Bank Mutual (BKMU) 10-Q 2016 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period endedSeptember 30, 2016

OR

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

Commission File Number:001-36528

BANK MUTUAL CORPORATION

(Exact name of registrant as specified in its charter)

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

4949 West Brown Deer Road

Milwaukee, Wisconsin  53223

(414) 354-1500

(Address, including Zip Code, and telephone number,

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

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

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)

Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨	Small reporting company	¨

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

Yes ¨ No x

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was45,671,782 shares, at November 7, 2016.

BANK MUTUAL CORPORATION

FORM 10-Q QUARTERLY REPORT

Table of Contents

Item		Page
PART I
Item l.	Financial Statements
	Unaudited Condensed Consolidated Statements of Financial Condition as of September 30, 2016, and December 31, 2015	3
	Unaudited Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2016 and 2015	4
	Unaudited Condensed Consolidated Statements of Total Comprehensive Income for the Three and Nine Months Ended September 30, 2016 and 2015	6
	Unaudited Condensed Consolidated Statements of Equity for the Nine Months Ended September 30, 2016 and 2015	7
	Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015	8
	Notes to Unaudited Condensed Consolidated Financial Statements	9
Item 2.	Management's Discussion and Analysis of Financial  Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	49
Item 4.	Controls and Procedures	53
PART II
Item 1A.	Risk Factors	54
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	54
Item 6.	Exhibits	54
SIGNATURES		55

2

PART I

Item 1. Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Financial Condition

	September 30			December 31
	2016			2015
	(Dollars in thousands)
Assets
Cash and due from banks	$	26,731		$	27,971
Interest-earning deposits		19,077			16,530
Cash and cash equivalents		45,808			44,501
Mortgage-related securities available-for-sale, at fair value		379,447			407,874
Mortgage-related securities held-to-maturity, at amortized cost (fair value of $105,932 in 2016 and $121,641 in 2015)		102,931			120,891
Loans held-for-sale		8,034			3,350
Loans receivable (net of allowance for loan losses of $19,202 in 2016 and $17,641 in 2015)		1,925,455			1,740,018
Mortgage servicing rights, net		6,611			7,205
Other assets		185,080			178,328
Total assets	$	2,653,366		$	2,502,167
Liabilities and shareholders’ equity
Liabilities:
Deposit liabilities	$	1,867,115		$	1,795,591
Borrowings		415,364			372,375
Advance payments by borrowers for taxes and insurance		30,219			3,382
Other liabilities		51,795			51,425
Total liabilities		2,364,493			2,222,773
Shareholders’ equity:
Preferred stock–$0.01 par value:
Authorized–20,000,000 shares in 2016 and 2015
Issued and outstanding–none in 2016 and 2015		–			–
Common stock–$0.01 par value:
Authorized–200,000,000 shares in 2016 and 2015
Issued–78,783,849 shares in 2016 and 2015
Outstanding–45,671,782 shares in 2016 and 45,443,548 in 2015		788			788
Additional paid-in capital		484,788			486,273
Retained earnings		170,067			164,482
Accumulated other comprehensive loss		(6,941	)		(9,365	)
Treasury stock–33,112,067 shares in 2016 and 33,340,301 in 2015		(359,829	)		(362,784	)
Total shareholders’ equity		288,873			279,394
Total liabilities and shareholders’ equity	$	2,653,366		$	2,502,167

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

3

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

	Three Months Ended September 30
	2016		2015
	(Dollars in thousands, except per share data)
Interest income:
Loans	$	18,209	$	16,464
Mortgage-related securities		3,139		2,912
Investment securities		117		61
Interest-earning deposits		5		4
Total interest income		21,470		19,441
Interest expense:
Deposit liabilities		1,468		1,206
Borrowings		1,290		1,243
Total interest expense		2,758		2,449
Net interest income		18,712		16,992
Provision for (recovery of) loan losses		1,395		(930	)
Net interest income after recovery of loan losses		17,317		17,922
Non-interest income:
Deposit-related fees and charges		2,991		2,975
Loan-related fees		1,136		476
Brokerage and insurance commissions		816		839
Mortgage banking revenue, net		1,354		798
Income from bank-owned life insurance (“BOLI”)		460		468
Gain on real estate held for investment		12		378
Other non-interest income		98		62
Total non-interest income		6,867		5,996
Non-interest expense:
Compensation, payroll taxes, and other employee benefits		10,452		11,427
Occupancy, equipment, and data processing costs		3,317		3,403
Advertising and  marketing		737		736
Federal insurance premiums		273		382
Losses and expenses on foreclosed real estate, net		169		150
Other non-interest expense		2,298		2,372
Total non-interest expense		17,246		18,470
Income before income taxes		6,938		5,448
Income tax expense		2,484		2,103
Net income	$	4,454	$	3,345
Per share data:
Earnings per share–basic	$	0.10	$	0.07
Earnings per share–diluted	$	0.10	$	0.07
Cash dividends per share paid	$	0.055	$	0.050

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

4

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

	Nine Months Ended September 30
	2016		2015
	(Dollars in thousands, except per share data)
Interest income:
Loans	$	52,505	$	49,318
Mortgage-related securities		9,122		8,625
Investment securities		338		166
Interest-earning deposits		23		14
Total interest income		61,988		58,123
Interest expense:
Deposit liabilities		4,319		3,452
Borrowings		3,790		3,552
Advance payments by borrowers for taxes and insurance		1		1
Total interest expense		8,110		7,005
Net interest income		53,878		51,118
Provision for (recovery of) loan losses		1,986		(2,646	)
Net interest income after recovery of loan losses		51,892		53,764
Non-interest income:
Deposit-related fees and charges		8,685		8,727
Loan-related fees		4,001		1,402
Brokerage and insurance commissions		2,529		2,827
Mortgage banking revenue, net		3,321		2,639
Income from bank-owned life insurance (“BOLI”)		1,387		1,410
Gain on real estate held for investment		12		212
Other non-interest income		186		232
Total non-interest income		20,121		17,449
Non-interest expense:
Compensation, payroll taxes, and other employee benefits		31,155		33,658
Occupancy, equipment, and data processing costs		10,133		10,518
Advertising and  marketing		2,292		1,603
Federal insurance premiums		1,078		1,110
Losses and expenses on foreclosed real estate, net		80		687
Other non-interest expense		6,993		6,893
Total non-interest expense		51,731		54,469
Income before income taxes		20,282		16,744
Income tax expense		7,406		6,257
Net income	$	12,876	$	10,487
Per share data:
Earnings per share–basic	$	0.28	$	0.23
Earnings per share–diluted	$	0.28	$	0.22
Cash dividends per share paid	$	0.16	$	0.14

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

5

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Total Comprehensive Income

	Three Months Ended September 30
	2016			2015
	(Dollars in thousands)
Net income	$	4,454		$	3,345
Other comprehensive income (loss), net of tax:
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $(539) in 2016 and $434 in 2015		(805	)		647
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $57 in 2016 and (90) in 2015		84			(136	)
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $34 in 2016 and $272 in 2015		51			409
Total other comprehensive income (loss), net of tax		(670	)		920
Total comprehensive income	$	3,784		$	4,265
	Nine Months Ended September 30
	2016			2015
	(Dollars in thousands)
Net income	$	12,876		$	10,487
Other comprehensive income (loss), net of tax:
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $1,599 in 2016 and $(133) in 2015		2,386			(199	)
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $(76) in 2016 and $(90) in 2015		(114	)		(136	)
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $101 in 2016 and $808 in 2015		152			1,213
Total other comprehensive income (loss), net of tax		2,424			878
Total comprehensive income	$	15,300		$	11,365

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

6

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Equity

									Accumulated						Non-Controlling
			Additional						Other						Interest in
	Common		Paid-In			Retained			Comprehensive			Treasury			Real Estate
	Stock		Capital			Earnings			Income (Loss)			Stock			Partnership			Total
	(Dollars in thousands, except per share data)
Balance at January 1, 2016	$	788	$	486,273		$	164,482		$	(9,365	)	$	(362,784	)		–		$	279,394
Net income		–		–			12,876			–			–			–			12,876
Other comprehensive income		–		–			–			2,424			–			–			2,424
Purchase of treasury stock		–		–			–			–			(221	)		–			(221	)
Issuance of restricted stock		–		(1,469	)		–			–			1,469			–			–
Exercise of stock options		–		(1,029	)		–			–			1,707			–			678
Share based payments		–		1,013			–			–			–			–			1,013
Cash dividends ($0.16 per share)		–		–			(7,291	)		–			–			–			(7,291	)
Balance at September 30, 2016	$	788	$	484,788		$	170,067		$	(6,941	)	$	(359,829	)		–		$	288,873
Balance at January 1, 2015	$	788	$	488,467		$	159,065		$	(11,136	)	$	(356,467	)	$	3,774		$	284,491
Net income		–		–			10,487			–			–			–			10,487
Other comprehensive income		–		–			–			878			–			–			878
Decrease in non-controlling interest in real estate partnership		–		–			–			–			–			(3,774	)		(3,774	)
Purchase of treasury stock		–		–			–			–			(9,394	)		–			(9,394	)
Issuance of restricted stock		–		(2,526	)		–			–			2,526			–			–
Exercise of stock options		–		(1,163	)		–			–			1,806			–			643
Share based payments		–		1,258			–			–			(274	)		–			984
Cash dividends ($0.14 per share)		–		–			(6,488	)		–			–			–			(6,488	)
Balance at September 30, 2015	$	788	$	486,036		$	163,064		$	(10,258	)	$	(361,803	)		–		$	277,827

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

7

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

	Nine Months Ended September 30
	2016			2015
	(Dollars in thousands)
Operating activities:
Net income	$	12,876		$	10,487
Adjustments to reconcile net income to net cash from operating activities:
Provision for (recovery of) loan losses		1,986			(2,646	)
Loss (gain) on foreclosed real estate, net		(199	)		333
Provision for depreciation		2,527			2,405
Amortization of mortgage servicing rights		1,636			1,458
Net premium amortization on securities		2,039			1,668
Loans originated for sale		(112,500	)		(83,897	)
Proceeds from loan sales		109,816			85,468
Gain on loan sales activities, net		(3,042	)		(2,085	)
Deferred income tax expense		2,956			6,078
Gain on real estate held for investment		(12	)		(212	)
Other, net		(10,045	)		(17,529	)
Net cash provided by operating activities		8,038			1,528
Investing activities:
Principal repayments on mortgage-related securities available-for-sale		86,977			85,295
Principal repayments on mortgage-related securities held-to-maturity		17,493			1,707
Purchases of mortgage-related securities available-for-sale		(56,137	)		(179,302	)
Purchases of FHLB of Chicago stock		(1,614	)		(3,382	)
Net increase in loans receivable		(188,675	)		(52,889	)
Proceeds from sale of foreclosed properties		2,048			2,328
Proceeds from sale of real estate held for investment		–			1,183
Net purchases of premises and equipment		(1,339	)		(3,133	)
Net cash used by investing activities		(141,247	)		(148,193	)
Financing activities:
Net increase in deposit liabilities		71,524			18,059
Net increase in short-term borrowings		115,000			97,200
Proceeds from long-term borrowings		–			20,000
Repayments of long-term borrowings		(72,011	)		(964	)
Net increase in advance payments by borrowers for taxes and insurance		26,837			25,075
Cash dividends		(7,291	)		(6,488	)
Purchases of treasury stock		(221	)		(9,394	)
Other, net		678			764
Net cash provided  by financing activities		134,516			144,252
Increase (decrease) in cash and cash equivalents		1,307			(2,413	)
Cash and cash equivalents at beginning of period		44,501			46,177
Cash and cash equivalents at end of period	$	45,808		$	43,764
Supplemental information:
Cash paid in period for:
Interest on deposit liabilities and borrowings	$	8,035		$	6,605
Income taxes		4,278			2,441
Non-cash transactions:
Loans transferred to foreclosed properties and repossessed assets		1,252			1,493

Refer to Notes to Unaudited Condensed Consolidated Financial Statement

8

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

1. Basis of Presentation

The Unaudited Condensed Consolidated Financial Statements include the accounts of Bank Mutual Corporation (the “Company”), its wholly-owned subsidiary Bank Mutual (the “Bank”), and the Bank’s subsidiaries.

The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information, Rule 10-01 of Regulation S-X, and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by GAAP for complete financial information. However, in the opinion of management, all adjustments (consisting of normal recurring entries) necessary for a fair presentation of operations, cash flows, and financial position have been included in the accompanying financial statements. This report should be read in conjunction with the Company’s 2015 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 2016, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2016.

In 2014 the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to the recognition of revenue from contracts with customers. In 2015 the FASB deferred the effective date one year from the date in the original guidance. The guidance is effective for fiscal years and interim periods beginning after December 15, 2018, which will be the first quarter of 2019 for the Company. In 2016 the FASB issued two new pronouncements to amend and clarify the original guidance with no change to the effective date. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

In 2015 the FASB issued new accounting guidance relating to the consolidation of legal entities for financial reporting purposes. For public companies, the guidance is effective for periods beginning after December 15, 2015, which was the first quarter of 2016 for the Company. The Company’s adoption of this new guidance did not have a material impact on its results of operations or financial condition.

In 2016 the FASB issued new accounting guidance related to certain aspects of the recognition and measurement of financial assets and liabilities. For public companies the guidance is effective for periods beginning after December 15, 2017, which will be the first quarter of 2018 for the Company. Early application of some aspects of the new guidance is also permitted, although the Company does not intend to adopt the guidance early. The Company’s eventual adoption of this new guidance is not expected to have a material impact on its results of operations or financial condition.

In 2016 the FASB issued new accounting guidance related to the accounting for lease assets and liabilities. For public companies the guidance is effective for periods beginning after December 15, 2018, which will be the first quarter of 2019 for the Company. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

In 2016 the FASB issued new accounting guidance related to the accounting for employee share-based compensation. For public companies the guidance is effective for periods beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance in the first quarter of 2016. The Company’s adoption of this item did not have a material impact on its results of operations or financial condition.

