Bank Mutual (BKMU) 10-Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

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

For the quarterly period ended September 30, 2006

OR

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

Commission File Number 000-31207

BANK MUTUAL CORPORATION

(Exact name of registrant as specified in its charter)

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

4949 West Brown Deer Road
Milwaukee, WI 53223
(414) 354-1500

(Address, including Zip Code, and telephone number,

including area code, of registrant’s principal executive offices)

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

Yesþ      Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero      Accelerated filerþ     Non-accelerated filero

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

Yeso      Noþ

The number of shares outstanding of the issuer’s common stock $0.01 par value per share, was 60,307,411 shares, at October 31, 2006.

BANK MUTUAL CORPORATION

10-Q INDEX

	Page No.
PART I. FINANCIAL INFORMATION
Item l. Financial Statements
Unaudited Consolidated Statements of Financial Condition as of September 30, 2006 and December 31, 2005	3
Unaudited Consolidated Statements of Income for the three months ended September 30, 2006 and 2005	4
Unaudited Consolidated Statements of Income for the nine months ended September 30, 2006 and 2005	5
Unaudited Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2006 and 2005	6
Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005	7-8
Notes to Unaudited Consolidated Financial Statements	9-21
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	22-40
Item 3. Quantitative and Qualitative Disclosures about Market Risk	41-44
Item 4. Controls and Procedures	44
PART II. OTHER INFORMATION
Item 1A. Risk Factors	44
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds	45
Item 6. Exhibits	45
Signatures	46
Certification
Certification
Certification
Certification

2

PART I — FINANCIAL INFORMATION

Item 1.Financial Statements

BANK MUTUAL CORPORATION
     AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

	September 30			December 31
	2006			2005
	(In thousands, except per
	share data)
Assets
Cash and due from banks	$	38,990		$	41,543
Interest-earning deposits		1,181			27,872
Cash and cash equivalents		40,171			69,415
Securities available-for-sale, at fair value:
Investment securities		48,328			63,361
Mortgage-related securities		1,085,103			1,087,816
Loans held for sale		4,741			2,312
Loans receivable, net		2,066,274			1,990,492
Goodwill		52,570			52,570
Other intangible assets		3,254			3,750
Mortgage servicing rights		4,682			4,771
Other assets		154,643			156,890
	$	3,459,766		$	3,431,377
Liabilities and shareholders’ equity
Liabilities:
Deposits	$	2,151,691		$	2,086,822
Borrowings		719,806			765,796
Advance payments by borrowers for taxes and insurance		31,731			2,529
Other liabilities		26,739			29,513
		2,929,967			2,884,660
Minority interest in real estate development		2,418			2,343
Shareholders’ equity:
Preferred stock — $.01 par value:
Authorized— 20,000,000 shares in 2006 and 2005
Issued and outstanding — none in 2006 and 2005		—			—
Common stock — $.01 par value:
Authorized— 200,000,000 shares in 2006 and 2005
Issued — 78,783,849 shares in 2006 and 2005
Outstanding — 60,205,388 in 2006 and 62,325,268 in 2005		788			788
Additional paid-in capital		493,584			497,589
Retained earnings		273,555			269,913
Unearned ESOP shares		(3,291	)		(3,966	)
Accumulated other comprehensive losses		(18,076	)		(17,346	)
Unearned deferred compensation		—			(6,955	)
Treasury stock — 18,578,461 shares in 2006 and 16,458,581 in 2005		(219,179	)		(195,649	)
Total shareholders’ equity		527,381			544,374
	$	3,459,766		$	3,431,377

See Notes to Unaudited Consolidated Financial Statements.

3

BANK MUTUAL CORPORATION
     AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

	Three Months Ended
	September 30
	2006		2005
	(In thousands, except per
	share data)
Interest income:
Loans	$	30,210	$	27,422
Investment securities		946		1,073
Mortgage-related securities		12,754		12,871
Interest-earning deposits		588		225
Total interest income		44,498		41,591
Interest expense:
Deposits		18,133		12,820
Borrowings		7,450		7,503
Advance payments by borrowers for taxes and insurance		8		9
Total interest expense		25,591		20,332
Net interest income		18,907		21,259
Provision for loan losses		178		92
Net interest income after provision for loan losses		18,729		21,167
Noninterest income:
Service charges on deposits		1,723		1,329
Brokerage and insurance commissions		634		658
Loan related fees and servicing revenue		441		354
Gain on sales of investments		—		83
Gain on sales of loans		339		564
Other		1,492		1,388
Total noninterest income		4,629		4,376
Noninterest expenses:
Compensation, payroll taxes and other employee benefits		9,343		9,386
Occupancy and equipment		2,675		2,641
Amortization of other intangible assets		165		165
Other		3,246		2,820
Total noninterest expenses		15,429		15,012
Income before income taxes		7,929		10,531
Income taxes		2,814		3,619
Net income	$	5,115	$	6,912
Per share data:
Earnings per share — basic	$	0.09	$	0.11
Earnings per share — diluted	$	0.09	$	0.11
Cash dividends paid	$	0.075	$	0.065

See Notes to Unaudited Consolidated Financial Statements.

4

BANK MUTUAL CORPORATION
     AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

	Nine Months Ended
	September 30
	2006		2005
	(In thousands, except per
	share data)
Interest income:
Loans	$	87,723	$	79,538
Investment securities		2,802		3,191
Mortgage-related securities		37,790		39,452
Interest-earning deposits		1,439		336
Total interest income		129,754		122,517
Interest expense:
Deposits		49,887		35,080
Borrowings		22,023		20,691
Advance payments by borrowers for taxes and insurance		16		17
Total interest expense		71,926		55,788
Net interest income		57,828		66,729
Provision for loan losses		297		479
Net interest income after provision for loan losses		57,531		66,250
Noninterest income:
Service charges on deposits		4,389		3,527
Brokerage and insurance commissions		1,768		1,851
Loan related fees and servicing revenue		1,140		1,018
Gain on sales of investments		694		1,470
Gain on sales of loans		851		1,372
Other		4,280		3,846
Total noninterest income		13,122		13,084
Noninterest expenses:
Compensation, payroll taxes and other employee benefits		28,083		28,685
Occupancy and equipment		7,924		7,805
Amortization of other intangible assets		496		496
Other		9,479		8,903
Total noninterest expenses		45,982		45,889
Income before income taxes		24,671		33,445
Income taxes		8,711		11,446
Net income	$	15,960	$	21,999
Per share data:
Earnings per share — basic	$	0.27	$	0.35
Earnings per share — diluted	$	0.26	$	0.34
Cash dividends paid	$	0.215	$	0.185

See Notes to Unaudited Consolidated Financial Statements.

5

BANK MUTUAL CORPORATION
     AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

												Accumulated
			Additional						Unearned			Other			Unearned
	Common		Paid-In			Retained			ESOP			Comprehensive			Deferred			Treasury
	Stock		Capital			Earnings			Shares			Income (Loss)			Compensation			Stock			Total
						(In thousands, except per share data)
For the Nine Months Ended September 30, 2006
Balance at January 1, 2006	$	788	$	497,589		$	269,913		$	(3,966	)	$	(17,346	)	$	(6,955	)	$	(195,649	)	$	544,374
Comprehensive income:
Net income		—		—			15,960			—			—			—			—			15,960
Other comprehensive income Change in net unrealized gain on securities available- for-sale, net of deferred income tax benefit of $516		—		—			—			—			(730	)		—			—			(730	)
Total comprehensive income		—		—			—			—			—			—			—			15,230
Purchase of treasury stock		—		—			—			—			—			—			(26,929	)		(26,929	)
Committed ESOP shares		—		2,201			—			675			—			—			—			2,876
Exercise of stock options		—		(1,620	)		—			—			—			—			3,438			1,818
Share based payments		—		2,369			—			—			—			—			(39	)		2,330
Impact of the adoption of SFAS No. 123(R)		—		(6,955	)		—			—			—			6,955			—			—
Cash dividends ($0.215 per share)		—		—			(12,318	)		—			—			—			—			(12,318	)
Balance at September 30, 2006	$	788	$	493,584		$	273,555		$	(3,291	)	$	(18,076	)	$	—		$	(219,179	)	$	527,381
For the Nine Months Ended September 30, 2005
Balance at January 1, 2005	$	788	$	495,858		$	258,110		$	(4,865	)	$	(4,844	)	$	(10,076	)	$	(64,517	)	$	670,454
Comprehensive income:
Net income		—		—			21,999			—			—			—			—			21,999
Other comprehensive income Change in net unrealized gain on securities available-for- sale, net of deferred income tax benefit of $6,016		—		—			—			—			(10,317	)		—			—			(10,317	)
Total comprehensive income		—		—			—			—			—			—			—			11,682
Purchase of treasury stock		—		—			—			—			—			—			(125,173	)		(125,173	)
Committed ESOP shares		—		2,115			—			674			—			—			—			2,789
Exercise of stock options		—		(708	)		—			—			—			—			2,347			1,639
Amortization of deferred compensation		—		—			—			—-			—			2,456			—			2,456
Cash dividends ($0.185 per share)		—		—			(12,138	)		—-			—			—			—			(12,138	)
Balance at September 30, 2005	$	788	$	497,265		$	267,971		$	(4,191	)	$	(15,161	)	$	(7,620	)	$	(187,343	)	$	551,709

See Notes to Unaudited Consolidated Financial Statements.

6

BANK MUTUAL CORPORATION
     AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Nine Months Ended
	September 30
	2006			2005
	(In thousands)
Operating activities:
Net income	$	15,960		$	21,999
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		297			479
Provision for depreciation		1,951			2,004
Amortization of intangibles		496			496
Net decrease (increase) in mortgage servicing rights		89			(132	)
Amortization of cost of stock benefit plans		5,208			5,245
Stock dividends on Federal Home Loan Bank stock		—			(9,899	)
Gains from sales of loans originated for sale		(851	)		(1,372	)
Net gain on sale of available-for-sale securities		(694	)		(1,470	)
Net (discount) premium amortization on securities		(534	)		115
Loans originated for sale		(70,403	)		(114,239	)
Proceeds from loan sales		68,825			108,390
Increase in other liabilities		1,331			14,879
Decrease (increase) in other assets		2,981			(6,950	)
Increase in accrued interest receivable		(920	)		(348	)
Net cash provided by operating activities		23,736			19,197
Investing activities:
Net purchases of mutual funds		(264	)		(1,062	)
Proceeds from maturities of investment securities		14,720			60,780
Purchases of investment securities		—			(55,429	)
Purchases of mortgage-related securities		(171,797	)		(193,858	)
Principal repayments on mortgage-related securities		174,368			271,146
Proceeds from sale of investments		702			1,486
Net increase in loans receivable		(77,377	)		(111,914	)
Proceeds from sale of foreclosed properties		510			1,154
Redemption of Federal Home Loan Bank stock		2,661			—
Net purchases of premises and equipment		(3,638	)		(4,019	)
Net cash used by investing activities		(60,115	)		(31,716	)

7

BANK MUTUAL CORPORATION
     AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

	Nine Months Ended
	September 30
	2006			2005
	(In thousands)
Financing activities:
Net increase in deposits	$	61,354		$	40,093
Net (decrease) increase in short-term borrowings		(93,000	)		12,400
Proceeds from long-term borrowings		50,210			109,632
Repayments of long-term borrowings		(3,200	)		(18,251	)
Net increase in advance payments by borrowers for taxes and insurance		29,202			28,001
Proceeds from exercise of stock options		1,401			1,639
Excess tax benefit from exercise of stock options		415			—
Cash dividends		(12,318	)		(12,138	)
Purchase of treasury stock		(26,929	)		(125,173	)
Net cash provided by financing activities		7,135			36,203
(Decrease) increase in cash and cash equivalents		(29,244	)		23,684
Cash and cash equivalents at beginning of period		69,415			37,575
Cash and cash equivalents at end of period	$	40,171		$	61,259
Supplemental information:
Interest paid or credited on deposits and borrowings	$	68,310		$	53,822
Income taxes paid		7,636			9,738
Loans transferred to foreclosed properties and repossessed assets		1,298			425

See Notes to Unaudited Consolidated Financial Statements.

