10-Q 1 v325270_10q.htm QUARTERLY REPORT

 

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 September 30, 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 November 6, 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 September 30, 2012, and December 31, 2011 3
       
    Unaudited Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2012 and 2011 4
       
    Unaudited Condensed Consolidated Statements of Total Comprehensive Income for the Three and Nine Months Ended September 30, 2012 and 2011 6
       
    Unaudited Condensed Consolidated Statements of Equity for the Nine Months Ended September 30, 2012 and 2011 7
       
    Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011 8
       
    Notes to Unaudited Condensed Consolidated Financial Statements 10
       
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations 34
       
Item 3.   Quantitative and Qualitative Disclosures about Market Risk 53
       
Item 4.   Controls and Procedures 57
       
PART II      
       
Item 1A.   Risk Factors 58
       
Item 6.   Exhibits 58
       
SIGNATURES     59

 

2
 

 

PART I

 

Item 1. Financial Statements

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Financial Condition

 

   September 30   December 31 
   2012   2011 
   (Dollars in thousands) 
Assets          
           
Cash and due from banks  $35,933   $52,306 
Interest-earning deposits   45,944    68,629 
Cash and cash equivalents   81,877    120,935 
Mortgage-related securities available-for-sale, at fair value   618,545    781,770 
Mortgage-related securities held-to-maturity, at amortized cost (fair value of $164,174  in 2012)   158,062     
Loans held-for-sale, net   26,908    19,192 
Loans receivable (net of allowance for loan losses of $20,979 in 2012 and $27,928 in 2011)   1,384,805    1,319,636 
Foreclosed properties and repossessed assets   13,558    24,724 
Mortgage servicing rights, net   6,319    7,401 
Other assets   194,967    224,826 
           
Total assets  $2,485,041   $2,498,484 
           
Liabilities and equity          
           
Liabilities:          
Deposit liabilities  $1,920,356   $2,021,663 
Borrowings   211,102    153,091 
Advance payments by borrowers for taxes and insurance   32,596    3,192 
Other liabilities   45,969    51,842 
Total liabilities   2,210,023    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 2011Outstanding–46,326,484 shares in 2012 and 46,228,984 in 2011   788    788 
Additional paid-in capital   489,371    490,159 
Retained earnings   143,852    140,793 
Accumulated other comprehensive loss   (2,467)   (5,379)
Treasury stock–32,457,365 shares in 2012 and 32,554,865 in 2011   (359,409)   (360,590)
Total shareholders’ equity   272,135    265,771 
Non-controlling interest in real estate partnership   2,883    2,925 
Total equity including non-controlling interest   275,018    268,696 
           
Total liabilities and equity  $2,485,041   $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
September 30
 
   2012   2011 
   (Dollars in thousands,
except per share data)
 
Interest income:          
Loans  $16,514   $17,468 
Mortgage-related securities   4,134    4,303 
Interest-earning deposits   30    27 
Investment securities   19    219 
Total interest income   20,697    22,017 
Interest expense:          
Deposit liabilities   3,543    4,731 
Borrowings   1,554    1,798 
Advance payments by borrowers for taxes and insurance   1    2 
Total interest expense   5,098    6,531 
Net interest income   15,599    15,486 
Provision for loan losses   657    1,093 
Net interest income after provision for loan losses   14,942    14,393 
Non-interest income:          
Service charges on deposits   1,832    1,683 
Brokerage and insurance commissions   678    765 
Loan related fees and servicing revenue, net   (1,091)   (1,036)
Gain on loan sales activities, net   3,412    2,288 
Increase in cash surrender value of life insurance   528    543 
Other non-interest income   1,486    1,231 
Total non-interest income   6,845    5,474 
Non-interest expense:          
Compensation, payroll taxes, and other employee benefits   10,465    9,642 
Occupancy and equipment   2,835    2,781 
Federal insurance premiums   831    756 
Advertising and marketing   376    583 
Losses and expenses on foreclosed real estate, net   1,748    1,662 
Other non-interest expense   2,535    2,496 
Total non-interest expense   18,790    17,920 
Income before income taxes   2,997    1,947 
Income tax expense   1,044    610 
Net income before non-controlling interest   1,953    1,337 
Net loss attributable to non-controlling interest   13    12 
Net income  $1,966   $1,349 
           
Per share data:          
Earnings per share–basic  $0.04   $0.03 
Earnings per share–diluted  $0.04   $0.03 
Cash dividends per share paid  $0.01   $0.01 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

4
 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

 

   Nine Months Ended
September 30
 
   2012   2011 
   (Dollars in thousands,
except per share data)
 
Interest income:          
Loans  $49,142   $52,887 
Mortgage-related securities   13,228    12,131 
Interest-earning deposits   130    125 
Investment securities   54    2,843 
Total interest income   62,554    67,986 
Interest expense:          
Deposit liabilities   11,467    15,210 
Borrowings   5,735    5,359 
Advance payments by borrowers for taxes and insurance   2    3 
Total interest expense   17,204    20,572 
Net interest income   45,350    47,414 
Provision for loan losses   2,438    5,078 
Net interest income after provision for loan losses   42,912    42,336 
Non-interest income:          
Service charges on deposits   5,055    4,709 
Brokerage and insurance commissions   2,224    2,211 
Loan related fees and servicing revenue, net   (2,348)   (452)
Gain on loan sales activities, net   9,867    3,405 
Gain on investments, net   543    1,113 
Other-than-temporary impairment (“OTTI”) losses:          
Total OTTI losses   (909)   (1,576)
Non-credit portion of OTTI losses   573    1,187 
Net OTTI losses   (336)   (389)
Increase in cash surrender value of life insurance   1,578    1,628 
Other non-interest income   4,468    3,803 
Total non-interest income   21,051    16,028 
Non-interest expense:          
Compensation, payroll taxes, and other employee benefits   31,738    28,643 
Occupancy and equipment   8,567    8,629 
Federal insurance premiums   2,533    2,525 
Advertising and marketing   1,446    1,228 
Losses and expenses on foreclosed real estate, net   5,496    5,389 
Other non-interest expense   7,669    7,170 
Total non-interest expense before goodwill impairment   57,449    53,584 
Goodwill impairment       52,570 
Total non-interest expense   57,449    106,154 
Income (loss) before income taxes   6,514    (47,790)
Income tax expense   2,107    1,236 
Net income (loss) before non-controlling interest   4,407    (49,026)
Net loss attributable to non-controlling interest   42    39 
Net income (loss)  $4,449   $(48,987)
           
Per share data:          
Earnings (loss) per share–basic  $0.10   $(1.07)
Earnings (loss) per share–diluted  $0.10   $(1.07)
Cash dividends per share paid  $0.03   $0.05 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

5
 

 

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Total Comprehensive Income

 

   Three Months Ended
September 30
 
   2012   2011 
   (Dollars in thousands) 
         
Net income before non-controlling interest  $1,953   $1,337 
Other comprehensive income (loss), net of tax:          
Unrealized holding gains (losses) during the period:          
Non-credit portion of OTTI on securities available-for sale, net of of deferred income taxes of $(111) in 2011       (166)
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $485 in 2012 and $3,139 in 2011   724    4,689 
    724    4,523 
Defined benefit pension plans:          
Amortization of prior period net loss included in net periodic pension cost, net of deferred income taxes of $176 in 2012   263     
    263     
Total other comprehensive income, net of tax   987    4,523 
Total comprehensive income before non-controlling interest   2,940    5,860 
Comprehensive loss attributable to non-controlling interest   13    12 
           
Total comprehensive income  $2,953   $5,872 

 

   Nine Months Ended
September 30
 
   2012   2011 
   (Dollars in thousands) 
         
Net income (loss) before non-controlling interest  $4,407   $(49,026)
Other comprehensive income (loss), net of tax:          
Unrealized holding gains (losses) during the period:          
Non-credit portion of OTTI on securities available-for sale, net of of deferred income taxes of $(230) in 2012 and $(476) in 2011   (343)   (711)
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $1,870 in 2012 and $6,668 in 2011   2,790    9,960 
Reclassification adjustment for realized gains on sales of securities available-for-sale, net of income taxes of $(218) in 2012 and $(446) in 2011   (325)   (667)
    2,122    8,582 
Defined benefit pension plans:          
Amortization of prior period net loss included in net periodic pension cost, net of deferred income taxes of $527 in 2012   790     
Other pension-related adjustments, net of deferred income taxes of $(41) in 2011       (62)
    790    (62)
Total other comprehensive income, net of tax   2,912    8,520 
Total comprehensive income (loss) before non-controlling interest   7,319    (40,506)
Comprehensive loss attributable to non-controlling interest   42    39 
           
Total comprehensive income (loss)  $7,361   $(40,467)

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

6
 

 

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           4,449                4,449 
Net loss attributable to non-controlling interest                       (42)   (42)
Other comprehensive income               2,912            2,912 
Issuance of management recognition plan shares       (1,181)           1,181         
Share based payments       393                    393 
Cash dividends ($0.03 per share)           (1,390)               (1,390)
                                    