In 2016 the FASB issued new accounting guidance related to the measurement of credit losses on financial instruments. The new guidance replaces the current methodology of measuring credit losses based on incurred losses at the balance sheet date with a methodology that measures credit losses based on the current estimate of expected credit losses. For the Company this guidance is effective for periods beginning after December 15, 2019, which will be the first quarter of 2020. Management has not yet completed the complex analysis required to determine the impact adoption of this new guidance could have on the Company’s results of operations or financial condition.

9

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

1. Basis of Presentation (continued)

In 2016 the FASB issued new accounting guidance related to the classification of certain cash receipts and cash payments in the statement of cash flows. For the Company this guidance is effective for periods beginning after December 15, 2017, which will be the first quarter of 2018. The Company’s adoption of this item is not expected to have a material impact on the statement of cash flows.

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

The amortized cost and fair value of mortgage-related securities available-for-sale and held-to-maturity are as follows:

	September 30, 2016
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	189,715	$	2,756	$	(8	)	$	192,463
Federal National Mortgage Association		164,513		2,579		(221	)		166,871
Government National Mortgage Association		2,343		20		–			2,363
Private-label CMOs		17,685		293		(228	)		17,750
Total available-for-sale	$	374,256	$	5,648	$	(457	)	$	379,447
Securities held-to-maturity:
Federal National Mortgage Association	$	102,931	$	3,001		–		$	105,932
Total held-to-maturity	$	102,931	$	3,001		–		$	105,932

	December 31, 2015
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	215,255	$	1,823	$	(800	)	$	216,278
Federal National Mortgage Association		169,792		853		(874	)		169,771
Government National Mortgage Association		21		3		–			24
Private-label CMOs		21,600		446		(245	)		21,801
Total available-for-sale	$	406,668	$	3,125	$	(1,919	)	$	407,874
Securities held-to-maturity:
Federal National Mortgage Association	$	120,891	$	750		–		$	121,641
Total held-to-maturity	$	120,891	$	750		–		$	121,641

10

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

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

The following tables summarize mortgage-related securities by amount of time the securities have had a gross unrealized loss as of the dates indicated:

	September 30, 2016
	Less Than 12 Months						Greater Than 12 Months
	in an Unrealized Loss Position						in an Unrealized Loss Position						Gross		Total
	Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Estimated Fair Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	6		2	$	4,389	$	2		1	$	180	$	8	$	4,569
Federal National Mortgage Association		92		2		7,788		129		5		15,657		221		23,445
Private-label CMOs		8		2		2,580		220		11		10,023		228		12,603
Total available-for-sale	$	106		6	$	14,757	$	351		17	$	25,860	$	457	$	40,617
	December 31, 2015
	Less Than 12 Months						Greater Than 12 Months
	in an Unrealized Loss Position						in an Unrealized Loss Position						Gross		Total
	Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Estimated Fair Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	777		17	$	107,807	$	23		3	$	7,937	$	800	$	115,744
Federal National Mortgage Association		634		16		79,273		240		4		10,679		874		89,952
Private-label CMOs		1		1		1,357		244		10		10,574		245		11,931
Total available-for-sale	$	1,412		34	$	188,437	$	507		17	$	29,190	$	1,919	$	217,627

The Company determined that the unrealized losses on its mortgage-related securities were temporary as of September 30, 2016, and December 31, 2015. 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, recent trends in the fair market values of the securities and, in the case of private-label collateralized mortgage obligations (“CMOs”), a review of the actual delinquency and/or default performance of the loan collateral that supports the securities.

As of September 30, 2016, and December 31, 2015, the Company had private-label CMOs, with a fair value of $12,759 and $15,725, respectively, and unrealized gains of $109 and $237, 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.

11

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

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

The following table contains a summary of other-than-temporary impairment (“OTTI”) related to credit losses that have been recognized in earnings as of the dates indicated for private label CMOs, as well as the end of period values for securities that have experienced such losses:

	Three Months Ended September 30						Nine Months Ended September 30
	2016			2015			2016			2015
Beginning balance of unrealized OTTI related to credit losses	$	522		$	657		$	592		$	789
Reductions for increase in cash flows expected to be received		(31	)		(31	)		(101	)		(163	)
Ending balance of unrealized OTTI related to credit losses	$	491		$	626		$	491		$	626
Adjusted cost at end of period	$	3,653		$	4,573		$	3,653		$	4,573
Estimated fair value at end of period	$	3,922		$	5,007		$	3,922		$	5,007

Results of operations included no gross realized gains or losses on the sale of securities during the three and nine months ended September 30, 2016 or 2015.

Mortgage-related securities available-for-sale with a fair value of approximately $87,174 and $67,923 at September 30, 2016, and December 31, 2015, respectively, were pledged to secure deposits, borrowings, and for other purposes as permitted or required by law.

12

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable

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

	September 30			December 31
	2016			2015
Commercial loans:
Commercial and industrial	$	230,114		$	235,313
Commercial real estate		364,351			299,550
Multi-family real estate		525,739			409,674
Construction and development loans:
Commercial real estate		30,378			28,156
Multi-family real estate		318,951			291,380
Land and land development		10,025			11,143
Total construction and development		359,354			330,679
Total commercial loans		1,479,558			1,275,216
Retail loans:
One- to four-family first mortgages:
Permanent		461,971			461,797
Construction		41,337			42,357
Total one- to four-family first mortgages		503,308			504,154
Home equity loans:
Fixed term home equity		109,815			122,985
Home equity lines of credit		71,758			75,261
Total home equity loans		181,573			198,246
Other consumer loans:
Student		7,114			8,129
Other		11,542			11,678
Total other consumer loans		18,656			19,807
Total retail loans		703,537			722,207
Gross loans receivable		2,183,095			1,997,423
Undisbursed loan proceeds		(236,620	)		(238,124	)
Allowance for loan losses		(19,202	)		(17,641	)
Deferred fees and costs, net		(1,818	)		(1,640	)
Total loans receivable, net	$	1,925,455		$	1,740,018

The Company’s commercial and retail borrowers are primarily located in the Company’s local lending areas in Wisconsin, Illinois, Michigan, Minnesota, and Iowa, as is the real estate and non-real estate collateral that secures the Company’s loans.

At September 30, 2016, and December 31, 2015, certain one- to four-family mortgage loans, multi-family mortgage loans, and home equity loans with aggregate carrying values of approximately $554,000 and $496,000 were pledged to secure advances from the Federal Home Loan Bank (“FHLB”) of Chicago.

The unpaid principal balance of loans serviced for others was $1,003,130 and $1,038,588 at September 30, 2016, and December 31, 2015, respectively. These loans are not reflected in the consolidated financial statements.

13

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable (continued)

The following tables summarize the activity in the allowance for loan losses by loan portfolio segment for the periods indicated. The tables also summarize the allowance for loan loss and loans receivable by the nature of the impairment evaluation, either individually or collectively, at the dates indicated (the loans receivable amounts in the table are net of undisbursed loan proceeds).

	At or for the Nine Months Ended September 30, 2016
	Commercial and Industrial			Commercial Real Estate			Multi- Family Real Estate			Construction and Development			One- to Four- Family			Home Equity and Other Consumer			Total
Allowance for loan losses:
Beginning balance	$	3,658		$	4,796		$	3,337		$	2,835		$	1,835		$	1,180		$	17,641
Provision (recovery)		166			(608	)		2,112			(48	)		291			73			1,986
Charge-offs		–			(179	)		–			–			(84	)		(334	)		(597	)
Recoveries		5			28			30			–			42			67			172
Ending balance	$	3,829		$	4,037		$	5,479		$	2,787		$	2,084		$	986		$	19,202
Loss allowance individually evaluated for impairment	$	167			–			–		$	1		$	11		$	44		$	223
Loss allowance collectively evaluated for impairment	$	3,662		$	4,037		$	5,479		$	2,786		$	2,073		$	942		$	18,979
Loan receivable balances at the end of the period:
Loans individually evaluated for impairment	$	5,658		$	6,250		$	3,957		$	1,889		$	4,616		$	644		$	23,014
Loans collectively evaluated for impairment		224,456			358,101			521,782			146,802			472,735			199,585			1,923,461
Total loans receivable	$	230,114		$	364,351		$	525,739		$	148,691		$	477,351		$	200,229		$	1,946,475
	At or for the Nine Months Ended September 30, 2015
	Commercial and Industrial			Commercial Real Estate			Multi- Family Real Estate			Construction and Development			One- to Four- Family			Home Equity and Other Consumer			Total
Allowance for loan losses:
Beginning balance	$	2,349		$	6,880		$	6,078		$	2,801		$	3,004		$	1,177		$	22,289
Provision (recovery)		565			(942	)		(2,472	)		(23	)		(428	)		654			(2,646	)
Charge-offs		(74	)		(69	)		–			–			(276	)		(561	)		(980	)
Recoveries		7			107			–			–			52			62			228
Ending balance	$	2,847		$	5,976		$	3,606		$	2,778		$	2,352		$	1,332		$	18,891
Loss allowance individually evaluated for impairment		–		$	262		$	611			–			–			–		$	873
Loss allowance collectively evaluated for impairment	$	2,847		$	5,714		$	2,995		$	2,778		$	2,352		$	1,332		$	18,018
Loan receivable balances at the end of the period:
Loans individually evaluated for impairment	$	8,281		$	9,629		$	9,572		$	2,132		$	4,461		$	619		$	34,694
Loans collectively evaluated for impairment		219,885			278,426			344,957			128,592			476,448			222,798		$	1,671,106
Total loans receivable	$	228,166		$	288,055		$	354,529		$	130,724		$	480,909		$	223,417		$	1,705,800

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 net charge-offs, 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 these factors were applied, resulted in an increase (decrease) in the total allowance for loan losses of $1,213 and $1,873 during the three and nine months ended September 30, 2016, and of $(1,139) and $(3,367) during the three and nine months ended September 30, 2015.

14

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable (continued)

The following tables present information regarding impaired loans that have a related allowance for loan loss and those that do not as of the dates indicated (the loans receivable amounts in the table are net of undisbursed loan proceeds).

	September 30, 2016
	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:
Commercial and industrial:
Term loans	$	367	$	367	$	167	$	92	$	15
Lines of credit		–		–		–		–		–
Total commercial and industrial		367		367		167		92		15
Commercial real estate:
Office		–		–		–		–		–
Retail/wholesale/mixed		–		–		–		–		–
Industrial/warehouse		–		–		–		–		–
Other		–		–		–		–		–
Total commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Construction and development:
Commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Land and land development		122		122		1		31		–
Total construction and development		122		122		1		31		–
One- to four-family		2,233		2,233		11		558		–
Home equity and other consumer:
Home equity		79		79		44		20		–
Student		–		–		–		–		–
Other		–		–		–		–		–
Total home equity and other consumer		79		79		44		20		–
Total with an allowance recorded	$	2,801	$	2,801	$	223	$	701	$	15
Impaired loans with no allowance recorded:
Commercial and industrial:
Term loans	$	89	$	104		–	$	101	$	3
Lines of credit		30		40		–		1,088		2
Total commercial and industrial		119		144		–		1,189		5
Commercial real estate:
Office		2,000		2,416		–		2,063		117
Retail/wholesale/mixed		1,402		2,238		–		1,512		83
Industrial/warehouse		184		265		–		189		10
Other		–		152		–		5		10
Total commercial real estate		3,586		5,071		–		3,769		220
Multi-family real estate		280		292		–		215		18
Construction and development:
Commercial real estate		508		597		–		563		–
Multi-family real estate		–		–		–		–		–
Land and land development		266		327		–		188		12
Total construction and development		774		924		–		751		12
One- to four-family		2,992		3,340		–		2,660		61
Home equity and other consumer:
Home equity		1,039		1,109		–		807		3
Student		–		–		–		–		–
Other		110		144		–		82		1
Total home equity and other consumer		1,149		1,253		–		889		4
Total with no allowance recorded	$	8,900	$	11,024		–	$	9,473	$	320

15

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable (continued)

	December 31, 2015
	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:
Commercial and industrial:
Term loans		–		–		–		–		–
Lines of credit	$	2,783	$	2,795	$	535	$	557	$	142
Total commercial and industrial		–		–		–		–		–
Commercial real estate:
Office
Retail/wholesale/mixed		–		–		–		1,538		–
Industrial/warehouse		–		–		–		–		–
Other		–		–		–		–		–
Total commercial real estate		–		–		–		1,538		–
Multi-family real estate		–		–		–		1,112		–
Construction and development:
Commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Land and land development		–		–		–		–		–
Total construction and development		–		–		–				–
One- to four-family		–		–		–		–		–
Home equity and other consumer:
Home equity		–		–		–		–		–
Student		–		–		–		–		–
Other		–		–		–		–		–
Total home equity and other consumer		–		–		–		–		–
Total with an allowance recorded	$	2,783	$	2,795	$	535	$	3,207	$	142
Impaired loans with no allowance recorded:
Commercial and industrial:
Term loans	$	116	$	133		–	$	129	$	3
Lines of credit		2,016		2,032		–		422		117
Total commercial and industrial		2,132		2,165		–		551		120
Commercial real estate:
Office		2,126		2,426		–		833		148
Retail/wholesale/mixed		1,637		2,348		–		1,672		79
Industrial/warehouse		194		265		–		204		18
Other		11		155		–		22		14
Total commercial real estate		3,968		5,194		–		2,731		259
Multi-family real estate		–		–		–				–
Construction and development:
Commercial real estate		597		597		–		597		–
Multi-family real estate		–		–		–		–		–
Land and land development		169		220		–		187		17
Total construction and development		766		817				784		17
One- to four-family		2,703		3,168		–		3,744		70
Home equity and other consumer:
Home equity		703		805		–		509		21
Student		–		–		–		–		–
Other		82		184		–		87		1
Total home equity and other consumer		785		989		–		596		22
Total with no allowance recorded	$	10,354	$	12,333		–	$	8,406	$	488

