10-K 1 mda2011c.htm 10-K FORM 10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

__________


FORM 10-K


T

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.


For the fiscal year ended December 31, 2011


£

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.


For the transition period from ............................... to...............................


Commission file number:  0-18542

MID-WISCONSIN FINANCIAL SERVICES, INC.

(Exact name of registrant as specified in its charter)


WISCONSIN

06-1169935

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)


132 West State Street

Medford, Wisconsin 54451

(Address of principal executive offices)  (Zip code)

Registrant's telephone number, including area code:  (715) 748-8300


Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:


$0.10 Par Value Common Stock

(Title of Class)


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  £

No  T


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  T


Indicate by check 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  T               No  £


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

  

      Yes  T

No  £


Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) 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.    S


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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   £       

                                      Accelerated filer                   £        

Non-accelerated filer     £(Do not check if a smaller reporting company) Smaller reporting company  S        

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

                                                                       Yes  £

        No  S


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As of June 30, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter) the aggregate market value of the voting and non-voting equity held by non-affiliates of the registrant was approximately $12,253,000 based upon a price per share of $8.00.  


As of March 1, 2012, there were 1,657,119 shares of $0.10 par value common stock were outstanding.  

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Document

Part of Form 10-K Into Which

 

       Proxy Statement for Annual Meeting of

         Portions of Documents Are Incorporated

Shareholders on April 24, 2012

Part III


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MID-WISCONSIN FINANCIAL SERVICES, INC.


2011 FORM 10-K TABLE OF CONTENTS



                                                                 

                     

                                            

PART I

 

 

Page

 

ITEM 1.

Business

4

 

ITEM 1A.

Risk Factors

16

 

ITEM 1B.

Unresolved Staff Comments

23

 

ITEM 2.

Properties

23

 

ITEM 3.

Legal Proceedings

24

 

ITEM 4.

Mine Safety Disclosures

24

 

 

 

 

PART II

 

 

 

 

ITEM 5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

24

 

ITEM 6.

Selected Financial Data

26

 

ITEM 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

27

 

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

56

 

ITEM 8.

Financial Statements and Supplementary Data

58

 

ITEM 9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

98

 

ITEM 9A

Controls and Procedures

98

 

ITEM 9B.

Other Information

98

 

 

 

 

PART III

 

 

 

 

ITEM 10.

Directors, Executive Officers and Corporate Governance

98

 

ITEM 11.

Executive Compensation

99

 

ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

99

 

ITEM 13.

Certain Relationships and Related Transactions, and Director Independence

99

 

ITEM 14.

Principal Accountant Fees and Services

99

 

 

 

 

PART IV

 

 

 

 

ITEM 15.

Exhibits and Financial Statement Schedules

100

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Special Note Regarding Forward-Looking Statements


This Annual Report on Form 10-K, including “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains forward-looking statements as defined in The Private Securities Litigation Reform Act of 1995, that involve risks, uncertainties, and assumptions.  Forward-looking statements are based on current management expectations and are not guarantees of future performance, nor should they be relied upon as representing management’s view as of any subsequent date. If the risks or uncertainties ever materialize or the assumptions prove incorrect, our results may differ materially from those presented, either expressed or implied, in this filing.  All statements other than statements of historical fact are statements that could be deemed forward-looking statements.  Forward-looking statements may be identified by, among other things, expressions of beliefs or expectations that certain events may occur or are anticipated, and projections or statements of expectations.  Such forward-looking statements include, without limitation, statements regarding expected financial and operating

activities and results that are preceded by, followed by, or that include words such as “will,” “expect,” “anticipate,” “estimate,”  “plan,”  “believe,” “should,” “intend,” or similar expressions.  Such statements are subject to important factors that could cause our actual results to differ materially from those anticipated by the forward-looking statements. These factors, many of which are beyond our control, include the following:

·

operating, legal and regulatory risks, including the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations promulgated thereunder;

·

economic, political and competitive forces affecting our banking and wealth management businesses;

·

changes in monetary policy and general economic conditions, which may impact our net interest income;

·

the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful;

·

other factors discussed under Item 1A, “Risk Factors” and elsewhere herein, and from time to time in our other filings with the Securities and Exchange Commission after the date of this report.

These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. We specifically disclaim any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.


PART I

ITEM 1.  BUSINESS


General

Our subsidiary operates under the name Mid-Wisconsin Bank (the “Bank”) and has its principal office in Medford, Wisconsin. We are a Wisconsin corporation organized in 1986 and, as the sole shareholder of the Bank, are a bank holding company registered with, and subject to, regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  This Annual Report on Form 10-K describes our business and that of the Bank in effect on December 31, 2011, and any reference to the “Company” refers to Mid-Wisconsin Financial Services, Inc. or the consolidated operations of Mid-Wisconsin Financial Services, Inc. and the Bank, as the context requires.

 

The Bank

The Bank was incorporated on September 1, 1890, as a state bank under the laws of Wisconsin.  The Bank operates thirteen retail banking locations throughout North Central Wisconsin serving markets in Clark, Eau Claire, Lincoln, Marathon, Oneida, Price, Taylor and Vilas counties.


The day-to-day management of the Bank rests with its officers with oversight provided by the board of directors.  The Bank is engaged in general commercial and retail banking services, including wealth management services.  The Bank serves individuals, businesses and governmental units and offers most forms of commercial and consumer lending, including lines of credit, term loans, real estate financing, mortgage lending and agricultural lending.  In addition, the Bank provides a full range of personal banking services, including checking accounts, savings and time products, installment and other personal loans, as well as mortgage loans.  To expand services to its customers on a 24-hour basis, the Bank offers ATM services, merchant capture, cash management, express phone, online and mobile banking. New services are frequently added.


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The Wealth Management area consists of two delivery methods of providing financial products and services to assist customers in building, investing, or protecting their wealth.  Through its state granted trust powers, Wealth Management provides fiduciary, administrative, and investment management services to personal trusts, estates, individuals, businesses, non-profits, and foundations for an asset based fee.  Through a third-party broker/dealer, LPL Financial, Member FINRA/SIPC, a registered broker/dealer, Wealth Management makes available a variety of retail investment and insurance products including equities, bonds, fixed and variable annuities, mutual funds, life insurance, long-term care insurance and brokered certificates of deposits, which are commission-based transactions. 


All of our products and services are directly or indirectly related to the business of community banking and all activity is reported as one segment of operations.  All revenue, profit and loss, and total assets are reported in one segment and represent our entire operations.


Employees

As of December 31, 2011, we employed 150 full-time equivalent employees.  None of our employees are represented by unions. We consider the relationship with our employees to be good.


Competition

The Bank competes for loans, deposits and financial services in all of its principal markets.  Much of this competition comes from companies which are larger and have greater resources.  The Bank competes directly with other banks, savings associations, credit unions, finance companies, mutual funds, life insurance companies, and other financial and non-financial companies.  


SUPERVISION AND REGULATION

General.

Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law.  As a result, the growth and earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also by requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Wisconsin Department of Financial Institutions (the “WDFI”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”),  the Federal Deposit Insurance Corporation (the “FDIC”) and the newly-created Bureau of Consumer Financial Protection (the “Bureau”).  Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed by the Financial Accounting Standards Board (the “FASB”) and securities laws administered by the Securities and Exchange Commission (the “SEC”) and state securities authorities have an impact on the business of the Company. The effect of these statutes, regulations, regulatory policies and accounting rules are significant to the operations and results of the Company and Bank, and the nature and extent of future legislative, regulatory or other changes affecting financial institutions are impossible to predict with any certainty.

Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of financial institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than shareholders.  These federal and state laws, and the regulations of the bank regulatory authorities issued under them, affect, among other things, the scope of business, the kinds and amounts of investments banks may make, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, the ability to merge, consolidate and acquire, dealings with insiders and affiliates and the payment of dividends.   In addition, turmoil in the credit markets in recent years prompted the enactment of unprecedented legislation that allowed the U.S. Department of the Treasury (“Treasury”) to make equity capital available to qualifying financial institutions to help restore confidence and stability in the U.S. financial markets, which imposes additional requirements on institutions in which Treasury invests.

In addition, the Company and Bank are subject to regular examination by their respective regulatory authorities, which results in examination reports and ratings (that are not publicly available) that can impact the conduct and growth of business. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are

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unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.  

The following is a summary of the material elements of the supervisory and regulatory framework applicable to the Company and the Bank.  It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described.  The descriptions are qualified in their entirety by reference to the particular statutory or regulatory provision.

Financial Regulatory Reform.

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law.  The Dodd-Frank Act represents a sweeping reform of the supervisory and regulatory framework applicable to financial institutions and capital markets in the United States, certain aspects of which are described below in more detail. The Dodd-Frank Act creates new federal governmental entities responsible for overseeing different aspects of the U.S. financial services industry, including identifying emerging systemic risks. It also shifts certain authorities and responsibilities among federal financial institution regulators, including the supervision of holding company affiliates and the regulation of consumer financial services and products. In particular, and among other things, the Dodd-Frank Act: creates a Bureau of Consumer Financial Protection authorized to regulate providers of consumer credit, savings, payment and other consumer financial products and services; narrows the scope of federal preemption of state consumer laws enjoyed by national banks and federal savings associations and expands the authority of state attorneys general to bring actions to enforce federal consumer protection legislation; imposes more stringent capital requirements on bank holding companies and subjects certain activities, including interstate mergers and acquisitions, to heightened capital conditions; significantly expands underwriting requirements applicable to loans secured by 1-4 family residential real property; restricts the interchange fees payable on debit card transactions for issuers with $10 billion in assets or greater; requires the originator of a securitized loan, or the sponsor of a securitization, to retain at least 5% of the credit risk of securitized exposures unless the underlying exposures are qualified residential mortgages or meet certain underwriting standards to be determined by regulation; creates a Financial Stability Oversight Council as part of a regulatory structure for identifying emerging systemic risks and improving interagency cooperation; provides for enhanced regulation of advisers to private funds and of the derivatives markets; enhances oversight of credit rating agencies; and prohibits banking agency requirements tied to credit ratings.

Numerous provisions of the Dodd-Frank Act are required to be implemented through rulemaking by the appropriate federal regulatory agencies.  Some of the required regulations have been issued and some have been released for public comment, but many have yet to be released in any form.  Furthermore, while the reforms primarily target systemically important financial service providers, their influence is expected to filter down in varying degrees to smaller institutions over time. Management of the Company and Bank will continue to evaluate the effect of the changes; however, in many respects, the ultimate impact of the Dodd-Frank Act will not be fully known for years, and no current assurance may be given that the Dodd-Frank Act, or any other new legislative changes, will not have a negative impact on the results of operations and financial condition of the Company and the Bank.  

The Increasing Importance of Capital.  

While capital has historically been one of the key measures of the financial health of both holding companies and depository institutions, its role is becoming fundamentally more important in the wake of the financial crisis. Not only will capital requirements increase, but the type of instruments that constitute capital will also change, and, as a result of the Dodd-Frank Act, after a phase-in period, bank holding companies will have to hold capital under rules as stringent as those for insured depository institutions.  Moreover, the actions of the international Basel Committee on Banking Supervision, a committee of central banks and bank supervisors, to reassess the nature and uses of capital in connection with an initiative called “Basel III,” discussed below, will have a significant impact on the capital requirements applicable to U.S. bank holding companies and depository institutions.


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Required Capital Levels.

The Dodd-Frank Act mandates the Federal Reserve to establish minimum capital levels for bank holding companies on a consolidated basis that are as stringent as those required for insured depository institutions.  The components of Tier 1 capital will be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  As a result, the proceeds of trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank holding companies with less than $15 billion of assets. As the Company has assets of less than $15 billion, it will be able to maintain its trust preferred proceeds as capital but it will have to comply with new capital mandates in other respects, and it will not be able to raise Tier 1 capital in the future through the issuance of trust preferred securities.

Under current federal regulations, the Bank is subject to, and, after a phase-in period, the Company will be subject to, the following minimum capital standards: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%.  For this purpose, Tier 1 capital consists primarily of common stock, noncumulative perpetual preferred stock and related surplus less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus Tier 2 capital, which includes other nonpermanent capital items such as certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the Bank’s allowance for loan and lease losses.  

The capital requirements described above are minimum requirements.  Federal law and regulations provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is “well-capitalized” may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities may qualify for expedited processing of other required notices or applications and may accept brokered deposits.  Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company (see “--Acquisitions, Activities and Changes in Control” below) is a requirement that all of its depository institution subsidiaries be “well-capitalized.”  Under the Dodd-Frank Act, that requirement is extended such that, as of July 21, 2011, bank holding companies, as well as their depository institution subsidiaries, had to be well-capitalized in order to operate as financial holding companies.  Under the capital regulations of the Federal Reserve, in order to be “well-capitalized” a banking organization must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.

Higher capital levels may also be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.  Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels.  See “– The Bank – Regulatory Proceedings Against the Bank” for a discussion regarding the heightened capital requirements which the Bank has agreed to maintain.

It is important to note that certain provisions of the Dodd-Frank Act and Basel III, discussed below, will ultimately establish strengthened capital standards for banks and bank holding companies, will require more capital to be held in the form of common stock and will disallow certain funds from being included in a Tier 1 capital determination.  Once fully implemented, these provisions may represent regulatory capital requirements which are meaningfully more stringent than those outlined above.

Prompt Corrective Action.

A banking organization’s capital plays an important role in connection with regulatory enforcement as well.  Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions.  The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation.  Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring

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the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.

As of December 31, 2011, the Bank exceeded its minimum regulatory capital requirements under Federal Reserve capital adequacy guidelines, as well as the heightened capital requirements that it has agreed to maintain with the FDIC and WDFI (as described under “– The Bank – Regulatory Proceedings Against the Bank”).  As of December 31, 2011, the Company had regulatory capital in excess of the Federal Reserve’s requirements and met the Dodd-Frank Act capital requirements.

Basel III.

The current risk-based capital guidelines that apply to the Bank and will apply to the Company are based upon the 1988 capital accord of the international Basel Committee on Banking Supervision, a committee of central banks and bank supervisors, as implemented by the U.S. federal banking agencies on an interagency basis.  In 2008, the banking agencies collaboratively began to phase-in capital standards based on a second capital accord, referred to as “Basel II,” for large or “core” international banks (generally defined for U.S. purposes as having total assets of $250 billion or more or consolidated foreign exposures of $10 billion or more).  Basel II emphasized internal assessment of credit, market and operational risk, as well as supervisory assessment and market discipline in determining minimum capital requirements.

On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced agreement to a strengthened set of capital requirements for banking organizations in the United States and around the world, known as Basel III.  The agreement is currently supported by the U.S. federal banking agencies.  As agreed to, Basel III is intended to be fully-phased in on a global basis on January 1, 2019.  Basel III requires, among other things: (i) a new required ratio of minimum common equity equal to 7% of total assets (4.5% plus a capital conservation buffer of 2.5%); (ii) an increase in the minimum required amount of Tier 1 capital from the current level of 4% of total assets to 6% of total assets; (iii) an increase in the minimum required amount of total capital, from the current level of 8% to 10.5% (including 2.5% attributable to the capital conservation buffer).  The purpose of the conservation buffer (to be phased in from January 2016 until January 1, 2019) is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. There will also be a required countercyclical buffer to achieve the broader goal of protecting the banking sector from periods of excess aggregate credit growth. 

Pursuant to Basel III, certain deductions and prudential filters, including minority interests in financial institutions, mortgage servicing rights and deferred tax assets from timing differences, would be deducted in increasing percentages beginning January 1, 2014, and would be fully deducted from common equity by January 1, 2018.  Certain instruments that no longer qualify as Tier 1 capital, such as trust preferred securities, also would be subject to phase-out over a 10-year period beginning January 1, 2013.

The Basel III agreement calls for national jurisdictions to implement the new requirements beginning January 1, 2013.  At that time, the U.S. federal banking agencies, including the Federal Reserve, will be expected to have implemented appropriate changes to incorporate the Basel III concepts into U.S. capital adequacy standards. 

The Company

General.

The Company, as the sole shareholder of the Bank, is a bank holding company.  As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  In accordance with Federal Reserve policy, and as now codified by the Dodd-Frank Act, the Company is legally obligated to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not otherwise do so.  Under the BHCA, the Company is subject to periodic examination by the Federal Reserve.  The Company is required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require.  

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Regulatory Proceedings Against the Company.

On May 10, 2011, the Company entered into a formal written agreement (the “Company Agreement”) with the Federal Reserve to help ensure the financial soundness of the Company and the Bank.  Pursuant to the Company Agreement, the Company has agreed to take certain actions and operate in compliance with the Company Agreement's provisions during its terms. Specifically, under the terms of the Company Agreement, the Company is required to: (i) ensure the Bank complies with the Agreement; (ii) refrain from (x) declaring or paying any dividend on its capital stock, (y) taking any dividend from the Bank, or (z) making any distributions on its subordinated debentures or the trust preferred securities related thereto issued by its nonbank subsidiary, each without the written consent of the Federal Reserve; (iii) refrain from incurring, increasing or guaranteeing any debt without the written consent of the Federal Reserve; (iv) refrain from purchasing or redeeming any shares of its capital stock without the written consent of the Federal Reserve; and (v) develop certain plans and projections with respect to its capital levels and cash flows, all as described in more detail in the Company Agreement.

While the Company’s board of directors and management team have assigned great importance to complying with the terms of the Company Agreement, and believe they have taken or commenced the steps necessary to resolve any and all matters presented therein, the Fed could take further enforcement actions if it is not satisfied with the actions taken by the Company.  A copy of the Company Agreement was filed as a part of the Company’s Quarterly Report on Form 10-Q filed on May 13, 2011 with the SEC.

Acquisitions, Activities and Change in Control.

The primary purpose of a bank holding company is to control and manage banks.  The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company.  Subject to certain conditions (including deposit concentration limits established by the BHCA and the Dodd-Frank Act), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.  Furthermore, in accordance with the Dodd-Frank Act, as of July 21, 2011, bank holding companies must be well-capitalized in order to effect interstate mergers or acquisitions.  For a discussion of the capital requirements, see “—The Increasing Importance of Capital” above.

The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries.  This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.”  This authority would permit the Company to engage in a variety of banking-related businesses, including the ownership and operation of a savings association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of nonbank subsidiaries of bank holding companies.

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.  As of the date of this filing, the Company has not applied for approval to operate as a financial holding company.

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Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator.  “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership.  

Capital Requirements.

Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines, as affected by the Dodd-Frank Act and Basel III.  For a discussion of capital requirements, see “—The Increasing Importance of Capital” above.

Emergency Economic Stabilization Act of 2008.

Events in the U.S. and global financial markets over the past several years, including deterioration of the worldwide credit markets, created significant challenges for financial institutions throughout the country.  In response to this crisis affecting the U.S. banking system and financial markets, on October 3, 2008, the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (the “EESA”).  The EESA authorized the Secretary of the Treasury to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions and stimulate the availability of credit within the U.S. financial system.  Financial institutions participating in certain of the programs established under the EESA are required to adopt Treasury’s standards for executive compensation and corporate governance.  

The TARP Capital Purchase Program.

On October 14, 2008, Treasury announced that it would provide Tier 1 capital (in the form of perpetual preferred stock) to eligible financial institutions.  This program, known as the TARP Capital Purchase Program (the “CPP”), allocated $250 billion from the $700 billion authorized by the EESA to Treasury for the purchase of senior preferred shares from qualifying financial institutions (the “CPP Preferred Stock”).  Under the program, eligible institutions were able to sell equity interests to the Treasury in amounts equal to between 1% and 3% of the institution’s risk-weighted assets.  The CPP Preferred Stock is nonvoting and pays dividends at the rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum.  In conjunction with the purchase of the CPP Preferred Stock, the Treasury received warrants to purchase common stock with an aggregate market price equal to 15% of the investment from participating institutions with an established trading market, and warrants to purchase shares of an additional series of CPP Preferred Stock with a liquidation preference equal to 5% of the aggregate investment from participating institutions without an established trading market.  Participating financial institutions were required to adopt Treasury’s standards for executive compensation and corporate governance for the period during which Treasury holds equity issued under the CPP.  These requirements are discussed in more detail in the Executive Officer Compensation section in the Company’s proxy statement, which is incorporated by reference in this Form 10-K.

Pursuant to the CPP, on February 20, 2009, the Company entered into a Letter Agreement with Treasury, pursuant to which the Company issued (i) 10,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), and (ii) a warrant to purchase 500 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock” and together with the Series A Preferred Stock, the “TARP Preferred Stock”), which were immediately exercised, for an aggregate purchase price of $10,000,000 in cash.  Although the Company is a public company, an established trading market for its stock does not exist, and therefore it was required to issue Treasury a warrant for additional CPP Preferred Stock rather than common stock. The Company’s federal regulators, the Treasury and the Treasury’s Office of the Inspector General maintain significant oversight over the Company as a participating institution, to evaluate how it is using the capital provided and to ensure that it strengthens its efforts to help its borrowers avoid foreclosure, which is one of the core aspects of the EESA.  

Dividend Payments.

The Company’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies.  As a Wisconsin corporation, the Company is subject to the limitations of the Wisconsin Business Corporation Law, which prohibit the Company from paying dividends if such payment would (i) render the Company unable to pay its debts as they become due in the usual course of business, or (ii) result in the Company’s assets being less than the sum of its total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of any

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shareholders with preferential rights superior to those shareholders receiving the dividend.  Consistent with the “source of strength” policy for subsidiary banks, the Federal Reserve has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the corporation’s capital needs, asset quality and overall financial condition.  The Federal Reserve also possesses enforcement powers over bank holding companies and their nonbank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.  Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.  As described under “—Regulatory Proceedings Against the Company,” on May 10, 2011 the Company entered into the Company Agreement with the Federal Reserve, pursuant to which the Company agreed to refrain from declaring or paying any dividend on its capital stock and making any distributions on its subordinated debentures or the trust preferred securities related thereto without the written consent of the Federal Reserve.

Furthermore, the Company’s ability to pay dividends on its common stock is restricted by the terms of certain of its other securities.  For example, under the terms of certain of the Company’s junior subordinated debentures, it may not pay dividends on its capital stock unless all accrued and unpaid interest payments on the subordinated debentures have been fully paid.  Additionally, the terms of the TARP Preferred Stock provide that no dividends on any common or preferred stock that ranks equal to or junior to the TARP Preferred Stock may be paid unless and until all accrued and unpaid dividends for all past dividend periods on the TARP Preferred Stock have been fully paid.  On May 12, 2012, in consultation with the Federal Reserve, the Company elected to begin deferring the interest payments due on its junior subordinated debentures, as well as the dividend payments due on the TARP Preferred Stock, and therefore may not pay common stock dividends until such time as these deferred payments have been made in full.

