committed to maintaining a strong liquidity position; therefore, management monitors the Company’s liquidity position on a daily basis. Based upon historical experience and available sources of liquidity, management anticipates that the Company will have sufficient funds to meet current funding commitments. For additional discussion refer to “Financial Condition,” above, and “Qualitative and Quantitative Disclosures about Market Risk” in Part I, Item 3, below.

 

Capital Resources   At March 31, 2012, the Bank exceeded each of the applicable regulatory capital requirements (refer to Note 8, “Shareholders’ Equity,” of the Unaudited Condensed Consolidated Financial Statements, above). In order to be classified as "well-capitalized" by the FDIC, the Bank is required to have Tier 1 (leverage) capital to total adjusted assets of at least 5.0% and total risk-based capital to risk-weighted assets of at least 10.0%. At March 31, 2012, the Bank had a Tier 1 capital ratio of 9.29% and a total risk-based capital ratio of 18.31%.

 

In 2011 the Company and the Bank agreed to address certain items identified by the OTS (their former regulator) by each entering into a separate memorandum of understanding (“MOU”) with the OTS. An MOU is an agreement between the regulator and a financial institution which requires the institution to exercise reasonable good faith efforts to comply with the requirements of the MOU, but the institution is not subject to direct judicial enforcement under the MOU as it would be under other forms of supervisory actions such as those required in formal consent orders or cease and desist orders. As a result of the elimination of the OTS under the Dodd-Frank Act, the FRB and OCC have succeeded the OTS as the administrators of the Company’s and Bank’s MOUs, respectively. Management does not believe that the MOUs have a material adverse impact on the Company’s or Bank’s operations. However, in addition to other regulatory requirements, under their respective MOUs the Company and the Bank are required to obtain the prior written non-objection of the FRB and, in the Bank’s case, approval of the OCC, prior to declaring or paying cash dividends and, in the case of the Company, prior to repurchasing common shares, or incurring, issuing, increasing, modifying or redeeming any debt or lines of credit. As such, the Company cannot provide any assurances that it will continue to pay dividends to shareholders, that dividend payments to shareholders will not be reduced, or that shares will be repurchased in the future.

 

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On May 7, 2012, the Company’s board of directors announced that it had declared a $0.01 per share dividend payable on June 1, 2012, to shareholders of record on May 18, 2012. During the three months ended March 31, 2012, the Company did not repurchase any shares of its common stock.

 

Contractual Obligations, Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements

 

Contractual Obligations The following table presents, as of March 31, 2012, significant fixed and determinable contractual obligations to third parties by payment date (excluding interest payments due in the future on deposits and borrowed funds).

 

   Payments Due In 
       One to   Three to   Over     
   One Year   Three   Five   Five     
   Or Less   Years   Years   Years   Total 
   (Dollars in thousands) 
Deposits with no stated maturity  $1,005,178               $1,005,178 
Certificates of deposits   725,846   $285,078   $16,844        1,027,768 
Borrowed funds   100,000    5,000    10,000   $67,786    182,786 
Operating leases   1,019    1,883    1,501    2,972    7,375 
Purchase obligations   1,680    3,360    3,360    4,200    12,600 
Non-qualified retirement plans and deferred compensation plans   1,080    2,215    1,627    7,368    12,290 

 

The above table excludes the $120.7 million in borrowed funds, which consist of FHLB of Chicago advances, that were drawn in April. These advances have term maturities ranging from three to nine years.

 

The Company’s operating lease obligations represent short- and long-term lease and rental payments for facilities, certain software and data processing equipment, and other equipment. Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The purchase obligation amounts presented above primarily relate to certain contractual payments for services provided for information technology.

 

The Company also has obligations under its deferred retirement plan for executives and directors as described in Note 10, “Employee Benefit Plans,” to the Unaudited Condensed Consolidated Financial Statements, above.

 

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Commitments to Extend Credit The following table details the amounts and expected maturities of approved commitments as of March 31, 2012.

 

   Payments Due In 
       One to   Three to   Over     
   One Year   Three   Five   Five     
   Or Less   Years   Years   Years   Total 
   (Dollars in thousands) 
One- to four-family mortgage loans  $16,262               $16,262 
Multi-family mortgage loans   31,776                31,776 
Commercial real estate loans   2,864                2,864 
Commercial business loans   54,253   $1,291       $10    55,554 
Home equity and credit card    lines of credit   153,302                153,302 

 

Approved commitments to extend credit do not necessarily represent future cash requirements, since these commitments often expire without being drawn upon.

 

Off-Balance Sheet Arrangements At March 31, 2012, the Company had forward commitments to sell one- to four-family mortgage loans of $74.2 million to Fannie Mae. As described in Note 12, “Financial Instruments with Off-Balance Sheet Risk,” to the Company’s Unaudited Condensed Consolidated Financial Statements, the Company uses forward commitments to sell loans to mitigate interest rate risk on one- to four-family IRLCs and loans held-for-sale.