16

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable (continued)

The following tables present information relating to the Company’s internal risk ratings of its loans receivable as of the dates indicated (all amounts in the tables are net of undisbursed loan proceeds):

	September 30, 2016
	Pass		Watch		Special Mention		Substandard		Total
Commercial and industrial:
Term loans	$	54,350	$	16,700	$	107	$	562	$	71,719
Lines of credit		117,231		24,321		11,747		5,096		158,395
Total commercial and industrial		171,581		41,021		11,854		5,658		230,114
Commercial real estate:
Office		120,813		5,336		14,450		2,000		142,599
Retail/wholesale/mixed use		116,999		26,705		14,934		3,806		162,444
Industrial/warehouse		38,705		12,543		–		444		51,692
Other		7,616		–		–		–		7,616
Total commercial real estate		284,133		44,584		29,384		6,250		364,351
Multi-family real estate		513,956		–		7,826		3,957		525,739
Construction and development:
Commercial real estate		5,434		1,029		–		508		6,971
Multi-family real estate		131,705		–		–		–		131,705
Land and land development		8,449		185		–		1,381		10,015
Total construction/development		145,588		1,214		–		1,889		148,691
One- to four-family		471,406		439		890		4,616		477,351
Home equity and other consumer:
Home equity		181,039		–		–		534		181,573
Student		7,114		–		–		–		7,114
Other		11,412		20		–		110		11,542
Total home equity and other consumer		199,565		20		–		644		200,229
Total	$	1,786,229	$	87,278	$	49,954	$	23,014	$	1,946,475

17

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable (continued)

	December 31, 2015
	Pass		Watch		Special Mention		Substandard		Total
Commercial and industrial:
Term loans	$	53,785	$	5,536	$	252	$	2,605	$	62,178
Lines of credit		145,118		17,086		1,299		9,632		173,135
Total commercial and industrial		198,903		22,622		1,551		12,237		235,313
Commercial real estate:
Office		69,223		5,567		15,063		2,126		91,979
Retail/wholesale/mixed use		103,634		28,091		14,510		6,599		152,834
Industrial/warehouse		46,545		1,326		588		1,598		50,057
Other		4,669		–		–		11		4,680
Total commercial real estate		224,071		34,984		30,161		10,334		299,550
Multi-family real estate		394,097		7,338		–		8,239		409,674
Construction and development:
Commercial real estate		13,928		–		–		597		14,525
Multi-family real estate		93,635		–		–		–		93,635
Land and land development		9,411		69		–		1,517		10,997
Total construction/development		116,974		69		–		2,114		119,157
One- to four-family		471,412		2,059		671		3,410		477,552
Home equity and other consumer:
Home equity		197,543		–		–		703		198,246
Student		8,129		–		–		–		8,129
Other		11,596		–		–		82		11,678
Total home equity and other consumer		217,268		–		–		785		218,053
Total	$	1,622,725	$	67,072	$	32,383	$	37,119	$	1,759,299

Loans rated “pass” or “watch” are generally current on contractual loan and principal payments and comply with other contractual loan terms. Pass loans generally have no noticeable credit deficiencies or potential weaknesses. Loans rated watch, however, will typically exhibit early signs of credit deficiencies or potential weaknesses that deserve management’s close attention. Loans rated “special mention” do not currently expose the Company to a sufficient degree of risk to warrant a lower rating, but possess clear trends in credit deficiencies or potential weaknesses that deserve management’s close attention. The allowance for loan losses on loans rated pass, watch, or special mention is typically evaluated collectively for impairment using a homogenous pool approach. This approach utilizes quantitative factors developed by management from its assessment of historical loss experience, qualitative factors, and other considerations.

Loans rated “substandard” involve a distinct possibility that the Company could sustain some loss if deficiencies associated with the loan are not corrected. Loans rated “doubtful” indicate that full collection is highly questionable or improbable. The Company did not have any loans that were rated doubtful at September 30, 2016, or December 31, 2015. Loans rated substandard or doubtful that are also considered in management’s judgment to be impaired are generally analyzed individually to determine an appropriate allowance for loan loss. A loan rated “loss” is considered uncollectible, even if a partial recovery could be expected in the future. The Company generally charges off loans that are rated as a loss. As such, the Company did not have any loans that were rated loss at September 30, 2016, or December 31, 2015.

18

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable (continued)

The following tables contain information relating to the past due and non-accrual status of the Company’s loans receivable as of the dates indicated (all amounts in the table are net of undisbursed loan proceeds):

	September 30, 2016
	Past Due Status												Total
	30-59 Days		60-89 Days		> 90 Days		Total Past Due		Total Current		Total Loans		Non- Accrual
Commercial and industrial:
Term loans		–	$	396	$	60	$	456	$	71,263	$	71,719	$	456
Lines of credit		–		–		–		–		158,395		158,395		30
Total commercial and industrial		–		396		60		456		229,658		230,114		486
Commercial real estate:
Office		–		1,691		–		1,691		140,908		142,599		2,000
Retail/wholesale/mixed	$	751		–		551		1,302		161,142		162,444		1,402
Industrial/warehouse		–		–		–		–		51,692		51,692		184
Other		–		–		–		–		7,616		7,616		–
Total commercial real estate		751		1,691		551		2,993		361,358		364,351		3,586
Multi-family real estate		454		–		–		454		525,285		525,739		280
Construction and development:
Commercial real estate		–		–		508		508		6,463		6,971		508
Multi-family real estate		–		–		–		–		131,705		131,705		–
Land and land development		–		–		–		–		10,015		10,015		151
Total construction		–		–		508		508		148,183		148,691		659
One- to four-family		8,187		1,860		2,796		12,843		464,508		477,351		3,130
Home equity and other consumer:
Home equity		430		247		534		1,211		180,362		181,573		534
Student		105		23		366		494		6,620		7,114		–
Other		26		23		110		159		11,383		11,542		110
Total home equity and other consumer		561		293		1,010		1,864		198,365		200,229		644
Total	$	9,953	$	4,240	$	4,925	$	19,118	$	1,927,357	$	1,946,475	$	8,785

19

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

3. Loans Receivable (continued)

	December 31, 2015
	Past Due Status												Total
	30-59 Days		60-89 Days		> 90 Days		Total Past Due		Total Current		Total Loans		Non- Accrual
Commercial and industrial:
Term loans		–		–	$	61	$	61	$	62,117	$	62,178	$	116
Lines of credit	$	8,901		–		–		8,901		164,234		173,135		4,799
Total commercial and industrial		8,901		–		61		8,962		226,351		235,313		4,915
Commercial real estate:
Office		–		–		–		–		91,979		91,979		2,126
Retail/wholesale/mixed		768	$	2		684		1,454		151,380		152,834		1,637
Industrial/warehouse		–		–		–		–		50,057		50,057		194
Other		–		–		–		–		4,680		4,680		11
Total commercial real estate		768		2		684		1,454		298,096		299,550		3,968
Multi-family real estate		721		–		–		721		408,953		409,674		–
Construction and  development:
Commercial real estate		–		–		597		597		13,928		14,525		597
Multi-family real estate		–		–		–		–		93,635		93,635		–
Land and land development		–		–		–		–		10,997		10,997		169
Total construction		–		–		597		597		118,560		119,157		766
One- to four-family		6,490		2,959		2,634		12,083		465,469		477,552		2,703
Home equity and other consumer:
Home equity		1,214		217		703		2,134		196,112		198,246		703
Student		178		62		484		724		7,405		8,129		–
Other		38		49		82		169		11,509		11,678		82
Total home equity and other consumer		1,430		328		1,269		3,027		215,026		218,053		785
Total	$	18,310	$	3,289	$	5,245	$	26,844	$	1,732,455	$	1,759,299	$	13,137

As of September 30, 2016, and December 31, 2015, $366 and $484 in student loans, respectively, were 90-days past due, but remained on accrual status because such loans were originated under programs guaranteed by the federal government. 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. As of September 30, 2016, and December 31, 2015, TDRs were $4,164 and $8,704, respectively, and consisted primarily of commercial and industrial and one- to four-family mortgage loans. TDRs in accrual status as of those same dates were $2,916 and $2,558, respectively. Additions to TDRs during the nine months ended September 30, 2016 and 2015, were immaterial. In addition, TDRs that experienced a payment default within one year of their restructuring during the nine months ended September 30, 2016, and twelve months ended September 30, 2015, were also immaterial. TDRs are evaluated for impairment and appropriate credit losses are recorded in accordance with the Company’s accounting policies and GAAP.

20

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

4. Mortgage Servicing Rights

The following table presents the activity in the Company’s mortgage servicing rights (“MSRs”) for the periods indicated:

	Nine Months Ended September 30
	2016			2015
MSRs at beginning of the period, net	$	7,205		$	7,867
Additions		1,042			945
Amortization		(1,636	)		(1,458	)
MSRs at end of the period, net	$	6,611		$	7,354

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

		Amount
Estimate for three months ending December 31:	2016		349
Estimate for years ending December 31:	2017		1,227
	2018		1,028
	2019		837
	2020		677
	2021		573
	Thereafter		1,920
	Total		6,611

The projections of amortization expense shown above for MSRs are based on existing asset balances and the existing interest rate environment as of September 30, 2016. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates, and market conditions.

5. Other Assets

The following table summarizes the components of other assets as of the dates indicated:

	September 30		December 31
	2016		2015
Accrued interest:
Loans receivable	$	5,158	$	4,894
Mortgage-related securities		1,023		1,141
Total accrued interest		6,181		6,035
Foreclosed properties and repossessed assets:
Commercial real estate		1,221		1,685
Land and land development		627		747
One-to four-family		861		874
Total foreclosed properties and repossessed assets		2,709		3,306
Bank-owned life insurance		63,058		61,656
Premises and equipment, net		47,949		49,218
Federal Home Loan Bank stock, at cost		19,205		17,591
Deferred tax asset, net		12,712		16,485
Other assets		33,266		24,037
Total other assets	$	185,080	$	178,328

21

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

5. Other Assets (continued)

Residential one-to four-family mortgage loans that were in the process of foreclosure were $2,281 and $2,576 at September 30, 2016, and December 31, 2015, respectively.

6. Deposit Liabilities

The following table summarizes the components of deposit liabilities as of the dates indicated:

	September 30		December 31
	2016		2015
Checking accounts:
Non-interest-bearing	$	268,905	$	213,761
Interest-bearing		264,375		277,606
Total checking accounts		533,280		491,367
Money market accounts		565,386		542,020
Savings accounts		231,582		217,633
Certificates of deposit:
Due within one year		320,672		282,584
After one but within two years		173,398		182,599
After two but within three years		37,245		61,806
After three but within four years		2,796		15,373
After four but within five years		2,756		2,209
Total certificates of deposits		536,867		544,571
Total deposit liabilities	$	1,867,115	$	1,795,591

7. Borrowings

The following table summarizes borrowings as of the dates indicated:

	September 30, 2016					December 31, 2015
			Weighted-					Weighted-
			Average					Average
	Balance		Rate			Balance		Rate
FHLB short-term advances	$	245,000		0.40	%	$	130,000		0.16	%
FHLB term advances maturing in:
2016		20,000		0.45			75,950		0.63
2017		51,408		1.19			56,183		1.20
2018		30,462		2.24			34,607		2.18
2019		16,886		3.09			19,127		2.98
2020		24,444		3.72			26,853		3.62
2021		14,724		3.04			16,971		2.97
Thereafter		12,440		4.55			12,684		4.55
Total borrowings	$	415,364		1.16	%	$	372,375		1.27	%

All of the Company’s term advances from the FHLB of Chicago are subject to prepayment penalties if voluntarily repaid by the Company prior to stated maturity.

22

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

7. Borrowings (continued)

As discussed in Note 12, “Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments,” the Company has entered into cash flow hedges using interest rate swaps to manage the interest rate risk exposure associated with certain forecasted borrowings from the FHLB of Chicago. Two advances maturing in October 2016 of $10,000 each have corresponding pay-fixed interest rate swaps that mature in 2018 and 2019, respectively. Although these advances have stated interest rates of 0.45%, they have effective interest rates including the impact of the interest rate swaps of 1.02% and 1.28%, respectively. However, these advances have been included in the table, above, at their contractual rates and maturities. If they had been included in the table at their hedge-adjusted rates and maturities, the advances reported as maturing in 2018 and 2019 would have each been $10,000 higher and the weighted average rates for those maturity years would have been 1.94% and 2.42% as of September 30, 2016, respectively. Furthermore, the weighted average rate reported for total borrowings would have been 1.19% as of the same date.

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) 22.2 times the FHLB of Chicago capital stock owned by the Company; or (iii) the total of 71% of the book value of one- to four-family mortgage loans, 72% of the book value of certain multi-family mortgage loans, 51% of the book value of certain home equity loans, and 98% of the fair value of certain mortgage-related securities.

23

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

8. Regulatory Capital Requirements

The Company and Bank are subject to various regulatory capital requirements administered by federal banking agencies and as defined in applicable regulations. Failure to meet minimum capital requirements can initiate certain mandatory actions and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Management believes that, as of September 30, 2016, and December 31, 2015, the Company and the Bank met or exceeded all regulatory capital adequacy requirements to which it is subject. The following table presents the Company and the Bank’s actual and required regulatory capital amounts and ratios as of the dates indicated.

