| SECURITIES AND EXCHANGE COMMISSION |
| Washington, D.C. 20549 |
| FORM 10-K |
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| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year endedDecember 31, 2012 |
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| Commission file number:000-31207 |
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| | BANK MUTUAL CORPORATION | |
| | (Exact name of registrant as specified in its charter) | |
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| Wisconsin | 39-2004336 |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
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| 4949 West Brown Deer Road, Milwaukee, Wisconsin | 53223 |
| (Address of principal executive offices) | (Zip Code) |
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| Registrant's telephone number, including area code:(414) 354-1500 |
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| Securities registered pursuant to Section 12(b) of the Act: |
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| Common Stock, $0.01 Par Value | The NASDAQ Stock Market LLC |
| (Title of each class) | (Name of each exchange on which registered) |
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| Securities registered pursuant to Section 12(g) of the Act: |
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| NONE |
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ¨ | Accelerated filer | x | Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the act).
As of February 28, 2013, 46,420,084 shares of Common Stock were validly issued and outstanding. The aggregate market value of the Common Stock (based upon the $4.41 last sale price on The NASDAQ Global Select Market on June 29, 2012, the last trading date of the Company’s second fiscal quarter) held by non-affiliates (excluding outstanding shares reported as beneficially owned by directors and executive officers; does not constitute an admission as to affiliate status) was approximately $189.9 million.
| | | Part of Form 10-K Into Which |
| Documents Incorporated by Reference | | Portions of Document are Incorporated |
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| Proxy Statement for Annual Meeting of Shareholders on May 6, 2013 | | Part III |
| BANK MUTUAL CORPORATION |
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FORM 10-K ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION |
| FOR THE YEAR ENDED DECEMBER 31, 2012 |
Table of Contents
| Item | | Page |
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| Part I | | | |
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| 1 | Business | | 3 |
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| 1A | Risk Factors | | 22 |
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| 1B | Unresolved Staff Comments | | 27 |
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| 2 | Properties | | 27 |
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| 3 | Legal Proceedings | | 27 |
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| 4 | Mine Safety Disclosures | | 27 |
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| Part II | | | |
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| 5 | Market for Registrant's Common Equity, Related Stockholders Matters, andIssuer Purchases of Equity Securities | | 28 |
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| 6 | Selected Financial Data | | 30 |
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| 7 | Management's Discussion and Analysis of Financial Condition andResults of Operations | | 32 |
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| 7A | Quantitative and Qualitative Disclosures About Market Risk | | 56 |
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| 8 | Financial Statements and Supplementary Data | | 60 |
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| 9 | Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure | | 104 |
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| 9A | Controls and Procedures | | 104 |
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| 9B | Other Information | | 106 |
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| Part III | | | |
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| 10 | Directors, Executive Officers, and Corporate Governance | | 107 |
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| 11 | Executive Compensation | | 107 |
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| 12 | Security Ownership of Certain Beneficial Owners, Management, andRelated Stockholder Matters | | 107 |
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| 13 | Certain Relationships and Related Transactions and Director Independence | | 107 |
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| 14 | Principal Accountant Fees and Services | | 107 |
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| Part IV | | | |
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| 15 | Exhibits, Financial Statement Schedules | | 108 |
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| SIGNATURES | | | 109 |
Part I
Cautionary Statement
This report contains or incorporates by reference various forward-looking statements concerning the Company's prospects that are based on the current expectations and beliefs of management. Forward-looking statements may contain, and are intended to be identified by, words such as “anticipate,” “believe,” “estimate,” “expect,” “objective,” “projection,” “intend,” and similar expressions; the use of verbs in the future tense and discussions of periods after the date on which this report is issued are also forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks, and uncertainties, many of which are beyond the Company's control, that could cause the Company's actual results and performance to differ materially from what is stated or expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company: general economic conditions, including volatility in credit, lending, and financial markets; declines in the real estate market, which could further affect both collateral values and loan activity; continuing relatively high unemployment and other factors which could affect borrowers’ ability to repay their loans; negative developments affecting particular borrowers, which could further adversely impact loan repayments and collection; legislative and regulatory initiatives and changes, including action taken, or that may be taken, in response to difficulties in financial markets and/or which could negatively affect the right of creditors; monetary and fiscal policies of the federal government; the effects of further regulation and consolidation within the financial services industry, including substantial changes under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”); regulators’ increasing expectations for financial institutions’ capital levels and restrictions imposed on institutions, as to payments of dividends or otherwise, to maintain or achieve those levels, including the possible effects of potential new regulatory capital requirements under Basel III; pending and/or potential rulemaking or other actions by the Consumer Financial Protection Bureau (“CFPB”); potential regulatory or other actions affecting the Company or the Bank; potential changes in the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), which could impact the home mortgage market; increased competition and/or disintermediation within the financial services industry; changes in tax rates, deductions and/or policies; potential further changes in Federal Deposit Insurance Corporation (“FDIC”) premiums and other governmental assessments; changes in deposit flows; changes in the cost of funds; fluctuations in general market rates of interest and/or yields or rates on competing loans, investments, and sources of funds; demand for loan or deposit products; illiquidity of financial markets and other negative developments affecting particular investment and mortgage-related securities, which could adversely impact the fair value of and/or cash flows from such securities; changes in customers’ demand for other financial services; the Company’s potential inability to carry out business plans or strategies; changes in accounting policies or guidelines; natural disasters, acts of terrorism, or developments in the war on terrorism; the risk of failures in computer or other technology systems or data maintenance, or breaches of security relating to such systems; and the factors discussed in “Item 1A. Risk Factors,” as well as Part II, “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.”
Item 1. Business
The discussion in this section should be read in conjunction with “Item 1A. Risk Factors,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Item 7A. Quantitative and Qualitative Disclosures about Market Risk,” and “Item 8. Financial Statements and Supplementary Data.”
General
Bank Mutual Corporation (the “Company”) is a Wisconsin corporation headquartered in Milwaukee, Wisconsin. The Company owns 100% of the common stock of Bank Mutual (the “Bank”) and currently engages in no substantial activities other than its ownership of such stock. Consequently, the Company’s net income and cash flows are derived primarily from the Bank’s operations and capital distributions. The Company is regulated as a savings and loan holding company by the Board of Governors of the Federal Reserve (“FRB”). The Company’s common stock trades on The NASDAQ Global Select Market under the symbol BKMU.
The Bank was founded in 1892 and is a federally-chartered savings bank headquartered in Milwaukee, Wisconsin. It is regulated by the Office of the Comptroller of the Currency (“OCC”) and its deposits are insured within limits established by the FDIC. The Bank's primary business is community banking, which includes attracting deposits from and making loans to the general public and private businesses, as well as governmental and non-profit entities. In addition to deposits, the Bank obtains funds through borrowings from the Federal Home Loan Bank (“FHLB”) of Chicago. These funding sources are principally used to originate loans, including one- to four-family residential loans, multi-family residential loans, commercial real estate loans, commercial business loans and lines of credit, and consumer loans and lines of credit. From time-to-time the Bank also purchases and/or participates in loans from third-party financial institutions and is an active seller of residential loans in the secondary market. It also invests in mortgage-related and other investment securities.
The Company’s principal executive office is located at 4949 Brown Deer Road, Milwaukee, Wisconsin, 53223, and its telephone number at that location is (414) 354-1500. The Company’s website is www.bankmutualcorp.com. The Company will make available through that website, free of charge, its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practical after the Company files those reports with, or furnishes them to, the Securities and Exchange Commission (“SEC”). Also available on the Company’s website are various documents relating to the corporate governance of the Company, including its Code of Ethics and its Code of Conduct.
Market Area
At December 31, 2012, the Company had 75 banking offices in Wisconsin and one in Minnesota. At June 30, 2012, the Company had a 1.50% market share of all deposits held by FDIC-insured institutions in Wisconsin. The Company is the fourth largest financial institution headquartered in Wisconsin, based on deposit market share.
The largest concentration of the Company’s offices is in southeastern Wisconsin, consisting of the Milwaukee Metropolitan Statistical Area (“MSA”), the Racine MSA, and the Kenosha, Wisconsin, and Lake County, Illinois MSA. The Company has 26 offices in these MSAs. The Company has also five offices in south central Wisconsin, consisting of the Madison MSA and the Janesville/Beloit MSA, as well as six other offices in communities in east central Wisconsin.
The Company also operates 20 banking offices in northeastern Wisconsin, including the Green Bay MSA. A few of the offices in this region are located near the Michigan border. Therefore, the Company also draws customers from the upper peninsula of Michigan. Finally, the Company has 18 offices in northwestern Wisconsin, including the Eau Claire MSA, and one office in Woodbury, Minnesota, which is located near the Wisconsin state border on the eastern edge of the Minneapolis-St. Paul MSA.
The services provided through the Company's banking offices are supplemented by services offered through a customer service call center, 24-hour phone banking, internet banking services, and ATMs located in the Company’s market areas.
Competition
The Company faces significant competition in attracting deposits, making loans, and selling other financial products and services. Wisconsin has many banks, savings banks, savings and loan associations, and tax-exempt credit unions, which offer the same types of banking products and services as the Company. The Company also faces competition from other types of financial service companies, such as mortgage brokerage firms, finance companies, insurance companies, investment brokerage firms, and mutual funds. As a result of electronic commerce, the Company also competes with financial service providers outside of Wisconsin.
Many of the Company’s competitors have greater resources and/or offer services that the Company currently does not provide. For example, the Company does not offer trust services. However, the Company does offer mutual fund investments, tax-deferred annuities, credit life and disability insurance, property and casualty insurance, and brokerage services through a subsidiary, BancMutual Financial & Insurance Services, Inc.
Lending Activities
GeneralAt December 31, 2012, the Company’s total loans receivable was $1.4 billion or 58.0% of total assets. The Company’s loan portfolio consists primarily of mortgage loans, which includes loans secured by one- to four-family residences, multi-family properties, and commercial real estate properties, as well as construction and development loans secured by the same types of properties and land. To a lesser degree, the loan portfolio includes consumer loans consisting principally of home equity lines of credit, fixed and adjustable-rate home equity loans, student loans, and automobile loans. Finally, the Company’s loan portfolio also contains commercial business loans, to which it has given increased emphasis in recent years. The nature, type, and terms of loans originated or purchased by the Company are subject to federal and state laws and regulations. The Company has no significant concentrations of loans to particular borrowers or to borrowers engaged in similar activities. In addition, the Company limits its lending activities primarily to borrowers and related loan collateral located in its market areas, which consist of Wisconsin and contiguous regions of Illinois, Minnesota, and northern Michigan, as previously described. For specific information related to the Company’s loans receivable for the periods covered by this report, refer to “Financial Condition—Loans Receivable” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Residential Mortgage Lending The Company originates and purchases first mortgage loans secured by one- to four-family properties. At December 31, 2012, the Company’s portfolio of these types of loans was $465.2 million or 31.0% of its gross loans receivable. Most of these loans are owner-occupied; however, the Company also originates first mortgage loans secured by second homes, seasonal homes, and investment properties.
The Company originates primarily conventional fixed-rate residential mortgage loans and adjustable-rate residential mortgage (“ARM”) loans with maturity dates up to 30 years. Such loans generally are underwritten to Fannie Mae standards. In general, ARM loans are retained by the Company in its loan portfolio. Conventional fixed-rate residential mortgage loans are generally sold in the secondary market without recourse, although the Company typically retains the servicing rights to such loans. From time-to-time, the Company may elect to retain in its loan portfolio conventional fixed-rate loans with maturities of up to 15 years. The Company also originates “jumbo” single family mortgage loans in excess of the Fannie Mae maximum loan amount, which was $417,000 for single family homes in its primary market areas in 2012. Fannie Mae has higher limits for two-, three- and four-family homes. The Company generally retains fixed-rate jumbo single family mortgage loans in its portfolio.
From time-to-time the Company also originates fixed-rate and ARM loans under special programs for low- to moderate-income households and first-time home buyers. These programs are offered to help meet the credit needs of the communities the Company serves and are retained by the Company in its loan portfolio. Among the features of these programs are lower down payments, no mortgage insurance, and generally less restrictive requirements for qualification compared to the Company’s conventional one- to four-family mortgage loans. These loans generally have maturities up to 30 years.
From time-to-time the Company also originates loans under programs administered by various federal and state government agencies such as the State Veteran’s Administration (“State VA”), the Wisconsin Housing and Economic Development Authority (“WHEDA”), the U.S. Department of Agriculture (“USDA”) Guaranteed Rural Housing Program, and the Federal Housing Administration (“FHA”). Loans originated under these programs may or may not be held by the Company in its loan portfolio and the Company may or may not retain the servicing rights for such loans.
ARM loans pose credit risks different from the risks inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments from the borrowers increase, which increases the potential for payment default. At the same time, the marketability and/or value of the underlying property may be adversely affected by higher interest rates. ARM loans generally have an initial fixed-rate term of one to seven years. Thereafter, they are adjusted on an annual basis up to a maximum of 200 basis points per year. The Company originates ARM loans with lifetime caps set at 6% above the origination rate. Monthly payments of principal and interest are adjusted when the interest rate adjusts. The Company does not offer ARM loans with negative amortization or with interest-only payment features. The Company currently utilizes the monthly average yield on United States treasury securities, adjusted to a constant maturity of one year (“constant maturity treasury index”) as the base index to determine the interest rate payable upon the adjustment date of ARM loans. Some of the ARM loans are granted with conversion options that provide for terms of up to seven years in which the borrower may convert the ARM loan to a fixed-rate mortgage loan. The terms at which the ARM loan may be converted to a fixed-rate loan are established at the date of loan origination and are set to allow the Company to sell the loan into the secondary market upon conversion. The volume and types of ARM loans the Company originates have been affected by the level of market interest rates, competition, consumer preferences, and the availability of funds. ARM loans are susceptible to early prepayment during periods of lower interest rates as borrowers refinance into fixed-rate loans.
The Company requires an appraisal of the real estate that secures a residential mortgage loan, which must be performed by an independent certified appraiser approved by the board of directors. A title insurance policy is required for all real estate first mortgage loans. Evidence of adequate hazard insurance and flood insurance, if applicable, is required prior to closing. Borrowers are required to make monthly payments to fund principal and interest as well as private mortgage insurance and flood insurance, if applicable. With some exceptions for lower loan-to-value ratio loans, borrowers are also generally required to escrow in advance for real estate taxes. Generally, no interest is paid on these escrow deposits. If borrowers with loans having a lower loan-to-value ratio want to handle their own taxes and insurance, an escrow waiver fee is charged. With respect to escrowed real estate taxes, the Company generally makes this disbursement directly to the borrower as obligations become due.
The Company’s staff underwriters review all pertinent information prior to making a credit decision on an application. All recommendations to deny are reviewed by a designated senior officer of the Company, in addition to staff underwriters, prior to the final disposition of the application. The Company’s lending policies generally limit the maximum loan-to-value ratio on single family mortgage loans secured by owner-occupied properties to 95% of the lesser of the appraised value or purchase price of the property. This limit is lower for loans secured by two-, three-, and four-family homes. Loans above 80% loan-to-value ratios are subject to private mortgage insurance to reduce the Company’s exposure to less than 80% of value, except for certain low to moderate income loan program loans.
In addition to servicing the loans in its own portfolio, the Company continues to service most of the loans that it sells to Fannie Mae and other third-party investors (“loans serviced for others”). Servicing mortgage loans, whether for its own portfolio or for others, includes such functions as collecting monthly principal and interest payments from borrowers, maintaining escrow accounts for real estate taxes and insurance, and making certain payments on behalf of borrowers. When necessary, servicing of mortgage loans also includes functions related to the collection of delinquent principal and interest payments, loan foreclosure proceedings, and disposition of foreclosed real estate. As of December 31, 2012, loans serviced for others amounted to $1.1 billion. These loans are not reflected in the Company’s Consolidated Statements of Financial Condition.
When the Company services loans for others, it is compensated through the retention of a servicing fee from borrowers' monthly payments. The Company pays the third-party investors an agreed-upon yield on the loans, which is generally less than the interest agreed to be paid by the borrowers. The difference, typically 25 basis points or more, is retained by the Company and recognized as servicing fee income over the lives of the loans, net of amortization of capitalized mortgage servicing rights (“MSRs”). The Company also receives fees and interest income from ancillary sources such as delinquency charges and float on escrow and other funds.
Management believes that servicing mortgage loans for third parties provides a natural hedge against other risks inherent in the Company's mortgage banking operations. For example, fluctuations in volumes of mortgage loan originations and resulting gains on sales of such loans caused by changes in market interest rates will generally be offset by opposite changes in the amortization of the MSRs. These fluctuations are usually the result of actual loan prepayment activity and/or changes in management expectations for future prepayment activity, which impacts the amount of MSRs amortized in a given period. However, fluctuations in the recorded value of MSRs may also be caused by valuation adjustments required to be recognized under generally accepted accounting principles (“GAAP”). That is, the value of servicing rights may fluctuate because of changes in the future prepayment assumptions or discount rates used to periodically value the MSRs. Although most of the Company's serviced loans that prepay are replaced by new serviced loans (thus preserving the future servicing cash flow), GAAP requires impairment losses resulting from a change in future prepayment assumptions to be recorded when the change occurs. MSRs are particularly susceptible to impairment losses during periods of declining interest rates during which prepayment activity typically accelerates to levels above that which had been anticipated when the servicing rights were originally recorded. Alternatively, in periods of increasing interest rates, during which prepayment activity typically declines, the Company could potentially recapture through earnings all or a portion of a previously established valuation allowance for impairment.
Multi-family and Commercial Real Estate Loans At December 31, 2012, the Company’s aggregate portfolio of multi-family and commercial real estate loans was $527.8 million or 35.2% of its gross loans receivable. The Company’s multi-family and commercial real estate loan portfolios consist of fixed-rate and adjustable-rate loans originated at prevailing market rates usually tied to various market indices. This portfolio generally consists of loans secured by apartment buildings, office buildings, retail centers, warehouses, and industrial buildings. Loans in this portfolio may be secured by either owner or non-owner occupied properties. Loans in this portfolio typically do not exceed 80% of the lesser of the purchase price or an independent appraisal by an appraiser designated by us. Loans originated with balloon maturities are generally amortized on a 25 to 30 year basis with a typical balloon term of 3 to 5 years.
Loans secured by multi-family and commercial real estate are granted based on the income producing potential of the property, the financial strength and/or income producing potential of the borrower, and the appraised value of the property. In most cases, the Company also obtains personal guarantees from the principals involved. The Company’s approval process includes a review of the other debt obligations and overall sources of cash flow available to the borrower and guarantors. The property’s net operating income must be sufficient to cover the payments relating to the outstanding debt. The Company generally requires an assignment of rents or leases to be assured that the cash flow from the property will be used to repay the debt. Appraisals on properties securing multi-family and larger commercial real estate loans are performed by independent state certified or licensed fee appraisers approved by the board of directors. Title and hazard insurance are required as well as flood insurance, if applicable. Environmental assessments are performed on certain multi-family and commercial real estate loans in excess of $1.0 million, as well as all loans secured by certain properties that the Company considers to be “environmentally sensitive.” In addition, the Company performs an annual credit review of its multi-family and commercial real estate loans over $1.0 million.
Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Such loans typically involve large balances to single borrowers or groups of related borrowers. The Bank has internal lending limits to single borrowers or a group of related borrowers that are adjusted from time-to-time, but are generally well below the Bank’s legal lending limit of approximately $40.0 million as of December 31, 2012. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. Furthermore, borrowers’ problems in areas unrelated to the properties that secure the Company’s loans may have an adverse impact on such borrowers’ ability to comply with the terms of the Company’s loans.
Construction and Development Loans At December 31, 2012, the Company’s portfolio of construction and development loans was $129.3 million or 8.6% of its gross loans receivable. These loans typically have terms of 18 to 24 months, are interest-only, and carry variable interest rates tied to the prime rate. Disbursements on these loans are based on draw requests supported by appropriate lien waivers. As a general matter, construction loans convert to permanent loans and remain in the Company’s loan portfolio upon the completion of the project. Development loans are typically repaid as the underlying lots or housing units are sold. Construction and development loans are generally considered to involve a higher degree of risk than mortgage loans on completed properties. The Company's risk of loss on a construction and development loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction, the estimated cost of construction, the appropriate application of loan proceeds to the work performed, and the borrower's ability to advance additional construction funds if necessary. In addition, in the event a borrower defaults on the loan during its construction phase, the construction project often needs to be completed before the full value of the collateral can be realized by the Company. The Company performs an annual credit review of its construction and development loans over $1.0 million.
Commercial Business Loans At December 31, 2012, the Company’s portfolio of commercial business loans was $132.4 million or 8.9% of its gross loans receivable. This portfolio consists of loans to businesses for equipment purchases, working capital, debt refinancing or restructuring, business acquisition or expansion, Small Business Administration (“SBA”) loans, and domestic standby letters of credit. Typically, these loans are secured by general business security agreements and personal guarantees. The Company offers variable, adjustable, and fixed-rate commercial business loans. The Company also has commercial business loans that have an initial period where interest rates are fixed, generally one to five years, and thereafter are adjustable based on various market indices. Fixed-rate loans are priced at either a margin over various market indices with maturities that correspond to the maturities of the notes or to match competitive conditions and yield requirements. Term loans are generally amortized over a three to seven year period. Commercial lines of credit generally have a term of one year and are subject to annual renewal thereafter. The Company performs an annual credit review of all commercial business borrowers having an exposure to the Company of $500,000 or more.
Consumer Loans At December 31, 2012, the Company’s portfolio of consumer loans was $246.9 million or 16.5% of its gross loans receivable. Consumer loans include fixed term home equity loans, home equity lines of credit, home improvement loans, automobile loans, recreational vehicle loans, boat loans, deposit account loans, overdraft protection lines of credit, unsecured consumer loans, and to a lesser extent, unsecured consumer loans through credit card programs that are administered by third parties. The Company no longer originates student loans through programs guaranteed by the federal government. Student loans that continue to be held by the Company are administered by a third party.
The Company’s primary focus in consumer lending has been the origination of loans secured by real estate, which includes home equity loans, home improvement loans, and home equity lines of credit. These loans are typically secured by junior liens on owner-occupied one- to four-family residences, but in many instances are secured by first liens on such properties. Underwriting procedures for the home equity and home equity lines of credit loans include a comprehensive review of the loan application, an acceptable credit score, verification of the value of the equity in the home, and verification of the borrower’s income. Home equity and home improvement loan originations are developed through cross-sales to existing customers, advertisements in local media, the Bank’s website, and from time-to-time, direct mail.
The Company originates fixed-rate home equity and home improvement term loans with loan-to-value ratios of up to 89.99% (when combined with any other mortgage on the property). Pricing on fixed-rate home equity and home improvement term loans is periodically reviewed by management. Generally, loan terms are in the three to fifteen year range in order to minimize interest rate risk.
The Company also originates home equity lines of credit. Home equity lines of credit are variable-rate loans secured by first liens or junior liens on owner-occupied one- to four-family residences. Current interest rates on home equity lines of credit are tied to an index rate, adjust monthly after an initial interest rate lock period, and generally have floors that vary depending on the loan-to-value ratio. Home equity line of credit loans are made for terms up to 10 years and require minimum monthly payments.
Consumer loans generally have shorter terms and higher rates of interest than conventional mortgage loans, but typically involve more credit risk because of the nature of the collateral and, in some instances, the absence of collateral. In general, consumer loans are more dependent upon the borrower's continuing financial stability, more likely to be affected by adverse personal circumstances, and often secured by rapidly depreciating personal property such as automobiles. In addition, various laws, including bankruptcy and insolvency laws, may limit the amount that may be recovered from a borrower. However, such risks are mitigated to some extent in the case of home equity loans and lines of credit. These types of loans are secured by a first or second mortgage on the borrower's residence for which the total principal balances outstanding (including the first mortgage) does not generally exceed 89.99% of the property's value at the time of the loan.
The Company believes that the higher yields earned on consumer loans compensate for the increased risk associated with such loans and that consumer loans are important to the Company’s efforts to increase the interest rate sensitivity and shorten the average maturity of its loan portfolio.
In conjunction with its consumer lending activities, the Company offers customers credit life and disability insurance products underwritten and administered by an independent insurance provider. The Company receives commission revenue related to the sales of these products, although such amounts are not a material source of revenue for the Company.
Asset Quality
General The Company has policies and procedures in place to manage its exposure to credit risk related to its lending operations. As a matter of policy, the Company limits its lending to geographic areas in which it has substantial familiarity and/or a physical presence. Currently, this is limited to certain specific market areas in Wisconsin and contiguous states. In addition, from time-to-time the Company will prohibit or restrict lending in situations in which the underlying business operations and/or collateral exceed management’s tolerance for risk. The Company obtains appraisals of value prior to the origination of mortgage loans or other secured loans. It also manages its exposure to risk by regularly monitoring loan payment status, conducting periodic site visits and inspections, obtaining regular financial updates from large borrowers and/or guarantors, corresponding regularly with large borrowers and/or guarantors, and/or updating appraisals as appropriate, among other things. These procedures are emphasized when a borrower has failed to make scheduled loan payments, has otherwise defaulted on the terms of the loan agreement, or when management has become aware of a significant adverse change in the financial condition of the borrower, guarantor, or underlying collateral. For specific information relating to the Company’s asset quality for the periods covered by this report, refer to “Financial Condition—Asset Quality” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Internal Risk Ratings and Classified Assets OCC regulations require thrift institutions to review and, if necessary, classify their assets on a regular basis. Accordingly, the Company has internal policies and procedures in place to internally evaluate risk ratings on all of its loans and certain other assets. In general, these internal risk ratings correspond with regulatory requirements to adversely classify problem loans and certain other assets as “substandard,” “doubtful,” or “loss.” A loan or other asset is adversely classified as substandard if it is determined to involve a distinct possibility that the Company could sustain some loss if deficiencies associated with the loan are not corrected. A loan or other asset is adversely classified as doubtful if full collection is highly questionable or improbable. A loan or other asset is adversely classified as loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations also provide for a “special mention” designation, described as loans or assets which do not currently expose the Company to a sufficient degree of risk to warrant adverse classification, but which demonstrate clear trends in credit deficiencies or potential weaknesses deserving management's close attention (refer to the following paragraph for additional discussion). As of December 31, 2012, $37.7 million or 2.7% the Company’s loans were classified as special mention and $57.6 million or 4.1% were classified as substandard. The latter includes all loans placed on non-accrual in accordance with the Company’s policies, as described below. In addition, as of December 31, 2012, $35.9 million of the Company’s mortgage-related securities, consisting of private-label collateralized mortgage obligations (“CMOs”) rated less than investment grade, were classified as substandard in accordance with regulatory guidelines. The Company had no loans or other assets classified as doubtful or loss at December 31, 2012.
Loans that are not classified as special mention or adversely classified as substandard, doubtful, or loss are classified as “pass” or “watch” in accordance with the Company’s internal risk rating policy. Pass loans are generally current on contractual loan and principal payments, comply with other contractual loan terms, and have no noticeable credit deficiencies or potential weaknesses. Watch loans are also generally current on payments and in compliance with loan terms, but a particular borrower’s financial or operating conditions may exhibit early signs of credit deficiencies or potential weaknesses that deserve management’s close attention. Such deficiencies and/or weaknesses typically include, but are not limited to, the borrower’s financial or operating condition, deterioration in liquidity, increased financial leverage, declines in the condition or value of related collateral, recent changes in management or business strategy, or recent developments in the economic, competitive, or market environment of the borrower. If adverse observations noted in these areas are not corrected, further downgrade of the loan may be warranted.
Delinquent LoansWhen a borrower fails to make required payments on a loan, the Company takes a number of steps to induce the borrower to cure the delinquency and restore the loan to a current status. In the case of one- to four-family mortgage loans, the Company’s loan servicing department is responsible for collection procedures from the 15th day of delinquency through the completion of foreclosure. Specific procedures include late charge notices, telephone contacts, and letters. If these efforts are unsuccessful, foreclosure notices will eventually be sent. The Company may also send either a qualified third party inspector or a loan officer to the property in an effort to contact the borrower. When contact is made with the borrower, the Company attempts to obtain full payment or work out a repayment schedule to avoid foreclosure of the collateral. Many borrowers pay before the agreed upon payment deadline and it is not necessary to start a foreclosure action. The Company follows collection procedures and guidelines outlined by Fannie Mae, Freddie Mac, State VA, WHEDA, and the Guaranteed Rural Housing Program.
The collection procedures for consumer loans, excluding student loans and credit card loans, include sending periodic late notices to a borrower and attempts to make direct contact with a borrower once a loan becomes 30 days past due. If collection activity is unsuccessful, the Company may pursue legal remedies itself, refer the matter to legal counsel for further collection effort, seek foreclosure or repossession of the collateral (if any), and/or charge-off the loan. All student loans are serviced by a third party, which guarantees that its servicing complies with all U.S. Department of Education guidelines. The Company’s student loan portfolio is guaranteed under programs sponsored by the U.S. government. Credit card loans are serviced by a third party administrator.
The collection procedures for multi-family, commercial real estate, and commercial business loans include sending periodic late notices to a borrower once a loan is past due. The Company attempts to make direct contact with a borrower once a loan becomes 15 days past due. The Company’s managers of the multi-family and commercial real estate loan areas review loans 10 days or more delinquent on a regular basis. If collection activity is unsuccessful, the Company may refer the matter to legal counsel for further collection effort. After 90 days, loans that are delinquent are typically proposed for repossession or foreclosure.
In working with delinquent borrowers, if the Company cannot develop a repayment plan that substantially complies with the original terms of the loan agreement, the Company’s practice has been to pursue foreclosure or repossession of the underlying collateral. As a matter of practice, the Company has not restructured or modified troubled loans in a manner that has resulted in a loss under accounting rules. However, the Company’s policies do not preclude such practice and the Company may elect in the future to restructure certain troubled loans in a manner that could result in losses under accounting rules. In most cases the Company continues to report restructured or modified troubled loans as non-performing loans unless the borrower has clearly demonstrated the ability to service the loan in accordance with the new terms.
The Company’s policies require that management continuously monitor the status of the loan portfolio and report to the board of directors on a monthly basis. These reports include information on classified loans, delinquent loans, restructured or modified loans, allowance for loan losses, and foreclosed real estate.
Non-Accrual Policy With the exception of student loans that are guaranteed by the U.S. government, the Company generally stops accruing interest income on loans when interest or principal payments are 90 days or more in arrears or earlier when the future collectability of such interest or principal payments may no longer be certain. In such cases, borrowers have often been able to maintain a current payment status, but are experiencing financial difficulties and/or the properties that secure the loans are experiencing increased vacancies, declining lease rates, and/or delays in unit sales. In such instances, the Company generally stops accruing interest income on the loans even though the borrowers are current with respect to all contractual payments. Although the Company generally no longer accrues interest on these loans, the Company may continue to record periodic interest payments received on such loans as interest income provided the borrowers remain current on the loans and provided, in the judgment of management, the Company’s net recorded investment in the loans are deemed to be collectible. The Company designates loans on which it stops accruing interest income as non-accrual loans and establishes a reserve for outstanding interest that was previously credited to income. All loans on non-accrual are considered to be impaired. The Company returns a non-accrual loan to accrual status when factors indicating doubtful or uncertain collection no longer exist. In general, non-accrual loans are also classified as substandard, doubtful, or loss in accordance with the Company’s internal risk rating policy. As of December 31, 2012, $25.8 million or 1.84% of the Company’s loans were considered to be non-performing in accordance with the Company’s policies.
Foreclosed Properties and Repossessed AssetsAs ofDecember 31, 2012, $14.0 million or 0.6% of the Company’s total assets consisted of foreclosed properties and repossessed assets. In the case of loans secured by real estate, foreclosure action generally starts when the loan is between the 90th and 120th day of delinquency following review by a senior officer and the executive loan committee of the board of directors. If, based on this review, the Company determines that repayment of a loan is solely dependent on the liquidation of the collateral, the Company will typically seek the shortest redemption period possible, thus waiving its right to collect any deficiency from the borrower. Depending on whether the Company has waived this right and a variety of other factors outside the Company’s control (including the legal actions of borrowers to protect their interests), an extended period of time could transpire between the commencement of a foreclosure action by the Company and its ultimate receipt of title to the property.
When the Company ultimately obtains title to the property through foreclosure or deed in lieu of foreclosure, it transfers the property to “foreclosed properties and repossessed assets” on the Company’s Consolidated Statements of Financial Condition. In cases in which a borrower has surrendered control of the property to the Company or has otherwise abandoned the property, the Company may transfer the property to foreclosed properties as an “in substance foreclosure” prior to actual receipt of title. Foreclosed properties and repossessed assets are adversely classified in accordance with the Company’s internal risk rating policy.
Foreclosed real estate properties are initially recorded at the lower of the recorded investment in the loan or fair value. Thereafter, the Company carries foreclosed real estate at fair value less estimated selling costs (typically 5% to 10%). Foreclosed real estate is inspected periodically to evaluate its condition. Additional outside appraisals are obtained as deemed necessary or appropriate. Additional write-downs may occur if the property value deteriorates further after it is acquired. These additional write-downs are charged to the Company’s results of operations as they occur.
In the case of loans secured by assets other than real estate, action to repossess the underlying collateral generally starts when the loan is between the 90th and 120th day of delinquency following review by management. The accounting for repossessed assets is similar to that described for real estate, above.
Loan Charge-Offs The Company typically records loan charge-offs when foreclosure or repossession becomes likely or legal proceedings related to such have commenced, the secondary source of repayment (consisting of a guarantor or operating entity) files for bankruptcy, or the loan is otherwise deemed uncollectible. The amount of the charge-off will depend on the fair market value of the underlying collateral, if any, and may be zero if the fair market value exceeds the loan amount. All charge-offs are recorded as a reduction to allowance for loan losses. All charge-off activity is reviewed by the board of directors.
Allowance for Loan Losses As of December 31, 2012, the Company’s allowance for loan losses was $21.6 million or 1.54% of loans receivable and 83.6% of non-performing loans. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on factors such as the size and current risk characteristics of the portfolio, an assessment of individual problem loans and pools of homogenous loans within the portfolio, and actual loss, delinquency, and/or risk rating experience within the portfolio. The Company also considers current economic conditions and/or events in specific industries and geographical areas, including unemployment levels, trends in real estate values, peer comparisons, and other pertinent factors, including regulatory guidance. Finally, as appropriate, the Company also considers individual borrower circumstances and the condition and fair value of the loan collateral, if any. For additional information relating to the Company’s allowance for loan losses for the periods covered by this report, refer to “Results of Operations—Provision for Loan Losses” and “Financial Condition—Asset Quality” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Determination of the allowance is inherently subjective as it requires significant management judgment and estimates, including the amounts and timing of expected future cash flows on loans, the fair value of underlying collateral (if any), estimated losses on pools of homogeneous loans based on historical loss experience, changes in risk characteristics of the loan portfolio, and consideration of current economic trends, all of which may be susceptible to significant change. Higher rates of loan defaults than anticipated would likely result in a need to increase provisions in future years. Also, increases in the Company’s multi-family, commercial real estate, construction and development, and commercial business loan portfolios could result in a higher allowance for loan losses as these loans typically carry a higher risk of loss. Finally, various regulatory agencies, as an integral part of their examination processes, periodically review the Company’s loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. One or more of these agencies, particularly the OCC, may require the Company to increase the allowance for loan losses or the valuation allowance for foreclosed real estate based on their judgments of information available to them at the time of their examination, thereby adversely affecting the Company’s results of operations. As a result of applying management judgment, it is possible that there may be periods when the amount of the allowance and/or its percentage to total loans or non-performing loans may decrease even though non-performing loans may increase.
Periodic adjustments to the allowance for loan loss are recorded through provision for loan losses in the Company’s Consolidated Statements of Income. Actual losses on loans are charged off against the allowance for loan losses. In the case of loans secured by real estate, charge-off typically occurs when foreclosure or repossession is likely or legal proceedings related to such have commenced, when the secondary source of repayment (consisting of a guarantor or operating entity) files for bankruptcy, or when the loan is otherwise deemed uncollectible in the judgment of management. Loans not secured by real estate, as well as unsecured loans, are charged off when the loan is determined to be uncollectible in the judgment of management. Recoveries of loan amounts previously charged off are credited to the allowance as received. Management reviews the adequacy of the allowance for loan losses on a monthly basis. The board of directors reviews management’s judgments related to the allowance for loan loss on at least a quarterly basis.
The Company maintains general allowances for loan loss against certain homogenous pools of loans. These pools generally consist of smaller one- to four-family, multi-family, commercial real estate, consumer, and commercial business loans that do not warrant individual review due to their size. In addition, pools may also consist of larger multi-family, commercial real estate, and commercial business loans that have not been individually identified as impaired by management. Certain of these pools, such as the one- to four-family and consumer loan pools, are further segmented according to the nature of the collateral that secures the loans. For example, the consumer loan pool is segmented by collateral type, such as loans secured by real estate, loans secured by automobiles, and loans secured by other collateral. The various loan pools are further segmented by management’s internal risk rating of the loans. Management has developed factors for each pool or segment based on the historical loss experience of each pool or segment, recent delinquency performance, internal risk ratings, and consideration of current economic trends, in order to determine what it believes is an appropriate level for the general allowance. Given the significant amount of management judgment involved in this process there could be significant variation in the Company’s allowance for loan losses and provision for loan losses from period to period.
The Company maintains specific allowances for loan loss against individual loans that have been identified by management as impaired. These loans are generally larger loans, but management may also establish specific allowances against smaller loans from time-to-time. The allowance for loan loss established against these loans is based on one of two methods: (1) the present value of the future cash flows expected to be received from the borrower, discounted at the loan’s effective interest rate, or (2) the fair value of the loan collateral, if the loan is considered to be collateral dependent. In the Company’s experience, loss allowances using the first method have been rare. In working with problem borrowers, if the Company cannot develop a repayment plan that substantially complies with the original terms of the loan agreement, the Company’s practice has been to pursue foreclosure or repossession of the underlying collateral. As a matter of practice, the Company does not restructure troubled loans in a manner that results in a loss under the first method. As a result, most loss allowances are established using the second method because the related loans have been deemed collateral dependent by management.
Management considers loans to be collateral dependent when, in its judgment, there is no source of repayment for the loan other than the ultimate sale or disposition of the underlying collateral and foreclosure is probable. Factors management considers in making this determination typically include, but are not limited to, the length of time a borrower has been delinquent with respect to loan payments, the nature and extent of the financial or operating difficulties experienced by the borrower, the performance of the underlying collateral, the availability of other sources of cash flow or net worth of the borrower and/or guarantor, and the borrower’s immediate prospects to return the loan to performing status. In some instances, because of the facts and circumstances surrounding a particular loan relationship, there could be an extended period of time between management’s identification of a problem loan and a determination that it is probable that such loan is or will become collateral dependent. Based on recent experience, however, management has noted the length of time has shortened between when a loan is classified as non-performing and when it is considered to be collateral dependent. Management believes this is a trend that will continue as long as economic conditions and/or commercial real estate values remain depressed.
Management generally measures impairment of impaired loans whether or not foreclosure is probable based on the estimated fair value of the underlying collateral. Such estimates are based on management’s judgment or, when considered appropriate, on an updated appraisal or similar evaluation. Updated appraisals are also typically obtained on or about the time of foreclosure or repossession of the underlying collateral. Prior to receipt of the updated appraisal, management has typically relied on the original appraisal and knowledge of the condition of the collateral, as well as the current market for the collateral, to estimate the Company’s exposure to loss on impaired loans. In the judgment of management, this practice was acceptable in periods of relative stability in real estate markets. However, as a result of deterioration in commercial real estate markets since 2008, as well as the Company’s recent experience, management believes that as long as economic conditions and/or real estate markets remain depressed updated appraisals will continue to be obtained on impaired loans earlier in the evaluation process than may have been typical during periods of more stable real estate markets.
Investment Activities
At December 31, 2012, the Company’s portfolio of mortgage-related securities available-for-sale was $550.2 million or 22.8% of its total assets. As of the same date its portfolio of mortgage-related securities held-to-maturity was $157.6 million or 6.5% of total assets. Mortgage-related securities consist principally of mortgage-backed securities (“MBSs”), real estate mortgage investment conduits (“REMICs”), and CMOs. Most of the Company’s mortgage-related securities are directly or indirectly insured or guaranteed by Freddie Mac, Fannie Mae, or the Government National Mortgage Association (“Ginnie Mae”). The remaining securities are private-label CMOs. Private-label CMOs generally carry higher credit risks and higher yields than mortgage-related securities insured or guaranteed by the aforementioned agencies of the U.S. Government. Although the latter securities have less exposure to credit risk, like private-label CMOs they remain exposed to fluctuating interest rates and instability in real estate markets, which may alter the prepayment rate of underlying mortgage loans and thereby affect the fair value of the securities. For additional information related to the Company’s mortgage-related securities, refer to “Financial Condition—Mortgage-Related Securities Available-for-Sale” and “Financial Condition—Mortgage-Related Securities Held-to-Maturity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
In addition to the mortgage-related securities previously described, the Company’s investment policy authorizes investment in various other types of securities, including U.S. Treasury obligations, federal agency obligations, state and municipal obligations, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements, federal funds, commercial paper, mutual funds, and, subject to certain limits, corporate debt and equity securities.
The objectives of the Company’s investment policy are to meet the liquidity requirements of the Company and to generate a favorable return on investments without compromising objectives related to overall exposure to risk, including interest rate risk, credit risk, and investment portfolio concentrations. In addition, the Company pledges eligible securities as collateral for certain deposit liabilities, FHLB of Chicago advances, and other purposes permitted or required by law.
The Company’s investment policy requires that securities be classified as trading, available-for-sale, or held-to-maturity at the date of purchase. The Company’s available-for-sale securities are carried at fair value with the change in fair value recorded as a component of shareholders’ equity rather than affecting the statement of operations. The Company’s held-to-maturity securities are carried at amortized cost. The Company has not engaged in trading activities.
The Company’s investment policy allows the use of hedging instruments such as financial futures, options, forward commitments, and interest rate swaps, but only with prior approval of the board of directors. Other than forward commitments related to its sale of residential loans in the secondary market, the Company did not have any investment hedging transactions in place at December 31, 2012. The Company’s investment policy prohibits the purchase of non-investment grade securities, although the Company may continue to hold investments that are reduced to less than investment grade after their purchase. Securities rated less than investment grade are adversely classified as substandard in accordance with federal guidelines (refer to Asset Quality—Internal Ratings and Classified Assets,” above).
Deposit Liabilities
At December 31, 2012, the Company’s deposit liabilities were $1.9 billion or 77.2% of its total liabilities and equity. The Company offers a variety of deposit accounts having a range of interest rates and terms for both retail and business customers. The Company currently offers regular savings accounts (consisting of passbook and statement savings accounts), interest-bearing demand accounts, non-interest-bearing demand accounts, money market accounts, and certificates of deposit. The Company also offers IRA time deposit accounts and health savings accounts. When the Company determines its deposit rates, it considers rates offered by local competitors, benchmark rates on U.S. Treasury securities, and rates on other sources of funds such as FHLB of Chicago advances. For additional information, refer to “Financial Condition—Deposit Liabilities” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Deposit flows are significantly influenced by general and local economic conditions, changes in prevailing interest rates, pricing of deposits, and competition. The Company’s deposits are primarily obtained from the market areas surrounding its bank offices. The Company relies primarily on competitive rates, quality service, and long-standing relationships with customers to attract and retain these deposits. The Company does not rely on a particular customer or related group of individuals, organizations, or institutions for its deposit funding. From time to time the Company has used third-party brokers and a nationally-recognized reciprocal deposit gathering network to obtain wholesale deposits. As of December 31, 2012, the Company did not have any brokered deposits outstanding and had less than $500,000 in reciprocal deposits outstanding.