8

BANK MUTUAL CORPORATION
     AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Note 1 — Basis of Presentation

The consolidated financial statements include the accounts of Bank Mutual Corporation (the “Company”), its wholly-owned subsidiary Bank Mutual (the “Bank”) and the Bank’s subsidiaries.

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, Rule 10-01 of Regulation S-X and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial information. In the opinion of the Company, the accompanying Unaudited Consolidated Statements of Financial Condition, Unaudited Consolidated Statements of Income, Unaudited Consolidated Statements of Shareholders’ Equity and Unaudited Consolidated Statements of Cash Flows contain all adjustments, which are of a normal recurring nature, necessary to present fairly the consolidated financial position of the Company and subsidiaries at September 30, 2006 and December 31, 2005, the results of their income for the three and nine months ended September 30, 2006 and 2005, and their cash flows for the nine months ended September 30, 2006 and 2005. The accompanying Unaudited Consolidated Financial Statements and related notes should be read in conjunction with the Company’s 2005 Annual Report on Form 10-K. Operating results for the nine months ended September 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

The Company adopted Statement of Financial Accounting Standards No. 123(revised 2004) (“SFAS No. 123(R)”) as of January 1, 2006. See Note 10 — Employee Benefit Plans.

Note 2 — Securities Available-for-Sale

The amortized cost and fair value of investment securities available-for-sale are as follows:

			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
			(In thousands)
At September 30, 2006:
Investment securities:
Mutual funds	$	47,776	$	—	$	(1,105	)	$	46,671
Stock in federal agencies		1,442		215		—			1,657
Total investment securities		49,218		215		(1,105	)		48,328
Mortgage-related securities:
Federal Home Loan Mortgage Corporation		460,315		76		(13,300	)		447,091
Federal National Mortgage Association		387,724		713		(11,053	)		377,384
Private Placement CMOs		216,755		246		(2,363	)		214,638
Government National Mortgage Association		47,210		6		(1,226	)		45,990
Total mortgage-related securities		1,112,004		1,041		(27,942	)		1,085,103
Total	$	1,161,222	$	1,256	$	(29,047	)	$	1,133,431

9

The Company does not believe any individual unrealized loss as of September 30, 2006 represents an other-than-temporary impairment. The unrealized losses reported for mortgage-related securities relate primarily to securities issued by FNMA, FHLMC and private institutions. These unrealized losses are primarily attributable to changes in interest rates.

			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In thousands)
At December 31, 2005:
Investment securities:
U.S. government and federal agency obligations	$	14,720	$	—	$	(135	)	$	14,585
Mutual funds		47,512		—		(1,104	)		46,408
Stock in federal agencies		1,450		918		—			2,368
Total investment securities		63,682		918		(1,239	)		63,361
Mortgage-related securities:
Federal Home Loan Mortgage Corporation		506,116		155		(12,966	)		493,305
Federal National Mortgage Association		419,552		915		(10,831	)		409,636
Private Placement CMOs		124,335		—		(2,033	)		122,302
Government National Mortgage Association		64,037		8		(1,472	)		62,573
Total mortgage-related securities		1,114,040		1,078		(27,302	)		1,087,816
Total	$	1,177,722	$	1,996	$	(28,541	)	$	1,151,177

     The amortized cost and fair values of securities by contractual maturity at September 30, 2006, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
	Cost		Value
	(In thousands)
Due in one year or less	$	—	$	—
Due after one year through five years		—		—
Due after five years through ten years		—		—
Mutual funds		47,776		46,671
Federal Home Loan Mortgage Corporation stock		1,442		1,657
Mortgage-related securities		1,112,004		1,085,103
	$	1,161,222	$	1,113,431

10

Note 3 — Loans Receivable

Loans receivable consist of the following:

	September 30			December 31
	2006			2005
	(In thousands)
Mortgage loans:
One-to-four family	$	1,136,386		$	1,048,881
Multifamily		154,210			155,908
Commercial real estate		170,255			175,090
Construction and development		197,145			155,205
Total mortgage loans		1,657,996			1,535,084
Consumer loans and other loans:
Fixed home equity		233,847			246,460
Home equity lines of credit		88,937			88,266
Student		20,981			19,821
Home improvement		33,283			30,067
Automobile		52,880			69,237
Other		11,487			12,944
Total consumer loans		441,415			466,795
Total commercial business loans		54,378			57,247
Total loans receivable		2,153,789			2,059,126
Less:
Undisbursed loan proceeds		78,872			60,014
Allowance for loan losses		12,346			12,090
Unearned loan fees and discounts		(3,703	)		(3,470	)
		87,515			68,634
Total loans receivable, net	$	2,066,274		$	1,990,492

The Company’s mortgage loans and home equity loans are primarily secured by properties housing one-to-four families which are generally located in the Bank’s local lending areas in Wisconsin, Minnesota, Michigan, and Illinois. In addition, the Bank has purchased some mortgage loans in other Midwest states.

11

Note 4 — Goodwill, Other Intangible Assets and Mortgage Servicing Rights

The carrying amount of mortgage servicing rights net of accumulated amortization and the associated valuation allowance at September 30, 2006 and December 31, 2005 are presented in the following table.

	September 30			December 31
Mortgage Servicing Rights	2006			2005
	(In thousands)
Mortgage servicing rights at beginning of year	$	4,771		$	4,542
Capitalized servicing rights		800			1,777
Amortization of servicing rights		(889	)		(1,548	)
Mortgage servicing rights at end of period		4,682			4,771
Valuation allowance		—			—
Balance	$	4,682		$	4,771

The carrying amounts of the intangible assets, net of accumulated amortization, valuation allowance and net carrying amounts of intangible assets at September 30, 2006 are presented in the following table.

	Intangible Asset Amount
	Net of Accumulated		Valuation		Carrying
Intangible Assets	Amortization		Allowance		Amount
	(In thousands)
Goodwill	$	52,570	$	—	$	52,570
Mortgage servicing rights		4,682		—		4,682
Deposit base intangibles		3,254		—		3,254
Total	$	60,506	$	—	$	60,506

The projections of amortization expense shown below for mortgage servicing rights are based on existing asset balances and the existing interest rate environment as of September 30, 2006. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.

12

The following table shows the current period and estimated future amortization expense for amortizable intangible assets:

	Mortgage
	Servicing		Deposit Base
	Rights		Intangibles		Total
	(In thousands)
Nine months ended September 30, 2006 (actual)	$	889	$	331	$	1,220
Three months ending December 31, 2006 (estimate)	$	204	$	165	$	369
Estimate for year ending December 31,
2007		818		661		1,479
2008		818		618		1,436
2009		817		405		1,222
2010		807		405		1,212
2011		613		405		1,018
Thereafter		605		595		1,200
	$	4,682	$	3,254	$	7,936

Note 5 — Other Assets

     Other Assets are summarized as follows:

	September 30		December 31
	2006		2005
	(In thousands)
Accrued interest:
Mortgage-related securities	$	4,267	$	4,014
Investment securities		11		117
Loans receivable		8,362		7,589
Total accrued interest		12,640		11,720
Foreclosed properties and repossessed assets		1,368		708
Premises and equipment		49,275		47,588
Federal Home Loan Bank stock, at cost		45,876		48,537
Bank owned life insurance		21,143		20,359
Other		24,341		27,978
	$	154,643	$	156,890

13

Note 6 — Deposits

Deposits are summarized as follows:

	September 30		December 31
	2006		2005
	(In thousands)
Checking accounts:
Noninterest-bearing	$	100,528	$	110,583
Interest-bearing		162,150		174,620
		262,678		285,203
Money market accounts		254,709		271,418
Savings accounts		208,119		224,408
Certificate accounts:
Due within one year		1,182,934		718,634
After one but within two years		134,416		453,386
After two but within three years		58,438		45,496
After three but within four years		41,114		66,397
After four but within five years		9,283		21,880
After five years		—		—
		1,426,185		1,305,793
	$	2,151,691	$	2,086,822

Note 7 — Borrowings

Borrowings consist of the following:

	September 30					December 31
	2006					2005
			Weighted-					Weighted-
			Average					Average
	Balance		Rate			Balance		Rate
	(Dollars in thousands)					(Dollars in thousands)
Federal Home Loan Bank advances maturing:
2006	$	303,290		3.58	%	$	607,955		3.35	%
2007		104,650		4.08			104,650		4.08
2008		1,025		5.90			1,025		5.90
2009		—		—			—		—
2010		—		—			—		—
Thereafter		303,841		4.39			52,166		5.18
Open-line of credit		7,000		5.62			—		—
Other borrowings		—		—			—		—
	$	719,806				$	765,796

Of the $303.8 million borrowings due after 2010, $50.0 million has a quarterly call provision beginning March 2007 and $200.0 million has a quarterly call provision beginning March 2008.

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The Bank is required to maintain unencumbered mortgage loans in its portfolio aggregating at least 167% of the amount of outstanding advances from the FHLB as collateral. The Bank’s borrowings at the FHLB are limited to the lesser of: 35% of total assets; twenty (20) times the FHLB capital stock owned by the Company; the total of 60% of the book value of certain multi-family mortgage loans and 75% of the book value of one- to -four family mortgage loans; and 97% of certain mortgage-related securities. Our advances are also collateralized by FHLB stock of $45,876 at September 30, 2006 and $48,537 at December 31, 2005.