Federal Securities Regulation.

The Company’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

Corporate Governance.

The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies.  The Dodd-Frank Act will increase shareholder influence over boards of directors by requiring companies to give shareholders a nonbinding vote on executive compensation and so-called “golden parachute” payments, and authorizing the SEC to promulgate rules that would allow shareholders to nominate and solicit voters for their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.

The Bank

General.

The Bank is a Wisconsin-chartered bank, the deposit accounts of which are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations.  As a Wisconsin-chartered, FDIC-insured, nonmember bank, the Bank is presently subject to the examination, supervision, reporting and enforcement requirements of the WDFI, the chartering authority for Wisconsin banks, and the FDIC, designated by federal law as the primary federal regulator of insured state banks that, like the Bank, are not members of the Federal Reserve System.

Regulatory Proceedings Against the Bank.

On November 9, 2010, the Bank entered into a formal written agreement (the “Agreement”) with the FDIC and WDFI.  Pursuant to the Agreement, the Bank agreed to take certain actions and operate in compliance with the Agreement’s provisions during its terms. The Agreement is based on the results of an annual examination of the Bank by the FDIC and WDFI and addresses certain matters that, in the view of the FDIC and WDFI, may impact the Bank’s overall safety and soundness. Specifically, under the terms of the Agreement, the Bank is required to, among other things: (i) maintain ratios of Tier 1 capital to each of total assets and total risk-weighted assets of at least 8.5% and 12%, respectively; (ii) refrain from declaring or paying any dividend without the written consent of the FDIC and WDFI; (iii) refrain from increasing its total assets by more than 5%

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during any three-month period without first submitting a growth plan to the FDIC and WDFI; (iv) develop and maintain a number of plans, policies and procedures, including, but not limited to, a management plan, a liquidity plan, and a strategic plan; and (v) take certain actions related to its loan portfolio and budgeting process, such as reducing the level of certain classified assets, reviewing (and, if necessary, adjusting) its allowance for loan losses, refraining from extending additional loans to certain classified borrowers, and revising certain of its budgets.

The Bank’s board of directors and management team have assigned great importance to complying with the terms of the Agreement, and believe they have taken or commenced the steps necessary to resolve any and all matters presented therein.  Further, as of December 31, 2011, the Bank’s ratio of Tier 1 capital to each of total assets and total risk-weighted assets was 8.7% and 14.2%, respectively, exceeding the ratios required under the Agreement.  Additionally, in accordance with the Agreement, the Bank has refrained from declaring dividends, taken measures to monitor and limit its growth, and provided various periodic progress reports to the FDIC and WDFI.

While management and the board of directors believes they have taken or commenced the necessary measures to resolve any and all remaining matters presented in the Agreement, the FDIC and WDFI could take further enforcement actions, including requiring the sale or liquidation of the Bank, if they are not satisfied with the corrective actions that are taken by the Bank.  In such case, there can be no assurance that the proceeds of any such sale or liquidation would result in a full return of capital to investors.  A copy of the Agreement was filed as a part of the Company’s Quarterly Report on Form 10-Q filed on November 12, 2010 with the SEC.

Deposit Insurance.

As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC.  The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification.  An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators.  

On November 12, 2009, the FDIC adopted a final rule that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012.  As such, on December 31, 2009, the Bank prepaid the FDIC its assessments based on its actual September 30, 2009 assessment base, adjusted quarterly by an estimated 5% annual growth rate through the end of 2012.  The FDIC also used the institution’s total base assessment rate in effect on September 30, 2009, increasing it by an annualized 3 basis points beginning in 2011.  The FDIC began to offset prepaid assessments on March 30, 2010, representing payment of the regular quarterly risk-based deposit insurance assessment for the fourth quarter of 2009.  Any prepaid assessment not exhausted after collection of the amount due on June 30, 2013, will be returned to the institution.

Amendments to the Federal Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance premiums paid to the DIF will be calculated.  Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity.  This may shift the burden of deposit insurance premiums toward those large depository institutions that rely on funding sources other than U.S. deposits.  Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds.  The FDIC is given until September 3, 2020 to meet the 1.35 reserve ratio target. Several of these provisions could increase the Bank’s FDIC deposit insurance premiums. 

The Dodd-Frank Act permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per insured depositor, retroactive to January 1, 2009.  Furthermore, the legislation provides that non-interest bearing transaction accounts have unlimited deposit insurance coverage through December 31, 2012. This temporary unlimited deposit insurance coverage replaces the Transaction Account Guarantee Program (“TAGP”) that expired on December 31, 2010.  It covers all depository institution non-interest-bearing transaction accounts, but not low interest-bearing accounts.  Unlike TAGP, there is no special assessment associated with the temporary unlimited insurance coverage, nor may institutions opt-out of the unlimited coverage.

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FICO Assessments.

The Financing Corporation (“FICO”) is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Competitive Equality Banking Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation.  FICO issued 30-year noncallable bonds of approximately $8.1 billion that mature in 2017 through 2019.  FICO’s authority to issue bonds ended on December 12, 1991.  Since 1996, federal legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s outstanding obligations.  These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2011, the FICO assessment rate was approximately 0.01% of deposits.  A rate reduction to .00680% began with the fourth quarter of 2011 to reflect the change from an assessment base computed on deposits to an assessment base computed on assets as required by the Dodd-Frank Act.

Supervisory Assessments.

All Wisconsin banks are required to pay supervisory assessments to the WDFI to fund the operations of the WDFI. The amount of the assessment is calculated on the basis of total assets. During the year ended December 31, 2011, the Bank paid supervisory assessments to the WDFI totaling $20,088.

Capital Requirements.

Banks are generally required to maintain capital levels in excess of other businesses.  For a discussion of the Bank’s capital requirements, see “—The Increasing Importance of Capital,” as well as “— Regulatory Proceedings Against the Bank.”

Dividend Payments.

The primary source of funds for the Company is dividends from the Bank.  Under Wisconsin state law, the board of directors of a bank may declare and pay a dividend from its undivided profits in an amount they consider expedient.  The board of directors shall provide for the payment of all expenses, losses, required reserves, taxes, and interest accrued or due from the bank before the declaration of dividends from undivided profits.  If dividends declared and paid in either of the two immediately preceding years exceeded net income for either of those two years respectively, the bank may not declare or pay any dividend in the current year that exceeds year-to-date net income except with the written consent of the WDFI.

The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized.  As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2011.  However, as described in “— Regulatory Proceedings Against the Bank,” the Bank has agreed to refrain from declaring or paying any dividend without the consent of the FDIC and WDFI.  Furthermore the Federal Reserve may prohibit the payment of any dividends by the Bank if the Federal Reserve determines such payment would constitute an unsafe or unsound practice.

Insider Transactions.

The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank and its “affiliates.” The Company is an affiliate of the Bank for purposes of these restrictions, and covered transactions subject to the restrictions include extensions of credit to the Company, investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank.  The Dodd-Frank Act enhances the requirements for certain transactions with affiliates as of July 21, 2011, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.

Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company, to principal shareholders of the Company and to “related interests” of such directors, officers and principal shareholders.  In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or the Bank or a principal shareholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.  

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Safety and Soundness Standards.

The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions.  The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals.  If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.

As described in further detail above, the Bank is currently subject to the Agreement with the FDIC and WDFI, pursuant to which it has agreed to maintain certain heightened capital ratios, refrain from declaring or paying dividends without prior regulatory approval, observe certain limitations on its asset growth, develop and maintain certain policies and procedures, and take certain actions related to its loan portfolio and budgeting process. The Bank’s board of directors and management team have assigned great importance to complying with the terms of the Agreement, and believe they have taken or commenced the steps necessary to resolve any and all matters presented therein.  See “— Regulatory Proceedings Against the Bank” for further detail on the Agreement.

Branching Authority.

Wisconsin banks, such as the Bank, have the authority under Wisconsin law to establish branches anywhere in the State of Wisconsin, subject to receipt of all required regulatory approvals.

Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger.  The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) has historically been permitted only in those states the laws of which expressly authorize such expansion. However, the Dodd-Frank Act permits well-capitalized banks to establish branches across state lines without these impediments.

State Bank Investments and Activities.

The Bank is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Wisconsin law.  However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank.  Federal law and FDIC regulations also prohibit FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member.  These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.   

Transaction Account Reserves.

Federal Reserve regulations require depository institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts). For 2012: the first $11.5 million of otherwise reservable balances are exempt from the reserve requirements; for transaction accounts aggregating more than $11.5 million to $71.0 million, the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $71.0 million, a 10% reserve ratio will be assessed. These reserve requirements are subject to annual adjustment by the Federal Reserve.  The Bank is in compliance with the foregoing requirements.

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 Consumer Financial Services.

There are numerous developments in federal and state laws regarding consumer financial products and services that impact the Bank’s business. Importantly, the current structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011 when the new Bureau of Consumer Financial Protection commenced operations to supervise and enforce consumer protection laws. The Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all providers of consumer products and services, including the Bank, as well as the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Bureau has examination and enforcement authority over providers with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, like the Bank, will continue to be examined by their applicable bank regulators. The Dodd-Frank Act also generally weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws. It is unclear what changes will be promulgated by the Bureau and what effect, if any, such changes would have on the Bank.

The Dodd-Frank Act contains additional provisions that affect consumer mortgage lending.  First, the new law significantly expands underwriting requirements applicable to loans secured by 1-4 residential real property and augments federal law combating predatory lending practices.  In addition to numerous new disclosure requirements, the Dodd-Frank Act imposes new standards for mortgage loan originations on all lenders, including banks and savings associations, in an effort to strongly encourage lenders to verify a borrower’s ability to repay.  Most significantly, the new standards limit the total points and fees that the Bank and/or a broker may charge on conforming and jumbo loans to 3% of the total loan amount. Also, the Dodd-Frank Act, in conjunction with the Federal Reserve’s final rule on loan originator compensation effective April 1, 2011, prohibits certain compensation payments to loan originators and prohibits steering consumers to loans not in their interest because it will result in greater compensation for a loan originator.  These standards may result in a myriad of new system, pricing and compensation controls in order to ensure compliance and to decrease repurchase requests and foreclosure defenses.  In addition, the Dodd-Frank Act generally requires lenders or securitizers to retain an economic interest in the credit risk relating to loans the lender sells and other asset-backed securities that the securitizer issues if the loans have not complied with the ability to repay standards.  The risk retention requirement generally will be 5%, but could be increased or decreased by regulation.

Foreclosure and Loan Modifications.

Federal and state laws further impact foreclosures and loan modifications, many of which laws have the effect of delaying or impeding the foreclosure process on real estate secured loans in default.  Mortgages on commercial property can be modified, such as by reducing the principal amount of the loan or the interest rate, or by extending the term of the loan, through plans confirmed under Chapter 11 of the Bankruptcy Code.  In recent years legislation has been introduced in Congress that would amend the Bankruptcy Code to permit the modification of mortgages secured by residences, although at this time the enactment of such legislation is not in prospect.  The scope, duration and terms of potential future legislation with similar effect continue to be discussed.

State legal and/or legislative action may be on the horizon in light of the settlement reached in early February of 2012 by 49 state attorneys general and the federal government with the country’s five largest loan servicers:  Ally/GMAC, Bank of America, Citi, JPMorgan Chase, and Wells Fargo.  Every state except Oklahoma signed on to the settlement. The settlement will provide as much as $25 billion in relief to distressed borrowers in the states who signed on to the settlement; and direct payments to signing states and the federal government.  The agreement settles state and federal investigations finding that the country’s five largest loan servicers routinely signed foreclosure related documents outside the presence of a notary public and without really knowing whether the facts they contained were correct and holds the banks accountable for their wrongdoing on robo-signing and mortgage servicing.  The agreement settles only some aspects of the banks’ conduct related to the financial crisis (foreclosure practices, loan servicing, and origination of loans). State cases against the rating agencies and bid-rigging in the municipal bond market, for example, continue.   

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Available Information.

Under the Securities Exchange Act of 1934, the Company is required to file annual, quarterly and current reports, proxy and other information to the SEC.  We make available, free of charge, on our website (www.midwisc.com) under the caption “Investor Relations,” our 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 practicable after we electronically file or furnish such materials to the SEC.  Materials that we file or furnish to the SEC may also be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.  Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.  Also, the SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information that we file electronically with the SEC.


ITEM 1A.  RISK FACTORS

An investment in our common stock is subject to risks inherent to our business.  The material risks and uncertainties that management believes affect us are described below.  Before making an investment decision, you should carefully consider the risks described below because they could materially and adversely affect our business, liquidity, financial condition, results of operation, and prospects.  This report is qualified in its entirety by these risk factors.  In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem immaterial also may materially and adversely affect our business, financial condition and results of operations.  See also, the cautionary statement in Item 1 regarding the use of forward-looking statements in this Annual Report on Form 10-K.

Our stock does not have a significant amount of trading activity.

There is no active public trading market for our stock. Therefore, low activity may increase the volatility of the price of our stock and result in a greater spread between the bid and ask prices as compared to more actively-traded stocks.  Investors may not be able to resell shares at the price or time they desire. The lack of an active public trading market may also limit our ability to raise additional capital through the issuance of new stock.

Changes in future rules applicable to TARP recipients could adversely affect our business, results of operations and financial condition.

The rules and policies applicable to recipients of capital under the CPP have evolved since we first elected on February 20, 2009 to participate in the program, and their scope, timing and effect may continue to evolve in the future.  Any redemption of the securities sold to the Treasury to avoid these restrictions would require prior Federal Reserve and Treasury approval.  Based on guidelines issued by the Federal Reserve, institutions seeking to redeem CPP Preferred Stock must demonstrate an ability to access the long-term debt markets, successfully demonstrate access to public equity markets and meet a number of additional requirements and considerations before such institutions can redeem any securities sold to the Treasury.

Our agreements with the Treasury under the CPP, as well as provisions of our outstanding Debentures, impose restrictions and obligations on us that limit, among other things, our ability to pay dividends and repurchase our common or preferred stock.

In February 2009, we issued preferred stock to the Treasury under the CPP.  In consultation with the Federal Reserve Bank of Minneapolis, on May 12, 2011, we exercised our right to suspend dividends on the outstanding TARP Preferred Stock.  Dividend payments on the TARP Preferred Stock may be deferred without default, but the dividend is cumulative and therefore will continue to accrue and, if we fail to pay dividends for an aggregate of six quarters, whether or not consecutive, the holder will have the right to appoint representatives to the Company’s board of directors. The terms of the TARP Preferred Stock also prevent us from paying cash dividends on or repurchasing our common stock while dividends are in arrears. Therefore we will not be able to pay dividends on our common stock until we have fully paid all accrued and unpaid dividends on the TARP Preferred Stock.

We also exercised our right to defer payment of interest due under the terms of the Debentures on May 12, 2011, in consultation with the Federal Reserve Bank of Minneapolis.  We are allowed to defer payments of interest for 20 quarterly periods without default or penalty, but such amounts will continue to accrue. Also during the deferral period, we generally may not pay cash dividends on or repurchase common stock or preferred stock, including the TARP Preferred Stock.  On December 31, 2011, we had $485 accrued and unpaid dividends on the TARP Preferred Stock and $146 accrued and unpaid interest due on the Debentures.


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Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.  We anticipate that our existing capital resources will satisfy our capital requirements for the foreseeable future.  However, we may at some point need to raise additional capital to support growth or counteract the effects of future losses.  Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance.  Accordingly, we cannot assure you of our ability to raise additional capital if needed on terms acceptable to us.  If we cannot raise additional capital when needed, our ability to expand our operations through internal growth and acquisitions could be materially impaired.

We operate in a highly competitive industry and market areas.

We operate exclusively in North Central Wisconsin. Increased competition within our markets may result in reduced demand for loans and deposits, increased expenses, and difficulty in recruiting and retaining talented employees.  Many competitors offer similar banking services in our market areas.  Such competitors include national, regional, and other community banks, as well as other types of financial institutions, including savings and loan associations, trust companies, finance companies, brokerage firms, insurance companies, credit unions, and other financial intermediaries.  The financial services industry could become even more competitive as a result of legislative, regulatory, and technological changes, and/or continued consolidation.  Furthermore, many nonbank competitors are not subject to the same regulatory restrictions as we are and may therefore provide customers with potentially attractive alternatives to traditional banking services.

Our ability to compete successfully depends on a number of factors, including, among other things:

·

Our ability to develop, maintain, and build upon long-term customer relationships based on top quality service, and high ethical standards.

·

Our ability to expand our market position.

·

The scope, relevance, and pricing of products and services offered to meet customer needs and demands.

·

The rate at which we introduce new products and services relative to our competitors.

·

Industry and general economic trends.

·

Failure to perform or other negative implications in any of these areas could significantly weaken our  competitive position and adversely affect our consolidated financial condition and results of operations.

Our profitability depends significantly on the economic conditions of the markets in which we operate.

Our success depends on the general economic conditions of North Central Wisconsin where substantially all of our loans are originated.  Local economic conditions have a significant impact on the demand for our products and services, the ability of our customers to repay loans, the value of the collateral securing loans, and the stability of our deposit funding sources. A significant decline in general local economic conditions, caused by inflation, recession, unemployment, changes in securities markets, changes in housing market prices, or other factors could impact local economic conditions and, in turn, have a material adverse effect on our consolidated financial condition and results of operations.

We continually encounter technological change.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends on being able to effectively implement new technology and in being successful in marketing these products and services to our customers. Many of our larger competitors have substantially greater resources to invest in technological improvements.  As a result, they may be able to offer additional or superior products to those we will be able to offer, which would put us at a competitive disadvantage.  Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

New lines of business or new products and services may subject us to additional risk.

From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in


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instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business and/or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business and/or new products or services could substantially increase our operating costs, direct capital from other more profitable lines of business, or lead to a variety of unforeseen risks, each of which could have a material adverse effect on our business, results of operations and financial condition.

Negative publicity could damage our reputation.

Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers, expose us to adverse legal and regulatory consequences or cause service providers to be reluctant to commit to long-term projects with us. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, sharing or inadequate protection of customer information, from our actual or perceived financial condition, and from actions taken by government regulators and community organizations in response to such conduct or financial condition.  

Credit risk cannot be eliminated.

There are risks in making any loan, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and cash flows available to service debt and risks resulting from economic and market conditions. We attempt to reduce our credit risk through loan application approval procedures, monitoring the concentration of loans within specific industries and geographic location, and periodic independent reviews of outstanding loans by our loan review and external parties. However, while such procedures should reduce our risks, they cannot be expected to completely eliminate our credit risks. If the overall economic climate in the United States, generally, and our market areas, specifically, worsens or fails to meaningfully improve, or even if it does, our borrowers may experience difficulties in repaying their loans, and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision for loan losses, which would cause our net income and return on equity to decrease.  

Commercial loans make up a significant portion of our loan portfolio.    

Commercial loans, defined as commercial business, commercial real estate, and real estate construction loans, comprised $193,923,000 and $201,378,000 or 58% and 60%, of our loan portfolio at December 31, 2011 and 2010, respectively.  Our commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower.  Most often, this collateral is accounts receivable, inventory, or machinery.  Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists.  As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of

these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.  The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Due to the larger average size of each commercial loan as compared with other loans such as residential loans, as well as collateral that is generally less readily-marketable, losses incurred on a small number of commercial loans could have a material adverse impact on our financial condition and results of operations.


Our agricultural loans involve a greater degree of risk than other loans, and the ability of the borrower to repay maybe affected by many factors outside of the borrower’s control.  

At December 31, 2011 and 2010, agricultural real estate loans totaled $45,351,000 and $39,671,000, or 14% and 12%, of our total loan portfolio, respectively.  Agricultural real estate lending involves a greater degree of risk and typically involves larger loans to single borrowers than lending on single-family residences. Payments on agricultural real estate loans are dependent on the profitable operation or management of the farm property securing the loan. The success of the farm may be affected by many factors outside the control of the farm


18


borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products (both domestically and internationally) and the impact of government regulations (including changes in price supports, subsidies and environmental regulations). In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm.  If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired.


Our loan portfolio has a large concentration of real estate loans, which involve risks specific to real estate values.

Real estate lending (including commercial, construction, land and residential) is a large portion of our loan portfolio. These categories were $85,614,000 or approximately 26% of our total loan portfolio as of December 31, 2011, as compared to $$91,974,000, or approximately 26%, as of December 31, 2010.  The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located.  Although a significant portion of such loans are secured by a secondary form of collateral, adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio.  Additionally, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.


If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.  In particular, if the declines in values that have occurred in the residential and commercial real estate markets worsen, particularly within our market area, the value of collateral securing our real estate loans could decline further.  In light of the uncertainty that exists in the economy and credit markets nationally, there can be no guarantee that we will not experience additional deterioration resulting from the downturn in credit performance by our real estate loan customers.

 

Our allowance for loan losses (“ALLL”) may be insufficient to absorb losses in our loan portfolio.  

We maintain an ALLL, which is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of potential credit losses that could be incurred within the existing loan portfolio. The ALLL, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the ALLL reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic and regulatory conditions, and unidentified losses inherent in the existing loan portfolio. The determination of the appropriate level of the ALLL involves a high degree of subjectivity and requires us to make significant estimates of current credit risks using existing qualitative and quantitative information, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in the ALLL. In addition, bank regulatory agencies periodically review our ALLL and may require an increase in the provision for loan losses or the recognition of additional loan charge-offs based on judgments different than those of management. An increase in the provision for loan losses to bolster the ALLL results in a decrease in net income, and possibly risk-based capital, and may have a material adverse effect on our consolidated financial condition and results of operations.

We depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, appraisals, and other financial information. Reliance on inaccurate or misleading financial statements, credit reports, appraisals, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our consolidated financial condition and results of operations.  


19


Liquidity is essential to our business.  

Our liquidity could be impaired by an inability to access the capital markets or unforeseen outflows of cash. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us. Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.

We rely on dividends from our subsidiaries for most of our revenue. 

The Company is a separate and distinct legal entity from the Bank. Historically a substantial portion of its revenue has come from dividends from the Bank. These dividends are the principal source of funds to pay dividends on our common and preferred stock, and to pay interest and principal on our debentures. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company.  Moreover, the Bank has agreed to refrain from paying dividends to the Company without the prior approval of the FDIC and WDFI, which in light of the current financial condition of the Bank, may not be granted in the near future.  In the event the Bank is unable to continue to pay dividends to the Company, the Company may not be able to service debt, pay obligations, or pay dividends on our common and preferred stock. The inability to receive dividends from the Bank could have a material adverse effect on our business, consolidated financial condition, and results of operations.

