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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended DECEMBER 31, 2002
Commission file number: 000-31207
BANK MUTUAL CORPORATION
(Exact name of registrant as specified in its charter)
UNITED STATES 39-2004336
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4949 WEST BROWN DEER ROAD, MILWAUKEE, WI 53223
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:(414) 354-1500
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 under the Exchange Act).
Yes |X| No | |
As of June 30, 2002, 22,341,665 shares of Common Stock were validly issued
with 22,151,371 shares outstanding. The aggregate market value of the Common
Stock (based upon the $20.37 last sale price quotation on The Nasdaq Stock
Market(R) on June 30, 2002) held by non-affiliates (excludes a total of
12,703,289 shares reported as beneficially owned by directors and executive
officers, held by Mutual Savings Bancorp, MHC or unallocated shares of the
Employee Stock Ownership Plan at March 10, 2003; does not constitute an
admission as to affiliate status) was approximately $192,457,000.
DOCUMENTS INCORPORATED BY REFERENCE
PART OF FORM 10-K INTO WHICH
DOCUMENT PORTIONS OF DOCUMENT ARE INCORPORATED
-------- -------------------------------------
Proxy Statement for Annual Meeting of
Shareholders on May 5, 2003 Part III
BANK MUTUAL CORPORATION
FORM 10-K ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION
FOR THE YEAR ENDED DECEMBER 31, 2002
TABLE OF CONTENTS
ITEM PAGE
PART I
1. Business .................................................................. 3-32
2. Properties ................................................................ 33-37
3. Legal Proceedings ......................................................... 38
4. Submission of Matters to a Vote of Security Holders ....................... 38
Executive Officers of the Registrant ...................................... 38-39
PART II
5. Market for Registrant's Common Equity and Related Stockholders Matters .... 40
6. Selected Financial Data ................................................... 41-42
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................... 43-58
7A. Quantitative and Qualitative Disclosures About Market Risk ................ 59-62
8. Financial Statements and Supplementary Data ............................... 63-95
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ................................. 96
PART III
10. Directors and Executive Officers of the Registrant ........................ 96
11. Executive Compensation .................................................... 96
12. Security Ownership of Certain Beneficial Owners and Management ............ 96
13. Certain Relationships and Related Transactions ............................ 97
14. Controls and Procedures ................................................... 97
PART IV
15. Exhibits, Financial Statement Schedules and Reports on Form 8-K ........... 98
Signatures ................................................................ 99
Certifications ............................................................ 100-101
2
PART 1
ITEM 1. BUSINESS
GENERAL
Bank Mutual Corporation ("Bank Mutual") is a United States corporation chartered
by the Office of Thrift Supervision ("OTS"). It was chartered on November 1,
2000, to become the mid-tier holding company in the regulatory restructuring of
Mutual Savings Bank into mutual holding company form. To accomplish the
transaction, Mutual Savings Bank adopted a plan of restructuring and, as of
November 1, 2000, converted from a mutual savings bank to a mutual holding
company form. Bank Mutual became a holder of all of the shares of Mutual Savings
Bank, which was rechartered as a federal stock savings bank. Mutual Savings
Bancorp, MHC (the "MHC"), a U.S. -chartered mutual holding company (now known as
"Bank Mutual Bancorp, MHC") of which Mutual Savings Bank's depositors hold all
of the voting and membership rights, owns 11,193,174 shares of common stock, or
51.5% at December 31, 2002, of Bank Mutual's stock. Bank Mutual issued 6,141,006
shares of common stock to public shareholders in the subscription stock offering
conducted in connection with the restructuring.
Also on November 1, 2000, Bank Mutual acquired First Northern Capital Corp.
("First Northern"), the parent of First Northern Savings Bank. In this
transaction, Bank Mutual issued to former First Northern shareholders 5,007,485
shares of Bank Mutual common stock and paid $75.1 million in cash. (In this
report, we refer to this transaction as the "First Northern Acquisition.") The
First Northern Acquisition was accounted for using the purchase method of
accounting; therefore, First Northern Savings Bank results and financial data
are included in Bank Mutual results and financial data only from and after the
November 1, 2000 acquisition date.
On March 16, 2003, Mutual Savings Bank and First Northern Savings Bank (the
"Banks") combined to form a single subsidiary bank of Bank Mutual which is named
"Bank Mutual" (the "Bank").
As a result of these transactions, Bank Mutual is the mid-tier holding company
for the Bank. The following chart shows our structure:
[ORGANIZATIONAL CHART]
This Bank is a community oriented financial institution, which emphasizes
traditional financial services to individuals and businesses within our market
areas. Our principal business is attracting retail deposits from the general
public and investing those deposits, together with funds generated from other
operations, in residential mortgage loans, consumer loans, commercial real
estate loans, and commercial business loans. We also invest in various
mortgage-related securities and investment securities. The principal lending is
on one-to four-family, owner-occupied homes, home equity loans and lines of
credit, automobile loans, multi-family and commercial real estate loans, and
commercial business loans.