Note 8 — Shareholders’ Equity

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

Quantitative measures established by federal regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets (as these terms are defined in regulations), and of Tier I capital to total assets (as these terms are defined in regulations). Management believes, as of September 30, 2006, that the Bank meets or exceeds all capital adequacy requirements to which it is subject.

											To Be Well
						Required					Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
						(Dollars in thousands)
The Bank
As of September 30, 2006:
Total risk-based capital	$	422,373		24.57	%	$	137,508		8.00	%	$	171,885		10.00	%
(to risk-weighted assets)
Tier I capital		410,027		23.85			68,754		4.00			103,131		6.00
(to risk-weighted assets)
Tier I capital		410,027		11.97			137,206		4.00			171,283		5.00
(to average assets)

The Company is not aware of any conditions or events which would change the Bank’s status from well capitalized. There are no conditions or events that management believes have changed the Bank’s category.

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Following are reconciliations of the Bank’s equity under generally accepted accounting principles to capital as determined by regulators:

	The Bank
	Risk-			Tier I
	Based			(Core)
	Capital			Capital
	(In thousands)
As of September 30, 2006:
Equity per Bank records	$	450,825		$	450,825
Unrealized losses on investments		17,497			17,497
Goodwill and deposit base intangibles, net of deferred taxes		(54,519	)		(54,519	)
Investment in “nonincludable” subsidiaries		(3,495	)		(3,495	)
Disallowed servicing assets		(281	)		(281	)
Allowance for loan losses		12,346			—
Regulatory capital	$	422,373		$	410,027

Note 9 — Earnings Per Share

The computation of basic and diluted earnings per share is presented in the following table:

	Three Months Ended				Nine Months Ended
	September 30				September 30
	2006		2005		2006		2005
	(Dollars in thousands,				(Dollars in thousands,
	except per share data)				except per share data)
Basic Earnings Per Share
Net Income	$	5,115	$	6,912	$	15,960	$	21,999
Weighted average shares outstanding net of unallocated ESOP and unvested MRP shares		58,034,253		60,609,649		58,918,771		63,077,362
Allocated ESOP shares for period		81,799		81,799		245,396		245,396
Vested MRP shares for period		63,620		89,079		223,867		339,226
		58,179,672		60,780,527		59,388,034		63,661,984
Basic earnings per share	$	0.09	$	0.11	$	0.27	$	0.35
Diluted Earnings Per Share
Net Income	$	5,115	$	6,912	$	15,960	$	21,999
Weighted average shares outstanding used in basic earnings per share		58,179,672		60,780,527		59,388,034		63,661,984
Net dilutive effect of:
Stock option shares		1,675,284		1,704,384		1,631,203		1,826,633
Unvested MRP shares		63,825		110,286		60,347		161,324
		59,918,781		62,595,197		61,079,584		65,649,941
Diluted earnings per share	$	0.09	$	0.11	$	0.26	$	0.34

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Note 10 — Employee Benefit Plans

The Company has a discretionary, defined contribution savings plan (the “Savings Plan”). The Savings Plan is qualified under Sections 401 and 401(k) of the Internal Revenue Code and provides employees meeting certain minimum age and service requirements the ability to make contributions to the Savings Plan on a pretax basis. The Company then matches a percentage of the employee’s contributions. Matching contributions made by the Company were $38,000 in the third quarter of 2006 and $39,000 in the third quarter of 2005. For the nine months ended September 30, 2006 and 2005, contributions made by the Company were $112,000 and $121,000, respectively.

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

The following table sets forth the net periodic benefit cost:

	For the Three Months						For the Nine Months
	Ended September 30						Ended September 30
	2006			2005			2006			2005
	(In thousands)						(In thousands)
Service cost	$	514		$	484		$	1,542		$	1,453
Interest cost		412			401			1,236			1,203
Expected return on plan assets		(553	)		(504	)		(1,659	)		(1,511	)
Amortization of prior service cost		25			31			75			93
Amortization of net loss		60			119			180			357
Net periodic benefit cost	$	458		$	531		$	1,374		$	1,595

Pension plan assets, which consist primarily of immediate participation guarantee contracts with an insurance company, are actively managed by investment professionals.

The investment objective is to minimize risk. Asset allocation strongly favors immediate participation contracts with an insurance company.

The Company expects to contribute $777,000 to the Plan during 2006. This amount was determined based on a number of factors including the results of the actuarial valuation report as of January 1, 2006.

The Bank has a deferred retirement plan, for non-officer directors who have provided at least five years of service. Six existing eligible directors’ benefits are vested. In the event a director dies prior to completion of these payments, payments will go to the director’s heirs. The Bank has funded these arrangements through “rabbi trust” arrangements, and based on actuarial analyses believes these obligations are adequately funded.

First Northern Savings Bank, acquired by the Company in 2000, had an unfunded deferred retirement plan for its non-employee directors. All members of First Northern Savings Bank’s Board of Directors were

17

eligible under the plan. Directors of predecessor institutions who were members of an advisory board were eligible at the discretion of First Northern Savings Bank. Currently there are four retired advisory board members in the plan. This plan was terminated as a consequence of the 2003 merger of First Northern Savings Bank into the Bank and former First Northern Savings Bank directors began to receive payments.

First Northern Savings Bank also had supplemental retirement plans for several executives.

The Company has two shareholder approved stock incentive plans. The 2001 Stock Incentive Plan, provided for the grant of stock options up to 4,089,935 shares and restricted stock (“MRP”) awards up to 1,226,977 shares. Of these, 1,210,630 MRP shares were granted in 2001 of which 124,737 shares were subsequently forfeited. Options to purchase 4,050,122 shares were granted in 2001 at an exercise price of $3.2056 of which 236,257 shares were subsequently forfeited. No further grants may be made under the 2001 Stock Incentive Plan. The 2004 Stock Incentive Plan provides for the grant of stock options to 4,106,362 shares and MRP awards up to 1,642,521 shares. In May 2004, options for 2,382,000 shares were granted of which 4,800 shares were subsequently forfeited and 955,000 MRP shares were granted of which 3,600 shares were subsequently forfeited. The May 2004 options were granted at an exercise price of $10.673. Total unvested outstanding MRP grants had a fair value of $7.5 million at September 30, 2006. The MRP grants are being amortized to compensation expense as employees become vested in the awarded shares.

The amount of MRP awards amortized to expense was $570,000 for the third quarter of 2006 as compared to $655,000 for the same period in 2005 and $1.8 million for the first nine months of 2006 as compared to $2.5 million for the same period in 2005.

In total, options for 4,677,896 shares remain outstanding at September 30, 2006, of which options for 3,250,296 shares were vested. In addition, since inception of the plans, options for 1,563,169 shares were exercised and options for 241,057 shares have been forfeited.

On December 16, 2004, FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004)(“SFAS No. 123 (R)”), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement beginning January 1, 2006 based on their fair values. Pro forma disclosure is no longer an alternative.

Historically, the Company accounted for share-based payments to employees using APB 25’s intrinsic value method and, as such, generally did not recognize compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method reduced Bank Mutual’s third quarter of 2006 net income by $47,000 and, assuming no additional option grants, will reduce fourth quarter of 2006 net income by $51,000.

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The estimated fair value of each option granted prior to January 1, 2006 is calculated using the Black-Scholes option-pricing model. The following summarizes the weighted average assumptions used in the model:

	For the Three Months Ended		For the Nine Months Ended
	September 30		September 30
	2006	2005	2006	2005
Risk-free interest rate	4.81 — 5.30%	4.81 — 5.30%	4.81 — 5.30%	4.81 — 5.30%
Dividend yield	2.00%	2.00%	2.00%	2.00%
Expected stock volatility	11.76 — 26.30%	11.76 — 26.30%	11.76 — 26.30%	11.76 — 26.30%
Expected years until exercise	3.25 — 7.50	4.25 - 8.50	3.25 — 7.50	4.25 - 8.50

The Black-Scholes option valuation model was developed for use in estimating the fair value of publicly traded options that have no vesting restrictions and are fully transferable. Option valuation models such as the Black-Scholes require the input of highly subjective assumptions including the expected stock price volatility. The Company’s stock options have characteristics significantly different from traded options and, therefore, changes in the subjective input assumptions can materially affect the fair value estimate.

The Company accounted for the stock options in accordance with APB Opinion 25 prior to January 1, 2006, as was allowed under FAS No. 123, and, therefore, no compensation cost has been recognized in connection with stock options granted in the three and nine months ended September 30, 2005. See Note 12 regarding accounting changes which will be effective in 2006. Pursuant to FAS No. 123 disclosure requirements as amended by FAS No. 148, pro forma net income and earnings per share are presented below as if compensation cost for stock options was determined under the fair value method and amortized to expense over the options’ vesting periods.

	For the Three Months Ended		For the Nine Months Ended
	September 30		September 30
	2005		2005
	(Dollars in thousands)		(Dollars in thousands)
Net income:
As reported	$	6,912	$	21,999
Pro forma	$	6,677	$	21,294
Basic earnings per share:
As reported	$	0.11	$	0.35
Pro forma	$	0.11	$	0.33
Diluted earnings per share:
As reported	$	0.11	$	0.34
Pro forma	$	0.11	$	0.32

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Note 11 — Financial Instruments with Off-Balance Sheet Risk

Off-balance sheet financial instruments or obligations whose contract amounts represent credit and/or interest rate risk at September 30, 2006 and December 31, 2005 are as follows:

	September 30		December 31
	2006		2005
	(In thousands)
Unused consumer lines of credit	$	156,010	$	153,133
Unused commercial lines of credit		21,556		16,523
Commitments to extend credit:
Fixed rate		14,620		18,569
Adjustable rate		37,089		49,380
Undisbursed commercial loans		4,597		5,930

Forward commitments to sell mortgage loans of $8.9 million at September 30, 2006 represent commitments obtained by the Bank from a secondary market agency to purchase mortgages from the Bank. Commitments to sell loans expose the Bank to interest rate risk if market rates of interest decrease during the commitment period. Commitments to sell loans are made to mitigate interest rate risk on commitments to originate loans and loans held for sale. There were $3.9 million of forward commitments at December 31, 2005.

Note 12 — Recent Accounting Developments

In November 2005, the FASB issued Staff Position FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS 115-1”). FSP FAS 115-1 was issued to address the steps in determining when an investment is considered impaired, whether the impairment is other-than-temporary, and the measurement of an impairment loss. FSP FAS 115-1 discusses accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain quantitative and qualitative disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP FAS 115-1 clarifies that an investor should recognize an impairment loss when the impairment loss is deemed other-than-temporary, even if the decision to sell has not been made. FSP FAS 115-1 replaces the impairment evaluation guidance set forth in paragraphs 10-18 of Emerging Issues Task Force Issue No. 03-1 (“EITF 03-1”) and amends existing other-than-temporary impairment guidance, including that provided in FASB Statement No. 115, “Accounting for Debt and Equity Securities,” and APB 18, “The Equity Method of Accounting for Investments in Common Stock.” FSP FAS 115-1 is effective for reporting periods beginning after December 15, 2005. In addition to the guidance under FSP FAS 115-1, the disclosure requirements under EITF 01-1 remain in effect. The adoption of FSP FAS 115-1 did not have a material impact on the Company’s financial position, results of operations, or liquidity.