We are subject to interest rate risk.

Our earnings are dependent upon our net interest income, which is the spread between the interest rates earned on investments and loans and the interest rates paid on deposits and other interest-bearing liabilities.  Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but such changes could also affect: (i) our ability to originate loans and obtain deposits; (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio and other interest-earning assets. If the interest rates paid on deposits and other liabilities increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.  

The impact of interest rates on our mortgage banking activities can have a significant impact on revenues.

Changes in interest rates can impact mortgage banking income. A decline in mortgage rates generally increases the demand for mortgage loans as borrowers refinance, but also generally leads to accelerated payoffs. Conversely, in a constant or increasing rate environment, we would expect fewer loans to be refinanced and a decline in payoffs.

Legislative and regulatory reforms applicable to the financial services industry may, if enacted or adopted, have a significant impact on our business, financial condition and results of operations.

On July 21, 2010, the Dodd-Frank Act was signed into law, which significantly changed the regulation of financial institutions and the financial services industry.  The Dodd-Frank Act, together with the regulations to be developed there under, included provisions affecting large and small financial institutions alike, including several provisions that will affect how community banks, thrifts and small bank and thrift holding companies will be regulated in the future.

The Dodd-Frank Act, among other things, imposed new capital requirements on bank holding companies; changed the base for FDIC insurance assessments to a bank’s average consolidated total assets minus average tangible equity, rather than upon its deposit base, and permanently raised the current standard deposit insurance limit to $250,000; and expanded the FDIC’s authority to raise insurance premiums.  The legislation also called for the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by September 30, 2020 and to “offset the effect” of increased assessments on insured depository institutions with assets of less than $10 billion.  The Dodd-Frank Act also authorized the Federal Reserve to limit interchange fees payable on debit card transactions, established the Bureau of Consumer Financial Protection as an


20


independent entity within the Federal Reserve, which will have broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards, and contained provisions on mortgage-related matters, such as steering incentives, determinations as to a borrower’s ability to repay and prepayment penalties.  The Dodd-Frank Act also included provisions that affect corporate governance and executive compensation at all publicly-traded companies and allowed financial institutions to pay interest on business checking accounts.

The Collins Amendment to the Dodd-Frank Act, among other things, eliminated certain trust preferred securities from Tier 1 capital, but certain trust preferred securities issued prior to May 19, 2010 by bank holding companies with total consolidated assets of $15 billion or less will continue to be includible in Tier 1 capital.  This provision also required the federal banking agencies to establish minimum leverage and risk-based capital requirements that will apply to both insured banks and their holding companies.

These provisions, or any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our business activities or change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs.  These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially and adversely affect our business, financial condition and results of operations.  Our management continues to stay abreast of developments with respect to the Dodd-Frank Act as its provisions are phased-in over time, and periodically reassesses its probable impact on our operations.  However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and us in particular, is uncertain at this time.

The U.S. Congress has also recently adopted additional consumer protection laws such as the Credit Card Accountability Responsibility and Disclosure Act of 2010, and the Federal Reserve has adopted numerous new regulations addressing banks’ credit card, overdraft and mortgage lending practices.  Additional consumer protection legislation and regulatory activity is anticipated in the near future.

The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, which is a strengthened set of capital requirements for banking organizations in the United States and around the world.  Basel III is currently supported by the U.S. federal banking agencies.  As agreed to, Basel III is intended to be fully-phased in on a global basis on January 1, 2019.  However, the ultimate timing and scope of any U.S. implementation of Basel III remains uncertain.  As agreed to, Basel III would require, among other things: (i) an increase in the minimum required common equity to 7% of total assets; (ii) an increase in the minimum required amount of Tier 1 capital from the current level of 4% of total assets to 8.5% of total assets; and (iii) an increase in the minimum required amount of total capital, from the current level of 8% to 10.5%.  Each of these increased requirements includes 2.5% attributable to a capital conservation buffer to position banking organizations to absorb losses during periods of financial and economic stress.  Basel III also calls for certain items that are currently included in regulatory capital to be deducted from common equity and Tier 1 capital.  The Basel III agreement calls for national jurisdictions to implement the new requirements beginning January 1, 2013.  At that time, the U.S. federal banking agencies will be expected to have implemented appropriate changes to incorporate the Basel III concepts into U.S. capital adequacy standards.  Basel III changes, as implemented in the United States, will likely result in generally higher regulatory capital standards for all banking organizations.

Such proposals and legislation, if finally adopted, would change banking laws and our operating environment and that of our subsidiaries in substantial and unpredictable ways.  We cannot determine whether such proposals and legislation will be adopted, or the ultimate effect that such proposals and legislation, if enacted, or regulations issued to implement the same, would have upon our business, financial condition or results of operations.

We may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on our financial condition and results of operation.

We may be involved from time to time in a variety of litigation arising out of our business. Our insurance may not cover all claims that may be asserted against us, regardless of merit or eventual outcome. Such litigation


21

may divert the focus of our management, and it is also possible that such litigation may harm our reputation. Should judgments or settlements in any litigation exceed our insurance coverage, they could have a material adverse effect on our financial condition and results of operation. In addition, we may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms, if at all.

Impairment of investment securities or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.

In assessing the impairment of investment securities, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. If the Company experiences a pre-tax loss position in the future there is a likelihood that an additional valuation allowance may be necessary against its deferred tax asset.  The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.

We may not be able to attract and retain skilled people.

Our past performance and growth has been influenced strongly by our ability to attract and retain management experienced in banking and financial services and familiar with the communities in our market areas.  Our ability to retain key employees of our bank subsidiary will continue to be important to the successful implementation of our strategy.  The unexpected loss of services of any key employees, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, results of operations and financial condition.

Further, we are subject to extensive restrictions on our ability to pay bonuses and other incentive compensation during the period in which we have any outstanding securities held by the Treasury that were issued under the CPP.  Many of the restrictions are not limited to our senior executives and could cover other employees whose contributions to revenue and performance can be significant.  The limitations may adversely affect our ability to recruit and retain these key employees in addition to our senior executive officers, especially if we are competing for talent against institutions that are not subject to the same restrictions.  The Dodd-Frank Act also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives. These rules, if adopted, may make it more difficult to attract and retain the people we need to operate our businesses and limit our ability to promote our objectives through our compensation and incentive programs.

We are subject to operational risk.

We are subject to operational risk which represents the risk of loss resulting from human error, inadequate or failed internal processes and systems, and external events.  Operational risk also encompasses compliance (legal) risk, which is the risk of loss from violations of, or noncompliance with, laws, rules, regulations, prescribed practices, or ethical standards.  Although we seek to mitigate operational risk through a system of internal controls, resulting losses from operational risk could take the form of explicit charges, increased operational costs, harm to our reputation, or forgone opportunities, any and all of which could have a material adverse effect on our financial condition and results of operations.

Our internal controls and procedures may fail or be circumvented.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures.  Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met.  Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, financial condition, and results of operations.


22

We rely on other companies to provide key components of our business infrastructure.

Third party vendors provide key components of our business infrastructure such as internet connections, online banking and core applications. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including a failure to provide us with their services for any reason or poor performance, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

System failure or breaches of our network security, including with respect to our internet banking activities, could subject us to increased operating costs as well as litigation and other liabilities.

The computer systems and network infrastructure we use in our operations and internet banking activities could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers.  Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, as well as that of our customers engaging in internet banking activities.  In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer data.  Although we have procedures in place to prevent or limit the effects of any of these potential problems and intend to continue to implement security technology and establish operational procedures to prevent such occurrences, there can be no assurance that these measures will be successful.  Any interruption in, or breach in security of, our computer systems and network infrastructure, or that of our internet banking customers, could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.  

ITEM 1B.  UNRESOLVED STAFF COMMENTS  

None.

ITEM 2.   PROPERTIES

Our headquarters are located at the Bank’s administrative office facility at 132 West State Street, Medford, Wisconsin.  We own one building in Wausau and lease the premises back to the Bank. The Bank owns nine buildings and leases three. All buildings owned or leased by the Bank are in good condition and considered adequate for present and near-term requirements.

Branch

Address

Square Feet

 

 

 

Medford-Plaza

134 South 8th Street, Medford, WI  54451

    20,000

Medford-Corporate

132 West State Street, Medford, WI  54451  

    15,900

Rib Mountain

3845 Rib Mountain Drive, Wausau, WI  54401

    13,000

Colby

101 South First Street, Colby, WI  54421

      8,767

Neillsville

500 West Street, Neillsville, WI  54456

      7,560

Minocqua*

8744 Highway 51 N, Suite 4, Minocqua, WI  54548

      4,500

Rhinelander

2170 Lincoln Street, Rhinelander, WI  54501

      4,285

Phillips

864 N Lake Avenue, Phillips, WI  54555

      4,285

Eagle River*

325 West Pine Street, Eagle River, WI  54521

      4,000

Abbotsford

119 North First Street, Abbotsford, WI  54405

      2,986

Weston *

7403 Stone Ridge Drive, Weston, WI  54476

      2,500

Rib Lake

717 McComb Avenue, Rib Lake, WI  54470

      2,112

Fairchild

111 N Front Street, Fairchild, WI  54741

      1,040

*Branch leased from third party.


23


ITEM 3.   LEGAL PROCEEDINGS


We engage in legal actions and proceedings, both as plaintiff and defendant, from time to time in the ordinary course of business.  In some instances, such actions and proceedings involve substantial claims for compensatory or punitive damages or involve claims for an unspecified amount of damages. There are, however, presently no proceedings pending or contemplated which, in our opinion, would have a material adverse effect on our consolidated financial position, results of operations or liquidity.


As previously reported, in 2007 we commenced a legal action against the guarantor of a loan to a former car dealership (“Impaired Borrower”) and others seeking relief for damages.  On September 30, 2010 a Marathon County jury found the Impaired Borrower liable for intentionally misrepresenting the financial condition of the dealership and for acts of conspiracy in enticing the Bank to extend credit to it. The jury awarded the Bank a $4,000,000 judgment for the losses it suffered as a result of this transaction. This judgment is subject to appeal and

the ability to collect is unclear at this time.  As a result of our continuing collection efforts to recover losses related to this transaction, the Bank received an insurance settlement in the amount of $500,000 in January 2011.  We continue to pursue all avenues of recovery.


ITEM 4.  MINE SAFETY DISCLOSURES


Not applicable.


PART II


ITEM 5.   MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES             


Market Information


There is no active established public trading market in our common stock, although two regional broker-dealers act as market makers for the stock.  Bid and ask prices are quoted on the OTC Bulletin Board under the symbol “MWFS.OB”.  Transactions in our common stock are limited and sporadic.


Market Prices and Dividends


The following table summarizes price ranges of over-the-counter quotations and cash dividends paid on our common stock for the periods indicated.  Prices represent the bid prices reported on the OTC Bulletin Board.  The prices do not reflect retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions.    


 

2011 Prices and Dividends

 

 

2010 Prices and Dividends

Quarter

High

Low

Dividends

 

Quarter

High

Low

Dividends

1st

$

8.05

$

7.90

$

0.00

 

1st

$

9.10

$

6.00

$

0.00

2nd

8.70

7.77

0.00

 

2nd

11.00

9.00

0.00

3rd

8.00

4.75

0.00

 

3rd

9.50

7.85

0.00

4th

5.00

3.50

0.00

 

4th

7.85

7.80

0.00


Holders


As of March 1, 2012, there were approximately 850 holders of record of our common stock. Some of our common stock is held in “street” or “nominee” name and the number of beneficial owners of such shares is not known nor included in the foregoing number.


Dividend Policy


Prior to 2009, dividends on our common stock were historically paid in cash on a quarterly basis in March, June, September, and December. In 2009, we declared a first quarter dividend payable to shareholders in March of that year. Subsequent to the payment of the 2009 first quarter dividend, we changed our dividend payment


24


policy on our common stock to declare semi-annual dividends, payable in February and August; however, following an analysis of our operating results, capital position and the general economic climate, we elected to defer dividends beginning in August 2009 and do not anticipate paying dividends on our common stock for the foreseeable future.  


Our ability to pay dividends depends in part upon the receipt of dividends from the Bank and these dividends are subject to limitation under banking laws and regulations. Our declaration of dividends to our shareholders is discretionary and will depend upon earnings, capital requirements, and the operating and financial condition of the Company. Prior to the third anniversary of the Treasury’s purchase of the Series A and B Preferred Stock, unless such stock has been redeemed, the consent of the Treasury will be required for us to increase our annual common stock dividend above $0.44 per common share.  We are also prohibited from paying dividends on our common stock if we fail to make distributions or scheduled payments on the Debentures or TARP Preferred Stock.  In consultation with the Federal Reserve Bank of Minneapolis, on May 12, 2011, the Company exercised its rights to suspend dividends on the outstanding TARP Preferred Stock and has also elected to defer interest on the Debentures.  As of December 31, 2011, the Company had $485 accrued and unpaid dividends on the TARP Preferred Stock and $146 accrued and unpaid interest due of the Debentures.  Consequently, we may not declare a dividend on our common

stock until such accrued amounts have been paid and we are current on all distributions due holders of the Debentures and TARP Preferred Stock.


Stock Buy-Back


Under the CPP, prior to February 20, 2012, we were required to obtain the consent of the Treasury prior to redemption, purchase or acquisition any shares of our capital stock, other than (i) redemptions, purchases or other acquisitions of the TARP Preferred Stock, (ii) redemptions, purchases or other acquisitions of shares of our common stock in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice and (iii) certain other redemptions, repurchases or other acquisitions as permitted under the CPP. We did not repurchase any shares of our capital stock in 2011, nor do we expect to in the near future.


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ITEM 6.  SELECTED FINANCIAL DATA


Table 1:  Earnings Summary and Selected Financial Data


Years Ended December 31,

2011

2010

2009

2008

2007

 

(In thousands, except per share data)

Results of operations:

 

 

 

 

 

Interest income

$

22,039  

$

25,062  

$

26,932  

$

29,732  

$

32,144  

Interest expense

6,485  

8,762  

10,500  

13,297  

16,564  

Net interest income

15,554  

16,300  

16,432  

16,435  

15,580  

Provision for loan losses

4,750  

4,755  

8,506  

3,200  

1,140  

Net interest income after provision for loan losses

10,804  

11,545  

7,926  

13,235  

14,440  

Noninterest income

4,287  

5,550  

4,421  

4,026  

4,057  

Other-than-temporary impairment losses, net

0  

412  

301  

0  

0  

Noninterest expense

17,187  

15,805  

16,450  

16,010  

17,334  

Income (loss) before income taxes

(2,096) 

878  

(4,404) 

1,251  

1,163  

Income tax (benefit) expense

1,861  

135  

(1,916) 

9  

45  

Net income (loss)

(3,957) 

743  

(2,488) 

1,242  

1,118  

Preferred stock dividends, discount and premium

(644) 

(641) 

(545) 

0  

0  

Net income (loss) available to common equity

($4,601) 

$

102  

($3,033) 

$

1,242  

$

1,118  

Earnings (loss) per common share:

 

 

 

 

 

Basic and diluted

($2.78) 

$

0.06  

($1.84) 

$

0.76  

$

0.68  

Cash dividends per common share

$

0.00  

$

0.00  

$

0.11  

$

0.55  

$

0.66  

Weighted average common shares outstanding:

 

 

 

 

 

Basic

1,654  

1,650  

1,645  

1,643  

1,640  

Diluted

1,654  

1,650  

1,646  

1,643  

1,641  

SELECTED FINANCIAL DATA

 

 

 

 

 

Year-End Balances:

 

 

 

 

 

Loans

$

329,863  

$

339,170  

$

358,616  

$

364,381  

$

357,988  

Allowance for loan losses

9,816  

9,471  

7,957  

4,542  

4,174  

Investment securities available-for-sale, at fair value

110,376  

101,310  

103,477  

81,038  

82,551  

Total assets

488,176  

509,082  

505,460  

496,459  

480,359  

Deposits

381,620  

400,610  

397,800  

385,675  

369,479  

Long-term borrowings

40,061  

42,561  

42,561  

49,429  

46,429  

Subordinated debentures

10,310  

10,310  

10,310  

10,310  

10,310  

Stockholders' equity

39,513  

42,970  

43,184  

35,805  

34,571  

Book value per common share

$

17.65  

$

19.85  

$

20.10  

$

21.78  

$

21.06  

Average Balances:

 

 

 

 

 

Loans

$

338,607  

$

355,575  

$

363,966  

$

361,883  

$

355,307  

Investment securities available-for-sale, at fair value

129,742  

123,103  

110,515  

90,776  

86,972  

Total assets

493,686  

505,597  

497,994  

477,274  

470,209  

Deposits

384,210  

394,872  

380,633  

364,710  

360,101  

Short-term borrowings

12,285  

10,410  

11,907  

11,634  

17,939  

Long-term borrowings

41,273  

42,561  

47,296  

51,874  

42,462  

Stockholders' equity

42,973  

43,976  

44,122  

35,317  

34,348  

Financial Ratios:

 

 

 

 

 

Return on average assets

(0.93%) 

0.02%

(0.61%) 

0.26%

0.24%

Return on average common equity

(14.05%) 

0.23%

(6.87%) 

3.52%

3.25%

Average equity to average assets

8.70%

8.70%

8.86%

7.21%

7.20%

Net interest margin (1)

3.38%

3.46%

3.53%

3.71%

3.60%

Total risk-based capital

15.57%

15.46%

14.49%

13.33%

13.32%

Net charge-offs to average loans

1.30%

0.91%

1.40%

0.78%

1.45%

Nonperforming loans to total loans

4.00%

3.70%

3.89%

2.47%

1.77%

Efficiency ratio (1)

85.53%

73.40%

79.20%

76.86%

86.71%

Noninterest income to average assets

0.87%

1.10%

0.89%

0.84%

0.86%

Noninterest expenses to average assets

3.48%

3.13%

3.30%

3.35%

3.69%

Dividend payout ratio

0.00%

0.00%

7.27%

72.68%

96.78%

Stock Price Information: (2)

 

 

 

 

 

High

$

8.70  

$

11.00  

$

16.25  

$

24.00  

$

38.00  

Low

3.50  

6.00  

7.00  

12.25  

19.75  

Market price at year end

3.50  

7.80  

7.00  

12.25  

19.75  

(1) Fully taxable equivalent basis, assuming a federal tax rate of 34% and adjusted for the disallowance of interest expense

(2) Bid Price


26


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


The following management's discussion and analysis reviews significant factors with respect to our consolidated financial condition at December 31, 2011 and 2010, and results of operations for the three-year period ended December 31, 2011.  This discussion should be read in conjunction with the consolidated financial statements, notes, tables, and selected financial data presented elsewhere in this report.  


Our discussion and analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance.  However, such performance involves risks and uncertainties that may cause actual results to differ materially from those discussed in such forward-looking statements.  A cautionary statement regarding forward-looking statements is set forth under the caption “Special Note Regarding Forward-Looking Statements” in Item 1 of this Annual Report on Form 10-K.  This discussion and analysis should be considered in light of such cautionary statements and the risk factors disclosed elsewhere in this report.


Critical Accounting Policies


Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industry in which we operate.  This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes.  These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements.  Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.  We believe the following policies are important to the portrayal of our financial condition and require subjective or complex judgments and, therefore, are critical accounting policies.


Investment Securities:  The fair value of our investment securities is important to the presentation of the consolidated financial statements since the investment securities are carried on the consolidated balance sheet at fair value.   We utilize a third party vendor to assist in the determination of the fair value of our investment portfolio. Adjustments to the fair value of the investment portfolio impact our consolidated financial condition by increasing or decreasing assets and shareholders’ equity, and possibly earnings.  Declines in the fair value of investment securities below their cost that are deemed to be other-than-temporarily impaired (“OTTI”) are reflected in earnings as realized losses and assigned a new cost basis.  In estimating OTTI, we consider many factors which include: (i) the length of time and the extent to which fair value has been less than cost; (ii) the financial condition and near-term prospects of the issuer; and (iii) our intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  To determine OTTI, we utilize a discounted cash flow model to estimate the fair value of the security.  The use of a discounted cash flow model involves judgment, particularly of interest rates, estimated default rates and prepayment speeds.


Allowance for Loan Losses:   Management’s evaluation process used to determine the adequacy of the ALLL is subject to the use of estimates, assumptions, and judgments. The evaluation process combines several factors: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio category; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses.  Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the ALLL, could change significantly.  As an integral part of their examination process, various regulatory agencies also review the ALLL. Such agencies may require that certain loan balances be classified differently or charged-off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. The Company believes the ALLL as recorded in the consolidated financial statements is adequate.


27


Other real estate owned (“OREO”):  Real estate acquired through, or in lieu of, loan foreclosure is held for sale and is initially recorded at fair value at the date of foreclosure, establishing a new cost basis.  The fair value is based on appraised or estimated values obtained, less estimated costs to sell, and adjusted based on highest and best use of the properties, or other changes.  There are uncertainties as to the price we may ultimately receive on the sale of the properties, potential property valuation allowances due to declines in the fair values, and the carrying costs of properties for expenses such as utilities, real estate taxes, and other ongoing expenses that may affect future earnings.   


Income taxes:  The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.  Quarterly assessments will be performed to determine if additional valuation allowances may be necessary against its deferred tax asset.  At December 31, 2011 the Company believes the tax assets and liabilities are adequate and properly recorded in the consolidated financial statements.


All remaining information included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are shown in thousands of dollars, except per share data.


Credit Management Process Enhancements


Our Principal Executive Officer, Executive Vice President and Chief Credit Officer (“Executive Management”) have been focused on continued enhancements to the Company’s credit management process to address credit quality and the effects of the economy.  To enhance credit risk management, the Company has taken several actions, including but not limited to: (i) the establishment of a credit administration function and hiring of an experienced Chief Credit Officer in November 2009; (ii) the expansion of its special assets and collection staff; (iii) the adoption of enhanced credit underwriting policies and procedures, including the requirement that exceptions to loan policies and procedures be approved by Executive Management; and (iv) loan officers prepare problem loan memos for all credits risk rated “special mention” and higher to identify risks and the remediation necessary to prevent continued credit quality declines in the loan portfolio.  These changes have prompted a number of personnel changes among our lending staff and in some instances the reassignment of duties and responsibilities among remaining staff members.