Borrowings
At December 31, 2012, the Company’s borrowed funds were $210.8 million or 8.7% of its total liabilities and equity. The Company borrows funds to finance its lending, investing, operating, and, when active, stock repurchase activities. Substantially all of its borrowings take the form of advances from the FHLB of Chicago and are on terms and conditions generally available to member institutions. The Company’s FHLB of Chicago borrowings typically carry fixed rates of interest, have stated maturities, and are generally subject to significant prepayment penalties if repaid prior to their stated maturity. The Company has pledged one- to four-family mortgage loans and certain multi-family mortgage loans and available-for-sale securities as blanket collateral for current and future advances. For additional information regarding the Company’s outstanding advances from the FHLB of Chicago as of December 31, 2012, refer to “Financial Condition—Borrowings” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Shareholders’ Equity
At December 31, 2012, the Company’s shareholders’ equity was $271.9 million or 11.24% of its total liabilities and equity. The Company is not currently required to maintain minimum regulatory capital at the holding company level. However, refer to “Regulation and Supervision—Regulation of the Company,” below, for additional information related to regulatory capital requirements for the Company.
Although the Company is not currently required to maintain minimum regulatory capital, the Bank is required to maintain specified amounts of regulatory capital pursuant to regulations promulgated by the OCC and the FDIC. The Bank’s objective is to maintain its regulatory capital in an amount sufficient to be classified in the highest regulatory category (i.e., as a “well capitalized” institution). At December 31, 2012, the Bank exceeded all regulatory minimum requirements, as well as the amount required to be classified as a “well capitalized” institution. For additional discussion relating to regulatory capital standards refer to “Regulation and Supervision of the Bank—Regulatory Capital Requirements” and “—Prompt Corrective Action,” below. For additional information related to the Company’s equity and the Bank’s regulatory capital for the periods covered by this report, refer to “Financial Condition—Shareholders’ Equity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as “Note 8. Shareholders’ Equity” in “Item 8. Financial Statements and Supplementary Data.”
The Company has paid quarterly cash dividends since its initial stock offering in 2000. The payment of dividends is discretionary with the Company’s board of directors and depends on the Company’s operating results, financial condition, compliance with regulatory capital requirements, and other considerations. In addition, the Company’s ability to pay dividends is highly dependent on the Bank’s ability to pay dividends to the Company. As such, there can be no assurance that the Company will be able to continue the payment of dividends or that the level of dividends will not be reduced in the future. For additional information, refer to “Regulation and Supervision of the Bank—Dividend and Other Capital Distribution Limitations,” below.
From time to time, the Company has repurchased shares of its common stock, and such repurchases have had the effect of reducing the Company’s capital. However, as with the payment of dividends above, the repurchase of common stock is discretionary with the Company’s board of directors and depends on a variety of factors, including market conditions for the Company’s stock, the financial condition of the Company and the Bank, compliance with regulatory capital requirements, and other considerations. The Company does not have a current stock repurchase program. As a result of these considerations, there can be no assurances as to if or when the Company will be able to resume repurchases of its common stock.
Subsidiaries
BancMutual Financial & Insurance Services, Inc. (“BMFIS”), a wholly-owned subsidiary of the Bank, provides investment, brokerage, and insurance services to the Bank’s customers and the general public. Investment services include tax-deferred and tax-free investments, mutual funds, and government securities. Personal insurance, business insurance, life and disability insurance, mortgage protection products, and investment advisory services are also offered by BMFIS. Certain of BMFIS’s brokerage services are provided through an operating agreement with a third-party, registered broker-dealer.
Mutual Investment Corporation (“MIC”), a wholly-owned subsidiary of the Bank, owns and manages investment and mortgage-related securities. First Northern Investment Inc. (“FNII”), a wholly-owned subsidiary of the Bank, also owns and manages investment and mortgage-related securities, as well a small number of one- to four-family mortgage loans.
MC Development LTD (“MC Development”), a wholly-owned subsidiary of the Bank, is involved in land development and sales. It owns five parcels of developed land totaling 15 acres in Brown Deer, Wisconsin. In addition, in 2004, MC Development established Arrowood Development LLC with an independent third party to develop approximately 300 acres for residential purposes in Oconomowoc, Wisconsin. In the initial transaction, the third party purchased approximately one-half interest in that land, all of which previously had been owned by MC Development.
In addition, the Bank has four wholly-owned subsidiaries that are inactive, but are reserved for possible future use in related or other areas.
Employees
At December 31, 2012, the Company employed 639 full time and 81 part time associates. Management considers its relations with its associates to be good.
Regulation and Supervision
General
The Company is a Wisconsin corporation and a registered savings and loan holding company under federal law. The Company files reports with and is subject to regulation and examination by the FRB.As a Wisconsin corporation, the Company is subject to the provisions of the Wisconsin Business Corporation Law, and as a public company, it is subject to regulation by the SEC.The Bank is a federally-chartered savings bank and is subject to OCC requirements as well as those of the FDIC. Any change in these laws and regulations, whether by the FRB, the OCC, the FDIC, or through legislation, could have a material adverse impact on the Company, the Bank, and the Company’s shareholders.
Certain current laws and regulations applicable to the Company and the Bank, and other material consequences of recent legislation, are summarized below. These summaries do not purport to be complete and are qualified in their entirety by reference to such laws, regulations, or administrative considerations.
Termination of Memoranda of Understanding
In May 2011 the Company and the Bank agreed to address certain items identified by the Office of Thrift Supervision (“OTS”), their former regulator, during a regular examination by each entering into a separate Memorandum of Understanding (“MOU”) with the OTS. An MOU is an agreement between the regulator and a financial institution which requires the institution to exercise reasonable good faith efforts to comply with the requirements of the MOU. In addition to other requirements, under their respective MOUs the Company and the Bank were required to obtain the prior written non-objection or approval of federal regulators prior to declaring or paying cash dividends and, in the case of the Company, prior to repurchasing common shares, or incurring, issuing, increasing, modifying or redeeming any debt or lines of credit. However, as a result of the Company’s and Bank’s compliance with the requirements of the MOUs, as well as their improved financial condition and operating results, the FRB and OCC recently terminated the MOUs with the Company and Bank, respectively.
Financial Services Industry Legislation and Related Actions
In response to instability in the U.S. financial system, lawmakers and federal banking agencies have taken various actions intended to stabilize the financial system and housing markets, and to strengthen U.S. financial institutions.
Dodd-Frank Act In 2010 Congress enacted the Dodd-Frank Act, which significantly changed the U.S. financial institution regulatory structure, as well as the lending, investment, trading, and operating activities of financial institutions and their holding companies. In 2011 the Dodd-Frank Act eliminated the OTS and transferred all of its functions and authority relating to federal thrifts, such as the Bank, to the OCC. In addition, the FRB acquired supervisory and rule-making authority over all savings and loan holding companies, such as the Company. The Dodd-Frank Act also requires the FRB to apply to savings and loan holding companies the current consolidated leverage and risk-based capital standards that insured depository institutions must follow, which will include capital requirements for the Company effective in July 2015 (refer to “Regulation and Supervision—Regulation of the Company,” below, for additional information related to regulatory capital requirements for the Company). Further, the Dodd-Frank Act has imposed new disclosure and governance requirements on publicly-held companies, such as the Company.
The Dodd-Frank Act also created the Consumer Financial Protection Bureau (“CFPB”) with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, such as the Bank. However, institutions with $10 billion or less in assets, such as the Bank, will be examined for CFPB compliance by their applicable bank regulators, rather than the CFPB itself.
The Dodd-Frank Act broadened the base for FDIC insurance assessments, which beginning in April 2011 was based on the average consolidated total assets less tangible equity capital of a financial institution. Prior to that time insurance assessments had been based on an insured institution’s domestic deposits. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for insured institutions to $250,000 per depositor.
Many of the provisions of the Dodd-Frank Act are subject to future rule-making procedures and studies, and the full effects of the Dodd-Frank Act on the Company and/or the Bank cannot yet be determined. The OCC is continuing a complete review of former OTS regulations that it now administers, with a goal of achieving consistency with the OCC's regulations for national banks and has already updated certain regulations and pronouncements. These provisions and reviews, or any other regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of the Company's or the Bank's business activities or change certain of their business practices, including the Bank’s ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose the Company to additional costs, including increased compliance costs. These changes also may require the Company to invest significant management attention and resources to make any necessary changes to operations in order to comply and could therefore also materially affect the Company's and the Bank's business, financial condition, and results of operations.
Regulation and Supervision of the Bank
General As a federally-chartered, FDIC-insured savings bank, the Bank is subject to extensive regulation by the OCC, as well as the regulations of the FDIC. Lending activities and other investments must comply with federal statutory and regulatory requirements. This federal regulation and supervision establishes a comprehensive framework of activities in which a federal savings bank may engage and is intended primarily for the protection of the FDIC and depositors rather than the shareholders of the Company. This regulatory structure gives authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies regarding the classification of assets and the establishment of adequate loan loss reserves.
The OCC regularly examines the Bank and issues a report on its examination findings to the Bank’s board of directors. The Bank’s relationships with its depositors and borrowers are also regulated by federal law, especially in such matters as the ownership of savings accounts and the form and content of the Bank’s loan documents.
The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition, and must obtain regulatory approvals prior to entering into transactions such as mergers or acquisitions.
Regulatory Capital RequirementsOCC regulations require savings associations such as the Bank to meet three capital standards. The minimum standards are tangible capital equal to at least 1.5% of adjusted total assets, Tier 1 (“core”) capital equal to at least 4% of adjusted total assets (also known as the “leverage ratio”), and total risk-based capital equal to at least 8% of total risk-weighted assets. If a savings association is rated in the OCC’s highest supervisory category, the minimum leverage ratio is reduced to 3%. These capital standards are in addition to the capital standards promulgated by the OCC under its prompt corrective action regulations and standards required by the FDIC, which in some cases are more stringent than the above standards.
In the Bank’s case, core capital is equal to tangible capital. Core capital generally consists of common shareholders’ equity, noncumulative perpetual preferred stock and related surplus, and minority interests in the equity accounts of consolidated subsidiaries, less goodwill, other intangible assets, and certain deferred tax assets. Supplemental bank capital generally consists of core capital plus the allowance for loan and lease losses (up to a maximum of 1.25% of risk-weighted assets), cumulative perpetual preferred stock, long-term preferred stock and any related surplus, certain hybrid capital investments, term subordinated debt instruments and related surplus, and up to 45% of the pretax net unrealized holding gains on various instruments and other assets. Supplemental capital may not represent more than 50% of the total capital for the risk-based capital standard.
A savings association calculates its risk-weighted assets by multiplying each asset and off-balance sheet item by various risk factors as determined by the OCC, which range from 0% for cash to 100% for delinquent loans, property acquired through foreclosure, commercial loans, and other assets. In addition, certain available-for-sale securities rated less than investment grade are assigned a risk factor of 200%.
The Bank’s objective is to maintain its regulatory capital in an amount sufficient to be classified in the highest regulatory category (i.e., as a “well capitalized” institution). At December 31, 2012, the Bank exceeded all regulatory minimum requirements, as well as those required to be classified as a “well capitalized” institution. For additional information related to the Bank’s regulatory capital for the periods covered by this report, refer to “Note 8. Shareholders’ Equity” in “Item 8. Financial Statements and Supplementary Data.”
Prompt Corrective Action The FDIC has established a system of prompt corrective action to resolve the problems of undercapitalized insured institutions and has a broad range of grounds under which it may appoint a receiver or conservator for an insured depository institution, particularly when an institution fails to meet adequate capitalization requirements. The OCC has adopted the FDIC’s regulations governing the supervisory actions that may be taken against undercapitalized institutions, the severity of which increases as a bank’s capital decreases with the three undercapitalized categories defined in the regulations. These regulations establish and define five capital categories, in the absence of a specific capital directive, as follows:
| | | Total Risk-Based | | | Tier 1 | | | Tier 1 | |
| | | Capital to Risk | | | Capital to Risk | | | Capital to | |
| Category: | | Weighted Assets | | | Weighted Assets | | | Total Assets | |
| Well capitalized | | | ≥ 10 | % | | | ≥ 6 | % | | | ≥ 5 | % |
| Adequately capitalized | | | ≥ 8 | % | | | ≥ 4 | % | | | ≥ 4 | %(1) |
| Under capitalized | | | < 8 | % | | | < 4 | % | | | < 4 | %(2) |
| Significantly undercapitalized | | | < 6 | % | | | < 3 | % | | | < 3 | % |
| Critically undercapitalized (3) | | | | | | | | | | | | |
(1) ≥ 3% if the bank receives the highest rating under the uniform system.
(2) < 3% if the bank receives the highest rating under the uniform system.
(3) Tangible assets to capital of equal to or less than 2%.
Proposed Regulatory Capital RequirementsIn 2012 the federal banking agencies issued proposed rules that would implement certain revisions to regulatory capital requirements as specified by the Basel Committee of Banking Supervision (known as Basel III). The proposed rules, if adopted, are expected to have a significant impact on the minimum regulatory requirements of regulated financial institutions such as the Bank. However, management believes the regulatory capital of the Bank will exceed the minimum requirements established in the proposed rules and that the implementation or timing of the rules will not have a significant adverse impact on the financial condition, liquidity, or operations of the Bank. It is not known at this time when the proposed rules will become effective or whether the proposed rules will be substantially modified prior to their becoming effective.
Dividend and Other Capital Distribution Limitations OCC regulations generally govern capital distributions by savings associations such as the Bank, which include cash dividends and stock repurchases. A savings association must file an application with the OCC for approval of a capital distribution if, among other things, the total amount of capital distributions for the applicable calendar year exceeds the sum of the savings association’s net income for that year to date plus the savings association’s retained net income for the preceding two years.
In addition, even if an application is not required, a savings association must give the OCC notice at least 30 days before the board of directors declares a dividend or approves a capital distribution if the savings association is a subsidiary of a savings and loan holding company (as is the Bank) or the proposed distribution would negatively affect the adequacy of capital. In the case of a subsidiary, there is an exception; if the subsidiary is filing a notice for a cash dividend and neither an application (discussed above) or a notice (discussed in this paragraph) with the OCC is otherwise required, then the subsidiary need only file an informational copy of such notice with the OCC, in which case the subsidiary dividend to the holding company is also subject to the approval or non-objection of the FRB.
The OCC may disapprove a notice or application if (i) the savings association would be undercapitalized, significantly undercapitalized or critically undercapitalized following the distribution; (ii) the proposed capital distribution raises safety and soundness concerns; or (iii) the capital distribution would violate any applicable statute, regulation, agreement or OCC-imposed condition. The OCC has substantial discretion in making these decisions. The FRB may disapprove a dividend for similar reasons.
For additional discussion related to the Bank and Company’s dividends and the Company’s share repurchases refer to “Financial Condition—Shareholders’ Equity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
Qualified Thrift Lender Test Federal savings associations must meet a qualified thrift lender (“QTL”) test or they become subject to operating restrictions. The Bank met the QTL test as of December 31, 2012, and anticipates that it will maintain an appropriate level of mortgage-related investments(which must be at least 65% of portfolio assets) and will otherwise continue to meet the QTL test requirements. Portfolio assets are all assets minus goodwill and other intangible assets, property used by the institution in conducting its business, and liquid assets not exceeding 20% of total assets. Compliance with the QTL test is determined on a monthly basis in nine out of every twelve months.
Liquidity Standards Each federal savings association must maintain sufficient liquidity to ensure its safe and sound operations. Management of the Bank believes it has established policies, procedures, and practices to maintain sufficient liquidity to meet the Bank’s obligations and otherwise ensure its safe and sound operation.
Federal Home Loan Bank System The Bank is a member of the FHLB of Chicago, one of twelve regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its region. It is funded primarily from funds deposited by member financial institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank System. The FHLB of Chicago makes loans (“advances”) to members pursuant to policies and procedures established by its board of directors. The FHLB of Chicago imposes limits on advances made to member banks, including limitations relating to the amount and type of collateral and the amount of advances.
As a member of the FHLB of Chicago, the Bank must meet certain eligibility requirements and must purchase and maintain common stock in the FHLB of Chicago in an amount equal to the greater of (i) 1% of its mortgage-related assets at the most recent calendar year end, (ii) 5% of its outstanding advances from the FHLB of Chicago, or (iii) $10,000. At December 31, 2012, the Bank owned $15.8 million in FHLB of Chicago common stock, which was approximately $5.3 million more than the Bank would otherwise be required to own under minimum guidelines established by the FHLB of Chicago. Management believes the FHLB of Chicago will repurchase this excess common stock in 2013, although there can be no assurances. During 2012, the FHLB of Chicago repurchased $30.3 million of excess common stock that had been owned by the Bank. For additional discussion related to the Bank’s investment in the common stock of the FHLB of Chicago, refer to “Item 1A. Risk Factors” and “Financial Condition—Other Assets” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Deposit Insurance The deposit accounts held by customers of the Bank are insured by the FDIC up to maximum limits, as provided by law. Insurance on deposits may be terminated by the FDIC if it finds that the Bank has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC. The management of the Bank does not know of any practice, condition, or violation that might lead to termination of the Bank’s deposit insurance.
The FDIC sets deposit insurance premiums based upon the risks a particular bank or savings association poses to its deposit insurance funds. Under the risk-based assessment system, the FDIC assigns an institution to one of three capital categorizations based on the institution’s financial information. With respect to these three categorizations, institutions are classified as well capitalized, adequately capitalized or undercapitalized using ratios that are substantially similar to the prompt corrective action capital ratios discussed above. The FDIC also assigns an institution to one of three supervisory sub-categorizations within each capital group. This assignment is based on a supervisory evaluation provided by the institution’s primary federal regulator and information that the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance fund.
An institution’s assessment rate depends on the capital categorizations and supervisory sub-categorizations to which it is assigned. Under the risk-based assessment system, there are then four assessment risk categories to which different assessment rates are applied (refer to the next paragraph for a description of these assessment rates). Any increase in insurance assessments could have an adverse effect on the earnings of insured institutions, including the Bank.
Effective in April 2011 the FDIC changed the definition of a financial institution’s deposit insurance assessment base and revised the deposit insurance risk-based assessment rate schedule, among other things. Under the revised rule the assessment base changed from an insured institution’s domestic deposits (minus certain allowable exclusions) to an insured institution’s average consolidated total assets minus average tangible equity and certain other adjustments. In addition, the assessment rates were established in a range of 2.5 to 45 basis points, depending on the institution’s capital category and supervisor sub-category, as previously described. For additional discussion, refer to “Results of Operations—Non-Interest Expense” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
In 2008 the FDIC created the Transaction Account Guarantee Program (“TAGP”), which provided participating banks with full deposit insurance coverage for non-interest-bearing transaction deposit accounts, regardless of dollar amount through December 31, 2012 (as subsequently extended). As of January 1, 2013, however, FDIC-insured financial institutions’ non-interest-bearing transaction deposit accounts are no longer fully-insured under this program. This development is not expected to have a material impact on the Bank or the deposit insurance premiums paid by the Bank.
Transactions With Affiliates Sections 23A and 23B of the Federal Reserve Act and FRB Regulation W govern transactions between an insured federal savings association, such as the Bank, and any of its affiliates, such as the Company. An affiliate is any company or entity that controls, is controlled by or is under common control with it. Sections 23A and 23B limit the extent to which an institution or a subsidiary may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such savings association’s capital stock and surplus, and limit all such transactions with all affiliates to 20% of such stock and surplus. The term “covered transaction” includes the making of loans, purchase of assets, issuance of guarantees, derivatives transactions, securities borrowing, and lending transactions to the extent that they result in credit exposure to an affiliate. Further, most loans by a savings association to any of its affiliates must be secured by specified collateral amounts. All such transactions must be on terms that are consistent with save and sound banking practices and must be on terms that are at least as favorable to the savings association as those that would be provided to a non-affiliate. At December 31, 2012, the Company and Bank did not have any covered transactions.
Acquisitions and Mergers Under the federal Bank Merger Act, any merger of the Bank with or into another institution would require the approval of the OCC, or the primary federal regulator of the resulting entity if it is not an OCC-regulated institution. Refer also to “Regulation and Supervision of the Company—Acquisition of Bank Mutual Corporation,” below.
Prohibitions Against Tying Arrangements Savings associations are subject to the prohibitions of 12 U.S.C. Section 1972 on certain tying arrangements. A savings association is prohibited, subject to exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor.
Uniform Real Estate Lending Standards The federal banking agencies adopted uniform regulations prescribing standards for extensions of credit that are secured by liens on interests in real estate or are made to finance the construction of a building or other improvements to real estate. All insured depository institutions must adopt and maintain written policies that establish appropriate limits and standards for such extensions of credit. These policies must establish loan portfolio diversification standards, prudent underwriting standards that are clear and measurable, loan administration procedures, and documentation, approval and reporting requirements.
These lending policies must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies that have been adopted by the federal bank regulators. These guidelines, among other things, require a depository institution to establish internal loan-to-value limits for real estate loans that are not in excess of specified supervisory limits, which generally vary and provide for lower loan-to-value limits for types of collateral that are perceived as having more risk, are subject to fluctuations in valuation, or are difficult to dispose. Although there is no supervisory loan-to-value limit for owner-occupied one- to four-family and home equity loans, the guidelines provide that an institution should require credit enhancement in the form of mortgage insurance or readily marketable collateral for any such loan with a loan-to-value ratio that equals or exceeds 90% at origination. The guidelines also clarify expectations for prudent appraisal and evaluation policies, procedures, and practices, and make other changes, in light of the Dodd-Frank Act and other recent federal statutory changes affecting appraisals.
Community Reinvestment Act Under the Community Reinvestment Act (“CRA”), any insured depository institution, including the Bank, must, consistent with its safe and sound operation, help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the OCC to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including applications for additional branches and acquisitions.
Among other things, the CRA regulations contain an evaluation system that rates an institution based on its actual performance in meeting community needs. In particular, the evaluation system focuses on three tests: (i) a lending test, to evaluate the institution’s record of making loans in its service areas, (ii) an investment test, to evaluate the institution’s record of making community development investments, and (iii) a service test, to evaluate the institution’s delivery of services through its branches, ATMs and other offices. The CRA requires the OCC to provide a written evaluation of the Bank’s CRA performance utilizing a four-tiered descriptive rating system and requires public disclosure of the CRA rating. The Bank received a “satisfactory” overall rating in its most recent CRA examination.
Safety and Soundness Standards Each federal banking agency, including the OCC, has guidelines establishing general standards relating to internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, customer privacy, liquidity, earnings, and compensation and benefits. The guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines also prohibit excessive compensation as an unsafe and unsound practice.
Loans to Insiders A savings association’s loans to its executive officers, directors, any owner of more than 10% of its stock (each, “an insider”) and certain entities affiliated with any such person (an insider’s “related interest”) are subject to the conditions and limitations imposed by Section 22(h) of the Federal Reserve Act and the FRB’s Regulation O thereunder. Under these restrictions, the aggregate amount of the loans to any insider and related interests may not exceed the loans-to-one-borrower limit applicable to national banks. All loans by a savings association to all insiders and related interests in the aggregate may not exceed the savings association’s unimpaired capital and surplus. With certain exceptions, the Bank’s loans to an executive officer (other than certain education loans and residential mortgage loans) may not exceed $100,000. Regulation O also requires that any proposed loan to an insider or a related interest be approved in advance by a majority of the Bank’s board of directors, without the vote of any interested director, if such loan, when aggregated with any existing loans to that insider and related interests, would exceed $500,000. Generally, such loans must be made on substantially the same terms as, and follow credit underwriting procedures that are no less stringent than, those for comparable transactions with other persons and must not present more than a normal risk of collectability. There is an exception for extensions of credit pursuant to a benefit or compensation plan of a savings association that is widely available to employees that does not give preference to officers, directors, and other insiders. As of December 31, 2012, total loans to insiders were $411,000 (including $138,000 which relates to residential mortgages that have been sold in the secondary market).
Regulation and Supervision of the Company
GeneralThe Company is a registered savings and loan holding company under federal law and is subject to regulation, supervision, and enforcement actions by the FRB. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a risk to the Bank and to monitor and regulate the Company’s capital and activities such as dividends and share repurchases that can affect capital. Under long-standing FRB policy, holding companies are expected to serve as a source of strength for their depository subsidiaries, and may be called upon to commit financial resources and support to those subsidiaries.The requirement that the Company act as a source of strength for the Bank, and the future capital requirements at the Company level (refer to “Regulatory Capital Requirements,” below), may affect the Company's ability to pay dividends or make other distributions.
The Company may engage in activities permissible for a savings and loan holding company, a bank holding company, or a financial holding company, which generally encompass a wider range of activities that are financial in nature. The Company may not engage in any activities beyond that scope without the approval of the FRB.
Federal law prohibits a savings and loan holding company from acquiring control of another savings institution or holding company without prior written regulatory approval. With some exceptions, it also prohibits the acquisition or retention of more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring an institution that is not federally-insured. In evaluating applications to acquire savings institutions, the regulator must consider the financial and managerial resources, future prospects of the institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
Regulatory Capital Requirements The Company is not currently required by the FRB to maintain minimum regulatory capital at the consolidated level. However, under the Dodd-Frank Act, the FRB is required to impose capital requirements on savings and loan holding companies effective in 2015. Management believes these capital requirements will be substantially the same as those currently required for bank holding companies. Management also believes the Company would have exceeded all regulatory minimum capital requirements as of December 31, 2012, had it been subject to bank holding company capital requirements as of that date.
Proposed Regulatory Capital Requirements In 2012 the federal banking agencies issued proposed regulatory capital rules under Basel III, as previously described. The proposed rules, if adopted, are expected to have a significant impact on the minimum regulatory requirements of regulated financial institutions such as the Company, to include accelerating the timing of the regulatory capital requirements for the Company at the consolidated level, as discussed in the previous paragraph. However, management believes the regulatory capital of the Company will exceed the minimum requirements established in the proposed rules and that the implementation or timing of the rules will not have a significant adverse impact on the financial condition, liquidity, or operations of the Company. It is not known at this time when the proposed rules will become effective or whether the proposed rules will be substantially modified prior to their becoming effective.
Federal Securities LawsThe Company’s common stock is registered with the SEC under the Securities Exchange Act of 1934. The Company is therefore subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act.As a publicly-traded company, the Company is also subject to legislation intended to strengthen the securities markets and public confidence in them. Because some FRB accounting and governance regulations also refer to the SEC’s regulations, the SEC rules may also affect the Bank.
Acquisition of Bank Mutual CorporationNo person may acquire control of the Company without first obtaining the approval of such acquisition by the appropriate federal regulator. Currently, under the federal Change in Bank Control Act and the Savings and Loan Holding Company Act, any person, including a company, or group acting in concert, seeking to acquire 10% or more of the outstanding shares of the Company must, depending on the circumstances, obtain the approval of, and/or file a notice with the FRB. Also, any person or group acting in concert seeking to acquire more than 25% of the Company’s common stock must obtain the prior approval of the FRB.
Federal and State Taxation
Federal Taxation The Company and its subsidiaries file a calendar year consolidated federal income tax return, reporting income and expenses using the accrual method of accounting. The federal income tax returns for the Company’s subsidiaries have been examined and audited or closed without audit by the Internal Revenue Service for tax years prior to 2007.
State Taxation The Company and its subsidiaries are subject to combined reporting in the state of Wisconsin. which includes the Bank’s out-of-state investment subsidiaries since 2009. For additional discussion regarding the impact of this change, refer to “Results of Operations—Income Tax Expense (Benefit)” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Also, refer to “Item 1A. Risk Factors,” for additional discussion.
Item 1A. Risk Factors
In addition to the discussion and analysis set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the cautionary statements set forth in “Item 1. Business,” the following risk factors should be considered when evaluating the Company’s results of operations, financial condition, and outlook. These risk factors should also be considered when evaluating any investment decision with respect to the Company’s common stock.
The Global Credit Market Volatility and Weak Economic Conditions May Significantly Affect the Company’s Liquidity, Financial Condition, and Results of Operations
Global financial markets continue to be unstable and unpredictable, and economic conditions have been relatively weak. Developments relating to the federal budget, federal borrowing authority, or other political issues could also negatively impact these markets, as could global developments such as the European sovereign debt crisis. Continued, and potentially increased, volatility, instability and weakness could affect the Company’s ability to sell investment securities and other financial assets, which in turn could adversely affect the Company’s liquidity and financial position. These factors could also affect the prices at which the Company could make any such sales, which could adversely affect its results of operations and financial condition. Conditions could also negatively affect the Company’s ability to secure funds or raise capital for acquisitions and other projects, which in turn, could cause the Company to use deposits or other funding sources for such projects.
In addition, the volatility of the markets and weakness of the economy could affect the strength of the Company’s customers or counterparties, their willingness to do business with, and/or their ability or willingness to fulfill their obligations to the Company, which could further affect the Company’s results of operations. Current conditions, including relatively high unemployment, weak corporate performance, and soft real estate markets, could negatively affect the volume of loan originations and prepayments, the value of the real estate securing the Company’s mortgage loans, and borrowers’ ability or willingness to repay loan obligations, all of which could adversely impact the Company’s results of operations and financial condition.
The Company’s Actual Loan Losses May Exceed its Allowance for Loan Losses, Which Could Have a Material Adverse Affect on the Company’s Results of Operations
The Companyhas policies and procedures in place to manage its exposure to risk related to its lending operations. However, despite these practices, the Company’s loan customers may not repay their loans according to the terms of the loans and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. Economic weakness, including high unemployment rates and lower values for the collateral underlying loans, may affect borrowers’ ability or willingness to repay their loan obligations that could lead to increased loan losses or provisions. As a result, the Company may experience significant loan losses,including losses that may exceed the amounts established in the allowance for loan losses, which could have a material adverse effect on its operating results and capital.
Further Declines in Real Estate Values May Continue to Adversely Affect Collateral Values and the Company’s Results of Operations
The Company’s market areas have generally experienced lower real estate values, higher levels of residential and non-residential tenant vacancies, and weakness in the market for sale of new or existing properties, for both commercial and residential real estate. These developments could continue to negatively affect the value of the collateral securing the Company’s mortgage and related loans. That decrease in value could in turn lead to increased losses on loans in the event of foreclosures. Increased losses would affect the Company’s loan loss allowance and may cause it to increase its provision for loan losses resulting in a charge to earnings and capital.
Some of the Company’s Lending Activities Are Riskier than One- to Four-Family Real Estate Loans
The Company has identified commercial real estate, commercial business, construction, and consumer loans as areas for lending emphasis and has augmented its personnel in recent periods to increase its penetration in the commercial lending market. While the Company is pursuing this lending diversification for the purpose of increasing net interest income, these types of loans historically have carried greater risk of payment default than residential real estate loans. As the volume of these types of loans increases, credit risk increases. In the event of continued substantial borrower defaults and/or increased defaults resulting from these diverse types of lending, the Company’s provision for loan losses would further increase and loans may be written off, and therefore, earnings would be reduced.
Further, as the portion of the Company's loans secured by the assets of commercial enterprises increases, the Company becomes increasingly exposed to environmental liabilities and compliance burdens. Even though the Company is subject to environmental requirements in connection with residential real estate lending, the possibility of liability increases in connection with commercial lending, particularly in industries that use hazardous materials and/or generate waste or pollution or that own property that was the subject of prior contamination. If the Company does not adequately assess potential environment risks, the value of the collateral it holds may be less than it expects, and it may be exposed to liability for remediation or other environmental compliance.
Regulators Are Becoming Increasingly Stringent, which may Affect the Company's Business and Results of Operations
In addition to new laws and increasing amounts of regulation, the regulatory climate in the U.S., particularly for financial institutions, has become increasingly strict and stringent. As a consequence, regulatory activity affecting specific institutions has also increased in recent periods. Further, because the responsibility for regulating savings associations and their holding companies has transitioned to different regulatory agencies, the FRB and the OCC, these agencies may approach that regulation in different or stricter ways than the predecessor agency, which also could affect the Company's and the Bank's costs of compliance and results of operations.
The Bank’s Ability to Pay Dividends to the Company Is Subject to Current and Potential Future Limitations That May Affect the Company’s Ability to Pay Dividends to Its Shareholders and Repurchase Its Stock
The Company is a separate legal entity from the Bank and engages in no substantial activities other than its ownership of the common stock of the Bank. Consequently, the Company’s net income and cash flows are derived primarily from the Bank’s operations and capital distributions. The availability of dividends from the Bank to the Company is limited by various statutes and regulations, including those of the OCC and FRB; as a result, it is possible, depending on the results of operations and the financial condition of the Bank and other factors, that the OCC and/or the FRB could restrict the payment by the Bank of dividends or other capital distributions or take other actions which could negatively affect the Bank's results and dividend capacity. The federal regulators have become increasingly stringent in their interpretation, application and enforcement of banks' capital requirements, which could affect the regulators’ willingness to allow Bank dividends to the Company. If the Bank is required to reduce its dividends to the Company, or is unable to pay dividends at all, or the FRB separately does not allow the Company to pay dividends, the Company may not be able to pay dividends to its shareholders at existing levels or at all and/or may not be able to repurchase its common stock.
Future Events May Result in a Valuation Allowance Against the Company’s Deferred Tax Asset Which May have a Significant Effect On the Company’s Results of Operations and Financial Condition
As of December 31, 2012, the Company’s net deferred tax asset was $34.2 million. Management evaluates this asset on an on-going basis to determine if a valuation allowance is required. Management determined that no valuation allowance was required to be recorded against the Company’s net deferred tax asset as of December 31, 2012. This determination required significant management judgment based on positive and negative considerations. Such considerations included the Company’s cumulative three-year net loss, the nature of the components of such cumulative loss, recent trends in earnings excluding one-time charges (such as the FHLB prepayment penalty in 2010 and the goodwill impairment in 2011), expectations for the Company’s future earnings, the duration of federal and state net operating loss carryforward periods, and other factors. Future events or circumstances could result in conditions that differ significantly from management’s current assessment of these positive and negative considerations, particularly as such relate to the Company’s future earnings. Changes in these considerations could result in a significant valuation allowance being recorded against the Company’s net deferred tax asset, which could have a significant effect on the Company’s future results of operations and financial condition.
Recent and Future Legislation and Rulemaking in Response to Market and Economic Conditions May Significantly Affect the Company’s Results of Operations and Financial Condition
Instability, volatility, and failures in the credit and financial institutions markets in recent years have ledregulators and legislators to consider and/or adopt proposals that will significantly affect financial institutions and their holding companies, including the Company.Legislation such as the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009, and the Dodd-Frank Act of 2010, as well as programs such as the Troubled Assets Relief Program, were adopted. In addition,in 2012 the federal banking agencies issued proposed rules to implement certain revisions to regulatory capital requirements as specified by Basel III.Although designed to address capital and liquidity issues in the banking system, there can be no assurance as to the ultimate impact of these actions on financial markets, which could have a material, adverse effect on the Company’s business, financial condition, results of operations, access to credit or the value of the Company’s securities. Further legislative and regulatory proposals to reform the U.S. financial system would also affect the Company and the Bank.
The Dodd-Frank Act created the CFPB, which has broad rulemaking and enforcement authority with respect to entities, including financial institutions, that offer to consumers covered financial products and services. The CFPB is required to adopt rules identifying practices or acts that are unfair, deceptive or abusive relating to any customer transaction for a consumer financial product or service, or the offering of a consumer financial product or service. The full scope of the impact of this authority has not yet been determined as related rules have not all yet been adopted. The Company cannot yet determine the costs and limitations related to these additional regulatory requirements; however, the costs of compliance and the effect on its business may have a material adverse effect on the Company's operations and results.
Recently enacted laws, proposed acts, taxes and fees, or any other legislation or regulations ultimately enacted, could materially affect the Company, the Bank and their operations and profitability by imposing additional regulatory burdens and costs, imposing limits on fees and other sources of income, and otherwise more generally affecting the conduct of their business.
The Interest Rate Environment May Have an Adverse Impact on the Company’s Net Interest Income
Volatile interest rate environments make it difficult for the Company to coordinate the timing and amount of changes in the rates of interest it pays on deposits and borrowings with the rates of interest it earns on loans and securities. In addition, volatile interest rate environments cause corresponding volatility in the demand by individuals and businesses for the loan and deposit products offered by the Company. These factors have a direct impact on the Company’s net interest income, and consequently, its net income. Future interest rates could continue to be volatile and management is unable to predict the impact such volatility would have on the net interest income and profits of the Company.
Changes in Market Interest Rates or Other Conditions May Have an Adverse Impact on the Fair Value of the Company’s Available-for-Sale Securities, Shareholders’ Equity, and Profits
GAAP requires the Company to carry its available-for-sale securities at fair value on its balance sheet. Unrealized gains or losses on these securities, reflecting the difference between the fair market value and the amortized cost, net of its tax effect, are included as a component of shareholders’ equity. When market rates of interest increase, the fair value of the Company’s securities available-for-sale generally decreases and equity correspondingly decreases. When rates decrease, fair value generally increases and shareholders’ equity correspondingly increases. However, due to significant disruptions in global financial markets, such as those which occurred in 2008, this usual relationship can be disrupted. Despite a generally declining interest rate environment since that time, certain of the Company’s available-for-sale securities (specifically, its private-label CMOs) from time-to-time have experienced fair values substantially less than amortized cost. Management expects continued volatility in the fair value of its private-label CMOs and is not able to predict when or if the fair value of such securities will fully recover.
Wisconsin Tax Developments Could Reduce the Company’s Net Income
Like many Wisconsin financial institutions, the Company has established non-Wisconsin subsidiaries that hold and manage investment assets and loans, the income from which had not previously been subject to Wisconsin tax prior to 2009. Under a Wisconsin Department of Revenue (the “Department”) audit program specifically aimed at financial institutions’ out-of-state investment subsidiaries, the Department has asserted the position that some or all of the income of the out-of-state subsidiaries in years prior to 2009 was taxable in Wisconsin. In 2010 the Department’s auditor issued a Notice of Proposed Audit Report to the Bank which proposes to tax all of the income of the Bank’s out-of-state investment subsidiaries for all periods that are still open under the statute of limitations, which includes tax years back to 1997. This is a preliminary determination made by the auditor and does not represent a formal assessment. The Bank’s outside legal counsel has met with representatives of the Department to discuss, and object to, the auditor’s proposed adjustments. The Department has requested further information to support the Company’s position, which the Company has provided. The Company is awaiting a further response from the Department.
Management continues to believe that the Bank has reported income and paid Wisconsin taxes in prior periods in accordance with applicable legal requirements and the Department’s long-standing interpretations of them and that the Bank’s position will prevail in discussions with the Department, court proceedings, or other actions that may occur. Ultimately, however, an adverse resolution of these matters could result in additional Wisconsin tax obligations for prior periods, which could have a substantial negative impact on the Bank’s earnings in the period such resolution is reached. The Bank may also incur further costs in the future to address and defend these issues.
Strong Competition Within the Company’s Market Area May Affect Net Income
The Company encounters strong competition both in attracting deposits and originating real estate and other loans. The Company competes with commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms. The Company’s market area includes branches of several commercial banks that are substantially larger than the Company in terms of deposits and loans. In addition, tax-exempt credit unions operate in most of the Company’s market area and aggressively price their products and services to a large part of the population. If competitors succeed in attracting business from the Company’s customers, its deposits and loans could be reduced, which would likely affect earnings.
Developments in the Marketplace, Such as Alternatives to Traditional Financial Institutions, or Adverse Publicity Could Affect the Company's Ongoing Business
Changes in the marketplace are allowing consumers to use alternative means to complete financial transactions that previously had been conducted through banks. For example, consumers can increasingly maintain funds in accounts other than bank deposits or through on-line alternatives, or complete payment transactions without the assistance of banks. Continuation or acceleration of these trends, including newly developing means of communications and technology, could cause consumers to utilize fewer of the Company's services, which could have a material adverse affect on its results.
Financial institutions such as the Company are increasingly under governmental, media and other scrutiny as to the conduct of their businesses, and potential issues and adverse developments (real and perceived) are receiving widespread media attention. If there were to be significant adverse publicity about the Company, that publicity could affect its reputation in the marketplace. If the Company's reputation is diminished, it could affect its business and results of operations as well as the price of the Company's common stock.
The Company Is Subject to Security Risks and Failures and Operational Risks Relating to the Use of Technology that Could Damage Its Reputation and Business
Security breaches in the Company’s internet, telephonic, or other electronic banking activities could expose it to possible liability and damage its reputation. Any compromise of the Company’s security also could deter customers from using its internet banking services that involve the transmission of confidential information. The Company relies on standard internet and other security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect the Company’s systems from compromises or breaches of its security measures, which could result in damage to the Company’s reputation and business and affect its results of operations.
Additionally, as a financial institution, the Company’s business is data intensive. Beyond the inherent nature of a financial institution that requires it to process and track extremely large numbers of financial transactions and accounts, the Company is required to collect and maintain significant data about its customers. These operations require the Company to obtain and maintain technology and security-related systems that are mission critical to its business. The Company’s failure to do so could significantly affect its ability to conduct business and its customers' confidence in it. Further, the Company outsources a large portion of its data processing to third parties. If these third party providers encounter technological or other difficulties or if they have difficulty in communicating with the Company, it will significantly affect the Company’s ability to adequately process and account for customer transactions, which would significantly affect business operations.
Further, the technology affecting the financial institutions industry and consumer financial transactions is rapidly changing, with the frequent introduction of new products, services, and alternatives. The future success of the Company requires that it continue to adapt to these changes in technology to address its customers' needs. Many of the Company's competitors have greater technological resources to invest in these improvements. These changes could be costly to the Company and if the Company does not continue to offer the services and technology demanded by the marketplace, this failure to keep pace with change could materially affect its business, financial condition, and results of operation.
Future FDIC Increases in Deposit Insurance Premiums Could Increase the Company’s Expenses
In 2009 the FDIC significantly increased the initial base assessment rates paid by financial institutions for deposit insurance and imposed a special assessment. These measures were partly in response to the high level of bank failures which has caused an increase in FDIC resolution costs and a reduction in the deposit insurance fund. Effective in April 2011 the FDIC issued a new rule that changed the assessment base and risk-based assessment rates of all insured financial institutions. Although this latest development benefited the Company by lowering the total dollar amount of its FDIC deposit insurance premiums, future changes in the assessment base and/or rates, if any, may have an adverse affect on the earnings of the Company.
The Company’s Ability to Grow May Be Limited if It Cannot Make Acquisitions
The Company will continue to seek to expand its banking franchise by growing internally, acquiring other financial institutions or branches, acquiring other financial services providers, and opening new offices. The Company’s ability to grow through selective acquisitions of other financial institutions or branches will depend on successfully identifying, acquiring, and integrating those institution or branches. The Company has not made any acquisitions in recent years, as management has not identified acquisitions for which it was able to reach an agreement on terms management believed were appropriate and/or that met its acquisition criteria. The Company cannot provide any assurance that it will be able to generate internal growth, identify attractive acquisition candidates, make acquisitions on favorable terms, or successfully integrate any acquired institutions or branches.
The Company Depends on Certain Key Personnel and the Company’s Business Could Be Harmed by the Loss of Their Services or the Inability to Attract Other Qualified Personnel
The Company’s success depends in large part on the continued service and availability of its management team, and on its ability to attract, retain and motivate qualified personnel. The management team has been augmented to attempt to increase the Company's penetration into the commercial lending market. The Company may need to attract further talent in the future. The competition for these individuals can be significant, and the loss of key personnel could harm the Company’s business. The Company cannot provide assurances that it will be able to retain existing key personnel or attract additional qualified personnel.
If the Company is Unable to Maintain Effective Internal Control Over Its Financial Reporting, Investors Could Lose Confidence in the Reliability of Its Financial Statements, Which Could Result in a Reduction in the Value of Its Common Stock
Under the Sarbanes-Oxley Act, public companies must include a report of management regarding companies' control over financial reporting in their annual reports and that report must contain an assessment by management of the effectiveness of the companies' internal control over financial reporting. In addition, the independent registered public accounting firm that audits a company's financial statements must attest to and report on the effectiveness of the company’s internal control over financial reporting.
If the Company is unable to maintain the required effective internal control over financial reporting, including in connection with regulatory changes and/or changes in accounting rules and standards that apply to it, this could lead to a failure to meet its reporting obligations to the SEC. Such a failure in turn could result in an adverse reaction to the Company in the marketplace or a decline in value of the Company's common stock, due to a loss of confidence in the reliability of the Company's financial statements.