In March 2006, the FASB issued FASB No. 156 “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140.” FASB No. 156 permits Bank Mutual to choose either the amortization method or fair value measurement method to measure servicing assets or liabilities. Bank Mutual will continue its current policy to amortize its servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or liabilities for impairment or increased obligations based on fair value at each reporting date. Bank Mutual will adopt FASB No. 156 effective January 1, 2007.

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In July 2006, the FASB issued Interpretation No. 48 which clarifies the “Accounting for Uncertainty in Income Taxes” in accordance with FASB Statement No. 109 “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. Bank Mutual is reviewing this interpretation; however, it is anticipated that it will not have a material impact on the Company’s financial position, results of operations, or liquidity.

In September 2006, the FASB issued FASB No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB No. 87, 88, 106, and 132(R)” which significantly changes the rules for reporting the obligations and expenses of pension plans, nonqualified deferred compensation plans and other post retirement benefits. FASB No. 158 is effective for fiscal years ending after December 15, 2006. Bank Mutual is reviewing the interpretation; however, it is anticipated that it will not have a material impact on the Company’s financial position, results of operations, or liquidity.

Note 13 — Reclassifications

Certain 2005 amounts have been reclassified to conform to the 2006 presentation.

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

Cautionary Statement Regarding Forward-Looking Information

This document contains various forward-looking statements concerning the Company’s prospects that are based on the current expectations and beliefs of management. Forward-looking statements may also be made by the Company from time to time in other reports and documents as well as oral presentations. When used in written documents or oral presentations, the words “anticipate,” “believe,” “estimate,” “expect,” “objective,” “projection” and similar expressions or use of verbs in the future tense are intended to identify forward-looking statements, and any discussions of periods after the quarter for which this report is filed, are also forward looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond the Company’s control, that could cause the Company’s actual results and performance to differ materially from what is expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company: general economic conditions; negative developments affecting particular borrowers; legislative and regulatory initiatives; monetary and fiscal policies of the federal government; deposit flows; disintermediation; the cost of funds and changes in those costs; general market rates of interest; interest rates or investment returns on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; changes in the quality or composition of Bank Mutual’s loan and investment portfolios; changes in petroleum prices; changes in real estate values; other general economic and political developments; and other factors referred to in the reports filed by the Company with the Securities and Exchange Commission (particularly under “Risk Factors” in Item 1A of the Company’s 2005 Annual Report on Form 10-K).

Significant Accounting Policies

There are a number of accounting policies that we established which require us to use our judgment and make estimates. Some of the more significant policies are as follows:

• Establishing the amount of the allowance for loan losses requires the use of our judgment. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans and actual loss experience, current economic events in specific industries and geographical areas, including unemployment levels, and other pertinent factors, including regulatory guidance and general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary. If we misjudge a major component and experience a loss, it will likely affect our earnings. Developments affecting loans can also cause the allowance to vary significantly between quarters. We consistently challenge ourselves in the review of the risk components to identify any changes in trends and their cause.

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• Another valuation that requires our judgment relates to mortgage servicing rights. Mortgage servicing rights are recorded as an asset when loans are sold with servicing rights retained. The capitalized value of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net future servicing revenue. Mortgage servicing rights are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. The carrying values are periodically evaluated for impairment. For purposes of measuring impairment, the servicing rights are stratified into pools based on term and interest rate. Impairment represents the excess of the remaining capitalized cost of a stratified pool over its fair value, and is recorded through a valuation allowance. The fair value of each servicing rights pool is calculated based on the present value of estimated future cash flows using a discount rate, given current market conditions. Estimates of fair value include assumptions about prepayment speeds, interest rates and other factors which are subject to change over time. Changes in these underlying assumptions could cause the fair value of mortgage servicing rights, and the related valuation allowance, if any, to change significantly in the future.

• We also use our judgment in the valuation of other intangible assets (core deposit base intangibles). Core deposit base intangible assets have been recorded for core deposits (defined as checking, money market and savings deposits) that have been acquired in acquisitions that were accounted for as purchase business combinations. The core deposit base intangible assets have been recorded using the assumption that they provide a more favorable source of funding than more expensive wholesale borrowings. An intangible asset has been recorded for the present value of the difference between the expected interest to be incurred on these deposits and interest expense that would be expected if these deposits were replaced by wholesale borrowings, over the expected lives of the core deposits. We currently estimate the underlying core deposits have lives of seven to fifteen years. If we find these deposits have a shorter life, we will have to write down the asset by expensing the amount that is impaired.

• We review goodwill at least annually for impairment, which requires the use of our judgment. Goodwill has been recorded as a result of two acquisitions in which the purchase price exceeded the fair value of tangible net assets acquired. If goodwill is determined to be impaired, it would be expensed in the period in which it became impaired.

• The assessment of our tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions, regulatory actions and regulatory positions or interpretations, or changes in positions of federal and state taxing authorities will not differ from management’s current assessment. The impact of these matters could be significant to the consolidated results of operations and reported earnings.

Comparison of Financial Condition at September 30, 2006 and December 31, 2005

Total Assets. The Company’s total assets increased $28.4 million in the first nine months of 2006. Total assets at September 30, 2006 were $3.5 billion as compared to $3.4 billion at December 31, 2005. The increase was largely attributed to the growth in the loan portfolio.

Cash and Cash Equivalents. Cash and cash equivalents decreased $29.2 million in the first nine months of 2006 primarily as a result of using funds which we previously maintained as short-term interest earning deposits to fund loan originations.

Securities Available-for-Sale. Investment securities decreased $15.0 million in the first nine months of 2006 primarily as a result of maturing investments.

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Mortgage-related securities decreased $2.7 million primarily as a result of the use of cash flows from mortgage-related securities to fund loan originations and to pay off borrowings. This decrease was partially offset by borrowing $100.0 million in the first quarter of 2006 and investing those proceeds into mortgage-related securities.

Loans Held for Sale. Loans held for sale increased $2.4 million as a result of fixed rate mortgage loan originations exceeding the sales of fixed rate mortgage loans. Currently, we sell some of our 15 year fixed rate mortgage loan originations. In the second quarter of 2006, we began to retain certain 20 and 30 year fixed rate mortgage loans as those loans have characteristics which historically have indicated that they will be outstanding for a relatively short period of time. Most of the other 20 and 30 year fixed rate mortgage loan originations that do not have these characteristics are sold.

Loans Receivable. Loans receivable increased $75.8 million in the first nine months of 2006, primarily as a result of an increase in the mortgage loan portfolio partially offset by a reduction in the consumer and commercial business loan portfolio.

The mortgage loan portfolio increased $122.9 million in the first nine months of 2006 primarily as a result of an increase in the one-to-four family and construction and development loan portfolios. The one-to-four family mortgage loans increased $87.5 million in the first nine months of 2006 primarily as a result of an increase in adjustable rate mortgage loan originations, continued correspondent mortgage loan purchases, and decreased prepayments. We have supplemented our mortgage loan originations by purchasing mortgage loans (almost all are adjustable rate mortgage loans) from various Wisconsin sources. Currently, all of these purchased mortgage loans are in Wisconsin. These purchased loans are either individually underwritten by our staff or have received an “approve” from FNMA desktop underwriting standards and conform to our underwriting standards.

We also have $184.0 million of adjustable interest only mortgage loans in our one- to -four family mortgage loan portfolio at September 30, 2006. These mortgage loans were either originated by our bank office network or purchased from our correspondents. The interest only provision is only for the initial fixed rate period (normally three or five years) and after this initial period, principal payments begin. Underwriting standards for this type of loan are higher than for traditional amortizing mortgage loans.

Multi-family mortgage loans decreased $1.7 million in the first nine months of 2006 primarily as a result of prepayments. The construction and development mortgage loan portfolio increased $41.9 million in the nine months ended September 30, 2006 primarily as the result of increased single-family, commercial real estate, and multi-family construction mortgage loan originations.

The commercial real estate portfolio decreased $4.8 million in the first nine months of 2006 primarily as a result of prepayments of commercial real estate loans. The increased prepayments are a result of sales of properties and some competitor institutions’ pricing and/or offering terms that we chose not to match.

The consumer loan portfolio decreased $25.4 million in the first nine months of 2006, primarily as a result of decreases in the automobile and fixed home equity portfolios, partially offset by increases in the student loan, home equity lines of credit, and home improvement portfolios. The home equity decreases were primarily the result of lower home equity originations. These originations were lower primarily as a result of increased interest rates offered on these products. In addition, we have discontinued indirect originations of automobile loans through Savings Financial Corporation, our 50% owned subsidiary, in the second quarter of 2006 as a result of reduced profitability of these products.

The commercial business loan portfolio decreased $2.9 million primarily as a result of payoffs of existing commercial business loans partially offset by new originations.

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The following table sets forth our mortgage, consumer and commercial loan originations and purchases:

LOAN ORIGINATIONS AND PURCHASES

	Three Months Ended					Nine Months Ended
	September 30					September 30
	2006			2005		2006		2005
				(In thousands)
Originations
Mortgage loans:
One- to four-family	$	60,693		$	75,733	$	167,941	$	215,662
Multi-family		29,674			15,696		62,531		41,904
Commercial real estate		9,552			20,190		40,978		46,648
Total mortgage loans		99,919			111,619		271,450		304,214
Consumer loans		42,499			65,451		126,287		172,579
Commercial business loans		15,912			9,876		32,461		32,440
Total loan originations		158,330			186,946		430,198		509,233
Purchases:			��
One-to four-family mortgage loans		44,814			67,853		140,792		205,137
Total loans purchased		44,814			67,853		140,792		205,137
Total loans originated and purchased	$	203,144		$	254,799	$	570,990	$	714,370

Management will continue to emphasize consumer, multi-family and non-residential mortgage loan and commercial business loan originations, as we believe they will continue to add to the overall profitability and aid in the management of interest rate risk. However, these loans can present higher credit risks than residential mortgage loans. Further, we cannot assure that we will be able to increase this portfolio.

Other Assets.Other assets decreased $2.2 million, during the first nine months of 2006. This decrease is primarily the result of a decrease in Federal Home Loan Bank of Chicago stock and other miscellaneous assets.