Balance at September 30, 2012  $788   $489,371   $143,852   $(2,467)  $(359,409)  $2,883   $275,018 
                                    
Balance at January 1, 2011  $788   $494,377   $191,238   $(6,897)  $(366,553)  $2,925   $315,878 
Net loss           (48,987)               (48,987)
Net loss attributable to non-controlling interest                       (39)   (39)
Other comprehensive income               8,520            8,520 
Equity contribution by non-controlling real estate partnership                       50    50 
Issuance of management recognition plan shares       (123)           123         
Exercise of stock options       (4,375)           5,840        1,465 
Share based payments       210                    210 
Cash dividends ($0.05 per share)           (2,418)               (2,418)
                                    
Balance at September 30, 2011  $788   $490,089   $139,833   $1,623   $(360,590)  $2,936   $274,679 
                                    

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

7
 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

 

   Nine Months Ended
September 30
 
   2012   2011 
   (Dollars in thousands) 
Operating activities:          
Net income (loss)  $4,449   $(48,987)
Adjustments to reconcile net income to net cash from operating activities:          
Net provision for loan losses   2,438    5,078 
Net loss on foreclosed real estate   4,559    4,002 
Provision for depreciation   1,913    1,931 
Goodwill impairment       52,570 
Net OTTI losses   336    389 
Amortization of mortgage servicing rights   3,004    1,718 
Increase in valuation allowance on MSRs   1,919    1,097 
Net premium amortization on securities   3,674    2,568 
Loans originated for sale   (359,514)   (139,577)
Proceeds from loan sales   357,824    150,531 
Net gain on loan sales activities   (9,867)   (3,405)
Net gain on sale of investments   (543)   (1,113)
Other, net   (3,412)   2,738 
Net cash provided by operating activities   6,780    29,540 
Investing activities:          
Proceeds from maturities of investment securities available-for-sale       185,824 
Proceeds from sale of investment securities       21,950 
Purchases of mortgage-related securities available-for-sale   (51,374)   (407,532)
Principal repayments on mortgage-related securities available-for-sale   194,020    92,253 
Proceeds from sales of mortgage-related securities available-for-sale   20,938     
Purchases of mortgage-related securities held-to-maturity   (158,915)    
Principal repayments on mortgage-related securities held-to-maturity   570     
Proceeds from redemption of FHLB of Chicago stock   27,021     
Net increase in loans receivable   (76,248)   (20,023)
Proceeds from sale of foreclosed properties   15,248    8,843 
Net purchases of premises and equipment   (1,816)   (1,193)
Net cash used by investing activities   (30,556)   (119,878)
           
         (continued) 

 

8
 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows (Continued)

 

   Nine Months Ended
September 30
 
   2012   2011 
   (Dollars in thousands) 
Financing activities:          
Net decrease in deposit liabilities  $(101,307)  $(69,165)
Proceeds from long-term borrowings   158,935    4,270 
Repayments of borrowings   (100,924)   (819)
Net increase in advance payments by borrowers for taxes and insurance   29,404    27,485 
Cash dividends   (1,390)   (2,418)
Other, net       1,515 
Net cash used by financing activities   (15,282)   (39,132)
Decrease  in cash and cash equivalents   (39,058)   (129,470)
Cash and cash equivalents at beginning of period   120,935    232,832 
Cash and cash equivalents at end of period  $81,877   $103,362 
           
Supplemental information:          
Cash paid in period for:          
Interest on deposit liabilities and borrowings  $17,462   $22,195 
Income taxes   171     
Non-cash transactions:          
Loans  transferred to foreclosed properties and repossessed assets   8,641    21,641 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

9
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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 and nine months ended September 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

 

In April 2011 the Financial Accounting Standards Board (“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) was effective for the Company in the third quarter of 2012. The adoption of this item did not have a material impact on its financial condition, results of operations, or liquidity. 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 item (ii) 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.

 

During the third quarter of 2012 the FASB issued new accounting guidance related to testing indefinite-lived intangible assets for impairment. The new guidance permits an entity to first assess qualitative factors to determine if it is more likely than not that an indefinite-lived intangible asset other than goodwill is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. This new guidance is effective for years beginning after September 15, 2012, which will be the first quarter of 2013 for the Company. The Company’s adoption of this new guidance is not expected to have a material impact in its financial condition, results of operations, or liquidity.

 

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

 

10
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

1. Basis of Presentation (continued)

 

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 and nine months ended September 30, 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 September 30, 2012. Information regarding the impact OTTI has had on the Company’s financial condition and results of operations for the three and nine months ended September 30, 2012 and 2011, can be found in Note 2, “Mortgage-Related Securities Available-for-Sale and Held-to-Maturity,” below.

 

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:

   September 30, 2012 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Securities available-for-sale:                    
Federal Home Loan Mortgage Corporation  $382,526   $8,052       $390,578 
Federal National Mortgage Association   170,749    2,947   $(24)   173,672 
Government National Mortgage Association   38    7        45 
Private-label CMOs   53,976    896    (622)   54,250 
Total available-for-sale  $607,289   $11,902   $(646)  $618,545 
Securities held-to-maturity:                    
Federal National Mortgage Association  $158,062   $6,112       $164,174 
Total held-to-maturity  $158,062   $6,112       $164,174 

 

   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 

 

11
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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 securities available-for-sale and held-to-maturity by amount of time the securities have had a gross unrealized loss as of the dates indicated:

 

   September 30, 2012 
   Less Than 12 Months   Greater Than 12 Months   Total     
   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  $24    1   $18,320               $24   $18,320 
Private-label CMOs              $622    13   $25,158    622    25,158 
Total available-for-sale  $24    1   $18,320   $622    13   $25,158   $646   $43,478 

 

   December 31, 2011     
   Less Than 12 Months   Greater Than 12 Months   Total     
   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 September 30, 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 does not intend to sell the securities and it is unlikely that it will 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 September 30, 2012, and December 31, 2011.

 

Except as noted below, the Company also determined that the unrealized loss on its private-label collateralized mortgage obligations (“CMOs”) was temporary as of September 30, 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 September 30, 2012, and December 31, 2011, the Company had private-label CMOs, with a fair value of $34,022 and $36,751 respectively, and unrealized losses of $284 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. In the second quarter of 2012 the Company recognized $336 in net OTTI losses in earnings related to its investment in four private-label CMOs. The Company recognized $389 in net OTTI losses in earnings the second quarter of 2011 on three private-label CMOs. The determination of the net OTTI loss was based on 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. The following assumptions were used in determining the amount of the credit loss in 2012: (i) prepayments speeds with a range of 5.1% to 16.5% and a weighted average rate of 9.9%, (ii) default rates with a range of 4.0% to 5.5% and a weighted average rate of 4.5%, (iii) loss severity rates with a range of 40.0% to 52.0% and a weighted average rate of 42.9%, and (iv) current credit enhancements with a range of 2.2% to 4.6% and a weighted average rate of 3.4%. The following assumptions were used in determining the amount of the credit loss in 2011: (i) prepayments speeds with a range of 6.1% to 14.9% and a weighted average rate of 11.6%, (ii) default rates with a range of 3.7% to 5.2% and a weighted average rate of 4.4%, (iii) loss severity rates with a range of 40.0% to 43.0% and a weighted average rate of 40.8%, and (iv) current credit enhancements with a range of 5.1% to 6.7% and a weighted average rate of 5.6%.

 

12
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

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

 

The following table is a summary of OTTI related to credit losses that have been recognized in earnings as of the dates indicated, as well as end of period values for securities that have experienced such losses:

 

   At or For the
Three Months Ended
September 30
   At or For the
Nine Months Ended
September 30
 
   2012   2011   2012   2011 
Beginning balance of unrealized OTTI related to credit losses  $725    389   $389     
Additional unrealized OTTI related to credit losses for which OTTI was not previously recognized      $    82   $389 
Additional unrealized OTTI related to credit losses for which OTTI was previously recognized           254     
Net OTTI losses recognized in earnings           336    389 
Ending balance of unrealized OTTI related to credit losses  $725   $389   $725   $389 
Adjusted cost at end of period  $8,541   $8,616   $8,541   $8,616 
Estimated fair value at end of period  $8,609   $7,429   $8,609   $7,429 

 

The three and nine months ended September 30, 2012, included gross realized gains on the sale of securities of zero, and $543, respectively. There were no gross realized losses during these periods. The three and nine months ended September 30, 2011, included gross realized gains on the sale of securities of zero and $1,113, respectively. There were no gross realized losses during these periods.

 

Mortgage-related securities available-for-sale with a fair value of approximately $71,702 and $91,731 at September 30, 2012, and December 31, 2011, respectively, were pledged to secure deposits, borrowings, and for other purposes as permitted or required by law.