The Cost to Provide Employee Healthcare Insurance and/or Benefits Could Increase in the Future
The Affordable Care Act (the “ACA”), which was adopted in 2010 and is being phased in over several years, significantly affects the provision of both health care services and benefits in the United States. It is possible that ACA the will negatively affect the Company’s cost of providing health insurance and/or benefits, and may also impact various other aspects of the Company’s business. While the ACA did not have a material impact on the Company in 2012, 2011 or 2010, the Company is continuing to assess the possible future impact of the ACA on its health care benefit costs.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The Company and its subsidiaries conduct their business through an executive office and 76 banking offices, which had an aggregate net book value of $48.1 million as of December 31, 2012, excluding furniture, fixtures, and equipment. As of December 31, 2012, the Company owned the building and land for 69 of its property locations and leased the space for eight.
The Company also owns 15 acres of developed land in a suburb of Milwaukee, Wisconsin, through its MC Development subsidiary, as well as approximately 300 acres of undeveloped land in another community located near Milwaukee through MC Development’s 50% ownership in Arrowood Development LLC. The net book value of these parcels of land was $5.4 million at December 31, 2012.
Item 3. Legal Proceedings
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Management believes that these routine legal proceedings, in the aggregate, are immaterial to the Company’s financial condition, results of operations, and cash flows. Refer also to “Item 1A. Risk Factors—Wisconsin Tax Developments Could Reduce the Company’s Net Income” regarding certain Wisconsin income tax developments.
Item 4. Mine Safety Disclosures
Not applicable.
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters’ and Issuer Purchase of Equity Securities
The common stock of the Company is traded on The NASDAQ Global Select Market under the symbol BKMU.
As of February 28, 2013, there were 46,420,084 shares of common stock outstanding and approximately 8,800 shareholders of record.
The Company paid a total cash dividend of $0.05 per share in 2012. A cash dividend of $0.02 per share was paid on March 1, 2013, to shareholders of record on February 15, 2013. For additional discussion relating to the Company’s dividends, refer to “Financial Condition—Shareholders’ Equity” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The payment of dividends in the future is discretionary with the Company’s board of directors and will depend on the Company’s operating results, financial condition, and other considerations. Interest on deposits will be paid prior to payment of dividends on the Company’s common stock. Refer also to “Item 1. Business—Regulation and Supervision” for information relating to regulatory limitations on the Company’s payment of dividends to shareholders, as well as the payment of dividends by the Bank to the Company, which in turn could affect the payment of dividends by the Company.
The high and low trading prices of the Company’s common stock from January 1, 2011, through December 31, 2012, by quarter, and the dividends paid in each quarter, were as follows:
| | | 2012 Stock Prices | | | 2011 Stock Prices | | | Cash Dividends Paid | |
| | | High | | | Low | | | High | | | Low | | | 2012 | | | 2011 | |
| 1st Quarter | | $ | 4.45 | | | $ | 3.15 | | | $ | 5.08 | | | $ | 3.81 | | | $ | 0.01 | | | $ | 0.03 | |
| 2nd Quarter | | | 4.41 | | | | 3.43 | | | | 4.28 | | | | 3.54 | | | | 0.01 | | | | 0.01 | |
| 3rd Quarter | | | 4.69 | | | | 3.95 | | | | 3.91 | | | | 2.57 | | | | 0.01 | | | | 0.01 | |
| 4th Quarter | | | 4.64 | | | | 4.03 | | | | 3.68 | | | | 2.43 | | | | 0.02 | | | | 0.01 | |
| | | | | | | | | | | | | | | | Total | | | $ | 0.05 | | | $ | 0.06 | |
From January 1, 2013, to February 28, 2013, the trading price of the Company's common stock ranged between $4.43 to $5.88 per share, and closed this period at $5.72 per share.
The Company did not repurchase any of its common stock during 2012 and the Company’s board of directors has not authorized a new stock repurchase program. For additional discussion relating to the Company’s repurchase of its common stock, refer to “Item 1. Business—Shareholders’ Equity” and “Item 1. Business—Regulation and Supervision.”
Set forth below is a line graph comparing the cumulative total shareholder return on Company common stock, based on the market price of the common stock and assuming reinvestment of cash dividends, with the cumulative total return of companies on the NASDAQ Stock Market U.S. Index (“NASDAQ Composite Index”) and the NASDAQ Stock Market Bank Index. The graph assumes that $100 was invested on December 31, 2007, in Company common stock and each of those indices.
| | | Period Ending | |
| Index | | 12/31/07 | | | 12/31/08 | | | 12/31/09 | | | 12/31/10 | | | 12/31/11 | | | 12/31/12 | |
| Bank Mutual Corporation | | | 100.00 | | | | 112.94 | | | | 70.63 | | | | 50.37 | | | | 34.04 | | | | 46.61 | |
| NASDAQ Composite Index | | | 100.00 | | | | 61.17 | | | | 87.93 | | | | 104.13 | | | | 104.69 | | | | 123.85 | |
| NASDAQ Bank Index | | | 100.00 | | | | 72.91 | | | | 60.66 | | | | 72.13 | | | | 64.51 | | | | 77.18 | |
Item 6. Selected Financial Data
The following table provides selected financial data for the Company for its past five fiscal years. The data is derived from the Company’s audited financial statements, although the table itself is not audited. The following data should be read together with the Company’s consolidated financial statements and related notes and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.”
| | | At December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | (Dollars in thousands, except number of shares and per share amounts) | |
| Selected financial condition data: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 2,418,264 | | | $ | 2,498,484 | | | $ | 2,591,818 | | | $ | 3,512,064 | | | $ | 3,489,689 | |
| Loans receivable, net | | | 1,402,246 | | | | 1,319,636 | | | | 1,323,569 | | | | 1,506,056 | | | | 1,829,053 | |
| Loans held-for-sale | | | 10,739 | | | | 19,192 | | | | 37,819 | | | | 13,534 | | | | 19,030 | |
| Investment securities available-for-sale | | | – | | | | – | | | | 228,023 | | | | 614,104 | | | | 419,138 | |
| Mortgage-related securities available-for-sale | | | 550,185 | | | | 781,770 | | | | 435,234 | | | | 866,848 | | | | 850,867 | |
| Mortgage-related securities held-to-maturity | | | 157,558 | | | | – | | | | – | | | | – | | | | – | |
| Foreclosed properties and repossessed assets | | | 13,961 | | | | 24,724 | | | | 19,293 | | | | 17,689 | | | | 4,768 | |
| Goodwill | | | – | | | | – | | | | 52,570 | | | | 52,570 | | | | 52,570 | |
| Mortgage servicing rights, net | | | 6,821 | | | | 7,401 | | | | 7,769 | | | | 6,899 | | | | 3,703 | |
| Deposit liabilities | | | 1,867,899 | | | | 2,021,663 | | | | 2,078,310 | | | | 2,137,508 | | | | 2,128,277 | |
| Borrowings | | | 210,786 | | | | 153,091 | | | | 149,934 | | | | 906,979 | | | | 907,971 | |
| Shareholders' equity | | | 271,853 | | | | 265,771 | | | | 312,953 | | | | 402,477 | | | | 399,611 | |
| Tangible shareholders' equity (1) | | | 271,853 | | | | 265,771 | | | | 260,383 | | | | 349,907 | | | | 347,041 | |
| Number of shares outstanding, net of treasury stock | | | 46,326,484 | | | | 46,228,984 | | | | 45,769,443 | | | | 46,165,635 | | | | 47,686,759 | |
| Book value per share | | $ | 5.87 | | | $ | 5.75 | | | $ | 6.84 | | | $ | 8.72 | | | $ | 8.38 | |
| Tangible shareholders’ equity per share (1) | | $ | 5.87 | | | $ | 5.75 | | | $ | 5.69 | | | $ | 7.58 | | | $ | 7.28 | |
| | | For the Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | (Dollars in thousands, except per share amounts) | |
| Selected operating data: | | | | | | | | | | | | | | | | | | | | |
| Total interest income | | $ | 83,022 | | | $ | 89,345 | | | $ | 112,569 | | | $ | 151,814 | | | $ | 177,556 | |
| Total interest expense | | | 21,641 | | | | 26,756 | | | | 66,276 | | | | 83,784 | | | | 104,191 | |
| Net interest income | | | 61,381 | | | | 62,589 | | | | 46,293 | | | | 68,030 | | | | 73,365 | |
| Provision for loan losses | | | 4,545 | | | | 6,710 | | | | 49,619 | | | | 12,413 | | | | 1,447 | |
| Total non-interest income | | | 29,259 | | | | 23,158 | | | | 40,603 | | | | 31,681 | | | | 17,881 | |
| Total non-interest expense (2) | | | 76,057 | | | | 124,900 | | | | 159,825 | | | | 68,155 | | | | 63,550 | |
| Income (loss) before income taxes | | | 10,038 | | | | (45,863 | ) | | | (122,548 | ) | | | 19,143 | | | | 26,250 | |
| Income tax expense (benefit) | | | 3,336 | | | | 1,752 | | | | (49,909 | ) | | | 5,418 | | | | 9,094 | |
| Net income (loss) before non-controlling interest | | | 6,702 | | | | (47,615 | ) | | | (72,639 | ) | | | 13,725 | | | | 17,155 | |
| Net loss (income) attributable to non-controlling interest | | | 52 | | | | 50 | | | | (1 | ) | | | – | | | | 1 | |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) | | $ | 13,725 | | | $ | 17,156 | |
| Earnings (loss) per share-basic | | $ | 0.15 | | | $ | (1.03 | ) | | $ | (1.59 | ) | | $ | 0.29 | | | $ | 0.36 | |
| Earnings (loss) per share-diluted | | $ | 0.15 | | | $ | (1.03 | ) | | $ | (1.59 | ) | | $ | 0.29 | | | $ | 0.35 | |
| Cash dividends paid per share | | $ | 0.05 | | | $ | 0.06 | | | $ | 0.20 | | | $ | 0.34 | | | $ | 0.36 | |
| (1) | This is a non-GAAP measure. Tangible shareholders’ equity is total shareholders’ equity minus goodwill. |
| (2) | Total non-interest expense in 2011 includes a goodwill impairment of $52.6 million and in 2010 includes $89.3 million in loss on early repayment of FHLB borrowings. |
| | | At or For the Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| Selected financial ratios: | | | | | | | | | | | | | | | | | | | | |
| Net interest margin (3) | | | 2.67 | % | | | 2.76 | % | | | 1.47 | % | | | 2.09 | % | | | 2.21 | % |
| Net interest rate spread | | | 2.57 | | | | 2.64 | | | | 1.26 | | | | 1.82 | | | | 1.85 | |
| Return on average assets | | | 0.27 | | | | (1.87 | ) | | | (2.12 | ) | | | 0.39 | | | | 0.48 | |
| Return on average shareholders' equity | | | 2.50 | | | | (16.37 | ) | | | (18.47 | ) | | | 3.40 | | | | 4.15 | |
| Efficiency ratio (4) | | | 84.04 | | | | 85.07 | | | | 99.36 | | | | 73.32 | | | | 68.77 | |
| Non-interest expense as a percent of adjusted average assets (5) | | | 3.03 | | | | 2.84 | | | | 2.06 | | | | 1.95 | | | | 1.80 | |
| Shareholders' equity to total assets | | | 11.24 | | | | 10.64 | | | | 12.07 | | | | 11.39 | | | | 11.45 | |
| Tangible shareholders' equity to adjusted total assets (6) | | | 11.24 | | | | 10.64 | | | | 10.25 | | | | 10.09 | | | | 10.07 | |
| | | | | | | | | | | | | | | | | | | | | |
| Selected asset quality ratios: | | | | | | | | | | | | | | | | | | | | |
| Non-performing loans to loans receivable, net | | | 1.84 | % | | | 5.69 | % | | | 9.29 | % | | | 2.83 | % | | | 1.81 | % |
| Non-performing assets to total assets | | | 1.64 | | | | 4.00 | | | | 5.49 | | | | 1.72 | | | | 1.08 | |
| Allowance for loan losses to non-performing loans | | | 83.64 | | | | 37.17 | | | | 39.03 | | | | 39.99 | | | | 36.89 | |
| Allowance for loan losses to total loans receivable, net | | | 1.54 | | | | 2.12 | | | | 3.63 | | | | 1.13 | | | | 0.67 | |
| Charge-offs to average loans | | | 0.78 | | | | 1.96 | | | | 1.26 | | | | 0.45 | | | | 0.05 | |
| (3) | Net interest margin is calculated by dividing net interest income by average earnings assets. |
| (4) | Efficiency ratio is calculated by dividing non-interest expense (excluding goodwill impairment and loss on early repayment of FHLB borrowings) by the sum of net interest income and non-interest income (excluding gains and losses on investments). |
| (5) | The ratio in 2011 excludes the impact of the goodwill impairment and in 2010 excludes the impact of the prepayment penalty on the early repayment of FHLB borrowings. |
| (6) | This is a non-GAAP measure. The ratio is calculated by dividing total shareholders’ equity less intangible assets (net of deferred taxes) divided by total assets less intangible assets (net). Intangible assets consist of goodwill and other intangible assets. Deferred taxes have been established only on other intangible assets and are immaterial in amount. |
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The discussion and analysis in this section should be read in conjunction with “Item 8. Financial Statements and Supplementary Data,” and “Item 7A. Quantitative and Qualitative Disclosures about Market Risk,” as well as “Item 1. Business” and “Item 1A. Risk Factors.”
Results of Operations
OverviewThe Company’s net income (loss) for the years ended December 31, 2012, 2011, and 2010, was $6.8 million, $(47.6) million, and $(72.6) million, respectively. Diluted earnings (loss) per share during these periods were $0.15, $(1.03), and $(1.59), respectively.
The Company’s net income in 2012 was impacted by the following favorable developments compared to 2011:
| • | a one-time $52.6 million loss in 2011 on the impairment of goodwill; |
| • | a $7.2 million or 121% increase in gain on loan sales activities; and |
| • | a $2.2 million or 32.3% decrease in provision for loan losses. |
These favorable developments were partially offset by the following unfavorable developments in 2012 compared to 2011:
| • | a $3.5 million or 8.9% increase in compensation-related costs; |
| • | a $1.5 million unfavorable change in net loan-related fees and servicing revenue; |
| • | a $1.2 million or 1.9% decrease in net interest income; and |
| • | a $1.6 million or 90.4% increase in income tax expense. |
The Company’s net loss in 2011 was impacted by the following unfavorable developments compared to 2010:
| • | a one-time $52.6 million loss in 2011 on the impairment of goodwill; |
| • | a $14.9 million or 93.0% decrease in gain on investments; |
| • | a $2.8 million or 7.9% increase in compensation-related expenses; |
| • | a $2.6 million or 30.4% decrease in gain on loan sales activities; and |
• a $51.7 million change in income taxes from a benefit of $49.9 million in 2010 to an expense of $1.8 million in 2011.
These unfavorable developments were partially offset by the following favorable developments in 2011 compared to 2010:
• a one-time $89.3 million loss in 2010 on early repayment of FHLB borrowings;
• a $42.9 million or 86.5% decrease in provision for loan losses;
• a $16.3 million or 35.2% increase in net interest income; and
• a $1.2 million or 14.6% decrease in net losses and expenses on foreclosed real estate.
The following paragraphs discuss these developments in greater detail, as well as other changes in the components of net income (loss) during the years ended December 31, 2012, 2011, and 2010.
Net Interest IncomeNet interest income declined by $1.2 million or 1.9% during the year ended December 31, 2012, compared to 2011. This decline was primarily attributable to a decrease in the Company’s net interest margin, which was 2.67% in 2012 compared to 2.76% in 2011. This decline was primarily the result of a lower interest rate environment in 2012, which reduced the return on the Company’s earning assets more than the cost of its funding sources. Contributing to the reduction in the cost of the Company’s funding sources in 2012 was its repayment of $100.0 million in high-cost borrowings from the FHLB of Chicago that matured during the period.
The impact of a lower net interest margin in 2012 was partially offset by the favorable impact of higher average earning assets during the year. In 2012 the Company purchased $158.9 million in held-to-maturity securities that were funded by term borrowings from the FHLB of Chicago (for additional discussion refer to “Financial Condition—Mortgage-Related Securities Held-to-Maturity”). In addition, during 2012 average total loans increased by $21.9 million or 1.6% compared to 2011.
Net interest income increased by $16.3 million or 35.2% during the year ended December 31, 2011, compared to 2010. This increase was primarily attributable to an improvement in the Company’s net interest margin, which increased to 2.76% in 2011 from 1.47% in 2010. This improvement was primarily the result of the Company’s early repayment of $756.0 million in high-cost borrowings from the FHLB of Chicago in December 2010, as described below. The repayment resulted in a significant decline in the average cost of interest-bearing liabilities in 2011 compared to 2010. Also contributing to the improvement in the Company’s net interest margin in 2011 was a decline in its average cost of deposits. The Company’s average cost of deposits declined by 40 basis points in 2011 compared to 2010. Also contributing to the improvement in the net interest margin in 2011 was a 38 basis point improvement in the yield on interest-earning assets compared to the previous year. This improvement was caused by a favorable change in the mix of earning assets from lower-yielding assets, such as overnight investments and short-term securities, to higher-yielding assets, such as loans receivable. Partially offsetting the favorable impact of this improved asset mix was a decrease in the average yield on loans receivable and available-for-sale securities in 2011 compared to 2010. These decreases were caused by a declining interest rate environment that resulted in lower yields on these assets in 2011. In addition, the Company sold a substantial number of higher-yielding securities in 2010 at gains, as noted below, which reduced the overall yield on its securities portfolio in 2011 compared to 2010.
In December 2010 the Company repaid $756.0 million in fixed-rate borrowings from the FHLB of Chicago prior to the stated maturities of the borrowings. As a result of this prepayment, the Company recognized a one-time charge of $89.3 million in 2010. At the time, the borrowings had an average remaining maturity of six years and a weighted-average interest cost of 4.17%. The Company considered it prudent to repay these borrowings prior to their stated maturities due to the lack of acceptable investment or lending alternatives that could provide sufficient yield to justify the high cost of the borrowings.
The following table presents certain details regarding the Company's average balance sheet and net interest income for the periods indicated. The tables present the average yield on interest-earning assets and the average cost of interest-bearing liabilities. The yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. The average balances are derived from daily balances over the periods indicated. Interest income includes fees, which are considered adjustments to yields. Net interest spread is the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin is derived by dividing net interest income by average interest-earning assets. No tax equivalent adjustments were made since the Company does not have any tax exempt investments.
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | | | | Interest | | | Avg. | | | | | | Interest | | | Avg. | | | | | | Interest | | | Avg. | |
| | | Average | | | Earned/ | | | Yield/ | | | Average | | | Earned/ | | | Yield/ | | | Average | | | Earned/ | | | Yield/ | |
| | | Balance | | | Paid | | | Cost | | | Balance | | | Paid | | | Cost | | | Balance | | | Paid | | | Cost | |
| | (Dollars in thousands) | |
| Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans receivable, net (1) | | $ | 1,389,313 | | | $ | 65,478 | | | | 4.71 | % | | $ | 1,367,450 | | | $ | 69,936 | | | | 5.11 | % | | $ | 1,478,433 | | | $ | 79,266 | | | | 5.36 | % |
| Mortgage-related securities | | | 792,989 | | | | 17,309 | | | | 2.18 | | | | 656,343 | | | | 16,374 | | | | 2.49 | | | | 589,070 | | | | 17,445 | | | | 2.96 | |
| Investment securities (2) | | | 25,443 | | | | 73 | | | | 0.29 | | | | 156,793 | | | | 2,877 | | | | 1.83 | | | | 840,424 | | | | 15,428 | | | | 1.84 | |
| Interest-earning deposits | | | 91,801 | | | | 162 | | | | 0.18 | | | | 84,505 | | | | 158 | | | | 0.19 | | | | 250,909 | | | | 430 | | | | 0.17 | |
| Total interest-earning assets | | | 2,299,546 | | | | 83,022 | | | | 3.61 | | | | 2,265,091 | | | | 89,345 | | | | 3.94 | | | | 3,158,836 | | | | 112,569 | | | | 3.56 | |
| Non-interest-earning assets | | | 210,599 | | | | | | | | | | | | 278,872 | | | | | | | | | | | | 266,270 | | | | | | | | | |
| Total average assets | | $ | 2,510,145 | | | | | | | | | | | $ | 2,543,963 | | | | | | | | | | | $ | 3,425,106 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities and equity: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Savings deposits | | $ | 217,255 | | | | 63 | | | | 0.03 | | | $ | 212,644 | | | | 78 | | | | 0.04 | | | $ | 208,544 | | | | 104 | | | | 0.05 | |
| Money market accounts | | | 434,549 | | | | 716 | | | | 0.16 | | | | 405,033 | | | | 1,696 | | | | 0.42 | | | | 347,906 | | | | 2,075 | | | | 0.60 | |
| Interest-bearing demand accounts | | | 219,038 | | | | 51 | | | | 0.02 | | | | 199,909 | | | | 85 | | | | 0.04 | | | | 200,292 | | | | 107 | | | | 0.05 | |
| Certificates of deposit | | | 954,047 | | | | 13,825 | | | | 1.45 | | | | 1,069,708 | | | | 17,709 | | | | 1.66 | | | | 1,234,411 | | | | 26,320 | | | | 2.13 | |
| Total deposit liabilities | | | 1,824,889 | | | | 14,655 | | | | 0.80 | | | | 1,887,294 | | | | 19,568 | | | | 1.04 | | | | 1,991,153 | | | | 28,606 | | | | 1.44 | |
| Advance payment by borrowers for taxes and insurance | | | 21,141 | | | | 2 | | | | 0.01 | | | | 19,551 | | | | 5 | | | | 0.03 | | | | 19,606 | | | | 6 | | | | 0.03 | |
| Borrowings | | | 227,573 | | | | 6,984 | | | | 3.07 | | | | 156,521 | | | | 7,183 | | | | 4.59 | | | | 871,212 | | | | 37,664 | | | | 4.32 | |
| Total interest-bearing liabilities | | | 2,073,603 | | | | 21,641 | | | | 1.04 | | | | 2,063,366 | | | | 26,756 | | | | 1.30 | | | | 2,881,971 | | | | 66,276 | | | | 2.30 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest-bearing deposits | | | 130,734 | | | | | | | | | | | | 110,784 | | | | | | | | | | | | 96,370 | | | | | | | | | |
| Other non-interest-bearing liabilities | | | 35,208 | | | | | | | | | | | | 79,314 | | | | | | | | | | | | 53,506 | | | | | | | | | |
| Total non-interest-bearing liabilities | | | 165,942 | | | | | | | | | | | | 190,098 | | | | | | | | | | | | 149,876 | | | | | | | | | |
| Total liabilities | | | 2,239,545 | | | | | | | | | | | | 2,253,464 | | | | | | | | | | | | 3,031,847 | | | | | | | | | |
| Total equity | | | 270,600 | | | | | | | | | | | | 290,499 | | | | | | | | | | | | 393,259 | | | | | | | | | |
| Total average liabilities and equity | | $ | 2,510,145 | | | | | | | | | | | $ | 2,543,963 | | | | | | | | | | | $ | 3,425,106 | | | | | | | | | |
| Net interest income and net interest rate spread | | | | | | $ | 61,381 | | | | 2.57 | % | | | | | | $ | 62,589 | | | | 2.64 | % | | | | | | $ | 46,293 | | | | 1.26 | % |
| Net interest margin | | | | | | | | | | | 2.67 | % | | | | | | | | | | | 2.76 | % | | | | | | | | | | | 1.47 | % |
| Average interest-earning assets to interest-bearing liabilities | | | 1.11 | x | | | | | | | | | | | 1.10 | x | | | | | | | | | | | 1.10 | x | | | | | | | | |
| (1) | For the purposes of these computations, non-accruing loans and loans held-for-sale are included in the average loans outstanding. |
| (2) | FHLB of Chicago stock is included in investment securities. |
The following tables present the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to the change attributable to change in volume (change in volume multiplied by prior rate), the change attributable to change in rate (change in rate multiplied by prior volume), and the net change. The change attributable to the combined impact of volume and rate has been allocated proportionately to the change due to volume and the change due to rate.
| | | Year Ended December 31, 2012, | |
| | | Compared to Year Ended December 31, 2011 | |
| | | Increase (Decrease) | |
| | | Volume | | | Rate | | | Net | |
| | (Dollars in thousands) | |
| Interest-earning assets: | | | | | | | | | | | | |
| Loans receivable | | $ | 1,084 | | | $ | (5,542 | ) | | $ | (4,458 | ) |
| Mortgage-related securities | | | 3,129 | | | | (2,194 | ) | | | 935 | |
| Investment securities | | | (1,395 | ) | | | (1,409 | ) | | | (2,804 | ) |
| Interest-earning deposits | | | 13 | | | | (9 | ) | | | 4 | |
| Total interest-earning assets | | | 2,831 | | | | (9,154 | ) | | | (6,323 | ) |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| Savings deposits | | | 6 | | | | (21 | ) | | | (15 | ) |
| Money market deposits | | | 116 | | | | (1,096 | ) | | | (980 | ) |
| Interest-bearing demand deposits | | | 7 | | | | (41 | ) | | | (34 | ) |
| Certificates of deposit | | | (1,808 | ) | | | (2,076 | ) | | | (3,884 | ) |
| Advance payment by borrowers for taxes and insurance | | | – | | | | (3 | ) | | | (3 | ) |
| Borrowings | | | 2,637 | | | | (2,836 | ) | | | (199 | ) |
| Total interest-bearing liabilities | | | 958 | | | | (6,073 | ) | | | (5,115 | ) |
| Net change in net interest income | | $ | 1,873 | | | $ | (3,081 | ) | | $ | (1,208 | ) |
| | | Year Ended December 31, 2011, | |
| | | Compared to Year Ended December 31, 2010 | |
| | | Increase (Decrease) | |
| | | Volume | | | Rate | | | Net | |
| | (Dollars in thousands) | |
| Interest-earning assets: | | | | | | | | | | | | |
| Loans receivable | | $ | (5,740 | ) | | $ | (3,590 | ) | | $ | (9,330 | ) |
| Mortgage-related securities | | | 1,882 | | | | (2,953 | ) | | | (1,071 | ) |
| Investment securities | | | (12,511 | ) | | | (40 | ) | | | (12,551 | ) |
| Interest-earning deposits | | | (311 | ) | | | 39 | | | | (272 | ) |
| Total interest-earning assets | | | (16,680 | ) | | | (6,544 | ) | | | (23,224 | ) |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| Savings deposits | | | (5 | ) | | | (21 | ) | | | (26 | ) |
| Money market deposits | | | 307 | | | | (686 | ) | | | (379 | ) |
| Interest-bearing demand deposits | | | – | | | | (22 | ) | | | (22 | ) |
| Certificates of deposit | | | (3,216 | ) | | | (5,395 | ) | | | (8,611 | ) |
| Advance payment by borrowers for taxes and insurance | | | – | | | | (1 | ) | | | (1 | ) |
| Borrowings | | | (32,668 | ) | | | 2,187 | | | | (30,481 | ) |
| Total interest-bearing liabilities | | | (35,582 | ) | | | (3,938 | ) | | | (39,520 | ) |
| Net change in net interest income | | $ | 18,902 | | | $ | (2,606 | ) | | $ | 16,296 | |
Provision for Loan LossesThe Company’s provision for loan losses was $4.5 million, $6.7 million, and $49.6 million during the years ended December 31, 2012, 2011, and 2010, respectively. In 2012 the Company recorded loss provisions of $6.3 million against a number of multi-family, commercial real estate, and business loan relationships, as well as residential and consumer loans. The losses on these loans were based on updated independent appraisals and/or internal management evaluations of the collateral that secures the loan, as well as management’s knowledge of current market conditions. This development was partially offset by $1.8 million in loss recaptures related to certain non-performing loans that paid off during the period and to recoveries related to previously charged-off loans.
In 2011 the Company recorded $11.8 million in loss provisions against a number of larger multi-family, commercial real estate, and business loan relationships, as well as certain smaller residential and consumer loans. The losses on these loans were based on updated independent appraisals and/or internal management evaluations of the collateral that secures the loan, as well as management’s knowledge of current market conditions. In addition, during 2011 the Company recorded approximately $2.4 million in additional loss provisions that reflected management’s general concerns at the time related to continued economic weakness, elevated levels of unemployment, depressed real estate values, and the internal downgrades of certain loans. These developments were partially offset by $7.5 million in loss recaptures on loans that were paid-off during the period, were upgraded to performing status, or improved in performance and/or prospects.
In 2010 the Company noted increased vacancy rates, declining rents, and/or delays in unit sales for many of the properties that secure Company’s loans. In many instances, management’s observations included loans that borrowers and/or loan guarantors had managed to keep current despite underlying difficulties with the collateral properties. In view of those developments and their expected continuation, as well an increasingly strict regulatory environment, management concluded in 2010 that the probability of a number of its loans being collateral dependent had increased, which resulted in a significant increase in provision for loan losses. In 2010 the Company recorded $31.0 million in loss provisions against 34 larger loan relationships aggregating $91.6 million. These loans were secured by commercial real estate, multi-family real estate, undeveloped land, and, in the case of a few commercial business loans, certain other non-real estate assets. During 2010 the Company also recorded $10.0 million in loss provisions on a large number of smaller commercial real estate, multi-family real estate, and commercial business loan relationships, as well as $1.3 million in loss provisions on one- to four-family loans and consumer loans. In general, these losses were based on updated independent appraisals that were received during 2010, but in some cases were based on management judgment. Finally, during 2010 the Company recorded $7.3 million in additional loss provisions that reflected management’s general concerns at the time related to declines in commercial real estate values, weak economic conditions, and high levels of unemployment.
The Company’s provision for loan losses was substantially lower in 2012 and 2011 than it was in 2010. This trend is directionally consistent with declines in the Company’s non-performing loans and classified loans, as described in “Financial Condition—Asset Quality,” below, and is consistent with general trends in the banking industry. It should be noted, however, that the Company’s loan portfolio continues to be impacted by slow economic growth, persistent unemployment, and low real estate values. These conditions are particularly challenging for borrowers whose loans are secured by commercial real estate, multi-family real estate, and land. As such, there can be no assurances that non-performing loans and/or classified loans will continue to trend lower in future periods or that the Company’s provision for loan losses will not vary considerably in future periods. Refer to “Item 1. Business—Asset Quality,” above, for additional discussion related to the Company’s policies and procedures related to its provision for loan losses, allowance for loan losses, and asset quality.
Non-Interest Income Total non-interest income for the years ended December 31, 2012, 2011, and 2010, was $29.3 million, $23.2 million, and $40.6 million, respectively. The following paragraphs discuss the principal components of non-interest income and primary reasons for their changes from 2011 to 2012, as well as 2010 to 2011.
Service charges on deposits were $6.9 million, $6.4 million, and $6.1 million in 2012, 2011, and 2010, respectively. Management attributes the improvements in 2012 and 2011 to an increase in the Company’s average checking accounts, which increased by $39.1 million or 11.8% in 2012 compared to 2011 and $14.0 million or 4.7% in 2011 compared to 2010. In addition, enhancements in recent periods to the Company’s commercial deposit products and services generated increased fee revenue in these years, particularly related to treasury management services.
Brokerage and insurance commissions were $3.0 million, $2.8 million, and $3.1 million for the years ended December 31, 2012, 2011, and 2010, respectively. This revenue item consists of commissions earned on sales of tax-deferred annuities, mutual funds, and certain other securities, as well as personal and business insurance products. Commission revenue in 2012 benefited from a lower interest rate environment that encouraged customers to purchase tax-deferred annuities due to higher returns compared to deposit-related products. Commission revenue in 2010 benefited from favorable trends in equity markets in the first half of that year, which resulted in increased revenue from sales of mutual funds and other equity investments relative to 2012 and 2011.
Net loan-related fees and servicing revenue was a loss of $1.9 million and $402,000 in 2012 and 2011, respectively, and income of $103,000 in 2010. The following table presents the primary components of net loan-related fees and servicing revenue for the periods indicated:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Gross servicing fees | | $ | 2,826 | | | $ | 2,718 | | | $ | 2,584 | |
| MSR amortization | | | (3,904 | ) | | | (2,747 | ) | | | (3,277 | ) |
| MSR valuation (loss) recovery | | | (1,528 | ) | | | (862 | ) | | | 281 | |
| Loan servicing revenue, net | | | (2,606 | ) | | | (891 | ) | | | (412 | ) |
| Other loan fee income | | | 695 | | | | 489 | | | | 515 | |
| Loan-related fees and servicing revenue, net | | $ | (1,911 | ) | | $ | (402 | ) | | $ | 103 | |
Gross servicing fees increased in 2012 and 2011 due to an increase in the amount of loans the Company services for third-party investors. During 2012, 2011, and 2010, the Company serviced an average of $1.13 billion, $1.09 billion, and $1.03 billion, respectively, in loans for third-party investors. Loans serviced for third-party investors have increased the past two years due to increased sales of loans by the Company in the secondary market, as described below. The Company typically retains the servicing on these loans. Related amortization of MSRs was higher in the 2012 and 2010 periods due to generally lower market interest rates for one- to four-family mortgage loans in those periods, which resulted in increased loan prepayments and faster amortization of the MSRs in such years.
Loan-related fees and servicing revenue is also impacted by changes in the valuation allowance that is established against MSRs. The change in this allowance is recorded as a recovery or charge, as the case may be, in the period in which the change occurs. In 2012 the valuation allowance increased by $1.5 million due principally to a decline in market interest rates, which resulted in increased loan prepayment expectations. The valuation allowance increased by $862,000 in 2011 due to a decline in market interest rates during the last few months of that year.
The valuation of MSRs, as well as the periodic amortization of MSRs, is significantly influenced by the level of market interest rates and loan prepayments. If market interest rates for one- to four-family loans increase and/or actual or expected loan prepayment expectations decrease in future periods, the Company could recover all or a portion of its previously established allowance on MSRs, as well as record reduced levels of MSR amortization expense. Alternatively, if interest rates continue to decrease and/or prepayment expectations increase, the Company could potentially record additional charges to earnings related to increases in the valuation allowance on its MSRs. In addition, amortization expense could increase further due to likely increases in loan prepayment activity. Lower interest rates also typically cause an increase in actual mortgage loan prepayment activity, which generally results in an increase in the amortization of MSRs.
Net gains on loan sales activities were $13.2 million, $6.0 million, and $8.6 million during the years ended December 31, 2012, 2011, and 2010, respectively. The Company’s policy is to sell substantially all of its fixed-rate, one- to four-family mortgage loan originations in the secondary market. During 2012, 2011, and 2010 sales of one- to four-family mortgage loans were $454.6 million, $292.7 million, and $409.4 million, respectively. Loan sales were elevated in the 2012 and 2010 periods as a result of generally lower market interest rates for one- to four-family mortgage loans in those periods, which encouraged a larger number of borrowers to refinance higher-rate loans into lower-rate loans during those years. Also contributing to the increase in gains on sales of loans in 2012 was an increase in the Company’s average gross profit margin on the sales of loans. In 2012 the average gross profit margin was 2.91% compared to 2.04% and 2.09% in 2011 and 2010, respectively. Management attributed this improvement to the burden that increased consumer demand has placed on the loan production capacity of the mortgage banking industry as a whole, which has caused gross profit margins to increase.
Market interest rates for one- to four-family mortgage loans have increased modestly in recent weeks and the pace of the Company’s loan originations and sales has diminished compared to 2012. In addition, the Company has experienced a decline in its gross profit margin on individual loan sales in recent months as production capacity within the mortgage banking industry has become less constrained. Absent a further decline in market interest rates for one- to four-family mortgage in 2013, management believes the Company’s gains on sales of loans will be substantially lower in 2013 than they were in 2012. However, management believes the impact of lower gains on sales will be partially offset by continued recovery of previously established MSR valuation allowances, as previously noted, as well as lower MSR amortization. However, there can be no assurances.
Net gain on sales of investments in 2012, 2011, and 2010 was $543,000, $1.1 million, and $16.0 million, respectively. In 2012 the Company sold $20.4 million in mortgage-related securities to provide additional liquidity to fund the repayment of $100.0 million in borrowings from the FHLB of Chicago that matured in third quarter of the year. In 2011 the Company sold its remaining investment in a mutual fund that management did not expect would perform well in future periods. In 2010 the Company sold mortgage-related and certain other securities to provide liquidity to fund the repayment of $756.0 million FHLB of Chicago borrowings in that year, as previously described.
The Company’s operating results in 2012 and 2011 included $400,000 and $389,000 in net OTTI charges, respectively. These losses consisted of the credit portion of the total OTTI loss related to the Company’s investment in certain private-label CMOs rated less than investment grade. Management attributes the net OTTI losses in these periods to low real estate values for residential properties on a nationwide basis. None of the Company’s remaining private-label CMOs were deemed to be other-than-temporarily impaired as of December 31, 2012. However, the collection of the amounts due on private-label CMOs is subject to numerous factors outside of the Company’s control and a future determination of OTTI could result in additional losses being recorded through earnings in future periods. As of December 31, 2012, the Company’s total investment in private-label CMOs was $50.6 million, of which $35.9 million was rated less than investment grade. Refer to “Financial Condition—Available-for-Sale Securities,” below, for additional discussion.
The Company’s operating results in 2010 included a $700,000 loss on a $2.6 million investment in partially-developed land that is held for development and sale. In the judgment of management at the time, a decline in real estate values justified the recognition of the loss.
Increase in cash surrender value of life insurance investments was $2.1 million, $2.4 million, and $2.4 million for the years ended December 31, 2012, 2011, and 2010, respectively. Management attributes the decrease in 2012 to a declining interest rate environment that has reduced the return on this type of investment, as well as lower payouts associated with excess death benefits.
Other non-interest income was $5.8 million, $5.2 million, and $5.1 million for the years ended December 31, 2012, 2011, and 2010, respectively. The changes between years were due primarily to increases in the fair value of assets held in trust for certain non-qualifying employee benefit plans, due to the effects of changes in interest rates and equity markets.
Non-Interest ExpenseTotal non-interest expense for the years ended December 31, 2012, 2011, and 2010 was $76.1 million, $124.9 million, and $159.8 million, respectively. Results in 2011 included a $52.6 million non-cash goodwill impairment recorded by the Company in the second quarter of that year. This impairment had no effect on the liquidity, operations, tangible capital, or regulatory capital of the Company or the Bank (for additional discussion refer to “Note 1. Basis of Presentation” of the Company’s consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data,” below). Results in 2010 included a one-time prepayment penalty of $89.3 million related to the Company’s repayment of $756.0 million in borrowings from the FHLB of Chicago prior to their scheduled maturities, as previously discussed. Excluding the goodwill impairment and prepayment penalty, total non-interest expense in 2012, 2011, and 2010 was $76.1 million, $72.3 million and $70.5 million, respectively. The following paragraphs discuss the principal components of non-interest expense and the primary reasons for their changes from 2011 to 2012, as well as 2010 to 2011.
Compensation and related expenses were $42.3 million, $38.8 million, and $36.0 million during the years ended December 31, 2012, 2011, and 2010, respectively. The increases in 2012 and 2011 were due principally to the Company’s hiring in recent years of certain senior management personnel, a number of commercial relationship managers, and certain other key administrative personnel, as well as annual merit increases for all employees. Also contributing was an increase in certain incentive and bonus payments during these years, including stock based compensation. Finally, the increases in compensation-related expense in 2012 and 2011 were also caused by an increase in costs related to the Company’s defined benefit pension plan, due to a decline in the discount rate used to determine the present value of the pension obligation. In 2011 these developments were partially offset by a decline in employee stock ownership plan (“ESOP”) expense compared to 2010 (due to the end in 2010 of the 10-year commitment to the ESOP), as well as a decline in the overall number of employees employed by the Company.
Effective January 1, 2013, the Company’s board of directors closed the qualified defined benefit pension plan to employees not eligible to participate in the plan as of that date, as well as any employees hired after that date. In addition, effective for service performed after March 1, 2013, the Company’s board of directors reduced certain future benefits formerly provided under the qualified and supplemental plans, but did not reduce all future benefits. Finally, effective January 1, 2013, employees that are not eligible to participate in the qualified plan will be eligible for an enhanced employer contribution in the Company’s defined contribution savings plan. Management does not expect the Company’s pension expense to be impacted significantly in the near term as a result of these actions, because it is anticipated that any cost savings from these actions will be substantially offset by the adverse impact of a continued decline in the discount rate used to determine the present value of the Company’s remaining pension obligations. For additional discussion refer to “Note 10. Employee Benefit Plans” of the Company’s consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data,” below.
As of December 31, 2012, the Company had 639 full-time associates and 81 part-time associates. This compared to 648 full-time and 71 part-time employees at December 31, 2011, and 682 full-time and 82 part-time associates at December 31, 2010.
Occupancy and equipment expense during the years ended December 31, 2012, 2011, and 2010 was $11.4 million, $11.5 million, and $11.2 million, respectively. The decrease in 2012 was principally caused by lower utility and snow removal costs due to a mild winter, reduced expenditures for maintenance and repair, and lower rental expense due to the closure of three leased banking offices. The impact of these developments was partially offset by an increase in data processing costs due to certain product and system enhancements implemented in 2012. The increase in 2011 was primarily caused by higher levels of repair and maintenance costs and rent expense in 2011 compared to 2010.
Federal insurance premiums were $3.3 million, $3.2 million, and $4.1 million during 2012, 2011, and 2010, respectively. In the second quarter of 2011 the FDIC implemented a new rule that changed the deposit insurance assessment base from an insured institution’s domestic deposits (minus certain allowable exclusions) to an insured institution’s average consolidated assets (minus average tangible equity and certain other adjustments). The Company benefited from the implementation of this new rule, which resulted in lower deposit insurance costs in 2012 and 2011 compared to 2010. Due to its improved operating results and financial condition, management believes the Company’s federal insurance premiums could be up to 25% lower in 2013 than they were in 2012 under the FDIC’s risk-based assessment system (for additional information, refer to “Regulation and Supervision of the Bank—Deposit Insurance” in Item 1. Business—Regulation and Supervision,” above). However, there can be no assurances.
Advertising and marketing expenses were $2.1 million, $2.0 million, and $2.1 million in 2012, 2011, and 2010, respectively. The Company has maintained its advertising and marketing expenses at approximately the same level since 2010. However, such expenditures depend on future management decisions and there can be no assurances that such expenditures will remain at this level in the future.
Net losses and expenses on foreclosed properties were $6.7 million, $7.1 million and $8.3 million during 2012, 2011, and 2010, respectively. Although the Company’s losses and expenses on foreclosed real estate have trended lower since 2010, such losses and expenses have remained elevated due to low real estate values and slow economic growth.
Other non-interest expense was $10.2 million, $9.7 million, and $8.8 million during the years ended December 31, 2012, 2011, and 2010, respectively. The increases in 2012 and 2011 were caused by higher legal, consulting, and accounting fees related to loan workouts and related professional services. In recent months, however, these expenses have declined as the Company has reduced its level of non-performing loans.
Income Tax Expense (Benefit) Income tax expense (benefit) was $3.3 million, $1.8 million, and $(49.9) million in 2012, 2011, and 2010, respectively. The large income tax benefit in 2010 was caused by the Company’s pre-tax loss, which was primarily the result of the FHLB prepayment penalty and the large provision for loan losses in that year, as previously described. Excluding the impact of the goodwill impairment in 2011 (which was not deductible for income tax purposes), the Company’s effective tax rate (“ETR”) in 2012, 2011, and 2010 was 33.2%, 26.1%, and 40.7%, respectively. The Company’s ETR will vary from period to period depending primarily on the impact of non-taxable revenue, such as earnings from bank-owned life insurance (“BOLI”). The ETR will generally be lower in periods in which non-taxable revenue comprises a larger portion of pre-tax income or loss, such as in 2011. For additional information related to an open issue related to the Company's income taxes in Wisconsin, refer to “Item 1A. Risk Factors.”