	Actual					Required to be Adequately Capitalized					Required to be Well Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2016:
At the Company:
Total risk-weighted capital	$	306,368		15.11	%	$	162,167		8.00	%	$	202,708		10.00	%
Tier 1 risk-weighted capital		287,166		14.17			121,625		6.00			162,167		8.00
CET1 risk-weighted capital		287,166		14.17			91,219		4.50			131,760		6.50
Tier 1 leverage capital		287,166		10.91			105,303		4.00			131,629		5.00
At the Bank:
Total risk-weighted capital	$	281,795		13.90	%	$	162,144		8.00	%	$	202,680		10.00	%
Tier 1 risk-weighted capital		262,593		12.96			121,608		6.00			162,144		8.00
CET1 risk-weighted capital		262,593		12.96			91,206		4.50			131,742		6.50
Tier 1 leverage capital		262,593		9.98			105,224		4.00			131,529		5.00
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2015:
At the Company:
Total risk-weighted capital	$	296,709		15.83	%	$	149,922		8.00	%	$	187,402		10.00	%
Tier 1 risk-weighted capital		279,068		14.89			112,441		6.00			149,922		8.00
CET1 risk-weighted capital		279,068		14.89			84,331		4.50			121,811		6.50
Tier 1 leverage capital		279,068		11.37			98,197		4.00			122,747		5.00
At the Bank:
Total risk-weighted capital	$	272,568		14.55	%	$	149,900		8.00	%	$	187,375		10.00	%
Tier 1 risk-weighted capital		254,927		13.61			112,425		6.00			149,900		8.00
CET1 risk-weighted capital		254,927		13.61			84,319		4.50			121,794		6.50
Tier 1 leverage capital		254,927		10.48			97,328		4.00			121,660		5.00

24

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

9. Earnings Per Share

The following table summarizes the computation of basic and diluted earnings per share for the periods indicated:

	Three Months Ended				Nine Months Ended
	September 30				September 30
	2016		2015		2016		2015
Net income	$	4,454	$	3,345	$	12,876	$	10,487
Weighted average shares outstanding		45,116,082		45,347,879		45,077,767		45,846,072
Vested restricted stock for period		123,485		69,266		111,223		61,437
Basic shares outstanding		45,239,567		45,417,145		45,188,990		45,907,509
Net dilutive effect of:
Stock option shares		379,310		352,596		392,738		351,454
Non-vested restricted stock		45,972		27,767		49,190		31,433
Diluted shares outstanding		45,664,849		45,797,508		45,630,918		46,290,396
Basic earnings per share	$	0.10	$	0.07	$	0.28	$	0.23
Diluted earnings per share	$	0.10	$	0.07	$	0.28	$	0.22

The Company had stock options for 359,834 and 345,200 shares outstanding as of September 30, 2016 and 2015, respectively, that were not included in the computation of diluted earnings per share because they were anti-dilutive. These options had weighted average exercise prices of $8.18 and $8.11 per share as of those dates, respectively.

10. Employee Benefit Plans

The Company has a discretionary, defined contribution savings plan (the “Savings Plan”). The Savings Plan is qualified under Sections 401 and 401(k) of the Internal Revenue Code and provides employees meeting certain minimum age and service requirements the ability to make contributions to the Savings Plan on a pretax basis. The Company then matches a percentage of the employee’s contributions. Matching contributions expensed by the Company were $205 and $190 during the three months ended September 30, 2016 and 2015, respectively, and $630 and $598 during the nine months ended September 30, 2016 and 2015, respectively.

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 the employee’s years of service and average annual wages, as defined in the plan. 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. In prior periods the Company closed the qualified defined benefit pension plan to new participants and froze the benefits of all existing participants. These changes resulted in the future benefits under the Company’s supplemental defined benefit pension plan also being effectively frozen.

25

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

10. Employee Benefit Plans (continued)

The following table summarizes the qualified plan’s net periodic benefit cost for the periods indicated:

	Three Months Ended September 30						Nine Months Ended September 30
	2016			2015			2016			2015
Service cost		–		$	242			–		$	726
Interest cost	$	669			660		$	2,007			1,980
Expected return on plan assets		(861	)		(735	)		(2,583	)		(2,205	)
Amortization of net loss from earlier periods		57			656			171			1,968
Net periodic benefit cost	$	(135	)	$	823		$	(405	)	$	2,469

The following table summarizes the supplemental plan’s net periodic costs for the periods indicated.

	Three Months Ended September 30				Nine Months Ended September 30
	2016		2015		2016		2015
Interest cost	$	93	$	99	$	279	$	297
Amortization of net loss from earlier periods		26		23		78		69
Net periodic benefit cost	$	119	$	122	$	357	$	366

A contribution of $650,000 to the qualified plan was made in the third quarter of 2016. This contribution was determined based on a number of factors, including the results of an actuarial valuation report as of January 1, 2016. No contribution is necessary in 2016 for the supplemental plan.

11. Stock-Based Benefit Plans

In 2004 the Company’s shareholders approved the 2004 Stock Incentive Plan (the “2004 Plan”). Options and restricted stock granted under the 2004 Plan vested over five years and options had expiration terms of ten years. No further awards may be made under the 2004 Plan.

In 2014 the Company’s shareholders approved the 2014 Incentive Compensation Plan (the “2014 Plan”), which provides for the award of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, and cash awards. Stock-related awards under the 2014 Plan vest over a period of three or more years and, if applicable, have a maximum term of ten years. The number of shares of common stock of the Company that may be issued under the 2014 Plan is limited to 3,000,000 shares. As of September 30, 2016, 2,497,600 shares remain eligible for award under the 2014 Plan.

Restricted stock 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 $265 and $148 for the three months ended September 30, 2016 and 2015, respectively. The amount amortized to expense was $744 and $553 for the nine months ended September 30, 2016 and 2015, respectively. Outstanding non-vested restricted stock grants had a fair value of $1,963 and an unamortized cost of $1,721 at September 30, 2016. The cost of these shares is expected to be recognized over a weighted-average period of 0.96 years.

During the three months ended September 30, 2016 and 2015, the Company recorded stock option compensation expense of $89 and $102, respectively. During the nine months ended September 30, 2016 and 2015, the Company recorded stock option compensation expense of $270 and $309, respectively. As of September 30, 2016, there was $522 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 0.97 years.

26

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

11. Stock-Based Benefit Plans (continued)

The following table summarizes the activity in the Company’s stock options during the periods indicated:

	Nine Months Ended September 30
	2016					2015
	Stock Options			Weighted Average Exercise Price		Stock Options			Weighted Average Exercise Price
Outstanding at beginning of period		1,421,500		$	5.4378		1,631,000		$	5.2980
Granted		56,300			7.2900		44,000			6.7780
Exercised		(138,834	)		4.8840		(157,600	)		4.5870
Forfeited		(13,132	)		5.0412		(61,500	)		5.3181
Outstanding at end of period		1,325,834		$	5.5783		1,455,900		$	5.4188

The following table provides additional information regarding the Company’s outstanding options as of September 30, 2016.

	Remaining		Non-Vested Options				Vested Options
	Contractual Life		Stock Options		Intrinsic Value		Stock Options		Intrinsic Value
Exercise price:
$11.160		1.6		–		–		32,000		–
$12.025		1.9		–		–		50,000		–
$7.226		3.6		–		–		50,000	$	23
$4.740		4.2		–		–		70,000		206
$5.050		4.3		–		–		172,000		452
$4.300		4.5		–		–		25,000		85
$3.720		4.8		–		–		12,500		50
$3.390		5.3		63,500	$	272		229,500		985
$3.800		5.5		2,000		8		8,000		31
$4.820		6.3		93,200		267		142,800		408
$5.360		6.6		8,000		19		12,000		28
$5.700		6.7		8,000		16		12,000		24
$6.340		6.8		4,000		5		6,000		8
$7.170		7.3		109,800		56		74,400		38
$6.010		7.6		4,500		8		3,000		5
$5.850		7.6		6,666		12		13,334		24
$6.100		7.9		6,666		11		13,334		21
$6.700		8.3		19,996		20		10,338		10
$7.190		8.8		4,666		2		2,334		1
$7.290		9.3		56,300		22		–		–
Total				387,294	$	718		938,540	$	2,399
Weighted-average remaining contractual life				7.1 Years				5.1 Years
Weighted-average exercise price			$	5.8298			$	5.4746

There were 138,834 options exercised during the nine months ended September 30, 2016, which had an intrinsic value of $367. There were 157,600 options exercised during the nine months ended September 30, 2015, which had an intrinsic value of $400. The weighted average grant date fair value of non-vested options at September 30, 2016, was $1.76 per share. During the nine months ended September 30, 2016, options for 56,300 shares were granted, options for 260,038 shares became vested, and 13,132 non-vested options shares were forfeited.

27

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

11. Stock-Based Benefit Plans (continued)

The Company uses the Black-Scholes option-pricing model to estimate the fair value of granted options. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. However, the Company's stock options have characteristics significantly different from traded options and changes in the subjective input assumptions can materially affect the fair value estimate. Option valuation models such as Black-Scholes require the input of highly subjective assumptions including the expected stock price volatility, which is computed using ten 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 56,300 options granted during the nine month period ended September 30, 2016: risk free rate of 1.80%, dividend yield of 2.74%, expected stock volatility of 31%, and expected term to exercise of 7.5 years. These options had a weighted-average value of $2.28 per option using these assumptions. The following weighted-average assumptions were used to value 44,000 options granted during the nine-month period ended September 30, 2015: risk free rate of 1.81%, dividend yield of 2.45%, expected stock volatility of 33.5%, and expected term to exercise of 7.5 years. These options had a weighted-average value of $2.11 per option using these assumptions.

12. Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments

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 and/or interest rate are summarized in the following table as of the dates indicated:

	September 30		December 31
	2016		2015
Unused commercial lines of credit	$	172,501	$	146,183
Commercial loans		7,304		6,772
Standby letters of credit		7,896		4,458
Real estate loan commitments:
Fixed rate		38,368		36,921
Adjustable rate		300,504		308,173
Unused consumer lines of credit		162,693		164,989

28

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

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

The Company sells substantially all of its long-term, fixed-rate, one- to four-family loan originations in the secondary market. The Company uses interest rate lock commitments (“IRLCs”) and forward commitments to sell loans to manage interest rate risk associated with its loan sales activities, both of which are considered to be free-standing derivative financial instruments under GAAP. Changes in the fair value of the derivative instruments are recognized currently through earnings. During the three months ended September 30, 2016 and 2015, net unrealized gains (losses) of $86 and $(197), respectively, were recognized in net gain on loan sales activities on these derivative instruments. During the nine months ended September 30, 2016 and 2015, net unrealized gains of $119 and $10, respectively, were recognized in net gain on loan sales activities on these derivative instruments. These amounts were exclusive of net unrealized gains of $36 and $68 on loans held-for-sale for the three months ended September 30, 2016 and 2015, respectively, and $172 and $5 for the nine months ended September 30, 2016 and 2015, respectively, which were also included in net gain on loan sales activities.

The Company enters into interest rate swap arrangements to manage the interest rate risk exposure associated with specific commercial loan relationships at the time such loans are originated. These interest rate swaps, as well as the embedded derivatives associated with certain of its commercial loan relationships, are free-standing derivative instruments under GAAP. As such, changes in the fair value of these derivative instruments are recognized currently through earnings. During the three months ended September 30, 2016 and 2015, net unrealized gains of $206 and $304, respectively, and net losses of $206 and $304, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees. During the nine months ended September 30, 2016 and 2015, net unrealized gains of $247 and $360, respectively, and net losses of $247 and $360, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees.

The Company also enters into interest rate swap arrangements to manage the interest rate risk exposure associated with certain forecasted borrowings from the FHLB of Chicago. These interest rate swaps have been designated as forecasted transaction cash flow hedges by management (refer to Note 7, “Borrowings”). As such, the effective portion of the change in the fair value of these derivatives is recorded in other comprehensive income and the ineffective portion was recorded in interest expense. During the three and nine months ended September 30, 2016, $84 and $(114) in unrealized gain (loss) net of tax related to interest rate swaps was recorded in other comprehensive income, respectively. During the three and nine months ended September 30, 2015, $136 and $136 in unrealized loss net of tax related to interest rate swaps was recorded in other comprehensive income, respectively. There was no ineffective portion of this hedge for any of these periods.

The following table summarizes the Company’s derivative assets and liabilities as of the dates indicated:

	September 30, 2016					December 31, 2015
	Notional Amount		Fair Value			Notional Amount		Fair Value
Interest rate lock commitments	$	21,882	$	517		$	7,961	$	166
Forward commitments to sell loans		22,607		(304	)		9,543		(72	)
Embedded free-standing derivatives on commercial loans		23,144		951			23,559		705
Receive-fixed free-standing interest rate swaps		240,496		12,474			82,780		2,648
Pay-fixed free-standing interest rate swaps		263,640		(13,425	)		106,339		(3,353	)
Pay-fixed cash flow hedge interest rate swaps		20,000		(189	)		20,000		–
Net unrealized gains (losses)			$	24				$	94

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.

29

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

13. Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing 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 measurements 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 nine months ended September 30, 2016.

The methods and assumptions used by the Company in estimating the fair value of its financial instruments, whether or not such fair values are recognized in the consolidated financial statements, are summarized below:

Cash and Cash Equivalents The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate those assets’ fair values. The Company considers the fair value of cash and cash equivalents to be Level 1 in the fair value hierarchy.

Mortgage-Related Securities Available-for-Sale and Held-to-Maturity Fair values for these securities are based on price estimates obtained from a third-party independent pricing service. This service utilizes pricing models that

vary by asset class and incorporate available trade, bid, ask, and other market information of comparable instruments. For structured securities, such as CMOs, the pricing models include cash flow estimates that consider the impact of loan performance data, including, but not limited to, expectations relating to loan prepayments, default rates, and loss severities. Management has reviewed the pricing methodology used by its pricing service to verify that prices are determined in accordance with the fair value guidance specified in GAAP. The Company considers the fair value of mortgage-related securities to be Level 2 in the fair value hierarchy.