 

Contingent Liabilities The Company did not have a material exposure to contingent liabilities as of March 31, 2012.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Gap Analysis

 

Repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring a financial institution's interest rate sensitivity "gap." An asset or liability is said to be "interest rate sensitive" within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period.

 

A gap is considered positive when the amount of interest-earning assets maturing or repricing within a specific time period exceeds the amount of interest-bearing liabilities maturing or repricing within that specific time period. A gap is considered negative when the amount of interest-bearing liabilities maturing or repricing within a specific time period exceeds the amount of interest-earning assets maturing or repricing within the same period. During a period of rising interest rates, a financial institution with a negative gap position would be expected, absent the effects of other factors, to experience a greater increase in the costs of its liabilities relative to the yields of its assets and thus a decrease in the institution's net interest income. An institution with a positive gap position would be expected, absent the effect of other factors, to experience the opposite result. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to reduce net interest income.

 

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The table on the next page presents the amounts of the Company’s interest-earning assets and interest-bearing liabilities outstanding at March 31, 2012, which management anticipates to reprice or mature in each of the future time periods shown. The information presented in the following table is based on the following assumptions:

 

·Mortgage-related securities—based upon known repricing dates (if applicable) and an independent outside source for determining estimated prepayment speeds. Actual cash flows may differ substantially from these assumptions. Mortgage-related securities that aggregate $66.2 million that were purchased in March but were not delivered until April are excluded from the analysis.

 

·Loans—based upon contractual maturities, repricing date, if applicable, scheduled repayments of principal, and projected prepayments of principal based upon the Company’s historical experience or anticipated prepayments. Actual cash flows may differ substantially from these assumptions.

 

·Deposit liabilities—based upon contractual maturities and the Company’s historical decay rates. Actual cash flows may differ from these assumptions.

 

·Borrowings—based upon final maturity.

 

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   At March 31, 2012 
   Within
Three
Months
   Three to
Twelve
Months
   More Than
One Year
To Three
Years
   More Than
Three Years
To Five
Years
   Over Five
Years
   Total 
Interest-earning assets:  (Dollars in thousands) 
Loans receivable:                              
Mortgage loans:                              
Fixed  $50,947   $72,257   $134,606   $142,847   $81,290   $481,947 
Adjustable   86,750    241,976    109,386    48,359    2,470    488,941 
Consumer loans   100,000    52,096    46,075    22,718    15,206    236,095 
Commercial business loans   36,330    16,321    25,781    9,787    86    88,305 
Interest-earning deposits   90,273                    90,273 
Mortgage-related securities:                              
Fixed   50,771    141,714    289,103    148,633    159,045    789,266 
Adjustable   60,845                    60,845 
Other interest-earning assets   27,675                    27,675 
Total interest-earning assets   503,591    524,364    604,951    372,344    258,097    2,263,347 
                               
Non-interest-bearing and interest-bearing liabilities:                              
Non-interest-bearing demand accounts   749    2,221    5,731    5,462    110,972    125,135 
Interest-bearing liabilities:                              
Deposit liabilities:                              
Interest-bearing demand accounts   1,416    4,196    10,827    10,319    209,648    236,406 
Savings accounts   1,453    4,298    11,031    10,433    190,424    217,639 
Money market accounts   425,997                    425,997 
Certificates of deposit   351,411    478,893    180,620    16,845        1,027,769 
Advance payments by borrowers for taxes and insurance       13,094                13,094 
Borrowings   307    100,950    10,388    17,956    53,185    182,786 
Total interest-bearing  and non-interest-bearing liabilities   781,333    603,652    218,597    61,015    564,228    2,228,826 
Interest rate sensitivity gap  $(277,742)  $(79,288)  $386,354   $311,329   $(306,131)  $34,522 
Cumulative interest rate sensitivity gap  $(277,742)  $(357,030)  $29,324   $340,653   $34,522      
Cumulative interest rate sensitivity gap as a percentage of total assets   (10.64)%   (13.68)%   1.12%   13.05%   1.32%     
Cumulative interest-earning assets as a percentage of interest bearing liabilities   64.45%   74.22%   101.83%   120.46%   101.55%     

 

Based on the above gap analysis, at March 31, 2012, the Company’s interest-bearing liabilities maturing or repricing within one year exceeded its interest-earning assets maturing or repricing within the same period by $357.0 million. This represented a negative cumulative one-year interest rate sensitivity gap of 13.68%, and a ratio of interest-earning assets maturing or repricing within one year to interest-bearing liabilities maturing or repricing within one year of 74.22%. Based on this information, over the course of the next year the Company’s net interest income could be adversely impacted by an increase in market interest rates. Alternatively, the Company’s net interest income could be favorably impacted by a decline in market interest rates. However, it should be noted that the Company’s future net interest income is affected by more than just future market interest rates. Net interest income is also affected by absolute and relative levels of earning assets and interest-bearing liabilities, the level of non-performing loans and other investments, and by other factors outlined in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” above, as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2011 Annual Report on Form 10-K.