 

13
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

3. Loans Receivable

 

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

 

   September 30   December 31 
   2012   2011 
Permanent mortgage loans:          
One- to four-family  $479,155   $508,503 
Multi-family   251,685    247,040 
Commercial real estate   239,970    226,195 
Total permanent mortgages   970,810    981,738 
Construction and development loans:          
One- to four-family   20,691    16,263 
Multi-family   55,124    29,409 
Commercial real estate   20,602    19,907 
Land   14,981    16,429 
Total construction and development   111,398    82,008 
Total real estate mortgage loans   1,082,208    1,063,746 
Consumer loans:          
Fixed home equity   121,873    102,561 
Home equity lines of credit   82,413    86,540 
Student   13,305    15,711 
Home improvement   18,144    24,237 
Automobile   1,761    2,228 
Other consumer   8,677    7,177 
Total consumer loans   246,173    238,454 
Commercial business loans   139,566    87,715 
Total loans receivable   1,467,947    1,389,915 
Undisbursed loan proceeds   (61,391)   (41,859)
Allowance for loan losses   (20,979)   (27,928)
Unearned loan fees and discounts   (772)   (492)
Total loans receivable, net  $1,384,805   $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 September 30, 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 $282,000 and $204,000 were pledged to secure advances from the FHLB of Chicago.

 

The unpaid principal balance of loans serviced for others was $1,134,302 and $1,102,126 at September 30, 2012, and December 31, 2011, respectively. These loans are not reflected in the consolidated financial statements.

 

14
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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).

 

   At or For the Nine Months Ended September 30, 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   2,408    (2,268)   1,198    597    682    (179)   2,438 
Charge-offs   (2,292)   (857)   (4,149)   (2,545)   (555)   (48)   (10,446)
Recoveries   3    568    428        34    26    1,059 
Ending balance  $3,320   $4,885   $6,944   $2,558   $1,375   $1,897   $20,979 
Loss allowance individually evaluated for impairment  $492   $319   $125   $300   $427   $65   $1,728 
Loss allowance collectively evaluated for impairment  $2,828   $4,566   $6,819   $2,258   $948   $1,832   $19,251 
                                    
Loan receivable balances at the end of the period:                                   
Loans individually evaluated for impairment  $9,231   $12,707   $25,716   $14,513   $1,749   $1,877   $65,793 
Loans collectively evaluated for impairment   463,075    238,978    214,252    42,343    244,462    137,653    1,340,763 
Total loans receivable  $472,306   $251,685   $239,968   $56,856   $246,211   $139,530   $1,406,556 

 

   At or For the Nine Months Ended September 30, 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   1,446    617    577    897    450    1,092    5,078 
Charge-offs   (2,519)   (4,812)   (6,941)   (2,607)   (724)   (551)   (18,154)
Recoveries   49    19    4    550    17    18    657 
Transfers       2,765    2,026    (4,791)            
Ending balance  $2,702   $7,854   $17,551   $4,190   $1,170   $2,100   $35,567 
Loss allowance individually evaluated for impairment  $145   $3,683   $10,301   $2,762   $367   $129   $17,387 
Loss allowance collectively evaluated for impairment  $2,557   $4,171   $7,250   $1,428   $803   $1,971   $18,180 
                                    
Loan receivable balances at the end of the period:                                   
Loans individually evaluated for impairment  $15,278   $25,112   $43,040   $20,915   $1,741   $4,871   $110,957 
Loans collectively evaluated for impairment   493,706    208,848    192,133    29,122    232,887    76,244    1,232,940 
Total loans receivable  $508,984   $233,960   $235,173   $50,037   $234,628   $81,115   $1,343,897 

 

During the nine months ended September 30, 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 a decrease of $372 and an increase of $961 in the total allowances for loan losses during the nine months ended September 30, 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.

 

15
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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).

   September 30, 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  $1,602   $1,602   $492   $2,689     
Multi-family   2,446    2,584    319    12,415     
Commercial real estate:                         
Office   137    145    77    993   $1 
Retail/wholesale/mixed   515    542    48    1,833    3 
Industrial/warehouse               379     
Other               240     
Total commercial real estate   652    687    125    3,445    4 
Construction and development:                         
One- to four-family               69     
Multi-family               1,117     
Commercial real estate               689     
Land   509    534    300    2,071     
Total construction and development   509    534    300    3,946     
Consumer:                         
Home equity   307    307    283    331     
Student                    
Other   144    144    144    94     
Total consumer   451    451    427    425     
Commercial business:                         
Term loans   105    109    65    208    1 
Lines of credit               37     
Total commercial business   105    109    65    245    1 
Total with an allowance recorded  $5,765   $5,967   $1,728   $23,165   $5 
                          
With no allowance recorded:                         
One- to four-family  $7,368   $9,779       $9,421   $161 
Multi-family   6,182    8,159        4,933    405 
Commercial real estate:                         
Office   2,292    3,959        3,356    34 
Retail/wholesale/mixed   8,631    13,841        7,472    244 
Industrial/warehouse   529    631        670    12 
Other               978     
Total commercial real estate   11,452    18,431        12,476    290 
Construction and development:                         
One- to four-family               19     
Multi-family       107        29     
Commercial real estate               685     
Land   629    2,173        1,057    6 
Total construction and development   629    2,280        1,790    6 
Consumer:                         
Home equity   1,249    1,249        1,073    22 
Student                    
Other   27    42        93    4 
Total consumer   1,276    1,291        1,166    26 
Commercial business:                         
Term loans   505    587        627    17 
Lines of credit   70    161        385    1 
Total commercial business   575    748        1,012    18 
Total with no allowance recorded  $27,482   $40,688       $30,798   $906 

 

16
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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   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 

 

17
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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):

 

   September 30, 2012 
   Pass   Watch   Special
Mention
   Substandard   Total 
One- to four-family  $462,010   $936   $129   $9,231   $472,306 
Multi-family   205,074    33,904        12,707    251,685 
Commercial real estate:                         
Office   48,328    7,533    18,168    3,984    78,013 
Retail/wholesale/mixed use   79,633    11,958    15,984    19,965    127,540 
Industrial/warehouse   24,700    3,242    6    1,567    29,515 
Other   4,700            200    4,900 
Total commercial real estate   157,361    22,733    34,158    25,716    239,968 
Construction and development:                         
One- to four-family   10,360                10,360 
Multi-family   3,135    4,350        12,172    19,657 
Commercial real estate   11,459    623            12,082 
Land   11,255    1,161        2,341    14,757 
Total construction/development   36,209    6,134        14,513    56,856 
Consumer:                         
Home equity   220,911            1,520    222,431 
Student   13,305                13,305 
Other   10,246            229    10,475 
Total consumer   244,462            1,749    246,211 
Commercial business:                         
Term loans   74,510    1,813    297    1,135    77,755 
Lines of credit   54,644    4,103    2,286    742    61,775 
Total commercial business   129,154    5,916    2,583    1,877    139,530 
Total  $1,234,270   $69,623   $36,870   $65,793   $1,406,556 

 

18
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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 September 30, 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 September 30, 2012, or December 31, 2011.

 

19
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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):

 

   September 30, 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  $7,201   $3,509   $7,752   $18,462   $453,844   $472,306   $8,970 
Multi-family   7,247        5,960    13,207    238,478    251,685    8,628 
Commercial real estate:                                   
Office           1,677    1,677    76,336    78,013    2,429 
Retail/wholesale/mixed   180        5,502    5,682    121,858    127,540    9,146 
Industrial/warehouse   74        456    530    28,985    29,515    529 
Other                   4,900    4,900     
Total commercial real estate   254        7,635    7,889    232,079    239,968    12,104 
Construction and development:                                   
One- to four-family                   10,360    10,360     
Multi-family                   19,657    19,657     
Commercial real estate                   12,082    12,082     
Land   10        271    281    14,476    14,757    1,138 
Total construction   10        271    281    56,575    56,856    1,138 
Consumer:                                   
Home equity   1,054    304    1,556    2,914    219,517    222,431    1,556 
Student   296    81    701    1,078    12,227    13,305     
Other   90    20    171    281    10,194    10,475    171 
Total consumer   1,440    405    2,428    4,273    241,938    246,211    1,727 
Commercial business:                                   
Term loans       69    289    358    77,397    77,755    610 
Lines of credit   422        33    455    61,320    61,775    70 
Total commercial   422    69    322    813    138,717    139,530    680 
Total  $16,574   $3,983   $24,368   $44,925   $1,361,631   $1,406,556   $33,247 

 

20
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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 September 30, 2012, and December 31, 2011, $700 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. Loans added as TDRs for the nine months ended September 30, 2012 consisted of nine one- to four-family residential loans totaling $2,147, one commercial real estate loan totaling $296, and one commercial business loan totaling $37. 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 nine months ended September 30, 2012, that were restructured within the preceding 12 months.