Loans Receivable Loans receivable are segregated by type such as one- to four-family, multi-family, and commercial real estate mortgage loans, consumer loans, and commercial business loans. The fair value of each type is calculated by discounting scheduled cash flows through the expected maturity of the loans using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan type. The estimated maturity is based on the Company’s historical experience with prepayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. The Company considers the fair value of loans receivable to be Level 3 in the fair value hierarchy.

Mortgage Servicing Rights The Company estimates the fair market value of MSRs for those loans that are sold with servicing rights retained. For valuation purposes, the related loans are stratified into pools by product type and, within product type, by interest rates. The fair value of the MSR pools is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing cost, and other factors. The Company considers the fair value of MSRs to be Level 3 in the fair value hierarchy.

30

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

13. Fair Value Measurements (continued)

The following table summarizes the significant inputs utilized by the Company to estimate the fair value of its MSRs as of September 30, 2016:

	Weighted- Average			Range
Loan size	$	115			$1.4-$414
Contractual interest rate		3.69	%		2.50%-7.10%
Constant prepayment rate (“CPR”)		12.96	%		1.94%-28.29%
Remaining maturity in months		217			2-480
Servicing fee		0.25	%		–
Annual servicing cost per loan (not in thousands)	$	60			–
Annual ancillary income per loan (not in thousands)	$	30			–
Discount rate		9.04	%		9.00%-10.75%

MSR pools with an amortized cost basis greater than fair value are carried at fair value in the Company’s financial statements. There were no pools determined to be impaired at September 30, 2016, or December 31, 2015. Accordingly, the Company had no valuation allowance as of September 30, 2016, or December 31, 2015.

Federal Home Loan Bank Stock FHLB of Chicago stock is carried at cost, which is its redeemable (fair) value, since the market for this stock is restricted. The Company considers the fair value of FHLB of Chicago stock to be Level 2 in the fair value hierarchy.

Accrued Interest Receivable and Payable The carrying values of accrued interest receivable and payable approximate their fair value. The Company considers the fair value of accrued interest receivable and payable to be Level 2 in the fair value hierarchy.

Deposit Liabilities and Advance Payments by Borrowers for Taxes and Insurance Fair value for demand deposits equal book value. The Company considers the fair value of demand deposits to be Level 2 in the fair value hierarchy. Fair values for certificates of deposits are estimated using a discounted cash flow calculation that applies

current market borrowing interest rates to a schedule of aggregated expected monthly maturities on deposits. The

Company considers the fair value of certificates of deposit to be Level 3 in the fair value hierarchy. The advance payments by borrowers for taxes and insurance are equal to their carrying amounts at the reporting date. The Company considers the fair value of advance payment by borrowers to be Level 2 in the fair value hierarchy.

Borrowings The fair value of long-term borrowings is estimated using discounted cash flow calculations with the discount rates equal to interest rates currently being offered for borrowings with similar terms and maturities. The carrying value on short-term borrowings approximates fair value. The Company considers the fair value of borrowings to be Level 2 in the fair value hierarchy.

Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments Off-balance sheet financial instruments consist of commitments to extend credit, IRLCs, forward commitments to sell loans, interest rate swaps, and embedded derivatives related to certain commercial loan relationships. 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, forward commitments to sell loans, interest rate swaps, and embedded derivatives is equal to their fair value. For IRLCs and forward commitments, the 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 fair value of the Company’s interest rate swaps and embedded derivatives is determined using discounted cash flow analysis on the expected cash flows of each derivative and also includes a nonperformance or credit risk component. The Company considers the fair value of IRLCs, forward commitments to sell loans, interest rate swaps, and embedded derivatives to be Level 2 in the fair value hierarchy.

31

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

13. Fair Value Measurements (continued)

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

	September 30 2016						December 31 2015
	Carrying Value			Fair  Value			Carrying Value			Fair  Value
Cash and cash equivalents	$	45,808		$	45,808		$	44,501		$	44,501
Mortgage related securities available-for-sale		379,447			379,447			407,874			407,874
Mortgage related securities held-to-maturity		102,931			105,932			120,891			121,641
Loans held-for-sale		8,034			8,034			3,350			3,350
Loans receivable, net		1,925,455			1,945,673			1,740,018			1,751,670
Mortgage servicing rights, net		6,611			7,241			7,205			9,455
Federal Home Loan Bank stock		19,205			19,205			17,591			17,591
Accrued interest receivable		6,181			6,181			6,035			6,035
Deposit liabilities		1,867,115			1,845,399			1,795,591			1,786,934
Borrowings		415,364			423,049			372,375			378,266
Advance payments by borrowers		30,219			30,219			3,382			3,382
Accrued interest payable		1,076			1,076			1,091			1,091
Unrealized gain (loss) on off-balance-sheet items:
Interest rate lock commitments		517			517			166			166
Forward commitments to sell loans		(304	)		(304	)		(72	)		(72	)
Embedded free-standing derivatives on commercial loans		951			951			705			705
Receive-fixed free-standing interest rate swaps		12,474			12,474			2,648			2,648
Pay-fixed free-standing interest rate swaps		(13,425	)		(13,425	)		(3,353	)		(3,353	)
Pay-fixed cash flow hedge interest rate swaps		(189	)		(189	)		–			–

The following table segregates by fair value hierarchy (i.e., Level 1, 2, or 3) all of the Company's assets and liabilities that were accounted for at fair value on a recurring basis as of the dates indicated:

	At September 30, 2016
	Level 1		Level 2		Level 3		Total
Loans held-for-sale		–	$	8,034		–	$	8,034
Mortgage-related securities available-for-sale		–		379,447		–		379,447

	At December 31, 2015
	Level 1		Level 2		Level 3		Total
Loans held-for-sale		–	$	3,350		–	$	3,350
Mortgage-related securities available-for-sale		–		407,874		–		407,874

32

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2016

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

13. Fair Value Measurements (continued)

Impaired Loans For non-accrual loans greater than an established threshold and individually evaluated for impairment and all renegotiated loans, impairment is measured based on: (i) the fair value of the loan or the fair value of the collateral less estimated selling costs (collectively the “collateral value method”) or (ii) the present value of the estimated cash flows discounted at the loan’s original effective interest rate (the “discounted cash flow method”). The resulting valuation allowance, if any, is a component of the allowance for loan losses. The discounted cash flow method is a fair value measure. For the collateral value method, the Company generally obtains appraisals on a periodic basis to support the fair value of collateral underlying the loans. Appraisals are performed by independent certified and/or licensed appraisers that have been reviewed by the Company and incorporate information such as recent sales prices for comparable properties, costs of construction, and net operating income of the property or business. Selling costs are generally estimated at 10%. Appraised values may be further discounted based on management judgment regarding changes in market conditions and other factors since the time of the appraisal. A significant unobservable input in using net operating income to estimate fair value is the capitalization rate. At September 30, 2016, the range of capitalization rates utilized to determine the fair value of the underlying collateral on certain loans was 5.5% to 11.5%. 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 $223 was recorded for loans with a recorded investment of $23,014 at September 30, 2016. These amounts were $535 and $37,119 at December 31, 2015, respectively. Provision for (recovery of) loan losses related to these loans was $222 during the nine months ended September 30, 2016, and $535 during the twelve month period ended December 31, 2015. Provision for (recovery of) loan losses related to impaired loans at September 30, 2015, was $32 for the nine months ended September 30, 2015.

Foreclosed Properties Foreclosed properties acquired through, or in lieu of, loan foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. In determining fair value, the Company generally obtains appraisals to support the fair value of foreclosed properties, as described in the previous paragraph. In certain instances, the Company may also use the selling list price, less estimated costs to sell, as the fair value of foreclosed properties. In such instances, the list price is generally less than the appraised value. The Company considers these fair values to be Level 3 in the fair value hierarchy. As of September 30, 2016, $2,453 in foreclosed properties was valued at collateral value compared to $2,794 at December 31, 2015. Losses of $137 and $330 related to these foreclosed properties were recorded during the nine months ended September 30, 2016, and the twelve months ended December 31, 2015, respectively. Losses on foreclosed properties valued at collateral value at September 30, 2015 were $384 for the nine months ended September 30, 2015.

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

Cautionary Statement

This report contains or incorporates by reference various forward-looking statements concerning the Company's prospects that are based on the current expectations and beliefs of management. Forward-looking statements may contain, and are intended to be identified by, words such as “anticipate,” “believe,” “estimate,” “expect,” “objective,” “projection,” “intend,” and similar expressions; the use of verbs in the future tense and discussions of periods after the date on which this report is issued are also forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks, and uncertainties, many of which are beyond the Company's control, that could cause the Company's actual results and performance to differ materially from what is stated or expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company: general economic conditions, including volatility in credit, lending, and financial markets; weakness and declines in the real estate market, which could affect both collateral values and loan activity; periods of relatively high unemployment or economic weakness and other factors which could affect borrowers’ ability to repay their loans; negative developments affecting particular borrowers, which could further adversely impact loan repayments and collection; legislative and regulatory initiatives and changes, including action taken, or that may be taken, in response to difficulties in financial markets and/or which could negatively affect the rights of creditors; monetary and fiscal policies of the federal government; the effects of further regulation and consolidation within the financial services industry; regulators’ strict expectations for financial institutions’ capital levels and restrictions imposed on institutions, as to payments of dividends, share repurchases, or otherwise, to maintain or achieve those levels; recent, pending, and/or potential rulemaking or various federal regulatory agencies that could affect the Company or the Bank; 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 or other global conflicts; the risk of failures in computer or other technology systems or data maintenance, or breaches of security relating to such systems; and the factors discussed in the Company’s filings with the Securities and Exchange Commission, particularly under Part I, Item 1A, “Risk Factors,” of the Company’s 2015 Annual Report on Form 10-K.

Results of Operations

Overview The Company reported net income of $4.5 million or $0.10 per diluted share in the third quarter of 2016, which was a 33.2% increase over net income of $3.3 million or $0.07 per diluted share in the same quarter of 2015. Year-to-date, the Company reported net income of $12.9 million or $0.28 per diluted share in 2016 compared to $10.5 million or $0.22 per diluted share in the same nine-month period in 2015. The improvements between these periods were primarily due to higher net interest income, higher loan-related fees, higher mortgage banking revenue, and lower compensation-related expenses. Also contributing to the year-to-date improvement were lower net losses and expenses on foreclosed real estate and lower occupancy, equipment, and data processing costs. These improvements were partially offset by provisions for loan losses in the 2016 periods compared to recoveries in the 2015 periods, as well as reduced gains on real estate held for investment and higher income tax expense. Also negatively impacting the year-to-date comparison were lower brokerage and insurance commissions and higher advertising and marketing expenses in 2016 compared to 2015. The following paragraphs describe these changes in greater detail, along with other matters affecting the Company’s results of operations during the three months ended September 30, 2016 and 2015.

34

Net Interest Income The Company’s net interest income increased by $1.7 million or 10.1% and by $2.8 million or 5.4% during the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015. These increases were due in part to an increase in the Company’s average earning assets in the 2016 periods compared to the same periods in the prior year, as well as an increase in funding from non-interest bearing checking accounts between the periods. Also contributing to the increase in the 2016 three- and nine-month periods were call premiums of $577,000 and $1.1 million, respectively, which the Company received on mortgage-related securities that were called during these periods. These favorable developments were partially offset by a decrease in the Company’s net interest margin in the 2016 periods compared to the same periods in 2015.

The Company’s average earning assets increased by $180.5 million or 8.2% during the nine months ended September 30, 2016, compared to the same period in 2015. This increase was primarily attributable to a $189.2 million or 11.6% increase in average loans receivable during the 2016 nine-month period compared to the same period in the prior year.

Also contributing favorably to the Company’s net interest income in the 2016 periods, as well as its net interest margin, was an increase in funding from non-interest-bearing checking accounts. The average balance in these accounts increased by $34.1 million or 16.7% during the nine months ended September 30, 2016, compared to the same period in 2015.

The Company’s net interest margin was 3.08% and 3.03% during the three and nine months ended September 30, 2016, respectively. However, excluding the impact of the aforementioned call premiums, net interest margin for these periods would have been 2.98% and 2.97%, respectively. These amounts compared to 3.05% and 3.12% during the same periods of 2015, respectively. During the nine months ended September 30, 2016, the average yield on the Company’s earning assets declined by 11 basis points (excluding call premiums) and its average cost of funds increased by four basis points compared to the same period in 2015. The decline in the average yield on earning assets was largely due to the continued repricing of the Company’s loan portfolio to lower yields in the current interest rate environment, as well as its continued emphasis on the origination of variable-rate loans, which generally have lower initial yields than fixed-rate loans. However, management is hopeful that the negative impact these developments have had on the Company’s loan portfolio yield may have run their course and that the loan portfolio yield may stabilize or even improve slightly in the near term. However, there can be no assurances; future results will depend in large part on developments affecting interest rates throughout the U.S. economy. Also contributing to the decline in yield on earning assets in the 2016 periods has been the purchase of mortgage-related securities in the current year at yields that were less than the prevailing rates in the investment portfolio.

The increase in the Company’s average cost of funds was primarily due to a six basis point increase in its average cost of deposits during the nine months ended September 30, 2016, compared to the same period in the prior year. The impact of this increase was offset slightly by a decline in the average cost of borrowings from the FHLB of Chicago. This decline was caused by an increase in overnight borrowings, which were drawn to fund growth in earning assets, as previously noted. Overnight borrowings generally have a lower interest cost than the rates the Company offers on its certificates of deposit.

35

The following tables present certain details regarding the Company's average balance sheet and net interest income for the periods indicated. The tables present the average yield on interest-earning assets and the average cost of interest-bearing liabilities. The yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. The average balances are derived from daily balances over the periods indicated. Interest income includes fees, which are considered adjustments to yields. Net interest spread is the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin is derived by dividing net interest income by average interest-earning assets. The Company’s tax exempt investments are insignificant, so no tax equivalent adjustments have been made.