3
Bank Mutual's revenues are derived principally from interest on our loans and
mortgage-related securities, interest and dividends on our investment
securities, and noninterest income (including loan servicing fees, deposit
servicing fees, gains on sales of loans and commissions on insurance, security
and annuity sales). Our primary sources of funds are deposits, borrowings,
scheduled amortization and prepayments of loan principal and mortgage-related
securities, maturities and calls of investment securities and funds provided by
operations.
Bank Mutual maintains a website at www.bankmutualcorp.com. We make available
through that website, free of charge, copies of our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to
those reports, as soon as reasonably practical after Bank Mutual electronically
files those materials with, or furnishes them to, the Securities and Exchange
Commission. You may access those reports by following the links under "Financial
Reports" at the Bank Mutual website.
CAUTIONARY FACTORS
This Form 10-K contains or incorporates by reference various forward-looking
statements concerning Bank Mutual's prospects that are based on the current
expectations and beliefs of management. Forward-looking statements may also be
made by Bank Mutual from time to time in other reports and documents as well as
oral presentations. When used in written documents or oral statements, the words
"anticipate," "believe," "estimate," "expect," "objective" and similar
expressions and verbs in the future tense, are intended to identify
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 Bank Mutual's control, that could cause Bank Mutual's
actual results and performance to differ materially from what is expected. In
addition to the assumptions and other factors referenced specifically in
connection with such statements, the following factors could impact the business
and financial prospects of Bank Mutual: general economic conditions; legislative
and regulatory initiatives; increased competition and other effects of the
deregulation and consolidation of the financial services industry; monetary and
fiscal policies of the federal government; deposit flows; disintermediation; the
cost of funds; general market rates of interest; interest rates or investment
returns on competing investments; demand for loan products; demand for financial
services; changes in accounting policies or guidelines; general economic
developments; acts of terrorism and developments in the war on terrorism; and
changes in the quality or composition of loan and investment portfolios. See
also the factors regarding future operations discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" below,
particularly those under the caption "Risk Factors."
MARKET AREA
The Bank has 69 banking offices located in 28 counties in Wisconsin, in addition
to the Minnesota office. At June 30, 2002, Bank Mutual had approximately a 2.53%
share of all Wisconsin bank, savings bank, and savings association deposits.
Counties in which Bank Mutual operates include 66% of the population of the
state. Bank Mutual is the fifth largest financial institution holding company
headquartered in the state of Wisconsin, based on asset size.
The largest concentration of our offices is in the Milwaukee metropolitan area,
which includes Milwaukee, Waukesha, Ozaukee, and Washington counties. There are
18 offices in this area, with an additional office expected to open in 2003. The
Milwaukee metro area is the largest population and commercial base in Wisconsin,
representing approximately 28% of Wisconsin's population. The Milwaukee area has
traditionally had an extensive manufacturing economic base, which is
diversifying into service and technology based businesses.
We operate 21 banking offices in nine northeastern counties that make up
approximately 13% of the state's population including the city of Green Bay. The
greater Green Bay area has an economic base of paper and other manufacturing,
health care, insurance and gaming, and is diversifying into technology based
businesses.
We have four offices in the Madison area. Madison is the state capital of
Wisconsin and is the second largest metropolitan area in Wisconsin representing
approximately 8% of the state's population. Our eight other south central and
southeastern Wisconsin offices are located in smaller cities that have economic
concentrations ranging from manufacturing to agriculture.
We also have 19 offices in the northwestern part of the state, largely resulting
from the First Federal Bancshares of Eau Claire, Inc. ("First Federal")
acquisition by Mutual Savings Bank in 1997. This part of the state has medium
sized to smaller cities and towns. Industry includes medium sized and small
business, with a significant agricultural component.
4
The counties in which the northwest region offices are located hold 8% of the
state's population. Our Minnesota office is located near the Wisconsin state
border on the eastern edge of the Minneapolis-St. Paul metropolitan area.
COMPETITION
We face significant competition in making loans and attracting deposits.
Wisconsin has many banks, savings banks, and savings and loan associations,
which offer the same types of banking products. Wisconsin also has an extensive
tax-exempt credit union industry, whose expanded powers have resulted in
increased competition to financial institutions.
Many of our competitors have greater resources than we do. Similarly, many
competitors offer services that we do not provide. For example, the Bank does
not provide trust or money management services. However, the Bank's subsidiary,
Lake Financial and Insurance Services, Inc. offers mutual funds and engages in
the sale of tax deferred annuities, credit life and disability insurance, and
property and casualty insurance. Its Great Northern Financial Services
Corporation subsidiary, which is merging into Lake Financial, offers brokerage
services to the public, including the sale of tax deferred annuities and mutual
funds and engages in the sale of credit life and disability insurance.