Additionally, while the board of directors has always provided oversight of the credit process, it has increased its involvement over the past several years.  Three independent directors and the President comprise the Bank’s Board Loan Committee (“BLC”).  The BLC meets at least twice each month (and other times as necessary) to review loan proposals for (i) secured loans risk rated acceptable or better and over $1,200; (ii) unsecured loans risk rated acceptable or better over $500; (iii) secured loans risk rated special mention or greater over $750; and (iv) unsecured loans risk rated special mention or greater over $100.  All actions or proposed actions for all loans risk rated substandard or doubtful, or which have been adversely classified by regulatory agencies, must be approved by the BLC.  Any secured loan over $7,000 or unsecured loan over $5,000 and all loan participations must be approved by the full board of directors.  The BLC annually reviews all loan relationships risk rated acceptable or better and over $1,200, all loan relationships risk rated special mention and over $750, and all loan relationships risk rated substandard or doubtful.  Delinquent loans are reviewed with the BLC on a regular basis.


Since 2009, the board’s Audit Committee has engaged the services of an independent third party to perform periodic reviews to evaluate the credit quality, loan administration and approval processes with respect to the Bank’s loan portfolio.  During 2011, the Audit Committee had the independent loan reviewer perform an in-depth review of “acceptable,” “special mention,” and “substandard” risk rated loans to confirm that the loan portfolio was appropriately risk rated. The review identified some loans that required the rating to be adjusted up or down, but overall confirmed that our loan procedures have improved.  Three independent loan reviews are scheduled to be performed in 2012 as well.


28


Results of Operations


Overview


The Company reported a net loss available to common shareholders of $4,601, or $2.78 per common share, for the year ended December 31, 2011, compared to net income available to common shareholders of $102, or $0.06 per common share, for the year ended December 31, 2010.  


The Company’s financial results for 2011 were significantly impacted by the credit quality of the Bank’s loan portfolio, as there is a strong correlation between performance and the level of provision for loan losses, charge-offs and costs of adverse credit quality.  As described further below, during the fourth quarter of 2011, a $2,911 valuation allowance was recognized in income tax expense to offset deferred tax assets.  Weak loan demand, combined with historically low interest rates, has created intense competition for high quality credits while other investment alternatives offer little return resulting in a compressed net interest margin.  We expect that the level of provision for loan losses, along with the costs of adverse credit quality will continue to put pressure on our earnings in 2012.


Key factors behind these results are discussed below:


·

Net interest income of $15,554 for the year ended December 31, 2011, decreased by 5% from 2010.  On a fully tax-equivalent basis, the net interest margin at December 31, 2011 decreased to 3.38% from 3.46% in 2010.  The decrease in net interest margin was primarily due to an elevated level of liquidity that was invested in lower-yielding assets, weak loan demand, high levels of nonaccrual loans, and the sale of higher yielding investment securities during the latter half of 2010.  Average loans outstanding decreased by $16,968 to $338,607 and the average balance of investment securities increased $9,940 to $105,868 at December 31, 2011, compared to a year earlier.  The average yield on earning assets was 4.76% at December 31, 2011 compared to 5.29% at December 31, 2010.


·

Loans of $329,863 at December 31, 2011, decreased $9,307 from December 31, 2010. Loan growth has been impacted by the current credit environment, lack of loan demand in our market area, loan payoffs, and charge-offs.  Although competition among local and regional banks for creditworthy borrowers and core deposit customers remains high, we remain committed to supporting our markets through lending to creditworthy borrowers despite the increasing regulatory burdens placed on financial institutions and the continuing economic challenges.


·

Total deposits were $381,620 at December 31, 2011, down $18,990 from the year ended December 31, 2010, primarily due to the maturity of brokered certificates of deposit and deposits acquired under a listing service.  The Company decided to not replace these funding sources due to excess liquidity and continued efforts to reduce reliance on non core deposits.

 

·

Net charge-offs were $4,405 for 2011, and $3,241 for 2010. The provision for loan losses was $4,750 for 2011, compared with $4,755 for 2010.  The continued high level of provision was due primarily to the levels of loan charge-offs, levels of nonperforming loans, depressed collateral values, and internal assessments of currently performing loans with increased risk for future delinquencies.  The Bank’s coverage ratio of the ALLL to total loans at December 31, 2011 was 2.98% compared to 2.79% at December 31, 2010.


·

Another major contributor to current year results was a $2,911 valuation allowance taken in the fourth quarter of 2011 that was recognized in income tax expense to offset deferred tax assets.  The valuation allowance was taken to account for the possibility that some portion of the deferred tax asset will not be realized in the future.   A deferred tax asset is the amount of tax deductions the Company has available to be utilized on future income tax returns.  Upon the generation of future taxable income during the periods in which the tax deductions become deductible all or a portion of the established valuation allowance could be reversed.  If the Company experiences a pre-tax loss position in the future there is likelihood that an additional valuation allowance may be necessary.  At December 31, 2011 the remaining balance of the deferred tax asset was $1,179.


29


·

Excluding a legal settlement of $500 and a $55 loss on the sale of investments in 2011 and the $1,054 gain on sale of investments recognized in 2010, noninterest income for 2011 was $3,842, down $654, or 15%, compared to 2010.  Noninterest income continued to decline as a result of regulatory changes under the Dodd-Frank Act limiting certain service fees and decreased mortgage banking income from the sales of residential real estate loans into the secondary market.  Mortgage banking income did increase in the third and fourth quarters of 2011 as compared to the first half of the year due to declines in interest rates; however, even with the uptick in refinancing, the activity was not as high as 2010 levels.  


·

Noninterest expense for 2011 was $17,187, an increase of $1,382, or 9%, over 2010, due primarily to increased foreclosure/OREO expenses, collection expenses, FDIC costs, marketing and product expenses associated with a new suite of deposit products, and loan servicing costs.


·

In 2010, the Company recognized OTTI write-downs of $412 from two private placement trust preferred securities as the unrealized losses appeared to be related to expected credit losses that will not be recovered by the Company.  No OTTI credit losses were recognized in earnings during 2011.


·

As of December 31, 2011, the Bank’s Tier One Capital Leverage ratio was 8.7% and Total Risk-Based capital ratio was 14.2%, compared to 9.0% and 13.9%, respectively, at December 31, 2010.  The Company’s Tier One Capital Leverage ratio was 9.6% and Total Risk-Based capital ratio was 15.6%, compared to 10.0% and 15.5%, respectively, at December 31, 2010.  All ratios are above the regulatory guidelines stipulated in the Bank’s and Company’s agreements with their primary regulators.


Net Interest Income


Our earnings are substantially dependent on net interest income which is the difference between interest earned on investments and loans and the interest paid on deposits and other interest-bearing liabilities. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.


Table 2 presents changes in the mix of average interest-earning assets and average interest-bearing liabilities for the three years ended December 31, 2011.  The mix of the balance sheet has shifted from loans to taxable securities funded by a growing allocation of savings deposits as compared to time deposits thus lowering the Company’s taxable-equivalent net interest income.


30


Table 2:  Mix of Average Interest Earning-Assets and Average Interest-Bearing Liabilities


 

Years Ended December 31,

($ in thousands)

2011

2010

2009

Loans

72%

74%

77%

Taxable securities

20%

18%

17%

Tax-exempt securities

3%

2%

2%

Other

5%

6%

4%

Total interest-earning assets

100%

100%

100%

Interest-bearing demand

9%

9%

7%

Savings deposits

30%

26%

26%

Time deposits

44%

49%

49%

Short-term borrowings

3%

3%

3%

Long-term borrowings

11%

10%

12%

Subordinated debentures

3%

3%

3%

Total interest-bearing liabilities

100%

100%

100%



Table 3:  Average Balance Sheet and Net Interest Income Analysis – Taxable-Equivalent Basis


 

Years Ended December 31,

 

2011

2010

2009

 

Average

 

Average

Average

 

Average

Average

 

Average

 

Balance

Interest

Rate

Balance

Interest

Rate

Balance

Interest

Rate

 

($ in thousands)

ASSETS

 

 

 

 

 

 

 

 

 

Earnings assets

 

 

 

 

 

 

 

 

 

Loans (1) (2) (3)

$

338,607 

$

18,980

5.61%

$

355,575 

$

21,391

6.02%

$

363,966 

$

22,814

6.27%

Investment securities:

 

 

 

 

 

 

 

 

 

  Taxable

93,511 

2,563

2.74%

85,925 

3,216

3.74%

79,030 

3,540

4.48%

  Tax-exempt (2)

12,357 

597

4.83%

10,003 

544

5.43%

11,795 

725

6.15%

Federal funds sold

12,296 

16

0.13%

17,182 

26

0.15%

12,164 

14

0.12%

Securities purchased under agreements to sell

8,065 

108

1.34%

3,833 

65

1.70%

0

0.00%

Other interest-earning assets

3,512 

39

1.11%

6,160 

64

1.04%

7,526 

135

1.79%

Total earning assets

$

468,348 

$

22,303

4.76%

$

478,678 

$

25,306

5.29%

$

474,481 

$

27,228

5.74%

Cash and due from banks

7,857 

 

 

7,789 

 

 

7,618 

 

 

Other assets

26,737 

 

 

27,797 

 

 

22,628 

 

 

Allowance for loan losses

(9,256)

 

 

(8,667)

 

 

(6,733)

 

 

Total assets

$

493,686 

 

 

$

505,597 

 

 

$

497,994 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

  Interest-bearing demand

$

35,785 

$

164

0.46%

$

35,100 

$

205

0.59%

$

29,639 

$

187

0.63%

  Savings deposits

116,802 

902

0.77%

107,622 

1,074

1.00%

105,330 

1,393

1.32%

  Time deposits

169,825 

3,500

2.06%

199,942 

5,123

2.56%

195,712 

6,221

3.18%

Short-term borrowings

12,285 

123

1.00%

10,410 

95

0.91%

11,907 

124

1.04%

Long-term borrowings

41,273 

1,614

3.91%

42,561 

1,670

3.92%

47,296 

1,961

4.15%

Subordinated debentures

10,310 

183

1.77%

10,310 

595

5.77%

10,310 

614

5.98%

Total interest-bearing liabilities

$

386,280 

$

6,486

1.68%

$

405,945 

$

8,762

2.16%

$

400,194 

$

10,500

2.62%

Noninterest-bearing demand deposits

61,798 

 

 

52,208 

 

 

49,952 

 

 

Other liabilities

2,635 

 

 

3,468 

 

 

3,726 

 

 

Stockholders' equity

42,973 

 

 

43,976 

 

 

44,122 

 

 

Total liabilities and stockholders' equity

$

493,686 

 

 

$

505,597 

 

 

$

497,994 

 

 

Net interest income and rate spread

 

$

15,817

3.08%

 

$

16,544

3.13%

 

$

16,728

3.12%

Net interest margin

 

 

3.38%

 

 

3.46%

 

 

3.53%


(1)

Nonaccrual loans are included in the daily average loan balances outstanding.

(2)

The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.

(3)

Interest income includes loan fees of $317 in 2011, $387 in 2010 and $489 in 2009.


31


Table 4:  Volume/Rate Variance – Taxable-Equivalent Basis


 

2011 vs. 2010

2010 vs. 2009

 

 

Due to

 

 

Due to

 

 

Volume

Rate (1)

Net

Volume

Rate (1)

Net

  Loans (2)

($1,021)

($1,390)

($2,411)

($526)

($897)

($1,423)

  Taxable investments

284 

(937)

(653)

309 

(633)

(324)

  Tax-exempt investments (2)

128 

(75)

53 

(110)

(71)

(181)

  Federal funds sold

(7)

(2)

(10)

12 

  Securities purchased under agreements to sell

72 

(29)

43 

65 

65 

  Other interest-earning assets

(28)

(25)

(25)

(46)

(71)

Total earning assets

($572)

($2,431)

($3,003)

($346)

($1,576)

($1,922)

  Interest-bearing demand

$

($45)

($41)

$

34 

($16)

$

18 

  Savings deposits

92 

(264)

(172)

30 

(349)

(319)

  Time deposits

(771)

(852)

(1,623)

135 

(1,233)

(1,098)

  Short-term borrowings

17 

11 

28 

(16)

(13)

(29)

  Long-term borrowings

(50)

(6)

(56)

(197)

(94)

(291)

  Subordinated debenture

(412)

(412)

(19)

(19)

Total interest-bearing liabilities

($708)

($1,568)

($2,276)

($14)

($1,724)

($1,738)

Net interest income

$

136 

($863)

($727)

($332)

$

148 

($184)


(1)

The change in interest due to both rate and volume has been allocated to rate.

(2)

The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.


Table 5: Yield on Earning Assets


 

December 31, 2011

December 31, 2010

December 31, 2009

 

Yield

Change

Yield

Change

Yield

Change

Yield on earning assets (1)

4.76%

(0.53)%

5.29%

(0.45)%

5.74%

(0.91)%

Effective rate on all liabilities as a percentage of earning assets

1.38%

(0.45)%

1.83%

(0.38)%

2.21%

(0.73)%

Net yield on earning assets

3.38%

(0.08)%

3.46%

(0.07)%

3.53%

(0.18)%


(1)

The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.


Comparison of 2011 versus 2010


Taxable-equivalent net interest income was $15,817 for 2011, a decrease of 4% from 2010 primarily attributable to unfavorable rate variances as the impact of interest rates received on loans and other investments decreased more than the interest rates paid on deposits and other borrowings.  Taxable-equivalent net interest income decreased $863 in 2011 compared to 2010 due to changes in rate.  


The taxable-equivalent net interest margin was 3.38% for 2011, down from 3.46% for 2010.  For 2011, the yield on earning assets of 4.76% was 53 basis points (“bps”) lower than the comparable period last year.  Loan yields decreased 41 bps, to 5.61%, impacted by levels of nonaccrual loans, lower loan yields given the repricing of adjustable rate loans, soft loan demand, and competitive pricing pressures to retain and/or obtain creditworthy borrowers.  The yield on investment securities decreased 94 bps to 2.98%, impacted by the Company’s excess liquidity position being invested in lower-yielding investment securities resulting from soft loan demand during 2011 and the sale of $33,184 of investment securities during the latter half of 2010.


32


The cost of interest-bearing liabilities of 1.68% for 2011 was 48 bps lower than 2010.  The average cost of interest-bearing deposits was 1.42%, down 45 bps due to decreasing deposit offering rates, while the cost of wholesale funding (comprised of short-term borrowings and long-term borrowings) decreased 9 bps to 3.24% for 2011.  The Company’s outstanding $10,310 of Debentures had a fixed rate of 5.98% through December 15, 2010, after which they have had a floating rate equal to the three-month LIBOR plus 1.43%, adjusted quarterly.  The interest rate at December 31, 2011 was 1.98%.  


Average earning assets of $468,348 for 2011 were $10,330 lower than the comparable period last year. Average investment securities grew $9,940 to $105,868, reflecting the Company’s increased liquidity position invested in lower-yielding assets.  Average loans decreased $16,968 to $338,607 as a result of soft loan demand, pay-offs and charge-offs.  Taxable-equivalent interest income in 2011 decreased $3,003 to $22,303 due to $572 unfavorable earning asset volume changes and $2,431 unfavorable rate variances.


Average interest-bearing liabilities of $386,280 for 2011 were down $19,665 compared to the related 2010 period. Average interest-bearing deposits decreased $20,252 while noninterest-bearing deposits increased $9,590.  For 2011, interest expense decreased $2,276 of which $1,568 was due to favorable rate changes and $708 was due to favorable volume changes.


Comparison of 2010 versus 2009


Taxable equivalent net interest income for 2010 was $16,544, a decrease of $184, or 1%, from $16,728 in 2009.  The decrease in taxable equivalent net interest income was a function of unfavorable volume variances (as balance sheet changes in both volume and mix decreased taxable equivalent net interest income by $332) and favorable interest rate changes (as the impact of changes in the interest rate environment and product pricing increased taxable equivalent interest income by $148).  The change in mix and volume of earning assets decreased taxable equivalent interest income by $346, while the change in volume and composition of interest-bearing liabilities decreased interest expense $14.  Rate changes on earning assets reduced interest income by $1,576, while changes in rates on interest-bearing liabilities lowered interest expense by $1,724, for a net favorable impact of $148.


The net interest margin for 2010 was 3.46%, compared to 3.53% in 2009.  For 2010, the yield on earning assets of 5.29% was 45 bps lower than 2009.  Loan yields decreased 25 bps, to 6.02%, impacted by the levels of nonaccrual loans, repricing of adjustable rate loans and competitive pricing pressures in a low interest rate environment. The yield on investment securities and other interest-earning assets decreased 81 bps, impacted by the Company’s excess liquidity position during most of 2010 and the sale of investment securities.


The cost of average interest-bearing liabilities of 2.16% in 2010 was 46 bps lower than 2009.  The average cost of interest-bearing deposits in 2010 was 1.87%, 49 bps lower than 2009, reflecting the low interest rate environment.  The cost of wholesale funding (comprised of short-term borrowings and long-term borrowings) decreased 19 bps to 3.33% for 2010.  The Debentures had a fixed rate of 5.98% through December 15, 2010, after which they have a floating rate of the three-month Libor plus 1.43%, adjusted quarterly.  The interest rate at December 31, 2010 was 1.73%.


Average earning assets of $478,678 in 2010 were $4,197 lower than 2009.  Average federal funds sold and overnight repurchase agreements and investment securities grew $10,849 and $5,103, respectively, reflecting the Company’s increased liquidity position.  Average loans decreased $8,391.  Taxable equivalent interest income in 2010 decreased $1,922 due to earning asset rate and volume changes.


Average interest-bearing liabilities of $405,945 in 2010 were up $5,751 versus 2009, attributable to a higher level of interest-bearing deposits. Average interest-bearing deposits grew $11,983 and average noninterest-bearing deposits increased $2,256.  Given the soft loan demand and growth in deposits, average wholesale funding decreased by $6,232.  In 2010, interest expense decreased $1,724 due to rate changes, with a $1,598 decrease from interest-bearing deposits and a $126 decrease due to short-term and long-term borrowings and subordinated debentures.


33


Provision for Loan Losses

 

The provision for loan losses in 2011 was $4,750, compared to $4,755 and $8,506 for 2010 and 2009, respectively. The continued high level of provision was due primarily to the levels of loan charge-offs, levels of nonperforming loans, depressed collateral values, existing economic conditions, and internal assessments of currently performing loans with increased risk for future delinquencies.  Net charge-offs were $4,405 for 2011, compared to $3,241 for 2010 and $5,091 for 2009.  The increase in net charge-offs from 2010 was primarily due to management’s decision, made in consultation with the Bank’s regulators, to charge-off certain impaired loans that were covered by specific reserve allocations identified in the ALLL in 2011.  At December 31, 2011, the ALLL was $9,816, an increase of $345 over December 31, 2010 and an increase of $1,859 over December 31, 2009. The ratio of the ALLL to total loans was 2.98%, 2.79%, and 2.22% for the years ended December 31, 2011, 2010, and 2009, respectively.  Nonperforming loans at December 31, 2011, were $13,200, compared to $12,543 at December 31, 2010, and $13,942 at December 31, 2009, representing 4.00%, 3.70%, and 3.89% of total loans, respectively.


The provision for loan losses is predominantly a function of the Company’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL.  The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses.  We believe the level of provisioning and the level of our ALLL followed the direction of our policies and was adequate to cover anticipated and unexpected loan losses inherent in our loan portfolio as of December 31, 2011.  However, we may need to increase our provisions in the future should the quality of the loan portfolio decline or other factors used to determine the allowance worsen.  Please refer to the discussion under “Balance Sheet Analysis-Allowance for Loan Losses” and “Balance Sheet Analysis-Impaired Loans and Nonperforming Assets” for further information.


Noninterest Income


Table 6: Noninterest Income


 

Years Ended December 31,

Change From Prior Year

($ in thousands)

2011

2010

2009

$ Change 2011

% Change 2011

$ Change 2010

% Change 2010

Service fees

$

953 

$

1,174

$

1,239

($221)

(19%) 

($65)

(5%) 

Trust service fees

1,066 

1,103

1,024

(37)

(3%) 

79 

8.0%

Investment product commissions

221 

221

237

0%

(16)

(7%) 

Mortgage banking

523 

955

564

(432)

(45%) 

391 

69%

Gain (loss) on sale of investments

(55)

1,054

449

(1,109)

(105%) 

605 

135%

Other

1,579 

1,043

908

536 

51%

135 

15%

Total noninterest income

$

4,287 

$

5,550

$

4,421

($1,263)

(23%) 

$

1,129 

26%


Comparison of 2011 versus 2010


Noninterest income was $4,287 for 2011, down $1,263, or 23%, from 2010.  Excluding a legal settlement of $500 and a $55 loss on the sale of investments in 2011 and the $1,054 gain on sale of investments recognized in 2010, noninterest income for the year ended December 31, 2011 totaled $3,842 down $654, or 15%, compared to 2010.  


Service fees on deposit accounts for 2011 were $953, down $221, or 19%, from 2010.  The decline in service fees was due to a general decrease in the amount of NSF/overdraft fees collected due to regulatory changes under the Dodd-Frank Act and changes in customer behavior.  For 2012, core fee-based revenues are expected to face challenges related to the same factors that have affected 2011 results.


34


The Wealth Management Services Group generates trust service fees and investment product commissions.  Trust service fees were $1,066 in 2011, down $37 from 2010, primarily due to a decrease in the valuations of assets under management, on which fees are based.  Investment product commissions remained unchanged at $221 for 2011 and 2010.


Mortgage banking income represents income received from the sale of residential real estate loans into the secondary market. During 2010, mortgage rates fell to historically low levels, prompting a wave of consumer refinancing activity generating $955 of mortgage banking income.  Mortgage banking income did increase in the third and fourth quarters of 2011 due to further declines in interest rates; however, even with the uptick in refinancing, the refinancing activity was not as high as 2010 levels.  


The Company recognized a $55 loss on the sale of investments in 2011.  The security sales were executed in an effort to increase the credit quality of the Company’s investment portfolio.  Excluding the $500 legal settlement noted above, other operating income increased $36 to $1,079 in 2011 compared to $1,043 in 2010.


Comparison of 2010 versus 2009


Noninterest income was $5,550 for 2010, an increase of $1,129, or 26%, from 2009.  


For 2010, mortgage banking income was $955, up $391 from 2009.  In 2010, 407 mortgage loans were sold totaling $68,886 into the secondary market compared to 301 loans totaling $47,436 for 2009.  Residential loan activity reached an all time high in 2010 due to the historically low interest rate environment.


Gain on sale of investments was $1,054 for 2010 compared to $449 in 2009.  Proceeds from 2010 sales totaled $38,146 while proceeds from 2009 were $12,717.  The sales of investments are considered a normal function of prudently managing the portfolio and taking advantage of gain positions when appropriate.  Sales also occurred to remove those mortgage securities that were considered too small to hold, to remove those securities that will have a tendency to react most negatively as rates rise and lastly to reposition the portfolio for future rising interest rates.