Deposits. Deposits increased $64.9 million in the first nine months of 2006 primarily as a result of growth in retail certificates of deposits and jumbo deposits. Jumbo deposits increased $14.5 million in the first nine months of 2006 primarily as a result of our emphasis on these deposits since they were less expensive and obtained more quickly than retail deposits. We believe competition for retail deposits has been strong which has increased the cost of those deposits more than what deposits costs would have otherwise increased in the current rising interest rate environment. We also believe that deposit growth (or shrinkage) for the balance of 2006 and future periods will depend, in significant part, on the performance of other investment alternatives and world events.

Borrowings. Borrowings decreased $46.0 million in the nine months of 2006 as a result of paying off a portion of a maturing borrowing.

Of our borrowings, approximately $303.3 million will mature early in the fourth quarter of 2006. We anticipate paying off a small portion of this borrowing with funds generated from payments or prepayment of investments or generated by deposit growth. To the extent that the cash flows from investments are not sufficient to pay off these borrowings, we expect to replace these borrowings with new borrowings at the Federal Home Loan Bank of Chicago (“FHLB”). However, we cannot assure that

25

FHLB borrowings or other sources of financing will be available or that the terms of any financing will be attractive or acceptable to us.

Advance Payments by Borrowers for Taxes and Insurance; Other Liabilities. Advance payments by borrowers for taxes and insurance (“escrow”) increased $29.2 million in the nine months of 2006. The increase of escrow dollars was the result of payments received for customers’ escrow accounts and is seasonally normal. These payments increase during the course of the calendar year until real estate tax obligations are primarily paid out in December of 2006 or January of the next year.

Other liabilities decreased $2.8 million primarily as a result of decreases to a number of other liability accounts.

Shareholders’ Equity. Shareholders’ equity decreased $17.0 million in the first nine months of 2006, primarily as a result of stock repurchases, cash dividends paid, and an increase in other comprehensive losses partially offset by our net income, amortization of share based stock plans, exercise of stock options and the accrual for vesting of ESOP shares.

During the nine months ended September 30, 2006, the Company repurchased 2,396,333 shares at an average price of $11.24 per share. There were no stock repurchases in the third quarter of 2006. The Board of Directors authorized a fourth stock repurchase program on May 1, 2006 for 3,000,000 shares. This stock repurchase program represented approximately 4.9% of outstanding shares at that date; 869,452 shares have now been purchased under that plan at an average price of $11.20 per share.

The stock repurchase programs have the effect of lowering capital, which does not have an interest cost. Management nonetheless determined that, at the price offered, it was appropriate to repurchase shares as a result of the Company’s very strong capital position which had resulted from the sale of stock in connection with the Company’s 2003 full conversion transaction.

Comprehensive losses (net of tax) increased as a result of marking the available-for-sale investments to current market value; decreases in value resulted from recent increases in market interest rates.

In addition, a cash dividend of $0.075 per share was paid September 1, 2006 to shareholders of record on August 17, 2006. The dividend payout ratio was 77.2% in the first nine months of 2006.

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ASSET QUALITY

The following table summarizes non-performing loans and assets:

NON-PERFORMING LOANS AND ASSETS

	At September 30			At December 31
	2006			2005
	(Dollars in thousands)
Non-accrual mortgage loans	$	5,711		$	2,214
Non-accrual consumer loans		725			616
Non-accrual commercial business loans		1,584			2,517
Accruing loans delinquent 90 days or more		512			487
Total non-performing loans		8,532			5,834
Foreclosed properties and repossessed assets, net		1,368			708
Total non-performing assets	$	9,900		$	6,542
Non-performing loans to total loans		0.41	%		0.29	%
Non-performing assets to total assets		0.29	%		0.19	%
Additional interest income that would have been recognized if non-accrual loans had been current	$	326		$	1,159
Allowance for loan losses as a percent of non-performing assets		124.71	%		184.81	%

Total non-performing loans increased as of September 30, 2006, as compared to December 31, 2005, primarily as a result of six non-performing commercial real estate loans, to one borrower, becoming non-performing in the second quarter of 2006 and five commercial real estate loans, to another borrower, becoming non-performing in the third quarter of 2006. We believe, that even with the non-accrual mortgage loan increase in the first nine months of 2006, our non-accrual mortgage loans are at a low dollar amount when compared to other financial institutions. Currently, we believe that we have an adequate reserve established for this borrower and that the collateral securing these loans is adequate.

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

ALLOWANCE FOR LOAN LOSSES

	At and for the			At and for the
	Nine Months Ended			Year Ended
	September 30, 2006			December 31, 2005
	(Dollars in thousands)
Balance at the beginning of the period	$	12,090		$	13,923
Provisions for the period		297			541
Charge-offs:
Mortgage loans		—			—
Consumer loans		(229	)		(327	)
Commercial business loans		—			(2,104	)
Total charge-offs		(229	)		(2,431	)
Recoveries:
Mortgage loans		—			—
Consumer loans		50			49
Commercial business loans		138			8
Total recoveries		188			57
Net recoveries (charge-offs)		(41	)		(2,374	)
Balance at the end of the period	$	12,346		$	12,090
Net charge-offs to average loans		0.00	%		(0.12	%)
Allowance as a percent of total loans		0.60	%		0.61	%
Allowance as a percent of non-performing loans		144.70	%		207.23	%

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

The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the adequacy of the allowance, which ultimately may or may not be correct. Higher rates of loan defaults than anticipated would likely result in a need to increase provisions in future years. Also, as multifamily and commercial loan portfolios increase, additional provisions would likely be added to the loan loss allowances as they carry a higher risk of loss. The dollar amount of the typical commercial real estate, development and commercial loan tends to be larger than our average single family loan and, therefore, any loss that we experience on these loans could be larger than what we have historically experienced on our single family loans. Depending on the type of commercial loan, the collateral may appeal only to a specialized group of people or businesses and, therefore, limit the number of potential buyers of the collateral, or in the case of collateral that is comprised of inventory and equipment, the liquidation of the collateral may be more uncertain. As a result of applying the methodologies described above in accordance with GAAP, it is possible that there may be periods when the amount of the allowance and/or its percentage to total loans may decrease even though non-

28

performing loans may increase; however, the Bank carefully monitors these factors and applies them consistently from period to period, which may lead to such results. To the extent required in the future, the Bank will make appropriate increases. See “Non-performing Loans” for factors affecting some particular loans which affected the loan loss provisions for the periods discussed. Also, see “Significant Accounting Policies” for a discussion on the use of judgment in determining the amount of the allowance for loan losses.

Average Balance Sheet and Yield/Rate Analysis

The following table presents certain information regarding the Company’s financial condition and net interest income at and for the three and nine months ended September 30, 2006 and 2005. The table presents the average yield on interest-earning assets and the average cost of interest-bearing liabilities for the periods indicated. The yields and costs are derived by dividing income or expense by the average balance of interest-earnings assets or interest-bearing liabilities respectively, for the periods shown. The average balances are derived from daily balances over the periods indicated. Interest income includes fees, which we considered adjustments to yields. Net interest spread is the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin is derived by dividing net interest income by net interest-earning assets. No tax equivalent adjustments were made since we do not have any tax exempt investments.

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AVERAGE BALANCE SHEET, INTEREST AND RATE PAID

	Three Months Ended September 30
	2006								2005
				Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
						(Dollars in thousands)
Assets:
Interest-earning assets:
Loans receivable (1)	$	2,066,614		$	30,210		5.85	%	$	2,000,593		$	27,422		5.48	%
Mortgage-related securities		1,145,523			12,754		4.45			1,228,793			12,871		4.19
Investment securities (2)		95,094			946		3.98			111,253			1,073		3.86
Interest-earning deposits		10,348			129		4.99			15,264			124		3.25
Federal funds		34,342			459		5.35			11,364			101		3.56
Total interest earning assets		3,351,921			44,498		5.31			3,367,267			41,591		4.94
Noninterest-earning assets		151,096								157,916
Total average assets	$	3,503,017							$	3,525,183
Liabilities and equity:
Interest-bearing liabilities:
Savings deposits	$	213,630			228		0.43		$	247,801			266		0.43
Money market accounts		255,632			1,918		3.00			277,685			1,543		2.22
Interest-bearing demand accounts		161,230			87		0.22			167,334			88		0.21
Time deposits		1,393,685			15,900		4.56			1,210,441			10,923		3.61
Total deposits		2,024,177			18,133		3.58			1,903,261			12,820		2.69
Advance payments by borrowers for taxes and insurance		26,951			8		0.12			26,593			9		0.14
Borrowings		801,666			7,450		3.72			899,611			7,503		3.34
Total Interest-bearing liabilities		2,852,794			25,591		3.59			2,829,465			20,332		2.87
Noninterest-bearing liabilities:
Noninterest-bearing deposits		94,781								104,422
Other noninterest-bearing liabilities		42,047								33,681
Total noninterest-bearing liabilities		136,828								138,103
Total liabilities		2,989,622								2,967,568
Shareholders’ equity		513,395								557,615
Total average liabilities and equity	$	3,503,017							$	3,525,183
Net interest income and net interest rate spread (3)				$	18,907		1.72	%				$	21,259		2.07	%
Net interest margin (4)							2.26	%							2.53	%
Average interest-earning assets to average interest-bearing liabilities		1.17	x							1.19	x

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AVERAGE BALANCE SHEET, INTEREST EARNED AND RATE PAID

	Nine Months Ended September 30
	2006								2005
				Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
						(Dollars in thousands)
Assets:
Interest-earning assets:
Loans receivable (1)	$	2,036,055		$	87,723		5.74	%	$	1,960,789		$	79,538		5.41	%
Mortgage-related securities		1,148,846			37,790		4.39			1,238,515			39,452		4.25
Investment securities (2)		104,310			2,802		3.58			114,330			3,191		3.72
Interest-earning deposits		11,311			362		4.27			11,532			235		2.72
Federal funds		29,199			1,077		4.92			3,830			101		3.52
Total interest earning assets		3,329,721			129,754		5.19			3,328,996			122,517		4.91
Noninterest-earning assets		146,415								166,436
Total average assets	$	3,476,136							$	3,495,432
Liabilities and equity:
Interest-bearing liabilities:
Savings deposits	$	218,438			694		0.42		$	248,523			795		0.43
Money market accounts		259,848			5,696		2.92			286,536			3,607		1.68
Interest-bearing demand accounts		163,170			258		0.21			168,609			281		0.22
Time deposits		1,351,985			43,239		4.26			1,168,049			30,397		3.47
Total deposits		1,993,441			49,887		3.33			1,871,717			35,080		2.50
Advance payments by borrowers for taxes and insurance		17,301			16		0.12			16,903			17		0.13
Borrowings		808,735			22,023		3.63			879,103			20,691		3.14
Total Interest-bearing liabilities		2,819,477			71,926		3.40			2,767,723			55,788		2.69
Noninterest-bearing liabilities:
Noninterest-bearing deposits		97,464								104,473
Other noninterest-bearing liabilities		29,626								34,023
Total noninterest-bearing liabilities		127,090								138,496
Total liabilities		2,946,567								2,906,219
Shareholders’ equity		529,569								589,213
Total average liabilities and equity	$	3,476,136							$	3,495,432
Net interest income and net interest rate spread (3)				$	57,828		1.79	%				$	66,729		2.22	%
Net interest margin (4)							2.32	%							2.67	%
Average interest-earning assets to average interest-bearing liabilities		1.18	x							1.20	x

(1)	For the purposes of these computations, non-accruing loans and loans held for sale are included in the average loans outstanding.
(2)	Federal Home Loan Bank stock is included in investment securities dollars outstanding and yields.
(3)	Interest rate spread is the difference between the average yield on interest-earning assets and the average rate on interest-bearing liabilities.
(4)	Net interest margin is determined by dividing annualized net interest income by total interest- earning assets.