	Three Months Ended September 30
	2016							2015
			Interest		Average					Interest		Average
	Average		Earned/		Yield/			Average		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(Dollars in thousands)
Assets:
Interest-earning assets:
Loans receivable (1)	$	1,896,762	$	18,209		3.84	%	$	1,650,143	$	16,464		3.99	%
Mortgage-related securities		501,960		3,139		2.50			541,776		2,912		2.15
Investment securities (2)		18,813		117		2.49			16,988		61		1.44
Interest-earning deposits		15,529		5		0.13			17,063		4		0.09
Total interest-earning assets		2,433,064		21,470		3.53			2,225,970		19,441		3.49
Non-interest-earning assets		205,468							225,816
Total average assets	$	2,638,532						$	2,451,786
Liabilities and equity:
Interest-bearing liabilities:
Regular savings deposits	$	229,929		8		0.01			220,593		11		0.02
Money market accounts		540,987		221		0.16			512,923		170		0.13
Interest-bearing demand accounts		257,470		11		0.02			247,139		7		0.01
Certificates of deposit		542,009		1,228		0.91			528,739		1,018		0.77
Total deposit liabilities		1,570,395		1,468		0.37			1,509,394		1,206		0.32
Advance payments by borrowers for taxes and insurance		26,129		–		0.00			26,064		–		0.00
Borrowings		418,933		1,290		1.23			345,102		1,243		1.44
Total interest-bearing liabilities		2,015,457		2,758		0.55			1,880,560		2,449		0.52
Non-interest-bearing liabilities:
Non-interest-bearing deposits		258,720							209,800
Other non-interest-bearing liabilities		76,791							83,199
Total non-interest-bearing liabilities		335,511							292,999
Total liabilities		2,350,968							2,173,559
Total equity		287,564							278,227
Total average liabilities and equity	$	2,638,532						$	2,451,786
Net interest income and net interest rate spread			$	18,712		2.98	%			$	16,992		2.97	%
Net interest margin						3.08	%						3.05	%
Average interest-earning assets to average interest-bearing liabilities		1.21X							1.18X

(1)     For the purposes of these computations, non-accruing loans and loans held-for-sale are included in loans receivable.

(2)     The carrying value and earnings on stock in the FHLB of Chicago is included in investment securities.

36

	Nine Months Ended September 30
	2016							2015
			Interest		Average					Interest		Average
	Average		Earned/		Yield/			Average		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(Dollars in thousands)
Assets:
Interest-earning assets:
Loans receivable (1)	$	1,818,232	$	52,505		3.85	%	$	1,629,024	$	49,318		4.04	%
Mortgage-related securities		515,183		9,122		2.36			525,762		8,625		2.19
Investment securities (2)		18,412		338		2.45			15,948		166		1.39
Interest-earning deposits		16,554		23		0.19			17,160		14		0.11
Total interest-earning assets		2,368,381		61,988		3.49			2,187,894		58,123		3.54
Non-interest-earning assets		203,065							221,223
Total average assets	$	2,571,446						$	2,409,117
Liabilities and equity:
Interest-bearing liabilities:
Regular savings deposits		225,572		22		0.01			220,501		39		0.02
Money market accounts		532,041		620		0.16			509,471		538		0.14
Interest-bearing demand accounts		262,720		36		0.02			244,679		22		0.01
Certificates of deposit		545,550		3,641		0.89			534,332		2,853		0.71
Total deposit liabilities		1,565,883		4,319		0.37			1,508,983		3,452		0.31
Advance payments by borrowers for taxes and insurance		17,237		1		0.01			17,840		1		0.01
Borrowings		386,894		3,790		1.31			311,868		3,552		1.52
Total interest-bearing liabilities		1,970,014		8,110		0.55			1,838,691		7,005		0.51
Non-interest-bearing liabilities:
Non-interest-bearing deposits		237,744							203,684
Other non-interest-bearing liabilities		78,648							86,295
Total non-interest-bearing liabilities		316,392							289,979
Total liabilities		2,286,406							2,128,670
Total equity		285,040							280,447
Total average liabilities and equity	$	2,571,446						$	2,409,117
Net interest income and net interest rate spread			$	53,878		2.94	%			$	51,118		3.03	%
Net interest margin						3.03	%						3.12	%
Average interest-earning assets to average interest-bearing liabilities		1.20X							1.19X

(3)     For the purposes of these computations, non-accruing loans and loans held-for-sale are included in loans receivable.

(4)     The carrying value and earnings on stock in the FHLB of Chicago is included in investment securities.

37

The following tables present the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to the change attributable to change in volume (change in volume multiplied by prior rate), the change attributable to change in rate (change in rate multiplied by prior volume), and the net change. The change attributable to the combined impact of volume and rate has been allocated proportionately to the change due to volume and the change due to rate.

	Three Months Ended September 30, 2016 Compared to September 30, 2015
	Increase (Decrease)
	Volume			Rate			Net
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	2,382		$	(637	)	$	1,745
Mortgage-related securities		(223	)		450			227
Investment securities		8			48			56
Interest-earning deposits		–			1			1
Total interest-earning assets		2,167			(138	)		2,029
Interest-bearing liabilities:
Savings accounts		3			(6	)		(3	)
Money market accounts		9			42			51
Interest-bearing demand accounts		–			4			4
Certificates of deposit		27			183			210
Total deposit liabilities		39			223			262
Advance payments by borrowers for taxes and insurance		–			–			–
Borrowings		243			(196	)		47
Total interest-bearing liabilities		282			27			309
Net change in net interest income	$	1,885		$	(165	)	$	1,720

	Nine Months Ended September 30, 2016 Compared to September 30, 2015
	Increase (Decrease)
	Volume			Rate			Net
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	5,586		$	(2,399	)	$	3,187
Mortgage-related securities		(163	)		660			497
Investment securities		29			143			172
Interest-earning deposits		–			9			9
Total interest-earning assets		5,452			(1,587	)		3,865
Interest-bearing liabilities:
Savings accounts		–			(17	)		(17	)
Money market accounts		25			57			82
Interest-bearing demand accounts		1			13			14
Certificates of deposit		61			727			788
Total deposit liabilities		87			780			867
Advance payments by borrowers for taxes and insurance		–			–			–
Borrowings		780			(542	)		238
Total interest-bearing liabilities		867			238			1,105
Net change in net interest income	$	4,585		$	(1,825	)	$	2,760

38

Provision for (recovery of) Loan Losses The Company’s provision for (recovery of) loan losses was $1.4 million in the third quarter of 2016 compared to $(930,000) in the same quarter last year. The provision (recovery) for the nine months ended September 30, 2016, was $2.0 million compared to $(2.6) million in the same period last year. Management believes that general economic, employment, and real estate conditions continue to be relatively stable in the Company local markets. In addition, the Company’s level of non-performing loans, as well as its actual loan charge-offs, have continued to trend lower in recent periods, as noted later in this report. However, economic growth in the United States has slowed in recent periods and the global economy, which has also slowed, has experienced increased political-, trade-, and currency-related challenges. In addition, the Company has experienced a modest increase in classified loans in recent months, as described later in this report. Management believes that these developments are early indications of emerging difficulties in the credit and lending environment for the Company. These considerations, along with growth in the Company’s loan portfolio, contributed to management’s conclusion that an increase in the allowance for loan losses was appropriate. As such, the Company’s allowance for loan losses increased from $17.6 million at December 31, 2015, to $19.2 million at September 30, 2016. Management anticipates that the Company’s provision for loan losses may continue to consist of provisions rather than recoveries for the foreseeable future. This is expected to be particularly true if the Company’s loan portfolio continues to grow as it has in recent periods.

Trends in the credit quality of the Company’s loan portfolio are subject to many factors that are outside of the Company’s control, such as economic and market conditions that can fluctuate considerably from period to period. As such, there can be no assurances that there will not be significant fluctuations in the Company’s non-performing loans, classified loans, and/or loan charge-off activity from period to period, which may result in significant variability in the Company’s provision for loan losses.

Non-Interest Income Total non-interest income increased by $871,000 or 14.5% and $2.6 million or 15.3% during the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015, respectively. Significant reasons for the changes in the components of non-interest income are discussed in the following paragraphs.

Deposit-related fees and charges increased slightly in the third quarter of 2016 compared to the same quarter in the prior year. Year-to-date, however, deposit-related fees were down modestly in 2016 compared to 2015. Deposit-related fees and charges consist of overdraft fees, ATM and debit card fees, merchant processing fees, account service charges, and other revenue items related to services performed by the Company for its retail and commercial deposit customers. Management attributes the fluctuations in deposit-related fees and charges to changes in customer spending behavior in recent years which has generally resulted in lower revenue from overdraft charges and from check printing commissions. Benefiting this revenue line item in recent periods, however, has been increased revenue from treasury management and merchant card processing services that the Company offers to commercial depositors.

Loan-related fees were $1.1 million and $4.0 million during the three and nine months ended September 30, 2016, respectively. These amounts compared to $476,000 and $1.4 million during the same periods in 2015, respectively. Loan-related fees consist of periodic income from lending activities that are not deferred as yield adjustments under the applicable accounting rules. The largest source of fees in this revenue category is interest rate swap fees related to commercial loan relationships. The Company mitigates the interest rate risk associated with certain of its loan relationships by executing interest rate swaps, the accounting for which results in the recognition of a certain amount of fee income at the time the swap contracts are executed. The increases in loan-related fees in the 2016 periods were the result of increased loan production, as well as a lower interest rate environment that has increased borrower preference for the types of loan transactions that generate interest rate swap fees. Management believes this source of revenue will vary considerably from period to period depending on the rate environment and on borrower preference for the types of transactions that generate interest rate swaps. Furthermore, a potential decline in the origination of multi-family and construction loans, which are the types of loans that generate most of the Company’s interest rate swap fees, could have a negative impact on such fee income in the future, as more fully discussed elsewhere in this report.

39

Brokerage and insurance commissions were slightly lower during the third quarter of 2016 than they were in the same quarter of the previous year. Year-to-date this source of revenue was $298,000 or 10.5% lower than the same period in 2015. This revenue item generally consists of commissions earned on sales of tax-deferred annuities, mutual funds, and certain other securities, fees earned for investment advisory services, and commissions earned on sales of personal and business insurance products. However, the prior year periods included certain non-recurring incentive payments. Excluding those payments, brokerage and insurance commissions during the three and nine months ended September 30, 2016, were approximately 15% and 30% higher in the 2016 periods than they were in the same periods of 2015, respectively. Management attributes these increases to new products, services, systems, and investment advisors that the Company has added in recent periods.

Mortgage banking revenue, net, was $1.4 million and $3.3 million during three and nine months ended September 30, 2016, respectively. This compared to $798,000 and $2.6 million during the same periods in 2015, respectively. The following table presents the components of mortgage banking revenue, net, for the periods indicated:

	Three Months Ended September 30						Nine Months Ended September 30
	2016			2015			2016			2015
	(Dollars in thousands)
Gross loan servicing fees	$	633		$	670		$	1,915		$	2,012
MSR amortization		(650	)		(458	)		(1,636	)		(1,458	)
Change in MSR valuation allowance		–			–			–			–
Loan servicing revenue, net		(17	)		212			279			554
Gain on loan sales activities, net		1,371			586			3,042			2,085
Mortgage banking revenue, net	$	1,354		$	798		$	3,321		$	2,639

Loan servicing revenue, net, decreased during the three- and nine-month periods in 2016 compared to the same periods in 2015. These decreases were caused in part by a decline in gross servicing fees due to an overall decline in loans serviced for third-party investors. As of September 30, 2016, the Company serviced $1.003 billion in loans for third-party investors compared to $1.039 billion at December 31, 2015. Also contributing to the decrease in loan servicing revenue, net, in the 2016 periods was an increase in amortization of MSR. These increases were caused by lower market interest rates for one- to four-family loans in 2016, which resulted in increased loan prepayment activity and faster amortization of the related MSRs.

The change in valuation allowance that the Company establishes against its MSRs is recorded as a recovery or loss, as the case may be, in the period in which the change occurs. As of September 30, 2016, the Company had no valuation allowance against its MSRs, which had a net book value of $6.6 million as of that date. MSR valuation allowances typically increase in periods of lower market interest rates, which results in a charge to earnings in the period of the increase. During lower market interest rate environments, such as that which has occurred in recent months, loan refinance activity and expectations for future loan prepayments generally increase, which typically reduces the fair value of MSRs and results in an increase in the MSR valuation allowance. However, market interest rates for one- to four-family mortgage loans as of September 30, 2016, were not sufficiently low enough to generate an MSR valuation allowance as of that date. However, there can be no assurances that an increase in the MSR valuation allowance will not be required in the future, particularly if market interest rates for one- to four-family residential loans remain low or decline further.

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Gain on loan sales activities, net, was $1.4 million and $3.0 million during the three and nine months ended September 30, 2016, respectively, compared to $586,000 and $2.1 million during the same periods in 2015, respectively. The Company typically sells most of the fixed-rate, one- to four-family mortgage loans that it originates. During the nine months ended September 30, 2016, sales of these loans were $108.0 million, which was $23.7 million or 28.1% higher than the same period of 2015. Management attributes this increase to lower market interest rates for one- to four-family mortgage loans in 2016 compared to 2015. The origination and sale of residential loans are subject to variations in market interest rates and other factors outside of management’s control. Accordingly, there can be no assurances that such originations and sales will not fluctuate considerably from period to period.

During the three months ended September 30, 2016 and 2015, the Company recorded $12,000 and $378,000 in gains on the disposition of certain real estate properties that it held for investment purposes, respectively. On a year-to-date basis, the gain in 2015 was only $212,000 because of net losses the Company recorded on the disposition of certain other real estate properties earlier in that year. The Company continues to actively market certain of the properties that it holds for investment purposes. There can be no assurances that the Company will be able to sell such properties or that gains or losses on sales, if any, will not fluctuate considerably from period to period.