Financial Condition
OverviewThe Company’s total assets decreased by $80.2 million or 3.2% during the twelve months ended December 31, 2012. During the period the Company’s securities available-for-sale declined by $231.6 million, its cash and cash equivalents declined by $33.9 million, its investment in common stock of the FHLB of Chicago (which is a component of other assets) declined by $30.3 million, its foreclosed and repossessed assets declined by $10.8 million, and its loans held-for-sale declined by $8.5 million. These developments were partially offset by an $82.6 million increase in the Company’s loan portfolio. Net cash flows from the changes in these assets were used to fund a $153.8 million decline in deposit liabilities during the year ended December 31, 2012,as well as the repayment of a $100.0 million term advance from the FHLB of Chicago. In addition, during 2012 the Company funded a $157.6 million increase in securities held-to-maturity using term advances from the FHLB of Chicago. The Company’s total shareholders’ equity increased from $265.8 million at December 31, 2011, to $271.9 million at December 31, 2012. Non-performing assets decreased from $99.9 million or 4.00% of total assets at December 31, 2011, to $39.8 million or 1.64% at December 31, 2012. The following paragraphs describe these changes in greater detail, as well as other changes in the Company’s financial condition during the twelve months ended December 31, 2012.
Cash and Cash EquivalentsCash and cash equivalents decreased from $120.9 million at December 31, 2011, to $87.1 million at December 31, 2012. This decrease was due to the funding of increases in the Company’s loan portfolio, as well as decreases in its deposit liabilities, as previously described.
Mortgage-Related Securities Available-for-Sale The Company’s portfolio of mortgage-related securities available-for-sale decreased by $231.6 million or 29.6% during the year ended December 31, 2012. This decrease was principally caused by periodic repayments and security sales that exceeded the Company’s purchase of new securities during the year.
The following table presents the carrying value of the Company’s mortgage-related securities available-for-sale at the dates indicated (carrying value is equal to fair value for all securities and for all periods presented):
| | | December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Freddie Mac | | $ | 343,682 | | | $ | 548,944 | | | $ | 314,067 | |
| Fannie Mae | | | 155,895 | | | | 170,020 | | | | 30,810 | |
| Ginnie Mae | | | 42 | | | | 778 | | | | 2,755 | |
| Private-label CMOs | | | 50,566 | | | | 62,028 | | | | 87,602 | |
| Total | | $ | 550,185 | | | $ | 781,770 | | | $ | 435,234 | |
The following table presents the activity in the Company’s portfolio of mortgage-related securities available-for-sale for the periods indicated:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Carrying value at beginning of period | | $ | 781,770 | | | $ | 435,234 | | | $ | 866,848 | |
| Purchases | | | 51,374 | | | | 507,052 | | | | 819,675 | |
| Sales | | | (20,395 | ) | | | – | | | | (1,058,055 | ) |
| Principal repayments | | | (260,953 | ) | | | (167,587 | ) | | | (187,664 | ) |
| Premium amortization, net | | | (4,152 | ) | | | (3,922 | ) | | | (2,383 | ) |
| Other-than-temporary impairment | | | (400 | ) | | | (389 | ) | | | – | |
| Increase (decrease) in net unrealized gain or loss | | | 2,941 | | | | 11,383 | | | | (3,187 | ) |
| Net increase (decrease) | | | (231,585 | ) | | | 346,536 | | | | (431,614 | ) |
| Carrying value at end of period | | $ | 550,185 | | | $ | 781,770 | | | $ | 435,234 | |
The table below presents information regarding the carrying values, weighted average yields, and contractual maturities of the Company’s mortgage-related securities available-for-sale at December 31, 2012:
| | | One Year or Less | | | More Than One Year
to Five Years | | | More Than Five
Years to Ten Years | | | More Than Ten Years | | | Total | |
| | | Carrying
Value | | | Weighted
Average
Yield | | | Carrying
Value | | | Weighted
Average
Yield | | | Carrying
Value | | | Weighted
Average
Yield | | | Carrying
Value | | | Weighted
Average
Yield | | | Carrying
Value | | | Weighted
Average
Yield | |
| | (Dollars in thousands) | |
| Securities by issuer and type: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Freddie Mac, Fannie Mae, and Ginnie Mae pass-throughs | | $ | 17 | | | | 6.42 | % | | $ | 887 | | | | 7.03 | % | | $ | 27,815 | | | | 2.60 | % | | $ | 41 | | | | 6.71 | % | | $ | 28,760 | | | | 2.74 | % |
| Freddie Mac, Fannie Mae, and Ginnie Mae REMICs | | | – | | | | – | | | | – | | | | – | | | | 32,611 | | | | 1.79 | | | | 438,248 | | | | 2.35 | | | | 470,859 | | | | 2.31 | |
| Private-label CMOs | | | – | | | | – | | | | – | | | | – | | | | 18,698 | | | | 5.11 | | | | 31,868 | | | | 3.17 | | | | 50,566 | | | | 3.86 | |
| Total | | $ | 17 | | | | 6.42 | % | | $ | 887 | | | | 7.03 | % | | $ | 79,124 | | | | 2.86 | % | | $ | 470,157 | | | | 2.41 | % | | $ | 550,185 | | | | 2.47 | % |
| Securities by coupon: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Adjustable-rate coupon | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | $ | 54,710 | | | | 2.04 | % | | $ | 54,710 | | | | 2.04 | % |
| Fixed-rate coupon | | $ | 17 | | | | 6.42 | % | | $ | 887 | | | | 7.03 | % | | $ | 79,124 | | | | 2.86 | % | | | 415,447 | | | | 2.46 | | | | 495,475 | | | | 2.53 | |
| Total | | $ | 17 | | | | 6.42 | % | | $ | 887 | | | | 7.03 | % | | $ | 79,124 | | | | 2.86 | % | | $ | 470,157 | | | | 2.41 | % | | $ | 550,185 | | | | 2.47 | % |
Changes in the fair value of mortgage-related securities available-for-sale are recorded through accumulated other comprehensive income (loss), net of related income tax effect, which is a component of shareholders’ equity. The fair value adjustment on the Company’s mortgage-related securities available-for-sale was a net unrealized gain of $10.7 million at December 31, 2012, compared to a net unrealized gain of $7.7 million at December 31, 2011. This increase was primarily caused by lower market interest rates at December 31, 2012, compared to December 31, 2011. Lower market interest rates typically result in higher fair values for the types of securities owned by the Company.
The Company maintains an investment in private-label CMOs that were purchased from 2004 to 2006 and are secured by prime residential mortgage loans. The securities were all rated “triple-A” by various credit rating agencies at the time of their purchase. However, all of the securities in the portfolio have been downgraded since their purchase. Securities rated less than investment grade are adversely classified as substandard in accordance with regulatory guidelines (refer to “Item 1. Business—Asset Quality”). The following table presents the credit ratings, carrying values, and unrealized losses of the Company’s private-label CMO portfolio as of the dates indicated (in instances of split ratings, each security has been classified according to its lowest rating):
| | | December 31, 2012 | | | December 31, 2011 | |
| | | Carrying
Value | | | Net
Unrealized
Gain (Loss) | | | Carrying
Value | | | Net
Unrealized
Gain (Loss) | |
| Credit rating: | | (Dollars in thousands) | |
| AAA/Aaa | | | – | | | | – | | | $ | 5,386 | | | $ | 210 | |
| AA/Aa | | | – | | | | – | | | | 2,512 | | | | 58 | |
| A | | $ | 7,400 | | | $ | 228 | | | | 6,951 | | | | (271 | ) |
| BBB/Baa | | | 7,248 | | | | 175 | | | | 10,428 | | | | (366 | ) |
| Less than investment grade | | | 35,918 | | | | (33 | ) | | | 36,751 | | | | (5,357 | ) |
| Total private-label CMOs | | $ | 50,566 | | | $ | 370 | | | $ | 62,028 | | | $ | (5,726 | ) |
During 2012 and 2011 management determined that it was unlikely the Company would collect all amounts due according to the contractual terms on certain of its securities rated less than investment grade. Accordingly, the Company recorded $400,000 and $389,000 in net OTTI loss on such securities in those periods, respectively (for additional discussion refer to “Results of Operations—Non-Interest Income,” above). As of December 31, 2012, management determined that none of the Company’s private-label CMOs had incurred additional OTTI as of that date. The Company does not intend to sell these securities and it is unlikely it would be required to sell them before recovery of their amortized cost. However, collection is subject to numerous factors outside of the Company’s control and a future determination of OTTI could result in significant losses being recorded through earnings in future periods. For additional discussion refer to “Critical Accounting Policies—Other-Than-Temporary Impairment,” below, and “Item 1. Business—Investment Activities” and “Item 1A. Risk Factors,” above.
Mortgage-Related Securities Held-to-Maturity During the twelve months ended December 31, 2012, the Company purchased $158.9 million in held-to-maturity securities that consisted of fixed-rate mortgage-backed securities issued and guaranteed by Fannie Mae and backed by multi-family residential loans. The Company funded the purchase of these securities with $158.9 million in term advances from the FHLB of Chicago. The securities had a an original weighted-average life of 7.7 years, an original weighted-average yield of 2.31%, and yield-maintenance fees that discourage the underlying borrowers from prepaying the underlying loans. The term advances have a weighted-average life of 5.5 years and cost of 1.47%. The purpose of this transaction was to supplement growth in the Company’s earning assets. The Company classified these securities as held-to-maturity because it has the ability and intent to hold them until they mature.
The following table presents the activity in the Company’s portfolio of mortgage-related securities held-to-maturity for the periods indicated:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Carrying value at beginning of period | | | – | | | | – | | | | – | |
| Purchases | | $ | 158,915 | | | | – | | | | – | |
| Sales | | | – | | | | – | | | | – | |
| Principal repayments | | | (902 | ) | | | – | | | | – | |
| Premium amortization | | | (455 | ) | | | – | | | | – | |
| Net increase | | $ | 157,558 | | | | – | | | | – | |
| Carrying value at end of period | | $ | 157,558 | | | | – | | | | – | |
All of the Company’s mortgage-related securities held-to-maturity as of December 31, 2012, had final maturities of five to ten years. The weighted-average yield on these securities was 2.20%.
Investment Securities Available-for-Sale In prior periods the Company has held investment securities available-for-sale, which have primarily consisted of mutual funds and U.S. government and federal agency obligations. However, the Company held no such securities as of December 31, 2012 or 2011. The following table presents the Company’s investment securities and mortgage-related securities activities for the periods indicated.
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Carrying value at beginning of period | | | – | | | $ | 228,024 | | | $ | 614,104 | |
| Purchases | | | – | | | | – | | | | 3,118,204 | |
| Sales | | | – | | | | (20,837 | ) | | | (709 | ) |
| Calls | | | – | | | | (205,825 | ) | | | (3,506,718 | ) |
| Discount accretion | | | – | | | | – | | | | 314 | |
| Increase (decrease) in net unrealized loss | | | – | | | | (1,362 | ) | | | 2,828 | |
| Net decrease in investment securities | | | – | | | | (228,024 | ) | | | (386,080 | ) |
| Carrying value at end of period | | | – | | | | – | | | $ | 228,024 | |
As of December 31, 2010, the Company’s investment securities available-for-sale consisted of mutual funds with a carrying value of $22.1 million and U.S. government and federal agency obligations with a carrying value of $206.0 million.
Loans Held-for-Sale The Company’s policy is to sell substantially all of its fixed-rate, one- to four-family mortgage loan originations in the secondary market. The following table presents a summary of the activity in the Company’s loans held-for-sale for the periods indicated:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Balance outstanding at beginning of period | | $ | 19,192 | | | $ | 37,819 | | | $ | 13,534 | |
| Origination of loans intended for sale (1) | | | 446,358 | | | | 272,785 | | | | 434,388 | |
| Principal balance of loans sold | | | (454,584 | ) | | | (292,720 | ) | | | (409,369 | ) |
| Change in net unrealized gains or losses (2) | | | (227 | ) | | | 1,308 | | | | (734 | ) |
| Total loans held-for-sale | | $ | 10,739 | | | $ | 19,192 | | | $ | 37,819 | |
| (1) | Does not include one- to four-family loans originated for the Company’s loan portfolio. |
| (2) | Refer to “Note 1. Basis of Presentation” in the Company’s consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data.” |
The origination of one- to four-family mortgage loans intended for sale and the corresponding sales of such loans were elevated in the 2012 and 2010 periods as a result of generally lower market interest rates in those periods, which encouraged a larger number of borrowers to refinance higher-rate loans into lower rate loans during those years. For additional discussion, refer to “Results of Operations—Non-Interest Income,” above.
Loans Receivable Loans receivable increased by $82.6 million or 6.3% as of December 31, 2012, compared to December 31, 2011. Total loans originated for portfolio increased by $164.8 million or 41.5% during this year compared to 2011. A portion of this improvement came from increased originations of commercial business loans, which increased by $40.5 million or 57.6% during the twelve months ended December 31, 2012, compared to 2011. Management attributed this increase to recent efforts to improve the Company’s share of the mid-tier commercial banking market (defined as business entities with sales revenues of $5 to $100 million), which was a new market segment for the Company in 2011. In the past two years the Company has added experienced leaders to its senior management team and has hired a number of commercial relationship managers and support personnel experienced in managing and selling financial services to the mid-tier commercial banking market. In the near term the Company expects to add additional professionals capable of serving this market segment, although there can be no assurances as to the extent or timing of such staff additions or the impact on operating results.
Originations of multi-family mortgage loans, both permanent and construction, also increased substantially during the period, which management believes reflects a general decline in the level of home ownership in recent periods. Finally, originations of consumer loans, which consist principally of home equity term loans and lines of credit, increased by $23.7 million or 25.8% during the twelve months ended December 31, 2012, due to more competitive pricing and increased marketing efforts for these types of loans.
The Company’s portfolio of one- to four-family loans declined from $508.5 million at December 31, 2011, to $465.2 million at December 31, 2012. In 2012 loan repayments exceeded the Company’s origination of one- to four-family loans that it retains in portfolio, which consists principally of adjustable-rate loans and, from time-to-time, fixed-rate loans with maturity terms of up to 15 years. The Company also retains certain 30-year, fixed-rate loans in its portfolio under an internal low-income lending program. Repayments of one- to four-family loans have been elevated in recent years due to lower market interest rates that encourage borrowers to refinance adjustable-rate loans, as well as higher-cost fixed-rate loans, into longer-term, fixed-rate loans that the Company sells in the secondary market. The Company’s originations of one- to four-family loans that it retains in portfolio were $89.0 million in 2012 compared to $91.0 million in 2011.
The following table presents the composition of the Company’s loan portfolio in dollar amounts and in percentages of the total portfolio at the dates indicated.
| | | December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | Amount | | | Percent
of
Total | | | Amount | | | Percent
of
Total | | | Amount | | | Percent
of
Total | | | Amount | | | Percent
of
Total | | | Amount | | | Percent
of
Total | |
| | (Dollars in thousands) | |
| Mortgage loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Permanent mortgage loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 465,170 | | | | 30.98 | % | | $ | 508,503 | | | | 36.59 | % | | $ | 531,874 | | | | 37.87 | % | | $ | 644,852 | | | | 41.45 | % | | $ | 867,810 | | | | 45.82 | % |
| Multi-family | | | 264,013 | | | | 17.58 | | | | 247,040 | | | | 17.77 | | | | 247,210 | | | | 17.60 | | | | 200,222 | | | | 12.87 | | | | 199,709 | | | | 10.54 | |
| Commercial real estate | | | 263,775 | | | | 17.57 | | | | 226,195 | | | | 16.27 | | | | 248,253 | | | | 17.68 | | | | 262,855 | | | | 16.90 | | | | 222,462 | | | | 11.74 | |
| Total permanent mortgages | | | 992,958 | | | | 66.12 | | | | 981,738 | | | | 70.63 | | | | 1,027,337 | | | | 73.15 | | | | 1,107,929 | | | | 71.22 | | | | 1,289,981 | | | | 68.10 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | 18,502 | | | | 1.23 | | | | 16,263 | | | | 1.17 | | | | 13,479 | | | | 0.96 | | | | 11,441 | | | | 0.74 | | | | 17,517 | | | | 0.92 | |
| Multi-family | | | 86,904 | | | | 5.79 | | | | 29,409 | | | | 2.12 | | | | 19,308 | | | | 1.37 | | | | 52,323 | | | | 3.36 | | | | 74,208 | | | | 3.92 | |
| Commercial real estate | | | 11,116 | | | | 0.74 | | | | 19,907 | | | | 1.43 | | | | 24,939 | | | | 1.78 | | | | 27,040 | | | | 1.74 | | | | 82,795 | | | | 4.37 | |
| Land | | | 12,826 | | | | 0.85 | | | | 16,429 | | | | 1.18 | | | | 25,764 | | | | 1.83 | | | | 33,758 | | | | 2.17 | | | | 43,601 | | | | 2.30 | |
| Total construction and development loans | | | 129,348 | | | | 8.61 | | | | 82,008 | | | | 5.90 | | | | 83,490 | | | | 5.94 | | | | 124,562 | | | | 8.01 | | | | 218,121 | | | | 11.51 | |
| Total mortgage loans | | | 1,122,306 | | | | 74.74 | | | | 1,063,746 | | | | 76.53 | | | | 1,110,827 | | | | 79.09 | | | | 1,232,491 | | | | 79.23 | | | | 1,508,102 | | | | 79.61 | |
| Consumer loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed term home equity | | | 116,988 | | | | 7.79 | | | | 102,561 | | | | 7.38 | | | | 103,619 | | | | 7.38 | | | | 124,519 | | | | 8.00 | | | | 173,104 | | | | 9.14 | |
| Home equity lines of credit | | | 81,898 | | | | 5.45 | | | | 86,540 | | | | 6.23 | | | | 87,383 | | | | 6.24 | | | | 88,796 | | | | 5.71 | | | | 86,962 | | | | 4.59 | |
| Student | | | 12,915 | | | | 0.86 | | | | 15,711 | | | | 1.13 | | | | 17,695 | | | | 1.25 | | | | 19,793 | | | | 1.27 | | | | 21,469 | | | | 1.13 | |
| Home improvement | | | 24,910 | | | | 1.66 | | | | 24,237 | | | | 1.74 | | | | 24,551 | | | | 1.76 | | | | 28,441 | | | | 1.83 | | | | 36,023 | | | | 1.90 | |
| Automobile | | | 1,814 | | | | 0.12 | | | | 2,228 | | | | 0.16 | | | | 2,814 | | | | 0.20 | | | | 4,077 | | | | 0.26 | | | | 11,775 | | | | 0.62 | |
| Other | | | 8,388 | | | | 0.56 | | | | 7,177 | | | | 0.52 | | | | 7,436 | | | | 0.52 | | | | 9,871 | | | | 0.63 | | | | 8,740 | | | | 0.46 | |
| Total consumer loans | | | 246,913 | | | | 16.44 | | | | 238,454 | | | | 17.16 | | | | 243,498 | | | | 17.35 | | | | 275,497 | | | | 17.71 | | | | 338,073 | | | | 17.84 | |
| Commercial business loans | | | 132,436 | | | | 8.82 | | | | 87,715 | | | | 6.31 | | | | 50,123 | | | | 3.56 | | | | 47,708 | | | | 3.07 | | | | 48,277 | | | | 2.55 | |
| Gross loans receivable | | | 1,501,655 | | | | 100.00 | % | | | 1,389,915 | | | | 100.00 | % | | | 1,404,448 | | | | 100.00 | % | | | 1,555,696 | | | | 100.00 | % | | | 1,894,452 | | | | 100.00 | % |
| Undisbursed loan proceeds | | | (76,703 | ) | | | | | | | (41,859 | ) | | | | | | | (32,345 | ) | | | | | | | (32,690 | ) | | | | | | | (54,187 | ) | | | | |
| Allowance for loan losses | | | (21,577 | ) | | | | | | | (27,928 | ) | | | | | | | (47,985 | ) | | | | | | | (17,028 | ) | | | | | | | (12,208 | ) | | | | |
| Deferred fees and costs, net | | | (1,129 | ) | | | | | | | (492 | ) | | | | | | | (549 | ) | | | | | | | 78 | | | | | | | | 996 | | | | | |
| Total loans receivable, net | | $ | 1,402,246 | | | | | | | $ | 1,319,636 | | | | | | | $ | 1,323,569 | | | | | | | $ | 1,506,056 | | | | | | | $ | 1,829,053 | | | | | |
The following table presents a summary of the Company’s activity in loans receivable for the periods indicated.
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Balance outstanding at beginning of period | | $ | 1,319,636 | | | $ | 1,323,569 | | | $ | 1,506,056 | |
| Originations: | | | | | | | | | | | | |
| One- to four-family loans (1) | | | 88,993 | | | | 91,042 | | | | 44,929 | |
| Multi-family loans | | | 66,724 | | | | 55,859 | | | | 25,091 | |
| Commercial real estate loans | | | 70,200 | | | | 63,376 | | | | 22,068 | |
| Construction and development loans | | | 109,908 | | | | 24,921 | | | | 29,029 | |
| Total mortgage loan originations | | | 335,825 | | | | 235,198 | | | | 121,117 | |
| Consumer loans | | | 115,344 | | | | 91,685 | | | | 78,198 | |
| Commercial business loans | | | 110,941 | | | | 70,404 | | | | 34,530 | |
| Total originations | | | 562,110 | | | | 397,287 | | | | 233,845 | |
| Principal payments and repayments: | | | | | | | | | | | | |
| Mortgage loans | | | (264,211 | ) | | | (232,814 | ) | | | (220,673 | ) |
| Consumer loans | | | (106,885 | ) | | | (96,729 | ) | | | (110,197 | ) |
| Commercial business loans | | | (66,220 | ) | | | (32,812 | ) | | | (32,115 | ) |
| Total principal payments and repayments | | | (437,316 | ) | | | (362,355 | ) | | | (362,985 | ) |
| Transfers to foreclosed properties, real estate owned, and repossessed assets | | | (13,054 | ) | | | (49,465 | ) | | | (22,108 | ) |
| Net change in undisbursed loan proceeds, allowance for loan losses, and deferred fees and costs | | | (29,130 | ) | | | 10,600 | | | | (31,239 | ) |
| Total loans receivable, net | | $ | 1,402,246 | | | $ | 1,319,636 | | | $ | 1,323,569 | |
| (1) | Does not include one- to four-family loans originated for sale. |
The following table presents the contractual maturity of the Company’s construction and development loans and its commercial business loans at December 31, 2012. The table does not include the effect of prepayments or scheduled principal amortization.
| | | December 31, 2012 | |
| | | Commercial
Business Loans | | | Construction and
Development
Loans | | | Total | |
| Amounts due: | | (Dollars in thousands) | |
| Within one year or less | | $ | 60,477 | | | $ | 11,216 | | | $ | 71,693 | |
| After one year through five years | | | 69,821 | | | | 92,535 | | | | 162,356 | |
| After five years | | | 2,138 | | | | 25,597 | | | | 27,735 | |
| Total due after one year | | | 71,959 | | | | 118,132 | | | | 190,091 | |
| Total commercial and construction loans | | $ | 132,436 | | | $ | 129,348 | | | $ | 261,784 | |
The following table presents, as of December 31, 2012, the dollar amount of the Company’s construction and development loans and its commercial loans due after one year and whether these loans have fixed interest rates or adjustable interest rates.
| | | Due After One Year | |
| | | Fixed Rate | | | Adjustable
Rate | | | Total | |
| | | (Dollars in thousands) | |
| Commercial business loans | | $ | 45,346 | | | $ | 26,613 | | | $ | 71,959 | |
| Construction and development loans | | | 49,741 | | | | 68,391 | | | | 118,132 | |
| Total loans due after one year | | $ | 95,087 | | | $ | 95,004 | | | $ | 190,091 | |
Foreclosed Properties and Repossessed Assets The following table summarizes the Company’s foreclosed properties and repossessed assets as of the dates indicated:
| | | December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Commercial real estate | | $ | 8,698 | | | $ | 13,115 | | | $ | 7,313 | |
| One- to four-family | | | 1,710 | | | | 6,557 | | | | 5,554 | |
| Multi-family | | | 146 | | | | 3,890 | | | | 4,079 | |
| Land | | | 3,407 | | | | 1,162 | | | | 2,329 | |
| Consumer | | | – | | | | – | | | | 18 | |
| Total | | $ | 13,961 | | | $ | 24,724 | | | $ | 19,293 | |
The decrease in the Company’s foreclosed properties and repossessed assets during the twelve months ended December 31, 2012, was caused by increased sales of foreclosed real estate, as well as continued charge-offs of foreclosed properties as management worked to aggressively reduce the Company’s level of non-performing assets. These developments were partially offset by foreclosures related to a number of smaller commercial real estate mortgage loans and, to a lesser extent, one- to four-family mortgage loans. The increase in foreclosed properties and repossessed assets in 2011 reflected management efforts to aggressively reduce the elevated level of non-performing loans held by the Company in 2011 and earlier periods. For additional discussion refer to “Financial Condition—Asset Quality,” below.
Mortgage Servicing Rights The carrying value of the Company’s MSRs was $6.8 million at December 31, 2012, compared to $7.4 million at December 31, 2011, net of valuation allowances of $2.4 million and $868,000, respectively. As of both December 31, 2012 and 2011, the Company serviced $1.1 billion in loans for third-party investors. For additional information refer to “Results of Operations—Non-Interest Income” and “Item 1. Business—Lending Activities,” above.
Other AssetsOther assets consist of the following items on the dates indicated:
| | | December 31 | |
| | | 2012 | | | 2011 | |
| | (Dollars in thousands) | |
| Accrued interest receivable: | | | | | | | | |
| Mortgage-related securities | | $ | 1,610 | | | $ | 1,320 | |
| Investment securities | | | 11 | | | | 537 | |
| Loans receivable | | | 4,636 | | | | 4,664 | |
| Total accrued interest receivable | | | 6,257 | | | | 6,521 | |
| Bank-owned life insurance | | | 58,609 | | | | 56,604 | |
| Premises and equipment | | | 50,536 | | | | 50,423 | |
| Federal Home Loan Bank stock, at cost | | | 15,841 | | | | 46,092 | |
| Deferred tax asset, net | | | 34,211 | | | | 37,454 | |
| Prepaid FDIC insurance premiums | | | 2,477 | | | | 5,673 | |
| Other assets | | | 21,764 | | | | 22,059 | |
| Total other assets | | $ | 189,695 | | | $ | 224,826 | |
BOLI is long-term life insurance on the lives of certain current and past employees where the insurance policy benefits and ownership are retained by the employer. Its cash surrender value is an asset that the Company uses to partially offset the future cost of employee benefits. The cash value accumulation on BOLI is permanently tax deferred if the policy is held to the insured person’s death and certain other conditions are met. The increase in BOLI in 2012 was a result of the increase in the accumulated cash value of the insurance policies during the period.
The Company and its subsidiaries conduct their business through an executive office and 76 banking offices, which had an aggregate net book value of $48.1 million as of December 31, 2012, excluding furniture, fixtures, and equipment. As of December 31, 2012, the Company owned the building and land for 69 of its office locations and leased the space for eight.
The FHLB of Chicago requires its members to own its common stock as a condition of membership, which is redeemable at par (for additional information refer to “Regulation and Supervision of the Bank—Federal Home Loan Bank System” in “Item 1. Business—Regulation and Supervision”). In 2012 the FHLB of Chicago redeemed $30.3 million of the common stock owned by the Company that was in excess of the amount the Company was required to own under the minimum guidelines established by the FHLB of Chicago. As of December 31, 2012, the Company continued to own approximately $5.3 million more in such common stock than required under the minimum guidelines. The Company anticipates that the FHLB of Chicago will redeem this remaining amount in 2013, although there can be no assurances. For additional discussion refer to the section entitled “Federal Home Loan Bank System” in “Item 1. Business—Regulation and Supervision.”
The Company’s net deferred tax asset decreased by $3.2 million or 8.7% during the year ended December 31, 2012. Management evaluates this asset on an on-going basis to determine if a valuation allowance is required. Management determined that no valuation allowance was required as of December 31, 2012. The evaluation of the net deferred tax asset requires significant management judgment based on positive and negative evidence. Such evidence includes the Company’s cumulative three-year net loss, the nature of the components of such cumulative loss, recent trends in earnings, expectations for the Company’s future earnings, the duration of federal and state net operating loss carryforward periods, and other factors. There can be no assurance that future events, such as adverse operating results, court decisions, regulatory actions or interpretations, changes in tax rates and laws, or changes in positions of federal and state taxing authorities will not differ from management’s current assessments. The impact of these matters could be significant to the consolidated financial condition, results of operations, and capital of the Company.
Prepaid FDIC insurance premiums declined from $5.7 million at December 31, 2011, to $2.5 million at December 31, 2012. In 2009 the FDIC required insured financial institutions to prepay a certain amount of their estimated FDIC deposit insurance premiums. The regular quarterly payments to the FDIC that are otherwise required from the Company were applied against this amount and expensed on a quarterly basis, which is the reason for the decline in the prepaid balance during 2012.
Deposit Liabilities Deposit liabilities decreased by $153.8 million or 7.6% during the twelve months ended December 31, 2012, to $1.9 billion compared to $2.0 billion at December 31, 2011. Core deposits, consisting of checking, savings and money market accounts, increased by $77.3 million or 7.9% during the period while certificates of deposits declined by $231.0 million or 22.2%. The Company continues to closely manage the rates it offers on certificates of deposit to control its overall liquidity position, which has resulted in a decline in certificates of deposit in recent periods. Core deposits have increased in recent years in response to management’s efforts to increase sales of such products and related services to commercial businesses, as well as efforts to focus its retail sales efforts on such products and related services. Also contributing to the increase in core deposits in recent periods, however, is customer reaction to the low interest rate environment. Management believes that this environment has encouraged some customers to switch to core deposits in an effort to retain flexibility in the event interest rates rise in the future.
The following table presents the distribution of the Company’s deposit accounts at the dates indicated by dollar amount and percent of portfolio, and the weighted average rate.
| | | December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | | | | Percent | | | Weighted | | | | | | Percent | | | Weighted | | | | | | Percent | | | Weighted | |
| | | | | | of Total | | | Average | | | | | | of Total | | | Average | | | | | | of Total | | | Average | |
| | | | | | Deposit | | | Nominal | | | | | | Deposit | | | Nominal | | | | | | Deposit | | | Nominal | |
| | | Amount | | | Liabilities | | | Rate | | | Amount | | | Liabilities | | | Rate | | | Amount | | | Liabilities | | | Rate | |
| | | (Dollars in thousands) | |
| Non-interest-bearing demand | | $ | 143,684 | | | | 7.69 | % | | | 0.00 | % | | $ | 112,211 | | | | 5.55 | % | | | 0.00 | % | | $ | 94,446 | | | | 4.54 | % | | | 0.00 | % |
| Interest-bearing demand | | | 236,380 | | | | 12.65 | | | | 0.01 | | | | 229,990 | | | | 11.38 | | | | 0.01 | | | | 219,136 | | | | 10.54 | | | | 0.02 | |
| Money market savings | | | 458,762 | | | | 24.56 | | | | 0.19 | | | | 432,248 | | | | 21.38 | | | | 0.19 | | | | 423,923 | | | | 20.40 | | | | 0.57 | |
| Savings accounts | | | 217,170 | | | | 11.63 | | | | 0.03 | | | | 204,263 | | | | 10.10 | | | | 0.03 | | | | 210,334 | | | | 10.12 | | | | 0.04 | |
| Total demand accounts | | | 1,055,996 | | | | 56.53 | | | | 0.09 | | | | 978,712 | | | | 48.41 | | | | 0.09 | | | | 947,839 | | | | 45.60 | | | | 0.27 | |
| Certificates of deposit: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| With original maturities of: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months or less | | | 9,259 | | | | 0.50 | | | | 0.07 | | | | 9,988 | | | | 0.49 | | | | 0.11 | | | | 12,922 | | | | 0.62 | | | | 0.25 | |
| Over three to 12 months | | | 184,194 | | | | 9.86 | | | | 0.20 | | | | 162,949 | | | | 8.06 | | | | 0.50 | | | | 194,458 | | | | 9.36 | | | | 0.94 | |
| Over 12 to 24 months | | | 315,189 | | | | 16.87 | | | | 0.77 | | | | 569,485 | | | | 28.17 | | | | 1.10 | | | | 663,576 | | | | 31.93 | | | | 1.60 | |
| Over 24 to 36 months | | | 148,503 | | | | 7.95 | | | | 1.94 | | | | 138,677 | | | | 6.86 | | | | 1.98 | | | | 92,268 | | | | 4.44 | | | | 2.10 | |
| Over 36 to 48 months | | | - | | | | 0.00 | | | | 0.00 | | | | 1,282 | | | | 0.06 | | | | 4.31 | | | | 5,137 | | | | 0.25 | | | | 4.36 | |
| Over 48 to 60 months | | | 154,758 | | | | 8.29 | | | | 3.48 | | | | 160,570 | | | | 7.95 | | | | 3.68 | | | | 162,110 | | | | 7.81 | | | | 3.81 | |
| Total certificates of deposit | | | 811,903 | | | | 43.47 | | | | 1.36 | | | | 1,042,951 | | | | 51.59 | | | | 1.51 | | | | 1,130,471 | | | | 54.40 | | | | 1.84 | |
| Total deposit liabilities | | $ | 1,867,899 | | | | 100.00 | % | | | 0.64 | % | | $ | 2,021,663 | | | | 100.00 | % | | | 0.82 | % | | $ | 2,078,310 | | | | 100.00 | % | | | 1.12 | % |
At December 31, 2012, the Company had certificates of deposit with balances of $100,000 and over maturing as follows:
| | | Amount | |
| | (In thousands) | |
| Maturing in: | | | | |
| Three months or less | | $ | 53,926 | |
| Over three months through six months | | | 54,785 | |
| Over six months through 12 months | | | 58,891 | |
| Over 12 months through 24 months | | | 47,169 | |
| Over 24 months through 36 months | | | 2,693 | |
| Over 36 months | | | 3,459 | |
| Total certificates of deposits greater than $100,000 | | $ | 220,923 | |
The following table presents the Company’s activity in its deposit liabilities for the periods indicated:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Total deposit liabilities at beginning of period | | $ | 2,021,663 | | | $ | 2,078,310 | | | $ | 2,137,508 | |
| Net withdrawals | | | (167,096 | ) | | | (74,632 | ) | | | (85,039 | ) |
| Interest credited, net of penalties | | | 13,332 | | | | 17,986 | | | | 25,841 | |
| Total deposit liabilities at end of period | | $ | 1,867,899 | | | $ | 2,021,663 | | | $ | 2,078,310 | |
Borrowings Borrowings, which consist of advances from the FHLB of Chicago, increased by $53.1 million or 37.7% during the twelve months ended December 31, 2012. As previously noted, during the period the Company borrowed $158.9 million in term advances from the FHLB of Chicago to fund the purchase of held-to-maturity securities. This development was partially offset by the repayment of $100.0 million in borrowings from the FHLB of Chicago that had a rate of 4.52% and that matured during the third quarter of the year.
Management believes that additional funds are available to be borrowed from the FHLB of Chicago or other sources in the future to fund loan originations or security purchases or to fund existing advances as they mature if needed or desirable. However, there can be no assurances of the future availability of borrowings or any particular level of future borrowings. For additional information refer to “Item 1. Business—Borrowings.”
The following table sets forth certain information regarding the Company’s borrowings at the end of and during the periods indicated:
| | | At or For the Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | (Dollars in thousands) | |
| Balance outstanding at end of year: | | | | | | | | | | | | | | | | | | | | |
| FHLB term advances | | $ | 210,786 | | | $ | 153,091 | | | $ | 149,934 | | | $ | 906,979 | | | $ | 907,971 | |
| Overnight borrowings from FHLB | | | – | | | | – | | | | – | | | | – | | | | – | |
| Weighted average interest rate at end of year: | | | | | | | | | | | | | | | | | | | | |
| FHLB term advances | | | 2.34 | % | | | 4.69 | % | | | 4.79 | % | | | 4.26 | % | | | 4.26 | % |
| Overnight borrowings from FHLB | | | – | | | | – | | | | – | | | | – | | | | – | |
| Maximum amount outstanding during the year: | | | | | | | | | | | | | | | | | | | | |
| FHLB term advances | | $ | 311,419 | | | $ | 199,493 | | | $ | 906,979 | | | $ | 907,971 | | | $ | 912,459 | |
| Overnight borrowings from FHLB | | | 5,000 | | | | – | | | | – | | | | – | | | | 5,000 | |
| Other borrowings | | | – | | | | – | | | | – | | | | – | | | | 1,103 | |
| Average amount outstanding during the year: | | | | | | | | | | | | | | | | | | | | |
| FHLB term advances | | $ | 227,573 | | | $ | 156,521 | | | $ | 871,212 | | | $ | 907,443 | | | $ | 910,517 | |
| Overnight borrowings from FHLB | | | 14 | | | | – | | | | – | | | | – | | | | 22 | |
| Other borrowings | | | – | | | | – | | | | – | | | | – | | | | 3 | |
| Weighted average interest rate during the year: | | | | | | | | | | | | | | | | | | | | |
| FHLB term advances | | | 3.07 | % | | | 4.59 | % | | | 4.32 | % | | | 4.32 | % | | | 4.34 | % |
| Overnight borrowings from FHLB | | | 0.30 | % | | | – | | | | – | | | | – | | | | 3.75 | % |
| Other borrowings | | | – | | | | – | | | | – | | | | – | | | | 1.92 | % |
Shareholders’ Equity The Company’s shareholders’ equity increased from $265.8 million at December 31, 2011, to $271.9 million at December 31, 2012. This increase was caused by net income during the period, as well as lower accumulated other comprehensive loss due to an increase in the fair value of available-for-sale securities. These developments were partially offset by the payment of cash dividends to shareholders during the year. The book value of the Company’s common stock was $5.87 per share at December 31, 2012, compared to $5.75 per share at December 31, 2011.
The Company’s ratio of shareholders’ equity to total assets was 11.24% at December 31, 2012, compared to 10.64% at December 31, 2011. The increase in this ratio was due primarily to a decrease in Bank Mutual’s total assets, as well as an increase in shareholders’ equity, as described in the previous paragraph. The Company is not currently required to maintain minimum capital for regulatory purposes. However, the Bank is required to maintain specified amounts of regulatory capital pursuant to regulations promulgated by the OCC and the FDIC. The Bank is “well capitalized” for regulatory capital purposes. As of December 31, 2012, the Bank had a total risk-based capital ratio of 18.02% and a Tier 1 capital ratio of 10.28%. The minimum ratios to be considered “well capitalized” under current supervisory regulations are 10% for total risk-based capital and 6% for Tier 1 capital. The minimum ratios to be considered “adequately capitalized” are 8% and 4%, respectively. For additional discussion refer to “Note 8. Shareholders’ Equity” in “Item 8. Financial Statements and Supplementary Data,” as well as “Item 1. Business—Regulation and Supervision.”
On February 4, 2013, the Company’s board of directors announced that it had declared a $0.02 per share dividend payable on March 1, 2013, to shareholders of record on February 15, 2013. In 2012 the Company did not repurchase any shares of its common stock and the Company does not currently have a program authorizing the purchase of shares.
The payment of dividends or the repurchase of common stock by the Company is highly dependent on the ability of the Bank to pay dividends or otherwise distribute capital to the Company. Such payments are subject to any requirements imposed by law or regulations and to the application and interpretation thereof by the OCC and FRB, which have become increasingly strict as to the amount of capital it expects financial institutions to maintain. The Company cannot provide any assurances that dividends will continue to be paid, the amount of any such dividends, or the possible future resumption of share repurchases. For further information about factors which could affect the Company’s payment of dividends, refer to “Item 1. Business—Regulation and Supervision,” as well as “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchase of Equity Securities,” above.
Asset Quality The following table presents information regarding non-accrual mortgage loans, consumer loans, commercial business loans, accruing loans delinquent 90 days or more, and foreclosed properties and repossessed assets as of the dates indicated.
| | | December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | (Dollars in thousands) | |
| Non-accrual mortgage loans: | | | |
| One- to four-family | | $ | 8,192 | | | $ | 14,868 | | | $ | 18,684 | | | $ | 12,126 | | | $ | 8,185 | |
| Multi-family | | | 6,824 | | | | 22,905 | | | | 31,660 | | | | 3,357 | | | | 13,255 | |
| Commercial real estate | | | 6,994 | | | | 23,997 | | | | 41,244 | | | | 18,840 | | | | 5,573 | |
| Construction and development | | | 937 | | | | 9,368 | | | | 26,563 | | | | 4,859 | | | | 2,847 | |
| Total non-accrual mortgage loans | | | 22,947 | | | | 71,138 | | | | 118,151 | | | | 39,182 | | | | 29,860 | |
| Non-accrual consumer loans: | | | | | | | | | | | | | | | | | | | | |
| Secured by real estate | | | 1,514 | | | | 1,457 | | | | 1,369 | | | | 1,433 | | | | 759 | |
| Other consumer loans | | | 59 | | | | 207 | | | | 275 | | | | 212 | | | | 400 | |
| Total non-accrual consumer loans | | | 1,573 | | | | 1,664 | | | | 1,644 | | | | 1,645 | | | | 1,159 | |
| Non-accrual commercial business loans | | | 693 | | | | 1,642 | | | | 2,779 | | | | 923 | | | | 1,494 | |
| Total non-accrual loans | | | 25,213 | | | | 74,444 | | | | 122,574 | | | | 41,750 | | | | 32,513 | |
| Accruing loans delinquent 90 days or more (1) | | | 584 | | | | 696 | | | | 373 | | | | 834 | | | | 576 | |
| Total non-performing loans | | | 25,797 | | | | 75,140 | | | | 122,947 | | | | 42,584 | | | | 33,089 | |
| Foreclosed real estate and repossessed assets | | | 13,961 | | | | 24,724 | | | | 19,293 | | | | 17,689 | | | | 4,768 | |
| Total non-performing assets | | $ | 39,758 | | | $ | 99,864 | | | $ | 142,240 | | | $ | 60,273 | | | $ | 37,857 | |
| | | | | | | | | | | | | | | | | | | | | |
| Non-performing loans to total loans | | | 1.84 | % | | | 5.69 | % | | | 9.29 | % | | | 2.83 | % | | | 1.81 | % |
| Non-performing assets to total assets | | | 1.64 | % | | | 4.00 | % | | | 5.49 | % | | | 1.72 | % | | | 1.08 | % |
| Interest income that would have been recognized if non-accrual loans had been current | | $ | 1,998 | | | $ | 4,535 | | | $ | 4,734 | | | $ | 2,671 | | | $ | 2,519 | |
| (1) | Consists of student loans that are guaranteed under programs sponsored by the U.S. government. |
The Company’s non-performing loans were $25.8 million or 1.84% of loans receivable as of December 31, 2012, compared to $75.1 million or 5.69% of loans receivable as of December 31, 2011. Non-performing assets, which includes non-performing loans, were $39.8 million or 1.64% of total assets and $99.9 million or 4.00% of total assets as of these same dates, respectively. The decline in non-performing loans in 2012 was due principally to a $41.5 million or 73.8% aggregate decrease in non-performing commercial real estate, multi-family, and construction loans. This decrease was primarily attributable to eight larger loans that aggregated $25.2 million that were paid off, six larger loans that aggregated $6.6 million that were transferred to foreclosed real estate, and one loan for $2.5 million that was returned to performing status due to the improved condition of the borrower. All of these loans were secured by commercial and multi-family real estate. In addition, non-performing one- to four-family loans declined by $6.7 million or 44.9% and non-performing commercial business loans declined by $949,000 or 57.8% during the twelve months ended December 31, 2012. In addition, foreclosed properties and repossessed assets, which is a component of non-performing assets, declined by $10.8 million or 43.5% during the twelve months ended December 31, 2012, for reasons previously described.