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Rate Volume Analysis of Net Interest Income

The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to:

(1)	changes attributable to changes in volume (change in volume multiplied by prior rate);
(2)	changes attributable to change in rate (changes in rate multiplied by prior volume); and
(3)	the net change.

The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

	Nine Months Ended
	September 30, 2006 Compared to September 30, 2005
	Increase (Decrease) Due To:
	Volume (1)			Rate (2)			Net (3)
	(In thousands)
Interest-earning assets:
Loans receivable	$	3,218		$	4,967		$	8,185
Mortgage-related securities		(2,933	)		1,271			(1,662	)
Investment securities		(272	)		(117	)		(389	)
Interest-earning deposits		(5	)		132			127
Federal funds		936			40			976
Total		944			6,293			7,237
Interest-bearing liabilities:
Savings deposits		(82	)		(19	)		(101	)
Money market deposits		(364	)		2,453			2,089
Interest-bearing demand deposits		(9	)		(14	)		(23	)
Time deposits		5,233			7,609			12,842
Total deposits		4,778			10,029			14,807
Advance payments by borrowers for taxes and insurance		—			(1	)		(1	)
Borrowings		(1,745	)		3,077			1,332
Total		3,033			13,105			16,138
Net change in net interest income	$	(2,089	)	$	(6,812	)	$	(8,901	)

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Comparison of Operating Results for the Three and Nine Months Ended September 30, 2006 and 2005

General. Net income was $5.1 million for the third quarter of 2006 as compared to $6.9 million for the third quarter of 2005 and $16.0 million for the nine months ended September 30, 2006 as compared to $22.0 million for the nine months ended September 30, 2005. The decreases for both periods were primarily the result of the net interest margin compression. The earnings decreases were partially offset by increases in interest income resulting from a larger loan portfolio, and higher yield on interest earning assets.

Short term interest rates being higher than or equal to long term interest rates, the increased competition for deposits and the increased costs of deposits and borrowings put pressure on our net interest margin and, looking forward, these factors are likely to continue to negatively affect our operating results in coming periods.

Total Interest Income. Total interest income increased $2.9 million, or 7.0%, to $44.5 million in the third quarter of 2006 as compared to $41.6 million for the same period in 2005 and increased $7.2 million, or 5.9%, to $129.8 million for the nine months ended September 30, 2006 as compared to $122.5 million for the same period in 2005. These increases were primarily the result of the increased average dollars outstanding in the loan portfolio and the increased yield on the loan portfolio.

Interest income on loans increased $2.8 million, or 10.2%, to $30.2 million in the third quarter of 2006 as compared to $27.4 million for the third quarter of 2005 and increased $8.2 million, or 10.3%, to $87.7 million in the first nine months of 2006 as compared to $79.5 million for the same period in 2005. These increases were the result of increased average dollars outstanding in the loan portfolio and the increased yield on the loan portfolio.

Total loan originations and purchases in the third quarter of 2006 were $203.1 million as compared to $254.8 million in the third quarter of 2005 and $571.0 million in the first nine months of 2006 as compared to $714.4 million in the first nine months of 2005. These decreases were primarily the result of reduced correspondent mortgage loan purchases, and reduced retail loan originations. Retail loan originations decreased as the result of increased interest rates on loans and decreased consumer demand for loans. These reduced loan originations were offset by reduced loan prepayments which allowed the total loan portfolio to grow.

Interest income on investments decreased in the third quarter of 2006 and in the first nine months of 2006 primarily as a result of reduced average dollars of investments outstanding. In addition, interest income on investments decreased for the nine months ended September 30, 2006, as a result of reduced yields on these investments.

Interest income on mortgage-related securities decreased $117,000 for the third quarter of 2006 as compared to the third quarter of 2005 and decreased $1.7 million in the first nine months of 2006 as compared to the same period in 2005. For the third quarter of 2006 and the first nine months of 2006, the average dollar amount of mortgage-related securities outstanding decreased, partially offset by an increase in the yield on the portfolio.

Interest income on deposits (which includes federal funds) increased $363,000 for the third quarter of 2006 and $1.1 million for the nine months ended September 30, 2006 as the result of increased average dollars outstanding and increased yield on those deposits. Short-term deposits were used to invest excess cash in anticipation of reducing borrowings or funding loan originations.

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Total Interest Expense.Total interest expense increased $5.3 million, or 25.9%, to $25.6 million in the third quarter of 2006 and $16.1 million, or 28.9%, to $71.9 million in the first nine months of 2006 as compared to the same periods in 2005. These increases were primarily the result of an increase in the interest rates paid on deposits and borrowings and an increase in the average deposits outstanding.

Interest expense on deposits increased $5.3 million, or 41.4%, in the third quarter of 2006 and $14.8 million, or 42.2%, in the first nine months of 2006 as a result of increased cost of deposits and, to a lesser extent, growth in time deposits. As market rates increased and deposit interest rates offered by competitors increased, it was necessary to increase the interest rates we offered to retain existing deposits and attract new deposits. In addition, as deposit offering interest rates increase, deposits that were in lower interest rate deposits will move to higher interest rate time deposits.

Interest expense on borrowings decreased $53,000, or 0.7%, in the third quarter of 2006 and increased $1.3 million, or 6.4%, in the first nine months of 2006 as compared to the same periods in 2005. The decrease in interest expense on borrowings in the third quarter of 2006 was the result of reduced borrowings outstanding partially offset by an increase in the cost of borrowings. The increase for the first nine months of 2006 was the result of the increased cost of borrowing partially offset by the decrease in the borrowings outstanding. Average borrowings were reduced in both periods as a result of deposit growth and using the cash flows from investments.

Net Interest Income. Net interest income decreased $2.4 million, or 11.1%, in the third quarter of 2006 and $8.9 million, or 13.3%, in the first nine months of 2006 compared to the same periods in 2005. The primary reason for the decreases was the result of the increased cost of deposits and borrowings and increased average dollar amount of deposits partially offset by an increase in the yield and dollar amount outstanding in the loan portfolio.

The net interest margin for the third quarter of 2006 was 2.26% as compared to 2.53% for the same period in 2005 and 2.32% for the first nine months of 2006 as compared to 2.67% for the first nine months of 2005.

The decrease in net interest margin for both periods was primarily the result of the increasing deposit interest rate environment (in which deposits repriced more quickly than loans) and the effects of our stock repurchase program. The funds used to repurchase stock resulted in a change from zero cost capital to increased interest-bearing borrowings and/or reduced interest-earning assets.

The current market interest rate environment of short term interest rates being higher than long term interest rates places ongoing pressure on our net interest rate margin. Specifically, the flattened or inverted yield curve, reduces our ability to price our loan offerings at interest rates that would allow us to increase the yield on our loan portfolio faster than the increase in our cost of funds. In addition, increased competition for deposits and the increased cost of borrowings to fund our stock repurchases have also put pressure on our net interest margin. Going forward, we expect the interest rate yield curve to continue to remain flat or inverted in the near term and thus continue to negatively affect our operating results in coming periods.

Provision for Loan Losses. Provision for loan losses was $178,000 for the third quarter of 2006 compared to $92,000 for the third quarter of 2005 and $297,000 in the nine months ended September 30, 2006 as compared to $479,000 for the same period in 2005. The increase in the provisions for loan losses in the third quarter of 2006 was primarily the result of an increase in non-accrual mortgage loans, growth in the loan portfolio and more specifically, growth in the commercial business loan portfolio. The decrease for the first nine months of 2006 was primarily the result of growth in our one- to four-family mortgage loan portfolio which has a relatively smaller risk for loss, and a decrease in the commercial business loan portfolio, which has a higher risk for loss, partially offset by an increase in non-performing mortgage loans. The total allowances for loan losses at September 30, 2006 was $12.3 million, or 144.7% of total non-performing loans as compared to $12.1 million, or 207.2%, of non-

34

performing loans at December 31, 2005. The loan loss allowance was 0.60% of total loans at September 30, 2006 as compared to 0.61% of total loans at December 31, 2005.

Noninterest Income. Total noninterest income increased $253,000 in the third quarter of 2006 and increased $38,000 in the first nine months of 2006 as compared to the same periods in 2005. The increase in the third quarter of 2006 and the first nine months of 2006 was the result of increased service charges on deposits and an increase in other noninterest income partially offset by reduced gains on the sales of loans and, for the nine months ended September 30, 2006, reduced gains on the sales of investments.

Service charges on deposits increased $394,000 in the third quarter of 2006 and $862,000 in the first nine months of 2006 as a result of an increase in the number of checking account overdrafts, an increase in our overdraft fee and a change in our overdraft policy for transactions at ATMs and point of sale.

Brokerage and insurance commissions decreased $24,000 in the third quarter of 2006 and $83,000 in the first nine months of 2006 primarily as a result of decreased securities sales. We have emphasized annuity sales which have increased modestly in 2006 as compared to 2005 however, we have experienced a decrease in security sales in 2006 which we believe is attributed to decreased internal referrals of customers for security sales. We continue to look for additional opportunities to expand this segment of our business.

Loan related fees and servicing income increased $87,000 in the third quarter of 2006 and $122,000 the first nine months of 2006 primarily as a result of a reduction in the amortization of originated mortgage servicing rights on mortgage loans that are sold. As market interest rates increase, the average lives of these mortgage loans tend to increase, thereby reducing the amortization of mortgage servicing rights.

Gains on sales of investments decreased $83,000 in the third quarter of 2006 and $776,000 in the first nine months of 2006 as compared to the same periods in 2005. In the third quarter of 2005, a sale of some stock resulted in the $83,000 gain and for the nine months ended September 30, 2005 the gain of $1.5 million was primarily the result of a regional ATM network that we had some ownership. The gain on the sale of investments for the first nine months of 2006 was the result of a gain on the sales of equity investments.

Gains on the sales of loans decreased $225,000 in the third quarter of 2006 and $521,000 in the first nine months of 2006 as compared to the same periods in 2005 primarily as a result of decreased fixed rate mortgage loan originations. We sell some of our 15 year fixed rate mortgage loans to the secondary market. In the second quarter of 2006, we began to retain certain 20 and 30 year fixed rate mortgage loans as those certain loans have characteristics which historically have indicated that these loans will be outstanding for a relatively short period. Most of the other 20 and 30 year fixed rate mortgage loan originations that do not have these characteristics are sold.

Other noninterest income increased $104,000 in the third quarter of 2006 and $434,000 in the first nine months of 2006 primarily as a result of increased fees on debit card usage, bank owned life insurance income, fees from our agent check program and other noninterest income items.

Noninterest Expense. Total noninterest expense increased $417,000 in the third quarter of 2006 and $93,000 in the first nine months of 2006 as compared to the same periods in 2005. The increases were primarily the result of increased costs associated with the new offices that were opened in the first nine months of 2006 and an increase in other expenses.

Compensation, payroll taxes, and other employee benefits decreased $43,000 in the third quarter of 2006 and $602,000 in the first nine months of 2006 as compared to the same periods in 2005. The decrease for both periods was primarily the result of not accruing for a short-term management incentive plan in 2006 and the completion of the vesting for awards made under the 2001 restricted stock plan. In addition, the

35

decrease for the nine months ended September 30, 2006 reflected the result of additional $417,000 of compensation in the first quarter of 2005 related to a former bank officer’s disability and subsequent retirement. The short-term management incentive plan’s expense accrual was eliminated as a result of not expecting to meet the threshold amounts for a payout of the incentive. These decreases were partially offset by a stock option expense of $73,000 for the third quarter of 2006 and $510,000 for the first nine months of 2006 in accordance with FASB 123(R), an increase in health care costs and a decrease in the deferral of loan origination costs.

Occupancy and equipment expense increased $34,000 in the third quarter of 2006 and $119,000 in the first nine months of 2006 primarily as the result of increased real estate taxes on our existing offices, the addition of new offices and increased utility costs.

Other expenses increased $426,000 in the third quarter of 2006 and $576,000 in the first nine months of 2006 primarily as a result of increased marketing expenses, payments of insurance deductibles related to robberies, losses on checking accounts attributed to our new check card overdraft policy, and consulting fees.

Income Taxes. The effective tax rate for the third quarter of 2006 was 35.5% as compared to 34.4% for the third quarter of 2005 and 35.3% for the nine months ended September 30, 2006 as compared to 34.2% for the same period in 2005.

Bank owned life insurance income is permanently tax deferred if the policy is held to the participant’s death and other conditions are met. Therefore, the income earned on the life insurance is not included in taxable income for the calculation of tax expense.

Like many Wisconsin financial institutions, we have non-Wisconsin subsidiaries which hold and manage investment assets, the income on which has not been subject to Wisconsin tax. The Wisconsin Department of Revenue has instituted an audit program specifically aimed at out of state bank subsidiaries. The Department has asserted the position that some or all of the income of the out of state subsidiaries is taxable in Wisconsin. The Department is conducting audits of many such organizations, including our Nevada subsidiaries; its audit of Bank Mutual and its Nevada subsidiaries has not yet been concluded, and the Department has not asserted a claim against the Bank or its subsidiaries. The Department has requested, and received, an extension of the statutes of limitations for the years under review.

The Department sent letters in late July 2004 to Wisconsin financial institutions (whether or not they were undergoing an audit) reporting on settlements relating to these issues involving, at that time, 17 financial institutions and their out-of-state investment subsidiaries. The letter provided a summary of available settlement parameters. For prior periods they include: restrictions on the types of subsidiary income excluded from Wisconsin taxation; assessment of certain back taxes relating to a limited time period; limitations on net operating loss carry forwards and interest on past-due taxes (but no penalties). For 2004 and going forward, the letter states similar provisions, including limits on subsidiaries’ assets which could be considered in determining income not subject to Wisconsin taxation. As outlined, the settlement would result in the rescission of prior letter rulings, and purport to be binding going forward except for future legislation or change by mutual agreement. However, the letter appears to implicitly accept the general proposition that some out-of-state investment subsidiary income is not subject to Wisconsin taxes. The Department’s positions may be challenged by one or more financial institution in the state.

The Company has engaged in discussions with the Department and has advised the Department that it wishes to receive and consider a proposal from the Department. In particular, the Company asked the Department to consider some specific factors which the Company believes may distinguish it from many

36

other institutions. We have received certain information from the Department to further evaluate its position and our alternatives under our particular circumstances. The Company believes that it will need more specific detail than was included in the Department’s July of 2004 letter or subsequent communications to quantify in any definitive way the Department’s view of its exposure, either for past periods or with respect to operations going forward, and to evaluate the Company’s alternatives. A determination on how to proceed will depend in part on further communication from and actions by the Department.

Depending upon the terms and circumstances, an adverse resolution of these matters could result in additional Wisconsin tax obligations for prior periods and/or higher Wisconsin taxes going forward, with a substantial negative impact on the earnings of Bank Mutual Corporation. The Company believes it has reported income and paid Wisconsin taxes in accordance with applicable legal requirements, and the Department’s long standing interpretations thereof. We also may incur further costs in the future to address these issues.

Net Income.As a result of the foregoing factors, net income for the three months ended September 30, 2006 was $5.1 million, a 26.0% decrease from the comparable period in 2005 and for the nine months ended September 30, 2006 was $16.0 million, a 27.5% decrease from the nine months ended September 30, 2005. Diluted earnings per share decreased 18.2% in the third quarter of 2006 as compared to 2005 and 23.5% in the first nine months of 2006 as compared to 2005. Earnings per share decreased at a slower rate than net income due to the effects of the Company’s stock repurchases which substantially reduced the average number of shares outstanding for the third quarter of 2006 and first nine months of 2006 as compared to the same periods in 2005.

Impact of Inflation and Changing Prices.The financial statements and accompanying notes of the Company have been prepared in accordance with the generally accepted accounting principles (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.

Outlook

(The following are forward looking statements; see “Cautionary Statements” above)
Bank Mutual Corporation’s management has identified a number of factors which may affect the Company’s operations and the results in the rest of 2006 and early 2007. They are as follows:

• The fourth quarter of 2006 and early 2007 may provide an environment of an economic slow down and a continued flat or inverted interest rate yield curve. If that is the case, there are a number of effects that Bank Mutual, like other financial institutions, would likely experience.

• Loan originations could decrease, along with related fee income.

• A slow down in the appreciation of the value of real estate or even a decrease in value may occur. This price action could negatively affect the volume of home sales, which in turn could affect mortgage loan originations and prepayments. It may also impact the quality of some of our loans which may result in increased delinquencies and lower collateral value.

• A flat or inverted yield curve will also likely continue to affect our net interest margin. The net interest margin would continue to be compressed as a result of the cost of deposits and borrowings rising faster than the yield on loans. Such a compression could negatively affect our net income as compared to prior periods.

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• Bank Mutual will continue to further emphasize consumer loans, and commercial real estate and commercial business loans, all of which can present a higher risk than residential mortgages. However, market conditions also may continue to affect our ability to increase our loan portfolio with these types of loans.

• Like many Wisconsin financial institutions, Bank Mutual has non-Wisconsin subsidiaries that hold and manage investment assets, the income from which has not been subject to Wisconsin tax. The Wisconsin Department of Revenue has instituted an audit program specifically aimed at out of state investment subsidiaries. The Department may take the position that all or some of the income of the out of state subsidiaries is taxable in Wisconsin, which may be challenged by financial institutions in the state. The Department has informed banks generally of potential settlement parameters relating to these issues, even where the Department has not asserted a claim. We have received certain information from the Department and are continuing to evaluate its position and our potential alternatives under our particular circumstances. However, a determination on how to proceed will depend in part on further communication from and actions by the Department. Depending upon the circumstances, an adverse resolution of this matter could result in tax obligations for prior periods and/or higher Wisconsin taxes going forward, with a substantial negative impact on the earnings of Bank Mutual Corporation.

Liquidity and Capital Resources

The term “liquidity” refers to our ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals, and operating expenses. Our primary sources of funds are deposits, scheduled amortization and prepayments of loan principal and mortgage-related securities, maturities and calls of investment securities, borrowings from the FHLB of Chicago and funds provided by our operations. Historically, these sources of funds have been adequate to maintain liquidity, with the Bank borrowing correspondingly more in periods in which its operations generate less cash. In the event these sources of liquidity would become inadequate, we believe that we could access the wholesale deposit market, although there can be no assurances that wholesale deposits would be available if needed.

Loan repayments and maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of investment securities and prepayments of loans and mortgage-related securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace. For example, during the first nine months of 2006, mortgage-related securities prepayments were reduced because of the interest rate environment. Another very different interest rate environment could lead to a significantly different result. These factors reduce the predictability of the timing of these sources of funds.

We are committed to maintaining a strong liquidity position; therefore, we monitor our liquidity position on a daily basis. Based upon our historical experience and available sources of liquidity, we anticipate that we will have sufficient funds to meet current funding commitments. In recent periods, we have increased borrowings as a source of liquidity as a result of current market conditions; as a result of our capital structure, we believe this has been a prudent source of funds. See also “Qualitative and Quantitative Disclosures about Market Risk – Gap Analysis” in Item 3 hereof, which is incorporated herein by reference, which discusses maturities.

Our primary investing activities are the origination and purchase of one-to four-family real estate loans, multi-family and commercial real estate loans, home equity loans, other consumer loans, commercial business loans, the purchase of mortgage-related securities, and to a lesser extent, the purchase of investment securities. These investing activities are funded by principal payments on mortgage loans and

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mortgage-related securities, calls and maturities on investment securities, borrowings, deposit growth, and funds provided by our operating activities.

Cash and cash equivalents decreased $29.2 million during the first nine months of 2006. Investing activities utilized $60.1 million of cash, primarily as a result of purchasing mortgage-related securities, and an increase in loans receivable. These uses were partially offset by principal repayments on mortgage-related securities. Cash provided by financing activities of $7.1 million resulted primarily from an increase in deposits, long term borrowings, and advance payments by borrowers for taxes and insurance partially offset by repayment of short-term borrowings, the purchase of treasury stock, and payment of cash dividends on the Company’s stock. See above under “Comparison of Financial Condition at September 30, 2006 and December 31, 2005—Borrowings” for a discussion of the Company’s plans relating to the refinancing of its borrowings which come due in 2006. Net cash provided by operating activities of $23.7 million consisted primarily of proceeds from loan sales, net income, amortization of cost of stock benefit plans and a decrease in other assets partially offset by the loans originated for sale.