Noninterest Expense


Table 7:  Noninterest Expense


 

Years Ended December 31,

Change From Prior Year

($ in thousands)

2011

2010

2009

$ Change 2011

% Change 2011

$ Change 2010

% Change 2010

Salaries and employee benefits

$

8,561

$

8,537

$

8,411

$

24 

0%

$

126 

1%

Occupancy

1,769

1,830

1,893

(61)

(3%) 

(63)

(3%) 

Data processing

667

651

648

16 

2%

0%

Foreclosure/OREO expense

857

243

1,278

614 

253%

(1,035)

(81%) 

Legal and professional fees

891

677

882

214 

32%

(205)

(23%) 

FDIC expense

1,117

1,036

1,057

81 

8%

(21)

(2%) 

Other

3,325

2,831

2,281

494 

17%

550 

24%

Total noninterest expense

$

17,187

$

15,805

$

16,450

$

1,382 

9%

($645)

(4%) 



 Comparison of 2011 versus 2010


Total noninterest expense was $17,187 for the full year of  2011, an increase of $1,382, or 9%, over  2010 due primarily to increased foreclosure/OREO expenses, collection expenses, FDIC costs, and marketing and product expenses associated with a new suite of deposit products.  The Company expects the costs of adverse credit quality to continue to stress earnings in 2012.


Foreclosure/OREO expense consists of the costs associated with OREO properties such as real estate taxes, utilities, maintenance costs, valuation adjustments against the carrying costs, and gains or losses on the sale of OREO properties.  Foreclosure/OREO expense was $857 for the full year 2011 and consisted of $1,098 of


35


OREO carrying costs offset by a $241 gain on the sales of various OREO properties.  Foreclosure/OREO expense also included $628 of valuation adjustments against the carrying cost of various foreclosed properties based on appraisals obtained during 2011, compared to $159 in 2010.  The majority of the remaining increase in foreclosure/OREO expense was due to real estate taxes and maintenance costs.


Legal and professional fees of $891 increased $214, or 32%, primarily due to higher legal costs associated with loan collection activities in 2011.  An increase in FDIC expense of $81 was primarily due to increased deposit insurance rates due to a change in our risk rating.


Other operating expenses were $3,325 for the full year 2011, an increase of $494 over 2010, primarily due to increased marketing costs and reward payments based on debit card usage associated with the introduction of a new deposit program.  The new deposit program did enhance our brand awareness across our markets and increased our balances in noninterest-bearing demand and savings deposits.  In 2012 we anticipate that the amount of rewards we will be able to pay our customers under this deposit program will decrease as a result of certain limitations to which the Bank is subject pursuant to its Agreement with the FDIC and WDFI.


In 2012, the Company has renewed efforts to reduce noninterest expenses, including but not limited to staff reductions and no merit increases for 2012, delaying non-critical projects, workflow changes, renegotiating vendor contracts, decreasing marketing expenses and reducing the levels of other discretionary spending.


Comparison of 2010 versus 2009


Noninterest expense declined $645, or 4%, from 2009, primarily from a reduction of $1,035 in expenses related to foreclosure/OREO expense as we were actively working out more loans in 2009 than in 2010.


Generally we continued to control noninterest expenses through staff reductions during 2010 (full-time-equivalents at December 31, 2010 were 151 compared to 158 at December 31, 2009), renegotiated vendor contracts and reduced our level of discretionary spending.


Our primary noninterest expense is salaries and benefits.  Overall, salaries were generally frozen for all employees in 2010 and related expenses declined $19; however, this was offset by increases of $145 in the Company’s insurance and medical plans, provided as an employee benefit, for a net increase of $126 in 2010.


Foreclosure/OREO expense for 2010 was $243, a reduction of $1,035 from 2009.  Savings of $698 were realized due to lower valuation adjustments required for OREO properties and the carrying expenses thereof, as well as a general reduction in foreclosure expenses.


Other expenses of $2,831 increased $550 in 2010 primarily due to $118 increase in advertising, marketing and public relations expenses; $289 in higher loan servicing expenses and $100 due to the recalculation of directors’ deferred compensation fees.


Income Taxes


Income tax expense for 2011 was $1,861 compared to $135 for 2010.  The basic principles for accounting for income taxes require that deferred income taxes be analyzed to determine if a valuation allowance is required.  A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized.  Primarily due to net operating loss carryovers in 2011, the Bank’s net deferred tax asset (prior to any valuation allowance) increased to $4,260.  All available evidence, both positive and negative, was considered to determine whether any impairment of this asset should be recognized.  Based on consideration of the available evidence including historical losses which must be treated as substantial negative evidence and the potential of future taxable income, a $3,081 valuation allowance was determined to be necessary at December 31, 2011 to adjust deferred tax assets to the amount of net operating losses that are expected to be realized.  If realized, the tax benefit for this item will reduce current tax expense for that period. If future earnings projections are not met there is a likelihood that an additional valuation allowance may be necessary.  


Both the Company and the Bank pay federal and state income taxes on their consolidated net earnings.  At December 31, 2011 tax net operating losses at the Company of approximately $4,071 federal and $10,038 state existed to offset future taxable income.  


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BALANCE SHEET ANALYSIS


Loans


The Bank services a diverse customer base throughout North Central Wisconsin including the following industries: agriculture (primarily dairy), retail, manufacturing, service, resort properties, timber and businesses supporting the general building industry.  We continue to concentrate our efforts in originating loans in our local markets and assisting our current loan customers.  We are actively utilizing government loan programs such as those provided by the U.S. Small Business Administration, U.S. Department of Agriculture, and USDA Farm Service Agency to help these customers weather current economic conditions and position their businesses for the future.


Total loans were $329,863 at December 31, 2011, a decrease of $9,307, or 3%, from December 31, 2010.  During 2011, the Company focused primarily on improving asset quality and working out current credit issues rather than loan growth.


Table 8:  Loan Composition


 

2011

 

2010

 

2009

 

2008

 

2007

 

 

 

% of

 

% of

 

% of

 

% of

 

% of

 

Amount

Total

Amount

Total

Amount

Total

Amount

Total

Amount

Total

 

($ in thousands)

Commercial business

$

41,347

12%

$

39,093

12%

$

35,673

10%

$

39,047

11%

$

39,892

11%

Commercial real estate

123,868

37%

132,079

39%

138,891

39%

127,209

34%

114,028

32%

Real estate construction

28,708

9%

30,206

9%

35,417

10%

45,665

13%

45,959

13%

Agricultural

45,351

14%

39,671

12%

42,280

12%

43,345

12%

40,804

11%

Real estate residential

85,614

26%

91,974

26%

99,116

27%

100,311

28%

107,239

30%

Installment

4,975

2%

6,147

2%

7,239

2%

8,804

2%

10,066

3%

Total loans

$

329,863

100%

$

339,170

100%

$

358,616

100%

$

364,381

100%

$

357,988

100%

Owner occupied

$

70,412

57%

$

83,115

63%

$

88,002

63%

$

54,749

43%

$

57,027

50%

Non-owner occupied

53,456

43%

48,964

37%

50,889

37%

72,460

57%

57,001

50%

  Commercial real estate

$

123,868

100%

$

132,079

100%

$

138,891

100%

$

127,209

100%

$

114,028

100%

1-4 family construction

$

1,837

6%

$

967

3%

$

3,523

10%

$

4,757

10%

$

8,034

17%

All other construction

26,871

94%

29,239

97%

31,894

90%

40,908

90%

37,925

83%

  Real estate construction

$

28,708

100%

$

30,206

100%

$

35,417

100%

$

45,665

100%

$

45,959

100%



Commercial business loans, commercial real estate, real estate construction loans and agricultural loans comprise 72% of our loan portfolio at December 31, 2011.  Such loans are considered to have more inherent risk of default than residential mortgage or installment loans.  The commercial balance per borrower is typically larger than that for residential and mortgage loans, implying higher potential losses on an individual customer basis.  Commercial loan growth throughout 2010 and 2011 has been negatively impacted by soft loan demand across all markets, the Company’s aggressive approach to recognizing risks associated with specific borrowers and the recognition of charge-offs on nonperforming loans in a timely manner.  


Commercial business loans were $41,347 at December 31, 2011, up $2,254, or 6%, since year end 2010, and comprised 12% of total loans.  The commercial business loan classification primarily consists of commercial loans to small businesses, multi-family residential income-producing businesses, and loans to municipalities. Loans of this type include a diverse range of industries. The credit risk related to commercial business loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any.


The commercial real estate loan classification primarily includes commercial-based mortgage loans that are secured by nonfarm/nonresidential real estate properties. Commercial real estate loans totaled $123,868 at December 31, 2011, down $8,211, or 6%, from December 31, 2010, and comprised 37% of total loans, down from 39% at the end of 2010.  The decrease in this segment was due to charge-offs, pay downs, and the bank


37


decreasing its credit exposure by encouraging the refinancing of certain loan relationships with other financial institutions.  Future lending in this segment will focus on loans that are secured by commercial income producing properties as opposed to speculative real estate development. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationship on an ongoing basis.


Real estate construction loans declined $1,498, or 5%, to $28,708, representing 9% of the total loan portfolio at the end of 2011 and 2010.  Loans in this classification provide financing for the acquisition or development of commercial income properties, multi-family residential development, and single-family consumer construction. The Company controls the credit risk on these types of loans by making loans in familiar markets, underwriting the loans to meet the requirements of institutional investors in the secondary market, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances.

 

Agricultural loans totaled $45,351 at December 31, 2011, up $5,680, or 14%, compared to December 31, 2010, and represented 14% of the 2011 year end loan portfolio, up from 12% at year end 2010.  The majority of the increase was from two new credit relationships.  Loans in this classification include loans secured by farmland and financing for agricultural production.  Credit risk is managed by employing sound underwriting guidelines, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationship on an ongoing basis.


Real estate residential loans totaled $85,614 at the end of 2011, down $6,360, or 7%, from the prior year end, but comprised 26% of total loans outstanding at year end 2011 and 2010.  Residential mortgage loans include conventional first lien home mortgages and home equity loans.  Home equity loans consist of home equity lines, and term loans, some of which are first lien positions.  If the declines in market values that have occurred in the residential real estate markets worsen, particularly in our market area, the value of collateral securing our real estate loans could decline further, which could cause an increase in our provision for loan losses.  In light of the uncertainty that exists in the economy and credit markets, there can be no guarantee that we will not experience additional deterioration resulting from a downturn in credit performance by our residential real estate loan customers.   As part of its management of originating residential mortgage loans, nearly all of the Company’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market without retaining the servicing rights. At December 31, 2011, $2,163 of residential mortgages were being held for resale to the secondary market, compared to $7,444 at December 31, 2010.


Installment loans totaled $4,975 at December 31, 2011, down $1,172, or 19%, compared to 2010, and represented 2% of the 2011 and 2010 year end loan portfolio.  The decline in aggregate installment loan balances is largely a result of the fact that the Company experiences extensive competition from local credit unions offering low rates on installment loans and therefore has directed resources toward more profitable lending segments.  Loans in this classification include short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and guaranty positions.

  

Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an adequate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls and enhance the direct participation by the Bank’s BLC in the credit process.


The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2011, no significant industry concentrations existed in the Company’s


38


portfolio in excess of 30% of total loans.  The Bank has also developed guidelines to manage its exposure to various types of concentration risks.


The following table presents the maturity distribution of the loan portfolio at December 31, 2011:


Table 9:  Loan Maturity Distribution


 

Loan Maturity

 

One Year

Over One Year

Over

 

or Less

to Five Years

Five Years

 

($ in thousands)

Commercial business

$

11,664

$

27,020

$

2,663

Commercial real estate

48,451

60,363

15,054

Real estate construction

10,726

12,956

5,026

Agricultural

17,240

20,177

7,934

Real estate residential

17,751

27,974

39,889

Installment

1,790

2,983

202

Total

$

107,622

$

151,473

$

70,768

Fixed rate

$

91,231

$

136,329

$

7,327

Variable rate

16,391

15,144

63,441

Total

$

107,622

$

151,473

$

70,768


Allowance for Loan Losses

 

Credit risks within the loan portfolio are inherently different for each loan type. Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.


The ALLL is established through a provision for loan losses charge to expense to appropriately provide for potential credit losses in the exiting loan portfolio.  Loans are charged against the ALLL when management believes that the collection of principal is unlikely.  The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, an allocation methodology is applied by the Company which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses.  Our methodology reflects guidance by regulatory agencies to all financial institutions.


At December 31, 2011, the ALLL was $9,816, compared to $9,471 at December 31, 2010 and $7,957 at December 31, 2009. The ALLL as a percentage of total loans was 2.98%, 2.79%, and 2.22% at December 31, 2011, 2010 and 2009, respectively.  The heightened level of the ALLL is appropriate while problem loans and charge-offs continue at elevated levels.  The level of the provision for loan losses is directly correlated to the amount of net charge-offs, as it is the Company’s policy that the loan loss provisions, over time, exceed net charge-offs and provide coverage for potential credit losses in the existing loan portfolio.  


Management allocates the ALLL by pools of risk within each loan portfolio segment.  The allocation methodology consists of the following components.  First a specific reserve, for the estimated collateral shortfall, is established for all impaired loans.  Impaired loans include all troubled debt-restructurings (“restructured loans”), loans risk-weighted as “substandard” and “doubtful” with balances greater than $100 and loans risk-weighted “special mention” with balances greater than $250 determined to be impaired by the Company.  During June 2011, to conservatively provide for unexpected changes within the impaired loans, the specific reserve in the ALLL is the greater of (i) the estimated collateral shortfall calculated in the impairment analysis, or (ii) an amount equal to 50% of the homogenous pool loss rate by loan segment and risk rating.  


39


Second, management allocates ALLL with loss factors by loan segment, primarily based on risk ratings in the larger and more volatile loan segments and the migration of loan balances from the “special mention” risk rating to “substandard” and “doubtful” risk ratings.  During the second quarter of 2011, management refined its process for determining historical loss rates by incorporating default and loss severity rates at a more granular level within each loan segment.  The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels for the rolling twelve months.  Lastly, management allocates ALLL to the remaining loan portfolio using qualitative factors, including but not limited to: (i) delinquency rate of loans 30 days or more past-due; (ii) unemployment rates in the seven counties the Company serves; (iii) consumer disposable income; (iv) loan management; (v) loan segmentation by risk of collectability; and (vi) historical loss history for the rolling 36 months, adjusted quarterly.


The ALLL was 74%, 76% and 57% of nonperforming loans at December 31, 2011, 2010 and 2009, respectively. Gross charge-offs were $4,988 for 2011, $4,034 for 2010, and $5,283 for 2009, while recoveries for the corresponding periods were $583, $793 and $192, respectively. As a result, net charge-offs for 2011 were $4,405, or 1.30%, of average loans, compared to $3,241, or 0.91% of average loans, for 2010 and $5,091, or 1.40% of average loans, for 2009.  The 2011 increase in net charge-offs of $1,164 was comprised of a $1,296 increase in commercial and real estate construction net charge-offs offset by a $132 decrease in agricultural, real estate residential and installment loans.  The 2011 increase in commercial net charge-offs was mainly attributable to management’s decision, made in consultation with its banking regulators, to charge-off certain impaired loans that were covered by specific reserve allocations identified in the ALLL.  Since 2007, aggregate net charge-offs have been $20,719, of which $15,598, or 75%, were from commercial loans.  Issues impacting asset quality during this period included historically depressed economic factors, such as heightened unemployment, depressed commercial and residential real estate markets, volatile energy prices, and depressed consumer confidence. Declining collateral values have significantly contributed to our elevated levels of nonperforming loans, net charge-offs, and ALLL.  The Company has been focused on implementing enhancements to the credit management process to address and enhance underwriting and risk-based pricing guidelines for commercial real estate and real estate construction lending, as well as on new home equity and residential mortgage loans, to reduce potential exposure within these portfolio segments.  The level of the provision for loan losses is directly correlated to the amount of net charge-offs, as it is the Company’s policy that the loan loss provisions, over time, exceed net charge-offs and provide coverage for potential credit losses in the existing loan portfolio.  Loans charged-off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses.


The largest portion of the ALLL at year end 2011 was allocated to commercial real estate loans and was

$3,685, representing 38% of the ALLL at year end 2011 compared to 46% at year end 2010. The decrease in the amount allocated to commercial real estate was attributable to the decrease in the percentage of nonaccrual loans represented by commercial real estate loans, 36% of total nonaccrual loans at year end 2011, compared to 49% at year end 2010 - and the decrease in the percentage of our total portfolio represented by commercial real estate to 37% of total loans at year end 2011, down from 39% at year end 2010.  The ALLL allocated to commercial business loans was $1,004 at year end 2011, an increase of $468 from year end 2010, and represented 10% of the ALLL at year end 2011, compared to 6% at year end 2010. The increase in the commercial business allocation was due to a $680 increase in nonaccrual loans which represented 7% of nonaccrual loans at year end 2011 compared to less than 1% at year end 2010.  At December 31, 2011, the ALLL allocated to real estate construction was $1,320, compared to $1,278 at December 31, 2010, representing 13% of the ALLL for 2011 and 2010. The allocation to real estate construction remained relatively unchanged as the level on nonaccrual loans in the category decreased $125 from 2010 but the category as a whole remained at 9% of total loans.  The ALLL allocation to agricultural loans remained at 12% for 2011 and 2010.  Agricultural loans as a percent of the total loan portfolio increased to 14% for 2011 up from 12% for 2010; however the credit quality of the agricultural loan portfolio improved during 2011 as the level of nonaccrual loans decreased to $134 at December 31, 2011 from $440 at year end 2010.  The ALLL allocation to real estate residential increased to 26% at December 31, 2011, compared to 22% at December 31, 2010, given the increase in real estate residential as a percentage of nonaccrual loans and net charge-offs. The ALLL allocation to installment loans remained at 1% for year end 2011 and 2010.  Management performs ongoing intensive analyses of its loan portfolios to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.


40


Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded.  While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect our customers. As an integral part of their examination process, various federal and state regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.


41


Table 10:  Loan Loss Experience


 

Years Ended December 31,

 

2011

2010

2009

2008

2007

 

($ in thousands)

Allowance for loan losses:

 

 

 

 

 

Balance at beginning of year

$

9,471  

$

7,957  

$

4,542  

$

4,174  

$

8,184  

Loans charged-off:

 

 

 

 

 

Commercial business

173  

435  

608  

299  

1,443  

Commercial real estate

2,005  

1,490  

1,990  

1,469  

3,309  

Real estate construction

1,295  

537  

1,556  

186  

6  

Agricultural

203  

206  

38  

25  

1  

  Total commercial

3,676  

2,668  

4,192  

1,979  

4,759  

Real estate residential

1,067  

1,207  

964  

895  

341  

Installment

245  

159  

127  

195  

98  

  Total loans charged-off

4,988  

4,034  

5,283  

3,069  

5,198  

Recoveries of loans previously charged-off:

 

 

 

 

 

Commercial business

37  

167  

4  

122  

1  

Commercial real estate

135  

275  

151  

16  

11  

Real estate construction

134  

149  

0  

0  

0  

Agricultural

90  

86  

4  

7  

0  

  Total commercial

396  

677  

159  

145  

12  

Real estate residential

101  

83  

13  

53  

10  

Installment

86  

33  

20  

39  

26  

  Total recoveries

583  

793  

192  

237  

48  

Total net charge-offs

4,405  

3,241  

5,091  

2,832  

5,150  

Provision for loan losses

4,750  

4,755  

8,506  

3,200  

1,140  

Balance at end of year

$

9,816  

$

9,471  

$

7,957  

$

4,542  

$

4,174  

Ratios at end of year:

 

 

 

 

 

Allowance for loan losses to total loans

2.98%

2.79%

2.22%

1.25%

1.17%

Allowance for loan losses to net charge-offs

2.2x

2.9x

1.6x

1.6x

0.8x

Net charge-offs to average loans

1.30%

0.91%

1.40%

0.78%

1.45%

Net loan charge-offs:

 

 

 

 

 

Commercial business

$

136  

$

268  

$

604  

$

177  

$

1,442  

Commercial real estate

1,870  

1,215  

1,839  

1,453  

3,298  

Real estate construction

1,161  

388  

1,556  

186  

6  

Agricultural

113  

120  

34  

18  

1  

  Total commercial

3,280  

1,991  

4,033  

1,834  

4,747  

Real estate residential

966  

1,124  

951  

842  

331  

Installment

159  

126  

107  

156  

72  

  Total net charge-offs

$

4,405  

$

3,241  

$

5,091  

$

2,832  

$

5,150  

Commercial Real Estate and Construction

net charge-off detail:

 

 

 

 

 

Owner occupied

$

1,431  

$

502  

$

757  

$

1,078  

($11) 

Non-owner occupied

439  

713  

1,082  

375  

3,309  

  Commercial real estate

$

1,870  

$

1,215  

$

1,839  

$

1,453  

$

3,298  

1-4 family construction

$

0  

($18) 

$

33  

$

186  

$

0  

All other construction

1,161  

406  

1,523  

0  

6  

  Real estate construction

$

1,161  

$

388  

$

1,556  

$

186  

$

6  



The allocation of the ALLL for each of the past five years is based on our estimate of loss exposure by category of loans is shown in Table 11.  


42


Table 11:  Allocation of the Allowance for Loan Losses


 

2011

% of Loan Type to Total Loans

2010

% of Loan Type to Total Loans

2009

% of Loan Type to Total Loans

2008

% of Loan Type to Total Loans

2007

% of Loan Type to Total Loans

 

($ in thousands)

ALLL allocation:

 

 

 

 

 

 

 

 

 

 

Commercial business

$

1,004  

12%

$

536  

12%

$

497  

10%

$

295  

11%

$

301  

11%

Commercial real estate

3,685  

37%

4,320  

39%

3,954  

39%

1,836  

34%

1,899  

32%

Real estate construction

1,320  

9%

1,278  

9%

685  

10%

836  

13%

351  

13%

Agricultural

1,139  

14%

1,146  

12%

981  

12%

450  

12%

374  

11%

  Total commercial

7,148  

72%

7,280  

72%

6,117  

71%

3,417  

70%

2,925  

67%

Real estate residential

2,530  

26%

2,060  

26%

1,753  

27%

1,010  

28%

1,056  

30%

Installment

138  

2%

131  

2%

87  

2%

115  

2%

193  

3%

Total allowance for loan losses

$

9,816  

100%

$

9,471  

100%

$

7,957  

100%

$

4,542  

100%

$

4,174  

100%

ALLL category as a percent of total ALLL:

 

 

 

 

 

 

 

 

 

 

Commercial business

10%

 

6%

 

6%

 

7%

 

7%

 

Commercial real estate

38%

 

46%

 

50%

 

40%

 

46%

 

Real estate construction

13%

 

13%

 

9%

 

18%

 

8%

 

Agricultural

12%

 

12%

 

12%

 

10%

 

9%

 

  Total commercial

73%

 

77%

 

77%

 

75%

 

70%

 

Real estate residential

26%

 

22%

 

22%

 

22%

 

25%

 

Installment

1%

 

1%

 

1%

 

3%

 

5%

 

Total allowance for loan losses

100.0%

 

100.0%

 

100.0%

 

100.0%

 

100.0%

 



Impaired Loans and Nonperforming Assets


As part of its overall credit risk management process, management has been committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized.


Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Previously accrued and uncollected interest on such loans is reversed, amortization of related loan fees is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash after a determination has been made that the principal balance of the loan is collectible. If collectability of the principal is in doubt, payments received are applied to loan principal.


Nonaccrual loans were $11,194, $11,540 and $13,925 at December 31, 2011, 2010, and 2009, respectively, reflecting the continued impact of the economy on the Company’s customers.  Total nonaccrual loans at December 31, 2011 were down $346 since year end 2010, with commercial nonaccrual loans down $1,345, while consumer-related nonaccrual loans were up $999 as this loan segment continues to exhibit signs of stress.  The number of impaired consumer mortgage loans has increased significantly over the past twelve months and virtually all are in foreclosure and the legally-required redemption period.  Between year end 2010 and 2009, total nonaccrual loans decreased $2,385, with commercial and consumer nonaccrual loans down $1,776 and $609, respectively.  Management’s ALLL methodology at December 31, 2011, included an impairment analysis on specifically identified commercial and consumer loans defined by the Company as impaired and incorporated the level of specific reserves for these credit relationships in determining the overall appropriate level of the ALLL.


43


Restructured loans involve the granting of some concession to the borrower as a result of their financial distress involving the modification of terms of the loan, such as changes in payment schedule or interest rate, which generally would not otherwise be considered, to increase the likelihood of long-term loan repayment.  Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing accrual status, depending on the individual facts and circumstances of the borrower.  Generally, restructured loans remain on nonaccrual until the customer has attained a sustained period of repayment performance, generally nine months.  At December 31, 2011, the Company had total restructured loans of $12,887 which consisted of $7,541 performing in accordance with the modified terms and $5,346 classified as nonaccrual, compared to total restructured loans of  $1,265 at December 31, 2010, all of which were performing in accordance with the modified terms.


The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the adequacy of the ALLL. Potential problem loans are generally defined by management to include loans rated as substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that the Company expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial loans covering a diverse range of businesses and real estate property types. Potential problem loans totaled $23,124 at December 31, 2011 and $33,025 at December 31, 2010.  Potential problem loans requires a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by the Company’s customers and on underlying real estate values.


OREO increased to $4,404 at December 31, 2011, compared to $4,230 at December 31, 2010 and $1,808 at December 31, 2009.  The increase in OREO during 2010 was primarily attributable to a $1,744 loan participation, which represents 40% of the current OREO balance, in a hotel/water park that was recorded into OREO.  Net gains on sales of OREO were $241 and $187 for 2011 and 2010, respectively, and a net loss of $91 was recorded for 2009.  Write-downs on OREO were $628, $159, and $958 for 2011, 2010, and 2009, respectively.  Management actively seeks to ensure properties held are monitored to minimize the Company’s risk of loss.  Evaluations of the fair market value of the OREO properties are done quarterly and valuation adjustments, if necessary, are recorded in our consolidated financial statements.


44


Table 12: Nonperforming Assets


 

2011

2010

2009

2008

2007

 

($ in thousands)

Nonaccrual loans not considered impaired:

 

 

 

 

 

  Commercial

$

1,937  

$

808  

$

751  

$

36  

$

32  

  Agricultural

30  

369  

371  

521  

0  

  Real estate residential

1,447  

1,605  

958  

1,273  

485  

  Installment

5  

2  

19  

47  

42  

  Total nonaccrual loans not considered impaired

3,419  

2,784  

2,099  

1,877  

559  

Nonaccrual loans considered impaired:

 

 

 

 

 

  Commercial

5,392  

7,561  

8,894  

5,632  

3,786  

  Agricultural

104  

71  

568  

216  

277  

  Real estate residential

2,279  

1,124  

2,363  

808  

1,140  

  Installment

0  

0  

0  

416  

499  

  Total nonaccrual loans considered impaired

7,775  

8,756  

11,825  

7,072  

5,702  

Impaired loans still accruing interest

1,985  

993  

0  

0  

0  

Accruing loans past due 90 days or more (credit cards)

21  

10  

18  

36  

64  

     Total nonperforming loans

13,200  

12,543  

13,942  

8,985  

6,325  

OREO

4,404  

4,230  

1,808  

2,556  

2,352  

Other repossessed assets

60  

0  

450  

5  

0  

Investment security (Trust Preferred)

0  

136  

211  

0  

0  

     Total nonperforming assets

$

17,664  

$

16,909  

$

16,411  

$

11,546  

$

8,677  

Restructured loans accruing

 

 

 

 

 

  Commercial

$

5,908  

$

278  

$

151  

$

569  

$

700  

  Agricultural

201  

0  

0  

0  

0  

  Real estate residential

1,411  

987  

0  

0  

0  

  Installment

21  

0  

0  

0  

0  

  Total restructured loans accruing

$

7,541  

$

1,265  

$

151  

$

569  

$

700  

RATIOS

 

 

 

 

 

Nonperforming loans to total loans

4.00%

3.70%

3.89%

2.47%

1.77%

Nonperforming assets to total loans plus OREO

5.28%

4.92%

4.55%

3.15%

2.41%

Nonperforming assets to total assets

3.62%

3.32%

3.25%

2.33%

1.81%

Allowance for loan losses to nonperforming loans

74%

76%

57%

51%

66%

Allowance for loan losses to total loans at end of year

2.98%

2.79%

2.22%

1.25%

1.17%

Nonperforming assets by type:

 

 

 

 

 

Commercial business

$

858  

$

54  

$

40  

$

160  

$

547  

Commercial real estate

5,937  

6,653  

8,858  

3,183  

3,155  

Real estate construction

2,519  

2,644  

747  

2,325  

0  

Agricultural

134  

440  

939  

737  

393  

    Total commercial

9,448  

9,791  

10,584  

6,405  

4,095  

Real estate residential

3,726  

2,740  

3,321  

2,081  

1,625  

Installment

26  

12  

37  

499  

605  

     Total nonperforming loans

13,200  

12,543  

13,942  

8,985  

6,325  

Commercial real estate owned

4,116  

3,683  

1,523  

1,827  

1,660  

Real estate residential owned

288  

547  

285  

729  

692  

    Total other real estate owned

4,404  

4,230  

1,808  

2,556  

2,352  

Other repossessed assets

60  

0  

450  

5  

0  

Investment security (Trust Preferred)

0  

136  

211  

0  

0  

     Total nonperforming assets

$

17,664  

$

16,909  

$

16,411  

$

11,546  

$

8,677  

CRE and Construction nonperforming loan detail:

 

 

 

 

 

Owner occupied

$

2,877  

$

5,210  

$

5,798  

$

2,255  

$

2,479  

Non-owner occupied

3,060  

1,443  

3,060  

928  

676  

  Commercial real estate

$

5,937  

$

6,653  

$

8,858  

$

3,183  

$

3,155  

1-4 family construction

$

0  

$

0  

$

0  

$

296  

$

0  

All other construction

2,519  

2,644  

747  

2,029  

0  

  Real estate construction

$

2,519  

$

2,644  

$

747  

$

2,325  

$

0  


45


The following tables shows the approximate gross interest that would have been recorded if the loans accounted for on nonaccrual basis and restructured loans for the years ended as indicated had performed in accordance with their original terms, in contrast to the amount of interest income that was included in interest income for the period.


Table 13:  Forgone Loan Interest


 

Years Ended December 31,

 

2011

2010

2009

 

($ in thousands)

Interest income in accordance with original terms

$

452 

$

819 

$

819 

Interest income recognized

(139)

(197)

(622)

Reduction in interest income

$

313 

$

622 

$

197 


Investment Securities Portfolio


The investment securities portfolio is intended to provide the Bank with adequate liquidity, flexible asset/liability management and a source of stable income.  The portfolio is structured with minimal credit exposure to the Bank. All securities are classified as available-for-sale and are carried at market value.  Unrealized gains and losses are excluded from earnings, but are reported as other comprehensive income in a separate component of shareholders’ equity, net of income tax.   Premium amortization and discount accretion are recognized as adjustments to interest income using the interest method.  Realized gains or losses on sales are based on the net proceeds and the adjusted carrying value amount of the securities sold using the specific identification method.


Table 14:  Investment Securities Portfolio at Estimated Fair Value


 

Years Ended December 31,

 

2011

2010

2009

 

($ in thousands)

U.S. Treasury securities and obligations of U.S. government corporations and agencies

$

18,808

$

22,567

$

3,179

Mortgage-backed securities

67,653

56,916

81,766

Obligations of states and political subdivisions

22,932

20,715

17,184

Corporate debt securities

832

961

1,198

Total debt securities

110,225

101,159

103,327

Equity securities

151

151

150

Total securities available-for-sale

$

110,376

$

101,310

$

103,477


At December 31, 2011, the total carrying value of investment securities was $110,376, an increase of $9,066, or 9%, compared to December 31, 2010, and represented 23% and 20% of total assets at December 31, 2011 and 2010, respectively.  Primarily due to soft loan demand in 2011, the Company’s excess liquidity was invested in securities resulting in the increase in investment securities experienced in 2011.  As loan demand increases in the future, we anticipate that the monthly pay downs received from the investment securities portfolio will be used to fund loans.


At December 31, 2011, with the exception of securities of the U.S. Government, the securities portfolio did not contain securities of any single issuer that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of shareholders’ equity.


The Company previously determined that OTTI existed in one non-agency mortgage-backed security and two corporate securities held, as the unrealized losses on these securities appeared to be related in part to expected credit losses that would not be recovered by the Company.  During 2010, the Company recognized OTTI write-downs of $412 on the two corporate securities.  In the first quarter 2011, the company sold these three OTTI securities, which resulted in net investment security losses of $55, to improve the credit quality of the


46


 investment portfolio.  As of December 31, 2011 the Company has determined that there are no remaining OTTI securities in the investment portfolio.


A summary of the investment portfolio is shown below:


Table 15:  Investments


Investment Category

Rating

December 31, 2011

December 31, 2010

 

 

Amount

%

Amount

%

 

($ in thousands)

U.S. Treasury &  Government Agencies Debt

 

 

 

 

 

 

AAA

$

18,808

100%

$

22,567

100%

 

Total

$

18,808

100%

$

22,567

100%

U.S. Treasury & Government Agencies Debt as % of Portfolio

 

 

17%

 

22%

Mortgage-Backed Securities

 

 

 

 

 

 

AAA

$

67,588

100%

$

56,205

99%

 

AA3

53

0%

0

0%

 

A+

12

0%

13

0%

 

Baa2

0

0%

60

0%

 

BA1

0

0%

308

0%

 

BA3

0

0%

330

1%

 

Total

$

67,653

100%

$

56,916

100%

Mortgage-Backed Securities as % of Portfolio

 

 

61%

 

57%

Obligations of States and Political Subdivisions

 

 

 

 

 

 

Aa1

$

3,457

15%

$

3,496

17%

 

Aa2

5,704

25%

4,492

22%

 

AA3

3,363

15%

2,665

13%

 

A1

990

4%

905

4%

 

Baa1

0

0%

339

2%

 

Baa2

337

1%

0

0%

 

NR

9,081

40%

8,818

42%

 

Total

$

22,932

100%

$

20,715

100%

Obligations of States and Political Subdivisions as % of Portfolio

 

 

21%

 

20%

Corporate Debt and Equity Securities

 

 

 

 

 

 

NR

$

983

100%

$

1,112

100%

 

Total

$

983

100%

$

1,112

100%

Corporate Debt and Equity Securities as % of Portfolio

 

 

1%

 

1%

Total Market Value of Securities Available-For-Sale

 

$

110,376

100%

$

101,310

100%


Obligations of States and Political Subdivisions (“municipal securities”):  At December 31, 2011 and 2010, municipal securities were $22,932 and $20,715, respectively, and represented 21% of total investment securities for 2011 and 20% for 2010 based on fair value.  The majority of municipal securities held are general obligations or essential service bonds.  Municipal bond insurance company downgrades have resulted in credit downgrades in certain municipal securities; however, it has been determined that due to the large number of small investments in these obligations the loss exposure on any particular obligation is mitigated.  The municipal portfolio is evaluated periodically for credit risk by a third party.  As of December 31, 2011, the total fair value of municipal securities reflected a net unrealized gain of $1,313.


Mortgage-Backed Securities:  At December 31, 2011 and 2010, mortgage-related securities (which include predominantly mortgage-backed securities and collateralized mortgage obligations) were $67,653 and $56,916, respectively, and represented 61% and 57%, respectively, of total investment securities based on fair value.  The fair value of mortgage-related securities is subject to inherent risks based upon the future performance of the underlying collateral (mortgage loans) for these securities. Future performance is impacted by prepayment risk and interest rate changes.  


47


Corporate Debt and Equity Securities:  At December 31, 2011 and 2010, corporate debt securities were $983 and $1,112, respectively, and represented 1% of total investment securities based on fair value.  Corporate debt and equity securities include trust preferred debt securities, corporate bonds, and common equity securities.

Corporate debt and equity securities at December 31, 2011, consisted of two trust preferred securities of $800, and other securities of $183.  Corporate debt securities at December 31, 2010, consisted of trust preferred securities of $937, and other equity securities of $175.  As of December 31, 2011, the interest payments on the two trust preferred securities were current.


The Company had $2,306 of Federal Home Loan Bank of Chicago (“FHLB”) stock at December 31, 2011 and 2010.  While the FHLB announced in October 2007 that it was under a consensual cease and desist order with its regulator, which among other things, restricted the FHLB from paying dividends or redeeming stock without prior approval, the FHLB resumed payment of dividends during the first quarter of 2011.  Recently, we have been notified by the FHLB that it will repurchase approximately $500,000 in excess capital stock held by its members on February 15, 2012. The Bank redeemed approximately $465 of its excess FHLB capital stock.  


Accounting guidance indicates that an investor in FHLB capital stock should recognize impairment if it concludes that it is not probable that it will ultimately recover the par value of its shares. The decision of whether impairment exists is a matter of judgment that should reflect the investor’s view of the FHLB’s long-term performance, which includes factors such as: (i) its operating performance; (ii) the severity and duration of declines in the market value of its net assets related to its capital stock amount; (iii) its commitment to make payments required by law or regulation and the level of such payments in relation to its operating performance; (iv) the impact of legislation and regulatory changes on FHLB, and on the members of FHLB; and (v) its liquidity and funding position. After evaluating all of these considerations, the Company believes the cost of the investment will be recovered, and no impairment has been recorded on these securities during 2011, 2010, and 2009. 


Table 16:  Investment Securities Portfolio Maturity Distribution


 

 

 

After

 

After

 

 

 

 

 

 

 

 

One But

 

Five but

 

 

 

 

 

 

Within

 

Within

 

Within

 

After

 

 

 

 

One Year

 

Five Years

 

Ten Years

 

Ten Years

 

Total

 

 

Amount

Yield

Amount

Yield

Amount

Yield

Amount

Yield

Amount

Yield

 

($ in thousands)

U.S. treasury securities and obligations of U.S. government corporations and agencies

$

0

0.00%

$

14,710

1.91%

$

4,098

2.10%

$

0

0.00%

$

18,808

1.95%

Mortgage-backed securities

1

4.25%

663

3.92%

19,604

2.53%

47,385

2.75%

67,653

2.69%

Obligations of states and political subdivisions

2,744

5.10%

7,721

4.68%

10,239

3.87%

2,228

4.07%

22,932

4.31%

Corporate debt securities

0

0.00%

25

4.99%

0

0.00%

958

3.08%

983

3.13%

Total securities available-for-sale

$

2,745

5.10%

$

23,119

2.90%

$

33,941

2.88%

$

50,571

2.81%

$

110,376

2.91%


(1)

The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34%  adjusted for the disallowance of interest expense.


Deposits


Deposits represent the Company’s largest source of funds.  The Company competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Competition for deposits remains high. Challenges to deposit growth include price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives.


At December 31, 2011 total deposits were $381,620, down $18,990 from year end 2010.  Consistent with the Company’s funding strategy, the Company continued to reduce noncore funding sources during 2011.  The decrease in total deposits included an $18,857 decrease in brokered certificates of deposit and deposits acquired


48


under a listing service.  The Company decided to not replace these funding sources due to excess liquidity and continued efforts to reduce reliance on non core deposits.  On February 1, 2011, the Company introduced a suite of new consumer deposit products that pay rewards based on customers’ debit card usage, which was a major contributor to the $10,344, or 17%, increase in non-interest bearing demand deposits and $5,998, or 5%, increase in savings deposits experienced in 2011.


Table 17:  Deposits


 

2011

 

2010

 

2009

 

 

Amount

% of Total

Amount

% of Total

Amount

% of Total

 

($ in thousands)

Noninterest-bearing demand deposits

$

70,790

19%

$

60,446

15%

$

55,218

14%

Interest-bearing demand deposits

39,160

10%

39,462

10%

33,375

8%

Savings deposits

120,513

32%

114,515

29%

104,822

26%

Time deposits

136,140

35%

159,201

39%

165,204

42%

Brokered certificates of deposit

15,017

4%

26,986

7%

39,181

10%

Total

$

381,620

100%

$

400,610

100%

$

397,800

100%



On average, deposits were $384,210 for 2011, down $10,662, or 3%, from the average for 2010. The mix of average deposits was also impacted by shift in customer preferences, predominantly toward the product design and pricing features of the new deposit suite of noninterest-bearing demand and savings deposits.   


Table 18: Average Deposits

 

2011

 

2010

 

2009

 

 

Amount

% of Total

Amount

% of Total

Amount

% of Total

 

($ in thousands)

Noninterest-bearing demand deposits

$

61,798

16%

$

52,208

13%

$

49,952

13%

Interest-bearing demand deposits

35,785

9%

35,100

9%

29,639

8%

Savings deposits

116,802

30%

107,622

27%

105,330

28%

Time deposits

150,461

39%

166,475

42%

151,827

40%

Brokered certificates of deposit

19,364

6%

33,467

9%

43,885

11%

Total

$

384,210

100%

$

394,872

100%

$

380,633

100%


A stipulation of the Bank’s Agreement with the FDIC and WDFI limits the rates of interest it may set on its deposit products.  As a result, in 2012, the amount of rewards we will be able to pay our customers for debit card usage related to the new suite of deposit products introduced in 2011will be reduced to a level at or below certain national rate caps.


49


Table 19:  Maturity Distribution of Certificates of Deposit of $100,000 or More


 

Years Ended December 31,

 

2011

2010

 

($ in thousands)

3 months or less

$

13,693

$

19,900

Over 3 months through 6 months

3,734

6,196

Over 6 months through 12 months

13,730

11,736

Over 12 months

15,538

23,277

Total

$

46,695

$

61,109



Other Funding Sources


Other funding sources, which include short-term and long-term borrowings, were $64,026 and $62,383 at December 31, 2011 and 2010, respectively.  Short-term borrowings consist of corporate repurchase agreements which totaled $13,655 at December 31, 2011 and $9,512 at December 31, 2010.  Long-term borrowings at December 31, 2011, were $40,061, a decrease of $2,500 from December 31, 2010 attributable to the maturity of FHLB advances during the year that were not replaced.  Also included in long-term borrowings are trust preferred securities.  In 2005, Mid-Wisconsin Statutory Trust I (the “Trust”), a Delaware Business Trust subsidiary of the Company, issued $10,000 in trust preferred securities.  The trust preferred securities were sold in a private placement to institutional investors.  The Trust used the proceeds from the offering along with the Company’s common ownership investment to purchase $10,310 of the Company’s Debentures.  The trust preferred securities and the Debentures mature on December 15, 2035, and had a fixed rate of 5.98% until December 15, 2010. They now have a floating rate of the three-month LIBOR plus 1.43%, adjusted quarterly.  The interest rates were 1.98% and 1.73% at December 31, 2011 and 2010, respectively.  


The following information relates to federal funds purchased, securities sold under repurchase agreements, and Federal Home Loan Bank open line of credit at December 31:


Table 20:  Short-Term Borrowings


 

Years Ended December 31,

 

2011

2010

2009

 

($ in thousands)

Balance end of year

$

13,655  

$

9,512  

$

7,983  

Average balance outstanding during year

$

12,285  

$

10,411  

$

12,031  

Maximum month-end balance outstanding

$

15,817  

$

18,329  

$

20,074  

Weighted average rate on amounts outstanding during year

1.00%

0.69%

1.06%

Weighted average rate on amounts outstanding at end of year

0.46%

0.49%

0.48%


At December 31, 2011 the Bank and Company had additional sources of liquidity available through pre-approved overnight federal funds lines of credit with corresponding banks, the Federal Reserve discount window and other long term borrowing agreements totaling $29,699.


Off-Balance Sheet Obligations


As of December 31, 2011 and 2010, we had the following commitments, which do not appear on our balance sheet:


50


Table 21: Commitments


 

2011

2010

 

($ in thousands)

Commitments to extend credit:

 

 

     Fixed rate

$

17,163

$

25,073

     Adjustable rate

23,515

33,406

Standby and irrevocable letters of credit-fixed rate

3,737

3,921

Credit card commitments

3,541

3,776



Further discussion of these commitments is included in Note 19, “Commitments and Contingencies” of the Notes to Consolidated Financial Statements.


Contractual Obligations


We are party to various contractual obligations requiring the use of funds as part of our normal operations.  The table below outlines principal amounts and timing of these obligations, excluding amounts due for interest, if applicable.  Most of these obligations are routinely refinanced into similar replacement obligations.  However, renewal of these obligations is dependent on our ability to offer competitive interest rates, liquidity needs, or availability of collateral for pledging purposes supporting the long-term advances.


Table 22:  Contractual Obligations


 

Payments due by period

 

Total

< 1 year

1-3 years

3-5 years

> 5 years

 

($ in thousands)

Subordinated debentures

$

10,310

$

0

$

0

$

0

$

10,310

Other long-term borrowings

10,000

0

5,000

5,000

0

FHLB borrowings

30,061

4,000

18,061

8,000

0

Total long-term borrowing obligations

$

50,371

$

4,000

$

23,061

$

13,000

$

10,310



Also, we have liabilities due to directors for services rendered with various payment terms depending on their anticipated retirement date or their election of payout terms following retirement. The total liability at December 31, 2011 for current and retired directors is $577, and is estimated to have a maturity in excess of five years.