 

21
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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:

 

   Nine Months Ended September 30 
   2012   2011 
MSRs at beginning of the period  $8,269   $7,775 
Additions   3,841    1,664 
Amortization   (3,004)   (1,718)
MSRs at end of period   9,106    7,721 
Valuation allowance at end of period   (2,787)   (1,103)
MSRs at end of the period, net  $6,319   $6,618 

 

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

 

       Amount 
Estimate for three months ended December 31:   2012   $256 
Estimate for years ended December 31:   2013    1,006 
    2014    986 
    2015    969 
    2016    947 
    2017    850 
    Thereafter    1,305 
    Total   $6,319 

 

The projections of amortization expense shown above for MSRs are based on existing asset balances and the existing interest rate environment as of September 30, 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:

 

   September 30   December 31 
   2012   2011 
Accrued interest:          
Loans receivable  $4,960   $4,664 
Mortgage-related securities   1,758    1,851 
Interest-earning deposits   5    6 
Total accrued interest   6,723    6,521 
Premises and equipment, net   50,321    50,423 
Federal Home Loan Bank stock, at cost   19,071    46,092 
Bank owned life insurance   58,096    56,604 
Prepaid FDIC insurance premiums   3,252    5,673 
Deferred tax asset, net   33,587    37,493 
Prepaid and other assets   23,917    22,020 
Total other assets  $194,967   $224,826 

 

22
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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:

 

   September 30   December 31 
   2012   2011 
Checking accounts:          
Non-interest-bearing  $138,993   $112,211 
Interest-bearing   220,903    229,990 
Total checking accounts   359,896    342,201 
Money market accounts   450,957    432,248 
Savings accounts   219,524    204,263 
Certificates of deposit:          
Due within one year   671,977    709,362 
After one but within two years   170,436    250,613 
After two but within three years   31,113    61,291 
After three but within four years   9,447    13,301 
After four but within five years   7,006    8,384 
Total certificates of deposits   889,979    1,042,951 
Total deposit liabilities  $1,920,356   $2,021,663 

 

7. Borrowings

 

The following table summarizes borrowings as of the dates indicated:

 

   September 30, 2012   December 31, 2011 
       Weighted-       Weighted- 
       Average       Average 
   Amount   Rate   Amount   Rate 
Federal Home Loan Bank advances maturing in:                    
2012          $100,000    4.52%
2013  $221    4.17%   233    4.17 
2014                
2015   23,450    0.80         
2016   23,450    1.04         
2017 and thereafter   163,981    2.74    52,858    5.00 
Total borrowings  $211,102    2.34%  $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.

 

23
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

7. Borrowings (continued)

 

At September 30, 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 September 30, 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:

 

   Actual   Required
For Capital
Adequacy Purposes
   To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of September 30, 2012:                              
Total capital (to risk-weighted assets)  $261,942    17.91%  $117,010    8.00%  $146,262    10.00%
Tier 1 capital (to risk-weighted assets)   243,626    16.66    58,505    4.00    87,757    6.00 
Tier 1 capital (to adjusted total assets)   243,626    9.93    98,101    4.00    122,626    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 
                               

 

24
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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
September 30
   Nine Months Ended
September 30
 
   2012   2011   2012   2011 
Basic earnings (loss) per share:                    
Net income (loss)  $1,966   $1,349   $4,449   $(48,987)
Weighted average shares outstanding   46,184,264    46,177,657    46,184,263    45,991,853 
Vested MRP shares for period   9,430    1,745    5,512    5,234 
Basic shares outstanding   46,193,694    46,179,402    46,189,775    45,997,087 
Basic earnings (loss) per share  $0.04   $0.03   $0.10   $(1.07)
                     
Diluted earnings per share:                    
Net income (loss)  $1,966   $1,349   $4,449   $(48,987)
Weighted average shares outstanding used in basic earnings per share basic earnings per share   46,193,694    46,179,402    46,189,775    45,997,087 
Net dilutive effect of:        46,179,402           
Stock option shares   16,627        5,542     
Unvested MRP shares   12,604        8,647     
Diluted shares outstanding   46,222,925    46,179,402    46,203,964    45,997,087 
Diluted earnings (loss) per share  $0.04   $0.03   $0.10   $(1.07)

 

The Company had stock options for 2,268,500 shares outstanding as of September 30, 2012, and for 2,382,500 shares as of September 30, 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 $9.37 and $9.46 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 $44 and $45 during the three months ended September 30, 2012 and 2011, respectively, and $143 and $124 during the nine months ended as of the same dates, 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.

 

25
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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
September 30
   Nine Months Ended
September 30
 
   2012   2011   2012   2011 
Service cost  $725   $626   $2,175   $1,878 
Interest cost   564    569    1,692    1,707 
Expected return on plan assets   (756)   (650)   (2,268)   (1,950)
Amortization of unrecognized prior service cost   440    216    1,320    648 
Net periodic benefit cost  $973   $761   $2,919   $2,283 

 

The net periodic benefit cost for the Company’s supplemental plan was $126 and $117 for the three months ended September 30, 2012 and 2011, respectively, and $378 and $351 for the nine months ended as of the same dates, respectively. The amount in 2012 consisted of interest cost of $282, amortization of unrecognized prior service costs of $9, and service costs of $87. The amount in 2011 consisted of interest cost of $312, amortization of unrecognized prior service costs of $5, and service costs of $34.

 

The Company does not expect to make a contribution to the qualified and supplemental plans in 2012. This determination was based on a number of factors, including the results of the Actuarial Valuation Reports as of January 1, 2012.

 

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 September 30, 2012, 520,221 MRP shares and options for 621,362 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 months ended September 30, 2012 and 2011, respectively, and $139 and $90 for the nine months ended as of the same dates, respectively. Outstanding non-vested MRP grants had a fair value of $499 and an unamortized cost of $463 at September 30, 2012. The cost of these shares is expected to be recognized over a weighted-average period of 1.78 years.

 

During the three months ended September 30, 2012 and 2011, the Company recorded stock option compensation expense of $58 and $40, respectively. During the nine months ended as of the same dates stock option compensation expense was $174 and $121, respectively. As of September 30, 2012, there was $745 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 1.82 years.

 

26
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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:

 

   Nine Months Ended September 30 
   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   412,500    3.3999    438,500    4.9730 
Exercised           (488,464)   3.2056 
Forfeited   (124,000)   10.6730    (30,000)   9.1735 
Outstanding at end of period   2,671,000   $8.4711    2,382,500   $9.4637 

 

The following table provides additional information regarding the Company’s outstanding options as of September 30, 2012.

 

    Remaining   Non-Vested Options   Vested Options 
    Contractual
Life in Years
   Stock
Options
   Intrinsic
Value
   Stock
Options
   Intrinsic
Value
 
Exercise Price:         
$10.6730    1.6            1,576,000     
$12.2340    3.8            50,000     
$11.1600    5.6    6,400        25,600     
$12.0250    5.9    10,000        40,000     
$7.2200    7.6    30,000        20,000     
$4.7400    8.2    56,000        14,000     
$5.0500    8.3    310,400        77,600     
$4.3000    8.5    20,000   $5    5,000   $1 
$3.7200    8.8    14,000    12    3,500    3 
$3.3900    9.3    402,500    467         
$3.8000    9.5    10,000    8         
Total         859,300   $492    1,811,700   $4 
Weighted average remaining contractual life         8.7 years         2.2 years      
Weighted average exercise price        $4.4010        $10.3970      

 

The intrinsic value of options exercised during the nine months ended September 30, 2011, was $296. There were no options exercised during the nine months ended September 30, 2012. The weighted average grant date fair value of non-vested options at September 30, 2012, was $1.06 per share. During the nine months ended September 30, 2012, options for 412,500 shares were granted, options for 112,500 shares became vested, and there were no forfeitures of non-vested options.

 

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

 

27
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

11. Stock-Based Benefit Plans (continued)

 

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 412,500 options granted during the nine months ended September 30, 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 nine months ended September 30, 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 risk are summarized in the following table as of the dates indicated:

 

   September 30   December 31 
   2012   2011 
Unused consumer lines of credit  $152,263   $151,807 
Unused commercial lines of credit   56,694    43,518 
Commitments to extend credit:          
Fixed rate   29,327    23,793 
Adjustable rate   40,353    17,197 
Undisbursed commercial loans   2,620    870 
Standby letters of credit   1,890    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 September 30, 2012, and December 31, 2011, net unrealized gains of $475 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 $1,265 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:

 

   September 30, 2012   December 31, 2011 
   Notional
Amount
   Fair Value   Notional
Amount
   Fair Value 
Interest rate lock commitments  $64,929   $2,743   $52,699   $1,012 
Forward commitments   73,979    (2,268)   62,025    (769)
Net unrealized gain       $475        $243 

 

28
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

12. Financial Instruments with Off-Balance Sheet Risk (continued)

 

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.

 

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 and nine months ended September 30, 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.

 

29
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

13. Fair Value Measurements (continued)

 

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.

 

The following table summarizes the significant inputs utilized by the Company to estimate the fair value of its MSRs as of September 30, 2012:

 

   Weighted-
Average
   Range 
Loan size  $126    $1 - $417 
Contractual interest rate   4.13%   2.00% - 7.75% 
Constant prepayment rate (“CPR”)   24.80%   13.68% - 31.62% 
Remaining maturity in months   261    42 - 417 
Servicing fee   0.25%    
Annual servicing cost per loan (not in thousands)  $82.66     
Annual ancillary income per loan (not in thousands)  $54.90     
Discount rate   3.20%   2.75% - 3.50% 

 

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 September 30, 2012, had an amortized cost basis of $8,299 and a fair value of $5,512 as of that date. Accordingly, the Company recorded a valuation allowance of $2,787 as of September 30, 2012, as well as a corresponding loss of $1,919 during the nine 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 loss of $1,097 during the nine month period ended September 30, 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 equals 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.

 

30
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

13. Fair Value Measurements (continued)

 

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.

 

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

   September 30, 2012   December 31, 2011 
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
 
Cash and cash equivalents  $81,877   $81,877   $120,935   $120,935 
Mortgage-related securities available-for-sale   618,545    618,545    781,770    781,770 
Mortgage-related securities held-to-maturity   158,062    164,174         
Loans held-for-sale   26,908    26,908    19,192    19,192 
Loans receivable, net   1,384,805    1,368,023    1,319,636    1,284,651 
Mortgage servicing rights, net   6,319    6,500    7,401    7,577 
Federal Home Loan Bank stock   19,071    19,071    46,092    46,092 
Accrued interest receivable   6,723    6,723    6,521    6,521 
Deposit liabilities   1,920,356    1,871,454    2,021,663    1,968,842 
Borrowings   211,102    229,361    153,091    167,418 
Advance payments by borrowers   32,596    32,596    3,192    3,192 
Accrued interest payable   491    491    750    750 
Unrealized gain (loss) on off-balance-sheet items:                    
Interest rate lock commitments on loans   2,743    2,743    1,012    1,012 
Forward commitments to sell loans   (2,268)   (2,268)   (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 September 30, 2012 
   Level 1   Level 2   Level 3   Total 
Loans held-for-sale      $26,908       $26,908 
Mortgage-related securities available-for-sale       618,545        618,545 

 

   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 

 

31
 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 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 September 30, 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 $1,728 was recorded for loans with a recorded investment of $65,793 at September 30, 2012. These amounts were $8,305 and $103,627 at December 31, 2011, respectively. Provision for loan losses related to these loans was $(2,911) during the nine months ended September 30, 2012, and $1,257 during the twelve month period ended December 31, 2011. Provision for loan losses related to impaired loans at September 30, 2011, was $510 for the nine months ended September 30, 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 September 30, 2012, $12,793 in foreclosed properties were valued at collateral value compared to $22,655 at December 31, 2011. Losses of $2,151 and $4,639 related to these foreclosed properties valued at collateral value were recorded during the nine months ended September 30, 2012, and the twelve months ended December 31, 2011, respectively. Losses on foreclosed properties valued at collateral value at September 30, 2011, were $2,990 for the nine months ended September 30, 2011. The following table summarizes foreclosed properties and repossessed assets as of the dates indicated:

 

   September 30   December 31 
   2012   2011 
Commercial real estate  $6,362   $13,115 
Land   4,007    3,890 
One- to four-family   3,031    6,557 
Multi-family   146    1,162 
Consumer   12     
   $13,558   $24,724 

 

14. Goodwill Impairment

 

During the three months ended June 30, 2011, the Company determined that the goodwill recorded as a result of the purchase of financial institutions in 1997 and 2000 was impaired. The Company performed a goodwill impairment test during that period as a result of a number of developments including the decline in the Company’s stock price and market capitalization and the Memoranda of Understanding (“MOU”) with the Office of Thrift Supervision (“OTS”). To determine the fair value of goodwill, as well as the amount of the impairment, the Company obtained a third-party independent appraisal of the Company, which consists of a single reporting unit, and its assets and liabilities. The fair value of the Company was estimated using a weighted average of three valuation methodologies, including a public market peers approach, a comparable transactions approach, and a discounted cash flow approach.

 

32
 

  

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

September 30, 2012

 

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

 

14. Goodwill Impairment (continued)

 

A comparison of the weighted average value from these approaches to the net carrying value of the Company indicated that potential impairment existed. The weighted average value of the Company was subsequently compared to the estimated net fair value of the Company’s individual assets and liabilities. As a result of this comparison, the Company concluded that goodwill was impaired and recorded an impairment charge of $52.6 million during the three months ended June 30, 2011, which represented the total amount of the Company’s goodwill.

 

Goodwill impairment is not deductible for income tax purposes. Accordingly, the Company recorded income tax expense of $1,236 during the nine months ended September 30, 2011, regardless of the fact that it incurred a net loss before income taxes. Excluding the goodwill impairment from the Company’s net loss before income taxes, the Company’s effective tax rate for the nine months ended September 30, 2011 was 25.8%.

 

33
 

 

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 issued 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”); 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 and potential new regulatory capital requirements under Basel III; 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 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 $2.0 million or $0.04 per diluted share during the three months ended September 30, 2012, which was a $617,000 or 45.7% improvement over the same period in 2011. The Company had net income of $1.3 million or $0.03 per diluted share during the three-month period in the prior year. The Company’s net income was $4.4 million or $0.10 per diluted share during the nine months ended September 30, 2012, compared to a net loss of $49.0 million or $1.07 per diluted share in the same period of 2011. The loss in the 2011 period was caused by a $52.6 million non-cash goodwill impairment in the second quarter of that year. Excluding this impairment, the Company’s earnings during the nine-month period in 2011 were $3.6 million or $0.08 per diluted share. The following paragraphs describe the reasons for the changes in the Company’s earnings during the three- and nine-month periods ended September 30, 2012 and 2011, along with other matters affecting the Company’s operations.

 

34
 

 

Net Interest Income The Company’s net interest income increased by $113,000 or 0.7% during the three months ended September 30, 2012, compared to the same period in 2011. This improvement was due in part to the repayment of $100.0 million in high-cost borrowings from the FHLB of Chicago that matured during the third quarter of 2012. Also contributing to the improvement was a $51.9 million or 2.3% increase in average earning assets in the third quarter of 2012 compared to the same quarter in the prior year. Earlier in 2012 the Company purchased $158.9 million in held-to-maturity securities that were funded by term borrowings from the FHLB of Chicago. In addition, during the three months ended September 30, 2012, average total loans increased by $38.7 million or 2.8% compared to the same period in 2011. These increases in average earning assets were partially offset by a $108.7 million or 19.8% decrease in average available-for-sale securities during the third quarter of 2012 compared to the same quarter in the previous year. The Company’s net interest margin during the third quarter of 2012 was slightly lower than it was in the third quarter of 2011. However, compared to the second quarter of 2012, the Company’s net interest margin improved by 24 basis points, due principally to the aforementioned repayment of the borrowings from the FHLB of Chicago.

 

The Company’s net interest income declined by $2.1 million or 4.4% during the nine months ended September 30, 2012, compared to the same period in 2011. This decline was primarily attributable to a decrease in the Company’s net interest margin, which was 2.61% in the 2012 nine-month period compared to 2.80% in the same period in 2011. This decline was primarily the result of a lower interest rate environment in 2012, which reduced the return on the Company’s earning assets more than the cost of its funding sources. This development was partially offset by the favorable impact of higher earning assets in 2012, as previously described.

 

35
 

 

The following tables present 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 September 30 
   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)  $1,401,016   $16,514    4.71%  $1,362,337   $17,468    5.13%
Mortgage-related securities   805,044    4,134    2.05    755,394    4,303    2.28 
Interest-earning deposits   76,761    30    0.16    59,058    27    0.18 
Investment securities (2)   21,697    19    0.35    75,875    219    1.15 
Total interest-earning assets   2,304,518    20,697    3.59    2,252,664    22,017    3.91 
Non-interest-earning assets   225,188              241,067           
Total average assets  $2,529,706             $2,493,731           
                               
Liabilities and equity:                              
Interest-bearing liabilities:                              
Regular savings deposits  $220,448    16    0.03   $213,942    18    0.03 
Money market accounts   432,249    165    0.15    408,888    435    0.43 
Interest-bearing demand accounts   216,361    7    0.01    193,627    25    0.05 
Certificates of deposit   930,692    3,355    1.44    1,067,048    4,253    1.59 
Total interest-bearing deposits   1,799,750    3,543    0.79    1,883,505    4,731    1.00 
Borrowings   237,306    1,554    2.62    149,958    1,798    4.80 
Advance payments by borrowers for taxes and insurance   27,954    1    0.01    25,960    2    0.03 
Total interest-bearing liabilities   2,065,010    5,098    0.99    2,059,423    6,531    1.27 
Non-interest-bearing liabilities:                              
Non-interest-bearing deposits   136,367              114,689           
Other non-interest-bearing liabilities   56,915              50,595           
Total non-interest-bearing liabilities   193,282              165,284           
Total liabilities   2,258,292              2,224,707           
Total equity   271,414              269,024           
Total average liabilities and equity  $2,529,706             $2,493,731           
Net interest income and net interest rate spread       $15,599    2.60%       $15,486    2.64%
Net interest margin             2.71%             2.75%
Average interest-earning assets to average interest-bearing liabilities   1.12x             1.09x          

  

(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.

 

36
 

 

   Nine Months Ended September 30 
   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)  $1,384,180   $49,142    4.73%  $1,366,840   $52,887    5.16%
Mortgage-related securities   812,989    13,228    2.17    613,668    12,131    2.64 
Interest-earning deposits   92,758    130    0.19    85,182    125    0.20 
Investment securities (2)   28,137    54    0.26    193,147    2,843    1.96 
Total interest-earning assets   2,318,064    62,554    3.60    2,258,837    67,986    4.01 
Non-interest-earning assets   210,193              300,275           
Total average assets  $2,528,257             $2,559,112           
                               
Liabilities and equity:                              
Interest-bearing liabilities:                              
Regular savings deposits  $216,075    47    0.03   $213,841    62    0.04 
Money market accounts   425,614    536    0.17    401,368    1,417    0.47 
Interest-bearing demand accounts   218,525    30    0.02    199,578    72    0.05 
Certificates of deposit   989,790    10,854    1.46    1,074,425    13,659    1.70 
Total interest-bearing deposits   1,850,004    11,467    0.83    1,889,212    15,210    1.07 
Borrowings   233,171    5,735    3.28    157,639    5,359    4.53 
Advance payments by borrowers for taxes and insurance   18,096    2    0.01    16,896    3    0.02 
Total interest-bearing liabilities   2,101,271    17,204    1.09    2,063,747    20,572    1.33 
Non-interest-bearing liabilities:                              
Non-interest-bearing deposits   126,686              106,325           
Other non-interest-bearing liabilities   30,649              92,707           
Total non-interest-bearing liabilities   157,335              199,032           
Total liabilities   2,258,606              2,262,779           
Total equity   269,651              296,333           
Total average liabilities and equity  $2,528,257             $2,559,112           
Net interest income and net interest rate spread       $45,350    2.51%       $47,414    2.68%
Net interest margin             2.61%             2.80%
Average interest-earning assets to average interest-bearing liabilities   1.10x             1.09x          

  

(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.

 

37
 

 

The following tables present 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 September 30, 2012
Compared to September 30, 2011
 
   Increase (Decrease) 
   Volume   Rate   Net 
  (Dollars in thousands) 
Interest-earning assets:               
Loans receivable  $506   $(1,460)  $(954)
Mortgage-related securities   283    (452)   (169)
Interest-earning deposits   7    (4)   3 
Investment securities   (101)   (99)   (200)
Total interest-earning assets   695    (2,015)   (1,320)
Interest-bearing deposits:               
Savings accounts   (2)       (2)
Money market accounts   24    (294)   (270)
Interest-bearing demand accounts   3    (21)   (18)
Certificates of deposit   (513)   (385)   (898)
Total interest-bearing deposits   (488)   (700)   (1,188)
Borrowings   781    (1,025)   (244)
Advance payments by borrowers for taxes and insurance       (1)   (1)
Total interest-bearing liabilities   293    (1,726)   (1,433)
Net change in net interest income  $402   $(289)  $113 

 

   Nine Months Ended September 30, 2012
Compared to September 30, 2011
 
   Increase (Decrease) 
   Volume   Rate   Net 
  (Dollars in thousands) 
Interest-earning assets:               
Loans receivable  $(774)  $(2,971)  $(3,745)
Mortgage-related securities   2,705    (1,608)   1,097 
Interest-earning deposits   8    (3)   5 
Investment securities   (921)   (1,868)   (2,789)
Total interest-earning assets   1,018    (6,450)   (5,432)
Interest-bearing deposits:               
Savings accounts   (4)   (11)   (15)
Money market accounts   54    (935)   (881)
Interest-bearing demand accounts   5    (47)   (42)
Certificates of deposit   (682)   (2,123)   (2,805)
Total interest-bearing deposits   (627)   (3,116)   (3,743)
Borrowings   1,411    (1,035)   376 
Advance payments by borrowers for taxes and insurance       (1)   (1)
Total interest-bearing liabilities   784    (4,152)   (3,368)
Net change in net interest income  $234   $(2,298)  $(2,064)

 

38
 

 

Provision for Loan Losses The Company’s provision for loan losses was $657,000 during the three months ended September 30, 2012, compared to $1.1 million in the same period last year. The provision for the nine months ended September 30, 2012, was $2.4 million compared to $5.1 million in the same period last year. During the third quarter of 2012 the Company recorded additional loss provision of $1.8 million against a number of multi-family, commercial real estate, and business loan relationships, as well as residential and consumer loans. This development was partially offset by a $541,000 loss recapture related to a $7.9 million non-performing loan that paid off during the quarter. In addition, Bank Mutual’s recorded $597,000 in net loss recaptures during the quarter that were related to a general decline in the dollar amount of its classified loans, as described later in this report.

 

During the third quarter of 2011, the Company recorded $1.8 million in loss provisions against two unrelated loan relationships that aggregated $6.1 million. During this quarter the Company also recorded $586,000 in loss provisions against a number of multi-family, commercial real estate, and business loan relationships, as well as certain residential and consumer loans. In addition, during the third quarter of 2011 the Company recorded $1.1 million in loss provision that reflected management’s concerns at the time relating to general economic and market conditions. The impact of these developments was partially offset by $2.4 million in loss recaptures related to payoffs of a number of non-performing loans.

 

On a year-to-date basis in 2012 the Company recorded additional loss provision of $4.2 million against a number of multi-family, commercial real estate, and business loan relationships, as well as residential and consumer loans. This development was partially offset by $1.8 million in loss recaptures related to non-performing loans that paid off during the period and to recoveries of previously charged-off loans.

 

On a year-to-date basis in 2011 the Company recorded $10.8 million in loss provisions against a number of multi-family, commercial real estate, and business loan relationships, and certain smaller residential and consumer loans, as well as loss provisions related to management’s general concerns regarding economic and market conditions, as previously described. These developments were partially offset by $5.7 million in loss recaptures on loans that paid-off during the period or were upgraded to performing status.

 

The Company’s provision for loan losses has been trending lower in recent periods. This trend is directionally consistent with recent declines in the Company’s non-performing loans and classified loans, as described in “Financial Condition—Asset Quality,” below, and is consistent with general trends in the banking industry. It should be noted, however, that the Company’s loan portfolio continues to be impacted by slow economic growth, persistent unemployment, and low real estate values. These conditions are particularly challenging for borrowers whose loans are secured by commercial real estate, multi-family real estate, and land. As such, there can be no assurances that non-performing loans and/or classified loans will continue to trend lower in future periods or that the Company’s provision for loan losses will not increase in future periods.

 

Non-Interest Income Total non-interest income increased by $1.4 million or 25.0% and $5.0 million or 31.3% during the three and nine months ended September 30, 2012, compared to the same periods in 2011, respectively. Significant reasons for this increase are discussed in the following paragraphs.

 

Service charges on deposits increased by $149,000 or 8.9% during the three months ended September 30, 2012, compared to the same period in 2011. During the nine-month period in 2012 this revenue item increased by $346,000 or 7.3% compared to the same period in 2011. Management attributes these improvements to an increase in the Company’s average checking accounts, which increased by $39.3 million or 12.8% during the nine months ended September 30, 2012, compared to the same period in the previous year. In addition, enhancements in recent periods to the Company’s commercial deposit products and services generated increased fee revenue in the 2012 periods, particularly related to treasury management services.

 

39
 

 

Brokerage and insurance commissions were $678,000 million during the three months ended September 30, 2012, a $87,000 or 11.4% decrease from the same period in the previous year. On a year-to-date basis, this source of revenue was $2.2 million in 2012, a $13,000 or 0.6% increase from the same period in 2011. This revenue item consists of commissions earned on sales of tax-deferred annuities, mutual funds, and certain other securities, as well as personal and business insurance products. As such, this revenue item will fluctuate from period to period depending on customer demand for these types of financial products and services, as well as differences caused by the timing of various sales initiatives.

 

Net loan-related fees and servicing revenue was a loss of $1.1 million during the three months ended September 30, 2012, compared to a loss of $1.0 million in the same period of the previous year. Net loan-related fees and servicing revenue was a loss of $2.3 million during the nine months ended September 30, 2012, compared to a loss of $452,000 in the same period of 2011. The following table presents the components of this income statement line item for the periods indicated:

 

   Three Months Ended
September 30
   Nine Months Ended
September 30
 
   2012   2011   2012   2011 
   (Dollars in thousands) 
Gross servicing fees  $664   $679   $2,104   $2,039 
Mortgage servicing rights amortization   (982)   (726)   (3,004)   (1,718)
Mortgage servicing rights valuation (loss) recovery   (944)   (1,103)   (1,919)   (1,097)
Loan servicing revenue, net   (1,262)   (1,150)   (2,819)   (776)
Other loan fee income   171    114    471    324 
Loan-related fees and servicing revenue, net  $(1,091)  $(1,036)  $(2,348)  $(452)

 

Amortization of MSRs increased in the 2012 periods compared to the same periods in the prior year 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 periods. 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. Lower market interest rates in 2012 and 2011 resulted in higher prepayment expectations, which caused increases in the MSR valuation allowance during these periods. As of September 30, 2012, the Company had a valuation allowance of $2.8 million against MSRs with a gross book value of $9.1 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.

 

Gains on sales of loans were $3.4 million during the three months ended September 30, 2012, compared to $2.3 million in the same quarter last year. During the nine months ended as of the same date gains on sales of loans were $9.9 million compared to $3.4 million during the same period in the prior year. The Company generally sells most of the fixed-rate, one- to four-family mortgage loans that it originates in the secondary market. During the three and nine months ended September 30, 2012, sales of these loans were $26.3 million or 37.5% higher and $202.2 million or 135% higher than they were during the same periods of 2011, respectively. Management attributes these increases 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 2012 periods. Also contributing to the increase in gains on sales of loans in the 2012 periods was an increase in the Company’s average gross profit margin on the sales of loans. During the nine months ended September 30, 2012, the average gross profit margin was 2.80% compared to 2.26% during the same period in 2011. Management attributed this improvement to the burden that increased consumer demand has placed on the loan production capacity of the mortgage banking industry as a whole, which has caused gross profit margins to increase.

 

40
 

 

Market interest rates for one- to four-family mortgage loans remain historically low. Despite this, management believes that it is possible such rates could trend lower in the near term as production capacity within the mortgage banking industry becomes less constrained. In addition, the recent announcement by the Federal Open Market Committee (“FOMC”) of the FRB that it intends to purchase government agency mortgage-backed securities is generally expected to result in lower interest rates for one- to four-family mortgage loans in the near term. As such, management expects that the Company’s sales of loans and gross profit margins could remain elevated for the remainder of the year. However, management also expects that amortization of MSRs, as well as valuation allowance adjustments related to MSRs, could also remain elevated during this time period.

 

The Company recorded $543,000 in gains on sales of investments during the nine months ended September 30, 2012. During this period the Company sold $20.4 million in mortgage-related securities. The purpose of this sale was to provide additional liquidity to fund the repayment of $100.0 million in borrowings from the FHLB of Chicago that matured during the third quarter, as previously described. During the nine months ended September 30, 2011, the Company recorded $1.1 million in net gains on sales of investments. 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.

 

During the nine months ended September 30, 2012 and 2011, the Company recorded $336,000 and $389,000 in net OTTI losses, respectively. These losses consisted of the credit portion of the total OTTI loss related to the Company’s investment in certain private-label CMOs rated less than investment grade. Management attributes the net OTTI losses in these periods to low real estate values for residential properties on a nationwide basis. None of the Company’s remaining private-label CMOs were deemed to be other-than-temporarily impaired as of September 30, 2012. However, the collection of the amounts due on private-label CMOs is subject to numerous factors outside of the Company’s control and a future determination of OTTI could result in additional losses being recorded through earnings in future periods. As of September 30, 2012, the Company’s total investment in private-label CMOs was $54.2 million, of which $34.0 million was rated less than investment grade.

 

Other non-interest income was $1.5 million and $4.5 million during the three and nine months ended September 30, 2012, respectively, compared to $1.2 million and $3.8 million during the same periods in 2011, respectively. The increase in the 2012 periods 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 was $18.8 million and $57.4 million during three and nine months ended September 30, 2012, respectively, and $17.9 million and $106.2 million during the same periods in 2011, respectively. The nine-month period in 2011 included a $52.6 million non-cash goodwill impairment that had no effect on the Company’s liquidity, operations, tangible capital, or regulatory capital. The Company determined that the value of its goodwill had become impaired in the second quarter of 2011 based on a number of factors including the decline in its stock price and market capitalization and the impact the MOU with the OTS had on the impairment valuation process (for additional discussion refer to “Note 14. Goodwill Impairment” in the Company’s Unaudited Condensed Consolidated Financial Statements). Total non-interest expense increased by $870,000 or 4.9% during the three months ended September 30, 2012, compared to the same period in 2011. Excluding the impact of the goodwill impairment, total non-interest expense increased by $3.9 million or 7.2% during the nine months ended September 30, 2012, compared to the same period in 2011. The following paragraphs discuss the components of the Company’s non-interest expense and the primary reasons for their changes during the three and nine months ended September 30, 2012, compared to the same periods in 2011.

 

41
 

 

Compensation-related expenses increased by $823,000 or 8.5% and by $3.1 million or 10.8% during the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011, respectively. These increases were 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 latter 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 increased by $75,000 or 9.8% and by $8,000 or 0.3% during the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011, respectively. These increases were caused by higher average total assets in the 2012 periods compared to the corresponding periods in 2011, for reasons described elsewhere in this report. The FDIC bases its quarterly deposit insurance assessments on an insured institution’s average total assets minus average tangible equity and certain other adjustments.

 

Advertising and marketing-related expenses decreased by $207,000 or 35.5% during the three months ended September 30, 2012, compared to the same period in the prior year. On a year-to-date basis, advertising and marketing-related expenses increased by $218,000 or 17.8% in 2012 compared to the same period in 2011. These changes were primarily caused by differences in the timing of the Company’s advertising and marketing efforts between the 2012 and 2011 periods. At this time management does not expect advertising and marketing-related expenses during the whole of 2012 to be substantially different than prior years. However, this will depend on future management decisions and there can be no assurances.

 

Net losses and expenses on foreclosed properties were $1.7 million and $5.5 million during the three and nine months ended September 30, 2012, respectively, compared to $1.7 million and $5.4 million in the same periods of the prior year, respectively. The Company’s losses and expenses on foreclosed real estate has remained elevated in recent periods due to lower real estate values and slow economic growth in such periods. If these conditions persist, losses on foreclosed real estate could remain elevated in the near term.

 

Other non-interest expense was $2.5 million and $7.7 million during the three and nine months ended September 30, 2012, respectively, compared to $2.5 million and $7.2 million during the same periods in 2011, respectively. The increase in the nine-month period of 2012 was primarily the result of higher costs for legal, consulting, and accounting fees related to loan workout efforts and related professional services. In recent months, however, these expenses have declined as the Compnay has reduced its level of non-performing loans.

 

Income Tax Expense Income tax expense was $1.0 million and $610,000 during the three months ended September 30, 2012 and 2011, respectively, and was $2.1 million and $1.2 million during the nine months ended as of the same dates, respectively. The Company’s effective tax rate (“ETR”) for the three months ended September 30, 2012 and 2011, was 34.8% and 31.3%, respectively. Excluding the 2011 goodwill impairment from income (loss) before taxes (which is not deductible for income tax purposes), the Company’s ETR for the nine-month periods in 2012 and 2011 was 32.3% and 25.9%, respectively. the Company’s ETR increased in the 2012 periods because non-taxable revenue, which consists primarily of earnings from bank-owned life insurance (“BOLI”), comprised a smaller portion of pre-tax earnings in 2012 than it did in 2011.

 

42
 

 

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 has provided. The Company is awaiting a further response from the Department.

 

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 decreased by $13.4 million or 0.5% during the nine months ended September 30, 2012. During the period the Company’s available-for-sale securities declined by $163.2 million, its cash and cash equivalents declined by $39.1 million, and its investment in common stock of the FHLB of Chicago declined by $27.0 million. These developments were partially offset by a $158.1 million increase in held-to-maturity securities and a $65.2 million increase in the loan portfolio. Net cash flows from the changes in these assets, as well as a $58.0 million increase in advances from the FHLB of Chicago and a $29.4 million increase in escrow deposits, were used to fund a $101.3 million decline in deposit liabilities during the nine months ended September 30, 2012. The Company’s total shareholders’ equity increased from $265.8 million at December 31, 2011, to $272.1 million at September 30, 2012. Non-performing assets decreased from $99.9 million or 4.00% of total assets at December 31, 2011, to $47.5 million or 1.91% at September 30, 2012. The following paragraphs describe these changes in greater detail, as well as other changes in the Company’s financial condition during the nine months ended September 30, 2012.

 

Cash and Cash Equivalents The Company’s cash and cash equivalents decreased by $39.1 million or 32.3% during the nine months ended September 30, 2012. This decrease was due to the funding of increases in the Company’s loan portfolio, as well as decreases in its deposit liabilities, as previously described.

 

Mortgage-Related Securities Available-for-Sale The Company’s portfolio of securities available-for-sale decreased by $163.2 million or 20.9% during the nine months ended September 30, 2012. This decrease was principally caused by periodic repayments and security sales that exceeded the Company’s purchase of new securities during the period. Also contributing to the decrease was a $20.4 million sale of securities, as previously described. The Company purchased $51.4 million of CMOs issued by government-sponsored entities during the nine months ended September 30, 2012.

 

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 September 30, 2012, compared to a net unrealized gain of $7.7 million at December 31, 2011.

 

43
 

 

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):

 

   September 30, 2012   December 31, 2011 
   Carrying
Value
   Unrealized
Gain (Loss),
Net
   Carrying
Value
   Unrealized
Gain (Loss),
Net
 
   (Dollars in thousands)
Credit rating:                    
AAA/Aaa  $3,969   $177   $5,386   $210 
AA/Aa   1,474    51    2,512    58 
A   4,466    102    6,951    (271)
BBB/Baa   10,319    228    10,428    (366)
Less than investment grade   34,022    (284)   36,751    (5,357)
Total private-label CMOs  $54,250   $274   $62,028   $(5,726)

 

During the second quarter of 2012 management determined that it is unlikely the Company will collect all amounts due according to the contractual terms on certain of its private-label CMOs rated less than investment grade. Accordingly, the Company recorded $336,000 in net OTTI losses on these securities in that quarter (for additional discussion refer to “Results of Operations—Non-Interest Income,” above). As of September 30, 2012, management has determined that none of the Company’s private-label CMOs had incurred additional OTTI losses as of that date. 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 nine months ended September 30, 2012, the Company purchased $158.9 million in held-to-maturity securities that consisted of mortgage-backed securities issued and guaranteed by Fannie Mae and backed by multi-family residential loans. The Company funded the purchase of these securities with $158.9 million in term advances from the FHLB of Chicago. The securities had a weighted-average life of 7.7 years, a yield of 2.31%, and yield-maintenance fees that discourage the underlying borrowers from prepaying the underlying loans. The term advances have a weighted-average life of 5.5 years and cost of 1.47%. 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 Held-for-Sale Loans held-for-sale were $26.9 million at September 30, 2012, compared to $19.2 million at December 31, 2011. The Company’s policy is to sell most of the fixed-rate, one- to four-family mortgage loans that it originates in the secondary market. During 2012 interest rates on residential mortgage loans have declined to historically low levels, which has resulted in increased borrower refinance activity and loans held-for-sale. As previously noted, management expects that originations and sales of such loans could be elevated in the near term as borrowers are incented to refinance higher, fixed-rate mortgage loans at lower rates.

 

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Loans Receivable Loans receivable increased by $65.2 million or 4.9% during the nine months ended September 30, 2012. Total loans originated for portfolio increased by $91.9 million or 33.4% during this period compared to the same period in 2011. A portion of this improvement came from increased originations of commercial business loans, which increased by $10.4 million or 16.2% during the nine months ended September 30, 2012, compared to the same period in 2011. Management attributed 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 two years the Company has added experienced leaders to its senior management team and has hired a number of commercial relationship managers and support personnel 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.

 

Originations of multi-family mortgage loans, both permanent and construction, also increased substantially during the period, which management believes reflects a general decline in the level of home ownership in recent periods. Finally, originations of consumer loans, which consist principally of home equity term loans and lines of credit, increased by $25.5 million or 41.1% during the nine months ended September 30, 2012, due to more competitive pricing and increased marketing efforts for these types of loans.

 

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

 

   Three Months Ended   Nine Months Ended 
   September 30   September 30 
   2012   2011   2012   2011 
   (Dollars in thousands) 
Mortgage loans:                    
One- to four-family (1)  $19,136   $13,522   $70,131   $58,831 
Multi-family   21,460    20,552    48,425    28,262 
Commercial real estate   10,579    15,627    26,951    38,025 
Construction and development loans   31,911    10,361    59,131    23,608 
Total mortgage loans   83,086    60,062    204,638    148,726 
Consumer loans   30,422    25,565    87,578    62,072 
Commercial business loans   23,484    35,626    75,080    64,635 
Total loans originated for portfolio  $136,992   $121,253   $367,296   $275,433 

 

(1)Excludes $96.5 million and $84.8 million in loans originated for sale during the three months ended September 30, 2012 and 2011, respectively, and $352.6 million and $139.6 million during the nine months ended as of the same dates, respectively.

 

Foreclosed Properties and Repossessed Assets The following table summarizes the Company’s foreclosed properties and repossessed assets as of the dates indicated:

 

   September 30   December 31 
   2012   2011 
Commercial real estate  $6,362   $13,115 
Land   4,007    1,162 
One- to four-family   3,031    6,557 
Multi-family   146    3,890 
Consumer   12     
Total foreclosed properties and repossessed assets  $13,558   $24,724 

 

The decrease in the Company’s foreclosed properties and repossessed assets during the nine months ended September 30, 2012, was caused by the sales of foreclosed real estate, as well as continued charge-offs of 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.

 

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Mortgage Servicing Rights The carrying value of the Company’s MSRs was $6.3 million at September 30, 2012, and $7.4 million at December 31, 2011, net of valuation allowances of $2.8 million and $868,000 as of such dates, respectively. As of both September 30, 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 $19.1 million at September 30, 2012. The FHLB of Chicago redeemed $27.0 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 September 30, 2012, Company owned approximately $8.5 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.

 

As of September 30, 2012, and December 31, 2011, the Company’s net deferred tax asset, which is included as component of other assets, was $33.6 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 condition, results of operations, and capital of the Company.

 

Deposit Liabilities Deposit liabilities decreased by $101.3 million or 5.0% during the nine months ended September 30, 2012. Core deposits, consisting of checking, savings and money market accounts, increased by $51.7 million or 5.3% during the period while certificates of deposits declined by $153.0 million or 14.7%. 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. Core deposits have increased in re cent periods in response to management’s efforts to focus retail sales efforts on such products and related services. Also contributing to the increase in core deposits, however, is customer reaction to the low interest rate environment. Management believes that this environment has encouraged some customers to switch to core deposits in an effort to retain flexibility in the event interest rates rise in the future.

 

Borrowings Borrowings, which consist of advances from the FHLB of Chicago, increased by $58.0 million or 37.9% during the nine months ended September 30, 2012. As previously noted, during the period the Company borrowed $158.9 million in term advances from the FHLB of Chicago to fund the purchase of held-to-maturity securities. This development was partially offset by the repayment of $100.0 million in borrowings from the FHLB of Chicago that had a rate of 4.52% and that matured during the third quarter.

 

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The following table presents the Company’s FHLB of Chicago advances by contractual maturities as September 30, 2012.

 

   Amount   Rate 
  (Dollars in thousands) 
FHLB advances maturing in:          
2013  $221    4.17%
2014        
2015   23,450    0.80 
2016   23,450    1.04 
2017 and thereafter   163,981    2.74 
Total FHLB advances  $211,102    2.34%

 

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 $32.6 million at September 30, 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.

 

Shareholders' Equity The Company’s shareholders’ equity increased from $265.8 million at December 31, 2011, to $272.1 million at September 30, 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 regular cash dividends to shareholders of $0.01 per share during each of the quarters in the year. The Company’s dividend payments during the three and nine months ended September 30, 2012, were 23.6% and 31.2% of net income, respectively. The book value of the Company’s common stock was $5.87 per share at September 30, 2012, compared to $5.75 per share at December 31, 2011.

 

On November 5, 2012, the Company’s board of directors announced that it had declared a $0.02 per share dividend payable on November 30, 2012, to shareholders of record on November 16, 2012. During the nine months ended September 30, 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.

 

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

 

   At September 30   At December 31 
   2012   2011 
  (Dollars in thousands) 
Non-accrual mortgage loans:          
One- to four-family  $8,970   $14,868 
Multi-family   8,628    22,905 
Commercial real estate   12,104    23,997 
Construction and development   1,138    9,368 
Total non-accrual mortgage loans   30,840    71,138 
Non-accrual consumer loans:          
Secured by real estate   1,556    1,457 
Other consumer loans   171    207 
Total non-accrual consumer loans   1,727    1,664 
Non-accrual commercial business loans   680    1,642 
Total non-accrual loans   33,247    74,444 
Accruing loans delinquent 90 days or more (1)   700    696 
Total non-performing loans   33,947    75,140 
Foreclosed properties and repossessed assets   13,558    24,724 
Total non-performing assets  $47,505   $99,864 
           
Non-performing loans to loans receivable, net   2.45%   5.69%
Non-performing assets to total assets   1.91%   4.00%
Interest income that would have been recognized if non-accrual loans had been current (2)  $2,065   $4,535 
Interest income on non-accrual loans included in interest income (2)  $911   $1,850 

 

(1)Consists of student loans that are guaranteed under programs sponsored by the U.S. government.
(2)Amounts shown are for the nine months ended September 30, 2012, and the twelve months ended December 31, 2011, respectively.