At September 30, 2006, we exceeded each of the applicable regulatory capital requirements for the Bank. In order to be classified as “well-capitalized” by the FDIC we are required to have a leverage (Tier I) capital to average assets ratio of at least 5.00%. To be classified as a well-capitalized bank by the FDIC, we must also have a total risk-based capital to risk-weighted assets ratio of at least 10.00%. At September 30, 2006, the Bank had a total risk-based capital ratio of 24.6% and a leverage ratio of 12.0%. See Notes to Unaudited Consolidated Financial Statements – “Note 8 — Shareholders’ Equity.”

From time to time, the Company repurchases shares of common stock, and these repurchases have had the effect of reducing the Company’s capital and increasing its dependence on borrowing; further repurchases will continue to have the same effect. Management believes that the repurchases of shares were appropriate in view of the Company’s very strong capital position as a result of the stock offering in connection with its 2003 full conversion transaction and its benefit to shareholders. In the third quarter of 2006, the Company has not repurchased any shares. For the first nine months of 2006, we repurchased 2,396,333 shares. The Board of Directors authorized a fourth stock repurchase program on May 1, 2006 for 3,000,000 additional shares, representing approximately 4.9% of outstanding shares at that date. At September 30, 2006, 869,452 of these shares had been repurchased at an average price of $11.20 per share.

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

The Company has various financial obligations, including contractual obligations and commitments, that may require future cash payments.

The following table presents, as of September 30, 2006, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.

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	Payments Due In
			One to		Three to		Over
	One Year		Three		Five		Five
	Or Less		Years		Years		Years		Total
	(In thousands)
Deposits without a stated maturity	$	725,506	$	—	$	—	$	—	$	725,506
Certificates of deposits		1,182,934		192,854		50,397		—		1,426,185
Borrowed funds (a)		414,940		1,025		—		303,841		719,806
Operating leases		1,069		1,586		692		439		3,786
Purchase obligations		2,160		4,320		1,260		—		7,740
Non-qualified retirement plans and deferred compensation plans		615		2,027		2,570		9,849		15,061

(a) Excludes interest to be paid in the periods indicated.

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

The Company also has obligations under its deferred retirement plan for directors as described in Note 10 to the unaudited consolidated financial statements.

The following table details the amounts and expected maturities of significant commitments as of September 30, 2006.

	Payments Due In
			One to		Three to		Over
	One Year		Three		Five		Five
	Or Less		Years		Years		Years		Total
			(In thousands)
Commitments to extend credit:
Commercial	$	8,111	$	—	$	—	$	—	$	8,111
Residential real estate		43,599		—		—		—		43,599
Revolving home equity and credit card lines		156,010		—		—		—		156,010
Standby letters of credit		135		—		—		—		135
Commercial lines of credit		21,556		—		—		—		21,556
Undisbursed commercial loans		4,597		—		—		—		4,597
Net commitments to sell mortgage loans		8,867		—		—		—		8,867

Commitments to extend credit, including loan commitments, standby letters of credit, unused lines of credit and commercial letters of credit do not necessarily represent future cash requirements, since these commitments often expire without being drawn upon.

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Item 3.Quantitative and Qualitative Disclosures about Market Risk

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

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

At September 30, 2006, based on the assumptions below, our interest-bearing liabilities maturing or repricing within one year exceeded our interest-earning assets maturing or repricing within the same period by $704.6 million. For additional information, see “Comparisons of Financial Condition at September 30, 2006 and December 31, 2005 — Borrowings.” This represents a negative cumulative one-year interest rate sensitivity gap of 20.4%, and a ratio of interest-earning assets maturing or repricing within one year to interest-bearing liabilities maturing or repricing within one year of 65.5%.

The following table presents the amounts of our interest-earning assets and interest-bearing liabilities outstanding at September 30, 2006, which we anticipate to reprice or mature in each of the future time periods shown. The information presented in the following table is based on the following assumptions:

i)	Investment securities — based upon contractual maturities and if applicable, call dates.
ii)	Mortgage-related securities — based upon an independent outside source for determining estimated cash flows (expected prepayment speeds).
iii)	Loans — based upon contractual maturities, repricing dates, if applicable, scheduled repayments of principal and projected prepayments of principal based upon our historical experience or anticipated prepayments.
iv)	Deposits — based upon contractual maturities and historical decay rates.
v)	Borrowings — based upon final maturity or call dates, whichever is earlier.

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	At September 30, 2006
							More Than			More Than
	Within			Three to			One Year			Three Years
	Three			Twelve			To Three			To Five			Over Five
	Months			Months			Years			Years			Years			Total
	(Dollars in thousands)
Interest-earning assets:
Loans receivable:
Mortgage loans:
Fixed	$	40,647		$	94,832		$	192,948		$	106,447		$	131,647		$	566,521
Adjustable		113,003			341,541			364,010			195,223			3,567			1,017,344
Consumer loans		100,070			122,695			139,677			50,144			28,829			441,415
Commercial business loans		10,482			17,789			21,712			3,848			547			54,378
Interest-earning deposits		1,181			—			—			—			—			1,181
Investment securities		49,218			—			—			—			—			49,218
Mortgage-related securities:
Fixed		68,088			201,251			377,420			156,379			176,588			979,726
Adjustable		132,278			—			—			—			—			132,278
Other interest-earning assets		45,876			—			—			—			—			45,876
Total interest-earning assets		560,843			778,108			1,095,767			512,041			341,178			3,287,937
Noninterest-bearing and interest-bearing liabilities:
Noninterest-bearing demand accounts		4,368			11,997			25,170			17,641			41,352			100,528
Interest-bearing liabilities:
Deposits:
Interest-bearing demand accounts		7,046			19,353			40,604			28,458			66,676			162,137
Savings accounts		10,629			28,565			56,757			36,986			75,182			208,119
Money market accounts		254,427			—			—			—			—			254,427
Time deposits		318,498			891,201			160,597			50,198			—			1,420,494
Advance payments by borrowers for taxes and insurance		31,731			—			—			—			—			31,731
Borrowings		310,481			155,274			202,910			2,108			49,033			719,806
Total interest-bearing and noninterest-bearing liabilities		937,180			1,106,390			486,038			135,391			232,243			2,897,242
Interest rate sensitivity gap	$	(376,337	)	$	(328,282	)	$	609,729		$	376,650		$	108,935		$	390,695
Cumulative interest rate sensitivity gap	$	(376,337	)	$	(704,619	)	$	(94,890	)	$	281,760		$	390,695
Cumulative interest rate sensitivity gap as a percentage of total assets		(10.88	)%		(20.37	)%		(2.74	)%		8.14	%		11.29	%
Cumulative interest-earning assets as a percentage of interest bearing liabilities		59.84	%		65.52	%		96.25	%		110.57	%		113.49	%

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The methods used in the previous table have some shortcomings. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Certain assets, such as adjustable-rate loans, have features which limit changes in interest rates on a short-term basis and over the life of the loan. If interest rates change, prepayment, and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of borrowers to make payments on their adjustable-rate loans may decrease if interest rates increase.

Net Equity Sensitivity

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

The following table presents the estimated present value of equity over a range of interest rate change scenarios at September 30, 2006. The present value ratio shown in the table is the present value of equity as a percent of the present value of total assets in each of the different rate environments. For purposes of this table, we have made assumptions such as prepayment rates and decay rates similar to those used for the gap analysis table.

									Present Value of Equity
									as a Percent of
	Present Value of Equity								Present Value of Assets
Change in	Dollar		Dollar			Percent			Present Value			Percent
Interest Rates	Amount		Change			Change			Ratio			Change
(Basis Points)	(Dollars in thousands)								(Dollars in thousands)
+300	$	330,299	$	(222,276	)		(40.2	)%		10.55	%		(35.0	)%
+200		406,277		(146,298	)		(26.5	)		12.62			(22.3	)
+100		478,508		(74,067	)		(13.4	)		14.46			(11.0	)
0		552,575		—			—			16.24			—
-100		592,789		40,214			7.3			17.07			5.1
-200		594,593		42,018			7.6			16.87			3.9
-300		582,449		29,874			5.4			16.32			0.5

As in the case of the gap analysis table, the methods we used in the previous table have some shortcomings. This type of modeling requires that we make assumptions which may not reflect the manner in which actual yields and costs respond to changes in market interest rates. For example, we make assumptions regarding the acceleration rate of the prepayment speeds of higher yielding mortgage loans. Prepayments will accelerate in a falling rate environment and the reverse will occur in a rising rate environment. We also

43

assume that decay rates on core deposits will accelerate in a rising rate environment and the reverse in a falling rate environment. The table assumes that we will take no action in response to the changes in interest rates, when in practice rate changes on certain products, such as savings deposits, may lag market changes. In addition, prepayment estimates and other assumptions within the model are subjective in nature, involve uncertainties, and therefore cannot be determined with precision. Accordingly, although the present value of equity model may provide an estimate of our interest rate risk at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in interest rates on our present value of equity.

Item 4.Controls and Procedures

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

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

PART II. OTHER INFORMATION

Item 1A.Risk Factors.

See “Risk Factors” in Item 1A of the Company’s annual report on Form 10-K for the year ended December 31, 2005. See also “Outlook” in Part I, Item 2 hereof.

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Item 2.Unregistered Sale of Equity Securities and Use of Proceeds.

The following table provides the specified information about the repurchases of shares by the Company during the third quarter of 2006.

					Total number
					of shares		Maximum
					purchased as		number of
					part of		shares that
					publicly		may yet be
	Total number		Average		announced		purchased
	of shares		price paid		plans or		under the plans
Period	purchased		per share		programs		or programs
July 1 — July 31, 2006		—	$	—		—		2,130,548
August 1 — August 31, 2006		7,915		12.15		—		2,130,548
September 1 — September 30, 2006		1,136		12.415		—		2,130,548
Total		9,051	$	12.183

Shares were not repurchased pursuant to the publicly announced stock repurchase program; rather, they were acquired by the Company as shares turned in as consideration for the exercise of stock options under the Company’s stock option plans.

Item 6.Exhibits

(a) Exhibits: See Exhibit Index, which follows the signature page hereof.

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	BANK MUTUAL CORPORATION (Registrant)
Date: November 3, 2006
	Michael T. Crowley, Jr. Chairman, President and Chief Executive Officer
Date: November 3, 2006
	Rick B. Colberg Chief Financial Officer

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EXHIBIT INDEX

BANK MUTUAL CORPORATION

Form 10-Q for Quarter Ended September 30, 2006

Exhibit No.	Description	Filed Herewith
31.1	Sarbanes-Oxley Act Section 302 Certification signed by the Chairman and Chief Executive Officer of Bank Mutual Corporation	X
31.2	Sarbanes-Oxley Act Section 302 Certification signed by the Chief Financial Officer of Bank Mutual Corporation	X
32.1	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chairman and Chief Executive Officer of Bank Mutual Corporation	X
32.2	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of Bank Mutual Corporation	X