In 2011 the Company’s non-performing loans declined by $47.8 million or 38.9%. Most of this decline was attributable to a $43.2 million aggregate decrease in non-performing commercial real estate, multi-family, and construction loans. In 2011 six larger loan relationships that aggregated $14.5 million were paid off, six larger loan relationships that aggregated $17.8 million were foreclosed, and the Company recorded $8.9 million in charge-offs related to seven larger loan relationships that that continued to be classified as non-performing as of the end of that year. The aggregate balance for these latter loans was $19.4 million (prior to the charge-offs). Finally, non-performing one- to four-family loans and non-performing commercial business loans declined by $3.8 million and $1.1 million, respectively, during the twelve months ended December 31, 2011. Also in 2011, the Company’s foreclosed properties and repossessed assets, which is a component of non-performing assets, increased by $5.4 million or 28.2%, due principally to the aforementioned foreclosures during the year. This development was partially offset by sales of foreclosed real estate, as well as continued charge-offs of foreclosed properties.
In 2010 the Company’s non-performing assets increased by $82.0 million or 136%. This increase was due in part to 15 unrelated loan relationships that aggregated $38.1 million that were current with respect to principal and interest payments. Management determined that these loans should be classified as non-performing as of December 31, 2010, in light of underlying difficulties with the properties that secure the loans, as well as an increasingly strict regulatory environment. These loans were secured by commercial real estate, multi-family real estate, undeveloped land, and commercial business assets. Also contributing to the increase in non-performing assets in 2010 were 16 larger loan relationships that aggregated $49.2 million that defaulted during the year. These loans were secured by commercial real estate, multi-family real estate, single-family real estate, undeveloped land, and commercial business assets. Also in 2010, non-performing one- to four-family loans increased by $4.0 million, smaller non-performing commercial business loans increased by $5.8 million, smaller non-performing commercial and multi-family real estate loans increased by $2.0 million, and foreclosed real estate and repossessed assets increased by $1.6 million. These developments were partially offset by the combined effects of loan charge-offs and a small decline in non-performing student loans during the year.
In 2009 the Company’s non-performing assets increased by $22.4 million or 59.2%. This increase was primarily caused by the default of $15.4 million in loans to seven borrowers that were secured by office and retail buildings, townhomes, and improved land. Also contributing was a $3.9 million increase in non-performing one- to four-family residential loans and a $744,000 increase in non-performing consumer and student loans. Foreclosed real estate and repossessed assets also increased by $12.9 million during 2009, due primarily to the foreclosure of a $9.1 million loan secured by a completed condominium development project that had defaulted in the prior year. These developments were partially offset by the combined effects of loan charge-offs and a small decline in non-performing commercial business loans during the year.
Non-performing assets are classified as “substandard” in accordance with the Company’s internal risk rating policy. In addition to non-performing assets, at December 31, 2012, management was closely monitoring $31.8 million in additional loans that were adversely classified as “substandard” and $37.7 million in additional loans that were classified as “special mention” in accordance with the Company’s internal risk rating policy. These amounts compared to $28.5 million and $51.6 million, respectively, as of December 31, 2011. The substantial decrease in loans classified as “special mention” during 2012 was due to loans that were further downgraded during the year to “substandard” or were upgraded because of improved performance. As of December 31, 2012, most of the additional loans classified as “substandard” or “special mention” were secured by commercial real estate, multi-family real estate, land, and certain commercial business assets. Although these additional loans were performing in accordance with their contractual terms and were not included in non-performing assets, management deemed their classification as “substandard” or “special mention” to be prudent in light of deterioration in the financial strength of the borrowers and/or the performance of the collateral, including an assessment of occupancy rates, lease rates, unit sales, and/or estimated changes in the value of the collateral. Further deterioration in the borrowers or related collateral could result in these additional loans becoming non-performing assets in future periods.The Company does not expect to incur a loss on these additional loans at this time, although there can be no assurance.
The Company’s classified loans and non-performing assets have declined substantially in recent periods. However, this trend is subject to many factors that are outside of Company’s control, such as economic and market conditions. As such, there can be no assurances that Company’s classified loans and non-performing loans and assets will continue to decline in future periods or that there will not be significant variability in the Company’s provision for loan losses from period to period.
In the third quarter of 2012 the OCC issued accounting and reporting guidance related to instances in which borrowers on one- to four-family mortgage loans have had debt discharged in bankruptcy and have not reaffirmed obligations related to their mortgage debt. The Company does not have a material exposure to one- to four-family mortgage loans that meet the criteria specified in the OCC guidance.
Loans considered to be impaired by the Company at December 31, 2012, totaled $25.8 million as compared to $75.1 million at December 31, 2011, $131.4 million at December 31, 2010, $42.6 million at December 31, 2009, and $33.1 million at December 31, 2008. The average annual balance of loans impaired as of December 31, 2012, was $52.4 million and the interest received and recognized on these loans while they were impaired was $1.2 million.
The following table presents the activity in the Company’s allowance for loan losses at or for the periods indicated.
| | | At or For the Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | (Dollars in thousands) | |
| Balance at beginning of period | | $ | 27,928 | | | $ | 47,985 | | | $ | 17,028 | | | $ | 12,208 | | | $ | 11,774 | |
| Provision for loan losses | | | 4,545 | | | | 6,710 | | | | 49,619 | | | | 12,413 | | | | 1,447 | |
| Charge-offs: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | (3,182 | ) | | | (3,047 | ) | | | (528 | ) | | | (397 | ) | | | (167 | ) |
| Multi-family | | | (857 | ) | | | (5,035 | ) | | | (140 | ) | | | (4,523 | ) | | | – | |
| Commercial real estate | | | (4,894 | ) | | | (15,286 | ) | | | (11,621 | ) | | | (1,989 | ) | | | (446 | ) |
| Construction and development | | | (2,693 | ) | | | (2,737 | ) | | | (3,515 | ) | | | – | | | | – | |
| Consumer | | | (812 | ) | | | (1,036 | ) | | | (776 | ) | | | (527 | ) | | | (411 | ) |
| Commercial business | | | (136 | ) | | | (551 | ) | | | (2,140 | ) | | | (210 | ) | | | (34 | ) |
| Total charge-offs | | | (12,574 | ) | | | (27,692 | ) | | | (18,720 | ) | | | (7,646 | ) | | | (1,058 | ) |
| Recoveries: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | 86 | | | | 49 | | | | 20 | | | | 1 | | | | – | |
| Multi-family | | | 568 | | | | 248 | | | | – | | | | – | | | | – | |
| Commercial real estate | | | 956 | | | | 40 | | | | 1 | | | | 19 | | | | – | |
| Construction and development | | | 1 | | | | 550 | | | | – | | | | – | | | | – | |
| Consumer | | | 41 | | | | 20 | | | | 37 | | | | 33 | | | | 45 | |
| Commercial business | | | 26 | | | | 18 | | | | – | | | | – | | | | – | |
| Total recoveries | | | 1,678 | | | | 925 | | | | 58 | | | | 53 | | | | 45 | |
| Net charge-offs | | | (10,896 | ) | | | (26,768 | ) | | | (18,662 | ) | | | (7,593 | ) | | | (1,013 | ) |
| Balance at end of period | | $ | 21,577 | | | $ | 27,928 | | | $ | 47,985 | | | $ | 17,028 | | | $ | 12,208 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net charge-offs to average loans | | | 0.78 | % | | | 1.96 | % | | | 1.26 | % | | | 0.45 | % | | | 0.05 | % |
| Allowance for loan losses to total loans | | | 1.54 | % | | | 2.12 | % | | | 3.63 | % | | | 1.13 | % | | | 0.67 | % |
| Allowance for loan losses to non-performing loans | | | 83.64 | % | | | 37.17 | % | | | 39.03 | % | | | 39.99 | % | | | 36.89 | % |
The changes in the Company’s allowance for loan losses in recent years has been consistent with overall changes in the Company’s level of non-performing loans, changes in loan charge-off activity, and industry trends. The changes are also consistent with changes in management’s assessment of overall economic conditions, unemployment, and real estate values during the periods. The Company’s ratio of allowance for loan losses as a percent of non-performing loans increased from 37.2% at December 31, 2011, to 83.6% at December 31, 2012. This increase was caused by a substantial decline in non-performing loans relative to the allowance for loan losses. This change is to be expected when non-performing loans (which are generally evaluated for impairment on an individual basis) decline in a period and, as a result, a larger portion of the allowance for loan losses relates to loans that are evaluated for impairment on a collective basis (refer to “Note 3. Loans Receivable” in “Item 8. Financial Statements and Supplementary Data”).
Although management believes the Company’s present level of allowance for loan losses is adequate, there can be no assurances that future adjustments to the allowance will not be necessary, which could adversely affect the Company’s results of operations. For additional discussion, refer to “Item 1. Business—Asset Quality,” above, and “Critical Accounting Policies—Allowance for Loan Losses,” below.
The following table represents the Company’s allocation of its allowance for loan losses by loan category on the dates indicated:
| | | December 31 | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | Amount | | | Percentage in
Category to
Total | | | Amount | | | Percentage
in Category
to Total | | | Amount | | | Percentage
in Category
to Total | | | Amount | | | Percentage
in Category
to Total | | | Amount | | | Percentage
in Category
to Total | |
| | | (Dollars in thousands) | |
| Loan category: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 3,267 | | | | 15.14 | % | | $ | 3,201 | | | | 11.46 | % | | $ | 3,726 | | | | 7.76 | % | | $ | 2,806 | | | | 16.47 | % | | $ | 3,038 | | | | 24.89 | % |
| Multi-family | | | 5,195 | | | | 24.08 | | | | 7,442 | | | | 26.65 | | | | 9,265 | | | | 19.31 | | | | 3,167 | | | | 18.60 | | | | 4,197 | | | | 34.38 | |
| Commercial real estate | | | 7,354 | | | | 34.08 | | | | 9,467 | | | | 33.90 | | | | 21,885 | | | | 45.61 | | | | 5,715 | | | | 33.56 | | | | 1,113 | | | | 9.12 | |
| Construction/development | | | 2,617 | | | | 12.13 | | | | 4,506 | | | | 16.13 | | | | 10,141 | | | | 21.13 | | | | 1,172 | | | | 6.88 | | | | 400 | | | | 3.28 | |
| Total mortgage loans | | | 18,433 | | | | 85.43 | | | | 24,616 | | | | 88.14 | | | | 45,017 | | | | 93.81 | | | | 12,860 | | | | 75.52 | | | | 8,748 | | | | 71.66 | |
| Consumer | | | 1,458 | | | | 6.76 | | | | 1,214 | | | | 4.35 | | | | 1,427 | | | | 2.97 | | | | 2,243 | | | | 13.17 | | | | 2,125 | | | | 17.41 | |
| Commercial business | | | 1,686 | | | | 7.81 | | | | 2,098 | | | | 7.51 | | | | 1,541 | | | | 3.21 | | | | 1,925 | | | | 11.31 | | | | 1,335 | | | | 10.94 | |
| Total allowance for loan losses | | $ | 21,577 | | | | 100.00 | % | | $ | 27,928 | | | | 100.00 | % | | $ | 47,985 | | | | 100.00 | % | | $ | 17,028 | | | | 100.00 | % | | $ | 12,208 | | | | 100.00 | % |
Critical Accounting Policies
There are a number of accounting policies that the Company has established which require a significant amount of management judgment. A number of the more significant policies are discussed in the following paragraphs.
Allowance for Loan Losses Establishing the amount of the allowance for loan losses requires the use of management 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 factors such as the size and current risk characteristics of the portfolio, an assessment of individual problem loans and pools of homogenous loans within the portfolio, and actual loss, delinquency, and/or risk rating experience within the portfolio. The Company also considers current economic conditions and/or events in specific industries and geographical areas, including unemployment levels, trends in real estate values, peer comparisons, and other pertinent factors, to include regulatory guidance. Finally, as appropriate, the Company also considers individual borrower circumstances and the condition and fair value of the loan collateral, if any.
Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on loans, the fair value of underlying collateral (if any), estimated losses on pools of homogeneous loans based on historical loss experience, changes in risk characteristics of the loan portfolio, and consideration of current economic trends, all of which may be susceptible to significant change. Higher rates of loan defaults than anticipated would likely result in a need to increase provisions in future years. 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 management misjudges a major component of the allowance and the Company experiences an unanticipated loss, it will likely affect earnings. Developments affecting loans can also cause the allowance to vary significantly between quarters. Management consistently challenges itself in the review of the risk components to identify any changes in trends and their causes.
Other-Than-Temporary Impairment Generally accepted accounting principles require enterprises to determine whether a decline in the fair value of an individual debt security below its amortized cost is other than temporary. If the decline is deemed to be other than temporary, the cost basis of the security must be written down through a charge to earnings. Determination of OTTI requires significant management judgment relating to the probability of future cash flows, the financial condition and near-term prospects of the issuer of the security, and/or the collateral for the security, the duration and extent of the decline in fair value, and the ability and intent of the Company to retain the security, among other things. Future changes in management’s assessment of OTTI on its securities could result in significant charges to earnings in future periods.
Income TaxesThe assessment of the Company’s tax assets and liabilities involves the use of estimates, forecasts, assumptions, interpretations, and judgment concerning the Company’s estimated future results of operations, as well as certain accounting pronouncements and federal and state tax codes. Management evaluates the Company’s net deferred tax asset on an on-going basis to determine if a valuation allowance is required. This evaluation requires significant management judgment based on positive and negative evidence. Such evidence includes the Company’s cumulative three-year net loss, the nature of the components of such cumulative loss, recent trends in earnings excluding one-time charges (such as the FHLB prepayment penalty in 2010 and the goodwill impairment in 2011), expectations for the Company’s future earnings, the duration of federal and state net operating loss carryforward periods, and other factors. There can be no assurance that future events, such as adverse operating results, court decisions, regulatory actions or interpretations, changes in tax rates and laws, or changes in positions of federal and state taxing authorities will not differ from management’s current assessments. The impact of these matters could be significant to the consolidated financial conditions and results of operations.
The Company describes all of its significant accounting policies in “Note 1. Basis of Presentation” in “Item 8. Financial Statements and Supplementary Data.”
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 December 31, 2012, significant fixed and determinable contractual obligations to third parties by payment date. All amounts in the table exclude interest costs to be paid in the periods indicated, if applicable.
| | | Payments Due In | |
| | | | | | One to | | | Three to | | | Over | | | | |
| | | One Year | | | Three | | | Five | | | Five | | | | |
| | | Or Less | | | Years | | | Years | | | Years | | | Total | |
| | | (Dollars in thousands) | |
| Deposit liabilities without a stated maturity | | $ | 1,055,996 | | | | – | | | | – | | | | – | | | $ | 1,055,996 | |
| Certificates of deposit | | | 618,487 | | | $ | 176,337 | | | $ | 17,079 | | | | – | | | | 811,903 | |
| Borrowed funds | | | 217 | | | | 23,450 | | | | 61,273 | | | $ | 125,846 | | | | 210,786 | |
| Operating leases | | | 964 | | | | 1,740 | | | | 1,123 | | | | 2,986 | | | | 6,813 | |
| Purchase obligations | | | 1,680 | | | | 3,360 | | | | 3,360 | | | | 2,940 | | | | 11,340 | |
| Deferred retirement plans and deferred compensation plans | | | 1,080 | | | | 2,041 | | | | 2,155 | | | | 6,211 | | | | 11,487 | |
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. Employee Benefit Plans” in “Item 8. Financial Statements and Supplementary Data.”
The following table details the amounts and expected maturities of significant off-balance sheet commitments as of December 31, 2012.
| | | Payments Due In | |
| | | | | | One to | | | Three to | | | Over | | | | |
| | | One Year | | | Three | | | Five | | | Five | | | | |
| | | Or Less | | | Years | | | Years | | | Years | | | Total | |
| | | (Dollars in thousands) | |
| Commitments to extend credit: | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate | | $ | 13,430 | | | | – | | | | – | | | | – | | | $ | 13,430 | |
| Residential real estate | | | 22,518 | | | | – | | | | – | | | | – | | | | 22,518 | |
| Revolving home equity and credit card lines | | | 152,109 | | | | – | | | | – | | | | – | | | | 152,109 | |
| Standby letters of credit | | | 256 | | | $ | 1,250 | | | | – | | | $ | 6 | | | | 1,512 | |
| Commercial lines of credit | | | 75,354 | | | | – | | | | – | | | | – | | | | 75,354 | |
| Undisbursed commercial loans | | | 2,740 | | | | 10 | | | $ | 250 | | | | – | | | | 3,000 | |
| Net commitments to sell mortgage loans | | | 75,750 | | | | – | | | | – | | | | – | | | | 75,750 | |
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.
Quarterly Financial Information
The following table sets forth certain unaudited quarterly data for the periods indicated:
| | | 2012 Quarter Ended | |
| | | March 31 | | | June 30 | | | September 30 | | | December 31 | |
| | | (Dollars in thousands, except per share amounts) | |
| Interest income | | $ | 20,777 | | | $ | 21,079 | | | $ | 20,697 | | | $ | 20,467 | |
| Interest expense | | | 5,879 | | | | 6,226 | | | | 5,098 | | | | 4,437 | |
| Net interest income | | | 14,898 | | | | 14,853 | | | | 15,599 | | | | 16,030 | |
| Provision for loan losses | | | 51 | | | | 1,730 | | | | 657 | | | | 2,107 | |
| Total non-interest income | | | 7,271 | | | | 6,934 | | | | 6,845 | | | | 8,209 | |
| Total non-interest expense | | | 20,517 | | | | 18,140 | | | | 18,790 | | | | 18,608 | |
| Income before taxes | | | 1,601 | | | | 1,917 | | | | 2,997 | | | | 3,524 | |
| Income tax expense | | | 462 | | | | 601 | | | | 1,044 | | | | 1,229 | |
| Net loss attributable to non-controlling interest | | | 16 | | | | 13 | | | | 13 | | | | 10 | |
| Net income | | $ | 1,155 | | | $ | 1,329 | | | $ | 1,966 | | | $ | 2,305 | |
| | | | | | | | | | | | | | | | | |
| Earnings per share-basic | | $ | 0.03 | | | $ | 0.03 | | | $ | 0.04 | | | $ | 0.05 | |
| Earnings per share-diluted | | $ | 0.03 | | | $ | 0.03 | | | $ | 0.04 | | | $ | 0.05 | |
| Cash dividend paid per share | | $ | 0.01 | | | $ | 0.01 | | | $ | 0.01 | | | $ | 0.02 | |
| | | 2011 Quarter Ended | |
| | | March 31 | | | June 30 | | | September 30 | | | December 31 | |
| | | (Dollars in thousands, except per share amounts) | |
| Interest income | | $ | 23,063 | | | $ | 22,906 | | | $ | 22,017 | | | $ | 21,359 | |
| Interest expense | | | 7,240 | | | | 6,801 | | | | 6,531 | | | | 6,183 | |
| Net interest income | | | 15,823 | | | | 16,105 | | | | 15,486 | | | | 15,176 | |
| Provision for loan losses | | | 3,180 | | | | 805 | | | | 1,093 | | | | 1,632 | |
| Total non-interest income | | | 5,795 | | | | 4,759 | | | | 5,474 | | | | 7,130 | |
| Total non-interest expense (1) | | | 17,050 | | | | 71,184 | | | | 17,920 | | | | 18,746 | |
| Income (loss) before taxes | | | 1,388 | | | | (51,125 | ) | | | 1,947 | | | | 1,928 | |
| Income tax expense | | | 361 | | | | 266 | | | | 610 | | | | 516 | |
| Net loss attributable to non-controlling interest | | | 13 | | | | 14 | | | | 12 | | | | 10 | |
| Net income (loss) | | $ | 1,040 | | | $ | (51,377 | ) | | $ | 1,349 | | | $ | 1,422 | |
| | | | | | | | | | | | | | | | | |
| Earnings (loss) per share-basic | | $ | 0.02 | | | $ | (1.12 | ) | | $ | 0.02 | | | $ | 0.03 | |
| Earnings (loss) per share-diluted | | $ | 0.02 | | | $ | (1.12 | ) | | $ | 0.02 | | | $ | 0.03 | |
| Cash dividend paid per share | | $ | 0.03 | | | $ | 0.01 | | | $ | 0.01 | | | $ | 0.01 | |
| (1) | Non-interest expense in the quarter ended June 30, 2011, included a $52.6 million goodwill impairment. |
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company’s ability to maintain net interest income depends upon earning a higher yield on assets than the rates it pays on deposits and borrowings. Fluctuations in market interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Company’s assets and liabilities. Fluctuations in interest rates will also affect the market value of all interest-earning assets and interest-bearing liabilities, other than those with a very short term to maturity.
Interest rate sensitivity is a measure of the difference between amounts of interest-earning assets and interest-bearing liabilities which either reprice or mature during a given period of time. The difference, or the interest rate sensitivity “gap, ” provides an indication of the extent to which the Company’s interest rate spread will be affected by changes in interest rates. Refer to “Gap Analysis,” below. Interest rate sensitivity is also measured through analysis of changes in the present value of the Company’s equity. Refer to “Present Value of Equity,” below.
To achieve the objectives of managing interest rate risk, the Company’s executive management meets periodically to discuss and monitor the market interest rate environment and provides reports to the board of directors. Management seeks to coordinate asset and liability decisions so that, under changing interest rate scenarios, the Company’s earnings will remain within an acceptable range. The primary objectives of the Company’s interest rate management strategy are to:
| · | maintain earnings and capital within self-imposed parameters over a range of possible interest rate environments; |
| · | coordinate interest rate risk policies and procedures with other elements of the Company’s business plan, all within the context of the current business environment and regulatory capital and liquidity requirements; and |
| · | manage interest rate risk in a manner consistent with the approved guidelines and policies set by the board of directors. |
The Company has employed certain strategies to manage the interest rate risk inherent in the asset/liability mix, including:
| · | emphasizing the origination of adjustable-rate mortgage loans and mortgage loans that mature or reprice within five years for portfolio, and selling most fixed-rate residential mortgage loans with maturities of 15 years or more in the secondary market; |
| · | emphasizing variable-rate and/or short- to medium-term, fixed-rate consumer and commercial business loans; |
| · | maintaining a significant level of mortgage-related and other investment securities available-for-sale that have weighted average life of less than five years or interest rates that reprice in less than five years; and |
| · | managing deposits and borrowings to provide stable funding. |
Management believes these strategies reduce the Company’s interest rate risk exposure to acceptable levels.
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.
The following table presents the amounts of the Company’s interest-earning assets and interest-bearing liabilities outstanding at December 31, 2012, which management anticipates to reprice or mature in each of the future time periods shown. The information presented in the following table is based on the following assumptions:
| · | Loans—based upon contractual maturities, repricing date, if applicable, scheduled repayments of principal, and projected prepayments of principal based upon the Company’s historical experience or anticipated prepayments. Actual cash flows may differ substantially from these assumptions. |
| · | Mortgage-related securities—based upon known repricing dates (if applicable) and an independent outside source for determining estimated prepayment speeds. Actual cash flows may differ substantially from these assumptions. |
| · | Deposit liabilities—based upon contractual maturities and the Company’s historical decay rates. Actual cash flows may differ from these assumptions. |
| · | Borrowings—based upon final maturity. |
| | | December 31, 2012 | |
| | | Within | | | Three to | | | More than | | | More than | | | | | | | |
| | | Three | | | Twelve | | | 1 Year to | | | 3 Years - | | | Over 5 | | | | |
| | | Months | | | Months | | | 3 Years | | | 5 Years | | | Years | | | Total | |
| | | (Dollars in thousands) | |
| Loans receivable: | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed | | $ | 39,832 | | | $ | 72,752 | | | $ | 164,205 | | | $ | 144,137 | | | $ | 107,303 | | | $ | 528,229 | |
| Adjustable | | | 106,604 | | | | 223,891 | | | | 91,642 | | | | 61,681 | | | | 28,672 | | | | 512,490 | |
| Consumer loans | | | 98,009 | | | | 46,009 | | | | 48,225 | | | | 27,033 | | | | 25,079 | | | | 244,355 | |
| Commercial business loans | | | 69,055 | | | | 22,027 | | | | 24,498 | | | | 19,786 | | | | 323 | | | | 135,689 | |
| Interest-earning deposits | | | 37,029 | | | | – | | | | – | | | | – | | | | – | | | | 37,029 | |
| Mortgage-related securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed | | | 52,518 | | | | 148,842 | | | | 223,029 | | | | 58,182 | | | | 159,580 | | | | 642,151 | |
| Adjustable | | | 54,938 | | | | – | | | | – | | | | – | | | | – | | | | 54,938 | |
| Other interest-earning assets | | | 15,841 | | | | – | | | | – | | | | – | | | | – | | | | 15,841 | |
| Total interest-earning assets | | | 473,826 | | | | 513,521 | | | | 551,599 | | | | 310,819 | | | | 320,957 | | | | 2,170,722 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposit liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest-bearing demand accounts | | | 861 | | | | 2,551 | | | | 6,581 | | | | 6,273 | | | | 127,418 | | | | 143,684 | |
| Interest-bearing demand accounts | | | 1,413 | | | | 4,189 | | | | 10,808 | | | | 10,301 | | | | 209,669 | | | | 236,380 | |
| Savings accounts | | | 1,443 | | | | 4,269 | | | | 10,959 | | | | 10,368 | | | | 190,131 | | | | 217,170 | |
| Money market accounts | | | 458,762 | | | | – | | | | – | | | | – | | | | – | | | | 458,762 | |
| Certificates of deposit | | | 331,310 | | | | 368,185 | | | | 95,329 | | | | 17,079 | | | | – | | | | 811,903 | |
| Advance payments by borrowers for taxes and insurance | | | – | | | | 4,956 | | | | – | | | | – | | | | – | | | | 4,956 | |
| Borrowings | | | 322 | | | | 1,182 | | | | 26,228 | | | | 64,182 | | | | 118,871 | | | | 210,786 | |
| Total non-interest- and interest- bearing liabilities | | | 794,111 | | | | 385,332 | | | | 149,905 | | | | 108,203 | | | | 646,089 | | | | 2,083,640 | |
| Interest rate sensitivity gap | | $ | (320,285 | ) | | $ | 128,189 | | | $ | 401,694 | | | $ | 202,616 | | | $ | (325,132 | ) | | $ | 87,082 | |
| Cumulative interest rate sensitivity gap | | $ | (320,285 | ) | | $ | (192,096 | ) | | $ | 209,598 | | | $ | 411,214 | | | $ | 87,082 | | | | | |
| Cumulative interest rate sensitivity gap as a percent of total assets | | | -13.26 | % | | | -7.94 | % | | | 8.67 | % | | | 17.05 | % | | | 3.60 | % | | | | |
| Cumulative interest-earning assets as a percentage of non-interest- and interest-bearing liabilities | | | 59.67 | % | | | 83.69 | % | | | 115.73 | % | | | 128.64 | % | | | 104.18 | % | | | | |
Based on the above gap analysis, at December 31, 2012, the Company’s interest-bearing liabilities maturing or repricing within one year exceeded its interest-earning assets maturing or repricing within the same period. Based on this information, over the course of the next year the Company’s net interest income could be adversely impacted by an increase in market interest rates. Alternatively, the Company’s net interest income could be favorably impacted by a decline in market interest rates. However, it should be noted that the Company’s future net interest income is affected by more than just future market interest rates. Net interest income is also affected by absolute and relative levels of earning assets and interest-bearing liabilities, the level of non-performing loans and other investments, and by other factors outlined in “Item 1. Business—Cautionary Statement,” “Item 1A. Risk Factors,” and “Item 7. Management Discussion of Financial Condition and Results of Operations.”
In addition to not anticipating all of the factors that could impact future net interest income, gap analysis has certain shortcomings. For example, although certain assets and liabilities may mature or reprice in similar periods, the interest rates on such react by different degrees to changes in market interest rates, especially in instances where changes in rates are limited by contractual caps or floors or instances where rates are influenced by competitive forces. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. For example, it is the Company’s past experience that rate changes on most of its deposit liabilities generally lag changes in market interest rates. Certain assets, such as adjustable-rate loans, have features which limit changes in interest rates on a short term basis and over the life of the loan. If interest rates change, prepayment, and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of borrowers to make payments on their adjustable-rate loans may decrease if interest rates increase.Because of these shortcomings, management of the Company believes that gap analysis is a better indicator of the relative change in the Company’s interest rate risk exposure from period to period than it is an indicator of the direction or amount of future change in net interest income.
Present Value of EquityIn addition to the gap analysis table, management also uses simulation models to monitor interest rate risk. The models report the present value of equity (“PVE”) in different interest rate environments, assuming an instantaneous and permanent interest rate shock to all interest rate sensitive assets and liabilities. The PVE is the difference between the present value of expected cash flows of interest rate sensitive assets and liabilities. The changes in market value of assets and liabilities due to changes in interest rates reflect the interest rate sensitivity of those assets and liabilities as their values are derived from the characteristics of the asset or liability (i.e., fixed rate, adjustable rate, caps, and floors) relative to the current interest rate environment. For example, in a rising interest rate environment, the fair market value of a fixed-rate asset will decline whereas the fair market value of an adjustable-rate asset, depending on its repricing characteristics, may not decline. Increases in the market value of assets will increase the PVE whereas decreases in market value of assets will decrease the PVE. Conversely, increases in the market value of liabilities will decrease the PVE whereas decreases in the market value of liabilities will increase the PVE.
The following table presents the estimated PVE over a range of interest rate change scenarios at December 31, 2012. The present value ratio shown in the table is the PVE as a percent of the present value of total assets in each of the different rate environments. For purposes of this table, management has made assumptions such as prepayment rates and decay rates similar to those used for the gap analysis table.
| | | | | | | | | | | | Present Value of Equity | |
| | | | | | | | | | | | as Percent of | |
| Change in | | Present Value of Equity | | | Present Value of Assets | |
| Interest Rates | | Dollar | | | Dollar | | | Percent | | | Present Value | | | Percent | |
| (Basis Points) | | Amount | | | Change | | | Change | | | Ratio | | | Change | |
| | | (Dollars in thousands) | | | | | | | | | | |
| +400 | | $ | 212,497 | | | $ | (138,752 | ) | | | (39.5 | )% | | | 9.50 | % | | | (33.6 | )% |
| +300 | | | 243,564 | | | | (107,685 | ) | | | (30.7 | ) | | | 10.64 | | | | (25.7 | ) |
| +200 | | | 279,983 | | | | (71,266 | ) | | | (20.3 | ) | | | 11.93 | | | | (16.6 | ) |
| +100 | | | 315,026 | | | | (36,223 | ) | | | (10.3 | ) | | | 13.11 | | | | (8.4 | ) |
| 0 | | | 351,249 | | | | – | | | | – | | | | 14.31 | | | | – | |
| -100 | | | 340,042 | | | | (11,207 | ) | | | (3.2 | ) | | | 13.58 | | | | (5.1 | ) |
Based on the above analysis, the Company’s PVE could be adversely affected by an increase in interest rates. The decline in the PVE as a result of an increase in rates is attributable to the combined effects of a decline in the present value of the Company’s earning assets (which is further impacted by an extension in duration in rising rate environments due to slower prepayments on loan and mortgage-related securities and reduced likelihood of calls on certain investment securities), partially offset by a decline in the present value of deposit liabilities and FHLB of Chicago advances. Also based on the above analysis, the Company’s PVE could be adversely impacted by a decrease in interest rates. However, it should be noted that the Company’s PVE is impacted by more than changes in market interest rates. Future PVE is also affected by management’s decisions relating to reinvestment of future cash flows, decisions relating to funding sources, and by other factors outlined in “Item 1. Business—Cautionary Statement,” “Item 1A. Risk Factors,” and “Item 7. Management Discussion of Financial Condition and Results of Operations.”
As is the case with gap analysis, PVE analysis also has certain shortcomings. PVE modeling requires management to make assumptions about future changes in market interest rates that are unlikely to occur, such as immediate, sustained, and parallel (or equal) changes in all market rates across all maturity terms. PVE modeling also requires that management make assumptions which may not reflect the manner in which actual yields and costs respond to changes in market interest rates. For example, it is the Company’s past experience that rate changes on most of its deposit liabilities generally lag changes in market interest rates. In addition, management makes assumptions regarding the changes in prepayment speeds of mortgage loans and securities. Prepayments will accelerate in a falling rate environment and the reverse will occur in a rising rate environment. Management also assumes that decay rates on core deposits will accelerate in a rising rate environment and the reverse in a falling rate environment. The model assumes that the Company will take no action in response to the changes in interest rates, when in practice rate changes on most deposit liabilities lag behind market changes and/or may be limited by competition. In addition, prepayment estimates and other assumptions within the model are subjective in nature, involve uncertainties, and therefore cannot be determined with precision. Accordingly, although the PVE model may provide an estimate of the Company’s interest rate risk at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in interest rates on the Company’s PVE. Because of these shortcomings, management of the Company believes that PVE analysis is a better indicator of the relative change in the Company’s interest rate risk exposure from period to period than it is an indicator of the direction or amount of future change in net interest income.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Bank Mutual Corporation
Milwaukee, Wisconsin
We have audited the accompanying consolidated statements of financial condition of Bank Mutual Corporation and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of income, total comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Bank Mutual Corporation and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on the criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2013, expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
Milwaukee, Wisconsin
March 8, 2013
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Financial Condition
| | | December 31 | |
| | | 2012 | | | 2011 | |
| | | (Dollars in thousands) | |
| Assets | | | | | | | | |
| | | | | | | | | |
| Cash and due from banks | | $ | 50,030 | | | $ | 52,306 | |
| Interest-earning deposits in banks | | | 37,029 | | | | 68,629 | |
| Cash and cash equivalents | | | 87,059 | | | | 120,935 | |
| Mortgage-related securities available-for-sale, at fair value | | | 550,185 | | | | 781,770 | |
| Mortgage-related securities held-to-maturity, at amortized cost (fair value of $163,589 in 2012) | | | 157,558 | | | | – | |
| Loans held-for-sale | | | 10,739 | | | | 19,192 | |
| Loans receivable (net of allowance for loan losses of $21,577 in 2012 and $27,928 in 2011) | | | 1,402,246 | | | | 1,319,636 | |
| Foreclosed properties and repossessed assets | | | 13,961 | | | | 24,724 | |
| Mortgage servicing rights, net | | | 6,821 | | | | 7,401 | |
| Other assets | | | 189,695 | | | | 224,826 | |
| | | | | | | | | |
| Total assets | | $ | 2,418,264 | | | $ | 2,498,484 | |
| | | | | | | | | |
| Liabilities and equity | | | | | | | | |
| | | | | | | | | |
| Liabilities: | | | | | | | | |
| Deposit liabilities | | $ | 1,867,899 | | | $ | 2,021,663 | |
| Borrowings | | | 210,786 | | | | 153,091 | |
| Advance payments by borrowers for taxes and insurance | | | 4,956 | | | | 3,192 | |
| Other liabilities | | | 59,837 | | | | 51,842 | |
| Total liabilities | | | 2,143,478 | | | | 2,229,788 | |
| Equity: | | | | | | | | |
| Preferred stock–$0.01 par value: | | | | | | | | |
| Authorized–20,000,000 shares in 2012 and 2011 | | | | | | | | |
| Issued and outstanding–none in 2012 and 2011 | | | – | | | | – | |
| Common stock–$0.01 par value: | | | | | | | | |
| Authorized–200,000,000 shares in 2012 and 2011 | | | | | | | | |
| Issued–78,783,849 shares in 2012 and 2011 | | | | | | | | |
| Outstanding–46,326,484 shares in 2012 and 46,228,984 in 2011 | | | 788 | | | | 788 | |
| Additional paid-in capital | | | 489,960 | | | | 490,159 | |
| Retained earnings | | | 145,231 | | | | 140,793 | |
| Accumulated other comprehensive income (loss) | | | (4,717 | ) | | | (5,379 | ) |
| Treasury stock–32,457,365 shares in 2012 and 32,554,865 in 2011 | | | (359,409 | ) | | | (360,590 | ) |
| Total shareholders' equity | | | 271,853 | | | | 265,771 | |
| Non-controlling interest in real estate partnership | | | 2,933 | | | | 2,925 | |
| Total equity including non-controlling interest | | | 274,786 | | | | 268,696 | |
| | | | | | | | | |
| Total liabilities and equity | | $ | 2,418,264 | | | $ | 2,498,484 | |
Refer to Notes to Consolidated Financial Statements
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Income
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands, except per share data) | |
| Interest income: | | | | | | | | | | | | |
| Loans | | $ | 65,478 | | | $ | 69,936 | | | $ | 79,266 | |
| Mortgage-related securities | | | 17,309 | | | | 16,374 | | | | 17,445 | |
| Investment securities | | | 73 | | | | 2,877 | | | | 15,428 | |
| Interest-earning deposits | | | 162 | | | | 158 | | | | 430 | |
| Total interest income | | | 83,022 | | | | 89,345 | | | | 112,569 | |
| Interest expense: | | | | | | | | | | | | |
| Deposit liabilities | | | 14,655 | | | | 19,568 | | | | 28,606 | |
| Borrowings | | | 6,984 | | | | 7,183 | | | | 37,664 | |
| Advance payments by borrowers for taxes and insurance | | | 2 | | | | 5 | | | | 6 | |
| Total interest expense | | | 21,641 | | | | 26,756 | | | | 66,276 | |
| Net interest income | | | 61,381 | | | | 62,589 | | | | 46,293 | |
| Provision for loan losses | | | 4,545 | | | | 6,710 | | | | 49,619 | |
| Net interest income (loss) after provision for loan losses | | | 56,836 | | | | 55,879 | | | | (3,326 | ) |
| Non-interest income: | | | | | | | | | | | | |
| Service charges on deposits | | | 6,903 | | | | 6,429 | | | | 6,126 | |
| Brokerage and insurance commissions | | | 3,009 | | | | 2,844 | | | | 3,067 | |
| Loan related fees and servicing revenue, net | | | (1,911 | ) | | | (402 | ) | | | 103 | |
| Gain on loan sales activities, net | | | 13,206 | | | | 5,963 | | | | 8,571 | |
| Gain on sales of investments, net | | | 543 | | | | 1,113 | | | | 15,966 | |
| Other-than-temporary impairment (“OTTI”) losses: | | | | | | | | | | | | |
| Total OTTI losses | | | (889 | ) | | | (1,794 | ) | | | – | |
| Non-credit portion of OTTI losses | | | 489 | | | | 1,405 | | | | – | |
| Net OTTI losses | | | (400 | ) | | | (389 | ) | | | – | |
| Loss on real estate held for investment | | | – | | | | – | | | | (700 | ) |
| Increase in cash surrender value of life insurance | | | 2,118 | | | | 2,374 | | | | 2,405 | |
| Other non-interest income | | | 5,791 | | | | 5,226 | | | | 5,065 | |
| Total non-interest income | | | 29,259 | | | | 23,158 | | | | 40,603 | |
| Non-interest expense: | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | | 42,304 | | | | 38,844 | | | | 36,009 | |
| Occupancy and equipment | | | 11,363 | | | | 11,514 | | | | 11,221 | |
| Federal insurance premiums | | | 3,308 | | | | 3,224 | | | | 4,069 | |
| Advertising and marketing | | | 2,139 | | | | 2,008 | | | | 2,114 | |
| Losses and expenses on foreclosed real estate, net | | | 6,725 | | | | 7,059 | | | | 8,266 | |
| Other non-interest expense | | | 10,218 | | | | 9,681 | | | | 8,798 | |
| | | | 76,057 | | | | 72,330 | | | | 70,477 | |
| Goodwill impairment | | | – | | | | 52,570 | | | | – | |
| Loss on early prepayment of FHLB borrowings | | | – | | | | – | | | | 89,348 | |
| Total non-interest expense | | | 76,057 | | | | 124,900 | | | | 159,825 | |
| Income (loss) before income taxes | | | 10,038 | | | | (45,863 | ) | | | (122,548 | ) |
| Income tax expense (benefit) | | | 3,336 | | | | 1,752 | | | | (49,909 | ) |
| Net income (loss) before non-controlling interest | | | 6,702 | | | | (47,615 | ) | | | (72,639 | ) |
| Net loss (income) attributable to non-controlling interests | | | 52 | | | | 50 | | | | (1 | ) |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) |
| | | | | | | | | | | | | |
| Per share data: | | | | | | | | | | | | |
| Earnings (loss) per share–basic | | $ | 0.15 | | | $ | (1.03 | ) | | $ | (1.59 | ) |
| Earnings (loss) per share–diluted | | $ | 0.15 | | | $ | (1.03 | ) | | $ | (1.59 | ) |
| Cash dividends per share paid | | $ | 0.05 | | | $ | 0.06 | | | $ | 0.20 | |
Refer to Notes to Consolidated Financial Statements
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Total Comprehensive Income
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| | | | | | | | | | |
| Net income (loss) before non-controlling interest | | $ | 6,702 | | | $ | (47,615 | ) | | $ | (72,639 | ) |
| Other comprehensive income (loss), net of income taxes: | | | | | | | | | | | | |
| Unrealized holding gains (losses) during the period: | | | | | | | | | | | | |
| Non-credit portion of OTTI on securities available-for sale, net of deferred income taxes of $(196) in 2012 and $(563) in 2011 | | | (293 | ) | | | (842 | ) | | | – | |
| Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $1,593 in 2012, $5,028 in 2011, and $6,259 in 2010 | | | 2,378 | | | | 7,511 | | | | 9,347 | |
| Reclassification adjustment for gain on securities included in income, net of income taxes of $(218) in 2012, $(446) in 2011, and $(6,403) in 2010 | | | (325 | ) | | | (667 | ) | | | (9,563 | ) |
| | | | 1,760 | | | | 6,002 | | | | (216 | ) |
| Defined benefit pension plans: | | | | | | | | | | | | |
| Pension asset, net of deferred income taxes of $(732) in 2012, $(2,990) in 2011, and $(2,850) in 2010 | | | (1,098 | ) | | | (4,484 | ) | | | (4,275 | ) |
| | | | (1,098 | ) | | | (4,484 | ) | | | (4,275 | ) |
| Total other comprehensive income, net of income taxes | | | 662 | | | | 1,518 | | | | (4,491 | ) |
| Total comprehensive income before non-controlling interest | | | 7,364 | | | | (46,097 | ) | | | (77,130 | ) |
| Comprehensive loss (income) attributable to non-controlling interest | | | 52 | | | | 50 | | | | (1 | ) |
| | | | | | | | | | | | | |
| Total comprehensive income (loss) | | $ | 7,416 | | | $ | (46,047 | ) | | $ | (77,131 | ) |
Refer to Notes to Consolidated Financial Statements
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Equity
| | | Common Stock | | | Additional Paid-In Capital | | | Retained Earnings | | | Unearned ESOP Shares | | | Accumulated Other Comprehensive Income (Loss) | | | Treasury Stock | | | Non- Controlling Interest in
Real Estate Partnership | | | Total | |
| | | (Dollars in thousands, except per share data) | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2009 | | $ | 788 | | | $ | 499,376 | | | $ | 272,518 | | | $ | (347 | ) | | $ | (2,406 | ) | | $ | (367,452 | ) | | $ | 2,924 | | | $ | 405,401 | |
| Net loss | | | – | | | | – | | | | (72,640 | ) | | | – | | | | – | | | | – | | | | – | | | | (72,640 | ) |
| Net income attributable to non-controlling interest | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 1 | | | | 1 | |
| Other comprehensive loss | | | – | | | | – | | | | – | | | | – | | | | (4,491 | ) | | | – | | | | – | | | | (4,491 | ) |
| Purchase of treasury stock | | | – | | | | – | | | | – | | | | – | | | | – | | | | (5,029 | ) | | | – | | | | (5,029 | ) |
| Issuance of management recognition plan shares | | | – | | | | (332 | ) | | | – | | | | – | | | | – | | | | 332 | | | | – | | | | – | |
| Committed ESOP shares | | | – | | | | 408 | | | | – | | | | 347 | | | | – | | | | – | | | | – | | | | 755 | |
| Exercise of stock options | | | – | | | | (5,212 | ) | | | – | | | | – | | | | – | | | | 5,596 | | | | – | | | | 384 | |
| Share based payments | | | – | | | | 137 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 137 | |
| Cash dividends ($0.20 per share) | | | – | | | | – | | | | (8,640 | ) | | | – | | | | – | | | | – | | | | – | | | | (8,640 | ) |
| Balance at December 31, 2010 | | $ | 788 | | | $ | 494,377 | | | $ | 191,238 | | | | – | | | $ | (6,897 | ) | | $ | (366,553 | ) | | $ | 2,925 | | | $ | 315,878 | |
| Net loss | | | – | | | | – | | | | (47,565 | ) | | | – | | | | – | | | | – | | | | – | | | | (47,565 | ) |
| Net loss attributable to non-controlling interest | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | (50 | ) | | | (50 | ) |
| Other comprehensive income | | | – | | | | – | | | | – | | | | – | | | | 1,518 | | | | – | | | | – | | | | 1,518 | |
| Equity contribution by non-controlling interest | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 50 | | | | 50 | |
| Issuance of management recognition plan shares | | | – | | | | (123 | ) | | | – | | | | – | | | | – | | | | 123 | | | | – | | | | – | |
| Exercise of stock options | | | – | | | | (4,375 | ) | | | – | | | | – | | | | – | | | | 5,840 | | | | – | | | | 1,465 | |
| Share based payments | | | – | | | | 280 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 280 | |
| Cash dividends ($0.06 per share) | | | – | | | | – | | | | (2,880 | ) | | | – | | | | – | | | | – | | | | – | | | | (2,880 | ) |
| Balance at December 31, 2011 | | $ | 788 | | | $ | 490,159 | | | $ | 140,793 | | | | – | | | $ | (5,379 | ) | | $ | (360,590 | ) | | $ | 2,925 | | | $ | 268,696 | |
| Net income | | | – | | | | – | | | | 6,754 | | | | – | | | | – | | | | – | | | | – | | | | 6,754 | |
| Net loss attributable to non-controlling interest | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | (52 | ) | | | (52 | ) |
| Other comprehensive income | | | – | | | | – | | | | – | | | | – | | | | 662 | | | | – | | | | – | | | | 662 | |
| Equity contribution by non-controlling interest | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 60 | | | | 60 | |
| Issuance of management recognition plan shares | | | – | | | | (1,181 | ) | | | – | | | | – | | | | – | | | | 1,181 | | | | – | | | | – | |
| Share based payments | | | – | | | | 982 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 982 | |
| Cash dividends ($0.05 per share) | | | – | | | | – | | | | (2,316 | ) | | | – | | | | – | | | | – | | | | – | | | | (2,316 | ) |
| Balance at December 31, 2012 | | $ | 788 | | | $ | 489,960 | | | $ | 145,231 | | | | – | | | $ | (4,717 | ) | | $ | (359,409 | ) | | $ | 2,933 | | | $ | 274,786 | |
Refer to Notes to Consolidated Financial Statements
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Cash Flows
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Operating activities: | | | | | | | | | | | | |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | | | | | | | | | | |
| Provision for loan losses | | | 4,545 | | | | 6,710 | | | | 49,619 | |
| Loss on foreclosed real estate, net | | | 5,525 | | | | 4,926 | | | | 6,346 | |
| Provision for depreciation | | | 2,569 | | | | 2,576 | | | | 2,600 | |
| Goodwill impairment | | | – | | | | 52,570 | | | | – | |
| Net OTTI losses | | | 400 | | | | 389 | | | | – | |
| Amortization of mortgage servicing rights | | | 3,904 | | | | 2,747 | | | | 3,277 | |
| Increase (decrease) in valuation on MSRs | | | 1,528 | | | | 862 | | | | (281 | ) |
| Net premium amortization on securities | | | 4,608 | | | | 3,923 | | | | 2,068 | |
| Loans originated for sale | | | (446,358 | ) | | | (272,785 | ) | | | (434,388 | ) |
| Proceeds from loan sales | | | 463,165 | | | | 294,134 | | | | 414,808 | |
| Gain on loan sales activities, net | | | (13,206 | ) | | | (5,963 | ) | | | (8,571 | ) |
| Gain on sales of investments, net | | | (543 | ) | | | (1,113 | ) | | | (15,966 | ) |
| Loss on real estate held for investment | | | – | | | | – | | | | 700 | |
| Loss on early repayment of FHLB borrowings | | | – | | | | – | | | | 89,348 | |
| Deferred income tax expense (benefit) | | | 3,286 | | | | 1,830 | | | | (32,075 | ) |
| Other, net | | | 7,850 | | | | 40,591 | | | | (28,689 | ) |
| Net cash provided (used) by operating activities | | | 44,027 | | | | 83,832 | | | | (23,844 | ) |
| Investing activities: | | | | | | | | | | | | |
| Purchases of investment securities available-for-sale | | | – | | | | – | | | | (3,118,204 | ) |
| Proceeds from maturities of investment securities available-for-sale | | | – | | | | 205,825 | | | | 3,506,718 | |
| Proceeds from sale of investment securities available-for-sale | | | 20,938 | | | | 21,950 | | | | – | |
| Purchases of mortgage-related securities available-for-sale | | | (51,374 | ) | | | (507,052 | ) | | | (819,675 | ) |
| Principal payments on mortgage-related securities available-for-sale | | | 260,953 | | | | 167,587 | | | | 187,664 | |
| Proceeds from sale of mortgage-related securities available-for-sale | | | – | | | | – | | | | 1,074,730 | |
| Purchases of mortgage-related securities held-to-maturity | | | (158,915 | ) | | | – | | | | – | |
| Principal payments on mortgage-related securities held-to-maturity | | | 902 | | | | – | | | | – | |
| Redemption of FHLB stock | | | 30,251 | | | | – | | | | – | |
| Net decrease (increase) in loans receivable | | | (100,209 | ) | | | (47,661 | ) | | | 112,261 | |
| Proceeds from sale of foreclosed properties | | | 18,801 | | | | 19,822 | | | | 6,259 | |
| Net purchases of premises and equipment | | | (2,689 | ) | | | (1,840 | ) | | | (2,049 | ) |
| Net cash provided (used) by investing activities | | | 18,658 | | | | (141,369 | ) | | | 947,704 | |
(continued)
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Cash Flows (continued)
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | (Dollars in thousands) | |
| Financing activities: | | | | | | | | | | | | |
| Net cash outflows from deposit liabilities | | $ | (153,764 | ) | | $ | (56,647 | ) | | $ | (59,198 | ) |
| Proceeds from long-term borrowings | | | 158,935 | | | | 4,270 | | | | – | |
| Repayments on long-term borrowings, including loss on prepayment | | | (101,240 | ) | | | (1,113 | ) | | | (846,393 | ) |
| Net increase in advance payments by borrowers for taxes and insurance | | | 1,764 | | | | 495 | | | | 189 | |
| Cash dividends | | | (2,316 | ) | | | (2,880 | ) | | | (8,640 | ) |
| Purchase of treasury stock | | | – | | | | – | | | | (5,029 | ) |
| Other, net | | | 60 | | | | 1,515 | | | | 385 | |
| Net cash used in financing activities | | | (96,561 | ) | | | (54,360 | ) | | | (918,686 | ) |
| Increase (decrease) in cash and cash equivalents | | | (33,876 | ) | | | (111,897 | ) | | | 5,174 | |
| Cash and cash equivalents at beginning of year | | | 120,935 | | | | 232,832 | | | | 227,658 | |
| Cash and cash equivalents at end of year | | $ | 87,059 | | | $ | 120,935 | | | $ | 232,832 | |
| | | | | | | | | | | | | |
| Supplemental information: | | | | | | | | | | | | |
| Cash received (paid) in period for: | | | | | | | | | | | | |
| Interest on deposits and borrowings | | $ | (21,915 | ) | | $ | (28,434 | ) | | $ | (68,070 | ) |
| Income taxes | | | (173 | ) | | | 23,412 | | | | (5,062 | ) |
| Non-cash transactions: | | | | | | | | | | | | |
| Loans transferred to foreclosed properties and repossessed assets | | | 13,054 | | | | 49,465 | | | | 22,407 | |
Refer to Notes to Consolidated Financial Statements
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
1. Summary of Significant Accounting Policies
BusinessBank Mutual Corporation (the “Company”), a Wisconsin corporation, is a federally-registered unitary savings and loan holding company which holds all of the outstanding shares of Bank Mutual, a federal savings bank (the “Bank”).