Liquidity and Interest Rate Sensitivity


Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries, repurchase common stock, and satisfy other operating requirements.


Funds are available from a number of basic banking activity sources, primarily from the core deposit base and from the repayment and maturity of loans and investment securities. Additionally, liquidity is available from the sale of investment securities and brokered deposits.  Volatility or disruptions in the capital markets may impact the Company’s ability to access certain liquidity sources.


While dividends and service fees from the Bank and proceeds from the issuance of capital have historically been the primary funding sources for the Company, these sources may continue to be limited or costly (such as by regulation increasing the capital needs of the Bank, or by limited appetite for new sales of company stock).  No dividends were received in cash from the Bank in 2011, 2010 or 2009.  Also, as discussed in Part 1, Item 1 the Bank’s written Agreement with the FDIC and WDFI places restrictions on the payment of dividends from the Bank to the Company without prior approval with our regulators.  On May 12, 2011 the Company also entered into a separate formal written agreement with the Federal Reserve Bank of Minneapolis.  Pursuant to the written agreement at the holding company level, the Company needs the written consent of the Federal Reserve Bank of Minneapolis to pay dividends to its stockholders.  We are also prohibited from paying dividends on our common stock if we fail to make distributions or required payments on the Company’s


51


Debentures or on the TARP Preferred Stock. In consultation with the Federal Reserve, on May 12, 2011, the Company exercised its rights to suspend dividends on the outstanding TARP Preferred Stock and has also elected to defer interest on the Debentures.  See Part 1, Item 1 for additional discussion.


Investment securities are an important tool to the Company’s liquidity objective.  All investment securities are classified as available-for-sale and are reported at fair value on the consolidated balance sheet.  Approximately $65,548 of the $110,376 investment securities portfolio on hand at December 31, 2011, were pledged to secure public deposits, short-term borrowings, and for other purposes as required by law.  The majority of the remaining securities could be sold to enhance liquidity, if necessary.  


The scheduled maturity of loans could also provide a source of additional liquidity.  The Bank has $107,622, or 33%, of its total loans maturing within one year.  Factors affecting liquidity relative to loans are loan renewals, origination volumes, prepayment rates, and maturity of the existing loan portfolio.  The Bank’s liquidity position is influenced by changes in interest rates, economic conditions, and competition.  Conversely, loan demand as a need for liquidity may cause us to acquire other sources of funding which could be more costly than deposits.


Deposits are another source of liquidity for the Bank.  Deposit liquidity is affected by core deposit growth levels, certificates of deposit maturity structure, and retention and diversification of wholesale funding sources.  Deposit outflows would require the Bank to access alternative funding sources which may not be as liquid and may be more costly.


Other funding sources for the Bank are in the form of short-term borrowings (corporate repurchase agreements, and federal funds purchased), and long-term borrowings.  Long-term borrowings are used for asset/liability matching purposes and to access more favorable interest rates than deposits.  The Bank's liquidity resources were sufficient in 2011 to fund our loans and the growth in investments, and to meet other cash needs when necessary.


 Interest Rate Sensitivity Gap Analysis

   

Table 23 represents a schedule of the Bank’s assets and liabilities maturing over various time intervals.  The primary market risk faced by the Company is interest rate risk.  The table reflects a cumulative positive interest sensitivity gap position, i.e. more rate sensitive assets maturing than rate sensitive liabilities.  We extensively evaluate the cumulative gap position at the one and two-year time frames.  At those time intervals the cumulative maturity gap was within our established guidelines of 60% to 120%.  


52


Table 23: Interest Rate Sensitivity Gap Analysis


 

December 31, 2011

 

0-90

91-180

181-365

1-5

Beyond

 

 

Days

 Days

 Days

 Years

5 Years

Total

 

($ in thousands)

Earning Assets:

 

 

 

 

 

 

     Loans

$

37,166  

$

37,000  

$

62,033  

$

163,421  

$

30,243  

$

329,863

     Securities

8,780  

6,466  

8,618  

57,848  

28,664  

110,376

     Other earning assets

13,072  

0  

0  

0  

0  

13,072

Total

$

59,018  

$

43,466  

$

70,651  

$

221,269  

$

58,907  

$

453,311

Cumulative rate sensitive assets

$

59,018  

$

102,484  

$

173,135  

$

394,404  

$

453,311  

 

Interest-bearing liabilities:

 

 

 

 

 

 

     Interest-bearing deposits (1)

$

47,194  

$

34,922  

$

63,796  

$

138,727  

$

26,191  

$

310,830

     Borrowings

15,655  

2,000  

0  

36,061  

0  

53,716

     Subordinated debentures

0  

0  

0  

0  

10,310  

10,310

Total

$

62,849  

$

36,922  

$

63,796  

$

174,788  

$

36,501  

$

374,856

Cumulative interest sensitive liabilities

$

62,849  

$

99,771  

$

163,567  

$

338,355  

$

374,856  

 

Interest sensitivity gap

($3,831) 

$

6,544  

$

6,855  

$

46,481  

$

22,406  

 

Cumulative interest sensitivity gap

($3,831) 

$

2,713  

$

9,568  

$

56,049  

$

78,455  

 

Cumulative ratio of rate sensitive assets

to rate sensitive liabilities

93.9%

102.7%

105.8%

116.6%

120.9%

 


(1) The interest rate sensitivity assumptions for savings accounts, money market accounts, and interest-bearing demand deposits accounts are based on the Office of the Comptroller of the Currency tables regarding portfolio retention and interest rate repricing behavior.  Based on these experiences, a portion of these balances are considered to be long-term and fairly stable and are, therefore, included in the “1-5 Years” and “Beyond 5 Years” categories.


In order to limit exposure to interest rate risk, we monitor the liquidity and gap analysis on a monthly basis and adjust pricing, term and product offerings when necessary to stay within our guidelines and maximize effectiveness of asset/liability management.


We also estimate the effect a sudden change in interest rates could have on expected net interest income through income simulation.  The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, 300 and 400 basis points or decreasing 100 or 200 basis points.  All rates are increased or decreased parallel to the change in prime rate. The simulation assumes a static mix of assets and liabilities. As a result of the simulation, over a 12-month time period ending December 31, 2011, net interest income is estimated to increase 0.9% if rates increase 200 basis points.  In a down 200 basis point rate environment assumption, net interest income is estimated to decrease 8.3% during the same period. These results are based solely on the modeled changes in the market rates and do not reflect the earnings sensitivity that may arise from other factors such as changes in the shape of the yield curve, changes in spreads between key market rates, or changes in consumer or business behavior. These results also do not include any management action to mitigate potential income variances within the modeled process. We realize actual net interest income is largely impacted by the allocation of assets, liabilities and product mix. The simulation results are one indicator of interest rate risk.  We also estimate the effect changes in the yield curve may have on net interest income through various non-parallel rate shifts.  Several scenarios are run for extended projection time frames.


Management continually reviews its interest rate risk position through our Asset/Liability Committee process.  This is also reported to the board of directors through the Board Investment Committee on a bi-monthly basis.


53



Capital


The Company regularly reviews the adequacy of its capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. Management actively reviews capital strategies for the Company and the Bank in light of perceived business risks associated with current and prospective earning levels, liquidity, asset quality, economic conditions in the markets served, and level of dividends available to shareholders.  It is management’s intent to maintain an optimal capital and leverage mix for growth and for shareholder return.


Management believes that the Company and Bank had strong capital bases at the end of 2011.  As of December 31, 2011 and 2010, the Tier One Risk-Based capital ratio, Total Risk-Based capital (Tier 1 and Tier 2) ratio, and Tier One Leverage ratio for the Company and Bank were in excess of regulatory minimum requirements, as well as the heightened requirements as set forth in the Bank’s Agreement with the FDIC and WDFI.


On November 9, 2010, the Bank entered into a formal Agreement with the FDIC and the WDFI.  Under the terms of the agreement, the Bank is required to: (i) maintain ratios of Tier 1 capital to each of total assets and total risk-weighted assets of at least 8.5% and 12%, respectively; (ii) refrain from declaring or paying any dividend without the written consent of the FDIC and WDFI; and (iii) refrain from increasing its total assets by more than 5% during any three-month period without first submitting a growth plan to the FDIC and WDFI.  Additionally, on May 10, 2011, the Company entered into a formal written agreement with the Federal Reserve Bank of Minneapolis.  Pursuant to the Company Agreement, the Company needs the written consent of the Federal Reserve Bank of Minneapolis to pay dividends to our stockholders.  We are also prohibited from paying dividends on our common stock if we fail to make distributions or required payments on the Debentures or on our TARP Preferred Stock.  


On October 14, 2008, the Treasury announced details of the CPP whereby the Treasury made direct equity investments into qualifying financial institutions in the form of preferred stock, providing an immediate influx of Tier 1 capital into the banking system. Participants also adopted the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under this program.


On February 20, 2009, under the CPP, the Company issued 10,000 shares TARP Preferred Stock to the Treasury.  Total proceeds received were $10,000.  The proceeds received were allocated between the Series A Preferred Stock and the Series B Preferred Stock based upon their relative fair values, which resulted in the recording of a discount on the Series A Preferred Stock and a premium on the Series B Preferred Stock.  The discount and premium will be amortized over five years.  The allocated carrying value of the Series A Preferred Stock and Series B Preferred Stock on the date of issuance (based on their relative fair values) was $9,442 and $558, respectively.  Cumulative dividends on the Series A Preferred Stock accrue and are payable quarterly at a rate of 5% per annum for five years. The rate will increase to 9% per annum thereafter if the shares are not redeemed by the Company.  The Series B Preferred Stock dividends accrue and are payable quarterly at 9%.  All $10,000 of the CPP Preferred Stock qualify as Tier 1 Capital for regulatory purposes at the Company.


A summary of the Company’s and Bank’s regulatory capital ratios as of December 31, 2011 and 2010 are as follows:


54


Table 24:  Capital


 

For Capital Adequacy

 

Purposes (1)

 

Amount

Ratio

Amount

Ratio

Amount

Ratio

 

($ in thousands)

December 31, 2011

 

 

 

 

 

 

Mid-Wisconsin Financial Services, Inc.

 

 

 

 

 

 

Tier 1 to average assets

$

46,729

9.6%

$

19,396

4.0%

 

 

Tier 1 risk-based capital ratio

46,729

14.3%

13,071

4.0%

 

 

Total risk-based capital ratios

50,884

15.6%

26,142

8.0%

 

 

Mid-Wisconsin Bank

 

 

 

 

 

 

Tier 1 to average assets

$

41,736

8.7%

$

19,261

4.0%

$

40,929

8.5%

Tier 1 risk-based capital ratio

41,736

12.9%

12,946

4.0%

19,419

6.0%

Total risk-based capital ratios

45,853

14.2%

25,891

8.0%

38,837

12.0%

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

Mid-Wisconsin Financial Services, Inc.

 

 

 

 

 

 

Tier 1 to average assets

$

50,575

10.0%

$

20,143

4.0%

 

 

Tier 1 risk-based capital ratio

50,575

14.2%

14,252

4.0%

 

 

Total risk-based capital ratios

55,091

15.5%

28,504

8.0%

 

 

Mid-Wisconsin Bank

 

 

 

 

 

 

Tier 1 to average assets

$

44,787

9.0%

$

20,024

4.0%

$

42,552

8.5%

Tier 1 risk-based capital ratio

44,787

12.7%

14,140

4.0%

21,210

6.0%

Total risk-based capital ratios

49,268

13.9%

28,280

8.0%

42,420

12.0%


(1) The Bank has agreed with the FDIC and WDFI that, until its formal written agreement with such parties is no longer in effect, it will maintain minimum capital ratios at specified levels higher that those otherwise required by applicable regulations as follows:  Tier 1 capital to total average assets - 8.5% and total capital to risk-weighted assets (total capital) - 12%.

(2) Prompt corrective action provisions are not applicable at the bank holding company level.



The Company’s ability to pay dividends depends in part upon the receipt of dividends from the Bank and these dividends are subject to limitation under banking laws and regulations. Pursuant to the Agreement with the FDIC and WDFI, the Bank needs the written consent of the regulators to pay dividends to the Company.  The Bank has not paid dividends to the Company since 2006.  In consultation with the Federal Reserve Bank of Minneapolis, on May 12, 2011, the Company exercised its rights to suspend dividends on the outstanding TARP Preferred Stock and has also elected to defer interest on the Debentures.  Under the terms of the Debentures, the Company is allowed to defer payments of interest for 20 quarterly periods without default or penalty, but such amounts will continue to accrue.  Also during the deferral period, the Company generally may not pay cash dividends on or repurchase its common stock or preferred stock, including the TARP Preferred Stock.  Dividend payments on the TARP Preferred Stock may be deferred without default, but the dividend is cumulative and therefore will continue to accrue and, if the Company fails to pay dividends for an aggregate of six quarters, whether or not consecutive, the holder will have the right to appoint representatives to the Company’s board of directors.  The terms of the TARP Preferred Stock also prevent the Company from paying cash dividends on or repurchasing its common stock while dividends are in arrears.  Therefore, the Company will not be able to pay dividends on its common stock until it has fully paid all accrued and unpaid dividends on the Debentures and the TARP Preferred Stock.  On December 31, 2011, the Company had $485 accrued and unpaid dividends on the TARP Preferred Stock and $146 accrued and unpaid interest due on the Debentures.


Effects of Inflation

The effect of inflation on a financial institution differs significantly from the effect on an industrial company.  While a financial institution’s operating expenses, particularly salary and employee benefits, are affected by general inflation, the asset and liability structure of a financial institution consists largely of monetary items.  Monetary items, such as cash, loans and deposits, are those assets and liabilities which are or will be converted


55


into a fixed number of dollars regardless of changes in prices.  As a result, changes in interest rates have a more significant impact on a financial institution’s performance than does general inflation.  For additional information regarding interest rates and changes in net interest income see “Liquidity and Interest Rate Sensitivity”.


Selected Quarterly Financial Data


The following is selected financial data summarizing the results of operations for each quarter in the years ended December 31, 2011, 2010 and 2009:


Table 25:  Selected Quarterly Financial Data


 

2011 Quarter Ended

 

December 31,

September 30,

June 30,

March 31,

 

(In thousands, except per share data)

Interest income

$

5,507 

$

5,368 

$

5,519 

$

5,645 

Interest expense

1,467 

1,594 

1,663 

1,761 

  Net interest income

4,040 

3,774 

3,856 

3,884 

Provision for loan losses

900 

900 

1,900 

1,050 

Income (loss) before income taxes

(589)

(395)

(1,249)

137 

Net (loss) available to common equity

(3,373)

(346)

(862)

(20)

Basic and diluted (loss) per common share

($2.04)

($0.21)

($0.52)

($0.01)


 

2010 Quarter Ended

 

December 31,

September 30,

June 30,

March 31,

 

(In thousands, except per share data)

Interest income

$

6,018

$

6,196

$

6,391

$

6,457 

Interest expense

2,004

2,175

2,255

2,328 

  Net interest income

4,014

4,021

4,136

4,129 

Provision for loan losses

1,500

900

955

1,400 

Income (loss) before income taxes

305

183

456

(66)

Net income (loss) available to common equity

80

2

168

(148)

Basic and diluted earnings (loss) per common share

$

0.05

$

0.00

$

0.10

($0.09)


 

2009 Quarter Ended

 

December 31,

September 30,

June 30,

March 31,

 

(In thousands, except per share data)

Interest income

$6,623

$6,665

$6,822

$6,822

Interest expense

2,456

2,554

2,701

2,789

  Net interest income

4,167

4,111

4,121

4,033

Provision for loan losses

2,856

2,150

2,750

750

Income (loss) before income taxes

(1,475)

(1,289)

(2,017)

377

Net income (loss) available to common equity

(1,155)

(833)

(1,252)

207

Basic and diluted earnings (loss) per common share

($0.70)

($0.51)

($0.76)

$0.13



ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


The information required by this Item 7A is set forth in “Liquidity and Interest Rate Sensitivity”  under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, which such information is incorporated herein by reference.


56



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



Report of Independent Registered Public Accounting Firm


Board of Directors and Stockholders

Mid-Wisconsin Financial Services, Inc.

Medford, Wisconsin


We have audited the accompanying consolidated balance sheets of Mid-Wisconsin Financial Services, Inc. and Subsidiary as of December 31, 2011 and 2010, and the related consolidated statements of income (loss), changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2011.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.


We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included considerations of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.


In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mid-Wisconsin Financial Services, Inc. and Subsidiary at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States.



WIPFLI LLP

Wipfli LLP




March 19, 2012

Oak Brook, Illinois


57



Mid-Wisconsin Financial Services, Inc. and Subsidiary

Consolidated Balance Sheets

December 31, 2011 and 2010

(In thousands, except share data)

 

2011

2010

Assets

 

 

Cash and due from banks

$

18,278 

$

9,502 

Interest-bearing deposits in other financial institutions

10 

Federal funds sold and securities purchased under agreements to sell

13,072 

32,473 

Investment securities available-for-sale, at fair value

110,376 

101,310 

Loans held for sale

2,163 

7,444 

Loans

329,863 

339,170 

Less: Allowance for loan losses

(9,816)

(9,471)

Loans, net

320,047 

329,699 

Accrued interest receivable

1,640 

1,853 

Premises and equipment, net

7,943 

8,162 

Other investments, at cost

2,616 

2,616 

Deferred tax asset

1,179 

3,959 

Other assets

10,852 

12,056 

Total assets

$

488,176 

$

509,082 

Liabilities and Stockholders' Equity

 

 

Noninterest-bearing deposits

$

70,790 

$

60,446 

Interest-bearing deposits

310,830 

340,164 

  Total deposits

381,620 

400,610 

Short-term borrowings

13,655 

9,512 

Long-term borrowings

40,061 

42,561 

Subordinated debentures

10,310 

10,310 

Accrued interest payable

878 

992 

Accrued expenses and other liabilities

2,139 

2,127 

Total liabilities

448,663 

466,112 

Stockholders' equity:

 

 

Series A preferred stock

9,745 

9,634 

Series B preferred stock

526 

538 

Common Stock

166 

165 

  Additional paid-in capital

11,945 

11,916 

  Retained earnings

15,526 

20,127 

  Accumulated other comprehensive income

1,605 

590 

  Total stockholders' equity

39,513 

42,970 

Total liabilities and stockholders' equity

$

488,176 

$

509,082 

Series A preferred stock authorized (no par value)

10,000 

10,000 

Series A preferred stock issued and outstanding

10,000 

10,000 

Series B preferred stock authorized (no par value)

500 

500 

Series B preferred stock issued and outstanding

500 

500 

Common stock authorized (par value $0.10 per share)

6,000,000 

6,000,000 

Common stock issued and outstanding

1,657,119 

1,652,122 

The accompanying notes to the consolidated financial statements are an integral part of these statements.


58



Mid-Wisconsin Financial Services, Inc. and Subsidiary

Consolidated Statements of Income (Loss)

Years Ended December 31, 2011, 2010, and 2009

(In thousands, except per share data)

 

2011

2010

2009

Interest Income

 

 

 

   Loans, including fees

$

18,910 

$

21,325 

$

22,756 

   Securities:

 

 

 

     Taxable

2,563 

3,216 

3,540 

     Tax-exempt

403 

366 

487 

   Other

163 

155 

149 

Total interest income

22,039 

25,062 

26,932 

Interest Expense

 

 

 

   Deposits

4,566 

6,402 

7,801 

   Short-term borrowings

122 

95 

124 

   Long-term borrowings

1,614 

1,670 

1,961 

   Subordinated debentures

183 

595 

614 

Total interest expense

6,485 

8,762 

10,500 

Net interest income

15,554 

16,300 

16,432 

Provision for loan losses

4,750 

4,755 

8,506 

Net interest income after provision for loan losses

10,804 

11,545 

7,926 

Noninterest Income

 

 

 

   Service fees

953 

1,174 

1,239 

   Trust service fees

1,066 

1,103 

1,024 

   Investment product commissions

221 

221 

237 

   Mortgage banking

523 

955 

564 

   Gain (loss) on sale of investments

(55)

1,054 

449 

   Other

1,579 

1,043 

908 

Total noninterest income

4,287 

5,550 

4,421 

Other-than-temporary impairment losses, net

 

 

 

  Total other-than-temporary impairment losses

(426)

(374)

  Amount in other comprehensive income, before taxes

14 

73 

Total impairment

(412)

(301)

Noninterest Expense

 

 

 

   Salaries and employee benefits

8,561 

8,537 

8,411 

   Occupancy

1,769 

1,830 

1,893 

   Data processing

667 

651 

648 

   Foreclosure/OREO expense

857 

243 

1,278 

   Legal and professional fees

891 

677 

882 

   FDIC expense

1,117 

1,036 

1,057 

   Other

3,325 

2,831 

2,281 

Total noninterest expense

17,187 

15,805 

16,450 

Income (loss) before income taxes

(2,096)

878 

(4,404)

Income tax (benefit) expense

1,861 

135 

(1,916)

Net income (loss)

(3,957)

743 

(2,488)

Preferred stock dividends, discount and premium

(644)

(641)

(545)

Net income (loss) available to common equity

($4,601)

$

102 

($3,033)

Earnings (loss) per common share:

 

 

 

Basic and diluted

($2.78)

$

0.06 

($1.84)

The accompanying notes to the consolidated financial statements are an integral part of these statements.