Most of our competition for loans traditionally has come from commercial banks,
savings banks, savings and loan associations and credit unions. Increasingly,
other types of companies, such as mortgage banking firms, finance companies,
insurance companies, and other providers of financial services also compete for
these products. For deposits, we also compete with traditional financial
institutions. However, competition for deposits now also includes mutual funds,
particularly short-term money market funds, and brokerage firms and insurance
companies. The recent increase in electronic commerce also increases competition
from institutions and other entities outside of Wisconsin.
LENDING ACTIVITIES
Loan Portfolio Composition. Bank Mutual's loan portfolio primarily consists of
one-to four-family residential mortgage loans. To a lesser degree, the loan
portfolio includes consumer loans, including home equity lines of credit and
fixed rate and adjustable rate second mortgage loans, automobile loans,
multi-family loans, commercial real estate loans and commercial business loans.
At December 31, 2002, our loan portfolio totaled $1.7 billion, of which $1.3
billion, or 71.8%, were mortgage loans. The remainder of our loans at December
31, 2002, amounting to $493.0 million, or 28.2% of total loans, consisted of
consumer loans ($431.9 million or 24.7%) and commercial business loans ($61.1
million or 3.5%).
We originate primarily adjustable rate mortgage ("ARM") loans for our own
portfolio. We also originate fixed rate mortgage loans with terms of 10 to 30
years. Most of the 20 year and longer fixed rate mortgage loans are immediately
sold into the secondary market. At times, we may also sell 15 year fixed rate
mortgage loans depending on the percentage of fixed interest rate loans in our
portfolio and the interest rate environment we are anticipating. We sold a large
portion of our 15 year fixed rate mortgage loan originations in 2002.
The loans that we originate are subject to federal and state laws and
regulations. The interest rates we charge on loans are affected principally by
the demand for loans, the cost and supply of money available for lending
purposes and the interest rates offered by our competitors. These factors are in
turn affected by, among other things, economic conditions, monetary policies of
the federal government, including the Federal Reserve Board, legislative tax
policies and governmental budgetary matters.
5
The following table presents the composition of our loan portfolio in dollar
amounts and in percentages of the total portfolio at the dates indicated.
AT DECEMBER 31,
----------------------------------------------------------------------------
2002 2001 2000(1)
---- ---- -------
PERCENT PERCENT PERCENT
OF OF OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ ----- ------ -----
Mortgage loans:
One to four-family ....................... $ 827,648 47.37% $ 992,126 52.46% $1,207,912 59.56%
Multi-family ............................. 112,189 6.42 131,925 6.97 105,925 5.22
Commercial real estate ................... 186,960 10.70 165,556 8.75 118,636 5.85
Construction and development ............. 127,174 7.28 125,611 6.64 94,235 4.65
---------- ------ ---------- ------ ---------- ------
Total mortgage loans ............ 1,253,971 71.77 1,415,218 74.82 $1,526,708 75.28
---------- ------ ---------- ------ ---------- ------
Consumer loans:
Fixed equity ............................. 234,049 13.40 200,500 10.61 193,394 9.54
Home equity lines of credit .............. 77,697 4.45 76,472 4.04 80,447 3.97
Student .................................. 22,636 1.30 25,410 1.34 27,076 1.34
Home improvement ......................... 6,993 0.40 9,439 0.50 12,778 0.63
Automobile ............................... 68,140 3.90 77,621 4.10 99,844 4.92
Other .................................... 22,434 1.28 25,886 1.37 27,827 1.37
---------- ------ ---------- ------ ---------- ------
Total consumer loans ............ 431,949 24.73 415,328 21.96 441,366 21.77
---------- ------ ---------- ------ ---------- ------
Commercial business loans .................... 61,060 3.50 60,932 3.22 59,844 2.95
---------- ------ ---------- ------ ---------- ------
Total loans receivable .......... 1,746,980 100.00% 1,891,478 100.00% 2,027,918 100.00%
Less:
Undisbursed loan proceeds ................ 46,048 44,467 37,490
Deferred fees and discounts .............. 12,743 12,245 5,554
Allowance for loan losses ................ 2,527 3,611 12,238
---------- ---------- ----------
Total loans receivable, net ..... $1,685,662 $1,831,155 $1,972,636
========== ========== ==========
AT DECEMBER 31,
-------------------------------------------------
1999 1998
---- ----
PERCENT PERCENT
OF OF
AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ -----
Mortgage loans:
One to four-family ....................... $ 743,993 67.37% $ 742,231 70.56%
Multi-family ............................. 53,777 4.87 53,521 5.09
Commercial real estate ................... 52,375 4.74 40,922 3.89
Construction and development ............. 26,530 2.40 21,939 2.09
---------- ------ ---------- ------
Total mortgage loans ............ 876,675 79.38 858,613 81.63
---------- ------ ---------- ------
Consumer loans:
Fixed equity ............................. 89,315 8.09 67,629 6.42
Home equity lines of credit .............. 50,618 4.58 45,827 4.36
Student .................................. 28,371 2.57 29,634 2.82
Home improvement ......................... 9,920 0.90 8,373 0.80
Automobile ............................... 5,902 0.54 8,762 0.83
Other .................................... 4,126 0.37 4,208 0.40
---------- ------ ---------- ------
Total consumer loans ............ 188,252 17.05 164,433 15.63
---------- ------ ---------- ------
Commercial business loans .................... 39,488 3.57 28,839 2.74
---------- ------ ---------- ------
Total loans receivable .......... 1,104,415 100.00% 1,051,885 100.00%
Less:
Undisbursed loan proceeds ................ 14,658 7,001
Deferred fees and discounts .............. 14 440
Allowance for loan losses ................ 6,948 6,855
---------- ----------
Total loans receivable, net ..... $1,082,795 $1,037,589
========== ==========
(1) On November 1, 2000, Bank Mutual Corporation acquired First Northern.