The Bank is a federal savings bank offering a full range of financial services to customers who are primarily located in the state of Wisconsin. The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits to originate residential and commercial real estate loans, consumer loans, and commercial and industrial loans.
Principles of ConsolidationThe consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The consolidated financial statements include the accounts and transactions of the Company and its wholly-owned subsidiaries. The Bank has the following wholly-owned subsidiaries: BancMutual Financial & Investment Services, Inc., Mutual Investment Corporation, First Northern Investments, Inc., and MC Development Ltd. MC Development Ltd. owns a 50% interest in Arrowood Development LLC, which is a variable interest entity and is consolidated into the financial statements. All intercompany accounts and transactions have been eliminated in consolidation.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the period. Actual results could differ from those estimates.
Cash and Cash EquivalentsThe Company considers interest-bearing deposits in banks and federal funds sold that have original maturities of three months or less to be cash equivalents. Under Regulation D, the Bank is required to maintain cash and reserve balances with the Federal Reserve Bank of Chicago. The average amount of required reserve balances for each of the years ended December 31, 2012 and 2011, was approximately $25.
Federal Home Loan Bank StockStock of the Federal Home Loan Bank of Chicago (“FHLB of Chicago”) is owned due to membership requirements and is carried at cost, which is its redemption value, and is included in other assets. FHLB stock is periodically reviewed for impairment based on management’s assessment of the ultimate recoverability of the investment rather than temporary declines in its estimated fair value.
Securities Available-for-Sale and Held-to-MaturityAvailable-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of accumulated other comprehensive income (loss) in shareholders’ equity. Held-to-maturity securities are stated at amortized cost.
The amortized cost of securities classified as available-for-sale or held-to-maturity is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-related securities, over the estimated life of the securities. Such accretion or amortization is included in interest income from investments. Interest and dividends are included in interest income from investments. Realized gains and losses and declines in value judged to be other-than-temporary are included in net gain or loss on sales of securities and are based on the specific identification method.
Impairment of available-for-sale and held-to-maturity securities is evaluated considering numerous factors, and their relative significance varies case-by-case. Factors considered include the length of time and extent to which the market value has been less than cost; the financial condition and near-term prospects of the issuer of a security; and the Company’s intent and/or likely need to sell the security before its anticipated recovery in fair value. Further, if the Company does not expect to recover the entire amortized cost of the security (i.e., a credit loss is expected), the Company will be unable to assert that it will recover its cost basis even if it does not intend to sell the security. If, based upon an analysis of each of these factors, it is determined that the impairment is other-than-temporary, the carrying value of the security is written down through earnings by the amount of the expected credit loss.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
1. Summary of Significant Accounting Policies (continued)
Loans Receivable and Loans Held-for-SaleLoans receivable are recorded at cost, net of undisbursed loan proceeds, allowance for loan losses, unamortized deferred fees and costs, and unamortized purchase premiums or discounts, if any. Loan origination and commitment fees and certain direct loan origination costs are deferred and amortized as an adjustment of loan yield. Purchase premiums and discounts are also amortized as an adjustment of yield.
Loans held-for-sale, which generally consists of recently originated fixed-rate residential mortgage loans, are recorded at market value determined on an individual loan basis. Fees received from the borrower are deferred and recorded as an adjustment of the carrying value.
Accrued Interest on LoansInterest on loans receivable is accrued and credited to income as earned. The Company measures the past due status of a loan by the number of days that have elapsed since the borrower has failed to make a contractual loan payment. Accrual of interest is generally discontinued when either (i) reasonable doubt exists as to the full, timely collection of interest or principal or (ii) when a loan becomes past due by more than 90 days. At that time, the loan is considered impaired and any accrued but uncollected interest is reversed. Additional interest income is recorded only to the extent that payments are received, collection of the principal is reasonably assured, and/or the net recorded investment in the loan is deemed to be collectible. Loans are generally restored to accrual status when the obligation is brought to a current status by the borrower.
Allowance for Loan Losses and Impaired LoansThe Company classifies its loan portfolio into six segments for purposes of determining its allowance for loan losses: one- to four-family, multi-family, commercial real estate, construction and development, consumer, and commercial business loans. This segmentation is based on the nature of the loan collateral and the purpose of the loan, which in the judgment of management are the primary risk characteristics that determine the allowance for loan loss. Loans in the one- to four-family, multi-family, and commercial real estate segments are secured principally by real estate. Loans in the consumer segment may be secured by real estate (such as of home equity loans and lines of credit), by personal property (such as automobiles), or may be unsecured. Loans in the commercial business segment are typically secured by equipment, inventory, receivables, other business assets, and in some instances, business and personal real estate, or may be unsecured. The commercial real estate segment consists of non-residential loans secured by office, retail/wholesale, industrial/warehouse, and other properties. The construction and development segment consists of loans secured by one- to four-family, multi-family, commercial real estate, and developed and undeveloped land.
The allowance for loan losses for each segment is maintained at a level believed adequate by management to absorb probable losses inherent in each segment and is based on factors such as the size and current risk characteristics of the segments, an assessment of individual problem loans and pools of homogenous loans within the segments, and actual loss, delinquency, and/or risk rating experience within the segments. The Company also considers current economic conditions and/or events in specific industries and geographical areas, including unemployment levels, trends in real estate values, peer comparisons, and other pertinent factors, to include regulatory guidance. Finally, as appropriate, the Company also considers individual borrower circumstances and the condition and fair value of the loan collateral, if any.
The allowance for loan losses for each segment is determined using a combined approach. Individual loans in the segments that have been identified as impaired are analyzed individually to determine an appropriate allowance for loan loss. In addition, the allowance for loan losses for each segment is augmented using a homogenous pool approach for loans in each segment that are current and/or have not been individually identified as impaired loans. The homogenous approach utilizes loss rates that are developed by management using the qualitative factors and other considerations outlined in the previous paragraph.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
1. Summary of Significant Accounting Policies (continued)
Loans are considered impaired when they are identified as such by the Company’s internal risk rating and loss evaluation process or when contractually past due 90 days or more with respect to interest or principal. Factors that indicate impairment include, but are not limited to, deterioration in a borrower’s financial condition, performance, or outlook, decline in the condition, performance, or fair value of the collateral for the loan (if any), payment or other default on the loan, and adverse economic or market developments in the borrower’s region or business segment. Accrual of interest is typically discontinued on impaired loans, although from time-to-time the Company may continue to accrue interest and/or recognize interest income on impaired loans when payments are being received and, in the judgment of management, collection of the principal is reasonably assured and/or the net recorded investment in the loan is deemed to be collectible.
The Company has various policies and procedures in place to monitor its exposure to credit risk including, but not limited to, a formal risk rating process, periodic loan delinquency reporting, periodic loan file reviews, financial updates from and visits to borrowers, and established past-due loan collection procedures. The Company formally evaluates its allowance for loan losses on a quarterly basis or more often as deemed necessary. A provision for loan loss is charged to operations based on this periodic evaluation. Actual loan losses are charged off against the allowance for loan losses, while recoveries of amounts previously charged off are credited to the allowance.
Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on loans, the fair value of underlying collateral (if any), estimated losses on pools of homogeneous loans based on historical loss experience, changes in risk characteristics of the loan portfolio, and consideration of current economic trends, all of which may be susceptible to significant change.
Mortgage Servicing RightsMortgage servicing rights are recorded as an asset when loans are sold with servicing rights retained. The total cost of loans sold is allocated between the loan balance and their servicing asset based on their relative fair values. 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.
Mortgage Banking Loan CommitmentsIn connection with its mortgage banking activities, the Company enters into loan commitments to fund residential mortgage loans at specified interest rates and within specified periods of time, generally up to 60 days from the time of rate lock. A loan commitment whose loan arising from exercise of the loan commitment will be held for sale upon funding is a derivative instrument, which must be recognized at fair value on the consolidated balance sheet in other assets and other liabilities with changes in its value recorded in income from mortgage banking operations.
In determining the fair value of its derivative loan commitments for economic purposes, the Company considers the value that would be generated when the loan arising from exercise of the loan commitment is sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondary mortgage market.
Foreclosed Properties and Repossessed AssetsForeclosed properties acquired through, or in lieu of, loan foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. Costs related to the development and improvement of property are capitalized provided such costs do not result in a carrying value in excess of the property’s fair value less estimated costs to sell, in which case such costs are expensed.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
1. Summary of Significant Accounting Policies (continued)
Costs related to holding the property are expensed. Gains and losses on sales are recognized based on the carrying value upon closing of the sale.
Premises and EquipmentLand, buildings, leasehold improvements and equipment are carried at amortized cost. Buildings and equipment are depreciated over their estimated useful lives (office buildings 40 to 44 years and furniture and equipment 3 to 10 years) using the straight-line method. Leasehold improvements are amortized over the shorter of their useful lives or expected lease terms. The Company reviews buildings, leasehold improvements and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment exists when the estimated undiscounted cash flows for the property are less than its carrying value. If identified, an impairment loss is recognized through a charge to earnings based on the fair value of the property.
GoodwillIn 2011 the Company determined that goodwill recorded as a result of the purchase of financial institutions in 1997 and 2000 was impaired. The Company performed an interim goodwill impairment test during that period as a result of a number of developments including the decline in the Company’s stock price and market capitalization and the announcement that the Company and Bank had each entered into a separate MOU with their primary regulators (these MOUs were terminated in 2013). To determine the fair value of goodwill, as well as the amount of the impairment, the Company obtained a third-party independent appraisal of the Company, which consists of a single reporting unit, and its assets and liabilities. The fair value of the Company was estimated using a weighted average of three valuation methodologies, including a public market peers approach, a comparable transactions approach, and a discounted cash flow approach. A comparison of the weighted average value from these approaches to the net carrying value of the Company indicated that potential impairment existed. The weighted average value of the Company was subsequently compared to the estimated net fair value of the Company’s individual assets and liabilities. As a result of this comparison, the Company concluded that goodwill was impaired and recorded an impairment charge of $52,570 in 2011, which represented the total amount of the Company’s goodwill. The goodwill impairment was not deductible for income tax purposes.
Life Insurance PoliciesInvestments in life insurance policies owned by the Company are carried at the amount that could be realized under the insurance contract if the Company cashed them in on the respective dates.
Income TaxesThe Company files consolidated federal and combined state income tax returns. A deferred tax asset or liability is determined based on the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date of the change. A valuation allowance is provided for any deferred tax asset for which it is more likely than not that the asset will not be realized. Changes in valuation allowances are recorded as a component of income taxes.
Earnings (Loss) Per ShareBasic and diluted earnings (loss) per share (“EPS”) are computed by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. ESOP shares committed to be released are considered outstanding for basic EPS calculations. Vested shares of restricted stock which have been awarded under the management recognition plan (“MRP”) provisions of the Company's 2004 Stock Incentive Plan are also considered outstanding for basic EPS. Non-vested MRP and stock option shares are considered dilutive potential common shares and are included in the weighted-average number of shares outstanding for diluted EPS.
Pension CostsThe Company has both defined benefit and defined contribution plans. The Company’s net periodic pension cost of the defined benefit plans consist of the expected cost of benefits earned by employees during the current period and an interest cost on the projected benefit obligation, reduced by the expected earnings on assetsheld by the plans, amortization of prior service cost, and amortization of recognized actuarial gains and losses over the estimated future service period of existing plan participants. The costs associated with the defined contribution plan consist of a predetermined percentage of compensation, which is determined by the Company’s board of directors.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
1. Summary of Significant Accounting Policies (continued)
Segment InformationThe Company has determinedthat it has one reportable segment—community banking. The Company offers a range of financial products and services to external customers, including: accepting deposits from the general public; originating residential, consumer and commercial loans; and marketing annuities and other insurance products.
Recent Accounting ChangesIn July 2010 the FASB issued new accounting guidance related to certain disclosures about the credit quality of financing receivables, allowances for credit losses, and troubled debt restructurings. Certain aspects of the new guidance were effective for reporting periods ending after December 15, 2010, which for the Company was the fourth quarter of 2010. Certain other aspects of the new guidance, as subsequently amended, were not effective until the accounting periods beginning after June 15, 2011, which for the Company was the third quarter of 2011. The Company's adoption of this new guidance had no impact on its financial condition, results of operations or liquidity, although it does affect matters that are disclosed in the financial statements related to the Company’s loans receivable.
In December 2010 the FASB issued new accounting guidance clarifying the presentation of pro forma information required for business combinations when a public company presents comparative financial information. The amendments in this guidance were effective prospectively for business combinations for which the acquisition date was on or after the first annual reporting period beginning on or after December 15, 2010, which for the Company was the first quarter of 2011. This newaccounting guidance did not have an impact on the Company’s financial condition, results of operations, or liquidity, but it may impact future financial disclosures if the Company were to engage in a future business combination.
During the second quarter of 2011 the FASB issued new accounting guidelines related to (i) accounting for repurchase agreements, (ii) certain fair value measurements of assets, liability, and instruments classified in shareholders’ equity, and (iii) presentation of net income, other comprehensive income, and total comprehensive income (certain aspects the adoption of which were deferred indefinitely in the fourth quarter of 2011). These new guidelines were effective for the first interim period beginning on or after December 15, 2011, which was the first quarter of 2012 for the Company. The Company's adoption of these guidelines did not have a material impact on its financial condition, results of operations, or liquidity. However, the guidelines do affect how matters are disclosed in the financial statements.
During the fourth quarter of 2011 the FASB issued new accounting guidelines related to (i) the determination of whether a parent should derecognize the in-substance real estate of a subsidiary that is in-substance real estate when the parent ceases to have a controlling financial interest in the subsidiary and (ii) the disclosure of both gross information and net information about instruments eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting agreement. Item (i) was effective for the Company in the third quarter of 2012. The adoption of this item did not have a material impact on its financial condition, results of operation, or liquidity. Item (ii) will be effective for interim and fiscal periods beginning on or after January 1, 2013, which for the Company will be the first quarter of 2013. The Company's adoption of item (ii) is not expected to have a material impact on its financial condition, results of operations, or liquidity. However, the new guidelines may affect matters that will be disclosed in the financial statements.
During the third quarter of 2012 the FASB issued new accounting guidance related to testing indefinite-lived intangible assets for impairment. This new guidance is effective for years beginning after September 15, 2012, which will be the first quarter of 2013 for the Company. The Company’s adoption of this new guidance is not expected to have a material impact in its financial condition, results of operations, or liquidity.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
1. Summary of Significant Accounting Policies (continued)
During the fourth quarter of 2012 the FASB issued new accounting guidance related to subsequent measurement of an indemnification asset recognized in a government-assisted acquisition of a financial institution. This new guidance is effective for fiscal years beginning on or after December 15, 2012, which is the first quarter of 2013 for the Company. The Company has not engaged in these types of transactions. As such, the Company’s adoption of this new guidance in not expected to have a material impact in its financial condition, results of operations, or liquidity.
2. Mortgage-Related Securities Available-for-Sale and Held-to-Maturity
The amortized cost and fair value of mortgage-related securities available-for-sale and held-to-maturity are as follows:
| | | December 31, 2012 | |
| | | | | | Gross | | | Gross | | | Estimated | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| Securities available-for-sale: | | | | | | | | | | | | | | | | |
| Federal Home Loan Mortgage Corporation | | $ | 336,289 | | | $ | 7,393 | | | | – | | | $ | 343,682 | |
| Federal National Mortgage Association | | | 153,010 | | | | 2,885 | | | | – | | | | 155,895 | |
| Government National Mortgage Association | | | 36 | | | | 6 | | | | – | | | | 42 | |
| Private-label CMOs | | | 50,196 | | | | 1,108 | | | $ | (738 | ) | | | 50,566 | |
| Total available-for-sale | | $ | 539,531 | | | $ | 11,392 | | | $ | (738 | ) | | $ | 550,185 | |
| Securities held-to-maturity: | | | | | | | | | | | | | | | | |
| Federal National Mortgage Association | | $ | 157,558 | | | $ | 6,031 | | | | – | | | $ | 163,589 | |
| Total held-to-maturity | | $ | 157,558 | | | $ | 6,031 | | | | – | | | $ | 163,589 | |
| | | December 31, 2011 | |
| | | | | | Gross | | | Gross | | | Estimated | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| Securities available-for-sale: | | | | | | | | | | | | | | | | |
| Federal Home Loan Mortgage Corporation | | $ | 537,935 | | | $ | 11,009 | | | | – | | | $ | 548,944 | |
| Federal National Mortgage Association | | | 167,601 | | | | 2,476 | | | $ | (57 | ) | | | 170,020 | |
| Government National Mortgage Association | | | 767 | | | | 10 | | | | – | | | | 777 | |
| Private-label CMOs | | | 67,754 | | | | 540 | | | | (6,265 | ) | | | 62,029 | |
| Total available-for-sale | | $ | 774,057 | | | $ | 14,035 | | | $ | (6,322 | ) | | $ | 781,770 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
2. Mortgage-Related Securities Available-for-Sale and Held-to-Maturity (continued)
The following tables identify mortgage-related securities by amount of time the securities have had a gross unrealized loss as of the dates indicated:
| | | December 31, 2012 | |
| | | Less Than 12 Months | | | Greater Than 12 Months | | | | | | | |
| | | in an Unrealized Loss Position | | | in an Unrealized Loss Position | | | Gross | | | Total | |
| | | Unrealized | | | Number | | | Estimated | | | Unrealized | | | Number | | | Estimated | | | Unrealized | | | Estimated | |
| | | Loss | | | of | | | Fair | | | Loss | | | of | | | Fair | | | Loss | | | Fair | |
| | | Amount | | | Securities | | | Value | | | Amount | | | Securities | | | Value | | | Amount | | | Value | |
| Securities available-for-sale: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Private-label CMOs | | $ | 500 | | | | 4 | | | $ | 9,703 | | | $ | 238 | | | | 5 | | | $ | 7,578 | | | $ | 738 | | | $ | 17,281 | |
| Total mortgage-related securities | | $ | 500 | | | | 4 | | | $ | 9,703 | | | $ | 238 | | | | 5 | | | $ | 7,578 | | | $ | 738 | | | $ | 17,281 | |
| | | December 31, 2011 | |
| | | Less Than 12 Months | | | Greater Than 12 Months | | | | | | | |
| | | in an Unrealized Loss Position | | | in an Unrealized Loss Position | | | Gross | | | Total | |
| | | Unrealized | | | Number | | | Estimated | | | Unrealized | | | Number | | | Estimated | | | Unrealized | | | Estimated | |
| | | Loss | | | of | | | Fair | | | Loss | | | of | | | Fair | | | Loss | | | Fair | |
| | | Amount | | | Securities | | | Value | | | Amount | | | Securities | | | Value | | | Amount | | | Value | |
| Securities available-for-sale: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal National Mortgage Association | | $ | 57 | | | | 1 | | | $ | 9,603 | | | | – | | | | – | | | | – | | | $ | 57 | | | $ | 9,603 | |
| Private-label CMOs | | | 1 | | | | 1 | | | | 448 | | | $ | 6,264 | | | | 20 | | | $ | 40,523 | | | | 6,265 | | | | 40,971 | |
| Total mortgage-related securities | | $ | 58 | | | | 2 | | | $ | 10,051 | | | $ | 6,264 | | | | 20 | | | $ | 40,523 | | | $ | 6,322 | | | $ | 50,574 | |
Certain of the Company’s available-for-sale securities that were in an unrealized loss position at December 31, 2011, consisted of mortgage-related securities issued by government-sponsored entities. As of those dates, the Company believed that it was probable that it would receive all future contractual cash flows related to such securities. The Company does not intend to sell the securities and it is unlikely that it would be required to sell the securities before the recovery of their amortized cost. Accordingly, the Company determined that the unrealized loss on mortgage-related securities issued by government-sponsored entities was temporary as of December 31, 2011.
Except as noted below, the Company also determined that the unrealized loss on its private-label CMOs was temporary as of December 31, 2012 and 2011. The Company does not intend to sell these securities and it is unlikely that it will be required to sell these securities before the recovery of their amortized cost. The Company believes it is probable that it will receive all future contractual cash flows related to these securities. This determination was based on management’s judgment regarding the nature of the loan collateral that supports the securities, a review of the current ratings issued on the securities by various credit rating agencies, a review of the actual delinquency and/or default performance of the loan collateral that supports the securities, and recent trends in the fair market values of the securities.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
2. Mortgage-Related Securities Available-for-Sale and Held-to-Maturity (continued)
As of December 31, 2012 and 2011, the Company had private-label CMOs with a fair value of $35,918 and $36,751 respectively, and unrealized losses of $33 and $5,357, respectively, that were rated less than investment grade. These private-label CMOs were analyzed using modeling techniques that considered the priority of cash flows in the CMO structure and various default and loss rate scenarios that management considered appropriate given the nature of the loan collateral. In 2012 and 2011 the Company recognized $400 and $389, respectively, in net OTTI losses related to its investment on a number of private-label CMOs. The determination of these net OTTI losses was based on modeling techniques that considered the priority of cash flows in the CMO structure and various default and loss rate scenarios that management considered appropriate given the nature of the loan collateral. The following assumptions were used in determining the amount of the credit loss in 2012: (i) prepayment speeds with a range of 5.5% to 16.5% and a weighted average rate of 9.9%, (ii) default rates with a range of 4.0% to 5.5% and a weighted average rate of 4.4%, (iii) loss severity rates with a range of 40.0% to 52.0% and a weighted average rate of 42.1%, and (iv) current credit enhancements with a range of 0.5% to 4.6% and a weighted average rate of 3.0%. The following assumptions were used in determining the amount of the credit loss in 2011: (i) prepayment speeds with a range of 6.1% to 14.9% and a weighted average rate of 11.6%, (ii) default rates with a range of 3.7% to 5.2% and a weighted average rate of 4.4%, (iii) loss severity rates with a range of 40.0% to 43.0% and a weighted average rate of 40.8%, and (iv) current credit enhancements with a range of 5.1% to 6.7% and a weighted average rate of 5.6%.
The following table contains a summary of OTTI related to credit losses that have been recognized in earnings as of the dates indicated, as well as the end of period values for securities that have experienced such losses:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Beginning balance of unrealized OTTI related to credit losses | | $ | 389 | | | | – | | | | – | |
| Additional unrealized OTTI related to credit losses for which OTTI was not previously recognized | | | 146 | | | $ | 389 | | | | – | |
| Additional unrealized OTTI related to credit losses for which OTTI was previously recognized | | | 254 | | | | – | | | | – | |
| Net OTTI losses recognized in earnings | | | 400 | | | | 389 | | | | – | |
| Ending balance of unrealized OTTI related to credit losses | | $ | 789 | | | $ | 389 | | | | – | |
| Adjusted cost at end of period | | $ | 9,541 | | | $ | 8,275 | | | | – | |
| Estimated fair value at end of period | | $ | 9,908 | | | $ | 6,871 | | | | – | |
Results of operations included gross realized gains on the sale of securities available-for-sale of $543, $1,113, and $16,041, 2012, 2011, and 2010, respectively. Gross realized losses on the sale of securities available-for-sale was zero for and 2012 and 2011, and $75 for 2010.
Mortgage-related securities with a fair value of approximately $80,274 and $91,731 at December 31, 2012 and 2011, respectively, were pledged to secure deposits, FHLB advances, and for other purposes as permitted or required by law.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable
| Loans receivable is summarized as follows: | | December 31 | |
| | | 2012 | | | 2011 | |
| Permanent mortgage loans: | | | | | | | | |
| One- to four-family | | $ | 465,170 | | | $ | 508,503 | |
| Multi-family | | | 264,013 | | | | 247,040 | |
| Commercial real estate | | | 263,775 | | | | 226,195 | |
| Total permanent mortgages | | | 992,958 | | | | 981,738 | |
| Construction and development loans: | | | | | | | | |
| One- to four-family | | | 18,502 | | | | 16,263 | |
| Multi-family | | | 86,904 | | | | 29,409 | |
| Commercial real estate | | | 11,116 | | | | 19,907 | |
| Land | | | 12,826 | | | | 16,429 | |
| Total construction and development | | | 129,348 | | | | 82,008 | |
| Total mortgage loans | | | 1,122,306 | | | | 1,063,746 | |
| Consumer loans: | | | | | | | | |
| Fixed term home equity | | | 116,988 | | | | 102,561 | |
| Home equity lines of credit | | | 81,898 | | | | 86,540 | |
| Student | | | 12,915 | | | | 15,711 | |
| Home improvement | | | 24,910 | | | | 24,237 | |
| Automobile | | | 1,814 | | | | 2,228 | |
| Other | | | 8,388 | | | | 7,177 | |
| Total consumer loans | | | 246,913 | | | | 238,454 | |
| Commercial business loans | | | 132,436 | | | | 87,715 | |
| Gross loans receivable | | | 1,501,655 | | | | 1,389,915 | |
| Undisbursed loan proceeds | | | (76,703 | ) | | | (41,859 | ) |
| Allowance for loan losses | | | (21,577 | ) | | | (27,928 | ) |
| Deferred fees and costs, net | | | (1,129 | ) | | | (492 | ) |
| Total loans receivable, net | | $ | 1,402,246 | | | $ | 1,319,636 | |
The Company’s first mortgage loans and home equity lines of credit are primarily secured by properties that are located in the Company’s local lending areas in Wisconsin, Illinois, Michigan, and Minnesota.
At December 31, 2012 and 2011, certain one- to four-family mortgage loans, multi-family mortgage loans, and home equity loans with aggregate carrying values of approximately $281,000 and $204,000, respectively, were pledged to secure FHLB advances.
The unpaid principal balance of loans serviced for others was $1,147,722 and $1,102,126 at December 31, 2012 and 2011, respectively. These loans are not reflected in the consolidated financial statements.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
The following tables summarize the allowance for loan losses by loan portfolio segment during the periods indicated. The tables also summarize the allowance for loan loss and loans receivable as of the dates indicated by the nature of the impairment evaluation, either individually or collectively (the loans receivable amounts in the table are net of undisbursed loan proceeds).