 

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In addition to not anticipating all of the factors that could impact future net interest income, gap analysis has certain shortcomings. For example, although certain assets and liabilities may mature or reprice in similar periods, the interest rates on such react by different degrees to changes in market interest rates, especially in instances where changes in rates are limited by contractual caps or floors or instances where rates are influenced by competitive forces. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates (for example, rate changes on most deposit liabilities generally lag changes in market interest rates). Certain assets, such as adjustable-rate loans, have features which limit changes in interest rates on a short term basis and over the life of the loan. If interest rates change, prepayment, and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of borrowers to make payments on their adjustable-rate loans may decrease if interest rates increase.

 

Present Value of Equity

 

In addition to the gap analysis table, management also uses simulation models to monitor interest rate risk. The models report the present value of equity (“PVE”) in different interest rate environments, assuming an instantaneous and permanent interest rate shock to all interest rate sensitive assets and liabilities. The PVE is the difference between the present value of expected cash flows of interest rate sensitive assets and liabilities. The changes in market value of assets and liabilities due to changes in interest rates reflect the interest rate sensitivity of those assets and liabilities as their values are derived from the characteristics of the asset or liability (i.e., fixed rate, adjustable rate, caps, and floors) relative to the current interest rate environment. For example, in a rising interest rate environment, the fair market value of a fixed-rate asset will decline whereas the fair market value of an adjustable-rate asset, depending on its repricing characteristics, may not decline. Increases in the market value of assets will increase the PVE whereas decreases in market value of assets will decrease the PVE. Conversely, increases in the market value of liabilities will decrease the PVE whereas decreases in the market value of liabilities will increase the PVE.

 

The following table presents the estimated PVE over a range of interest rate change scenarios at March 31, 2012. The present value ratio shown in the table is the PVE as a percent of the present value of total assets in each of the different rate environments. For purposes of this table, management has made assumptions such as prepayment rates and decay rates similar to those used for the gap analysis table.

 

               Present Value of Equity 
               as a Percent of 
Change in  Present Value of Equity   Present Value of Assets 
Interest Rates  Dollar   Dollar   Percent   Present Value   Percent 
(Basis Points)  Amount   Change   Change   Ratio   Change 
   (Dollars in thousands)     
+400  $186,128   $(165,829)   (47.1)%   7.73%   (42.0)%
+300   227,291    (124,666)   (35.4)   9.22    (30.9)
+200   272,272    (79,685)   (22.6)   10.78    (19.1)
+100   313,319    (38,638)   (11.0)   12.13    (9.1)
      0   351,957            13.34     
-100   353,314    1,357    0.4    13.17    (1.2)

 

Based on the above analysis, the Company’s PVE could be adversely affected by an increase in interest rates. The decline in the PVE as a result of an increase in rates is attributable to the combined effects of a decline in the present value of the Company’s earning assets (which is further impacted by an extension in duration in rising rate environments due to slower prepayments on loan and mortgage-related securities and reduced likelihood of calls on certain investment securities), partially offset by a decline in the present value of deposit liabilities and FHLB of Chicago advances. Also based on the above analysis, the Company’s PVE could be favorably impacted by a modest amount by a decrease in interest rates. However, it should be noted that the Company’s PVE is impacted by more than changes in market interest rates. Future PVE is also affected by management’s decisions relating to reinvestment of future cash flows, decisions relating to funding sources, and by other factors outlined in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” above, as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2011 Annual Report on Form 10-K.

 

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As is the case with gap analysis, PVE analysis also has certain shortcomings. PVE modeling requires management to make assumptions about future changes in market interest rates that are unlikely to occur, such as immediate, sustained, and parallel (or equal) changes in all market rates across all maturity terms. PVE modeling also requires that management make assumptions which may not reflect the manner in which actual yields and costs respond to changes in market interest rates. For example, management makes assumptions regarding the acceleration rate of the prepayment speeds of higher yielding mortgage loans. Prepayments will accelerate in a falling rate environment and the reverse will occur in a rising rate environment. Management also assumes that decay rates on core deposits will accelerate in a rising rate environment and the reverse in a falling rate environment. The model assumes that the Company will take no action in response to the changes in interest rates, when in practice rate changes on most deposit liabilities lag behind market changes and/or may be limited by competition. In addition, prepayment estimates and other assumptions within the model are subjective in nature, involve uncertainties, and therefore cannot be determined with precision. Accordingly, although the PVE model may provide an estimate of the Company’s interest rate risk at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in interest rates on the Company’s PVE.

 

Item 4. Controls and Procedures

 

Disclosure Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such terms are defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.

 

Internal Control Over Financial Reporting

 

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

 

Item 1A. Risk Factors

 

Refer to “Risk Factors” in Part I, Item 1A, of the Company’s 2011 Annual Report on Form 10-K. Refer also to "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement