10-K 1 v369563_10k.htm ANNUAL REPORT
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10 - K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
 
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 incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
4949 West Brown Deer Road, Milwaukee, Wisconsin
53223
(Address of principal executive offices)
(Zip Code)
 
Registrant's telephone number, including area code: (414) 354-1500
 
Securities registered pursuant to Section 12(b) of the Act:
 
Common Stock, $0.01 Par Value
The NASDAQ Stock Market LLC
(Title of each class)
(Name of each exchange on which registered)
 
Securities registered pursuant to Section 12(g) of the Act:
 
NONE
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act
Yes   ¨     No   x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes   ¨     No   x
 
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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes   x     No   ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
 
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 ¨    Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the act).
Yes   ¨     No   x
 
As of February 28, 2014, 46,551,284 shares of Common Stock were validly issued and outstanding. The aggregate market value of the Common Stock (based upon the $5.64 last sale price on The NASDAQ Global Select Market on June 28, 2013, the last trading date of the Company’s second fiscal quarter) held by non-affiliates (excluding outstanding shares reported as beneficially owned by directors and executive officers; does not constitute an admission as to affiliate status) was approximately $242.8 million.
 
 
 
Part of Form 10-K Into Which
Documents Incorporated by Reference
 
Portions of Document are Incorporated
 
 
 
Proxy Statement for Annual Meeting of Shareholders on May 5, 2014
 
Part III
 
 
 
BANK MUTUAL CORPORATION
 
FORM 10-K ANNUAL REPORT TO
THE SECURITIES AND EXCHANGE COMMISSION
FOR THE YEAR ENDED DECEMBER 31, 2013
 
Table of Contents
 
Item
 
Page
 
 
 
Part I
 
 
 
 
 
1
Business
3
 
 
 
1A
Risk Factors
21
 
 
 
1B
Unresolved Staff Comments
26
 
 
 
2
Properties
26
 
 
 
3
Legal Proceedings
26
 
 
 
4
Mine Safety Disclosures
26
 
 
 
Part II
 
 
 
 
 
5
Market for Registrant's Common Equity, Related Stockholders Matters, and Issuer Purchases of Equity Securities
27
 
 
 
6
Selected Financial Data
29
 
 
 
7
Management's Discussion and Analysis of Financial Condition and Results of Operations
31
 
 
 
7A
Quantitative and Qualitative Disclosures About Market Risk
53
 
 
 
8
Financial Statements and Supplementary Data
57
 
 
 
9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
102
 
 
 
9A
Controls and Procedures
102
 
 
 
9B
Other Information
104
 
 
 
Part III
 
 
 
 
 
10
Directors, Executive Officers, and Corporate Governance
105
 
 
 
11
Executive Compensation
105
 
 
 
12
Security Ownership of Certain Beneficial Owners, Management, and Related Stockholder Matters
105
 
 
 
13
Certain Relationships and Related Transactions and Director Independence
105
 
 
 
14
Principal Accountant Fees and Services
105
 
 
 
Part IV
 
 
 
 
 
15
Exhibits, Financial Statement Schedules
106
 
 
 
SIGNATURES
 
107
 
 
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Part I
 
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; the use of verbs in the future tense and 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 volatility in credit, lending, and financial markets; weakness and declines in the real estate market, which could further affect both collateral values and loan activity; periods of relatively high unemployment or economic weakness 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 rights 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’ strict 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 effects of 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 changes in the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), which could impact the home mortgage market; increased competition and/or disintermediation within the financial services industry; changes in tax rates, deductions and/or policies; potential further changes in Federal Deposit Insurance Corporation (“FDIC”) premiums and other governmental assessments; changes in deposit flows; changes in the cost of funds; fluctuations in general market rates of interest and/or yields or rates on competing loans, investments, and sources of funds; demand for loan or deposit products; illiquidity of financial markets and other negative developments affecting particular investment and mortgage-related securities, which could adversely impact the fair value of and/or cash flows from such securities; changes in customers’ demand for other financial services; the Company’s potential inability to carry out business plans or strategies; changes in accounting policies or guidelines; natural disasters, acts of terrorism, or developments in the war on terrorism; the risk of failures in computer or other technology systems or data maintenance, or breaches of security relating to such systems; and the factors discussed in “Item 1A. Risk Factors,” as well as Part II, “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.”
 
Item 1.    Business
 
The discussion in this section should be read in conjunction with “Item 1A. Risk Factors,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Item 7A. Quantitative and Qualitative Disclosures about Market Risk,” and “Item 8. Financial Statements and Supplementary Data.”
 
General
 
Bank Mutual Corporation (the “Company”) is a Wisconsin corporation headquartered in Milwaukee, Wisconsin. The Company owns 100% of the common stock of Bank Mutual (the “Bank”) and currently engages in no substantial activities other than its ownership of such stock. Consequently, the Company’s net income and cash flows are derived primarily from the Bank’s operations and capital distributions. The Company is regulated as a savings and loan holding company by the Board of Governors of the Federal Reserve (“FRB”). The Company’s common stock trades on The NASDAQ Global Select Market under the symbol BKMU.
 
 
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The Bank was founded in 1892 and is a federally-chartered savings bank headquartered in Milwaukee, Wisconsin. It is regulated by the Office of the Comptroller of the Currency (“OCC”) and its deposits are insured within limits established by the FDIC. The Bank's primary business is community banking, which includes attracting deposits from and making loans to the general public and private businesses, as well as governmental and non-profit entities. In addition to deposits, the Bank obtains funds through borrowings from the Federal Home Loan Bank (“FHLB”) of Chicago. These funding sources are principally used to originate loans, including commercial and industrial loans, multi-family residential loans, non-residential commercial real estate loans, one- to four-family loans, home equity loans, and other consumer loans. From time-to-time the Bank also purchases and/or participates in loans from third-party financial institutions and is an active seller of residential loans in the secondary market. It also invests in mortgage-related and other investment securities.
 
The Company’s principal executive office is located at 4949 Brown Deer Road, Milwaukee, Wisconsin, 53223, and its telephone number at that location is (414) 354-1500. The Company’s website is www.bankmutualcorp.com. The Company will make available through that website, free of charge, its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practical after the Company files those reports with, or furnishes them to, the Securities and Exchange Commission (“SEC”). Also available on the Company’s website are various documents relating to the corporate governance of the Company, including its Code of Ethics and its Code of Conduct.
 
Market Area
 
At December 31, 2013, the Company had 75 banking offices in Wisconsin and one in Minnesota. At June 30, 2013, the Company had a 1.40% market share of all deposits held by FDIC-insured institutions in Wisconsin. The Company is the fourth largest financial institution headquartered in Wisconsin, based on deposit market share.
 
The largest concentration of the Company’s offices is in southeastern Wisconsin, consisting of the Milwaukee Metropolitan Statistical Area (“MSA”), the Racine MSA, and the Kenosha, Wisconsin, and Lake County, Illinois MSA. The Company has 26 offices in these MSAs. The Company has also five offices in south central Wisconsin, consisting of the Madison MSA and the Janesville/Beloit MSA, as well as six other offices in communities in east central Wisconsin.
 
The Company also operates 20 banking offices in northeastern Wisconsin, including the Green Bay MSA. A few of the offices in this region are located near the Michigan border. Therefore, the Company also draws customers from the upper peninsula of Michigan. Finally, the Company has 18 offices in northwestern Wisconsin, including the Eau Claire MSA, and one office in Woodbury, Minnesota, which is part of the Minneapolis-St. Paul MSA.
 
The services provided through the Company's banking offices are supplemented by services offered through a customer service call center, 24-hour phone banking, internet banking services, and ATMs located in the Company’s market areas.
 
Competition
 
The Company faces significant competition in attracting deposits, making loans, and selling other financial products and services. Wisconsin has many banks, savings banks, savings and loan associations, and tax-exempt credit unions, which offer the same types of banking products and services as the Company. The Company also faces competition from other types of financial service companies, such as mortgage brokerage firms, finance companies, insurance companies, investment brokerage firms, and mutual funds. As a result of electronic commerce, the Company also competes with financial service providers outside of Wisconsin.
 
Many of the Company’s competitors have greater resources and/or offer services that the Company currently does not provide. For example, the Company does not offer trust services. However, the Company does offer mutual fund investments, tax-deferred annuities, credit life and disability insurance, property and casualty insurance, and brokerage services through a subsidiary, BancMutual Financial & Insurance Services, Inc.
 
Lending Activities
 
General At December 31, 2013, the Company’s total loans receivable was $1.5 billion or 64.3% of total assets. The Company’s loan portfolio consists of loans to both commercial and retail borrowers. Loans to commercial borrowers include loans secured by real estate such as multi-family properties, non-residential commercial properties (referred to as “commercial real estate”), and construction and development projects secured by these same types of properties, as well as land. In addition, commercial loans include loans to businesses that are not secured by real estate (referred to as “commercial and industrial loans”). Loans to retail borrowers include loans to individuals that are secured by real estate such as one- to four-family first mortgages, home equity term loans, and home equity lines of credit. In addition, retail loans include student loans, automobile loans, and other loans not secured by real estate (collectively referred to as “other consumer loans”). The Company’s classification of loans as commercial and retail represents a “line of business” classification format, which is a change from prior years when the classification format focused on loan collateral type (i.e., mortgage and non-mortgage). Prior years’ data in this report has been presented in accordance with this revised classification format.
 
 
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The nature, type, and terms of loans originated or purchased by the Company are subject to federal and state laws and regulations. The Company has no significant concentrations of loans to particular borrowers or to borrowers engaged in similar activities. In addition, the Company limits its lending activities primarily to borrowers and related loan collateral located in its market areas, which consist of Wisconsin and contiguous regions of Illinois, Minnesota, and northern Michigan, as previously described. For specific information related to the Company’s loans receivable for the periods covered by this report, refer to “Financial Condition—Loans Receivable” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Commercial and Industrial Loans At December 31, 2013, the Company’s portfolio of commercial and industrial loans was $166.8 million or 10.1% of its gross loans receivable. This portfolio consists of loans and lines of credit to businesses for equipment purchases, working capital, debt refinancing or restructuring, business acquisition or expansion, Small Business Administration (“SBA”) loans, and domestic standby letters of credit. Typically, these loans are secured by general business security agreements and personal guarantees. The Company offers variable, adjustable, and fixed-rate commercial and industrial loans. The Company also has commercial and industrial loans that have an initial period where interest rates are fixed, generally one to five years, and thereafter are adjustable based on various market indices. Fixed-rate loans are priced at either a margin over various market indices with maturities that correspond to the maturities of the notes or to match competitive conditions and yield requirements. Term loans are generally amortized over a three to seven year period. Commercial lines of credit generally have a term of one year and are subject to annual renewal thereafter. The Company performs an annual credit review of all commercial and industrial borrowers having an exposure to the Company of $500,000 or more.
 
Multi-family and Commercial Real Estate Loans At December 31, 2013, the Company’s aggregate portfolio of multi-family and commercial real estate loans was $542.4 million or 32.8% of its gross loans receivable. The Company’s multi-family and commercial real estate loan portfolios consist of fixed-rate and adjustable-rate loans originated at prevailing market rates usually tied to various market indices. This portfolio generally consists of loans secured by apartment buildings, office buildings, retail centers, warehouses, and industrial buildings. Loans in this portfolio may be secured by either owner or non-owner occupied properties. Loans in this portfolio typically do not exceed 80% of the lesser of the purchase price or an independent appraisal by an appraiser designated by us. Loans originated with balloon maturities are generally amortized on a 25 to 30 year basis with a typical balloon term of 3 to 5 years.
 
Loans secured by multi-family and commercial real estate are granted based on the income producing potential of the property, the financial strength and/or income producing potential of the borrower, and the appraised value of the property. In most cases, the Company also obtains personal guarantees from the principals involved. The Company’s approval process includes a review of the other debt obligations and overall sources of cash flow available to the borrower and guarantors. The property’s expected net operating income must be sufficient to cover the payments relating to the outstanding debt. The Company generally requires an assignment of rents or leases to be assured that the cash flow from the property will be used to repay the debt. Appraisals on properties securing multi-family and larger commercial real estate loans are performed by independent state certified or licensed fee appraisers approved by the board of directors. Title and hazard insurance are required as well as flood insurance, if applicable. Environmental assessments are performed on certain multi-family and commercial real estate loans in excess of $1.0 million, as well as all loans secured by certain properties that the Company considers to be “environmentally sensitive.” In addition, the Company performs an annual credit review of its multi-family and commercial real estate loans over $500,000.
 
Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Such loans typically involve large balances to single borrowers or groups of related borrowers. The Bank has internal lending limits to single borrowers or a group of related borrowers that are adjusted from time-to-time, but are generally well below the Bank’s legal lending limit of approximately $41 million as of December 31, 2013. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. Furthermore, borrowers’ problems in areas unrelated to the properties that secure the Company’s loans may have an adverse impact on such borrowers’ ability to comply with the terms of the Company’s loans.
 
 
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Construction and Development Loans At December 31, 2013, the Company’s portfolio of construction and development loans was $199.5 million or 12.1% of its gross loans receivable. These loans typically have terms of 18 to 24 months, are interest-only, and carry variable interest rates tied to the prime rate. Disbursements on these loans are based on draw requests supported by appropriate lien waivers. Construction loans typically convert to permanent loans at the completion of a project, but may or may not remain in the Company’s loan portfolio depending on the competitive environment for permanent financing at the end of the construction term. Development loans are typically repaid as the underlying lots or housing units are sold. Construction and development loans are generally considered to involve a higher degree of risk than mortgage loans on completed properties. The Company's risk of loss on a construction and development loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction, the estimated cost of construction, the appropriate application of loan proceeds to the work performed, and the borrower's ability to advance additional construction funds if necessary. In addition, in the event a borrower defaults on the loan during its construction phase, the construction project often needs to be completed before the full value of the collateral can be realized by the Company. The Company performs an annual credit review of its construction and development loans over $500,000.
 
Residential Mortgage Loans At December 31, 2013, the Company’s portfolio of one- to four-family first mortgage loans was $490.2 million or 29.9% of its gross loans receivable. Most of these loans are owner-occupied; however, the Company also originates first mortgage loans secured by second homes, seasonal homes, and investment properties.
 
The Company originates primarily conventional fixed-rate residential mortgage loans and adjustable-rate residential mortgage (“ARM”) loans with maturity dates up to 30 years. Such loans generally are underwritten to Fannie Mae standards. In general, ARM loans are retained by the Company in its loan portfolio. Conventional fixed-rate residential mortgage loans are generally sold in the secondary market without recourse, although the Company typically retains the servicing rights to such loans. From time-to-time, the Company may elect to retain in its loan portfolio conventional fixed-rate loans with maturities of up to 15 years. The Company also originates “jumbo” single family mortgage loans in excess of the Fannie Mae maximum loan amount, which was $417,000 for single family homes in its primary market areas in 2013. Fannie Mae has higher limits for two-, three- and four-family homes. The Company generally retains fixed-rate jumbo single family mortgage loans in its portfolio.
 
From time-to-time the Company also originates fixed-rate and ARM loans under special programs for low- to moderate-income households and first-time home buyers. These programs are offered to help meet the credit needs of the communities the Company serves and are retained by the Company in its loan portfolio. Among the features of these programs are lower down payments, no mortgage insurance, and generally less restrictive requirements for qualification compared to the Company’s conventional one- to four-family mortgage loans. These loans generally have maturities up to 30 years.
 
From time-to-time the Company also originates loans under programs administered by various federal and state government agencies such as the State Veteran’s Administration (“State VA”), the Wisconsin Housing and Economic Development Authority (“WHEDA”), the U.S. Department of Agriculture (“USDA”) Guaranteed Rural Housing Program, and the Federal Housing Administration (“FHA”). Loans originated under these programs may or may not be held by the Company in its loan portfolio and the Company may or may not retain the servicing rights for such loans.
 
ARM loans pose credit risks different from the risks inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments from the borrowers increase, which increases the potential for payment default. At the same time, the marketability and/or value of the underlying property may be adversely affected by higher interest rates. ARM loans generally have an initial fixed-rate term of one to seven years. Thereafter, they are adjusted on an annual basis up to a maximum of 200 basis points per year. The Company originates ARM loans with lifetime caps set at 6% above the origination rate. Monthly payments of principal and interest are adjusted when the interest rate adjusts. The Company does not offer ARM loans with negative amortization or with interest-only payment features. The Company currently utilizes the monthly average yield on United States treasury securities, adjusted to a constant maturity of one year (“constant maturity treasury index”) as the base index to determine the interest rate payable upon the adjustment date of ARM loans. Some of the ARM loans are granted with conversion options that provide for terms of up to seven years in which the borrower may convert the ARM loan to a fixed-rate mortgage loan. The terms at which the ARM loan may be converted to a fixed-rate loan are established at the date of loan origination and are set to allow the Company to sell the loan into the secondary market upon conversion. The volume and types of ARM loans the Company originates have been affected by the level of market interest rates, competition, consumer preferences, and the availability of funds. ARM loans are susceptible to early prepayment during periods of lower interest rates as borrowers refinance into fixed-rate loans.
 
 
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The Company requires an appraisal of the real estate that secures a residential mortgage loan, which must be performed by an independent certified appraiser approved by the board of directors. A title insurance policy is required for all real estate first mortgage loans. Evidence of adequate hazard insurance and flood insurance, if applicable, is required prior to closing. Borrowers are required to make monthly payments to fund principal and interest as well as private mortgage insurance and flood insurance, if applicable. With some exceptions for lower loan-to-value ratio loans, borrowers are also generally required to escrow in advance for real estate taxes. Generally, no interest is paid on these escrow deposits. If borrowers with loans having a lower loan-to-value ratio want to handle their own taxes and insurance, an escrow waiver fee is charged. With respect to escrowed real estate taxes, the Company generally makes this disbursement directly to the borrower as obligations become due.
 
The Company’s staff underwriters review all pertinent information prior to making a credit decision on an application. All recommendations to deny are reviewed by a designated senior officer of the Company, in addition to staff underwriters, prior to the final disposition of the application. The Company’s lending policies generally limit the maximum loan-to-value ratio on single family mortgage loans secured by owner-occupied properties to 95% of the lesser of the appraised value or purchase price of the property. This limit is lower for loans secured by two-, three-, and four-family homes. Loans above 80% loan-to-value ratios are subject to private mortgage insurance to reduce the Company’s exposure to less than 80% of value, except for certain low to moderate income loan program loans.
 
In addition to servicing the loans in its own portfolio, the Company continues to service most of the loans that it sells to Fannie Mae and other third-party investors (“loans serviced for others”). Servicing mortgage loans, whether for its own portfolio or for others, includes such functions as collecting monthly principal and interest payments from borrowers, maintaining escrow accounts for real estate taxes and insurance, and making certain payments on behalf of borrowers. When necessary, servicing of mortgage loans also includes functions related to the collection of delinquent principal and interest payments, loan foreclosure proceedings, and disposition of foreclosed real estate. As of December 31, 2013, loans serviced for others amounted to $1.1 billion. These loans are not reflected in the Company’s Consolidated Statements of Financial Condition.
 
When the Company services loans for others, it is compensated through the retention of a servicing fee from borrowers' monthly payments. The Company pays the third-party investors an agreed-upon yield on the loans, which is generally less than the interest agreed to be paid by the borrowers. The difference, typically 25 basis points or more, is retained by the Company and recognized as servicing fee income over the lives of the loans, net of amortization of capitalized mortgage servicing rights (“MSRs”). The Company also receives fees and interest income from ancillary sources such as delinquency charges and float on escrow and other funds.
 
Management believes that servicing mortgage loans for third parties partially mitigates other risks inherent in the Company's mortgage banking operations. For example, fluctuations in volumes of mortgage loan originations and resulting gains on sales of such loans caused by changes in market interest rates will generally be offset by opposite changes in the amortization of the MSRs. These fluctuations are usually the result of actual loan prepayment activity and/or changes in management expectations for future prepayment activity, which impacts the amount of MSRs amortized in a given period. However, fluctuations in the recorded value of MSRs may also be caused by valuation allowances required to be recognized under generally accepted accounting principles (“GAAP”). That is, the value of servicing rights may fluctuate because of changes in the future prepayment assumptions or discount rates used to periodically assess the impairment of MSRs. Although most of the Company's serviced loans that prepay are replaced by new serviced loans (thus preserving the future servicing cash flow), GAAP requires impairment losses resulting from a change in future prepayment assumptions to be recorded when the change occurs. MSRs are particularly susceptible to impairment losses during periods of declining interest rates during which prepayment activity typically accelerates to levels above that which had been anticipated when the servicing rights were originally recorded. Alternatively, in periods of increasing interest rates, during which prepayment activity typically declines, the Company could potentially recapture through earnings all or a portion of a previously established valuation allowance for impairment.
 
 
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Home Equity Loans At December 31, 2013, the Company’s portfolio of home equity loans was $228.2 million or 13.8% of its gross loans receivable. Home equity loans include fixed term home equity loans and home equity lines of credit. These loans are typically secured by junior liens on owner-occupied one- to four-family residences, but in many instances are secured by first liens on such properties. Underwriting procedures for the home equity and home equity lines of credit loans include a comprehensive review of the loan application, an acceptable credit score, verification of the value of the equity in the home, and verification of the borrower’s income.
 
The Company originates fixed-rate home equity term loans with loan-to-value ratios of up to 89.99% (when combined with any other mortgage on the property). Pricing on fixed-rate home equity term loans is periodically reviewed by management. Generally, loan terms are in the three to fifteen year range in order to minimize interest rate risk.
 
The Company also originates home equity lines of credit. Home equity lines of credit are variable-rate loans secured by first liens or junior liens on owner-occupied one- to four-family residences. Current interest rates on home equity lines of credit are tied to an index rate, adjust monthly after an initial interest rate lock period, and generally have floors that vary depending on the loan-to-value ratio. Home equity line of credit loans are made for terms up to 10 years and require minimum monthly payments.
 
Other Consumer Loans At December 31, 2013, the Company’s portfolio of other consumer loans was $24.1 million or 14.6% of its gross loans receivable. Other consumer loans include student loans, automobile loans, recreational vehicle and boat loans, deposit account loans, overdraft protection lines of credit, and unsecured consumer loans, including loans through credit card programs that are administered by third parties. The Company no longer originates student loans through programs guaranteed by the federal government. Student loans that continue to be held by the Company are administered by a third party.
 
Other consumer loans generally have shorter terms and higher rates of interest than conventional mortgage loans, but typically involve more credit risk because of the nature of the collateral and, in some instances, the absence of collateral. In general, other consumer loans are more dependent upon the borrower's continuing financial stability, more likely to be affected by adverse personal circumstances, and often secured by rapidly depreciating personal property. In addition, various laws, including bankruptcy and insolvency laws, may limit the amount that may be recovered from a borrower. The Company believes that the higher yields earned on other consumer loans compensate for the increased risk associated with such loans and that consumer loans are important to the Company’s efforts to increase the interest rate sensitivity and shorten the average maturity of its loan portfolio.
 
Asset Quality
 
General The Company has policies and procedures in place to manage its exposure to credit risk related to its lending operations. As a matter of policy, the Company limits its lending to geographic areas in which it has substantial familiarity and/or a physical presence. Currently, this is limited to certain specific market areas in Wisconsin and contiguous states. In addition, from time-to-time the Company will prohibit or restrict lending in situations in which the underlying business operations and/or collateral exceed management’s tolerance for risk. The Company obtains appraisals of value prior to the origination of mortgage loans or other secured loans. It also manages its exposure to risk by regularly monitoring loan payment status, conducting periodic site visits and inspections, obtaining regular financial updates from large borrowers and/or guarantors, corresponding regularly with large borrowers and/or guarantors, and/or updating appraisals as appropriate, among other things. These procedures are emphasized when a borrower has failed to make scheduled loan payments, has otherwise defaulted on the terms of the loan agreement, or when management has become aware of a significant adverse change in the financial condition of the borrower, guarantor, or underlying collateral. For specific information relating to the Company’s asset quality for the periods covered by this report, refer to “Financial Condition—Asset Quality” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Internal Risk Ratings and Classified Assets OCC regulations require thrift institutions to review and, if necessary, classify their assets on a regular basis. Accordingly, the Company has internal policies and procedures in place to evaluate and/or maintain risk ratings on all of its loans and certain other assets. In general, these internal risk ratings correspond with regulatory requirements to adversely classify problem loans and certain other assets as “substandard,” “doubtful,” or “loss.” A loan or other asset is adversely classified as substandard if it is determined to involve a distinct possibility that the Company could sustain some loss if deficiencies associated with the loan are not corrected. A loan or other asset is adversely classified as doubtful if full collection is highly questionable or improbable. A loan or other asset is adversely classified as loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations also provide for a “special mention” designation, described as loans or assets which do not currently expose the Company to a sufficient degree of risk to warrant adverse classification, but which demonstrate clear trends in credit deficiencies or potential weaknesses deserving management's close attention (refer to the following paragraph for additional discussion). As of December 31, 2013, $52.7 million or 3.5% the Company’s loans were classified as special mention and $49.1 million or 3.3% were classified as substandard. The latter includes all loans placed on non-accrual in accordance with the Company’s policies, as described below. In addition, as of December 31, 2013, $28.8 million of the Company’s mortgage-related securities, consisting of private-label collateralized mortgage obligations (“CMOs”) rated less than investment grade, were classified as substandard in accordance with regulatory guidelines. The Company had no loans or other assets classified as doubtful or loss at December 31, 2013.
 
 
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Loans that are not classified as special mention or adversely classified as substandard, doubtful, or loss are classified as “pass” or “watch” in accordance with the Company’s internal risk rating policy. Pass loans are generally current on contractual loan and principal payments, comply with other contractual loan terms, and have no noticeable credit deficiencies or potential weaknesses. Watch loans are also generally current on payments and in compliance with loan terms, but a particular borrower’s financial or operating conditions may exhibit early signs of credit deficiencies or potential weaknesses that deserve management’s close attention. Such deficiencies and/or weaknesses typically include, but are not limited to, the borrower’s financial or operating condition, deterioration in liquidity, increased financial leverage, declines in the condition or value of related collateral, recent changes in management or business strategy, or recent developments in the economic, competitive, or market environment of the borrower. If adverse observations noted in these areas are not corrected, further downgrade of the loan may be warranted.
 
Delinquent Loans When a borrower fails to make required payments on a loan, the Company takes a number of steps to induce the borrower to cure the delinquency and restore the loan to a current status. In the case of one- to four-family mortgage loans, the Company’s loan servicing department is responsible for collection procedures from the 15th day of delinquency through the completion of foreclosure. Specific procedures include late charge notices, telephone contacts, and letters. If these efforts are unsuccessful, foreclosure notices will eventually be sent. The Company may also send either a qualified third party inspector or a loan officer to the property in an effort to contact the borrower. When contact is made with the borrower, the Company attempts to obtain full payment or work out a repayment schedule to avoid foreclosure of the collateral. Many borrowers pay before the agreed upon payment deadline and it is not necessary to start a foreclosure action. The Company follows collection procedures and guidelines outlined by Fannie Mae, Freddie Mac, State VA, WHEDA, and the Guaranteed Rural Housing Program.
 
The collection procedures for retail loans, excluding student loans and credit card loans, include sending periodic late notices to a borrower and attempts to make direct contact with a borrower once a loan becomes 30 days past due. If collection activity is unsuccessful, the Company may pursue legal remedies itself, refer the matter to legal counsel for further collection effort, seek foreclosure or repossession of the collateral (if any), and/or charge-off the loan. All student loans are serviced by a third party that guarantees that its servicing complies with all U.S. Department of Education guidelines. The Company’s student loan portfolio is guaranteed under programs sponsored by the U.S. government. Credit card loans are serviced by a third party administrator.
 
The collection procedures for commercial loans include sending periodic late notices to a borrower once a loan is past due. The Company attempts to make direct contact with a borrower once a loan becomes 15 days past due. The Company’s managers of the multi-family and commercial real estate loan areas review loans 10 days or more delinquent on a regular basis. If collection activity is unsuccessful, the Company may refer the matter to legal counsel for further collection effort. After 90 days, loans that are delinquent are typically proposed for repossession or foreclosure.
 
In working with delinquent borrowers, if the Company cannot develop a repayment plan that substantially complies with the original terms of the loan agreement, the Company’s practice has been to pursue foreclosure or repossession of the underlying collateral. As a matter of practice, the Company has not restructured or modified troubled loans in a manner that has resulted in a loss under accounting rules. However, the Company’s policies do not preclude such practice and the Company may elect in the future to restructure certain troubled loans in a manner that could result in losses under accounting rules. In most cases the Company continues to report restructured or modified troubled loans as non-performing loans unless the borrower has clearly demonstrated the ability to service the loan in accordance with the new terms.
 
The Company’s policies require that management continuously monitor the status of the loan portfolio and report to the board of directors on a monthly basis. These reports include information on classified loans, delinquent loans, restructured or modified loans, allowance for loan losses, and foreclosed real estate.
 
 
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Non-Accrual Policy With the exception of student loans that are guaranteed by the U.S. government, the Company generally stops accruing interest income on loans when interest or principal payments are 90 days or more in arrears or earlier when the future collectability of such interest or principal payments may no longer be certain. In such cases, borrowers have often been able to maintain a current payment status, but are experiencing financial difficulties and/or the properties that secure the loans are experiencing increased vacancies, declining lease rates, and/or delays in unit sales. In such instances, the Company generally stops accruing interest income on the loans even though the borrowers are current with respect to all contractual payments. Although the Company generally no longer accrues interest on these loans, the Company may continue to record periodic interest payments received on such loans as interest income provided the borrowers remain current on the loans and provided, in the judgment of management, the Company’s net recorded investment in the loans are deemed to be collectible. The Company designates loans on which it stops accruing interest income as non-accrual loans and establishes a reserve for outstanding interest that was previously credited to income. All loans on non-accrual are considered to be impaired. The Company returns a non-accrual loan to accrual status when factors indicating doubtful or uncertain collection no longer exist. In general, non-accrual loans are also classified as substandard, doubtful, or loss in accordance with the Company’s internal risk rating policy. As of December 31, 2013, $13.0 million or 0.86% of the Company’s loans were considered to be non-performing in accordance with the Company’s policies.
 
Foreclosed Properties and Repossessed Assets As of December 31, 2013, $6.7 million or 2.9% of the Company’s total assets consisted of foreclosed properties and repossessed assets. In the case of loans secured by real estate, foreclosure action generally starts when the loan is between the 90th and 120th day of delinquency following review by a senior officer and the executive loan committee of the board of directors. If, based on this review, the Company determines that repayment of a loan is solely dependent on the liquidation of the collateral, the Company will typically seek the shortest redemption period possible, thus waiving its right to collect any deficiency from the borrower. Depending on whether the Company has waived this right and a variety of other factors outside the Company’s control (including the legal actions of borrowers to protect their interests), an extended period of time could transpire between the commencement of a foreclosure action by the Company and its ultimate receipt of title to the property.
 
When the Company ultimately obtains title to the property through foreclosure or deed in lieu of foreclosure, it transfers the property to “foreclosed properties and repossessed assets” on the Company’s Consolidated Statements of Financial Condition. In cases in which a borrower has surrendered control of the property to the Company or has otherwise abandoned the property, the Company may transfer the property to foreclosed properties as an “in substance foreclosure” prior to actual receipt of title. Foreclosed properties and repossessed assets are adversely classified in accordance with the Company’s internal risk rating policy.
 
Foreclosed real estate properties are initially recorded at the lower of the recorded investment in the loan or fair value. Thereafter, the Company carries foreclosed real estate at fair value less estimated selling costs (typically 5% to 10%). Foreclosed real estate is inspected periodically to evaluate its condition. Additional outside appraisals are obtained as deemed necessary or appropriate. Additional write-downs may occur if the property value deteriorates further after it is acquired. These additional write-downs are charged to the Company’s results of operations as they occur.
 
In the case of loans secured by assets other than real estate, action to repossess the underlying collateral generally starts when the loan is between the 90th and 120th day of delinquency following review by management. The accounting for repossessed assets is similar to that described for real estate, above.
 
Loan Charge-Offs The Company typically records loan charge-offs when foreclosure or repossession becomes likely or legal proceedings related to such have commenced, the secondary source of repayment (consisting of a guarantor or operating entity) files for bankruptcy, or the loan is otherwise deemed uncollectible. The amount of the charge-off will depend on the fair value of the underlying collateral, if any, and may be zero if the fair market value exceeds the loan amount. All charge-offs are recorded as a reduction to allowance for loan losses. All charge-off activity is reviewed by the board of directors.
 
Allowance for Loan Losses As of December 31, 2013, the Company’s allowance for loan losses was $23.6 million or 1.56% of loans receivable and 181.6% of non-performing loans. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on factors such as the size and current risk characteristics of the portfolio, an assessment of individual problem loans and pools of homogenous loans within the portfolio, and actual loss, delinquency, and/or risk rating experience within the portfolio. The Company also considers current economic conditions and/or events in specific industries and geographical areas, including unemployment levels, trends in real estate values, peer comparisons, and other pertinent factors, including regulatory guidance. Finally, as appropriate, the Company also considers individual borrower circumstances and the condition and fair value of the loan collateral, if any. For additional information relating to the Company’s allowance for loan losses for the periods covered by this report, refer to “Results of Operations—Provision for Loan Losses” and “Financial Condition—Asset Quality” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
 
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Determination of the allowance is inherently subjective as it requires significant management judgment and estimates, including the amounts and timing of expected future cash flows on loans, the fair value of underlying collateral (if any), estimated losses on pools of homogeneous loans based on historical loss experience, changes in risk characteristics of the loan portfolio, and consideration of current economic trends, all of which may be susceptible to significant change. Higher rates of loan defaults than anticipated would likely result in a need to increase provisions in future years. Also, increases in the Company’s multi-family, commercial real estate, construction and development, and commercial and industrial loan portfolios could result in a higher allowance for loan losses as these loans typically carry a higher risk of loss. Finally, various regulatory agencies, as an integral part of their examination processes, periodically review the Company’s loan and foreclosed real estate portfolios and the related allowance for loan losses and valuations of foreclosed real estate. One or more of these agencies, particularly the OCC, may require the Company to increase the allowance for loan losses or reduce the recorded value of foreclosed real estate based on their judgments of information available to them at the time of their examination, thereby adversely affecting the Company’s results of operations. As a result of applying management judgment, it is possible that there may be periods when the amount of the allowance and/or its percentage to total loans or non-performing loans may decrease even though non-performing loans may increase.
 
Periodic adjustments to the allowance for loan loss are recorded through provision for loan losses in the Company’s Consolidated Statements of Income. Actual losses on loans are charged off against the allowance for loan losses. In the case of loans secured by real estate, charge-off typically occurs when foreclosure or repossession is likely or legal proceedings related to such have commenced, when the secondary source of repayment (consisting of a guarantor or operating entity) files for bankruptcy, or when the loan is otherwise deemed uncollectible in the judgment of management. Loans not secured by real estate, as well as unsecured loans, are charged off when the loan is determined to be uncollectible in the judgment of management. Recoveries of loan amounts previously charged off are credited to the allowance as received. Management reviews the adequacy of the allowance for loan losses on a monthly basis. The board of directors reviews management’s judgments related to the allowance for loan loss on at least a quarterly basis.
 
The Company maintains general allowances for loan loss against certain homogenous pools of loans. These pools generally consist of smaller loans of all types that do not warrant individual review due to their size. In addition, pools may also consist of larger commercial loans that have not been individually identified as impaired by management. Certain of these pools are further segmented by management’s internal risk rating of the loans. Management has developed factors for each pool or segment based on the historical loss experience of each pool or segment, recent delinquency performance, internal risk ratings, and consideration of current economic trends, in order to determine what it believes is an appropriate level for the general allowance. Given the significant amount of management judgment involved in this process there could be significant variation in the Company’s allowance for loan losses and provision for loan losses from period to period.
 
The Company maintains specific allowances for loan loss against individual loans that have been identified by management as impaired. These loans are generally larger loans, but management may also establish specific allowances against smaller loans from time-to-time. The allowance for loan loss established against these loans is based on one of two methods: (1) the present value of the future cash flows expected to be received from the borrower, discounted at the loan’s effective interest rate, or (2) the fair value of the loan collateral, if the loan is considered to be collateral dependent. In the Company’s experience, loss allowances using the first method have been rare. In working with problem borrowers, if the Company cannot develop a repayment plan that substantially complies with the original terms of the loan agreement, the Company’s practice has been to pursue foreclosure or repossession of the underlying collateral. As a matter of practice, the Company does not restructure troubled loans in a manner that results in a loss under the first method. As a result, most loss allowances are established using the second method because the related loans have been deemed collateral dependent by management.
 
 
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Management considers loans to be collateral dependent when, in its judgment, there is no source of repayment for the loan other than the ultimate sale or disposition of the underlying collateral and foreclosure is probable. Factors management considers in making this determination typically include, but are not limited to, the length of time a borrower has been delinquent with respect to loan payments, the nature and extent of the financial or operating difficulties experienced by the borrower, the performance of the underlying collateral, the availability of other sources of cash flow or net worth of the borrower and/or guarantor, and the borrower’s immediate prospects to return the loan to performing status. In some instances, because of the facts and circumstances surrounding a particular loan relationship, there could be an extended period of time between management’s identification of a problem loan and a determination that it is probable that such loan is collateral dependent. Based on recent experience, however, management has noted the length of time has shortened between when a loan is classified as non-performing and when it is considered to be collateral dependent. Management believes this is a trend that will continue as long as economic conditions and/or commercial real estate values remain depressed.
 
Management generally measures impairment of impaired loans whether or not foreclosure is probable based on the estimated fair value of the underlying collateral. Such estimates are based on management’s judgment or, when considered appropriate, on an updated appraisal or similar evaluation. Updated appraisals are also typically obtained on impaired loans on at least on annual basis or when foreclosure or repossession of the underlying collateral is considered to be imminent. Prior to receipt of an updated appraisal, management has typically relied on the latest appraisal and knowledge of the condition of the collateral, as well as the current market for the collateral, to estimate the Company’s exposure to loss on impaired loans.
 
Investment Activities
 
At December 31, 2013, the Company’s portfolio of mortgage-related securities available-for-sale was $446.6 million or 19.0% of its total assets. As of the same date its portfolio of mortgage-related securities held-to-maturity was $155.5 million or 6.6% of total assets. Mortgage-related securities consist principally of mortgage-backed securities (“MBSs”) and CMOs. Most of the Company’s mortgage-related securities are directly or indirectly insured or guaranteed by Freddie Mac, Fannie Mae, or the Government National Mortgage Association (“Ginnie Mae”). The remaining securities are private-label CMOs. Private-label CMOs generally carry higher credit risks and higher yields than mortgage-related securities insured or guaranteed by the aforementioned agencies of the U.S. Government. Although the latter securities have less exposure to credit risk, like private-label CMOs they remain exposed to fluctuating interest rates and instability in real estate markets, which may alter the prepayment rate of underlying mortgage loans and thereby affect the fair value of the securities. For additional information related to the Company’s mortgage-related securities, refer to “Financial Condition—Mortgage-Related Securities Available-for-Sale” and “Financial Condition—Mortgage-Related Securities Held-to-Maturity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
In addition to the mortgage-related securities previously described, the Company’s investment policy authorizes investment in various other types of securities, including U.S. Treasury obligations, federal agency obligations, state and municipal obligations, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements, federal funds, commercial paper, mutual funds, and, subject to certain limits, corporate debt and equity securities.
 
The objectives of the Company’s investment policy are to meet the liquidity requirements of the Company and to generate a favorable return on investments without compromising objectives related to overall exposure to risk, including interest rate risk, credit risk, and investment portfolio concentrations. In addition, the Company pledges eligible securities as collateral for certain deposit liabilities, FHLB of Chicago advances, and other purposes permitted or required by law.
 
The Company’s investment policy requires that securities be classified as trading, available-for-sale, or held-to-maturity at the date of purchase. The Company’s available-for-sale securities are carried at fair value with the change in fair value recorded as a component of shareholders’ equity rather than affecting results of operations. The Company’s held-to-maturity securities are carried at amortized cost. The Company has not engaged in trading activities.
 
The Company’s investment policy prohibits the purchase of non-investment grade securities, although the Company may continue to hold investments that are reduced to less than investment grade after their purchase. Securities rated less than investment grade are adversely classified as substandard in accordance with federal guidelines (refer to Asset Quality—Internal Ratings and Classified Assets,” above).
 
 
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Financial Derivatives
 
The Company’s policies permit the use of financial derivatives such as financial futures, options, forward commitments, and interest rate swaps, to manage its exposure to interest rate risk, but only with prior approval of the board of directors. At December 31, 2013, the Company was using forward commitments to manage interest rate risk related to its sale of residential loans in the secondary market, as well as interest rate swaps to manage interest rate risk related to certain fixed-rate commercial loans. For additional information, refer to “Note 13. Financial Instruments with Off-Balance-Sheet Risk” in “Item 8. Financial Statements and Supplementary Data.”
 
Deposit Liabilities
 
At December 31, 2013, the Company’s deposit liabilities were $1.8 billion or 75.1% of its total liabilities and equity. The Company offers a variety of deposit accounts having a range of interest rates and terms for both retail and business customers. The Company currently offers regular savings accounts (consisting of passbook and statement savings accounts), interest-bearing demand accounts, non-interest-bearing demand accounts, money market accounts, and certificates of deposit. The Company also offers IRA time deposit accounts and health savings accounts. When the Company determines its deposit rates, it considers rates offered by local competitors, benchmark rates on U.S. Treasury securities, and rates on other sources of funds such as FHLB of Chicago advances. For additional information, refer to “Financial Condition—Deposit Liabilities” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Deposit flows are significantly influenced by general and local economic conditions, changes in prevailing interest rates, pricing of deposits, and competition. The Company’s deposits are primarily obtained from the market areas surrounding its bank offices. The Company relies primarily on competitive rates, quality service, and long-standing relationships with customers to attract and retain these deposits. The Company does not rely on a particular customer or related group of individuals, organizations, or institutions for its deposit funding. From time to time the Company has used third-party brokers and a nationally-recognized reciprocal deposit gathering network to obtain wholesale deposits.
 
Borrowings
 
At December 31, 2013, the Company’s borrowed funds were $244.9 million or 10.4% of its total liabilities and equity. The Company borrows funds to finance its lending, investing, operating, and, when active, stock repurchase activities. Substantially all of its borrowings take the form of advances from the FHLB of Chicago and are on terms and conditions generally available to member institutions. The Company’s FHLB of Chicago borrowings typically carry fixed rates of interest, have stated maturities, and are generally subject to significant prepayment penalties if repaid prior to their stated maturity. The Company has pledged certain one- to four-family first and second mortgage loans, as well as certain multi-family mortgage loans, as blanket collateral for current and future advances. For additional information regarding the Company’s outstanding advances from the FHLB of Chicago as of December 31, 2013, refer to “Financial Condition—Borrowings” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Shareholders’ Equity
 
At December 31, 2013, the Company’s shareholders’ equity was $281.0 million or 12.0% of its total liabilities and equity. The Company is not currently required to maintain minimum regulatory capital at the holding company level. However, refer to “Regulation and Supervision—Regulation of the Company,” below, for additional information related to regulatory capital requirements for the Company.
 
Although the Company is not currently required to maintain minimum regulatory capital, the Bank is required to maintain specified amounts of regulatory capital pursuant to regulations promulgated by the OCC and the FDIC. The Bank’s objective is to maintain its regulatory capital in an amount sufficient to be classified in the highest regulatory category (i.e., as a “well capitalized” institution). At December 31, 2013, the Bank exceeded all regulatory minimum requirements, as well as the amount required to be classified as a “well capitalized” institution. For additional discussion relating to regulatory capital standards refer to “Regulation and Supervision of the Bank—Regulatory Capital Requirements” and “—Prompt Corrective Action,” below. For additional information related to the Company’s equity and the Bank’s regulatory capital for the periods covered by this report, refer to “Financial Condition—Shareholders’ Equity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as “Note 8. Shareholders’ Equity” in “Item 8. Financial Statements and Supplementary Data.”
 
 
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The Company has paid quarterly cash dividends since its initial stock offering in 2000. The payment of dividends is discretionary with the Company’s board of directors and depends on the Company’s operating results, financial condition, compliance with regulatory capital requirements, and other considerations. In addition, the Company’s ability to pay dividends is highly dependent on the Bank’s ability to pay dividends to the Company. As such, there can be no assurance that the Company will be able to continue the payment of dividends or that the level of dividends will not be reduced in the future. For additional information, refer to “Regulation and Supervision of the Bank—Dividend and Other Capital Distribution Limitations,” below.
 
From time to time, the Company has repurchased shares of its common stock, and such repurchases have had the effect of reducing the Company’s capital. However, as with the payment of dividends above, the repurchase of common stock is discretionary with the Company’s board of directors and depends on a variety of factors, including market conditions for the Company’s stock, the financial condition of the Company and the Bank, compliance with regulatory capital requirements, and other considerations. The Company does not have a current stock repurchase program. As a result of these considerations, there can be no assurance as to if or when the Company will be able to resume repurchases of its common stock.
 
Subsidiaries
 
BancMutual Financial & Insurance Services, Inc. (“BMFIS”), a wholly-owned subsidiary of the Bank, provides investment, brokerage, and insurance services to the Bank’s customers and the general public. Investment services include tax-deferred and tax-free investments, mutual funds, and government securities. Personal insurance, business insurance, life and disability insurance, mortgage protection products, and investment advisory services are also offered by BMFIS. Certain of BMFIS’s brokerage services are provided through an operating agreement with a third-party, registered broker-dealer.
 
Mutual Investment Corporation (“MIC”) and First Northern Investment Inc. (“FNII”) are wholly-owned subsidiaries of the Bank that own and manage certain mortgage-related securities and, in the case of FNII, a small number of one- to four-family mortgage loans.
 
MC Development LTD (“MC Development”), a wholly-owned subsidiary of the Bank, is involved in land development and sales. It owns five parcels of developed land totaling 15 acres in Brown Deer, Wisconsin. In addition, in 2004, MC Development established Arrowood Development LLC with an independent third party to develop approximately 300 acres for residential purposes in Oconomowoc, Wisconsin. In the initial transaction, the third party purchased approximately one-half interest in that land, all of which previously had been owned by MC Development.
 
In addition, the Bank has four wholly-owned subsidiaries that are inactive, but are reserved for possible future use in related or other areas.
 
Employees
 
At December 31, 2013, the Company employed 637 full time and 85 part time associates. Management considers its relations with its associates to be good.
 
Regulation and Supervision
 
General
 
The Company is a Wisconsin corporation and a registered savings and loan holding company under federal law. The Company files reports with and is subject to regulation and examination by the FRB. The Bank is a federally-chartered savings bank and is subject to OCC requirements as well as those of the FDIC. Any change in these laws and regulations, whether by the FRB, the OCC, the FDIC, or through legislation, could have a material adverse impact on the Company, the Bank, and the Company’s shareholders.
 
 
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Certain current laws and regulations applicable to the Company and the Bank, and other material consequences of recent legislation, are summarized below. These summaries do not purport to be complete and are qualified in their entirety by reference to such laws, regulations, or administrative considerations.
 
Financial Services Industry Legislation and Related Actions
 
In response to instability in the U.S. financial system, lawmakers and federal banking agencies have taken various actions intended to stabilize the financial system and housing markets, and to strengthen U.S. financial institutions.
 
Dodd-Frank Act
 
In 2010 Congress enacted the Dodd-Frank Act, which significantly changed the U.S. financial institution regulatory structure, as well as the lending, investment, trading, and operating activities of financial institutions and their holding companies. In 2011 the Dodd-Frank Act transferred federal regulatory functions and authority relating to federal thrifts, such as the Bank, to the OCC. In addition, the FRB acquired supervisory and rule-making authority over all savings and loan holding companies, such as the Company. The Dodd-Frank Act also requires the FRB to apply to savings and loan holding companies the same consolidated leverage and risk-based capital standards that insured depository institutions must follow, which will include capital requirements for the Company effective in 2015 (refer to “Regulation and Supervision—Regulation of the Company,” below, for additional information related to regulatory capital requirements for the Company). Further, the Dodd-Frank Act has imposed new disclosure and governance requirements on publicly-held companies, such as the Company.
 
The Dodd-Frank Act also created the Consumer Financial Protection Bureau (“CFPB”) with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, such as the Bank. However, institutions with $10 billion or less in assets, such as the Bank, are examined for CFPB compliance by their applicable bank regulators, rather than the CFPB itself.
 
Some provisions of the Dodd-Frank Act remain subject to future rule-making procedures and studies, and the full effects of the Dodd-Frank Act on the Company and/or the Bank cannot yet be determined.
 
Regulation and Supervision of the Bank
 
General As a federally-chartered, FDIC-insured savings bank, the Bank is subject to extensive regulation by the OCC, as well as the regulations of the FDIC. This federal regulation and supervision establishes a comprehensive framework of activities in which a federal savings bank may engage and is intended primarily for the protection of the FDIC and depositors rather than the shareholders of the Company. This regulatory structure gives authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies regarding the classification of assets and the establishment of adequate loan loss reserves.
 
The OCC regularly examines the Bank and issues a report on its examination findings to the Bank’s board of directors. The Bank’s relationships with its depositors and borrowers are also regulated by federal law, especially in such matters as the ownership of savings accounts and the form and content of the Bank’s loan documents. The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition, and must obtain regulatory approvals prior to entering into transactions such as mergers or acquisitions.
 
Regulatory Capital Requirements OCC regulations require savings associations such as the Bank to meet three capital standards. The minimum standards are tangible capital equal to at least 1.5% of adjusted total assets, Tier 1 (“core”) capital equal to at least 4% of adjusted total assets (also known as the “leverage ratio”), and total risk-based capital equal to at least 8% of total risk-weighted assets. If a savings association is rated in the OCC’s highest supervisory category, the minimum leverage ratio is reduced to 3%. These capital standards are in addition to the capital standards promulgated by the OCC under its prompt corrective action regulations and standards required by the FDIC, which in some cases are more stringent than the above standards.
 
In the Bank’s case, core capital is equal to tangible capital. Core capital generally consists of common shareholders’ equity, noncumulative perpetual preferred stock and related surplus, and minority interests in the equity accounts of consolidated subsidiaries, less goodwill, other intangible assets, and certain deferred tax assets. Supplemental bank capital generally consists of core capital plus the allowance for loan and lease losses (up to a maximum of 1.25% of risk-weighted assets), cumulative perpetual preferred stock, long-term preferred stock and any related surplus, certain hybrid capital investments, term subordinated debt instruments and related surplus, and up to 45% of the pretax net unrealized holding gains on various instruments and other assets. Supplemental capital may not represent more than 50% of the total capital for the risk-based capital standard.
 
 
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A savings association calculates its risk-weighted assets by multiplying each asset and off-balance sheet item by various risk factors as determined by the OCC, which range from 0% for cash to 100% for delinquent loans, property acquired through foreclosure, commercial loans, and other assets, to 200% for certain available-for-sale securities rated less than investment grade.
 
The Bank’s objective is to maintain its regulatory capital in an amount sufficient to be classified in the highest regulatory category (i.e., as a “well capitalized” institution). At December 31, 2013, the Bank exceeded all regulatory minimum requirements, as well as those required to be classified as a “well capitalized” institution. For additional information related to the Bank’s regulatory capital for the periods covered by this report, refer to “Note 8. Shareholders’ Equity” in “Item 8. Financial Statements and Supplementary Data.”
 
Prompt Corrective Action The FDIC has established a system of prompt corrective action to resolve the problems of undercapitalized insured institutions and has a broad range of grounds under which it may appoint a receiver or conservator for an insured depository institution, particularly when an institution fails to meet adequate capitalization requirements. The OCC has adopted the FDIC’s regulations governing the supervisory actions that may be taken against undercapitalized institutions, the severity of which increases as a bank’s capital decreases with the three undercapitalized categories defined in the regulations. These regulations establish and define five capital categories, in the absence of a specific capital directive, as follows:
 
 
 
Total Risk-Based
 
Tier 1
 
Tier 1
 
 
 
Capital to Risk
 
Capital to Risk
 
Capital to
 
Category:
 
Weighted Assets
 
Weighted Assets
 
Total Assets
 
Well capitalized
 
≥ 10%
 
≥ 6%
 
≥ 5%
 
Adequately capitalized
 
≥ 8%
 
≥ 4%
 
≥ 4% (1)
 
Under capitalized
 
< 8%
 
< 4%
 
< 4% (2)
 
Significantly undercapitalized
 
< 6%
 
< 3%
 
< 3%
 
Critically undercapitalized (3)
 
 
 
 
 
 
 
(1) ≥ 3% if the bank receives the highest rating under the uniform system.
(2) < 3% if the bank receives the highest rating under the uniform system.
(3) Tangible assets to capital of equal to or less than 2%.
 
Future Regulatory Capital Requirements In 2013 the federal banking agencies issued final rules that implement certain revisions to regulatory capital requirements as specified by the Basel Committee of Banking Supervision (known as Basel III). These new rules will become effective on January 1, 2015, although certain aspects will phase in over the following four years. Although there can be no assurances, management does not expect the new rules to have an impact on the Bank’s regulatory capital classification as well capitalized nor does it expect the new rules to have a significant impact on the Bank’s financial condition or results of operations.
 
Dividend and Other Capital Distribution Limitations OCC regulations generally govern capital distributions by savings associations such as the Bank, which include cash dividends and stock repurchases. Currently, as a subsidiary of a savings and loan holding company, the Bank generally must give the FRB and the OCC at least 30 days notice before the board of directors declares a dividend or approves a capital distribution. In certain other circumstances, a savings association must file an application with the OCC for approval of a capital distribution if, among other things, the total amount of capital distributions for the applicable calendar year exceeds the sum of the savings association’s net income for that year to date plus the savings association’s retained net income for the preceding two years.
 
The FRB or the OCC may disapprove a notice or application if (i) the savings association would be undercapitalized, significantly undercapitalized or critically undercapitalized following the distribution; (ii) the proposed capital distribution raises safety and soundness concerns; or (iii) the capital distribution would violate any applicable statute, regulation, agreement or regulatory-imposed condition. The FRB and OCC have substantial discretion in making these decisions.
 
 
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For additional discussion related to the Bank and Company’s dividends and the Company’s share repurchases refer to “Financial Condition—Shareholders’ Equity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
 
Qualified Thrift Lender Test Federal savings associations must meet a qualified thrift lender (“QTL”) test or they become subject to operating restrictions. The Bank met the QTL test as of December 31, 2013, and anticipates that it will maintain an appropriate level of mortgage-related investments (which must be at least 65% of portfolio assets as defined in the regulations) and will otherwise continue to meet the QTL test requirements.
 
Federal Home Loan Bank System The Bank is a member of the FHLB of Chicago. The FHLB of Chicago makes loans (“advances”) to its members and provides certain other financial services to its members pursuant to policies and procedures established by its board of directors. The FHLB of Chicago imposes limits on advances made to member banks, including limitations relating to the amount and type of collateral and the amount of advances.
 
As a member of the FHLB of Chicago, the Bank must meet certain eligibility requirements and must purchase and maintain common stock in the FHLB of Chicago in an amount equal to the greater of (i) 1% of its mortgage-related assets at the most recent calendar year end, (ii) 5% of its outstanding advances from the FHLB of Chicago, or (iii) $10,000. At December 31, 2013, the Bank owned $12.2 million in FHLB of Chicago common stock, which was in compliance with the minimum common stock ownership guidelines established by the FHLB of Chicago. For additional discussion related to the Bank’s investment in the common stock of the FHLB of Chicago, refer to “Item 1A. Risk Factors” and “Financial Condition—Other Assets” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Deposit Insurance The deposit accounts held by customers of the Bank are insured by the FDIC up to maximum limits, as provided by law. Insurance on deposits may be terminated by the FDIC if it finds that the Bank has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC. The management of the Bank does not know of any practice, condition, or violation that might lead to termination of the Bank’s deposit insurance.
 
The FDIC sets deposit insurance premiums based upon the risks a particular bank or savings association poses to its deposit insurance fund. Under the risk-based assessment system, the FDIC assigns an institution to one of three capital categorizations based on the institution’s financial information; institutions are classified as well capitalized, adequately capitalized or undercapitalized using ratios that are substantially similar to the prompt corrective action capital ratios discussed above. The FDIC also assigns an institution to one of three supervisory sub-categorizations within each capital group. This assignment is based on a supervisory evaluation provided by the institution’s primary federal regulator and information that the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance fund.
 
An institution’s assessment rate depends on the capital categorizations and supervisory sub-categorizations to which it is assigned. Under the risk-based assessment system, there are four assessment risk categories to which different assessment rates are applied. The assessment rates range from 2.5 to 45 basis points, depending on the institution’s capital category and supervisory sub-category. Since April 2011 the assessment base used by the FDIC in determining deposit insurance premiums has consisted of an insured institution’s average consolidated total assets minus average tangible equity and certain other adjustments. For additional discussion, refer to “Results of Operations—Non-Interest Expense” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Transactions With Affiliates Sections 23A and 23B of the Federal Reserve Act and FRB Regulation W govern transactions between an insured federal savings association, such as the Bank, and any of its affiliates, such as the Company. An affiliate is any company or entity that controls, is controlled by or is under common control with it. Sections 23A and 23B limit the extent to which an institution or a subsidiary may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such savings association’s capital stock and surplus, and limit all such transactions with all affiliates to 20% of such stock and surplus. The term “covered transaction” includes the making of loans, purchase of assets, issuance of guarantees, derivatives transactions, securities borrowing, and lending transactions to the extent that they result in credit exposure to an affiliate. Further, most loans by a savings association to any of its affiliates must be secured by specified collateral amounts. All such transactions must be on terms that are consistent with safe and sound banking practices and must be on terms that are at least as favorable to the savings association as those that would be provided to a non-affiliate. At December 31, 2013, the Company and Bank did not have any covered transactions.
 
 
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Acquisitions and Mergers Under the federal Bank Merger Act, any merger of the Bank with or into another institution would require the approval of the OCC, or the primary federal regulator of the resulting entity if it is not an OCC-regulated institution. Refer also to “Regulation and Supervision of the Company—Acquisition of Bank Mutual Corporation,” below.
 
Prohibitions Against Tying Arrangements Savings associations are subject to the prohibitions of 12 U.S.C. Section 1972 on certain tying arrangements. A savings association is prohibited, subject to exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor.
 
Uniform Real Estate Lending Standards The federal banking agencies adopted uniform regulations prescribing standards for extensions of credit that are secured by liens on interests in real estate or are made to finance the construction of a building or other improvements to real estate. All insured depository institutions must adopt and maintain written policies that establish appropriate limits and standards for such extensions of credit. These policies must establish loan portfolio diversification standards, prudent underwriting standards that are clear and measurable, loan administration procedures, and documentation, approval and reporting requirements.
 
These lending policies must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies that have been adopted by the federal bank regulators. These guidelines, among other things, require a depository institution to establish internal loan-to-value limits for real estate loans that are not in excess of specified supervisory limits, which generally vary and provide for lower loan-to-value limits for types of collateral that are perceived as having more risk, are subject to fluctuations in valuation, or are difficult to dispose. Although there is no supervisory loan-to-value limit for owner-occupied one- to four-family and home equity loans, the guidelines provide that an institution should require credit enhancement in the form of mortgage insurance or readily marketable collateral for any such loan with a loan-to-value ratio that equals or exceeds 90% at origination. The guidelines also clarify expectations for prudent appraisal and evaluation policies, procedures, and practices, and make other changes, in light of the Dodd-Frank Act and other recent federal statutory changes affecting appraisals.
 
Other Mortgage Lending Regulations In 2013 the CFPB issued a regulation commonly known as the “qualified mortgage” rule, which generally requires mortgage lenders such as the Bank to make a reasonable, good faith determination of a borrower’s ability to repay loans secured by single family residential properties (excluding home equity lines of credit and certain other types of loans) in order to obtain certain protections from liability under the rule for such qualified mortgages. These new rules were effective on January 10, 2014. Management does not expect this new rule to have a significant impact on the Bank’s single family mortgage lending or sales operations.
 
Also in 2013, federal regulators issued a revised proposed rule relating to risk retention requirements on sales of single family residential mortgage loans. The risk retention requirements generally require institutions such as the Bank to retain no less than 5% of the credit risk in loans it sells into a securitization and prohibits such institutions from directly or indirectly hedging or otherwise transferring the credit risk that the institution is required to retain, subject to limited exceptions. One significant exception is for securities entirely collateralized by “qualified residential mortgages” (“QRMs”), which are defined the same as the “qualified mortgage” rule issued by the CFPB, as discussed in the previous paragraph. Management does not expect the revised proposed rule, if adopted, to have a significant impact on the Bank’s single family mortgage lending or sales operations.
 
Community Reinvestment Act Under the Community Reinvestment Act (“CRA”), any insured depository institution, including the Bank, must, consistent with its safe and sound operation, help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the OCC to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including applications for additional branches and acquisitions.
 
Among other things, the CRA regulations contain an evaluation system that rates an institution based on its actual performance in meeting community needs. In particular, the evaluation system focuses on three tests: (i)                a lending test, to evaluate the institution’s record of making loans in its service areas, (ii) an investment test, to evaluate the institution’s record of making community development investments, and (iii) a service test, to evaluate the institution’s delivery of services through its branches, ATMs and other offices. The CRA requires the OCC to provide a written evaluation of the Bank’s CRA performance utilizing a four-tiered descriptive rating system and requires public disclosure of the CRA rating. The Bank received a “satisfactory” overall rating in its most recent CRA examination.
 
 
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Safety and Soundness Standards Each federal banking agency, including the OCC, has guidelines establishing general standards relating to internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, customer privacy, liquidity, earnings, and compensation and benefits. The guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines also prohibit excessive compensation as an unsafe and unsound practice.
 
Loans to Insiders A savings association’s loans to its executive officers, directors, any owner of more than 10% of its stock (each, “an insider”) and certain entities affiliated with any such person (an insider’s “related interest”) are subject to the conditions and limitations imposed by Section 22(h) of the Federal Reserve Act and the FRB’s Regulation O thereunder. Under these restrictions, the aggregate amount of the loans to any insider and related interests may not exceed the loans-to-one-borrower limit applicable to national banks. All loans by a savings association to all insiders and related interests in the aggregate may not exceed the savings association’s unimpaired capital and surplus. With certain exceptions, the Bank’s loans to an executive officer (other than certain education loans and residential mortgage loans) may not exceed $100,000. Regulation O also requires that any proposed loan to an insider or a related interest be approved in advance by a majority of the Bank’s board of directors, without the vote of any interested director, if such loan, when aggregated with any existing loans to that insider and related interests, would exceed $500,000. Generally, such loans must be made on substantially the same terms as, and follow credit underwriting procedures that are no less stringent than, those for comparable transactions with other persons and must not present more than a normal risk of collectability. There is an exception for extensions of credit pursuant to a benefit or compensation plan of a savings association that is widely available to employees that does not give preference to officers, directors, and other insiders. As of December 31, 2013, total loans to insiders were $349,000 (including $130,000 which relates to residential mortgages that have been sold in the secondary market).
 
Regulation and Supervision of the Company
 
General The Company is a registered savings and loan holding company under federal law and is subject to regulation, supervision, and enforcement actions by the FRB. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a risk to the Bank and to monitor and regulate the Company’s capital and activities such as dividends and share repurchases that can affect capital. Under long-standing FRB policy, holding companies are expected to serve as a source of strength for their depository subsidiaries, and may be called upon to commit financial resources and support to those subsidiaries. The requirement that the Company act as a source of strength for the Bank, and the future capital requirements at the Company level (refer to “Regulatory Capital Requirements,” below), may affect the Company's ability to pay dividends or make other distributions.
 
The Company may engage in activities permissible for a savings and loan holding company, a bank holding company, or a financial holding company, which generally encompass a wider range of activities that are financial in nature. The Company may not engage in any activities beyond that scope without the approval of the FRB.
 
Federal law prohibits a savings and loan holding company from acquiring control of another savings institution or holding company without prior regulatory approval. With some exceptions, it also prohibits the acquisition or retention of more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring an institution that is not federally-insured. In evaluating applications to acquire savings institutions, the regulator must consider the financial and managerial resources, future prospects of the institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
 
Regulatory Capital Requirements The Company is not currently required by the FRB to maintain minimum regulatory capital at the consolidated level. However, under the Dodd-Frank Act, the FRB is required to impose capital requirements on savings and loan holding companies beginning in 2015. These capital requirements will be substantially the same as those required for bank holding companies under Basel III, which also become effective in 2015 (although certain aspects of Basel III are phased in over the following four years). Although there can be no assurance, management believes that the Company will be well capitalized for regulatory capital purposes at the consolidated level when it becomes subject to such capital requirements in 2015. In addition, management does not expect the new capital requirements to have a significant impact on the Company’s financial condition or results of operations.
 
 
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Acquisition of Bank Mutual Corporation No person may acquire control of the Company without first obtaining the approval of such acquisition by the appropriate federal regulator. Currently, any person, including a company, or group acting in concert, seeking to acquire 10% or more of the outstanding shares of the Company must, depending on the circumstances, obtain the approval of, and/or file a notice with the FRB.
 
Federal and State Taxation
 
Federal Taxation The Company and its subsidiaries file a calendar year consolidated federal income tax return, reporting income and expenses using the accrual method of accounting. The federal income tax returns for the Company and its subsidiaries have been examined and audited or closed without audit by the Internal Revenue Service (“IRS”) for tax years prior to 2010.
 
State Taxation The Company and its subsidiaries are subject to combined reporting in the state of Wisconsin, which includes the Bank’s out-of-state investment subsidiaries since 2009. For additional information related to the resolution of a matter related to the Company's income taxes in Wisconsin, refer to “Note 12. Income Taxes” of the Company’s consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data.”
 
 
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Item 1A. Risk Factors
 
In addition to the discussion and analysis set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the cautionary statements set forth in “Item 1. Business,” the following risk factors should be considered when evaluating the Company’s results of operations, financial condition, and outlook. These risk factors should also be considered when evaluating any investment decision with respect to the Company’s common stock.
 
The Company’s Actual Loan Losses May Exceed its Allowance for Loan Losses, Which Could Have a Material Adverse Affect on the Company’s Results of Operations
 
The Company has policies and procedures in place to manage its exposure to risk related to its lending operations. However, despite these practices, the Company’s loan customers may not repay their loans according to the terms of the loans and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. Economic weakness, including high unemployment rates and lower values for the collateral underlying loans, may affect borrowers’ ability or willingness to repay their loan obligations that could lead to increased loan losses or provisions. As a result, the Company may experience significant loan losses, including losses that may exceed the amounts established in the allowance for loan losses, which could have a material adverse effect on its operating results and capital.
 
Declines in Real Estate Values CouldAdversely Affect Collateral Values and the Company’s Results of Operations
 
From time-to-time the Company’s market areas have experienced lower real estate values, higher levels of residential and non-residential tenant vacancies, and weakness in the market for sale of new or existing properties, for both commercial and residential real estate. Such developments could negatively affect the value of the collateral securing the Company’s mortgage and related loans and could in turn lead to increased losses on loans and foreclosed real estate. Increased losses would affect the Company’s loan loss allowance and may cause it to increase its provision for loan losses resulting in a charge to earnings and capital.
 
A Significant Portion of the Company’s Lending Activities Are Focused on Commercial Lending
 
The Company has identified multi-family, commercial real estate, commercial and industrial, and construction and development loans as areas for lending emphasis and has augmented its personnel in recent periods to increase its penetration in the commercial lending market. While the Company is pursuing this lending diversification for the purpose of increasing net interest income, these types of loans have historically carried greater risk of payment default than loans to retail borrowers. As the volume of commercial lending increases, credit risk increases. In the event of increased defaults from commercial borrowers, the Company’s provision for loan losses would further increase and loans may be written off and, therefore, earnings would be reduced.
 
Further, as the portion of the Company's loans secured by the assets of commercial enterprises increases, the Company becomes increasingly exposed to environmental liabilities and related compliance burdens. Even though the Company is also subject to environmental requirements in connection with residential real estate lending, the possibility of liability increases in connection with commercial lending, particularly in industries that use hazardous materials and/or generate waste or pollution or that own property that was the subject of prior contamination. If the Company does not adequately assess potential environment risks, the value of the collateral it holds may be less than it expects, and it may be exposed to liability for remediation or other environmental compliance.
 
Regulators Continue to be Strict, which may Affect the Company's Business and Results of Operations
 
In addition to the effect of new laws and regulations, the regulatory climate in the U.S., particularly for financial institutions, continues to be strict. As a consequence, regulatory activity affecting financial institutions relating to a wide variety of safety and soundness and compliance issues continues to be elevated. Such regulatory activity, if directed at the Company or the Bank, could have an adverse affect on the Company's or the Bank's costs of compliance and results of operations.
 
 
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The Bank’s Ability to Pay Dividends to the Company Is Subject to Limitations That May Affect the Company’s Ability to Pay Dividends to Its Shareholders and Repurchase Its Stock
 
The Company is a separate legal entity from the Bank and engages in no substantial activities other than its ownership of the common stock of the Bank. Consequently, the Company’s net income and cash flows are derived primarily from the Bank’s operations and capital distributions. The availability of dividends from the Bank to the Company is limited by various statutes and regulations, including those of the OCC and FRB; as a result, it is possible, depending on the results of operations and the financial condition of the Bank and other factors, that the OCC and/or the FRB could restrict the payment by the Bank of dividends or other capital distributions or take other actions which could negatively affect the Bank's results and dividend capacity. The federal regulators continue to be stringent in their interpretation, application and enforcement of banks' capital requirements, which could affect the regulators’ willingness to allow Bank dividends to the Company. If the Bank is required to reduce its dividends to the Company, or is unable to pay dividends at all, or the FRB separately does not allow the Company to pay dividends, the Company may not be able to pay dividends to its shareholders at existing levels or at all and/or may not be able to repurchase its common stock.
 
Global Credit Market Volatility and Weak Economic Conditions May Significantly Affect the Company’s Liquidity, Financial Condition, and Results of Operations
 
Global financial markets continue to be unstable and unpredictable, and economic conditions have been relatively weak. Developments relating to the federal budget, federal borrowing authority, or other political issues could also negatively impact these markets, as could global developments such as a foreign sovereign debt crisis. Continued, and potentially increased, volatility, instability and weakness could affect the Company’s ability to sell investment securities and other financial assets, which in turn could adversely affect the Company’s liquidity and financial position. These factors could also affect the prices at which the Company could make any such sales, which could adversely affect its results of operations and financial condition. Conditions could also negatively affect the Company’s ability to secure funds or raise capital for acquisitions and other projects, which in turn, could cause the Company to use deposits or other funding sources for such projects.
 
In addition, the volatility of the markets and weakness of the economy could affect the strength of the Company’s customers or counterparties, their willingness to do business with, and/or their ability or willingness to fulfill their obligations to the Company, which could further affect the Company’s results of operations. Current conditions, including relatively high unemployment, weak corporate performance, and soft real estate markets, could negatively affect the volume of loan originations and prepayments, the value of the real estate securing the Company’s mortgage loans, and borrowers’ ability or willingness to repay loan obligations, all of which could adversely impact the Company’s results of operations and financial condition.
 
Future Events May Result in a Valuation Allowance Against the Company’s Deferred Tax Asset Which May have a Significant Effect On the Company’s Results of Operations and Financial Condition
 
As of December 31, 2013, the Company’s net deferred tax asset was $27.4 million. 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 to be recorded against the Company’s net deferred tax asset as of December 31, 2013. This determination required significant management judgment based on positive and negative considerations. Such considerations included the Company’s cumulative three-year net loss, the nature of the components of such cumulative loss, recent trends in earnings excluding non-recurring charges (such as the goodwill impairment in 2011), expectations for the Company’s future earnings, the duration of federal and state net operating loss carryforward periods, and other factors. Future events or circumstances could result in conditions that differ significantly from management’s current assessment of these positive and negative considerations, particularly as such relate to the Company’s future earnings. Changes in these considerations could result in a significant valuation allowance being recorded against the Company’s net deferred tax asset, which could have a significant effect on the Company’s future results of operations and financial condition.
 
 
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Recent and Future Legislation and Rulemaking May Significantly Affect the Company’s Results of Operations and Financial Condition
 
Instability, volatility, and failures in the credit and financial institutions markets in recent years have led regulators and legislators to consider and/or adopt proposals that will significantly affect financial institutions and their holding companies, including the Company. Legislation such as the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009, and the Dodd-Frank Act of 2010, as well as programs such as the Troubled Assets Relief Program, were adopted. Although designed to address safety, soundness, and compliance issues in the banking system, there can be no assurance as to the ultimate impact of these actions on financial markets, which could have a material, adverse effect on the Company’s business, financial condition, results of operations, access to credit or the value of the Company’s securities. Further legislative and regulatory proposals to reform the U.S. financial system would also affect the Company and the Bank.
 
The Dodd-Frank Act created the CFPB, which has broad rulemaking and enforcement authority with respect to entities, including financial institutions, that offer to consumers covered financial products and services. The CFPB is required to adopt rules identifying practices or acts that are unfair, deceptive or abusive relating to any customer transaction for a consumer financial product or service, or the offering of a consumer financial product or service. Although rules implemented to date are not expected to have a significant adverse impact on the Company, the full scope of the impact of the CFPB’s authority has not yet been determined as all related rules have not all yet been adopted. The Company cannot yet determine the costs and limitations related to these additional regulatory requirements; however, the costs of compliance and the effect on its business may have a material adverse effect on the Company's operations and results.
 
The Interest Rate Environment May Have an Adverse Impact on the Company’s Net Interest Income
 
Volatile interest rate environments make it difficult for the Company to coordinate the timing and amount of changes in the rates of interest it pays on deposits and borrowings with the rates of interest it earns on loans and securities. In addition, volatile interest rate environments cause corresponding volatility in the demand by individuals and businesses for the loan and deposit products offered by the Company. These factors have a direct impact on the Company’s net interest income, and consequently, its net income. Future interest rates could continue to be volatile and management is unable to predict the impact such volatility would have on the net interest income and profits of the Company.
 
Changes in Market Interest Rates or Other Conditions May Have an Adverse Impact on the Fair Value of the Company’s Available-for-Sale Securities, Shareholders’ Equity, and Profits
 
GAAP requires the Company to carry its available-for-sale securities at fair value on its balance sheet. Unrealized gains or losses on these securities, reflecting the difference between the fair market value and the amortized cost, net of its tax effect, are included as a component of shareholders’ equity. When market rates of interest increase, the fair value of the Company’s securities available-for-sale generally decreases and equity correspondingly decreases. When rates decrease, fair value generally increases and shareholders’ equity correspondingly increases. However, due to significant disruptions in global financial markets, such as those which occurred in 2008, this usual relationship can be disrupted. Despite a generally declining interest rate environment since that time, certain of the Company’s available-for-sale securities (specifically, its private-label CMOs) from time-to-time have experienced fair values substantially less than amortized cost. Management expects continued volatility in the fair value of its private-label CMOs and is not able to predict when or if the fair value of such securities will fully recover.
 
Strong Competition Within the Company’s Market Area May Affect Net Income
 
The Company encounters strong competition both in attracting deposits from customers and originating loans to commercial and retail borrowers. The Company competes with commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms. The Company’s market area includes branches of several commercial banks that are substantially larger than the Company in terms of deposits and loans. In addition, tax-exempt credit unions operate in most of the Company’s market area and aggressively price their products and services to a large part of the population. If competitors succeed in attracting business from the Company’s customers, its deposits and loans could be reduced, which would likely affect earnings.
 
Developments in the Marketplace, Such as Alternatives to Traditional Financial Institutions, or Adverse Publicity Could Affect the Company's Ongoing Business
 
Changes in the marketplace are allowing consumers to use alternative means to complete financial transactions that previously had been conducted through banks. For example, consumers can increasingly maintain funds in accounts other than bank deposits or through the internet, or complete payment transactions without the assistance of banks. Continuation or acceleration of these trends, including newly developing means of communications and technology, could cause consumers to utilize fewer of the Company's services, which could have a material adverse affect on its results.
 
 
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Financial institutions such as the Company are increasingly under governmental, media and other scrutiny as to the conduct of their businesses, and potential issues and adverse developments (real and perceived) are receiving widespread media attention. If there were to be significant adverse publicity about the Company, that publicity could affect its reputation in the marketplace. If the Company's reputation is diminished, it could affect its business and results of operations as well as the price of the Company's common stock.
 
The Company Is Subject to Security Risks and Failures and Operational Risks Relating to the Use of Technology that Could Damage Its Reputation and Business
 
Security breaches in the Company’s internet, telephonic, or other electronic banking activities could expose it to possible liability and damage its reputation. Any compromise of the Company’s security also could deter customers from using its internet banking services that involve the transmission of confidential information. The Company relies on standard internet and other security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect the Company’s systems from compromises or breaches of its security measures, which could result in damage to the Company’s reputation and business and affect its results of operations.
 
Additionally, as a financial institution, the Company’s business is data intensive. Beyond the inherent nature of a financial institution that requires it to process and track extremely large numbers of financial transactions and accounts, the Company is required to collect, maintain, and keep secure significant data about its customers. These operations require the Company to obtain and maintain technology and security-related systems that are mission critical to its business. The Company’s failure to do so could significantly affect its ability to conduct business and its customers' confidence in it. Further, the Company outsources a large portion of its data processing to third parties. If these third party providers encounter technological or other difficulties or if they have difficulty in communicating with the Company or if there is a breach of security, it will significantly affect the Company’s ability to adequately process and account for customer transactions, which would significantly affect the Company’s business operations and reputation.
 
Further, the technology affecting the financial institutions industry and consumer financial transactions is rapidly changing, with the frequent introduction of new products, services, and alternatives. The future success of the Company requires that it continue to adapt to these changes in technology to address its customers' needs. Many of the Company's competitors have greater technological resources to invest in these improvements. These changes could be costly to the Company and if the Company does not continue to offer the services and technology demanded by the marketplace, this failure to keep pace with change could materially affect its business, financial condition, and results of operation.
 
The Company’s Ability to Grow May Be Limited if It Cannot Make Acquisitions
 
The Company will continue to seek to expand its banking franchise by growing internally, acquiring other financial institutions or branches, acquiring other financial services providers, and opening new offices. The Company’s ability to grow through selective acquisitions of other financial institutions or branches will depend on successfully identifying, acquiring, and integrating those institution or branches. The Company has not made any acquisitions in recent years, as management has not identified acquisitions for which it was able to reach an agreement on terms management believed were appropriate and/or that met its acquisition criteria. The Company cannot provide any assurance that it will be able to generate internal growth, identify attractive acquisition candidates, make acquisitions on favorable terms, or successfully integrate any acquired institutions or branches.
 
The Company Depends on Certain Key Personnel and the Company’s Business Could Be Harmed by the Loss of Their Services or the Inability to Attract Other Qualified Personnel
 
The Company’s success depends in large part on the continued service and availability of its management team, and on its ability to attract, retain and motivate qualified personnel. The management team has been augmented to attempt to increase the Company's penetration into the commercial lending market. The Company may need to attract further talent in the future. The competition for these individuals can be significant, and the loss of key personnel could harm the Company’s business. The Company cannot provide assurances that it will be able to retain existing key personnel or attract additional qualified personnel.
 
 
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If the Company is Unable to Maintain Effective Internal Control Over Its Financial Reporting, Investors Could Lose Confidence in the Reliability of Its Financial Statements, Which Could Result in a Reduction in the Value of Its Common Stock
 
Under the Sarbanes-Oxley Act, public companies must include a report of management regarding companies' control over financial reporting in their annual reports and that report must contain an assessment by management of the effectiveness of the companies' internal control over financial reporting. In addition, the independent registered public accounting firm that audits a company's financial statements must attest to and report on the effectiveness of the company’s internal control over financial reporting.
 
If the Company is unable to maintain the required effective internal control over financial reporting, including in connection with regulatory changes and/or changes in accounting rules and standards that apply to it, this could lead to a failure to meet its reporting obligations to the SEC. Such a failure in turn could result in an adverse reaction to the Company in the marketplace or a decline in value of the Company's common stock, due to a loss of confidence in the reliability of the Company's financial statements.
 
The Cost to Provide Employee Healthcare Insurance and/or Benefits Could Increase in the Future
 
The Affordable Care Act (the “ACA”), which was adopted in 2010 and is being phased in over several years, significantly affects the provision of both health care services and benefits in the United States. It is possible that ACA the will negatively affect the Company’s cost of providing health insurance and/or benefits, and may also impact various other aspects of the Company’s business. While the ACA has not yet had a material impact on the Company, the Company is continuing to assess the possible future impact of the ACA on its health care benefit costs.
 
 
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Item 1B.    Unresolved Staff Comments
 
None.
 
Item 2.    Properties
 
The Company and its subsidiaries conduct their business through an executive office and 76 banking offices, which had an aggregate net book value of $48.1 million as of December 31, 2013, excluding furniture, fixtures, and equipment. As of December 31, 2013, the Company owned the building and land for 69 of its property locations and leased the space for eight.
 
The Company also owns 15 acres of developed land in a suburb of Milwaukee, Wisconsin, through its MC Development subsidiary, as well as approximately 300 acres of undeveloped land in another community located near Milwaukee through MC Development’s 50% ownership in Arrowood Development LLC. The net book value of these parcels of land was $5.4 million at December 31, 2013.
 
Item 3.    Legal Proceedings
 
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Management believes that these routine legal proceedings, in the aggregate, are immaterial to the Company’s financial condition, results of operations, and cash flows.
 
Item 4.    Mine Safety Disclosures
 
Not applicable.
 
 
26

 
Part II
 
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters’ and Issuer Purchase of Equity Securities
 
The common stock of the Company is traded on The NASDAQ Global Select Market under the symbol BKMU.
 
As of February 28, 2014, there were 46,551,284 shares of common stock outstanding and approximately 8,900 shareholders of record.
 
The Company paid a total cash dividend of $0.10 per share in 2013. A cash dividend of $0.03 per share was paid on February 28, 2014, to shareholders of record on February 14, 2014. For additional discussion relating to the Company’s dividends, refer to “Financial Condition—Shareholders’ Equity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The payment of dividends in the future is discretionary with the Company’s board of directors and will depend on the Company’s operating results, financial condition, and other considerations. Interest on deposits will be paid prior to payment of dividends on the Company’s common stock. Refer also to “Item 1. Business—Regulation and Supervision” for information relating to regulatory limitations on the Company’s payment of dividends to shareholders, as well as the payment of dividends by the Bank to the Company, which in turn could affect the payment of dividends by the Company.
 
The high and low trading prices of the Company’s common stock from January 1, 2011, through December 31, 2013, by quarter, and the dividends paid in each quarter, were as follows:
 
 
 
2013 Stock Prices
 
2012 Stock Prices
 
Cash Dividends Paid
 
 
 
High
 
Low
 
High
 
Low
 
2013
 
2012
 
1st Quarter
 
$
5.88
 
$
4.43
 
$
4.45
 
$
3.15
 
$
0.02
 
$
0.01
 
2nd Quarter
 
 
5.90
 
 
5.04
 
 
4.41
 
 
3.43
 
 
0.02
 
 
0.01
 
3rd Quarter
 
 
6.73
 
 
5.65
 
 
4.69
 
 
3.95
 
 
0.03
 
 
0.01
 
4th Quarter
 
 
7.17
 
 
6.04
 
 
4.64
 
 
4.03
 
 
0.03
 
 
0.02
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
0.10
 
$
0.05
 
 
From January 1, 2014, to February 28, 2014, the trading price of the Company's common stock ranged between $6.26 to $7.34 per share, and closed this period at $6.62 per share.
 
The Company did not repurchase any of its common stock during 2013 and the Company’s board of directors has not authorized a new stock repurchase program. For additional discussion relating to the Company’s repurchase of its common stock, refer to “Item 1. Business—Shareholders’ Equity” and “Item 1. Business—Regulation and Supervision.”
 
 
27

 
Set forth below is a line graph comparing the cumulative total shareholder return on Company common stock, based on the market price of the common stock and assuming reinvestment of cash dividends, with the cumulative total return of companies on the NASDAQ Stock Market U.S. Index (“NASDAQ Composite Index”) and the NASDAQ Stock Market Bank Index. The graph assumes that $100 was invested on December 31, 2007, in Company common stock and each of those indices.
 
Total Return Performance
 
 
 
 
Period Ending
 
Index
 
12/31/08
 
12/31/09
 
12/31/10
 
12/31/11
 
12/31/12
 
12/31/13
 
Bank Mutual Corporation
 
100.00
 
62.53
 
44.60
 
30.14
 
41.27
 
68.39
 
NASDAQ Composite Index
 
100.00
 
129.26
 
151.94
 
152.42
 
177.46
 
236.88
 
NASDAQ Bank Index
 
100.00
 
98.65
 
109.85
 
81.92
 
110.37
 
150.79
 
 
 
28

 
Item 6.   Selected Financial Data
 
The following table provides selected financial data for the Company for its past five fiscal years. The data is derived from the Company’s audited financial statements, although the table itself is not audited. The following data should be read together with the Company’s consolidated financial statements and related notes and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.”
 
 
 
At December 31
 
 
 
2013
 
2012
 
2011
 
2010
 
2009
 
 
 
(Dollars in thousands, except number of shares and per share amounts)
 
Selected financial condition data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
2,347,349
 
$
2,418,264
 
$
2,498,484
 
$
2,591,818
 
$
3,512,064
 
Loans receivable, net
 
 
1,508,996
 
 
1,402,246
 
 
1,319,636
 
 
1,323,569
 
 
1,506,056
 
Loans held-for-sale
 
 
1,798
 
 
10,739
 
 
19,192
 
 
37,819
 
 
13,534
 
Investment securities available-for-sale
 
 
 
 
 
 
 
 
228,023
 
 
614,104
 
Mortgage-related securities available-for-sale
 
 
446,596
 
 
550,185
 
 
781,770
 
 
435,234
 
 
866,848
 
Mortgage-related securities held-to-maturity
 
 
155,505
 
 
157,558
 
 
 
 
 
 
 
Foreclosed properties and repossessed assets
 
 
6,736
 
 
13,961
 
 
24,724
 
 
19,293
 
 
17,689
 
Goodwill
 
 
 
 
 
 
 
 
52,570
 
 
52,570
 
Mortgage servicing rights, net
 
 
8,737
 
 
6,821
 
 
7,401
 
 
7,769
 
 
6,899
 
Deposit liabilities
 
 
1,762,682
 
 
1,867,899
 
 
2,021,663
 
 
2,078,310
 
 
2,137,508
 
Borrowings
 
 
244,900
 
 
210,786
 
 
153,091
 
 
149,934
 
 
906,979
 
Shareholders' equity
 
 
281,037
 
 
271,853
 
 
265,771
 
 
312,953
 
 
402,477
 
Tangible shareholders' equity (1)
 
 
281,037
 
 
271,853
 
 
265,771
 
 
260,383
 
 
349,907
 
Number of shares outstanding, net of treasury stock
 
 
46,438,284
 
 
46,326,484
 
 
46,228,984
 
 
45,769,443
 
 
46,165,635
 
Book value per share
 
$
6.05
 
$
5.87
 
$
5.75
 
$
6.84
 
$
8.72
 
Tangible shareholders’ equity per share (1)
 
 
6.05
 
 
5.87
 
 
5.75
 
 
5.69
 
 
7.58
 
 
 
 
For the Year Ended December 31
 
 
 
2013
 
2012
 
2011
 
2010
 
2009
 
 
 
(Dollars in thousands, except per share amounts)
 
Selected operating data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest income
 
$
79,456
 
$
83,022
 
$
89,345
 
$
112,569
 
$
151,814
 
Total interest expense
 
 
13,112
 
 
21,641
 
 
26,756
 
 
66,276
 
 
83,784
 
Net interest income
 
 
66,344
 
 
61,381
 
 
62,589
 
 
46,293
 
 
68,030
 
Provision for loan losses
 
 
4,506
 
 
4,545
 
 
6,710
 
 
49,619
 
 
12,413
 
Total non-interest income
 
 
26,116
 
 
29,259
 
 
23,158
 
 
40,603
 
 
31,681
 
Total non-interest expense (2)
 
 
71,504
 
 
76,057
 
 
124,900
 
 
159,825
 
 
68,155
 
Income (loss) before income taxes
 
 
16,450
 
 
10,038
 
 
(45,863)
 
 
(122,548)
 
 
19,143
 
Income tax expense (benefit)
 
 
5,702
 
 
3,336
 
 
1,752
 
 
(49,909)
 
 
5,418
 
Net income (loss) before non-
    controlling interest
 
 
10,748
 
 
6,702
 
 
(47,615)
 
 
(72,639)
 
 
13,725
 
Net loss (income) attributable to
    non-controlling interest
 
 
48
 
 
52
 
 
50
 
 
(1)
 
 
 
Net income (loss)
 
$
10,796
 
$
6,754
 
$
(47,565)
 
$
(72,640)
 
$
13,725
 
Earnings (loss) per share-basic
 
$
0.23
 
$
0.15
 
$
(1.03)
 
$
(1.59)
 
$
0.29
 
Earnings (loss) per share-diluted
 
 
0.23
 
 
0.15
 
 
(1.03)
 
 
(1.59)
 
 
0.29
 
Cash dividends paid per share
 
 
0.10
 
 
0.05
 
 
0.06
 
 
0.20
 
 
0.34
 
 
(1) This is a non-GAAP measure. Tangible shareholders’ equity is total shareholders’ equity minus goodwill.
(2) Total non-interest expense in 2011 includes a goodwill impairment of $52.6 million and in 2010 includes $89.3 million in loss on early repayment of FHLB borrowings.
 
 
29

 
 
 
At or For the Year Ended December 31
 
 
 
2013
 
2012
 
2011
 
2010
 
2009
 
Selected financial ratios:
 
 
 
 
 
 
 
 
 
 
 
Net interest margin (3)
 
3.11
%
2.67
%
2.76
%
1.47
%
2.09
%
Net interest rate spread
 
3.02
 
2.57
 
2.64
 
1.26
 
1.82
 
Return on average assets
 
0.46
 
0.27
 
(1.87)
 
(2.12)
 
0.39
 
Return on average shareholders' equity
 
3.93
 
2.50
 
(16.37)
 
(18.47)
 
3.40
 
Efficiency ratio (4)
 
77.34
 
84.04
 
85.07
 
99.36
 
73.32
 
Non-interest expense as a percent of
    adjusted average assets (5)
 
3.03
 
3.03
 
2.84
 
2.06
 
1.95
 
Shareholders' equity to total assets
 
11.97
 
11.24
 
10.64
 
12.07
 
11.39
 
Tangible shareholders' equity to adjusted
    total assets (6)
 
11.97
 
11.24
 
10.64
 
10.25
 
10.09
 
 
 
 
 
 
 
 
 
 
 
 
 
Selected asset quality ratios:
 
 
 
 
 
 
 
 
 
 
 
Non-performing loans to loans
    receivable, net
 
0.86
%
1.84
%
5.69
%
9.29
%
2.83
%
Non-performing assets to total assets
 
0.84
 
1.64
 
4.00
 
5.49
 
1.72
 
Allowance for loan losses to non-
    performing loans
 
181.62
 
83.64
 
37.17
 
39.03
 
39.99
 
Allowance for loan losses to total
    loans receivable, net
 
1.56
 
1.54
 
2.12
 
3.63
 
1.13
 
Charge-offs to average loans
 
0.18
 
0.78
 
1.96
 
1.26
 
0.45
 
 
(3) Net interest margin is calculated by dividing net interest income by average earnings assets.
(4) Efficiency ratio is calculated by dividing non-interest expense (excluding goodwill impairment and loss on early repayment of FHLB borrowings) by the sum of net interest income and non-interest income (excluding gains and losses on investments).
(5) The ratio in 2011 excludes the impact of the goodwill impairment and in 2010 excludes the impact of the prepayment penalty on the early repayment of FHLB borrowings.
(6) This is a non-GAAP measure. The ratio is calculated by dividing total shareholders’ equity less intangible assets (net of deferred taxes) divided by total assets less intangible assets (net). Intangible assets consist of goodwill and other intangible assets. Deferred taxes have been established only on other intangible assets and are immaterial in amount.
 
 
30

 
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
The discussion and analysis in this section should be read in conjunction with “Item 8. Financial Statements and Supplementary Data,” and “Item 7A. Quantitative and Qualitative Disclosures about Market Risk,” as well as “Item 1. Business” and “Item 1A. Risk Factors.”
 
Results of Operations
 
Overview The Company’s net income (loss) for the years ended December 31, 2013, 2012, and 2011, was $10.8 million, $6.8 million, and $(47.6) million, respectively. Diluted earnings (loss) per share during these periods were $0.23, $0.15, and $(1.03), respectively.
 
The Company’s net income in 2013 was impacted by the following favorable developments compared to 2012:
 
a $5.2 million favorable change in net loan-related fees and servicing revenue;
 
a $5.0 million or 8.1% increase in net interest income;
 
a $4.4 million or 65.9% decrease in net losses and expenses on foreclosed real estate; and
 
a $1.4 million or 43.7% decrease in federal deposit insurance premiums.
 
These favorable developments were partially offset by the following unfavorable developments in 2013 compared to 2012:
 
an $8.8 million or 66.6% decrease in gain on loan sales activities;
 
a $1.6 million or 3.7% increase in compensation-related expenses; and
 
a $2.4 million or 70.9% increase in income tax expense.
 
The Company’s net income in 2012 was impacted by the following favorable developments compared to 2011:
 
the non-recurrence of a $52.6 million loss in 2011 on the impairment of goodwill;
 
a $7.2 million or 121% increase in gain on loan sales activities; and
 
a $2.2 million or 32.3% decrease in provision for loan losses.
 
These favorable developments were partially offset by the following unfavorable developments in 2012 compared to 2011:
 
a $3.5 million or 8.9% increase in compensation-related costs;
 
a $1.5 million unfavorable change in net loan-related fees and servicing revenue;
 
a $1.2 million or 1.9% decrease in net interest income; and
 
a $1.6 million or 90.4% increase in income tax expense.
 
The following paragraphs discuss these developments in greater detail, as well as other changes in the components of net income (loss) during the years ended December 31, 2013, 2012, and 2011.
 
Net Interest Income Net interest income increased by $5.0 million or 8.1% during the year ended December 31, 2013, compared to 2012. This increase was primarily attributable to a 44 basis point improvement in the Company’s net interest margin, from 2.67% in 2012 to 3.11% in 2013. This improvement was due in part to an improved earning asset mix and an improved deposit funding mix in 2013 compared to 2012. The Company’s average loans receivable (which generally have higher yields) increased by $43.3 million or 3.1% and its average mortgage-related securities, investment securities, and overnight investments (which generally have lower yields) declined by $209.2 million or 23.0% in the aggregate in 2013 compared to 2012. With respect to the Company’s deposit funding mix, its average checking and savings deposits (which generally have a lower interest cost or no interest cost) increased by $46.7 million or 4.7% in the aggregate and its average certificates of deposit (which generally have a higher interest cost) declined by $241.0 million or 25.3% in 2013 compared to 2012.
 
 
31

 
Also contributing to the improvement in net interest margin in 2013 compared to 2012 was a 39 basis point decline in the average cost of the Company’s certificates of deposit, as well as the Company’s repayment of $100.0 million in high-cost borrowings from the FHLB of Chicago in the third quarter of 2012. Management anticipates that the Company’s cost of certificates of deposit may continue to decline modestly over the next few months as older, higher-cost certificates of deposit continue to mature and are replaced by lower cost deposits. However, management does not believe that the pace of decline in 2014 will match that of recent years. Refer to “Financial Condition—Deposit Liabilities” for additional discussion related to the impact possible increases in future interest rates could have on the Company’s cost of funds and net interest margin.
 
The favorable impact of the aforementioned developments on net interest income was partially offset by a $165.9 million or 7.2% decrease in average earning assets in 2013 compared to 2012. The Company’s earning assets declined in 2013 as it has used cash flows from its mortgage-related securities portfolio to fund a decline in its certificates of deposit, as previously noted.
 
Net interest income declined by $1.2 million or 1.9% during the year ended December 31, 2012, compared to 2011. This decline was primarily attributable to a decrease in the Company’s net interest margin, which was 2.67% in 2012 compared to 2.76% 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. Contributing to the reduction in the cost of the Company’s funding sources in 2012 was the aforementioned repayment of $100.0 million in high-cost borrowings from the FHLB of Chicago that matured during the third quarter of that year.
 
The impact of a lower net interest margin in 2012 was partially offset by the favorable impact of higher average earning assets in 2012 compared to 2011. 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 2012 average total loans increased by $21.9 million or 1.6% compared to 2011.
 
 
32

 
The following table presents certain details regarding the Company's average balance sheet and net interest income for the periods indicated. The tables present the average yield on interest-earning assets and the average cost of interest-bearing liabilities. The yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. The average balances are derived from daily balances over the periods indicated. Interest income includes fees, which are considered adjustments to yields. Net interest spread is the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin is derived by dividing net interest income by average interest-earning assets. The Company’s tax exempt investments are insignificant, so no tax equivalent adjustments have been made.
 
 
 
Year Ended December 31
 
 
 
2013
 
2012
 
2011
 
 
 
 
 
 
Interest
 
Avg.
 
 
 
 
Interest
 
Avg.
 
 
 
 
Interest
 
Avg.
 
 
 
Average
 
Earned/
 
Yield/
 
Average
 
Earned/
 
Yield/
 
Average
 
Earned/
 
Yield/
 
 
 
Balance
 
Paid
 
Cost
 
Balance
 
Paid
 
Cost
 
Balance
 
Paid
 
Cost
 
 
 
(Dollars in thousands)
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, net (1)
 
$
1,432,606
 
$
64,638
 
4.51
%
$
1,389,313
 
$
65,478
 
4.71
%
$
1,367,450
 
$
69,936
 
5.11
%
Mortgage-related securities
 
 
626,084
 
 
14,666
 
2.34
 
 
792,989
 
 
17,309
 
2.18
 
 
656,343
 
 
16,374
 
2.49
 
Investment securities (2)
 
 
12,168
 
 
54
 
0.44
 
 
25,443
 
 
73
 
0.29
 
 
156,793
 
 
2,877
 
1.83
 
Interest-earning deposits
 
 
62,742
 
 
98
 
0.16
 
 
91,801
 
 
162
 
0.18
 
 
84,505
 
 
158
 
0.19
 
Total interest-earning assets
 
 
2,133,600
 
 
79,456
 
3.72
 
 
2,299,546
 
 
83,022
 
3.61
 
 
2,265,091
 
 
89,345
 
3.94
 
Non-interest-earning assets
 
 
228,010
 
 
 
 
 
 
 
210,599
 
 
 
 
 
 
 
278,872
 
 
 
 
 
 
Total average assets
 
$
2,361,610
 
 
 
 
 
 
$
2,510,145
 
 
 
 
 
 
$
2,543,963
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and equity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
 
$
226,307
 
 
62
 
0.03
 
$
217,255
 
 
63
 
0.03
 
$
212,644
 
 
78
 
0.04
 
Money market accounts
 
 
478,938
 
 
694
 
0.14
 
 
434,549
 
 
716
 
0.16
 
 
405,033
 
 
1,696
 
0.42
 
Interest-bearing demand accounts
 
 
220,381
 
 
32
 
0.01
 
 
219,038
 
 
51
 
0.02
 
 
199,909
 
 
85
 
0.04
 
Certificates of deposit
 
 
713,043
 
 
7,537
 
1.06
 
 
954,047
 
 
13,825
 
1.45
 
 
1,069,708
 
 
17,709
 
1.66
 
Total deposit liabilities
 
 
1,638,669
 
 
8,325
 
0.51
 
 
1,824,889
 
 
14,655
 
0.80
 
 
1,887,294
 
 
19,568
 
1.04
 
Advance payment by borrowers for
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
taxes and insurance
 
 
21,881
 
 
2
 
0.01
 
 
21,141
 
 
2
 
0.01
 
 
19,551
 
 
5
 
0.03
 
Borrowings
 
 
207,404
 
 
4,785
 
2.31
 
 
227,573
 
 
6,984
 
3.07
 
 
156,521
 
 
7,183
 
4.59
 
Total interest-bearing liabilities
 
 
1,867,954
 
 
13,112
 
0.70
 
 
2,073,603
 
 
21,641
 
1.04
 
 
2,063,366
 
 
26,756
 
1.30
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing deposits
 
 
122,677
 
 
 
 
 
 
 
130,734
 
 
 
 
 
 
 
110,784
 
 
 
 
 
 
Other non-interest-bearing liabilities
 
 
96,215
 
 
 
 
 
 
 
35,208
 
 
 
 
 
 
 
79,314
 
 
 
 
 
 
Total non-interest-bearing liabilities
 
 
218,892
 
 
 
 
 
 
 
165,942
 
 
 
 
 
 
 
190,098
 
 
 
 
 
 
Total liabilities
 
 
2,086,846
 
 
 
 
 
 
 
2,239,545
 
 
 
 
 
 
 
2,253,464
 
 
 
 
 
 
Total equity
 
 
274,764
 
 
 
 
 
 
 
270,600
 
 
 
 
 
 
 
290,499
 
 
 
 
 
 
Total average liabilities and equity
 
$
2,361,610
 
 
 
 
 
 
$
2,510,145
 
 
 
 
 
 
$
2,543,963
 
 
 
 
 
 
Net interest income and net interest
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
rate spread
 
 
 
 
$
66,344
 
3.02
%
 
 
 
$
61,381
 
2.57
%
 
 
 
$
62,589
 
2.64
%
Net interest margin
 
 
 
 
 
 
 
3.11
%
 
 
 
 
 
 
2.67
%
 
 
 
 
 
 
2.76
%
Average interest-earning assets to
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
interest-bearing liabilities
 
 
1.14x
 
 
 
 
 
 
 
1.11x
 
 
 
 
 
 
 
1.10x
 
 
 
 
 
 
 
(1) For the purposes of these computations, non-accruing loans and loans held-for-sale are included in the average loans outstanding.
(2) FHLB of Chicago stock is included in investment securities.
 
 
33

 
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.
 
 
 
Year Ended December 31, 2013,
 
 
 
Compared to Year Ended December 31, 2012
 
 
 
Increase (Decrease)
 
 
 
Volume
 
Rate
 
Net
 
 
 
(Dollars in thousands)
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
Loans receivable
 
$
1,989
 
$
(2,829)
 
$
(840)
 
Mortgage-related securities
 
 
(3,843)
 
 
1,200
 
 
(2,643)
 
Investment securities
 
 
(48)
 
 
29
 
 
(19)
 
Interest-earning deposits
 
 
(48)
 
 
(16)
 
 
(64)
 
Total interest-earning assets
 
 
(1,950)
 
 
(1,616)
 
 
(3,566)
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
Savings deposits
 
 
(1)
 
 
 
 
(1)
 
Money market deposits
 
 
67
 
 
(89)
 
 
(22)
 
Interest-bearing demand deposits
 
 
 
 
(19)
 
 
(19)
 
Certificates of deposit
 
 
(3,040)
 
 
(3,248)
 
 
(6,288)
 
Advance payment by borrowers for taxes and insurance
 
 
 
 
 
 
 
Borrowings
 
 
(579)
 
 
(1,620)
 
 
(2,199)
 
Total interest-bearing liabilities
 
 
(3,553)
 
 
(4,976)
 
 
(8,529)
 
Net change in net interest income
 
$
1,603
 
$
3,360
 
$
4,963
 
 
 
 
Year Ended December 31, 2012,
 
 
 
Compared to Year Ended December 31, 2011
 
 
 
Increase (Decrease)
 
 
 
Volume
 
Rate
 
Net
 
 
 
(Dollars in thousands)
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
Loans receivable
 
$
1,084
 
$
(5,542)
 
$
(4,458)
 
Mortgage-related securities
 
 
3,129
 
 
(2,194)
 
 
935
 
Investment securities
 
 
(1,395)
 
 
(1,409)
 
 
(2,804)
 
Interest-earning deposits
 
 
13
 
 
(9)
 
 
4
 
Total interest-earning assets
 
 
2,831
 
 
(9,154)
 
 
(6,323)
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
Savings deposits
 
 
6
 
 
(21)
 
 
(15)
 
Money market deposits
 
 
116
 
 
(1,096)
 
 
(980)
 
Interest-bearing demand deposits
 
 
7
 
 
(41)
 
 
(34)
 
Certificates of deposit
 
 
(1,808)
 
 
(2,076)
 
 
(3,884)
 
Advance payment by borrowers for taxes and insurance
 
 
 
 
(3)
 
 
(3)
 
Borrowings
 
 
2,637
 
 
(2,836)
 
 
(199)
 
Total interest-bearing liabilities
 
 
958
 
 
(6,073)
 
 
(5,115)
 
Net change in net interest income
 
$
1,873
 
$
(3,081)
 
$
(1,208)
 
 
Provision for Loan Losses The Company’s provision for loan losses was $4.5 million, $4.5 million, and $6.7 million during the years ended December 31, 2013, 2012, and 2011, respectively. The Company’s provision in 2013 was due largely to increases in general loan loss allowances related to growth in its multi-family, commercial real estate, and commercial business loan portfolios, as well as an increase in classified loans during the period, as described in “Financial Condition—Asset Quality,” below. In contrast, the provision in 2012 was influenced by $6.3 million in specific loan loss allowances on a number of multi-family, commercial real estate, and business loan relationships, as well as residential and other consumer loans. The losses on these loans were based on updated independent appraisals and/or internal management evaluations of the collateral that secures the loan, as well as management’s knowledge of current market conditions. These losses were partially offset by $1.8 million in loss recaptures related to certain non-performing loans that paid off in 2012, as well as recoveries related to previously charged-off loans.
 
 
34

 
In 2011 the Company recorded $11.8 million in loss provisions against a number of larger multi-family, commercial real estate, and business loan relationships, as well as certain smaller residential and other consumer loans. The losses on these loans were based on updated independent appraisals and/or internal management evaluations of the collateral that secures the loan, as well as management’s knowledge of current market conditions. In addition, during 2011 the Company recorded approximately $2.4 million in additional loss provisions that reflected management’s general concerns at the time related to continued economic weakness, elevated levels of unemployment, depressed real estate values, and the internal downgrades of certain loans. These developments were partially offset by $7.5 million in loss recaptures on loans that were paid-off during the period, were upgraded to performing status, or improved in performance and/or prospects.
 
General economic, employment, and real estate conditions continue to improve in the Company’s markets, although at a relatively slow pace. However, current conditions continue to be challenging for certain borrowers, particularly those whose loans are secured by commercial real estate or land. As such, there can be no assurances that non-performing loans will continue to trend lower in future periods or that the Company’s provision for loan losses will not vary considerably in future periods. Refer also to “Item 1. Business—Asset Quality,” above, for additional discussion related to the Company’s policies and procedures related to its provision for loan losses, allowance for loan losses, and asset quality.
 
Non-Interest Income Total non-interest income for the years ended December 31, 2013, 2012, and 2011, was $26.1 million, $29.3 million, and $23.2 million, respectively. The following paragraphs discuss the principal components of non-interest income and primary reasons for their changes from 2012 to 2013, as well as 2011 to 2012.
 
Service charges on deposits were $6.8 million, $6.9 million, and $6.4 million in 2013, 2012, and 2011, respectively. Management attributes the decrease in 2013 to relatively slow economic growth in recent years which has impacted customer spending patterns and has resulted in lower revenue from overdraft charges. Despite recent declines, management anticipates modest growth in this revenue item in 2014, although there can be no assurances.
 
Management attributes the increase in service charges on deposits in 2012 to an increase in the Company’s average checking accounts during that year. In addition, enhancements in 2011 and 2012 in the Company’s commercial deposit products and services generated increased fee revenue in 2012 compared 2011, particularly related to treasury management services. Improvements in fee revenue from treasury management services continued in 2013, but such were offset by the impact of lower revenue from overdraft charges, as previously noted.
 
Brokerage and insurance commissions were $3.1 million, $3.0 million, and $2.8 million for the years ended December 31, 2013, 2012, and 2011, respectively. 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. Commission revenue in 2013 and 2012 benefited from a lower interest rate environment that encouraged customers to purchase tax-deferred annuities due to higher returns compared to deposit-related products. Commission revenue in 2013 also benefited from favorable trends in equity markets, which resulted in increased revenue from sales of mutual funds and other equity investments relative to 2012.
 
Net loan-related fees and servicing revenue was $3.3 million in 2013 compared to a loss of $1.9 million and $402,000 in 2012 and 2011, respectively. The following table presents the primary components of net loan-related fees and servicing revenue for the periods indicated:
 
 
 
Year Ended December 31
 
 
 
2013
 
2012
 
2011
 
 
 
(Dollars in thousands)
 
Gross servicing fees
 
$
2,885
 
$
2,826
 
$
2,718
 
MSR amortization
 
 
(2,809)
 
 
(3,904)
 
 
(2,747)
 
MSR valuation (loss) recovery
 
 
2,395
 
 
(1,528)
 
 
(862)
 
Loan servicing revenue, net
 
 
2,471
 
 
(2,606)
 
 
(891)
 
Other loan fee income
 
 
844
 
 
695
 
 
489
 
Loan-related fees and servicing revenue, net
 
$
3,315
 
$
(1,911)
 
$
(402)
 
 
 
35

 
The change in the valuation allowance that the Company maintains against its MSRs is recorded as a recovery or loss, as the case may be, in the period in which the change occurs. Higher market interest rates for residential loans in 2013 resulted in lower future prepayment expectations on the loans underlying the MSRs, which resulted in a decrease in the valuation allowance during the year. Higher rates in this period also resulted in lower MSR amortization in 2013 compared to 2012 due to a lower level of actual loan prepayments. In contrast, lower market interest rates in 2012 and 2011 resulted in higher future prepayment expectations and an increase in the valuation allowance during those years. In addition, lower market rates also resulted in higher MSR amortization in 2012 because of an increased level of actual loan prepayments in that year. As of December 31, 2013, the Company had a remaining valuation allowance of only $1,400 against MSRs with a book value of $8.7 million. As of the same date the Company serviced $1.1 billion in loans for third-party investors compared to similar amount at the end of 2012.
 
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 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, if any, as well as record reduced levels of MSR amortization expense. Alternatively, if interest rates decrease and/or prepayment expectations increase, the Company could record additional charges to earnings related to increases in the valuation allowance on MSRs. In addition, amortization expense could increase due to likely increases in loan prepayment activity. Lower interest rates also typically cause an increase in actual mortgage loan prepayment activity, which generally results in an increase in the amortization of MSRs.
 
Net gains on loan sales activities were $4.4 million, $13.2 million, and $6.0 million during the years ended December 31, 2013, 2012, and 2011, respectively. The Company’s policy is to sell substantially all of its fixed-rate, one- to four-family mortgage loan originations in the secondary market. During 2013, 2012, and 2011 sales of one- to four-family mortgage loans were $252.3 million, $454.6 million, and $292.7 million, respectively. Loan sales were lower in 2013 due to a generally higher level of market interest rates for one- to four-family mortgage loans during the year, which reduced the incentive for borrowers to refinance higher-rate loans into lower-rate loans during the period. Also contributing to the decrease in gains on sales of loans in 2013 was a decrease in the Company’s average gross profit margin on the sales of loans. In 2013 the average gross profit margin was 1.75% compared to 2.91% and 2.04% in 2012 and 2011, respectively. Management attributes this decline to the reduced burden that consumer demand placed on the loan production capacity of the mortgage banking industry as a whole, due to the increase in market interest rates in 2013, which caused gross profit margins to decrease. If market interest rates remain at their current level or trend higher, management anticipates that the Company’s gains on sales of loans will be substantially lower in 2014 than they were in the past three years.
 
Net gain on sales of investments in 2012 and 2011 was $543,000 and $1.1 million, respectively. The Company did not sell any securities in 2013. In 2012 the Company sold $20.4 million in mortgage-related securities to provide additional liquidity to fund the repayment of $100.0 million in borrowings from the FHLB of Chicago that matured in third quarter of that year. In 2011 the Company sold its remaining investment in a mutual fund that management did not expect would perform well in future periods.
 
The Company’s operating results in 2012 and 2011 included $400,000 and $389,000 in net OTTI charges, 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. The Company did not record any OTTI losses in 2013 and none of its private-label CMOs were deemed to be other-than-temporarily impaired as of December 31, 2013. 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 December 31, 2013, the Company’s total investment in private-label CMOs was $38.7 million, of which $28.8 million was rated less than investment grade. Refer to “Financial Condition—Available-for-Sale Securities,” below, for additional discussion.
 
Income from bank-owned life insurance (“BOLI”) was $2.4 million, $2.1 million, and $2.4 million for the years ended December 31, 2013, 2012, and 2011, respectively. Fluctuations in this revenue item in recent years have been primarily caused by the timing of excess death benefits that are received under the terms of the insurance contracts.
 
Other non-interest income was $6.1 million, $5.8 million, and $5.2 million for the years ended December 31, 2013, 2012, and 2011, respectively. Contributing to the increase in 2013 was an increase in fees generated from a debit card cash rewards program that the Company introduced to checking account customers during the year. Also contributing to the increase in both 2013 and 2012 were increases in the fair value of assets held in trust for certain non-qualifying employee benefit plans, due to the effects of changes in interest rates and equity markets.
 
 
36

 
Non-Interest Expense Total non-interest expense for the years ended December 31, 2013, 2012, and 2011 was $71.5 million, $76.1 million, and $124.9 million, respectively. Results in 2011 included a $52.6 million non-cash goodwill impairment recorded by the Company in the second quarter of that year. This impairment had no effect on the liquidity, operations, tangible capital, or regulatory capital of the Company or the Bank (for additional discussion refer to “Note 1. Basis of Presentation” of the Company’s consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data,” below). Excluding the goodwill impairment, total non-interest expense in 2013, 2012, and 2011 was $71.5 million, $76.1 million and $72.3 million, respectively. The following paragraphs discuss the principal components of non-interest expense and the primary reasons for their changes from 2012 to 2013, as well as 2011 to 2012.
 
Compensation and related expenses were $43.9 million, $42.3 million, and $38.8 million during the years ended December 31, 2013, 2012, and 2011, respectively. The increase in 2013 compared to 2012 was due primarily to annual merit increases, as well as increases in certain payroll taxes and pension-related costs. These developments were partially offset by a decline in commissions due to lower originations of single-family loans (as previously described), as well as a modest decline in employee healthcare costs due to a renegotiation of such costs with the insurance provider.
 
The increase in compensation and related expenses in 2012 compared to 2011 was due primarily to the Company’s hiring of certain senior management personnel, commercial relationship managers, and other key administrative personnel as a result of the Company’s efforts to enhance its commercial banking line of business. Also contributing was an increase due to annual merit increases and certain incentive and bonus payments, including stock based compensation. Finally, the increase in compensation-related expense in 2012 was also caused by an increase in costs related to the Company’s defined benefit pension plan, due to a decline in the discount rate used to determine the present value of the pension obligation.
 
Effective January 1, 2013, the Company’s board of directors closed the qualified defined benefit pension plan to employees not eligible to participate in the plan as of that date, as well as any employees hired after that date. In addition, effective for service performed after March 1, 2013, the Company’s board of directors reduced certain future benefits formerly provided under the plan, but did not reduce all future benefits at that time. However, effective January 1, 2014, the Company’s board of directors froze the benefits of participants in the qualified defined benefit pension plan who had less than 20 years of service. This change also resulted in the future benefits under the Company’s supplemental defined benefit pension plan being effectively frozen. The employees impacted by these changes will be eligible for enhanced employer contributions in the Company’s defined contribution savings plan in 2014 and future years. Although there can be no assurances, management estimates that these developments could result in a net cost savings of $1.4 million to $2.2 million in 2014 depending on the level of discretionary contributions, if any, the Company could make to the defined contribution savings plan. For additional discussion relating to the Company’s pension plans, refer to “Note 10. Employee Benefit Plans” of the Company’s consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data,” below. Finally, during 2013 the Company also implemented certain changes in the way in which employees earn vacation and other paid time off benefits after December 31, 2013. This change is expected to reduce the Company’s expense for compensated absences by approximately $1.3 million in 2014 compared to 2013.
 
As of December 31, 2013, the Company had 637 full-time associates and 85 part-time associates. This compared to 639 full-time and 81 part-time employees at December 31, 2012, and 648 full-time and 71 part-time associates at December 31, 2011.
 
Occupancy and equipment expense during the years ended December 31, 2013, 2012, and 2011 was $11.9 million, $11.4 million, and $11.5 million, respectively. The increase in 2013 was principally caused by increases in data processing costs, certain repairs and maintenance on the Company’s facilities, and snow removal costs earlier in 2013. The decrease in 2012 was principally caused by lower utility and snow removal costs due to a milder winter at the beginning of the year, reduced expenditures for maintenance and repair, and lower rental expense due to the closure of three leased banking offices. The impact of these developments was partially offset by an increase in data processing costs due to certain product and system enhancements implemented in 2012.
 
Federal insurance premiums were $1.9 million, $3.3 million, and $3.2 million during 2013, 2012, and 2011, respectively. The decrease in the 2013 was caused by improvements during the year in the Company’s financial condition and operating results. Under the FDIC’s risk-based premium assessment system, these improvements resulted in lower deposit insurance costs for the Company in 2013 compared to prior years (for additional information, refer to “Regulation and Supervision of the Bank—Deposit Insurance” in Item 1. Business—Regulation and Supervision,” above).
 
 
37

 
Advertising and marketing expenses were $1.8 million, $2.1 million, and $2.0 million in 2013, 2012, and 2011, respectively. The Company reduced its advertising and marketing expenses in 2013 in an effort to control the growth in its overall expenses. Management expects that advertising and marketing expenditures will continue to be managed in a manner consistent with recent periods. However, such expenditures depend on future management decisions and there can be no assurances that such expenditures will remain at the current level in the future.
 
Net losses and expenses on foreclosed properties were $2.3 million, $6.7 million, and $7.1 million during 2013, 2012, and 2011, respectively. The Company has experienced lower losses and expenses on foreclosed real estate in recent periods due to lower levels of foreclosed properties. Management expects this trend to continue in the near term, although there can be no assurances.
 
Other non-interest expense was $9.8 million, $10.2 million, and $9.7 million during the years ended December 31, 2013, 2012, and 2011, respectively. The decrease in 2013 was primarily caused by lower professional fees, due principally to reduced expenditures for loan workouts, as well as lower regulatory assessments related to the Company’s improved financial condition. The increase in 2012 was primarily caused by higher professional fees related to loan workouts.
 
Income Tax Expense Income tax expense was $5.7 million, $3.3 million, and $1.8 million in 2013, 2012, and 2011, respectively. Excluding the impact of the goodwill impairment in 2011 (which was not deductible for income tax purposes), the Company’s effective tax rate (“ETR”) in 2013, 2012, and 2011 was 34.7%, 33.2%, and 26.1%, respectively. The Company’s ETR will vary from period to period depending primarily on the impact of non-taxable revenue, such as tax-exempt interest income and earnings from BOLI. The ETR will generally be lower in periods in which non-taxable revenue comprises a larger portion of pre-tax income or loss, such as in 2011. For additional information related to the resolution of a matter related to the Company's income taxes in Wisconsin, refer to “Note 12. Income Taxes” of the Company’s consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data,” below.
 
Financial Condition
 
Overview The Company’s total assets decreased by $70.9 million or 2.9% during the twelve months ended December 31, 2013. During the period the Company’s mortgage-related securities available-for-sale declined by $103.6 million and its cash and cash equivalents declined by $44.6 million. Cash flow from these sources, as well as a $34.1 million increase in borrowings, funded a $106.8 million increase in the Company’s loan portfolio and a $105.2 million decrease in deposit liabilities during the year. The Company’s total shareholders’ equity increased from $271.9 million at December 31, 2012, to $281.0 million at December 31, 2013. Non-performing assets decreased from $39.8 million or 1.64% of total assets at December 31, 2012, to $19.7 million or 0.84% at December 31, 2013. The following paragraphs describe these changes in greater detail, as well as other changes in the Company’s financial condition during the twelve months ended December 31, 2013.
 
Cash and Cash Equivalents Cash and cash equivalents decreased from $87.1 million at December 31, 2012, to $42.5 million at December 31, 2013. 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 mortgage-related securities available-for-sale decreased by $103.6 million or 18.8% during the year ended December 31, 2013. This decrease was principally caused by periodic repayments that exceeded the Company’s purchase of new securities during the year.
 
 
38

 
The following table presents the carrying value of the Company’s mortgage-related securities available-for-sale at the dates indicated (carrying value is equal to fair value for all securities and for all periods presented):
 
 
 
December 31
 
 
 
2013
 
2012
 
2011
 
 
 
(Dollars in thousands)
 
Freddie Mac
 
$
228,873
 
$
343,682
 
$
548,944
 
Fannie Mae
 
 
179,021
 
 
155,895
 
 
170,020
 
Ginnie Mae
 
 
33
 
 
42
 
 
778
 
Private-label CMOs
 
 
38,669
 
 
50,566
 
 
62,028
 
Total
 
$
446,596
 
$
550,185
 
$
781,770
 
 
The following table presents the activity in the Company’s portfolio of mortgage-related securities available-for-sale for the periods indicated:
 
 
 
Year Ended December 31
 
 
 
2013
 
2012
 
2011
 
 
 
(Dollars in thousands)
 
Carrying value at beginning of period
 
$
550,185
 
$
781,770
 
$
435,234
 
Purchases
 
 
88,094
 
 
51,374
 
 
507,052
 
Sales
 
 
 
 
(20,395)
 
 
 
Principal repayments
 
 
(186,674)
 
 
(260,953)
 
 
(167,587)
 
Premium amortization, net
 
 
(1,460)
 
 
(4,152)
 
 
(3,922)
 
Other-than-temporary impairment
 
 
 
 
(400)
 
 
(389)
 
Increase (decrease) in net unrealized gain or loss
 
 
(3,549)
 
 
2,941
 
 
11,383
 
Net increase (decrease)
 
 
(103,589)
 
 
(231,585)
 
 
346,536
 
Carrying value at end of period
 
$
446,596
 
$
550,185
 
$
781,770
 
 
The table below presents information regarding the carrying values, weighted-average yields, and contractual maturities of the Company’s mortgage-related securities available-for-sale at December 31, 2013:
 
 
 
 
 
 
 
 
 
More Than One Year
 
 
More Than Five
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One Year or Less
 
 
to Five Years
 
 
Years to Ten Years
 
 
More Than Ten Years
 
 
Total
 
 
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
Carrying
 
Average
 
 
Carrying
 
Average
 
 
Carrying
 
Average
 
 
Carrying
 
Average
 
 
Carrying
 
Average
 
 
 
Value
 
Yield
 
 
Value
 
Yield
 
 
Value
 
Yield
 
 
Value
 
Yield
 
 
Value
 
Yield
 
 
 
(Dollars in thousands)
 
Securities by issuer and type:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac, Fannie Mae,
     and Ginnie Mae MBSs
 
$
166
 
7.01
%
 
$
232
 
 
6.84
%
 
$
102,472
 
 
2.15
%
 
$
34
 
 
6.70
%
 
$
102,904
 
 
2.17
%
Freddie Mac and Fannie
     Mae CMOs
 
 
 
 
 
 
3,997
 
 
1.49
 
 
 
46,827
 
 
2.54
 
 
 
254,201
 
 
2.39
 
 
 
305,025
 
 
2.40
 
Private-label CMOs