| | | December 31, 2012 | |
| | | One- to
Four-
Family | | | Multi-
Family | | | Commercial
Real Estate | | | Construction
and
Development | | | Consumer | | | Commercial
Business | | | Total | |
| Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 3,201 | | | $ | 7,442 | | | $ | 9,467 | | | $ | 4,506 | | | $ | 1,214 | | | $ | 2,098 | | | $ | 27,928 | |
| Provision | | | 3,162 | | | | (1,958 | ) | | | 1,825 | | | | 803 | | | | 1,015 | | | | (302 | ) | | | 4,545 | |
| Charge-offs | | | (3,182 | ) | | | (857 | ) | | | (4,894 | ) | | | (2,693 | ) | | | (812 | ) | | | (136 | ) | | | (12,574 | ) |
| Recoveries | | | 86 | | | | 568 | | | | 956 | | | | 1 | | | | 41 | | | | 26 | | | | 1,678 | |
| Ending balance | | $ | 3,267 | | | $ | 5,195 | | | $ | 7,354 | | | $ | 2,617 | | | $ | 1,458 | | | $ | 1,686 | | | $ | 21,577 | |
| Loss allowance individually evaluated for impairment | | $ | 191 | | | $ | 914 | | | $ | 123 | | | $ | 295 | | | $ | 456 | | | $ | 62 | | | $ | 2,041 | |
| Loss allowance collectively evaluated for impairment | | $ | 3,076 | | | $ | 4,281 | | | $ | 7,231 | | | $ | 2,322 | | | $ | 1,002 | | | $ | 1,624 | | | $ | 19,536 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loan receivable balances at December 31, 2012: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans individually evaluated for impairment | | $ | 8,344 | | | $ | 6,967 | | | $ | 24,130 | | | $ | 14,825 | | | $ | 1,631 | | | $ | 1,741 | | | $ | 57,638 | |
| Loans collectively evaluated for impairment | | | 451,154 | | | | 257,046 | | | | 239,645 | | | | 43,492 | | | | 245,282 | | | | 130,695 | | | | 1,367,314 | |
| Total loans receivable | | $ | 459,498 | | | $ | 264,013 | | | $ | 263,775 | | | $ | 58,317 | | | $ | 246,913 | | | $ | 132,436 | | | $ | 1,424,952 | |
| | | December 31, 2011 | |
| | | One- to
Four-
Family | | | Multi-
Family | | | Commercial
Real Estate | | | Construction
and
Development | | | Consumer | | | Commercial
Business | | | Total | |
| Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 3,726 | | | $ | 9,265 | | | $ | 21,885 | | | $ | 10,141 | | | $ | 1,427 | | | $ | 1,541 | | | $ | 47,985 | |
| Provision | | | 2,473 | | | | 199 | | | | 802 | | | | 1,343 | | | | 803 | | | | 1,090 | | | | 6,710 | |
| Charge-offs | | | (3,047 | ) | | | (5,035 | ) | | | (15,286 | ) | | | (2,737 | ) | | | (1,036 | ) | | | (551 | ) | | | (27,692 | ) |
| Recoveries | | | 49 | | | | 248 | | | | 40 | | | | 550 | | | | 20 | | | | 18 | | | | 925 | |
| Transfers | | | – | | | | 2,765 | | | | 2,026 | | | | (4,791 | ) | | | – | | | | – | | | | – | |
| Ending balance | | $ | 3,201 | | | $ | 7,442 | | | $ | 9,467 | | | $ | 4,506 | | | $ | 1,214 | | | $ | 2,098 | | | $ | 27,928 | |
| Loss allowance individually evaluated for impairment | | $ | 364 | | | $ | 2,357 | | | $ | 1,884 | | | $ | 3,196 | | | $ | 376 | | | $ | 128 | | | $ | 8,305 | |
| Loss allowance collectively evaluated for impairment | | $ | 2,837 | | | $ | 5,085 | | | $ | 7,583 | | | $ | 1,310 | | | $ | 838 | | | $ | 1,970 | | | $ | 19,623 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loan receivable balances at December 31, 2011: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans individually evaluated for impairment | | $ | 16,075 | | | $ | 24,108 | | | $ | 37,006 | | | $ | 20,075 | | | $ | 1,695 | | | $ | 4,668 | | | $ | 103,627 | |
| Loans collectively evaluated for impairment | | | 486,456 | | | | 222,711 | | | | 187,230 | | | | 28,226 | | | | 236,759 | | | | 83,047 | | | | 1,244,429 | |
| Total loans receivable | | $ | 502,531 | | | $ | 246,819 | | | $ | 224,236 | | | $ | 48,301 | | | $ | 238,454 | | | $ | 87,715 | | | $ | 1,348,056 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
| | | December 31, 2010 | |
| | | One- to
Four-
Family | | | Multi-
Family | | | Commercial
Real Estate | | | Construction
and
Development | | | Consumer | | | Commercial
Business | | | Total | |
| Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 2,806 | | | $ | 3,167 | | | $ | 5,715 | | | $ | 1,172 | | | $ | 2,243 | | | $ | 1,925 | | | $ | 17,028 | |
| Provision | | | 1,428 | | | | 6,238 | | | | 27,790 | | | | 12,484 | | | | (77 | ) | | | 1,756 | | | | 49,619 | |
| Charge-offs | | | (528 | ) | | | (140 | ) | | | (11,621 | ) | | | (3,515 | ) | | | (776 | ) | | | (2,140 | ) | | | (18,720 | ) |
| Recoveries | | | 20 | | | | – | | | | 1 | | | | – | | | | 37 | | | | – | | | | 58 | |
| Ending balance | | $ | 3,726 | | | $ | 9,265 | | | $ | 21,885 | | | $ | 10,141 | | | $ | 1,427 | | | $ | 1,541 | | | $ | 47,985 | |
| Loss allowance individually evaluated for impairment | | $ | 1,122 | | | $ | 7,134 | | | $ | 12,853 | | | $ | 9,384 | | | $ | 641 | | | $ | 437 | | | $ | 31,571 | |
| Loss allowance collectively evaluated for impairment | | $ | 2,604 | | | $ | 2,131 | | | $ | 9,032 | | | $ | 757 | | | $ | 786 | | | $ | 1,104 | | | $ | 16,414 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loan receivable balances at December 31, 2010: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans individually evaluated for impairment | | $ | 18,972 | | | $ | 40,675 | | | $ | 55,849 | | | $ | 27,607 | | | $ | 1,763 | | | $ | 4,799 | | | $ | 149,665 | |
| Loans collectively evaluated for impairment | | | 505,100 | | | | 206,034 | | | | 189,536 | | | | 34,442 | | | | 241,673 | | | | 45,653 | | | | 1,222,438 | |
| Total loans receivable | | $ | 524,072 | | | $ | 246,709 | | | $ | 245,385 | | | $ | 62,049 | | | $ | 243,336 | | | $ | 50,452 | | | $ | 1,372,103 | |
The Company adjusts certain factors used to determine the allowance for loan losses on loans that are collectively evaluated for impairment. Management considered these adjustments necessary and prudent in light of trends in real estate values, economic conditions, and unemployment. The Company estimates that these changes, as well as overall changes in the balance of loans to which the various factors were applied, resulted in a reduction of $87 in 2012 and an increase of $3,209 and $7,636 in 2011 and 2010, respectively, in the total allowance for loan losses. The transfers noted in 2011 were the result of reclassifying certain construction loans to permanent loans as a result of completed construction.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
The following tables present information regarding impaired loans that have a related allowance for loan loss and those that do not as of the dates indicated (the loans receivable amounts in the tables are net of undisbursed loan proceeds):
| | | December 31, 2012 | |
| | | Loans
Receivable
Balance, Net | | | Unpaid
Principal
Balance | | | Related
Allowance
for Loss | | | Average Loan
Receivable
Balance, Net | | | Interest
Income
Recognized | |
| Impaired loans with an allowance recorded: | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 797 | | | $ | 797 | | | $ | 191 | | | $ | 2,528 | | | | – | |
| Multi-family | | | 3,875 | | | | 4,038 | | | | 914 | | | | 12,701 | | | $ | 106 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
| Office | | | 132 | | | | 143 | | | | 74 | | | | 992 | | | | 1 | |
| Retail/wholesale/mixed | | | 516 | | | | 535 | | | | 49 | | | | 1,833 | | | | 19 | |
| Industrial/warehouse | | | – | | | | – | | | | – | | | | 379 | | | | – | |
| Other | | | – | | | | – | | | | – | | | | 240 | | | | – | |
| Total commercial real estate | | | 648 | | | | 678 | | | | 123 | | | | 3,444 | | | | 20 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | – | | | | – | | | | – | | | | 69 | | | | – | |
| Multi-family | | | – | | | | – | | | | – | | | | 1,117 | | | | – | |
| Commercial real estate | | | – | | | | – | | | | – | | | | 689 | | | | – | |
| Land | | | 500 | | | | 530 | | | | 295 | | | | 2,069 | | | | 3 | |
| Total construction and development | | | 500 | | | | 530 | | | | 295 | | | | 3,944 | | | | 3 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 424 | | | | 424 | | | | 397 | | | | 354 | | | | – | |
| Student | | | – | | | | – | | | | – | | | | – | | | | – | |
| Other | | | 59 | | | | 59 | | | | 59 | | | | 77 | | | | – | |
| Total consumer | | | 483 | | | | 483 | | | | 456 | | | | 431 | | | | – | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | 102 | | | | 108 | | | | 62 | | | | 207 | | | | 1 | |
| Lines of credit | | | – | | | | – | | | | – | | | | 37 | | | | – | |
| Total commercial business | | | 102 | | | | 108 | | | | 62 | | | | 244 | | | | 1 | |
| Total with an allowance recorded | | $ | 6,405 | | | $ | 6,634 | | | $ | 2,041 | | | $ | 23,292 | | | $ | 130 | |
| | | | | | | | | | | | | | | | | | | | | |
| Impaired loans with no allowance recorded: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 7,395 | | | $ | 8,897 | | | | – | | | $ | 9,426 | | | $ | 219 | |
| Multi-family | | | 2,949 | | | | 4,952 | | | | – | | | | 4,286 | | | | 478 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
| Office | | | 1,328 | | | | 2,005 | | | | – | | | | 3,163 | | | | 41 | |
| Retail/wholesale/mixed | | | 4,790 | | | | 8,861 | | | | – | | | | 6,704 | | | | 270 | |
| Industrial/warehouse | | | 228 | | | | 325 | | | | – | | | | 609 | | | | 16 | |
| Other | | | – | | | | 292 | | | | – | | | | 978 | | | | – | |
| Total commercial real estate | | | 6,346 | | | | 11,483 | | | | – | | | | 11,454 | | | | 327 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | – | | | | – | | | | – | | | | 19– | | | | – | |
| Multi-family | | | – | | | | 107 | | | | – | | | | 29 | | | | – | |
| Commercial real estate | | | – | | | | – | | | | – | | | | 685 | | | | – | |
| Land | | | 437 | | | | 1,936 | | | | – | | | | 1,019 | | | | 8 | |
| Total construction and development | | | 437 | | | | 2,043 | | | | – | | | | 1,752 | | | | 8 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 1,090 | | | | 1,090 | | | | – | | | | 1,041 | | | | 42 | |
| Student | | | – | | | | – | | | | – | | | | – | | | | – | |
| Other | | | – | | | | 13 | | | | – | | | | 87 | | | | 4 | |
| Total consumer | | | 1,090 | | | | 1,103 | | | | – | | | | 1,128 | | | | 46 | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | 533 | | | | 684 | | | | – | | | | 632 | | | | 29 | |
| Lines of credit | | | 58 | | | | 173 | | | | – | | | | 382 | | | | 4 | |
| Total commercial business | | | 591 | | | | 857 | | | | – | | | | 1,014 | | | | 33 | |
| Total with no allowance recorded | | $ | 18,808 | | | $ | 29,335 | | | | – | | | $ | 29,060 | | | $ | 1,111 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
| | | December 31, 2011 | |
| | | Loans
Receivable
Balance, Net | | | Unpaid
Principal
Balance | | | Related
Allowance
for Loss | | | Average Loan
Receivable
Balance, Net | | | Interest
Income
Recognized | |
| Impaired loans with an allowance recorded: | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 2,606 | | | $ | 2,606 | | | $ | 364 | | | $ | 3,916 | | | $ | 51 | |
| Multi-family | | | 19,006 | | | | 19,106 | | | | 2,357 | | | | 23,158 | | | | 851 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
| Office | | | 2,474 | | | | 2,474 | | | | 746 | | | | 7,917 | | | | 30 | |
| Retail/wholesale/mixed | | | 3,220 | | | | 3,225 | | | | 570 | | | | 16,931 | | | | 78 | |
| Industrial/warehouse | | | 1,250 | | | | 1,250 | | | | 250 | | | | 1,286 | | | | – | |
| Other | | | 959 | | | | 964 | | | | 318 | | | | 1,175 | | | | 67 | |
| Total commercial real estate | | | 7,903 | | | | 7,913 | | | | 1,884 | | | | 27,309 | | | | 175 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | – | | | | – | | | | – | | | | – | | | | – | |
| Multi-family | | | 4,466 | | | | 4,488 | | | | 678 | | | | 4,482 | | | | 248 | |
| Commercial real estate | | | 152 | | | | 153 | | | | 84 | | | | 1,908 | | | | 11 | |
| Land | | | 2,993 | | | | 2,995 | | | | 2,434 | | | | 2,944 | | | | 58 | |
| Total construction and development | | | 7,611 | | | | 7,636 | | | | 3,196 | | | | 9,334 | | | | 317 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 413 | | | | 413 | | | | 327 | | | | 446 | | | | – | |
| Student | | | – | | | | – | | | | – | | | | – | | | | – | |
| Other | | | 67 | | | | 67 | | | | 49 | | | | 126 | | | | – | |
| Total consumer | | | 480 | | | | 480 | | | | 376 | | | | 572 | | | | – | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | 164 | | | | 165 | | | | 83 | | | | 690 | | | | 15 | |
| Lines of credit | | | 117 | | | | 117 | | | | 45 | | | | 324 | | | | 5 | |
| Total commercial business | | | 281 | | | | 282 | | | | 128 | | | | 1,014 | | | | 20 | |
| Total with an allowance recorded | | $ | 37,887 | | | $ | 38,023 | | | $ | 8,305 | | | $ | 65,303 | | | $ | 1,414 | |
| | | | | | | | | | | | | | | | | | | | | |
| Impaired loans with no allowance recorded: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 12,262 | | | $ | 13,645 | | | | – | | | $ | 12,382 | | | $ | 264 | |
| Multi-family | | | 3,899 | | | | 4,413 | | | | – | | | | 7,117 | | | | 306 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
| Office | | | 6,580 | | | | 8,520 | | | | – | | | | 2,937 | | | | 375 | |
| Retail/wholesale/mixed | | | 8,716 | | | | 15,318 | | | | – | | | | 7,797 | | | | 712 | |
| Industrial/warehouse | | | 530 | | | | 754 | | | | – | | | | 1,146 | | | | 25 | |
| Other | | | 268 | | | | 1,044 | | | | – | | | | 673 | | | | 9 | |
| Total commercial real estate | | | 16,094 | | | | 25,636 | | | | – | | | | 12,553 | | | | 1,121 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | – | | | | – | | | | – | | | | – | | | | – | |
| Multi-family | | | – | | | | – | | | | – | | | | 20 | | | | – | |
| Commercial real estate | | | – | | | | – | | | | – | | | | 2,459 | | | | – | |
| Land | | | 1,757 | | | | 1,967 | | | | – | | | | 3,219 | | | | 28 | |
| Total construction and development | | | 1,757 | | | | 1,967 | | | | – | | | | 5,698 | | | | 28 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 1,044 | | | | 1,044 | | | | – | | | | 962 | | | | 43 | |
| Student | | | – | | | | – | | | | – | | | | – | | | | – | |
| Other | | | 140 | | | | 140 | | | | – | | | | 110 | | | | 4 | |
| Total consumer | | | 1,184 | | | | 1,184 | | | | – | | | | 1,072 | | | | 47 | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | 787 | | | | 896 | | | | – | | | | 825 | | | | 44 | |
| Lines of credit | | | 574 | | | | 699 | | | | – | | | | 268 | | | | 40 | |
| Total commercial business | | | 1,361 | | | | 1,595 | | | | – | | | | 1,094 | | | | 84 | |
| Total with no allowance recorded | | $ | 36,557 | | | $ | 48,440 | | | | – | | | $ | 39,915 | | | $ | 1,850 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
The following tables present information relating to the Company’s internal risk ratings of its loans receivable as of the dates indicated (all amounts in the tables are net of undisbursed loan proceeds):
| | | December 31, 2012 | |
| | | Pass | | | Watch | | | Special
Mention | | | Substandard | | | Total | |
| One- to four-family | | $ | 450,078 | | | $ | 948 | | | $ | 128 | | | $ | 8,344 | | | $ | 459,498 | |
| Multi-family | | | 218,918 | | | | 36,126 | | | | 2,002 | | | | 6,967 | | | | 264,013 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
| Office | | | 44,678 | | | | 10,938 | | | | 15,471 | | | | 5,605 | | | | 76,692 | |
| Retail/wholesale/mixed use | | | 90,668 | | | | 11,102 | | | | 15,949 | | | | 14,657 | | | | 132,376 | |
| Industrial/warehouse | | | 39,758 | | | | 5,031 | | | | 1,292 | | | | 1,266 | | | | 47,347 | |
| Other | | | 4,758 | | | | – | | | | – | | | | 2,602 | | | | 7,360 | |
| Total commercial real estate | | | 179,862 | | | | 27,071 | | | | 32,712 | | | | 24,130 | | | | 263,775 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | 10,259 | | | | – | | | | – | | | | – | | | | 10,259 | |
| Multi-family | | | 14,656 | | | | – | | | | – | | | | 12,621 | | | | 27,277 | |
| Commercial real estate | | | 7,425 | | | | – | | | | 621 | | | | – | | | | 8,046 | |
| Land | | | 10,392 | | | | 139 | | | | – | | | | 2,204 | | | | 12,735 | |
| Total construction/development | | | 42,732 | | | | 139 | | | | 621 | | | | 14,825 | | | | 58,317 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 222,282 | | | | – | | | | – | | | | 1,514 | | | | 223,796 | |
| Student | | | 12,915 | | | | – | | | | – | | | | – | | | | 12,915 | |
| Other | | | 10,085 | | | | – | | | | – | | | | 117 | | | | 10,202 | |
| Total consumer | | | 245,282 | | | | – | | | | – | | | | 1,631 | | | | 246,913 | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | 67,879 | | | | 1,651 | | | | 280 | | | | 943 | | | | 70,753 | |
| Lines of credit | | | 56,127 | | | | 2,772 | | | | 1,986 | | | | 798 | | | | 61,683 | |
| Total commercial business | | | 124,006 | | | | 4,423 | | | | 2,266 | | | | 1,741 | | | | 132,436 | |
| Total | | $ | 1,260,878 | | | $ | 68,707 | | | $ | 37,729 | | | $ | 57,638 | | | $ | 1,424,952 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
| | | December 31, 2011 | |
| | | Pass | | | Watch | | | Special
Mention | | | Substandard | | | Total | |
| One- to four-family | | $ | 482,271 | | | $ | 4,044 | | | $ | 141 | | | $ | 16,075 | | | $ | 502,531 | |
| Multi-family | | | 196,231 | | | | 18,123 | | | | 8,357 | | | | 24,108 | | | | 246,819 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
| Office | | | 49,324 | | | | 1,853 | | | | 20,405 | | | | 9,054 | | | | 80,636 | |
| Retail/wholesale/mixed use | | | 50,108 | | | | 9,376 | | | | 19,870 | | | | 19,849 | | | | 99,203 | |
| Industrial/warehouse | | | 24,431 | | | | 3,237 | | | | 2,230 | | | | 5,698 | | | | 35,596 | |
| Other | | | 4,897 | | | | 1,318 | | | | 181 | | | | 2,405 | | | | 8,801 | |
| Total commercial real estate | | | 128,760 | | | | 15,784 | | | | 42,686 | | | | 37,006 | | | | 224,236 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | 7,704 | | | | – | | | | – | | | | – | | | | 7,704 | |
| Multi-family | | | 4,503 | | | | – | | | | – | | | | 14,347 | | | | 18,850 | |
| Commercial real estate | | | 4,411 | | | | – | | | | – | | | | 908 | | | | 5,319 | |
| Land | | | 11,125 | | | | 299 | | | | 184 | | | | 4,820 | | | | 16,428 | |
| Total construction/development | | | 27,743 | | | | 299 | | | | 184 | | | | 20,075 | | | | 48,301 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 211,834 | | | | – | | | | – | | | | 1,505 | | | | 213,339 | |
| Student | | | 15,711 | | | | – | | | | – | | | | – | | | | 15,711 | |
| Other | | | 9,214 | | | | – | | | | – | | | | 190 | | | | 9,404 | |
| Total consumer | | | 236,759 | | | | – | | | | – | | | | 1,695 | | | | 238,454 | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | 35,433 | | | | 1,342 | | | | – | | | | 2,823 | | | | 39,598 | |
| Lines of credit | | | 44,291 | | | | 1,729 | | | | 252 | | | | 1,845 | | | | 48,117 | |
| Total commercial business | | | 79,724 | | | | 3,071 | | | | 252 | | | | 4,668 | | | | 87,715 | |
| Total | | $ | 1,151,488 | | | $ | 41,321 | | | $ | 51,620 | | | $ | 103,627 | | | $ | 1,348,056 | |
Loans rated “pass” or “watch” are generally current on contractual loan and principal payments and comply with other contractual loan terms. Pass loans generally have no noticeable credit deficiencies or potential weaknesses. Loans rated watch, however, will typically exhibit early signs of credit deficiencies or potential weaknesses that deserve management’s close attention. Loans rated “special mention” do not currently expose the Company to a sufficient degree of risk to warrant a lower rating, but possess clear trends in credit deficiencies or potential weaknesses that deserve management’s close attention. The allowance for loan losses on loans rated pass, watch, or special mention is typically evaluated collectively for impairment using a homogenous pool approach. This approach utilizes quantitative factors developed by management from its assessment of historical loss experience, qualitative factors, and other considerations.
Loans rated “substandard” involve a distinct possibility that the Company could sustain some loss if deficiencies associated with the loan are not corrected. Loans rated “doubtful” indicate that full collection is highly questionable or improbable. The Company did not have any loans that were rated doubtful at December 31, 2012 and 2011. Loans rated substandard or doubtfulthat are also considered in management’s judgment to be impaired are generally analyzed individually to determine an appropriate allowance for loan loss. A loan rated “loss” is considered uncollectible, even if a partial recovery could be expected in the future. The Company generally charges off loans that are rated as a loss. As such, the Company did not have any loans that were rated loss at December 31, 2012 and 2011.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
The following tables contain information relating to the past due and non-accrual status of the Company’s loans receivable as of the dates indicated (all amounts in the table are net of undisbursed loan proceeds):
| | | December 31, 2012 | |
| | | Past Due Status | | | | | | | | | Total | |
| | | 30-59
Days | | | 60-89
Days | | | > 90
Days | | | Total
Past Due | | | Total
Current | | | Total
Loans | | | Non-
Accrual | |
| One- to four-family | | $ | 6,083 | | | $ | 3,412 | | | $ | 6,311 | | | $ | 15,806 | | | $ | 443,692 | | | $ | 459,498 | | | $ | 8,192 | |
| Multi-family | | | 661 | | | | – | | | | 2,734 | | | | 3,396 | | | | 260,617 | | | | 264,013 | | | | 6,824 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Office | | | – | | | | – | | | | 719 | | | | 719 | | | | 75,973 | | | | 76,692 | | | | 1,460 | |
| Retail/wholesale/mixed | | | 3,262 | | | | 189 | | | | 2,118 | | | | 5,568 | | | | 126,808 | | | | 132,376 | | | | 5,306 | |
| Industrial/warehouse | | | – | | | | 2,325 | | | | 160 | | | | 2,485 | | | | 44,861 | | | | 47,347 | | | | 228 | |
| Other | | | – | | | | – | | | | – | | | | – | | | | 7,360 | | | | 7,360 | | | | – | |
| Total commercial real estate | | | 3,262 | | | | 2,514 | | | | 2,997 | | | | 8,772 | | | | 255,002 | | | | 263,775 | | | | 6,994 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | – | | | | – | | | | – | | | | – | | | | 10,259 | | | | 10,259 | | | | – | |
| Multi-family | | | 563 | | | | – | | | | – | | | | 563 | | | | 26,715 | | | | 27,277 | | | | – | |
| Commercial real estate | | | – | | | | – | | | | – | | | | – | | | | 8,046 | | | | 8,046 | | | | – | |
| Land | | | 44 | | | | – | | | | 147 | | | | 191 | | | | 12,544 | | | | 12,735 | | | | 937 | |
| Total construction | | | 607 | | | | – | | | | 147 | | | | 754 | | | | 57,564 | | | | 58,317 | | | | 937 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 851 | | | | 192 | | | | 1,514 | | | | 2,556 | | | | 221,240 | | | | 223,796 | | | | 1,514 | |
| Student | | | 210 | | | | 196 | | | | 584 | | | | 990 | | | | 11,925 | | | | 12,915 | | | | – | |
| Other | | | 49 | | | | 17 | | | | 59 | | | | 124 | | | | 10,078 | | | | 10,202 | | | | 59 | |
| Total consumer | | | 1,110 | | | | 405 | | | | 2,157 | | | | 3,670 | | | | 243,243 | | | | 246,913 | | | | 1,573 | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | – | | | | 184 | | | | 261 | | | | 445 | | | | 70,308 | | | | 70,753 | | | | 635 | |
| Lines of credit | | | 191 | | | | – | | | | 58 | | | | 249 | | | | 61,434 | | | | 61,683 | | | | 58 | |
| Total commercial | | | 191 | | | | 184 | | | | 319 | | | | 694 | | | | 131,742 | | | | 132,436 | | | | 693 | |
| Total | | $ | 11,914 | | | $ | 6,515 | | | $ | 14,665 | | | $ | 33,092 | | | $ | 1,391,860 | | | $ | 1,424,952 | | | $ | 25,213 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
3. Loans Receivable (continued)
| | | December 31, 2011 | |
| | | Past Due Status | | | | | | | | | Total | |
| | | 30-59
Days | | | 60-89
Days | | | > 90
Days | | | Total
Past Due | | | Total
Current | | | Total
Loans | | | Non-
Accrual | |
| One- to four-family | | $ | 10,713 | | | $ | 2,491 | | | $ | 12,890 | | | | 26,094 | | | $ | 476,437 | | | $ | 502,531 | | | $ | 14,868 | |
| Multi-family | | | 7,692 | | | | – | | | | 9,949 | | | | 17,640 | | | | 229,179 | | | | 246,819 | | | | 22,905 | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Office | | | 745 | | | | – | | | | 3,743 | | | | 4,488 | | | | 76,147 | | | | 80,636 | | | | 9,054 | |
| Retail/wholesale/mixed | | | 695 | | | | 154 | | | | 7,214 | | | | 8,063 | | | | 91,139 | | | | 99,203 | | | | 11,936 | |
| Industrial/warehouse | | | 2,230 | | | | – | | | | 1,474 | | | | 3,704 | | | | 31,892 | | | | 35,596 | | | | 1,780 | |
| Other | | | – | | | | – | | | | 560 | | | | 560 | | | | 8,241 | | | | 8,801 | | | | 1,227 | |
| Total commercial real estate | | | 3,670 | | | | 154 | | | | 12,991 | | | | 16,815 | | | | 207,419 | | | | 224,236 | | | | 23,997 | |
| Construction and development: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | | – | | | | – | | | | – | | | | – | | | | 7,704 | | | | 7,704 | | | | – | |
| Multi-family | | | – | | | | 4,466 | | | | – | | | | 4,466 | | | | 14,384 | | | | 18,850 | | | | 4,466 | |
| Commercial real estate | | | – | | | | – | | | | – | | | | – | | | | 5,319 | | | | 5,319 | | | | 152 | |
| Land | | | 238 | | | | 1,046 | | | | 3,310 | | | | 4,594 | | | | 11,834 | | | | 16,428 | | | | 4,750 | |
| Total construction | | | 238 | | | | 5,512 | | | | 3,310 | | | | 9,060 | | | | 39,241 | | | | 48,301 | | | | 9,368 | |
| Consumer: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Home equity | | | 1,172 | | | | 439 | | | | 1,457 | | | | 3,067 | | | | 210,271 | | | | 213,339 | | | | 1,457 | |
| Student | | | 396 | | | | 310 | | | | 696 | | | | 1,403 | | | | 14,309 | | | | 15,711 | | | | – | |
| Other | | | 137 | | | | 64 | | | | 202 | | | | 404 | | | | 9,000 | | | | 9,404 | | | | 207 | |
| Total consumer | | | 1,705 | | | | 813 | | | | 2,355 | | | | 4,874 | | | | 233,580 | | | | 238,454 | | | | 1,664 | |
| Commercial business: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Term loans | | | 86 | | | | 169 | | | | 412 | | | | 668 | | | | 38,930 | | | | 39,598 | | | | 951 | |
| Lines of credit | | | 58 | | | | – | | | | 608 | | | | 665 | | | | 47,452 | | | | 48,117 | | | | 691 | |
| Total commercial | | | 144 | | | | 169 | | | | 1,020 | | | | 1,333 | | | | 86,382 | | | | 87,715 | | | | 1,642 | |
| Total | | $ | 24,162 | | | $ | 9,139 | | | $ | 42,515 | | | $ | 75,816 | | | $ | 1,272,238 | | | $ | 1,348,056 | | | $ | 74,444 | |
As of December 31, 2012 and 2011, $584 and $696 in student loans, respectively, were 90-days past due, but remained on accrual status. No other loans 90-days past due were in accrual status as of either date.
The Company classifies a loan modification as a troubled debt restructuring (“TDR”) when it has granted a borrower experiencing financial difficulties a concession that it would otherwise not consider. Loan modifications that result in insignificant delays in the receipt of payments (generally six months or less) are not considered TDRs under the Company’s TDR policy. TDRs are relatively insignificant and/or infrequent in the Company and generally consist of loans placed in interest-only status for a short period of time or payment forbearance for greater than six months. There were two commercial real estate loans with balances of $183, and eleven one-to-four family loans with balances of $2,448 added to TDRs during the year ended December 31, 2012. There were no loans that had a payment default in the twelve months ended December 31, 2012, that were restructured during that period. TDRs are evaluated for impairment and appropriate credit losses are recorded in accordance with the Company’s accounting policies and GAAP.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
4. Mortgage Servicing Rights
The activity in mortgage servicing rights during the years ended December 31 is presented in the following table.
| | | 2012 | | | 2011 | | | 2010 | |
| Mortgage servicing rights at beginning of year | | $ | 8,269 | | | $ | 7,775 | | | $ | 7,186 | |
| Additions | | | 4,852 | | | | 3,241 | | | | 3,866 | |
| Amortization | | | (3,904 | ) | | | (2,747 | ) | | | (3,277 | ) |
| Mortgage servicing rights at end of year | | | 9,217 | | | | 8,269 | | | | 7,775 | |
| Valuation allowance | | | (2,396 | ) | | | (868 | ) | | | (6 | ) |
| Mortgage servicing rights at end of year | | $ | 6,821 | | | $ | 7,401 | | | $ | 7,769 | |
The following table shows the estimated future amortization expense for mortgage servicing rights for the years ended December 31:
| 2013 | | $ | 1,097 | |
| 2014 | | | 1,077 | |
| 2015 | | | 1,060 | |
| 2016 | | | 1,038 | |
| 2017 | | | 948 | |
| Thereafter | | | 1,601 | |
| Total | | $ | 6,821 | |
The projection of amortization for mortgage servicing rights is based on existing asset balances and the interest rate environment as of December 31, 2012. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates, loan prepayments, and market conditions.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
5. Other Assets
Other assets are summarized as follow:
| | | December 31 | |
| | | 2012 | | | 2011 | |
| Accrued interest: | | | | | | | | |
| Loans receivable | | $ | 4,636 | | | $ | 4,664 | |
| Mortgage-related securities | | | 1,610 | | | | 1,851 | |
| Interest-bearing deposits in banks | | | 11 | | | | 6 | |
| Total accrued interest | | | 6,257 | | | | 6,521 | |
| Bank-owned life insurance | | | 58,609 | | | | 56,604 | |
| Premises and equipment, net | | | 50,536 | | | | 50,423 | |
| Federal Home Loan Bank stock, at cost | | | 15,841 | | | | 46,092 | |
| Deferred tax asset, net | | | 34,211 | | | | 37,454 | |
| Prepaid FDIC insurance premiums | | | 2,477 | | | | 5,673 | |
| Other assets | | | 21,764 | | | | 22,059 | |
| Total other assets | | $ | 189,695 | | | $ | 224,826 | |
| Premises and equipment are summarized as follows: | | December 31 | |
| | | 2012 | | | 2011 | |
| Land and land improvements | | $ | 17,787 | | | $ | 17,655 | |
| Office buildings | | | 54,438 | | | | 53,139 | |
| Furniture and equipment | | | 18,576 | | | | 18,951 | |
| Leasehold improvements | | | 940 | | | | 1,208 | |
| Total cost | | | 91,741 | | | | 90,953 | |
| Accumulated depreciation and amortization | | | (41,205 | ) | | | (40,530 | ) |
| Total premises and equipment, net | | $ | 50,536 | | | $ | 50,423 | |
Depreciation expense for 2012, 2011, and 2010 was $2,569, $2,576, and $2,600, respectively.
The Company leases various branch offices, office facilities and equipment under non-cancelable operating leases which expire on various dates through 2033. Future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more for the years indicated are as follows at December 31, 2012:
| | | Amount | |
| 2013 | | | 964 | |
| 2014 | | | 908 | |
| 2015 | | | 832 | |
| 2016 | | | 703 | |
| 2017 | | | 420 | |
| Thereafter | | | 2,986 | |
| Total | | $ | 6,813 | |
Rent expense was $955, $1,002, and $969, in 2012, 2011, and 2010, respectively.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
6. Deposits Liabilities
Deposit liabilities are summarized as follows:
| | | December 31 | |
| | | 2012 | | | 2011 | |
| Checking accounts: | | | | | | | | |
| Non-interest-bearing | | $ | 143,684 | | | $ | 112,211 | |
| Interest-bearing | | | 236,380 | | | | 229,990 | |
| Total checking accounts | | | 380,064 | | | | 342,201 | |
| Money market accounts | | | 458,762 | | | | 432,248 | |
| Savings accounts | | | 217,170 | | | | 204,263 | |
| Certificate of deposits: | | | | | | | | |
| Due within one year | | | 618,487 | | | | 709,362 | |
| After one but within two years | | | 159,340 | | | | 250,613 | |
| After two but within three years | | | 16,997 | | | | 61,291 | |
| After three but within four years | | | 7,994 | | | | 13,301 | |
| After four but within five years | | | 9,085 | | | | 8,384 | |
| Total certificates of deposit | | | 811,903 | | | $ | 1,042,951 | |
| Total deposit liabilities | | $ | 1,867,899 | | | $ | 2,021,663 | |
The aggregate amount of certificate accounts with balances of one hundred thousand dollars or more was $220,923 and $291,385 at December 31, 2012 and 2011, respectively.
Interest expense on deposits was as follows:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Interest-bearing checking accounts | | $ | 51 | | | $ | 85 | | | $ | 107 | |
| Money market accounts | | | 716 | | | | 1,696 | | | | 2,075 | |
| Savings accounts | | | 63 | | | | 78 | | | | 104 | |
| Certificate of deposits | | | 13,825 | | | | 17,710 | | | | 26,320 | |
| Total interest expense on deposit liabilities | | $ | 14,655 | | | $ | 19,568 | | | $ | 28,606 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
7. Borrowings
Borrowings consist of the following:
| | | December 31, 2012 | | | December 31, 2011 | |
| | | | | | Weighted- | | | | | | Weighted- | |
| | | | | | Average | | | | | | Average | |
| | | Balance | | | Rate | | | Balance | | | Rate | |
| Federal Home Loan Bank advances maturing in: | | | | | | | | | | | | | | | | |
| 2012 | | | – | | | | – | | | $ | 100,000 | | | | 4.52 | % |
| 2013 | | $ | 217 | | | | 4.17 | % | | | 233 | | | | 4.17 | |
| 2014 | | | – | | | | – | | | | – | | | | – | |
| 2015 | | | 23,450 | | | | 0.80 | | | | – | | | | – | |
| 2016 | | | 23,450 | | | | 1.04 | | | | – | | | | – | |
| 2017 and thereafter | | | 163,669 | | | | 2.74 | | | | 52,858 | | | | 5.00 | |
| Total borrowings | | $ | 210,786 | | | | 2.34 | % | | $ | 153,091 | | | | 4.69 | % |
All of the Company’s FHLB advances are subject to prepayment penalties if voluntarily repaid prior to their stated maturity.
The Company is required to pledge certain unencumbered mortgage loans and mortgage-related securities as collateral against its outstanding advances from the FHLB of Chicago. Advances are also collateralized by the shares of capital stock of the FHLB of Chicago that are owned by the Company. The Company’s borrowings at the FHLB of Chicago are limited to the lesser of: (i) 35% of total assets; (ii) twenty (20) times the FHLB of Chicago capital stock owned by the Company; or (iii) the total of 60% of the book value of certain multi-family mortgage loans, 75% of the book value of one- to four-family mortgage loans, and 95% of certain mortgage-related securities.
At December 31, 2012 and 2011, the Company had lines of credit with two financial institutions that totaled $10,000 as of both dates. At December 31, 2012 and 2011, there were no amounts outstanding on these lines of credit.
8. Shareholders’ Equity
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional discretionary, actions by regulators, that, 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 its assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by federal regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets (as these terms are defined in regulations). Management believes, as of December 31, 2012, that the Bank met all capital adequacy requirements.Management is not aware of any conditions or events, which would change the Bank’s status as well capitalized.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
8. Shareholders’ Equity (continued)
The Bank’s actual and required regulatory capital amounts and ratios as of December 31, 2012 and 2011, are presented in the following table:
| | | Actual | | | For Capital
Adequacy Purposes | | | To Be Well Capitalized
Under Prompt
Corrective Action
Provisions | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| As of December 31, 2012: | | | | | | | | | | | | | | | | | | | | | | | | |
| Total capital | | $ | 264,012 | | | | 18.02 | % | | $ | 117,195 | | | | 8.00 | % | | $ | 146,494 | | | | 10.00 | % |
| (to risk-weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 capital | | | 245,660 | | | | 16.77 | | | | 58,598 | | | | 4.00 | | | | 87,897 | | | | 6.00 | |
| (to risk-weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 capital | | | 245,660 | | | | 10.28 | | | | 95,553 | | | | 4.00 | | | | 119,441 | | | | 5.00 | |
| (to adjusted total assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2011: | | | | | | | | | | | | | | | | | | | | | | | | |
| Total capital | | $ | 253,815 | | | | 18.34 | % | | $ | 110,714 | | | | 8.00 | % | | $ | 138,392 | | | | 10.00 | % |
| (to risk-weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 capital | | | 236,516 | | | | 17.09 | | | | 55,354 | | | | 4.00 | | | | 83,035 | | | | 6.00 | |
| (to risk-weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 capital | | | 236,516 | | | | 9.59 | | | | 98,601 | | | | 4.00 | | | | 123,252 | | | | 5.00 | |
| (to adjusted total assets) | | | | | | | | | | | | | | | | | | | | | | | | |
The following table presents reconciliations of the Bank’s equity under generally accepted accounting principles to capital as determined by regulators:
| | | December 31, 2012 | | | December 31, 2011 | |
| | | Risk-
Based
Capital | | | Tier 1
(Core)
Capital | | | Risk-
Based
Capital | | | Tier 1
(Core)
Capital | |
| Stockholder’s equity according to the Bank’s records | | $ | 269,446 | | | $ | 269,446 | | | $ | 264,928 | | | $ | 264,928 | |
| Net unrealized gain on securities available for sale, net of taxes | | | (6,380 | ) | | | (6,380 | ) | | | (4,619 | ) | | | (4,619 | ) |
| Additional minimum pension asset, net of taxes | | | 11,098 | | | | 11,098 | | | | 9,998 | | | | 9,998 | |
| Goodwill and intangibles | | | (395 | ) | | | (395 | ) | | | (594 | ) | | | (594 | ) |
| Investment in “non-includable” subsidiaries | | | (3,109 | ) | | | (3,109 | ) | | | (3,197 | ) | | | (3,197 | ) |
| Disallowed deferred tax assets | | | (25,000 | ) | | | (25,000 | ) | | | (30,000 | ) | | | (30,000 | ) |
| Allowance for loan losses | | | 18,352 | | | | – | | | | 17,299 | | | | – | |
| Regulatory capital | | $ | 264,012 | | | $ | 245,660 | | | $ | 253,815 | | | $ | 236,516 | |
The following table summarizes the components of accumulated other comprehensive income (loss), net of related income tax effects, as of the dates shown:
| | | December 31 | |
| | | 2012 | | | 2011 | |
| Net unrealized gain on securities available-for-sale | | $ | 6,380 | | | $ | 4,619 | |
| Qualified and supplemental defined benefit plans | | | (10,998 | ) | | | (9,908 | ) |
| Other post-retirement benefit plans | | | (99 | ) | | | (90 | ) |
| Accumulated other comprehensive loss | | $ | (4,717 | ) | | $ | (5,379 | ) |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
9. Earnings (Loss) Per Share
The computation of the Company’s basic and diluted earnings (loss) per share is presented in the following table.
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Basic earnings (loss) per share: | | | | | | | | | | | | |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) |
| Weighted average shares outstanding | | | 46,184,264 | | | | 46,038,686 | | | | 45,529,126 | |
| Allocated ESOP shares during the period | | | – | | | | – | | | | 63,088 | |
| Vested MRP shares during the period | | | 7,104 | | | | 6,978 | | | | 4,276 | |
| Basic shares outstanding | | | 46,191,368 | | | | 46,045,664 | | | | 45,596,490 | |
| Basic earnings (loss) per share | | $ | 0.15 | | | $ | (1.03 | ) | | $ | (1.59 | ) |
| | | | | | | | | | | | | |
| Diluted earnings (loss) per share: | | | | | | | | | | | | |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) |
| Weighted average shares outstanding used in basic earnings (loss) per share | | | 46,191,368 | | | | 46,045,664 | | | | 45,569,490 | |
| Net dilutive effect of: | | | | | | | | | | | | |
| Stock option shares | | | 8,654 | | | | – | | | | – | |
| Non-vested MRP shares | | | 9,557 | | | | – | | | | – | |
| Diluted shares outstanding | | | 46,209,579 | | | | 46,045,664 | | | | 45,569,490 | |
| Diluted earnings (loss) per share | | $ | 0.15 | | | $ | (1.03 | ) | | $ | (1.59 | ) |
The Company had stock options for 2,268,500, 2,382,500, and 1,974,000 shares outstanding at December 31, 2012, 2011, and 2010, respectively, which were not included in the computation of diluted earnings (loss) per share because they were anti-dilutive. These shares had weighted average exercise prices of $9.37, $9.46, and $10.56, as of those same dates, respectively.
10. Employee Benefit Plans
The Company has a discretionary, defined contribution savings plan (the “Savings Plan”). The Savings Plan is qualified under Sections 401 and 401(k) of the Internal Revenue Code and provides employees meeting certain minimum age and service requirements the ability to make contributions to the Savings Plan on a pretax basis. The Company then matches a percentage of the employee’s contributions. Matching contributions made by the Company were $198 in 2012, $173 in 2011 and $169 in 2010.
The Company also has a qualified defined benefit pension plan covering employees meeting certain minimum age and service requirements and a supplemental defined benefit pension plan for certain eligible employees. The supplemental pension plan is funded through a "rabbi trust" arrangement. The benefits under these plans 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.
Effective January 1, 2013, the Company closed the qualified defined benefit pension plan to employees that were not eligible to participate in the plan as of that date, as well as any employees hired after that date. In addition, effective for service performed after March 1, 2013, the Company reduced certain benefits paid under the qualified and supplemental plans related to any employee service performed after that date.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
10. Employee Benefit Plans (continued)
The changes in plan assets and benefit obligations at December 31, 2012 and 2011, are presented in the following table.
| | | Qualified | | | Supplemental | |
| | | Pension Plan | | | Pension Plan | |
| | | 2012 | | | 2011 | | | 2012 | | | 2011 | |
| Change in plan assets: | | | | | | | | | | | | | | | | |
| Fair value of plan assets at beginning of year | | $ | 47,107 | | | $ | 40,658 | | | | – | | | | – | |
| Actual return on plan assets | | | 5,476 | | | | 2,489 | | | | – | | | | – | |
| Employer contributions | | | – | | | | 5,000 | | | $ | 297 | | | $ | 297 | |
| Benefits paid | | | (1,171 | ) | | | (1,040 | ) | | | (297 | ) | | | (297 | ) |
| Fair value of plan assets at end of year | | | 51,412 | | | | 47,107 | | | | – | | | | – | |
| Change in benefit obligation: | | | | | | | | | | | | | | | | |
| Benefit obligation at beginning of year | | | 54,144 | | | | 43,404 | | | | 9,102 | | | | 7,959 | |
| Service cost | | | 2,898 | | | | 2,505 | | | | 116 | | | | 46 | |
| Interest cost | | | 2,254 | | | | 2,275 | | | | 377 | | | | 417 | |
| Actuarial loss | | | 4,713 | | | | 7,000 | | | | 1,326 | | | | 977 | |
| Benefits paid | | | (1,171 | ) | | | (1,040 | ) | | | (297 | ) | | | (297 | ) |
| Benefit obligation at end of year | | | 62,838 | | | | 54,144 | | | | 10,624 | | | | 9,102 | |
| Funded status at the end of the year | | $ | (11,426 | ) | | $ | (7,037 | ) | | $ | (10,624 | ) | | $ | (9,102 | ) |
The underfunded status of the qualified and supplemental pension plans at December 31, 2012, are recognized in the statement of condition as accrued pension liability, which is included as a component of other liabilities.
The following tables summarize the changes in pension plan assets and benefit obligations recognized in accumulated other comprehensive income (loss), net of related income tax effect, for the periods indicated:
| | | Qualified | | | Supplemental | |
| | | Pension Plan | | | Pension Plan | |
| | | 2012 | | | 2011 | | | 2012 | | | 2011 | |
| Balance in accumulated other comprehensive income (loss) at the beginning of year | | $ | (9,542 | ) | | $ | (5,792 | ) | | $ | (366 | ) | | $ | 217 | |
| Change in unrecognized loss | | | (302 | ) | | | (3,750 | ) | | | (796 | ) | | | (549 | ) |
| Change in prior service cost | | | – | | | | – | | | | 8 | | | | (34 | ) |
| Total recognized in other comprehensive loss | | | (302 | ) | | | (3,750 | ) | | | (788 | ) | | | (583 | ) |
| Balance in accumulated other comprehensive loss at the end of year | | $ | (9,844 | ) | | $ | (9,542 | ) | | $ | (1,154 | ) | | $ | (366 | ) |
The $1,154 in accumulated other comprehensive loss as of December 31, 2012, for the supplemental pension plan consisted of $1,128 in unrecognized loss and $26 in prior service costs. All other period-end balances in the table consisted of unrecognized loss.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
10. Employee Benefit Plans (continued)
The estimated net of tax costs that will be amortized from accumulated other comprehensive income (loss) into net periodic cost over the next fiscal year is $1,732 for the qualified plan. The accumulated benefit obligations for the defined benefit pension plan were $58,965 at December 31, 2012, and $50,874 at December 31, 2011.
The assumptions used to determine the benefit obligation as of December 31 is as follows:
| | | 2012 | | | 2011 | |
| Discount rate | | | 3.70 | % | | | 4.21 | % |
| Rate of increase in compensation levels | | | 3.00 | % | | | 3.00 | % |
| Expected long-term rate of return on plan assets (qualified plan) | | | 6.50 | % | | | 6.50 | % |
The assumptions used to determine the net cost for the years ended December 31 is as follows:
| | | 2012 | | | 2011 | | | 2010 | |
| Discount rate | | | 4.21 | % | | | 5.32 | % | | | 5.84 | % |
| Rate of increase in compensation levels | | | 3.00 | % | | | 3.50 | % | | | 3.50 | % |
| Expected long-term rate of return on plan assets (qualified plan) | | | 6.50 | % | | | 6.50 | % | | | 6.50 | % |
The expected long-term rate of return was estimated using a combination of the expected rate of return for immediate participation contracts and the historical rate of return for immediate participation contracts.
Using an actuarial measurement date of December 31, 2012, 2011, and 2010, components of net periodic benefit cost follow:
| | | 2012 | | | 2011 | | | 2010 | |
| Qualified pension plan: | | | | | | | | | | | | |
| Interest cost | | $ | 2,254 | | | $ | 2,275 | | | $ | 2,023 | |
| Service cost | | | 2,898 | | | | 2,505 | | | | 1,939 | |
| Expected return on plan assets | | | (3,022 | ) | | | (2,601 | ) | | | (2,291 | ) |
| Amortization of net loss | | | 1,759 | | | | 865 | | | | – | |
| Net periodic cost | | $ | 3,889 | | | $ | 3,044 | | | $ | 1,671 | |
| Supplemental pension plan: | | | | | | | | | | | | |
| Interest cost | | $ | 377 | | | $ | 417 | | | $ | 426 | |
| Service cost | | | 116 | | | | 46 | | | | – | |
| Amortization of prior service cost | | | 13 | | | | 6 | | | | – | |
| Net periodic cost | | $ | 506 | | | $ | 469 | | | $ | 426 | |
At December 31, 2012, the projected benefit payments for each of the plans are as follows:
| | | Qualified
Pension Plan | | | Supplemental
Pension Plan | | | Total | |
| 2013 | | $ | 1,368 | | | $ | 297 | | | $ | 1,665 | |
| 2014 | | | 1,898 | | | | 1,139 | | | | 3,037 | |
| 2015 | | | 2,162 | | | | 968 | | | | 3,130 | |
| 2016 | | | 2,419 | | | | 946 | | | | 3,365 | |
| 2017 | | | 2,667 | | | | 915 | | | | 3,582 | |
| 2018 – 2022 | | | 17,204 | | | | 4,238 | | | | 21,442 | |
| Total | | $ | 27,718 | | | $ | 8,503 | | | $ | 36,221 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
10. Employee Benefit Plans (continued)
The following tables summarize the fair value of the Company’s qualified pension plan assets as of the dates indicated:
| | | December 31, 2012 | |
| | | | | | Fair Value Hierarchy | |
| | | Amount | | | Level 1 | | | Level 2 | | | Level 3 | |
| Asset category: | | | | | | | | | | | | | | | | |
| Money market fund | | $ | 325 | | | | – | | | $ | 325 | | | | – | |
| Equity security | | | 808 | | | $ | 808 | | | | – | | | | – | |
| Immediate participation guarantee contract | | | 50,279 | | | | – | | | | – | | | $ | 50,279 | |
| Total | | $ | 51,412 | | | $ | 808 | | | $ | 325 | | | $ | 50,279 | |
| | | December 31, 2011 | |
| | | | | | Fair Value Hierarchy | |
| | | Amount | | | Level 1 | | | Level 2 | | | Level 3 | |
| Asset category: | | | | | | | | | | | | | | | | |
| Money market fund | | $ | 293 | | | | – | | | $ | 293 | | | | – | |
| Equity security | | | 632 | | | $ | 632 | | | | – | | | | – | |
| Immediate participation guarantee contract | | | 46,182 | | | | – | | | | – | | | $ | 46,182 | |
| Total | | $ | 47,107 | | | $ | 632 | | | $ | 293 | | | $ | 46,182 | |
The investment objective is to minimize risk. The assets of the qualified pension plan are concentrated in a group annuity contract issued by a life insurance company. Pension plan contributions are maintained in the general account of the insurance company, which invests primarily in corporate and government notes and bonds with ten to fifteen years to maturity. The group annuity contract is valued at fair value by discounting the related cash flows based on current yields of similar instruments with comparable durations and considering the credit worthiness of the issuer.
The equity securities are shares of stock issued by the life insurance company when it demutualized. This investment is valued at the closing price reported in the active market in which the security is traded. The money market fund, which invests in short-term U.S. government securities, is based on a $1 net asset value (“NAV”) specified by the fund manager. The fund is not traded in an active market. The fund manager bases its estimate of the NAV on quoted prices for similar assets in active markets.
The following table presents a summary of the changes in the fair value of the pension plan’s Level 3 asset during the periods indicated. As noted above, the Company’s Level 3 asset consists entirely of a group annuity contract issued by an insurance company.
| | | 2012 | | | 2011 | |
| Fair value at the beginning of the period | | $ | 46,182 | | | $ | 39,374 | |
| Actual return on plan assets | | | 5,268 | | | | 2,848 | |
| Employer contribution | | | – | | | | 5,000 | |
| Benefits paid | | | (1,171 | ) | | | (1,040 | ) |
| Fair value at the end of the period | | $ | 50,279 | | | $ | 46,182 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
10. Employee Benefit Plans (continued)
The Company has a deferred retirement plan for certain non-officer directors who have provided at least five years of service. All eligible directors’ benefits have vested. In the event a director dies prior to completion of these payments, payments will go to the director’s heirs. The Company has funded these arrangements through “rabbi trust” arrangements and, based on actuarial analyses, believes these obligations are adequately funded. The Company also has supplemental retirement plans for certain executives of a financial institution it acquired in 2000. The liabilities related to these plans were $3,453 and $3,362 at December 31, 2012 and 2011 respectively. The net expense related to these plans for the years ended December 31, 2012, 2011, and 2010 was $189, $194, and $221, respectively.
11. Stock-Based Benefit Plans
In 2004 the Company’s shareholders approved the 2004 Stock Incentive Plan (the “2004 Plan”), which provides for stock option awards of up to 4,106,362 shares. Options granted under the 2004 Plan vest over five years and have expiration terms of ten years. The 2004 Plan also provides for MRP awards of up to 1,642,521 shares. MRP shares awarded under the 2004 Plan vest over five years. As of December 31, 2012, options for 621,362 shares and 520,221 MRP shares remain eligible for award under the 2004 Plan.
MRP grants are amortized to compensation expense as the Company’s employees and directors become vested in the granted shares. The amount amortized to expense was $186 for 2012, $120 for 2011, and $91 for 2010. Outstanding non-vested MRP grants had a fair value of $436 and an unamortized cost of $417 at December 31, 2012. The cost of these shares is expected to be recognized over a weighted-average period of 1.7 years.
The Company recorded stock option compensation expenses of $232, $161, and $46, for 2012, 2011, and 2010 respectively. As of December 31, 2012, there was $676 in total unrecognized stock option compensation expense related to non-vested options. This cost is expected to be recognized over a weighted-average period of 1.7 years.
The following schedule reflects activity in the Company’s vested and non-vested stock options and related weighted average exercise prices for the periods indicated.
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | Stock
Options | | | Weighted
Average
Exercise | | | Stock
Options | | | Weighted
Average
Exercise | | | Stock
Options | | | Weighted
Average
Exercise | |
| Outstanding at beginning of year | | | 2,382,500 | | | $ | 9.4637 | | | | 2,462,464 | | | $ | 9.0184 | | | | 3,129,398 | | | $ | 8.1823 | |
| Granted | | | 412,500 | | | | 3.3999 | | | | 438,500 | | | | 4.9730 | | | | 120,000 | | | | 5.7733 | |
| Exercised | | | – | | | | – | | | | (488,464 | ) | | | 3.2056 | | | | (576,934 | ) | | | 3.2056 | |
| Forfeited | | | (124,000 | ) | | | 10.6730 | | | | (30,000 | ) | | | 9.1735 | | | | (210,000 | ) | | | 10.673 | |
| Outstanding at end of year | | | 2,671,000 | | | $ | 8.4711 | | | | 2,382,500 | | | $ | 9.4637 | | | | 2,462,464 | | | $ | 9.0184 | |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
11. Stock-Based Benefit Plans (continued)
The following table provides additional information regarding the Company’s outstanding options as of December 31, 2012.
| | | | Remaining | | | Non-Vested Options | | | Vested Options | |
| | | | Contractual
Life | | | Stock
Options | | | Intrinsic
Value | | | Stock
Options | | | Intrinsic
Value | |
| Exercise price: | | | | | | | | | | | | | | | | |
| $ | 10.6730 | | | 1.3 | | | | – | | | | – | | | | 1,576,000 | | | | – | |
| $ | 12.2340 | | | 3.5 | | | | – | | | | – | | | | 50,000 | | | | – | |
| $ | 11.1600 | | | 5.3 | | | | 6,400 | | | | – | | | | 25,600 | | | | – | |
| $ | 12.0250 | | | 5.6 | | | | 10,000 | | | | – | | | | 40,000 | | | | – | |
| $ | 7.2260 | | | 7.3 | | | | 30,000 | | | | – | | | | 20,000 | | | | – | |
| $ | 4.7400 | | | 8.0 | | | | 42,000 | | | | – | | | | 28,000 | | | | – | |
| $ | 5.0500 | | | 8.0 | | | | 310,400 | | | | – | | | | 77,600 | | | | – | |
| $ | 4.3000 | | | 8.2 | | | | 20,000 | | | | – | | | | 5,000 | | | | – | |
| $ | 3.7200 | | | 8.6 | | | | 14,000 | | | $ | 8 | | | | 3,500 | | | $ | 2 | |
| $ | 3.3900 | | | 9.0 | | | | 402,500 | | | | 366 | | | | – | | | | – | |
| $ | 3.8000 | | | 9.3 | | | | 10,000 | | | | 5 | | | | – | | | | – | |
| | Total | | | | | | | | 845,300 | | | $ | 379 | | | | 1,825,700 | | | $ | 2 | |
| Weighted average remaining contractual life | | | | | | | | 8.4 years | | | | | | | | 2.0 years | | | | | |
| Weighted average exercise price | | | | | | | $ | 4.3954 | | | | | | | $ | 10.3536 | | | | | |
The total intrinsic value of options exercised was $296 and $1,844 during 2011 and 2010, respectively. There were no options exercised in 2012. The weighted average grant date fair value of non-vested options at December 31, 2012, was $1.06 per share. In 2012 no non-vested options were forfeited, 412,500 options were granted, and 126,500 options vested.
The Company uses the Black-Scholes option-pricing model to estimate the fair value of granted options. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. However, the Company's stock options have characteristics significantly different from traded options and changes in the subjective input assumptions can materially affect the fair value estimate. Option valuationmodels such as Black-Scholes require the input of highly subjective assumptions including the expected stock price volatility, which is computed using five-years of actual price activity in the Company’s stock. The Company uses historical data of employee behavior as a basis to estimate the expected life of the options, as well as forfeitures due to employee terminations. The Company also uses its actual dividend yield at the time of the grant, as well as actual U.S. Treasury yields in effect at the time of the grant to estimate the risk-free rate. The following weighted-average assumptions were used to value 412,500 options granted during 2012: risk free interest rate of 1.50%, dividend yield of 1.18%, expected stock volatility of 25%, and expected term to exercise of 7.5 years. The following weighted-average assumptions were used to value 438,500 options granted during 2011: risk free interest rate of 2.06%, dividend yield of 2.00%, expected stock volatility of 25%, and expected term to exercise of 7.5 years. The following weighted-average assumptions were used to value 120,000 options granted during 2010: risk free interest rate of 2.42%, dividend yield of 2.44%, expected stock volatility of 25.0%, and expected term to exercise of 7.5 years.
The Company maintains an ESOP for employees that had attained at least 21 years of age and completed one year of service as of December 31, 2010. The ESOP is a qualifying plan under Internal Revenue Service guidelines. In 2000 and 2001, the ESOP borrowed a total of $8,999 and purchased 3,271,946 of the Company’s common shares on various dates in 2000, 2001, and 2002. ESOP expense was recognized based on the fair value (average stock price) of shares scheduled to be released from the ESOP trust. Beginning in 2001, one-tenth of the shares were scheduled to be released each year. Also, additional shares could have been released as the ESOP trust received cash dividends from the unallocated shares held in the trust. As of December 31, 2011, no shares remained to be allocated in the ESOP. ESOP expense was zero for both of the years ended December 31, 2012 and 2011, and was $782 for the year ended December 31, 2010.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
11. Stock-Based Benefit Plans (continued)
The Company has no stock compensation plans that have not been approved by shareholders.
12. Income Taxes
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and Wisconsin and Minnesota. The Company is no longer subject to U.S. federal and Minnesota income tax examinations by tax authorities for years prior to 2007 and, for Wisconsin, years prior to 1997. If any interest and/or penalties would be imposed by an appropriate taxing authority, the Company would report the interest component through other non-interest expense and penalties through income tax expense. The Company had no material uncertain tax positions and had not recorded a liability for unrecognized tax benefits as of or during the three years ended December 31, 2012.
The provision for income taxes consists of the following:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Current income tax expense (benefit): | | | | | | | | | | | | |
| Federal | | $ | 47 | | | $ | 45 | | | $ | (17,924 | ) |
| State | | | 3 | | | | (123 | ) | | | 90 | |
| Current income tax expense (benefit) | | | 50 | | | | (78 | ) | | | (17,834 | ) |
| Deferred income tax expense (benefit): | | | | | | | | | | | | |
| Federal | | | 2,629 | | | | 1,475 | | | | (22,388 | ) |
| State | | | 657 | | | | 355 | | | | (9,687 | ) |
| Deferred income tax expense (benefit) | | | 3,286 | | | | 1,830 | | | | (32,075 | ) |
| Income tax expense (benefit) | | $ | 3,336 | | | $ | 1,752 | | | $ | (49,909 | ) |
Income tax expense (benefit) differs from the provision computed at the federal statutory corporate rate as follows:
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Income (loss) before income taxes | | $ | 10,038 | | | $ | (45,863 | ) | | $ | (122,548 | ) |
| Tax expense (benefit) at federal statutory rate | | $ | 3,531 | | | $ | (16,035 | ) | | $ | (42,892 | ) |
| Increase (decrease) in taxes resulting from: | | | | | | | | | | | | |
| State income taxes, net of federal tax benefit | | | 429 | | | | 239 | | | | (6,269 | ) |
| Bank-owned life insurance | | | (741 | ) | | | (831 | ) | | | (842 | ) |
| Goodwill impairment | | | – | | | | 18,399 | | | | – | |
| Reversal of valuation allowance, net of federal benefit | | | – | | | | (135 | ) | | | – | |
| Other | | | 117 | | | | 115 | | | | 94 | |
| Income tax expense (benefit) | | $ | 3,336 | | | $ | 1,752 | | | $ | (49,909 | ) |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
12. Income Taxes (continued)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of the Company’s deferred tax assets and liabilities are summarized as follows:
| | | December 31 | |
| | | 2012 | | | 2011 | |
| Deferred tax assets: | | | | | | | | |
| Federal net operating losses and AMT credits | | $ | 18,441 | | | $ | 18,914 | |
| Pension | | | 9,400 | | | | 10,588 | |
| Loan loss reserves | | | 8,662 | | | | 11,211 | |
| State net operating losses | | | 6,172 | | | | 6,229 | |
| Non-deductible losses on foreclosed real estate | | | 2,836 | | | | 3,365 | |
| Deferred compensation | | | 1,558 | | | | 1,460 | |
| Other-than-temporary impairment of investment securities | | | 258 | | | | 156 | |
| Restricted stock amortization | | | 205 | | | | 154 | |
| Other | | | 1,371 | | | | 1,013 | |
| Total deferred tax assets | | | 48,903 | | | | 53,090 | |
| Deferred tax liabilities: | | | | | | | | |
| Unrealized gain on investment securities | | | 4,273 | | | | 3,094 | |
| Purchase accounting adjustments | | | 2,967 | | | | 3,125 | |
| Mortgage servicing rights | | | 2,737 | | | | 2,970 | |
| FHLB stock dividends | | | 2,592 | | | | 5,130 | |
| Property and equipment depreciation | | | 1,776 | | | | 1,095 | |
| Other | | | 347 | | | | 222 | |
| Total deferred tax liabilities | | | 14,692 | | | | 15,636 | |
| Net deferred tax asset | | $ | 34,211 | | | $ | 37,454 | |
As of December 31, 2012, the Company had $49,623 and $118,701 in net operating loss carryovers for federal and state income tax purposes, respectively, and $1,073 in AMT credit carryovers available to offset against future income. The net operating loss carryovers expire in various years through 2031 if unused. The AMT credit carryovers have no expiration date.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
13. Financial Instruments with Off-Balance-Sheet Risk
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated statements of financial condition. The contract amounts reflect the extent of involvement the Company has in particular classes of financial instruments and also represents the Company’s maximum exposure to credit loss.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and generally require payment of a fee. As some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates the collateral needed and creditworthiness of each customer on a case by case basis. The Company generally extends credit only on a secured basis. Collateral obtained varies, but consists principally of one- to four-family residences.
Off-balance sheet financial instruments or obligations whose contract amounts represent credit risk and/or interest rate risk are summarized in the following table as of the dates indicated:
| | | December 31 | |
| | | 2012 | | | 2011 | |
| Unused consumer lines of credit | | $ | 152,109 | | | $ | 151,807 | |
| Unused commercial lines of credit | | | 75,354 | | | | 43,518 | |
| Commitments to extend credit: | | | | | | | | |
| Fixed rate | | | 15,054 | | | | 23,793 | |
| Adjustable rate | | | 20,894 | | | | 17,197 | |
| Undisbursed commercial loans | | | 3,000 | | | | 870 | |
| Standby letters of credit | | | 1,512 | | | | 410 | |
The Company sells substantially all of its long-term, fixed-rate, one- to four-family loan originations in the secondary market. The Company uses derivative instruments to manage interest rate risk associated with these activities. Specifically, the Company enters into interest rate lock commitments (“IRLCs”) with borrowers, which are considered to be derivative instruments. The Company manages its exposure to interest rate risk in IRLCs (as well as interest rate risk in its loans held-for-sale) by entering into forward commitments to sell loans to the Fannie Mae. Commitments to sell loans expose the Company to interest rate risk if market rates of interest decrease during the commitment period. Such forward commitments are considered to be derivative instruments. These derivatives are not designated as accounting hedges as specified in GAAP. As such, changes in the fair value of the derivative instruments are recognized currently through earnings.
As of December 31, 2012 and 2011, net unrealized gains of $1,215 and $243, respectively, were recognized in net gain on loan sales activities on the derivative instruments specified in the previous paragraph. These amounts were exclusive of net unrealized gains of $277 and $507 on loans held-for-sale as of those dates, respectively, which were also included in net gain on loan sales activities.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
13. Financial Instruments with Off-Balance-Sheet Risk (continued)
The following table summarizes the Company’s derivative assets and liabilities as of the dates indicated.
| | | December 31, 2012 | | | December 31, 2011 | |
| | | Notional
Amount | | | Fair Value | | | Notional
Amount | | | Fair Value | |
| Interest rate lock commitments | | $ | 83,882 | | | $ | 1,414 | | | $ | 52,699 | | | $ | 1,012 | |
| Forward commitments | | | 75,750 | | | | (199 | ) | | | 62,025 | | | | (769 | ) |
| Net unrealized gains | | | | | | $ | 1,215 | | | | | | | $ | 243 | |
The unrealized gains shown in the above table were included as a component of other assets as of the dates indicated. The unrealized losses were included in other liabilities as of the dates indicated.
14. Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company primarily applies the market approach for recurring value measurements and endeavors to utilize the best available information. Accordingly, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company is able to classify fair value balances based on the observability of those inputs. Accounting guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1), the next highest priority is given to prices based on models, methodologies, and/or management judgments that rely on direct or indirect observable inputs (Level 2), and the lowest priority to prices derived from models, methodologies, and/or management judgments that rely on significant unobservable inputs (Level 3). There were no transfers of assets or liabilities between categories of the fair value hierarchy during the years ended December 31, 2012 and 2011.
The following methods and assumptions are used by the Company in estimating its fair value disclosures of financial instruments:
Cash and Cash Equivalents The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate those assets’ fair values. The Company considers the fair value of cash and cash equivalents to be Level 1 in the fair value hierarchy.
Mortgage-Related Securities Available-for-Saleand Held-to-Maturity Fair values for these securities are based on price estimates obtained from a third-party independent pricing service. This service utilizes pricing models that vary by asset class and incorporate available trade, bid, ask and other market information of comparable instruments. For structured securities, such as CMOs, the pricing models include cash flow estimates that consider the impact of loan performance data, including, but not limited to, expectations relating to loan prepayments, default rates, and loss severities. Management has reviewed the pricing methodology used by its pricing service to verify that prices are determined in accordance with the fair value guidance specified in GAAP. The Company considers the fair value of mortgage-related securities to be Level 2 in the fair value hierarchy.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
14. Fair Value Measurements (continued)
Loans Held-for-Sale The fair value of loans held-for-sale is based on the current market price for securities collateralized by similar loans. The Company considers the fair value of loans held-for-sale to be Level 2 in the fair value hierarchy.
Loans ReceivableLoans receivable are segregated by type such as one- to four-family, multi-family, and commercial real estate mortgage loans, consumer loans, and commercial business loans. The fair value of each type is calculated by discounting scheduled cash flows through the expected maturity of the loans using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan type. The estimated maturity is based on the Company’s historical experience with prepayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. The Company considers the fair value of loans receivable to be Level 3 in the fair value hierarchy.
Mortgage Servicing Rights The Company has calculated the fair market value of mortgage servicing rights for those loans that are sold with servicing rights retained. For valuation purposes, loans are stratified by product type and, within product type, by interest rates. The fair value of mortgage servicing rights is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing cost and other factors. The Company considers the fair value of mortgage servicing rights to be Level 3 in the fair value hierarchy.
The following table summarizes the significant inputs utilized by the Company to estimate the fair value of its MSRs as of December 31, 2012:
| | | Weighted-
Average | | | Range |
| Loan size | | $ | 126 | | | $2 - $415 |
| Contractual interest rate | | | 4.02 | % | | 2.00% - 7.75% |
| Constant prepayment rate (“CPR”) | | | 22.32 | % | | 15.78% - 29.22% |
| Remaining maturity in months | | | 259 | | | 39 - 417 |
| Servicing fee | | | 0.25 | % | | – |
| Annual servicing cost per loan (not in thousands) | | $ | 82.66 | | | – |
| Annual ancillary income per loan (not in thousands) | | $ | 54.81 | | | – |
| Discount rate | | | 3.07 | % | | 2.63% - 3.38% |
MSR pools with an amortized cost basis greater than fair value are carried at fair value in the Company’s financial statements. Pools determined to be impaired at December 31, 2012, had an amortized cost basis of $8,523 and a fair value of $6,127 as of that date. Accordingly, the Company recorded a valuation allowance of $2,396 as of December 31, 2012, as well as a corresponding loss of $1,528 during the twelve month period then ended, which was equal to the change in the valuation allowance during that period. Pools determined to be impaired at December 31, 2011, had an amortized cost basis of $6,812 and a fair value of $5,944 as of that date. Accordingly, the Company recorded a valuation allowance of $868 as of December 31, 2011, as well as a corresponding loss of $862 during the twelve month period then ended, which was equal to the change in the valuation allowance during that period.
Federal Home Loan Bank Stock FHLB of Chicago stock is carried at cost, which is its redeemable (fair) value, since the market for this stock is restricted. The Company considers the fair value of FHLB of Chicago stock to be Level 2 in the fair value hierarchy.
Accrued Interest Receivable and Payable The carrying values of accrued interest receivable and payable approximate their fair value. The Company considers the accrued interest receivable and payable to be Level 2 in the fair value hierarchy.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
14. Fair Value Measurements (continued)
Deposit Liabilities and Advance Payments by Borrowers for Taxes and Insurance Fair value for demand deposits equal book value. The Company considers the fair value of demand deposits to be Level 2 in the fair value hierarchy. Fair values for certificate of deposits are estimated using a discounted cash flow calculation that applies
current market borrowing interest rates to a schedule of aggregated expected monthly maturities on deposits. The Company considers the fair value of certificates of deposit to be Level 3 in the fair value hierarchy. The advance payments by borrowers for taxes and insurance are equal to their carrying amounts at the reporting date. The Company considers the fair value of advance payments by borrowers to be Level 2 in the fair value hierarchy.
BorrowingsThe fair value of long-term borrowings is estimated using discounted cash flow calculations with the discount rates equal to interest rates currently being offered for borrowings with similar terms and maturities. The carrying value on short-term borrowings approximates fair value. The Company considers the fair value of borrowings to be Level 2 in the fair value hierarchy.
Off-Balance Sheet Financial InstrumentsOff-balance sheet financial instruments consist of commitments to extend credit, IRLCs, and forward commitments to sell loans. Commitments to extend credit that are not IRLCs generally carry variable rates of interest. As such, the fair value of these instruments is not material. The Company considers the fair value of these instruments to be Level 2 in the fair value hierarchy. The carrying value of IRLCs and forward commitments to sell loans, which is equal to their fair value, is the difference between the current market prices for securities collateralized by similar loans and the notional amounts of the IRLCs and forward commitments. The Company considers the fair value of IRLCs and forward commitments to sell loans to be Level 2 in the fair value hierarchy.
The carrying values and fair values of the Company’s financial instruments are presented in the following table as of the indicated dates.
| | | December 31, 2012 | | | December 31, 2011 | |
| | | Carrying
Value | | | Fair
Value | | | Carrying
Value | | | Fair
Value | |
| Cash and cash equivalents | | $ | 87,059 | | | $ | 87,059 | | | $ | 120,935 | | | $ | 120,935 | |
| Mortgage related securities available-for-sale | | | 550,185 | | | | 550,185 | | | | 781,770 | | | | 781,770 | |
| Mortgage related securities held-to-maturity | | | 157,558 | | | | 163,589 | | | | – | | | | – | |
| Loans held-for-sale | | | 10,739 | | | | 10,739 | | | | 19,192 | | | | 19,192 | |
| Loans receivable, net | | | 1,402,246 | | | | 1,400,415 | | | | 1,319,636 | | | | 1,284,651 | |
| Mortgage servicing rights, net | | | 6,821 | | | | 7,032 | | | | 7,401 | | | | 7,577 | |
| Federal Home Loan Bank stock | | | 15,841 | | | | 15,841 | | | | 46,092 | | | | 46,092 | |
| Accrued interest receivable | | | 6,257 | | | | 6,257 | | | | 6,521 | | | | 6,521 | |
| Deposit liabilities | | | 1,867,899 | | | | 1,807,016 | | | | 2,021,663 | | | | 1,968,842 | |
| Borrowings | | | 210,786 | | | | 227,957 | | | | 153,091 | | | | 167,418 | |
| Advance payments by borrowers | | | 4,956 | | | | 4,956 | | | | 3,192 | | | | 3,192 | |
| Accrued interest payable | | | 476 | | | | 476 | | | | 750 | | | | 750 | |
| Unrealized gain (loss) on off-balance-sheet items: | | | | | | | | | | | | | | | | |
| Interest rate lock commitments on loans | | | 1,414 | | | | 1,414 | | | | 1,012 | | | | 1,012 | |
| Forward commitments to sell loans | | | (199 | ) | | | (199 | ) | | | (769 | ) | | | (769 | ) |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
14. Fair Value Measurements (continued)
The following table segregates by fair value hierarchy (i.e., Level 1, 2, or 3) all of the Company’s assets and liabilities as of December 31, 2011 and 2010, that are measured at fair value on a recurring basis.
| | | December 31, 2012 | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Loans held-for-sale | | | – | | | $ | 10,739 | | | | – | | | $ | 10,739 | |
| Mortgage-related securities available-for-sale | | | – | | | | 550,185 | | | | – | | | | 550,185 | |
| Total | | | – | | | $ | 560,924 | | | | – | | | $ | 560,924 | |
| | | December 31, 2011 | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Loans held-for-sale | | | – | | | $ | 19,192 | | | | – | | | $ | 19,192 | |
| Mortgage-related securities available-for-sale | | | – | | | | 781,770 | | | | – | | | | 781,770 | |
| Total | | | – | | | $ | 800,962 | | | | – | | | $ | 800,962 | |
Impaired Loans For non-accrual loans greater than an established threshold and individually evaluated for impairment and all renegotiated loans, impairment is measured based on: (i) the fair value of the loan or the fair value of the collateral less estimated selling costs (collectively the “collateral value method”) or (ii) the present value of the estimated cash flows discounted at the loan’s original effective interest rate (the “discounted cash flow method”). The resulting valuation allowance, if any, is a component of the allowance for loan losses. The discounted cash flow method is a fair value measure. For the collateral value method, the Company generally obtains appraisals on a periodic basis to support the fair value of collateral underlying the loans. Appraisals are performed by independent certified and/or licensed appraisers that have been reviewed by the Company and incorporate information such as recent sales prices for comparable properties, costs of construction, and net operating income of the property or business. Selling costs are generally estimated at 10%. Appraised values may be further discounted based on management judgment regarding changes in market conditions and other factors since the time of the appraisal. A significant unobservable input in using net operating income to estimate fair value
is the capitalization rate. At December 31, 2012, the range of capitalization rates utilized to determine the fair value of the underlying collateral on certain loans was 6% to 12%. The Company considers these fair values to be Level 3 in the fair value hierarchy. For those loans individually evaluated for impairment using the collateral value method, a valuation allowance of $2,041 was recorded for loans with a recorded investment of $57,638 at December 31, 2012. These amounts were $8,305 and $103,627 at December 31, 2011, respectively.Provision for loan losses related to these loans was $428 and $1,257 in 2012 and 2011, respectively.
Foreclosed Properties Foreclosed properties acquired through, or in lieu of, loan foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. In determining fair value, the Company generally obtains appraisals to support the fair value of foreclosed properties, as described in the previous paragraph. In certain instances, the Company may also use the selling list price, less estimated costs to sell, as the fair value of foreclosed properties. In such instances, the list price is generally less than the appraised value. The Company considers these fair values to be Level 3 in the fair value hierarchy. As of December 31, 2012, $12,170 in foreclosed properties were valued at collateral value compared to $22,655 at December 31, 2011. Losses of $2,497 and $4,639 related to these foreclosed properties valued at collateral value were recorded during the twelve months ended December 31, 2012 and 2011, respectively.
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
15. Condensed Parent Company Only Financial Statements
STATEMENT OF FINANCIAL CONDITION
| | | December 31 | |
| | | 2012 | | | 2011 | |
| Assets | | | | | | | | |
| | | | | | | | | |
| Cash and cash equivalents | | $ | 3,284 | | | $ | 2,067 | |
| Investment in subsidiary | | | 266,513 | | | | 262,002 | |
| Other assets | | | 2,056 | | | | 1,807 | |
| | | | | | | | | |
| Total assets | | $ | 271,853 | | | $ | 265,876 | |
| | | | | | | | | |
| Liabilities and shareholders’ equity | | | | | | | | |
| | | | | | | | | |
| Other liabilities | | | – | | | $ | 105 | |
| Shareholders’ equity: | | | | | | | | |
| Common stock–$0.01 par value: | | | | | | | | |
| Authorized–200,000,000 shares in 2012 and 2011 | | | | | | | | |
| Issued–78,783,849 shares in 2012 and 2011 | | | | | | | | |
| Outstanding–46,326,484 in 2012 and 46,228,984 shares in 2011 | | $ | 788 | | | | 788 | |
| Additional paid-in capital | | | 489,960 | | | | 490,159 | |
| Retained earnings | | | 145,231 | | | | 140,793 | |
| Accumulated other comprehensive income (loss) | | | (4,717 | ) | | | (5,379 | ) |
| Treasury stock–32,457,365 shares in 2012 and 32,554,865 shares in 2011 | | | (359,409 | ) | | | (360,590 | ) |
| Total shareholders’ equity | | | 271,853 | | | | 265,771 | |
| | | | | | | | | |
| Total liabilities and shareholders’ equity | | $ | 271,853 | | | $ | 265,876 | |
STATEMENT OF INCOME
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Total income | | $ | 3 | | | $ | 17 | | | $ | 43 | |
| Total expenses | | | 796 | | | | 863 | | | | 846 | |
| Loss before income taxes | | | (793 | ) | | | (846 | ) | | | (803 | ) |
| Income tax benefit | | | (306 | ) | | | (464 | ) | | | (313 | ) |
| Loss before equity in earnings of subsidiary | | | (487 | ) | | | (382 | ) | | | (490 | ) |
| Equity in earnings (loss) of subsidiary | | | 7,241 | | | | (47,183 | ) | | | (72,150 | ) |
| | | | | | | | | | | | | |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) |
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2012
(Dollars in thousands, except share and per share amounts)
15. Condensed Parent Company Only Financial Statements (continued)
STATEMENT OF TOTAL COMPREHENSIVE INCOME
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) |
| Other comprehensive income (loss), net of income taxes: | | | | | | | | | | | | |
| Unrealized holding gains (losses) during the period: | | | | | | | | | | | | |
| Non-credit portion of OTTI on securities available-for sale, net of deferred income taxes of $(196) in 2012 and $(563) in 2011 | | | (293 | ) | | | (842 | ) | | | – | |
| Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $1,593 in 2012, $5,028 in 2011, and $6,259 in 2010 | | | 2,378 | | | | 7,511 | | | | 9,347 | |
| Reclassification adjustment for gain on securities included in income, net of income taxes of $(218) in 2012, $(446) in 2011, and $(6,403) in 2010 | | | (325 | ) | | | (667 | ) | | | (9,563 | ) |
| | | | 1,760 | | | | 6,002 | | | | (216 | ) |
| Defined benefit pension plans: | | | | | | | | | | | | |
| Pension asset, net of deferred income taxes of $(732) in 2012, $(2,990) in 2011, and $(2,850) in 2010 | | | (1,098 | ) | | | (4,484 | ) | | | (4,275 | ) |
| | | | (1,098 | ) | | | (4,484 | ) | | | (4,275 | ) |
| Total other comprehensive income, net of income taxes | | | 662 | | | | 1,518 | | | | (4,491 | ) |
| | | | | | | | | | | | | |
| Total comprehensive income (loss) | | $ | 7,416 | | | $ | (46,047 | ) | | $ | (77,131 | ) |
STATEMENT OF CASH FLOWS
| | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Operating activities: | | | | | | | | | | | | |
| Net income (loss) | | $ | 6,754 | | | $ | (47,565 | ) | | $ | (72,640 | ) |
| Adjustment to reconcile net income (loss) to net cash provided by operating activities: | | | | | | | | | | | | |
| Equity in loss (earnings) of Bank subsidiary | | | (7,241 | ) | | | 47,183 | | | | 72,150 | |
| Stock-based compensation | | | 88 | | | | 67 | | | | 39 | |
| Change in other operating activities | | | (353 | ) | | | (1,577 | ) | | | 1,547 | |
| Net cash provided (used) by operating activities | | | (752 | ) | | | (1,892 | ) | | | 1,096 | |
| Investing activities: | | | | | | | | | | | | |
| Dividends from Bank subsidiary | | | 4,130 | | | | 730 | | | | 7,450 | |
| Other investing activities | | | (409 | ) | | | 170 | | | | 78 | |
| Net cash provided by investing activities | | | 3,721 | | | | 900 | | | | 7,528 | |
| Financing activities: | | | | | | | | | | | | |
| Cash dividends | | | (2,316 | ) | | | (2,880 | ) | | | (8,640 | ) |
| Purchase of treasury stock | | | – | | | | – | | | | (5,029 | ) |
| Proceeds from exercise of stock options | | | – | | | | 1,416 | | | | 359 | |
| Excess tax benefit from exercise of stock options | | | 564 | | | | 49 | | | | 26 | |
| Payments received on ESOP | | | – | | | | – | | | | 347 | |
| Net cash used in financing activities | | | (1,752 | ) | | | (1,415 | ) | | | (12,937 | ) |
| Decrease in cash and cash equivalents | | | 1,217 | | | | (2,407 | ) | | | (4,313 | ) |
| Cash and cash equivalents at beginning of year | | | 2,067 | | | | 4,474 | | | | 8,787 | |
| | | | | | | | | | | | | |
| Cash and cash equivalents at end of year | | $ | 3,284 | | | $ | 2,067 | | | $ | 4,474 | |
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The management of the Company, including its Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of 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 that evaluation, the Chief Executive Officer and Chief Financial Officer concluded as of December 31, 2012, that the disclosure controls and procedures were effective.
Change in 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 final fiscal quarter of the year to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. The Company’s management, including its Chief Executive Officer and Chief Financial Officer, has assessed the effectiveness of its internal control over financial reporting as of December 31, 2012, based on the criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).Based upon its assessment and those criteria, management believes that as of December 31, 2012, the Company’s internal control over financial reporting was effective.
Deloitte & Touche LLP, the Company’s independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as a part of its audit, has audited the effectiveness of the Company’s internal control over financial reporting. That report can be found on the following page as part of this Item 9A.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Bank Mutual Corporation
Milwaukee, Wisconsin
We have audited the internal control over financial reporting of Bank Mutual Corporation and subsidiaries (the “Company”) as of December 31, 2012, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2012 of the Company and our report dated March 8, 2013 expressed an unqualified opinion on those financial statements.
/s/ Deloitte & Touche LLP
Milwaukee, Wisconsin
March 8, 2013
Item 9B. Other Information
Not applicable.
Part III
Item 10. Directors, Executive Officers, and Corporate Governance
Information in response to this item is incorporated herein by reference to “Election of Directors”, “Section 16(a) Beneficial Ownership Reporting Compliance”, and “Executive Officers” in the Company’s definitive Proxy Statement for its Annual Meeting of Shareholders on May 6, 2013 (the “2013 Annual Meeting Proxy Statement”).
Item 11. Executive Compensation
Information in response to this item is incorporated by reference to “Election of Directors—Board Meetings and Committees—Compensation Committee Interlocks and Insider Participation,” “Directors' Compensation,” “Compensation Discussion and Analysis,” “Compensation Committee Report on Executive Compensation,” “Executive Compensation,” and “Risk Management and Compensation” in the 2013 Annual Meeting Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information in response to this item is incorporated by reference to “Security Ownership of Certain Beneficial Owners” in the 2013 Annual Meeting Proxy Statement.
The following chart gives aggregate information regarding grants under all equity compensation plans of the Company through December 31, 2012.
| Plan category | | Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights | | | Weighted-average
exercise price of
outstanding options,
warrants and rights | | | Number of securities
remaining available
for future issuance under
equity compensation
plans (excluding
securities reflected
in 1st column) | |
| Equity compensation plans approved by security holders (1) | | | 2,671,000 | | | $ | 8.4711 | | | | 1,141,583 | |
| Equity compensation plans not approved by security holders | | | None | | | | None | | | | None | |
| (1) | All amounts in these columns relate to the 2004 Plan, which was approved by the shareholders in 2004. |
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information in response to this item is incorporated by reference to “Election of Directors—Board Meetings and Committees” and “Certain Transactions and Relationships with the Company” in the 2013 Annual Meeting Proxy Statement.
Item 14. Principal Accountant Fees and Services
Information in response to this item is incorporated by reference to “Independent Registered Public Accounting Firm” in the 2013 Annual Meeting Proxy Statement.
Part IV
Item 15. Exhibits, Financial Statement Schedules
(a) Documents filed as part of the Report:
1. and 2. Financial Statements and Financial Statement Schedules.
The following consolidated financial statements of the Company and subsidiaries are filed as part of this report under “Item 8. Financial Statements and Supplementary Data”:
| · | Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm, on the consolidated financial statements. |
| · | Consolidated Statements of Financial Condition—As of December 31, 2012 and 2011. |
| · | Consolidated Statements of Income—Years Ended December 31, 2012, 2011, and 2010. |
| · | Consolidated Statements of Total Comprehensive Income—Years Ended December 31, 2012, 2011, and 2010 |
| · | Consolidated Statements of Equity—Years Ended December 31, 2012, 2011, and 2010. |
| · | Consolidated Statements of Cash Flows—Years Ended December 31, 2012, 2011, and 2010. |
| · | Notes to Consolidated Financial Statements. |
All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
(b) Exhibits. Refer to the Exhibit Index following the signature page of this report, which is incorporated herein by reference. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this report is identified in the Exhibit Index by an asterisk following its exhibit number.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 |
| March 8, 2013 | | |
| | | |
| | By: | /s/ Michael T. Crowley, Jr. |
| | | Michael T. Crowley, Jr. |
| | | Chairman and Chief Executive Officer |
_________________
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes Michael T. Crowley, Jr., Michael W. Dosland, Richard L. Schroeder or any of them, as attorneys-in-fact with full power of substitution, to execute in the name and on behalf of such person, individually, and in each capacity stated below or otherwise, and to file, any and all amendments to this report.
________________
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.*
Signature and Title
| /s/ Michael T. Crowley, Jr. | | /s/ Thomas H. Buestrin |
| Michael T. Crowley, Jr., Chairman, | | Thomas H. Buestrin, Director |
| Chief Executive Officer, and Director | | |
| (Principal Executive Officer) | | |
| | | |
| /s/ David A. Baumgarten | | /s/ Mark C. Herr |
| David A. Baumgarten, President and Director | | Mark C. Herr, Director |
| | | |
| /s/ Michael W. Dosland | | /s/ Thomas J. Lopina, Sr. |
Michael W. Dosland, Senior Vice President and
Chief Financial Officer (Principal Financial Officer) | | Thomas J. Lopina, Sr., Director |
| | | |
| /s/ Richard L. Schroeder | | /s/ William J. Mielke |
| Richard L. Schroeder, Vice President and | | William J. Mielke, Director |
| Controller (Principal Accounting Officer) | | |
| | | |
| /s/ David C. Boerke | | /s/ Robert B. Olson |
| David C. Boerke, Director | | Robert B. Olson, Director |
| | | |
| /s/ Richard A. Brown | | /s/ Jelmer G. Swoboda |
| Richard A. Brown, Director | | Jelmer G. Swoboda, Director |
* Each of the above signatures is affixed as of March 8, 2013.
BANK MUTUAL CORPORATION
(“Bank Mutual Corporation” or the “Company”)
Commission File No. 000-32107
EXHIBIT INDEX
TO
2012 REPORT ON FORM 10-K
The following exhibits are filed with, or incorporated by reference in, this Report on Form 10-K for the year ended December 31, 2012:
| Exhibit | | Description | | Incorporated Herein by
Reference To | | Filed
Herewith |
| | | | | | | |
| 3(i) | | Restated Articles of Incorporation, as last amended May 29, 2003, of Bank Mutual Corporation (the “Articles”) | | Exhibit 3(i) to the Company's Registration Statement on Form S-1, Registration No. 333-105685 | | |
| | | | | | | |
| 3(ii) | | Bylaws, as last amended May 7, 2007, of Bank Mutual Corporation | | Exhibit 3.1 to the Company’s Report on Form 8-K dated May 7, 2007 | | |
| | | | | | | |
| 4.1 | | The Articles | | Exhibit 3(i) above | | |
| | | | | | | |
| 10.1* | | Bank Mutual Corporation Savings Restoration Plan and Bank Mutual Corporation ESOP Restoration Plan | | Exhibit 10.1(b) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 (“2003 10-K”) | | |
| | | | | | | |
| 10.2* | | Bank Mutual Corporation Outside Directors’ Retirement Plan | | Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 10-K”) | | |
| | | | | | | |
| 10.3* | | Mutual Savings Bank Executive Excess Benefit Plan ** | | Exhibit 10.3 to Bank Mutual Corporation’s Registration Statement on Form S-1, Registration No. 333-39362 (“2000 S-1”) | | |
| | | | | | | |
| 10.4* | | Agreement regarding deferred compensation dated May 16, 1988 between Mutual Savings Bank and Michael T. Crowley, Sr. | | Exhibit 10.4 to 2000 S-1 | | |
| | | | | | | |
| 10.5(a)* | | Employment Agreement between Mutual Savings Bank and Michael T. Crowley Jr. dated December 21, 1993 (continuing , as amended, through 2015) | | Exhibit 10.5(a) to 2000 S-1 | | |
| | | | | | | |
| 10.5(b)* | | Amendment thereto dated February 17, 1998 | | Exhibit 10.5(b) to 2000 S-1 | | |
| | | | | | | |
| 10.6* | | Form of Employment Agreement (with Messrs. Anderegg, Dosland, Larson, and Mayne; continuing through 2013) | | Exhibit 10.6(c) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (“2010 10-K”) | | |
| | | | | | | |
| Exhibit | | Description | | Incorporated Herein by
Reference To | | Filed
Herewith |
| | | | | | | |
| 10.7* | | Employment Agreement of Mr. Baumgarten with Bank Mutual dated as of April 5, 2010 (continuing through 2014) | | Exhibit 10.1 to the Company’s Report on Form 8-K dated April 5, 2010 | | |
| | | | | | | |
| 10.8(a)* | | Non-Qualified Deferred Retirement Plan for Directors of First Northern Savings Bank | | Exhibit 10.10(a) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000 | | |
| | | | | | | |
| 10.8(b)* | | Amendment No. 1 thereto | | Exhibit 10.3.2 to First Northern Capital Corp.’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998 | | |
| | | | | | | |
| 10.9(a)* | | Bank Mutual Corporation 2004 Stock Incentive Plan | | Appendix A to Proxy Statement for 2004 Annual Meeting of Shareholders | | |
| | | | | | | |
| 10.9(b)(i)* | | Form of Option Agreement thereunder—Bank Mutual Corporation Director Stock Option Agreement (superseded) | | Exhibit 10.1(b) to the Company’s Report on Form 10-Q for the quarter ended June 30, 2004 (“6/30/04 10-Q”) | | |
| | | | | | | |
| 10.9(b)(ii)* | | 2011 updated Form of Bank Mutual Corporation Director Stock Option Agreement | | Exhibit 10.11(b)(ii) to the 2010 10-K | | |
| | | | | | | |
| 10.9(c)(i)* | | Form of Option Agreement thereunder—Bank Mutual Corporation Incentive Stock Option Agreement (superseded) | | Exhibit 10.1(c ) to the 6/30/04 10-Q | | |
| | | | | | | |
| 10.9(c)(ii)* | | 2010 updated Form of Bank Mutual Corporation Incentive Stock Option Agreement | | Exhibit 10.11(c )(ii) to the 2010 10-K | | |
| | | | | | | |
| 10.9(c)(iii)* | | 2012 alternate Form of Bank Mutual Corporation Incentive Stock Option Agreement | | Exhibit 10.10(c)(iii) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 10-K”) | | |
| | | | | | | |
| 10.9(d)* | | Form of Restricted Stock Agreement thereunder - Bank Mutual Corporation Directors Management Recognition Award | | Exhibit 10.1(d) to the 6/30/04 10-Q | | |
| | | | | | | |
| 10.9(e)(i)* | | Form of Restricted Stock Agreement thereunder—Bank Mutual Corporation Officers Management Recognition Award | | Exhibit 10.1(e) to the 6/30/04 10-Q | | |
| | | | | | | |
| 10.9(e)(ii)* | | 2011 updated Form of Bank Mutual Corporation Officers Management Recognition Award | | Exhibit 10.11(e)(ii) to the 2010 10-K | | |
| Exhibit | | Description | | Incorporated Herein by
Reference To | | Filed
Herewith |
| | | | | | | |
| 10.9(e)(iii)* | | 2012 alternate Form of Bank Mutual Corporation Officers Management Recognition Award | | Exhibit 10.10(e)(iii) to the 2011 10-K | | |
| | | | | | | |
| 10.10* | | Bank Mutual Corporation Management Incentive Plan updated for 2012 | | Exhibit 10.11(b) to the 2011 10-K | | |
| | | | | | | |
| 21.1 | | List of Subsidiaries | | | | X |
| | | | | | | |
| 23.1 | | Consent of Deloitte & Touche LLP | | | | X |
| | | | | | | |
| 24.1 | | Powers of Attorney | | Signature Page of this Report | | |
| | | | | | | |
| 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 Senior Vice President and 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 Senior Vice President and Chief Financial Officer of Bank Mutual Corporation | | | | X |
| | | | | | | |
| 101+ | | The following materials are furnished from Bank Mutual Corporation’s Annual Report on Form 10-K for the year ended December 31, 2012, formatted in Extensible Business Reporting Language (“XBRL”): (i) the Unaudited Condensed Consolidated Statements of Financial Condition, (ii) Unaudited Condensed Consolidated Statements of Income, (iii) Unaudited Condensed Consolidated Statements of Equity, (iv) Unaudited Condensed Consolidated Statements of Cash Flow, and (v) Notes to Unaudited Condensed Consolidated Financial Statements tagged as blocks of text. |
| | | | | | | |
| 101.INS+ | | XBRL Instance Document | | | | X |
| | | | | | | |
| 101.SCH+ | | XBRL Taxonomy Extension Schema Document | | | | X |
| | | | | | | |
| 101.CAL+ | | XBRL Taxonomy Extension Calculation Linkbase Document | | | | X |
| | | | | | | |
| 101.LAB+ | | XBRL Extension Labels Linkbase Document | | | | X |
| Exhibit | | Description | | Incorporated Herein by
Reference To | | Filed
Herewith |
| | | | | | | |
| 101.PRE+ | | XBRL Taxonomy Extension Presentation Linkbase Document | | | | X |
| | | | | | | |
| 101.DEF+ | | XBRL Taxonomy Extension Definition Linkbase Document | | | | X |
| * | Designates management or compensatory agreements, plans or arrangements required to be filed as exhibits pursuant to Item 15(b) of Form 10-K. |
| ** | Mutual Savings Bank is now known as “Bank Mutual.” |
| + | In accordance with SEC rules, this interactive data file is deemed “furnished” and not “filed” for purposes of Sections 11 or 12 of the Securities Act of 1933 and Section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under those sections or acts. |