Under the purchase accounting method, First Northern's results are
included from the date of acquisition.
At December 31, 2002, our one-to four-family first mortgage loans were pledged
as collateral under a blanket pledge to the Federal Home Loan Bank ("FHLB") of
Chicago. As of December 31, 2002, there were no other significant concentrations
of loans such as loans to a number of borrowers engaged in similar activities.
Bank Mutual's mortgage loans, fixed equity, home equity lines of credit and home
improvement loans are primarily secured by properties housing one-to
four-families which are generally located in our local lending areas in
Wisconsin.
6
Loan Maturity. The following table presents the contractual maturity of our
loans at December 31, 2002. The table does not include the effect of prepayments
or scheduled principal amortization.
AT DECEMBER 31, 2002
-----------------------------------------------------------------
COMMERCIAL
MORTGAGE LOANS CONSUMER LOANS BUSINESS LOANS TOTAL
-------------- -------------- -------------- -----
(IN THOUSANDS)
AMOUNTS DUE:
Within one year ..................... $ 44,706 $ 36,829 $27,194 $ 108,729
After one year
One to two years ................ 42,083 26,470 15,169 83,722
Two to three years .............. 35,839 27,719 5,405 68,963
Three to five years ............. 49,279 77,831 8,453 135,563
Five to ten years ............... 160,043 205,383 268 365,694
Ten to twenty years ............. 441,406 57,717 4,571 503,694
Over twenty years ............... 480,615 -- -- 480,615
---------- -------- ------- ----------
Total due after one year ... 1,209,265 395,120 33,866 1,638,251
---------- -------- ------- ----------
Total loans receivable ..... $1,253,971 $431,949 $61,060 $1,746,980
========== ======== ======= ==========
The following table presents, as of December 31, 2002, the dollar amount of all
loans due after December 31, 2003, and whether these loans have fixed interest
rates or adjustable interest rates.
DUE AFTER DECEMBER 31, 2003
--------------------------------------
FIXED ADJUSTABLE TOTAL
----- ---------- -----
(IN THOUSANDS)
Mortgage loans ................................ $482,228 $727,037 $1,209,265
Consumer loans ................................ 254,467 140,653 395,120
Commercial business loans ..................... 29,903 3,963 33,866
-------- -------- ----------
Total loans due after one year ... $766,598 $871,653 $1,638,251
======== ======== ==========
The following table presents our loan originations, purchases, sales and
principal payments for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------
2002 2001 2000
---------- ---------- ----------
(IN THOUSANDS)
Balance outstanding at beginning of period ........... $1,923,799 $2,035,387 $1,104,956
ORIGINATIONS:
Mortgage loans .................................. 752,771 691,466 189,706
Consumer loans ................................. 293,320 242,580 141,943
Commercial business loans ....................... 27,141 30,202 23,189
---------- ---------- ----------
Total loan originations ................ 1,073,232 964,248 354,838
---------- ---------- ----------
PURCHASES:
One-to four-family mortgage loans ............... 4,042 8,885 19,213
First Northern loans (1) ........................ -- -- 847,888
---------- ---------- ----------
Total loan purchases .................... 4,042 8,885 867,101
---------- ---------- ----------
LESS:
Principal payments and repayments:
Mortgage loans ............................... 537,368 483,298 134,317
Consumer loans ............................... 276,728 267,592 89,637
Commercial business loans .................... 23,158 23,792 32,412
---------- ---------- ----------
Total principal payments ................ 837,254 774,682 256,366
---------- ---------- ----------
Transfers to foreclosed real estate ............. 1,271 409 2,697
---------- ---------- ----------
Loan sales:
Mortgage loans ............................... 368,597 307,843 32,397
Education loans .............................. -- 1,787 48
---------- ---------- ----------
Total loan sales ........................ 368,597 309,630 32,445
---------- ---------- ----------
Total loans receivable and loans held for sale .. $1,793,951 $1,923,799 $2,035,387
========== ========== ==========
(1) First Northern loans before deductions of undisbursed loan proceeds,
allowances for loan losses, discounts and premiums.