Non-Interest Expense Total non-interest expense decreased by $1.2 million or 6.6% and $2.7 million or 5.0% during the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015, respectively. Significant reasons for the changes in the components of non-interest expense are discussed in the following paragraphs.

Compensation-related expenses decreased by $975,000 or 8.5% and $2.5 million or 7.4% during the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015. These decreases were mostly due to lower costs associated with the Company’s defined benefit pension plan, which was due in part to an increase in the discount rate used to determine the present value of the pension obligation, but also to a freeze of the plan’s benefits at the end of 2015. This latter change also resulted in a lengthening of the amortization period for unrealized losses in the pension plan, which further contributed to lower pension costs in 2016. Also contributing to the decreases in compensation-related expenses in the 2016 periods compared to the same periods in the prior year was a decline in the number of employees at the Company. This decline was primarily due to the consolidation of seven retail banking offices in the third quarter of 2015 and an additional four in the first quarter of 2016. These developments were partially offset by normal annual merit increases granted to most employees at the beginning of 2016, as well as higher stock-based compensation and employee commission expense compared to the 2015 periods.

Occupancy, equipment, and data processing expenses were $3.3 million and $10.1 million during the three and nine months ended September 30, 2016, respectively. These amounts compared to $3.4 million and $10.5 million during the same periods in 2015, respectively. The nine-month period in 2015 included $269,000 in one-time costs associated with the Company’s consolidation of seven retail branch offices in that period. Other on-going occupancy costs related to these consolidations, as well as four others that were completed in the first quarter of 2016, declined by $65,000 and $418,000 during the quarter and year-to-date periods in 2016, respectively, compared to the same periods in 2015. However, these cost reductions were partially offset by increased data processing, software, and equipment costs associated with other initiatives undertaken by the Company in the past few periods.

Advertising and marketing-related expenses were $737,000 and $2.3 million during the three and nine months ended September 30, 2016, respectively, compared to $736,000 and $1.6 million during the same periods in 2015. The Company has generally increased spending on advertising and marketing in 2016 in an effort to increase sales and expand the Company’s overall brand awareness, especially as such relates to the retail deposit business. Management anticipates that for the entire year 2016 the Company’s advertising and marketing-related expenses are likely to be 20% to 25% higher than they were in 2015. However, this increase depends on future management decisions and there can be no assurances.

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Federal deposit insurance premiums were $273,000 and $382,000 during the three months ended September 30, 2016 and 2015, respectively. Year-to-date, these premiums were $1.1 million in both the 2016 and 2015 periods. Earlier in 2016 the FDIC issued a final rule that changed how insured financial institutions less than $10 billion in assets, such as the Company, will be assessed for deposit insurance. The new rule, which became effective in the third quarter of 2016, resulted in a lower deposit insurance assessment rate for the Company during the period.

Net losses and expenses on foreclosed real estate were $169,000 and $150,000 during the three months ended September 30, 2016 and 2015, respectively. On a year-to-date basis these amounts were $80,000 and $687,000 in 2016 and 2015, respectively. Although the third quarter of 2016 was an exception, the Company has generally experienced lower net losses and expenses related to foreclosed properties in recent periods due to reduced holdings of such properties.

Other non-interest expenses were $2.3 million and $7.0 million during the three and nine months ended September 30, 2016, respectively. During these periods the Company elected to prepay certain fixed-rate FHLB of Chicago advances and incurred prepayment penalties of $134,000 and $341,000, respectively. These advances had originally been drawn to fund the purchase of mortgage-related securities that were called by the issuer during the periods, as previously noted. Excluding these prepayment penalties, other non-interest expenses were $2.2 million and $6.7 million during the three and nine months ended September 30, 2016, respectively. These amounts compared to $2.4 million and $6.9 million during the same periods in 2015, respectively. In 2016 the Company has experienced lower processing costs related to its ATM network, lower deposit account fraud losses, and lower amortization expense related to certain intangible assets. Also, the 2015 periods included a one-time cost to terminate a contract with a third-party vendor.

Income Tax Expense Income tax expense was $2.5 million and $2.1 million during the third quarters of 2016 and 2015, respectively, and was $7.4 million and $6.3 million during the year-to-date periods in the same years, respectively. The effective tax rates (“ETRs”) for the quarter periods were 35.8% and 38.6%, respectively, and for the year-to-date periods were $36.5% and 37.4%, respectively. The Company’s ETR will vary from period to period due primarily to the impact of non-taxable revenue items, such as earnings from BOLI and tax-exempt interest income. The ETR will also vary because of certain tax deductions related to employee exercises of stock options, which is the primary reason the ETR declined in the 2016 periods.

Financial Condition

Overview The Company’s total assets increased by $151.2 million or 6.0% during the nine months ended September 30, 2016, due principally to an increase in total loans receivable. This increase was primarily funded by increases in deposit liabilities, other borrowings, and advance payments by borrowers. Also providing funds for the increase in loans receivable was a decrease in mortgage-related securities during the nine-month period. The Company’s total shareholders’ equity was $288.9 million at September 30, 2016, compared to $279.4 million at December 31, 2015

Mortgage-Related Securities Available-for-Sale The Company’s portfolio of mortgage-related securities available-for-sale decreased by $28.4 million or 7.0% during the nine months ended September 30, 2016. This decrease was due to normal periodic principal repayments in the portfolio that were partially offset by the purchase of $56.1 million in securities.

Changes in the fair value of the Company’s mortgage-related securities available-for-sale are recorded through accumulated other comprehensive loss (net of deferred income taxes), which is a component of shareholders’ equity. The fair value adjustment on the Company’s mortgage-related securities available-for-sale was a net unrealized gain of $5.2 million at September 30, 2016, compared to a net unrealized gain of $1.2 million at December 31, 2015. This increase was caused by a decline in market interest rates during the period, which had a favorable impact on the fair value of the Company’s mortgage-related securities.

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Mortgage-Related Securities Held-to-Maturity The Company maintains a portfolio of mortgage-related securities held-to-maturity that consists of securities issued and guaranteed by the Federal National Mortgage Association (“Fannie Mae”) and backed by multi-family residential loans. The Company has classified these securities has held-to-maturity because it has the ability and intent to hold these securities until they mature. The Company’s portfolio of mortgage-related securities held-to-maturity decreased by $18.0 million or 14.9% during the nine months ended September 30, 2016. During this period securities with a carrying value of $16.2 million were called by Fannie Mae. As a result, the Company recorded call premiums in interest income of $1.1 million, as previously described. The Company did not purchase any held-to-maturity securities during the nine months ended September 30, 2016.

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. Loans held-for-sale were $8.0 million and $3.4 million at September 30, 2016, and December 31, 2015, respectively.

Loans Receivable The Company’s loans receivable increased by $185.4 million or 10.7% during the nine months ended September 30, 2016. During this period increases in multi-family, commercial real estate, and construction loans (net of the undisbursed portion) were partially offset by declines in most of the Company’s other loan categories. Management attributes the increases in part to a low interest rate environment that has encouraged loan growth in the Company’s local markets, particularly for loans secured by multi-family and commercial real estate. This rate environment has also improved the competitiveness of the Company’s loan offerings linked to its interest rate swap loan program, as noted earlier in this report. Because of this improvement, the Company has been able to increase new loan production, as well as retain in its loan portfolio a larger portion of construction loans transitioning to permanent financing than it typically has in prior periods. However, management is not certain that the loan growth experienced in recent periods can be sustained in the future. The loan portfolio is subject to economic, market, and competitive factors outside of the Company’s control and there can be no assurances that expected loan growth will continue or that total loans will not decrease in future periods.

The following table sets forth the Company’s commercial and retail loans that were originated for portfolio during the periods indicated:

	Nine Months Ended September 30
	2016		2015
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	56,637	$	67,387
Commercial real estate		73,579		57,330
Multi-family real estate		118,968		67,369
Construction and development		185,424		209,911
Total commercial loans		434,608		401,997
Retail loans:
One- to four-family first mortgages (1)		81,944		73,820
Home equity		24,261		25,151
Other consumer		1,665		1,112
Total retail loans		107,870		100,083
Total loan originations	$	542,478	$	502,080

(1)   Excludes $112.5 million and $83.9 million in loans originated for sale during the nine months ended September 30, 2016 and 2015, respectively.

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In recent months banking regulatory agencies have publicly expressed increased concern about financial institutions whose holdings of non-owner-occupied commercial real estate and construction loans and whose growth in such loans exceed guidelines established in certain regulatory pronouncements. Specifically, financial institutions whose holdings of such loans exceed 300% of total risk-based capital and whose growth in such loans exceeds 50% over the past three years can expect increased scrutiny from their primary regulator. As of September 30, 2016, the Company’s holdings of and three-year growth in these types of loans exceed these guidelines. As such, the Company’s regulator could subject its lending operations and risk management controls to increased scrutiny. Although management of the Company is confident of the quality of its lending operations and controls, it is likely that growth in multi-family and construction loans will be lower in future periods than it has been in recent periods. Such decline could have a negative impact on the Company’s net interest income and interest rate swap fees in future periods.

Mortgage Servicing Rights The carrying value of the Company’s MSRs was $6.6 million at September 30, 2016, and $7.2 million at December 31, 2015, respectively. The Company maintained no valuation allowance against its MSRs as of either of those dates. As of September 30, 2016, the Company serviced $1.003 billion in loans for third-party investors compared to $1.039 billion at December 31, 2015. Refer to “Results of Operations—Non-Interest Income,” above, for additional discussion related to the Company’s MSRs.

Deposit Liabilities The Company’s deposit liabilities increased by $71.5 million or 4.0% during the nine months ended September 30, 2016. Transaction deposits, which consist of checking, savings, and money market accounts, increased by $79.2 million or 6.3% during the period and certificates of deposit decreased by $7.7 million or 1.4%. Management believes that the increase in transaction deposits in recent periods, particularly a $55.1 million or 25.8% increase in non-interest-bearing checking accounts, is due in part to improved marketing and sales efforts. However, management also believes that the low interest rate environment that has persisted for the past few years has encouraged some customers to switch to transaction deposits in an effort to retain flexibility in the event interest rates increase in the future. If interest rates increase in the future, customer preference may shift from transaction deposits back to certificates of deposit, which typically have a higher interest cost to the Company. This development could increase the Company’s cost of funds in the future, which would also have an adverse impact on its net interest margin.

Borrowings Borrowings, which consist of advances from the FHLB of Chicago, increased by $43.0 million or 11.5% during the nine months ended September 30, 2016. This increase was primarily caused by overnight borrowings from the FHLB of Chicago, which were drawn to fund growth in the Company’s earning assets during the period, as previously described. Management believes that additional funds are available to be borrowed from the FHLB of Chicago or other sources in the future to fund maturing term advances, loan originations, security purchases, and other corporate purposes, if needed or desirable. However, there can be no assurances of the future availability of borrowings or any particular level of future borrowings.

Advance Payments by Borrowers for Taxes and Insurance Advance payments by borrowers for taxes and insurance (i.e., escrow deposits) were $30.2 million at September 30, 2016, compared to $3.4 million at December 31, 2015. Escrow deposits typically increase during the course of the calendar year until real estate tax obligations are paid, generally in December of each year or January of the following year.

Shareholders' Equity The Company’s shareholders’ equity was $288.9 million at September 30, 2016, compared to $279.4 million at December 31, 2015. This increase was due to $12.9 million in net income and a $2.4 million decrease in accumulated other comprehensive loss. These developments were only partially offset by $7.3 million in regular cash dividends. The decrease in accumulated other comprehensive loss was mostly due to an increase in the fair value of available-for-sale securities (net of income tax effect), which was caused by a decline in market interest rates during the period. The Company did not repurchase a significant amount of its common stock during the nine months ended September 30, 2016. The book value of the Company’s common stock was $6.32 per share at September 30, 2016, compared to $6.15 at December 31, 2015.

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On November 7, 2016, the Company’s board of directors declared a $0.055 per share dividend payable on November 28, 2016, to shareholders of record on November 18, 2016. For additional discussion relating to the Company’s ability to pay dividends or repurchase its common stock refer to “Liquidity and Capital Resources—Capital Resources,” below.

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

	September 30			December 31
	2016			2015
	(Dollars in thousands)
Non-accrual commercial loans:
Commercial and industrial	$	486		$	4,915
Commercial real estate		3,586			3,968
Multi-family real estate		280			–
Construction and development		659			766
Total commercial loans		5,011			9,649
Non-accrual retail loans:
One- to four-family first mortgages		3,130			2,703
Home equity		534			703
Other consumer		110			82
Total non-accrual retail loans		3,774			3,488
Total non-accrual loans		8,785			13,137
Accruing loans delinquent 90 days or more (1)		366			484
Total non-performing loans		9,151			13,621
Foreclosed real estate and repossessed assets		2,709			3,306
Total non-performing assets	$	11,860		$	16,927
Non-performing loans to total loans		0.48	%		0.78	%
Non-performing assets to total assets		0.45	%		0.68	%
Interest income that would have been recognized if non-accrual loans had been current (2)	$	498		$	637
Interest income on non-accrual loans included in interest income (2)	$	335		$	630

(1)  Consists of student loans that are guaranteed under programs sponsored by the U.S. government.

(2)  Amounts shown are for the nine months ended September 30, 2016, and the twelve months ended December 31, 2015, respectively.

The Company’s non-performing loans were $9.2 million or 0.48% of loans receivable as of September 30, 2016, compared to $13.6 million or 0.78% of loans receivable as of December 31, 2015. Non-performing assets, which includes non-performing loans, were $11.9 million or 0.45% of total assets and $16.9 million or 0.68% of total assets as of these same dates, respectively. The decreases noted in the 2016 figures were primarily the result of the payoff of a $4.8 million non-performing commercial loan relationship in the third quarter.