 

 Mid-Wisconsin Financial Services, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders' Equity

Years Ended December 31, 2011, 2010, and 2009

(In thousands, except per share data)

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

Additional

 

Other

 

 

Preferred Stock

Common Stock

Paid-In

Retained

Comprehensive

 

 

Shares

Amount

Shares

Amount

Capital

Earnings

Income (Loss)

Totals

Balance, January 1, 2009

0

0

1,644

164

11,804

23,239 

598

35,805 

Comprehensive loss:

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

(2,488)

 

(2,488)

Other comprehensive income

 

 

 

 

 

 

370

370 

Reclassification adjustment for net realized gains on securities available-for-sale included in earnings, net of tax

 

 

 

 

 

 

88

88 

Total comprehensive loss

 

 

 

 

 

 

 

(2,030)

Issuance of preferred stock Series A

10,000

9,442 

 

 

 

 

 

9,442 

Issuance of preferred stock Series B

500

558 

 

 

 

 

 

558 

Accretion of preferred stock discount

 

85 

 

 

 

(85)

 

Amortization of preferred stock premium

 

(9)

 

 

 

 

Issuance of common stock:

 

 

 

 

 

 

 

 

Proceeds from stock purchase plans

 

 

4

1

34

 

 

35 

Cash dividends:

 

 

 

 

 

 

 

 

Preferred stock

 

 

 

 

 

(401)

 

(401)

Common stock, $0.11 per share

 

 

 

 

 

(181)

 

(181)

Dividends - Preferred stock

 

 

 

 

 

(68)

 

(68)

Stock-based compensation

 

 

 

 

24

 

 

24 

Balance, December 31, 2009

10,500

$

10,076

1,648

$

165

$

11,862

$

20,025

$

1,056

$

43,184

Comprehensive income:

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

743 

 

743 

Other comprehensive loss

 

 

 

 

 

 

(854)

(854)

Reclassification adjustment for net realized gains on securities available-for-sale included in earnings, net of tax

 

 

 

 

 

 

388 

388 

Total comprehensive income

 

 

 

 

 

 

 

277 

Accretion of preferred stock discount

 

107 

 

 

 

(107)

 

Amortization of preferred stock premium

 

(11)

 

 

 

11 

 

Issuance of common stock:

 

 

 

 

 

 

 

 

Proceeds from stock purchase plans

 

 

4

0

32

 

 

32 

Dividends - Preferred stock

 

 

 

 

 

(545)

 

(545)

Stock-based compensation

 

 

 

 

22

 

 

22

Balance, December 31, 2010

10,500

$

10,172 

1,652

$

165

$

11,916

$

20,127 

$

590 

$

42,970 

Comprehensive loss:

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

(3,957)

 

(3,957)

Other comprehensive income

 

 

 

 

 

 

982

982 

Reclassification adjustment for net realized losses on securities available-for-sale included in earnings, net of tax

 

 

 

 

 

 

33

33 

Total comprehensive loss

 

 

 

 

 

 

 

(2,942)

Accretion of preferred stock discount

 

111 

 

 

 

(111)

 

Amortization of preferred stock premium

 

(12)

 

 

 

12 

 

Issuance of common stock:

 

 

 

 

 

 

 

 

Proceeds from stock purchase plans

 

 

5

1

29

 

 

30 

Dividends - Preferred stock

 

 

 

 

 

(545)

 

(545)

Balance, December 31, 2011

10,500

$

10,271

1,657

$

166

$

11,945

$

15,526

$

1,605

$

39,513

The accompanying notes to the consolidated financial statements are an integral part of these statements.

 

 


60



Mid-Wisconsin Financial Services, Inc. and Subsidiary

 

 

 

Consolidated Statements of Cash Flows

 

 

 

Years Ended December 31, 2011, 2010, and 2009

 

 

 

(In thousands, except per share data)

 

 

 

 

2011

2010

2009

Increase (decrease) in cash and due from banks:

 

 

 

     Cash flows from operating activities:

 

 

 

     Net income (loss)

($3,957)

$

743 

($2,488)

     Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

Depreciation and amortization

1,094 

911 

961 

 

Provision for loan losses

4,750 

4,755 

8,506 

 

Provision for valuation allowance OREO

628 

159 

958 

 

Benefit for deferred income taxes

(868)

(90)

(1,578)

 

(Gain) loss on sale of investment securities

55 

(1,054)

(449)

 

Other-than-temporary impairment losses, net

412 

301 

 

(Gain) loss on premises and equipment disposals

(44)

12 

 

(Gain) loss on sale of foreclosed OREO

(241)

(187)

91 

 

Stock-based compensation

22 

24 

 

Valuation allowance - deferred taxes

2,911 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 Loans held for sale

5,281 

(1,992)

(4,968)

 

 

 Other assets

1,590 

939 

(3,906)

 

 

 Other liabilities

(510)

(503)

(376)

Net cash provided by (used in) operating activities

10,689 

4,115 

(2,912)

     Cash flows from investing activities:

 

 

 

 

Net (increase) decrease in interest-bearing deposits in other financial institutions

(2)

 

Net (increase) decrease in federal funds sold

19,401 

(23,409)

13,236 

 

Securities available for sale:

 

 

 

 

 

Proceeds from sales

641 

38,146 

12,717 

 

 

Proceeds from maturities

33,184 

32,614 

25,238 

 

 

Payment for purchases

(41,563)

(68,747)

(59,552)

 

Net increase (decrease) in loans

2,346 

12,220 

(639)

 

Capital expenditures

(685)

(682)

(280)

 

Proceeds from sale of premises and equipment

223 

 

Proceeds from sale of OREO

1,995 

1,590 

1,012 

Net cash provided by (used in) investing activities

15,540 

(8,263)

(8,251)


61



Mid-Wisconsin Financial Services, Inc. and Subsidiary

 

 

 

Consolidated Statements of Cash Flows

 

 

 

Years Ended December 31, 2011, 2010, and 2009

 

 

 

(In thousands, except per share data)

 

 

 

 

 

 

2011

2010

2009

      Cash flows from financing activities:

 

 

 

 

Net increase (decrease) in deposits

($18,990)

$

2,810 

$

12,125 

 

Net increase (decrease) in short-term borrowings

4,143 

1,529 

(3,328)

 

Proceeds from issuance of long-term borrowings

22,061 

6,500 

 

Principal payments on long-term borrowings

(2,500)

(22,061)

(13,368)

 

Proceeds from issuance of preferred stock and common stock warrants

10,000 

 

Proceeds from stock benefit plans

30 

32 

35 

 

Cash dividends paid preferred stock

(136)

(545)

(401)

 

Cash dividends paid common stock

(181)

Net cash provided by (used in) financing activities

(17,453)

3,826 

11,382 

Net increase (decrease) in cash and due from banks

8,776 

(322)

219 

Cash and due from banks at beginning of year

9,502 

9,824 

9,605 

Cash and due from banks at end of year

$

18,278 

$

9,502 

$

9,824 

Supplemental disclosures of cash flow information:

 

 

 

Cash paid  (refunded) during the year for:

 

 

 

Interest

$

6,599 

$

9,057 

$

10,931 

Income  taxes

250 

(19)

Noncash investing and financing activities:

 

 

 

Loans transferred to OREO

$

2,631 

$

4,965 

$

1,652 

Loans charged-off

4,988 

4,034 

5,283 

Dividends declared but not yet paid on preferred stock

477 

68 

68 

Loans made in connection with the sale of OREO

75 

981 

339 

The accompanying notes to the consolidated financial statements are an integral part of these statements.

 


62


Mid-Wisconsin Financial Services, Inc. and Subsidiary

Notes to Consolidated Financial Statements

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


Note 1- Summary of Significant Accounting Policies


Principal Business Activity

Mid-Wisconsin Financial Services, Inc. (the “Company”) operates as a full-service financial institution with a primary market area including, but not limited to, Clark, Eau Claire, Lincoln, Marathon, Oneida, Price, Taylor and Vilas Counties, Wisconsin. It provides a variety of traditional banking product sales, insurance services, and wealth management services. The Company is regulated by federal and state agencies and is subject to periodic examinations by those agencies.


Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiary, Mid-Wisconsin Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, Mid-Wisconsin Investment Corporation. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform to generally accepted accounting principles and to general practices within the banking industry.


The Company also owns Mid-Wisconsin Statutory Trust 1 (the “Trust”), a wholly owned subsidiary that is a variable interest entity because the Company is not the primary beneficiary and, as a result, the Trust’s financial statements are not consolidated with the Company. The Trust is a qualifying special-purpose entity established for the sole purpose of issuing trust preferred securities. The proceeds from the issuance were used by the Trust to purchase subordinated debentures (the “Debentures”) of the Company, which is the sole asset of the Trust. Liabilities on the consolidated balance sheets include the subordinated debentures related to the Trust, as more fully described in Note 11.


Estimates

The preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ significantly from those estimates.  Estimates that are susceptible to significant change include the determination of the allowance for loan losses and the valuation of investment securities.


Cash Equivalents

For purposes of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption “Cash and due from banks.” Cash and due from banks include cash on hand and non-interest-bearing deposits at correspondent banks.


Investment Securities Available-for-Sale

Securities are classified as available-for-sale and are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in stockholders’ equity as a separate component of other comprehensive income.  Amortization of premiums and accretion of discounts are recognized in interest income using the interest method over the terms of the securities. Declines in fair value of securities that are deemed to be other-than-temporary are reflected in earnings as a realized loss, and a new cost basis is established. In estimating other-than-temporary impairment losses, management considers the length of time and the extent to which fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are determined using the specific-identification method.


Loans Held for Sale

Loans held for sale consist of the current origination of certain fixed rate mortgage loans and are recorded at the lower of aggregate cost or fair value. A gain or loss is recognized at the time of the sale reflecting the present value of the difference between the contractual interest rate of the loans sold and the yield to the investor. All


63


Notes to Consolidated Financial Statements (Continued)

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


loans held for sale at December 31, 2011 and 2010 have a forward sale commitment from an investor. Mortgage servicing rights are not retained.


Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest on loans is accrued and credited to income based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.


Loans are considered past due if the required principal and interest payments have not been received as of the date such payments are due.  Loans are generally placed on nonaccrual status when management has determined collection of such interest is doubtful or when a loan is contractually past due 90 days or more as to interest or principal payments.  When loans are placed on nonaccrual status or charged-off, all current year unpaid accrued interest is reversed against interest income. The interest on these loans is subsequently accounted for on the cash basis until qualifying for return to accrual status.  If collectability of the principal is in doubt, payments received are applied to loan principal.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  


A loan is accounted for as a troubled debt restructuring if the Company, for economic or legal reasons related to the borrower’s financial condition, grants a significant concession to the borrower that it would not otherwise consider.  A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate, a reduction of accrued interest, an extension of the maturity date at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions.  All restructured loans are considered impaired for reporting and measurement purposes.  A loan that has been modified at a below market rate will return to performing status if it satisfies the nine-month performance requirement; however, it will remain classified as a restructured loan.  


Allowance for Loan Losses

The allowance for loan losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio, and is based on quarterly evaluations of the collectability and historical loss experience of loans.  Loans are charged against the allowance for loan losses when management believes the collectability of the principal in unlikely.  A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio.


The allocation methodology applied by the Company to assess the appropriateness of the allowance for loan losses focuses on evaluation of several factors, including but not limited to:  (i) the establishment of specific reserve allocations on impaired credits when a high risk of loss is anticipated but not yet realized; (ii) management’s ongoing review and grading of the loan portfolio; (ii) consideration of historical loan loss and delinquency experience on each portfolio category; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various classifications of loans; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses.  The total allowance is available to absorb losses from any segment of the portfolio.


The allowance for loan losses includes specific allowances related to loans which have been judged to be impaired under current accounting standards. A loan is impaired when, based on current information, it is probable the Company will not collect all amounts due in accordance with the original contractual terms of the loan agreement, including both principal and interest. Management has determined that loans that have a nonaccrual status or have had their terms restructured in a trouble debt restructuring meet this definition. Large groups of homogeneous loans, such as mortgage and consumer loans, are primarily evaluated using historical


64


Notes to Consolidated Financial Statements (Continued)

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


loss rates. Specific allowances on impaired loans are based on an evaluation of the customers’ cash flow ability to repay the loan or the fair value of the collateral if the loan is collateral dependent.


Management believes that the level of the allowance for loan loss is appropriate.  While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions.  


In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to make additions to the allowance for loan losses and certain loan balances to be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.


Premises and Equipment

Premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed on a straight-line method and is based on the estimated useful lives of the assets.  Maintenance and repair costs are charged to expense as incurred. Gains or losses on disposition of premises and equipment are reflected in income.


Other Real Estate Owned (“OREO”)

OREO consists of real estate properties acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure.  OREO is recorded at the lower of the recorded investment in the loan at the time of acquisition or the fair value of the underlying property value, less estimated selling costs.  Any write-down in the carrying value of a property at the time of acquisition is charged to the allowance for loan losses.  Any subsequent write-downs to reflect current fair market value, as well as gains and losses on sale, and revenues and expenses incurred in maintaining such properties, are treated as period costs.  OREO is included in the balance sheet caption “Other assets.”


Federal Home Loan Bank (“FHLB”) Stock

As a member of the FHLB system, the Company is required to hold stock in the FHLB based on the outstanding amount of FHLB borrowings.  This stock is recorded at cost, which approximates fair value. The FHLB of Chicago is under regulatory requirements which require approval of dividend restrictions and stock redemptions.  The stock is evaluated for impairment on an annual basis. However, the stock is viewed as a long-term investment; therefore, its value is determined based on the ultimate recovery of the par value rather than recognizing temporary declines in value. Transfer of the stock is substantially restricted.  FHLB stock is included in the balance sheet caption “Other investments, at cost” and totals $2,306 at December 31, 2011 and 2010.


Income Taxes

Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws.  Deferred income taxes, which arise from temporary differences between the amounts reported in the financial statements and the tax basis of assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities as measured by the current enacted tax rates which will be in effect when these differences are expected to reverse. Provision (credit) for deferred taxes is the result of changes in deferred tax assets and liabilities. A deferred tax valuation allowance is established if it is more likely than not that all or a portion of deferred tax assets will not be realized.


The Company may also recognize a liability for unrecognized tax benefits from uncertain tax positions.  Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements.  Interest and penalties related to unrecognized tax benefits are classified as income taxes.  


65


Notes to Consolidated Financial Statements (Continued)

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


Off-Balance Sheet Financial Instruments

In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commitments under commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.


Rate Lock Commitments

The Company enters into commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The mortgage loans are sold to the secondary market shortly after the loan is closed.  The fair value of the mortgage loan rate lock commitments is immaterial to the financial statements.  The Company’s rate lock commitments were $13,655 and $8,542 at December 31, 2011 and 2010, respectively.


Segment Information

The Company, through a branch network of its banking subsidiary, provides a full range of consumer and commercial banking services to individuals, businesses, and farms in north central Wisconsin. These services include demand, time, and savings deposits; safe deposit services; credit cards; notary services; night depository; money orders; traveler’s checks; cashier’s checks; savings bonds; secured and unsecured consumer, commercial, and real estate loans; ATM processing; cash management; merchant capture; online banking; and trust and financial planning.


While the Company’s management monitors the revenue streams of various Company products and services, operations are managed and financial performance is evaluated on a companywide basis.  Accordingly, all of the Company’s banking operations are considered by management to be aggregated in one reportable operating segment.


Advertising Costs

Advertising costs are generally expensed as incurred.


Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale, net of tax, which are recognized as a separate component of equity, and accumulated other comprehensive income (loss).


Earnings (loss) per Common Share

Earnings (loss) per common share is calculated by dividing net income (loss) available to common equity by the weighted average number of common shares outstanding.


Diluted earnings (loss) per common share includes the potential common stock shares issuable under stock option plans.


Stock-Based Compensation

The Company accounts for employee stock compensation plans using the fair value based method of accounting. Under this method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is also the vesting period.


Reclassifications

Certain reclassifications have been made to prior year financial statements to conform to the 2011 classifications.


Subsequent Events

Management has reviewed the Company’s operations for potential disclosure of information or financial statement impacts related to events occurring after December 31, 2011, but prior to the release of these financial statements.  Based on the results of this review, no subsequent event disclosures are required as of the release date.


66


Notes to Consolidated Financial Statements (Continued)

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


Recent Accounting Pronouncements

In April 2011, the FASB issued clarifying guidance regarding which loan modifications constitute troubled debt restructurings.  In evaluating whether a restructuring constitutes a troubled debt restructuring, the guidance maintains a creditor must separately conclude that the restructuring constitutes a concession and the debtor is experiencing financial difficulties.  The accounting standard provides further guidance with respect to whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties.  The measurement guidance is effective for interim and annual periods beginning on or after June 15, 2011, while the disclosure guidance is effective for interim and annual periods beginning on or after June 15, 2011 with retrospective application to restructurings occurring on or after the beginning of the fiscal year.  The Company adopted the accounting standard as of the beginning of the third quarter of 2011, as required, with no material impact on its results of operations, financial position, and liquidity.


In July 2010, the FASB issued guidance for improving disclosures about an entity’s allowance for loan losses and the credit quality of its loans.  The guidance requires additional disclosure to facilitate financial statement users’ evaluation of the following: (1) the nature of credit risk inherent in the entity’s loan portfolio, (2) how that risk is analyzed and assessed in arriving at the allowance for loan losses, and (3) the changes and reasons for those changes in the allowance for loan losses.  The increased disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010.  Increased disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 31, 2010.  The Company adopted the accounting standard as of December 31, 2010, with no material impact on the consolidated financial statements of the Company.


In January 2010, the FASB issued an accounting standard providing additional guidance relating to fair value measurement disclosures.  Specifically, companies are required to separately disclose significant transfers into and out of Level 1 and Level 2 measurements in the fair value hierarchy and the reasons for those transfers.  Significance should generally be based on earnings and total assets or liabilities, or when changes are recognized in other comprehensive income, based on total equity.  Companies may take different approaches in determining when to recognize such transfers, including using the actual date of the event or change in circumstances causing the transfer, or using the beginning or ending of a reporting period.  For Level 3 fair value measurements, the new guidance requires presentation of separate information about purchases, sales, issuances and settlements.  The FASB also clarified existing fair value measurement disclosure requirements relating to the level of disaggregation, inputs, and valuation techniques.  This accounting standard was effective at the beginning of 2010, except for the detailed Level 3 disclosures which were effective at the beginning of 2011.  The Company adopted the accounting standard including the Level 3 disclosures with no material impact on the consolidated financial statements of the Company.


In April 2011, the FASB issued an accounting standard that modifies the criteria for determining when repurchase agreements would be accounted for as a secured borrowing rather than as a sale.  Currently, an entity that maintains effective control over transferred financial assets must account for the transfer as a secured borrowing rather than as a sale.  The provisions remove from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee.  The FASB believes that contractual rights and obligations determine effective control and that there does not need to be a requirement to assess the ability to exercise those rights.  The accounting standard does not change the other existing criteria used in the assessment of effective control and is effective prospectively for transactions, or modifications of existing transactions, that occur on or after January 1, 2012.  As the Company accounts for all of its repurchase agreements as collateralized financing arrangements, the adoption of this accounting standard is not expected to have a material impact on the consolidated financial statements of the Company.

 

67


Notes to Consolidated Financial Statements (Continued)

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


In May 2011, the FASB issued an accounting standard that provides a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) and International Financial Reporting Standards (“IFRS”).  The changes to U.S. GAAP as a result of the accounting standard are as follows:  (1) the concepts of highest and best use and valuation premise are only relevant when measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities); (2) U.S. GAAP currently prohibits application of a blockage factor in valuing financial instruments with quoted prices in active markets, while the new accounting standard extends that prohibition to all fair value measurements; (3) an exception is provided to the basic fair value measurement principles for an entity that holds a group of financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk that are managed on the basis of the entity’s net exposure to either of those risks, which such exception allows the entity, if certain criteria are met, to measure the fair value of the net asset or liability position in a manner consistent with how market participants would price the net risk position; (4) the fair value measurement of instruments classified within an entity’s shareholders’ equity have been aligned with the guidance for liabilities; and (5) disclosure requirements have been enhanced for recurring Level 3 fair value measurements to disclose quantitative information about unobservable inputs and assumptions used, to describe the valuation processes used by the entity, and to describe the sensitivity of fair value measurements to changes in unobservable inputs and interrelationships between those inputs.  In addition, entities must report the level in the fair value hierarchy of items that are not measured at fair value in the statement of condition but whose fair value must be disclosed.  The provisions of the accounting standard are effective for the Company’s interim reporting period beginning on or after December 15, 2011.  The adoption of this accounting standard is not expected to have a material impact on the consolidated financial statements of the Company.

 

In June 2011, the FASB issued an accounting standard that allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  The statement(s) are required to be presented with equal prominence as the other primary financial statements.  The accounting pronouncement eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity but does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The provisions of this accounting standard are effective for the Company’s interim reporting period beginning on or after December 15, 2011, with retrospective application required.  The adoption of this accounting standard will have no material impact on the consolidated financial statements of the Company.


Note 2- Earnings (Loss) per Common Share


Earnings (loss) per common share is calculated by dividing net income (loss) available to common equity by the weighted average number of common shares outstanding.  Diluted earnings (loss) per share is calculated by dividing net income (loss) available to common equity by the weighted average number of shares adjusted for the dilutive effect of common stock awards.  Presented below are the calculations for basic and diluted earnings (loss) per common share.


68


Notes to Consolidated Financial Statements (Continued)

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


 

For the Years Ended December 31,

 

2011

2010

2009

Net income (loss)

($3,957)

$

743 

($2,488)

Preferred stock dividends, discount and premium

(644)

(641)

(545)

Net income (loss) available to common equity

($4,601)

$

102 

($3,033)

Weighted average common shares outstanding

1,654 

1,650 

1,645 

Effect of dilutive stock options

Diluted weighted average common shares outstanding

1,654 

1,650 

1,646 

Basic and diluted earnings (loss) per common share

($2.78)

$

0.06 

($1.84)


Note 3- Cash and Due From Banks


Cash and due from banks in the amount of $257 and $298 was restricted at December 31, 2011 and 2010, respectively, to meet the reserve requirements of the Federal Reserve System.


In the normal course of business, the Bank maintains cash and due from bank balances with correspondent banks. Accounts at each institution are insured in full by the Federal Deposit Insurance Corporation (“FDIC”). Federal funds sold invested in other institutions are not insured.  


69


Notes to Consolidated Financial Statements (Continued)

December 31, 2011, 2010, and 2009 (In thousands, except per share data)


Note 4- Securities


The amortized cost and fair values of investment securities available-for-sale at December 31, 2011 and 2010 were as follows:


 

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair Value

December 31, 2011

 

 

 

 

U.S. Treasury securities and obligations of U.S. government corporations and agencies

$

18,479

$

329

$

0

$

18,808

Mortgage-backed securities

66,622

1,110

79

67,653

Obligations of states and political subdivisions

21,619

1,316

3

22,932

Corporate debt securities

831

1

0

832

Total debt securities

107,551

2,756

82

110,225

Equity securities

151

0

0

151

Total securities available-for-sale

$

107,702

$

2,756

$

82

$

110,376


 

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair Value

December 31, 2010

 

 

 

 

U.S. Treasury securities and obligations of U.S. government corporations and agencies

$

22,732

$

69

$

234

$

22,567

Mortgage-backed securities

56,292

908

284

56,916

Obligations of states and political subdivisions

20,239

661

185

20,715

Corporate debt securities

974

0

13

961

Total debt securities

100,237