7
Residential Mortgage Lending. Our primary lending activity has been the
origination of first mortgage loans secured by one- to four-family properties,
within our primary lending area. Most of these loans are owner-occupied;
however, we do originate first mortgage loans on second homes, seasonal homes
and investment properties. In addition to our loan originations, we have
purchased one- to four-family first mortgage loans of $4.0 million in 2002, $8.9
million in 2001, and $19.2 million in 2000. We review these loans for compliance
with our underwriting standards, and generally only invest in loans in the
midwestern United States.
We offer conventional fixed rate mortgage loans and ARM loans with maturity
dates up to 30 years. Residential mortgage loans generally are underwritten to
Federal National Mortgage Association Standards ("Fannie Mae") or Federal Home
Loan Mortgage Corporation ("Freddie Mac") guidelines. All ARM mortgage loans and
some fixed rate mortgage loans with maturities of up to 20 years are held in our
portfolio. Fixed rate mortgage loans with maturities greater than 15 years
typically are sold without recourse, servicing retained, into the secondary
market. During the past few years we have generally not charged loan origination
fees. The interest rates charged on mortgage loan originations at any given date
will vary, depending upon conditions in the local and secondary markets.
We also originate "jumbo single family mortgage loans" in excess of the Fannie
Mae or Freddie Mac maximum loan amount, which was $300,700 for both agencies in
2002. Effective for 2003, the maximum loan amount increased to $322,700 for both
agencies. Fixed rate jumbo mortgage loans generally are sold servicing released
without recourse to secondary market purchasers of such loans. ARM jumbo
mortgage loans are underwritten in accordance with our underwriting guidelines
and are retained in our loan portfolio.
Mortgage loan originations are solicited from real estate brokers, builders,
existing customers, community groups and residents of the local communities
located in our primary market area through our loan origination staff. We also
advertise our mortgage loan products through local newspapers, periodicals,
internal customer communications and our website.
We currently offer loans that conform to underwriting standards that are based
on standards specified by Fannie Mae or Freddie Mac ("conforming loans") and
also originate a limited amount of non-conforming loans for our own portfolio or
for sale. Loans may be fixed rate one- to four-family mortgage loans or
adjustable rate one- to four-family mortgage loans with maturities of up to 30
years. The average size of our one- to four-family mortgage loans originated in
2002, 2001 and 2000 was approximately $114,000, $105,000 and $94,000,
respectively. The overall average size of our one- to four-family mortgage loans
was approximately $114,382 at December 31, 2002. We are an approved
seller/servicer for Fannie Mae, Freddie Mac, the FHLB of Chicago's Mortgage
Partnership Finance Program, Wisconsin Housing and Economic Development
Authority ("WHEDA") and Wisconsin Department of Veterans Affairs ("WDVA").
The focus of our residential mortgage loan portfolio is the origination of 30
year ARM loans with interest rates adjustable in one, two, three, or five years.
ARM loans typically are adjusted by a maximum of 200 basis points per adjustment
period. Prior to the merger of the Banks, there was a lifetime cap of 6% above
the origination rate for First Northern Savings Bank and a lifetime interest
rate cap of 12.9% for Mutual Savings Bank. Going forward, the Bank will
originate ARM loans with a lifetime cap of 6% above the origination rate.
Monthly payments of principal and interest are adjusted when the interest rate
adjusts. We do not offer ARM loans which provide for negative amortization. The
initial rates offered on ARM loans fluctuate with general interest rate changes
and are determined by secondary market pricing, competitive conditions and our
yield requirements. We currently utilize the monthly average yield on United
States treasury securities, adjusted to a constant maturity of one year
("constant treasury maturity index") or the National Monthly Median Cost of
Funds ("NMCOF") for Savings Association Insurance Fund ("SAIF") insured
institutions as the indexes to determine the interest rate payable upon the
adjustment date of our ARM loans. Some of the ARM loans are granted with
conversion options which provide terms under which the borrower may convert the
mortgage loan to a fixed rate mortgage loan for a limited period early in the
term of the ARM loan. The terms at which the ARM loan may be converted to a
fixed rate loan are established at the date of loan origination and are set at a
level allowing us to sell the loan into the secondary market upon conversion.
ARM loans may pose credit risks different from the risks inherent in fixed rate
loans, primarily because as interest rates rise, the underlying payments from
the borrowers rise, thereby increasing the potential for payment default. At the
same time, the marketability of the underlying property may be adversely
affected by higher interest rates.