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Non-performing assets are classified as “substandard” in accordance with the Company’s internal risk rating policy. In addition to these non-performing assets, at September 30, 2016, management was closely monitoring $63.8 million in additional loans that were classified as either “special mention” or “substandard” in accordance with the Company’s internal risk rating policy. This amount compared to $55.9 million at December 31, 2015. As of September 30, 2016, most of these additional classified loans were secured by commercial real estate, multi-family real estate, land, and certain commercial business assets. Management does not believe any of these loans were impaired as of September 30, 2016, although there can be no assurances that the loans will not become impaired in future periods. The increase in additional classified loans during the nine months ended September 30, 2016, was primarily the result of management’s assessment that the credit condition of a number of commercial loan relationships, most of which were manufacturing related, had deteriorated in recent months.

Trends in the credit quality of the Company’s loan portfolio are subject to many factors that are outside of the Company’s control, such as economic and market conditions that can fluctuate considerably from period to period. As such, there can be no assurances that there will not be significant fluctuations in the Company’s non-performing loans, classified loans, and/or loan charge-off activity from period to period, which may result in significant variability in the Company’s provision for loan losses.

A summary of the Company’s allowance for loan losses is shown below for the periods indicated:

	Nine Months Ended September 30
	2016			2015
	(Dollars in thousands)
Balance at beginning of period	$	17,641		$	22,289
Provision for (recovery of) loan losses		1,986			(2,646	)
Charge-offs:
Commercial and industrial		–			(74	)
Commercial real estate		(179	)		(69	)
Multi-family real estate		–			–
Construction and development		–			–
One- to four-family first mortgages		(84	)		(276	)
Home equity		(35	)		(130	)
Other consumer		(299	)		(431	)
Total charge-offs		(597	)		(980	)
Recoveries:
Commercial and industrial		5			7
Commercial real estate		28			107
Multi-family real estate		30			–
Construction and development		–			–
One- to four-family first mortgages		42			52
Home equity		15			24
Other consumer		52			38
Total recoveries		172			228
Net charge-offs		(425	)		(752	)
Balance at end of period	$	19,202		$	18,891

	September 30			December 31
	2016			2015
Allowance for loan losses to total loans		1.00	%		1.01	%
Allowance for loan losses to non-performing loans		209.83	%		129.51	%
Net charge-offs to average loans (1)		0.03	%		0.06	%

(1)    The rate for the nine months ended September 30, 2016, is annualized.

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The Company’s allowance for loan losses was $19.2 million or 1.00% of loans receivable at September 30, 2016, compared to $17.6 million or 1.01% at December 31, 2015. As a percent of non-performing loans, the Company’s allowance for loan losses was 209.8% at September 30, 2016, compared to 129.5% at December 31, 2015. The reasons for the increase in the dollar amount of the Company’s allowance for loan losses during the nine months ended September 30, 2016, were described earlier in this report. The significant increase in the allowance as a percent of non-performing loans during this period was primarily the result of the aforementioned payoff of a non-performing commercial loan relationship. Management believes the allowance for loan losses at September 30, 2016, was adequate to cover probable and estimable losses in the Company’s loan portfolio as of that date. However, future increases to the allowance may be necessary and results of operations could be adversely affected if future conditions differ from the assumptions used by management to determine the allowance for loan losses as of the end of the period.

Management is responsible for the timely and periodic determination of the amount of the allowance required. Future provisions for loan losses will continue to be based upon management’s assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions, and other relevant factors. To the best of management’s knowledge, all known and inherent losses have been provided for in the allowance for loan losses.

Refer to “Operating Results—Provision for Loan Losses,” above, for additional discussion.

Liquidity and Capital Resources

Liquidity The term "liquidity" refers to the Company’s ability to generate cash flow to fund loan originations, loan purchases, deposit withdrawals, and operating expenses. The Company’s primary sources of funds are deposit liabilities, scheduled payments, prepayments, and maturities of loans and mortgage-related securities, sales of one- to four-family loans in the secondary market, borrowings from the FHLB of Chicago, and cash flow provided by the Company’s operations. From time-to-time the Company may also sell securities classified as available-for-sale. Historically, these sources of funds have been adequate to maintain liquidity, with the Company borrowing correspondingly more in periods in which its operations generate less cash.

Scheduled payments and maturities of loans and mortgage-related securities are relatively predictable sources of funds. However, cash flows from customer deposits, calls of investment securities (if any), prepayments of loans and mortgage-related securities, loan originations, and draws by borrowers on unused lines of credit are strongly influenced by interest rates, general and local economic conditions, and/or competition in the marketplace. These factors increase the variability of cash flows from these sources of funds.

The Company is committed to maintaining a strong liquidity position; therefore, management monitors the Company’s liquidity position on a daily basis. Based upon historical experience and available sources of liquidity, management anticipates that the Company will have sufficient funds to meet current funding commitments. For additional discussion refer to “Financial Condition,” above, and “Qualitative and Quantitative Disclosures about Market Risk” in Part I, Item 3, below.

Capital Resources The Company’s ratio of shareholders’ equity to total assets was 10.89% at September 30, 2016, compared to 11.17% at December 31, 2015. This decrease was primarily due to an increase in the Company’s total assets during the period, as previously described. The Company is required to maintain specified amounts of regulatory capital pursuant to regulations promulgated by the Federal Reserve Bank (“FRB”). The Company is “well capitalized” for regulatory capital purposes. As of September 30, 2016, the Company had a total risk-based capital ratio of 15.11% and a Tier 1 leverage capital ratio of 10.91%. The minimum ratios to be considered “well capitalized” under current supervisory regulations are 10% for total risk-based capital and 5% for Tier 1 capital. The minimum ratios to be considered “adequately capitalized” are 8% and 4%, respectively. For additional discussion refer to “Note 8. Regulatory Capital Requirements” in “Item 1. Financial Statements.”

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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 also subject to any requirements imposed by law or regulations and to the application and interpretation thereof by the OCC and FRB. The Company cannot provide any assurances that dividends will continue to be paid, the amount of any such dividends, or whether the Company will choose to or be able to repurchase its common stock in future periods.

Contractual Obligations, Commitments, Off-Balance Sheet Arrangements, and Contingencies

Contractual ObligationsThe following table presents, as of September 30, 2016, significant fixed and determinable contractual obligations to third parties by payment date (excluding interest payments due in the future on deposits and borrowed funds):

	Payments Due In
			One to		Three to		Over
	One Year		Three		Five		Five
	Or Less		Years		Years		Years		Total
	(Dollars in thousands)
Deposits with no stated maturity	$	1,330,248		–		–		–	$	1,330,248
Certificates of deposit		320,672	$	210,643	$	5,552		–		536,867
Borrowed funds		296,409		65,114		41,402		12,439		415,364
Operating leases		878		1,604		1,398		3,028		6,908
Purchase obligations		2,640		5,280		–		–		7,920
Deferred retirement plans and deferred compensation plans		789		1,618		1,247		4,323		7,977

The Company’s operating lease obligations represent short- and long-term lease and rental payments for facilities, certain software and data processing equipment, 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 executives and directors as described in Note 10, “Employee Benefit Plans,” to the Unaudited Condensed Consolidated Financial Statements, above.

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Commitments to Extend Credit The following table details the amounts and expected maturities of approved commitments as of September 30, 2016:

	Payments Due In
			One to		Three to		Over
	One Year		Three		Five		Five
	Or Less		Years		Years		Years		Total
	(Dollars in thousands)
Commercial lines of credit	$	172,501		–		–		–	$	172,501
Commercial loans		7,304		–		–		–		7,304
Standby letters of credit		6,867	$	754	$	275		–		7,896
Multi-family and commercial real estate loans		288,235		12,302		–		–		300,537
Residential real estate loans		38,335		–		–		–		38,335
Revolving home equity and credit card lines		162,693		–		–		–		162,693
Net commitments to sell mortgage loans		22,607		–		–		–		22,607

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.

Off-Balance Sheet Arrangements At September 30, 2016, the Company had forward commitments to sell one- to four-family mortgage loans of $22.6 million to Fannie Mae. As described in Note 12, “Financial Instruments with Off-Balance Sheet Risk,” to the Company’s Unaudited Condensed Consolidated Financial Statements, the Company uses forward commitments to sell loans to mitigate interest rate risk on one- to four-family IRLCs and loans held-for-sale.

Contingent Liabilities The Company did not have a material exposure to contingent liabilities as of September 30, 2016.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Gap Analysis

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

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

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The following table presents the amounts of the Company’s interest-earning assets and interest-bearing liabilities outstanding at September 30, 2016, 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 substantially from these assumptions.

· Borrowings—based upon final maturity.

	September 30, 2016
	Within Three Months			Three to Twelve Months			More than 1 Year to 3 Years			More than 3 Years - 5 Years			Over 5 Years			Total
Loans receivable:	(Dollars in thousands)
Commercial loans:
Fixed	$	30,496		$	73,595		$	167,487		$	67,493		$	17,536		$	356,607
Adjustable		796,665			45,456			70,325			12,296			3			924,745
Retail loans:
Fixed		23,101			39,202			73,474			43,078			57,080			235,935
Adjustable		101,793			129,461			85,557			67,311			46,467			430,589
Interest-earning deposits		19,072			–			–			–			–			19,072
Mortgage-related securities:
Fixed		44,108			91,047			186,961			65,982			74,609			462,707
Adjustable		14,479			–			–			–			–			14,479
Other interest-earning assets		19,205			–			–			–			–			19,205
Total interest-earning assets		1,048,919			378,761			583,804			256,160			195,695			2,463,339
Deposit liabilities:
Non-interest-bearing demand accounts		–			–			–			–			268,954			268,954
Interest-bearing demand accounts		–			–			–			–			262,039			262,039
Savings accounts		–			–			–			–			231,582			231,582
Money market accounts		567,673			–			–			–			–			567,673
Certificates of deposit		101,629			223,493			206,193			5,552			–			536,867
Advance payments by borrowers
for taxes and insurance		30,219			–			–			–			–			30,219
Borrowings		254,557			45,657			64,613			39,962			10,575			415,364
Total non-interest- and interest- bearing liabilities		954,078			269,150			270,806			45,514			773,150			2,312,698
Interest rate sensitivity gap	$	94,841		$	109,611		$	312,998		$	210,646		$	(577,455	)	$	150,641
Cumulative interest rate sensitivity gap	$	94,841		$	204,452		$	517,450		$	728,096		$	150641
Cumulative interest rate sensitivity gap
as a percent of total assets		3.57	%		7.71	%		19.50	%		27.44	%		5.68	%
Cumulative interest-earning assets as a
percentage of non-interest- and interest-bearing liabilities		109.94	%		116.71	%		134.63	%		147.29	%		106.51	%

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Based on the above gap analysis, at September 30, 2016, the Company’s interest-bearing assets maturing or repricing within one year exceeds its interest-earning liabilities maturing or repricing within the same period. Based on this information, over the course of the next year net interest income could be favorably impacted by an increase in market interest rates. Alternatively, net interest income could be unfavorably impacted by a decrease 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 Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2015 Annual Report on Form 10-K.

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 Equity

In 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.

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The following table presents the estimated present value ratio over a range of interest rate change scenarios at September 30, 2016. The present value ratio 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 a Percent of the
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	$	358,316	$	27,654		8.4	%		14.19	%		15.1	%
+300		357,355		26,693		8.1			13.93			13.0
+200		351,681		21,019		6.4			13.50			9.5
+100		338,602		7,940		2.4			12.82			3.9
0		330,662		–		–			12.33			–
-100		345,722		15,060		4.6			12.68			2.8

Based on the above analysis, the Company’s PVE is generally expected to benefit from changes in market interest rates, although such impact is not expected to be significant. 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 Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” above, as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2015 Annual Report on Form 10-K.

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.

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Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

Internal Control Over Financial Reporting

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

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PART II

Item 1A. Risk Factors

Refer to “Risk Factors” in Part I, Item 1A, of the Company’s 2015 Annual Report on Form 10-K. Refer also to "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement" in Part I, Item 2, above.

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

The following discloses information regarding the shares of the Company’s common stock repurchased by the Company during the third quarter of 2016, all of which were purchased pursuant to stock repurchase plans authorized by its board of directors.

Period	Shares Purchased		Average Price per Share		Shares Purchased as Part of Announced Plans		Shares Remaining to be Purchased Under Announced Plans
July 2016		–		–		–		970,332
August 2016		–		–		–		970,332
September 2016		–		–		–		970,332
Total/Average		–		–		–

Item 6. Exhibits

Refer to Exhibit Index, which follows the signature page hereof.

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SIGNATURES

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

		BANK MUTUAL CORPORATION
		(Registrant)
Date:	November 8, 2016	/s/ David A. Baumgarten
		David A. Baumgarten
		President and Chief Executive Officer
Date:	November 8, 2016	/s/ Michael W. Dosland
		Michael W. Dosland
		Senior Vice President and
		Chief Financial Officer

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EXHIBIT INDEX

BANK MUTUAL CORPORATION

Form 10-Q for Quarter Ended September 30, 2016

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

101 The following materials are provided from Bank Mutual Corporation’s Quarterly Report on Form 10-Q for the period ended September 30, 2016, 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 Statements of Comprehensive Income (iv) Unaudited Condensed Consolidated Statements of Equity, (v) Unaudited Condensed Consolidated Statements of Cash Flow, and (vi) Notes to Unaudited Condensed Consolidated Financial Statements.

101.INS	XBRL Instance Document	X
101.SCH	XBRL Taxonomy Extension Schema Document	X
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document	X

Exhibit No.	Description	Incorporated Herein by Reference To	Filed Herewith
101.LAB	XBRL Extension Labels Linkbase Document		X
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document		X
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document		X