8
The volume and types of ARM loans we originate have been affected by the level
of market interest rates, competition, consumer preferences and the availability
of funds. Although we will continue to offer ARM loans, we cannot guarantee that
we will be able to originate a sufficient volume of ARM loans to increase or
maintain the proportion that these loans bear to our total loans.
In addition to conventional fixed rate and ARM loans, we are authorized to
originate mortgages utilizing various government programs, including programs
offered by the Federal Housing Administration, the Federal Veterans
Administration, and Guaranteed Rural Housing. We also participate in two
state-sponsored mortgage programs operated by WHEDA and WDVA. We originate these
state-sponsored loans as an agent and assign them to the agency immediately
after closing. Servicing is retained by us on both WHEDA and WDVA loans.
Upon receipt of a completed mortgage loan application from a prospective
borrower, a credit report is ordered, income and other information is verified,
and if necessary, additional financial information is requested. An appraisal of
the real estate to secure the loan is required, which must be performed by a
certified appraiser approved by the board of directors. A title insurance policy
is required on all real estate first mortgage loans. Evidence of adequate hazard
insurance and flood insurance, if applicable, is required prior to closing.
Borrowers are required to make monthly payments to fund principal and interest
as well as private mortgage insurance and flood insurance, if applicable. With
some exceptions for lower loan-to-value ratio loans, borrowers also generally
are required to escrow in advance for real estate taxes. We make disbursements
for these items from the escrow account as the obligations become due.
In addition to our full documentation loan program, increasingly we process
loans as reduced documentation loans. These loans are processed under the Fannie
Mae or Freddie Mac alternative documentation program. We require applicants for
reduced documentation loans to complete a Fannie Mae or Freddie Mac loan
application and request income, asset and debt information from the borrower. In
addition to obtaining outside vendor credit reports on all borrowers, we also
look at other information to ascertain the creditworthiness of the borrower. In
most instances, we utilize the Fannie Mae's "Desktop Underwriter" or Freddie
Mac's "Loan Prospector" automated underwriting process to further reduce the
necessary documentation. For example, a simplified appraisal or inspection may
be used to verify the value of the property. All loans that are processed with
reduced documentation conform to secondary market standards and are generally
saleable.
Our Underwriting Department reviews all pertinent information prior to making a
credit decision to approve or deny an application. All recommendations to deny
are reviewed by a designated officer of the Bank prior to the final disposition
of the loan application. Our lending policies generally limit the maximum
loan-to-value ratio on one- to four-family mortgage loans secured by
owner-occupied properties to 97% of the lesser of the appraised value or
purchase price of the property. Loans above 80% loan-to-value ratios are subject
to the availability of private mortgage insurance. Coverage is required to
reduce our exposure to less than 80% of value.
Our originations of residential mortgage loans amounted to $700.5 million in
2002, $617.8 million in 2001, and $117.6 million in 2000. A number of our
mortgage loan originations have been the result of refinancing of our existing
loans due to the relatively low interest rate levels over the past three years.
The First Northern acquisition also affects the comparison between 2000 and
other years. Total refinancings of our existing mortgage loans were as follows:
PERCENTAGE OF
MORTGAGE LOAN
PERIOD AMOUNT ORIGINATIONS
- ------ ------ ------------
(DOLLARS IN MILLIONS)
Year ended December 31, 2002 .................. $278.6 40.1%
Year ended December 31, 2001 .................. 239.2 34.6
Year ended December 31, 2000 .................. 17.6 9.3
In addition to our standard mortgage and consumer credit products, we have
developed mortgage programs designed to specifically address the credit needs of
low- to moderate-income home mortgage applicants and first-time home buyers.
Among the features of the low- to moderate-income home mortgage and first-time
home buyer's programs are reduced rates, lower down payments, reduced fees and
closing costs, and generally less restrictive requirements for qualification
compared with our traditional one- to four-family mortgage loans. For instance,
certain of these programs currently provide for loans with up to 97%
loan-to-value ratios and rates which are lower than our traditional mortgage
loans.
9
Consumer Loans. We have been expanding our consumer loan originations because
higher yields can be obtained, there is strong consumer demand for such
products, and we have experienced relatively low delinquency and few losses on
such products. In addition, we believe that offering consumer loan products
helps to expand and create stronger ties to our existing customer base by
increasing the number of customer relationships and providing cross-marketing
opportunities. At December 31, 2002, $431.9 million, or 24.7%, of our gross loan
portfolio was in consumer loans. Consumer loan products offered within our
market areas include home equity loans, home equity lines of credit, home
improvement loans, automobile loans, recreational vehicle loans, marine loans,
deposit account loans, overdraft protection lines of credit, unsecured consumer
loans through the MasterCard and Visa credit card programs (offered through Elan
Financial Services), unsecured consumer loans with existing customers and
federally guaranteed student loans.
Our focus in consumer lending has been the origination of home equity loans,
home improvement, home equity lines of credit and automobile loans. At December
31, 2002, we had $386.9 million or 89.6% of the consumer loan portfolio in such
loans. Underwriting procedures for the home equity and home equity lines of
credit loans include a comprehensive review of the loan application, and require
an acceptable credit rating and verification of the value of the equity in the
home and income of the borrower. The loan-to-value ratio and the total debt
ratios to income are determining factors in the underwriting process. Home
equity loan and home improvement loan originations are developed through the use
of direct mail, cross-sales to existing customers, radio advertisement, and
advertisements in local newspapers.
We make indirect automobile loans through applications taken by selected
automobile dealers on application forms approved by us. The applications are
delivered to Savings Financial Corporation ("SFC"), a 50% owned subsidiary of
the Bank, for underwriting. If an application is approved, money is funded to
the dealer and the loan becomes a part of the SFC automobile portfolio. From
time to time, the SFC automobile portfolio is then sold to either of the parent
companies of SFC or to the Bank's subsidiary First Northern Investments Inc.
We originate both fixed rate and variable rate home equity loans and home
improvement loans with combined loan-to-value ratios to 100%. Pricing on fixed
rate home equity and home improvement loans is reviewed by management, and
generally terms are in the three to fifteen year range in order to minimize
interest rate risk. During 2002 we originated approximately $130.9 million of
fixed rate home equity or home improvement loans. These loans carry a weighted
average written term of 8.9 years and a fixed rate ranging from 3.75% to 12.75%.
We also offer adjustable rate home equity and home improvement loans. At
December 31, 2002, $78.2 million or 32.5% of the home equity and home
improvement loan portfolio carried an adjustable rate. The adjustable rate loans
have a fixed rate for six months to three years then adjust annually or monthly
depending upon the offering, with terms of up to twenty years. Our home equity
and home improvement loans are originated in amounts which, together with the
amount of the first mortgage, do not exceed 100% of the value of the property
securing the loan. Many of our home equity and home improvement loans are
secured by a first mortgage.
Our home equity credit line loans, which totaled $77.7 million, or 18.0% of
total consumer loans at December 31, 2002, are adjustable rate loans secured by
a first or second mortgage on owner-occupied one- to four-family residences
located in the state of Wisconsin. Current interest rates on home equity credit
lines are tied to the prime rate, adjust monthly after an initial interest rate
lock period, and range from prime rate to 350 basis points over the prime rate,
depending on the loan-to-value ratio. Home equity line of credit loans are made
for terms up to 10 years and require a minimum monthly payment of interest only
or the greater of $100 or 1 1/2% of the month end balance. An annual fee is
charged on home equity lines of credit.
At December 31, 2002, student loans amounted to $22.6 million, or 5.2% of our
consumer loan portfolio. These loans are serviced by Great Lakes Higher
Education Servicing Corporation.
Multi-family and Commercial Real Estate Loans. At December 31, 2002, our
multi-family and commercial real estate loan portfolio was $299.1 million or
17.1% of our total loans receivable. The multi-family and commercial real estate
loan portfolio consist of fixed rate, ARM and balloon loans originated at
prevailing market rates. This portfolio generally consists of loans secured by
apartment buildings, office buildings, warehouses, industrial buildings and
retail centers. These loans typically do not exceed 80% of the lesser of the
purchase price or an appraisal by an appraiser
10
designated by us. Balloon loans generally are amortized on a 15 to 25 year basis
with a typical loan term of 3 to 10 years.
Loans secured by multi-family and commercial real estate are granted based on
the income producing potential of the property and the financial strength of the
borrower. The net operating income, which is the income derived from the
operation of the property less all operating expenses, must be sufficient to
cover the payments relating to the outstanding debt. In most cases, we obtain
joint and several personal guarantees from the principals involved. We generally
require an assignment of rents or leases in order to be assured that the cash
flow from the project will be used to repay the debt. Appraisals on properties
securing multi-family and commercial real estate loans are performed by
independent state certified fee appraisers approved by the board of directors.
Title and hazard insurance are required as well as flood insurance, if
applicable. Environmental assessments are performed on certain multi-family and
commercial real estate loans in excess of $500,000. In addition, an annual
review is performed by us on multi-family and commercial real estate loans over
$1.0 million.
At December 31, 2002, the largest outstanding loan on a multi-family property
was $12.0 million on a 148 unit apartment project located in Oak Creek,
Wisconsin. At the same date, the largest outstanding loan on a commercial real
estate property was $21.3 million on a retail/office building complex located in
Brookfield, Wisconsin. At December 31, 2002, these loans were current and
performing in accordance with their terms.
Loans secured by multi-family and commercial real estate properties are
generally larger and involve a greater degree of credit risk than one- to
four-family residential mortgage loans. Such loans typically involve large
balances to single borrowers or groups of related borrowers. Because payments on
loans secured by multi-family and commercial real estate properties are often
dependent on the successful operation or management of the properties, repayment
of such loans may be subject to adverse conditions in the real estate market or
the economy. If the cash flow from the project decreases, or if leases are not
obtained or renewed, the borrower's ability to repay the loan may be impaired.
Commercial Business Loans. At December 31, 2002, our commercial business loan
portfolio consisted of loans totaling $61.1 million or 3.5% of our total loans
receivable. The commercial loan portfolio consists of loans to businesses for
equipment purchases, working capital lines of credit, debt refinancing, SBA
loans and domestic stand-by letters of credit. Typically, these loans are
secured by business assets and personal guarantees. We offer both variable and
fixed rate loans. Approximately 22.5% of the commercial business loans have an
interest rate adjusted monthly based on the prevailing prime rate. Term loans
are generally amortized over a three to seven year period. Fixed rate loans are
priced at a margin over the yield on US Treasury issues with maturities that
correspond to the maturities of the notes. All lines of credit and term loans
with balances over $500,000 are reviewed annually. The largest commercial
business loan at December 31, 2002 had an outstanding balance of $16.8 million
and was secured by equipment and chattel paper.
LOAN APPROVAL AUTHORITY
Prior to their merger, Mutual Savings Bank and First Northern Savings Bank had
somewhat different underwriting approval limits and authority. Both Banks have
reviewed their approval limits through a combined "best practices" committee and
the new loan approval authority for the Bank is summarized below.
For one- to four- family residential loans intended for sale into the secondary
market, the underwriters are authorized by the board of directors to approve
loans processed through the Fannie Mae "Desktop Underwriter" automated
underwriting system or the Freddie Mac "Loan Prospector" automated underwriting
system up to the Fannie Mae/Freddie Mac limits ($322,700 for a single family
residential units; higher limits for two, three, and four family units). For
one- to eight- family residential loans intended to be held in the Bank's
portfolio, the underwriters are authorized to approve loans processed through
the Fannie Mae "Desktop Underwriter" automated underwriting system or the
Freddie Mac " Loan Prospector" automated underwriting system up to $200,000,
provided the loan-to-value is 80% or less and the loan meets other specific
underwriting criteria. All portfolio loans in excess of $200,000, with a
loan-to-value greater than 80%, or failing to meet other specific underwriting
criteria must be approved by a senior officer.
Consumer loan underwriters have individual approval authorities for secured
loans ranging from $20,000 to $100,000 provided the loan-to-value on real estate
does not exceed 80% or 90% on personal property and that the loan meets
11
other specific underwriting criteria. All consumer loans in excess of $100,000,
with a loan-to-value greater than 80% on real estate, 90% on personal property,
or failing to meet other specific underwriting criteria must be approved by a
senior officer. Consumer loan underwriters have individual approval authorities
for unsecured loans ranging from $2,000 to $15,000 provided the loan meets other
specific underwriting criteria. All unsecured consumer loans in excess of
$15,000, or not meeting specific underwriting criteria, must be approved by a
senior officer.
Individual lenders in the investment real estate department have lending
authorities of $100,000 for multi-family and commercial loan proposals for both
existing and proposed construction of investment real estate properties. Senior
officers have individual lending authority of $250,000 and two senior officers
together have lending authority of $500,000 for investment real estate loans.
All investment real estate loans over $500,000 require approval of the executive
committee of the board of directors.
Individual lenders in the commercial banking department have individual lending
authorities ranging from $50,000 to $150,000 for secured commercial business
loans. Senior officers have individual lending authority of $250,000 and two
senior officers together have lending authority of $500,000 for secured
commercial business loans. All secured business loans over $500,000 require
approval of the executive committee of the board of directors. Individual
lenders in the commercial banking department have individual lending authorities
ranging from $10,000 to $25,000 for unsecured commercial business loans. Senior
officers have individual lending authority of $50,000 and two senior officers
together have lending authority of $150,000 for unsecured commercial business
loans. All unsecured business loans over $150,000 require approval of the
executive committee of the board of directors.
All loans approved by individuals and senior officers must be ratified by the
board of directors at the next meeting following the approval.
ASSET QUALITY
One of our key operating objectives has been and continues to be to maintain a
high level of asset quality. Through a variety of strategies, including, but not
limited to, borrower workout arrangements and aggressive marketing of foreclosed
properties and repossessed assets, we have been proactive in addressing problem
and non-performing assets. These strategies, as well as our emphasis on quality
loan underwriting, our maintenance of sound credit standards for new loan
originations and relatively favorable economic and real estate market conditions
have resulted in historically low delinquency ratios. However in 2002, we did
experience a rise in commercial business loan delinquencies.. These factors have
helped strengthen our financial condition.
Delinquent Loans and Foreclosed Assets. When a borrower fails to make required
payments on a loan, we take a number of steps to induce the borrower to cure the
delinquency and restore the loan to a current status. In the case of one-to-four
family mortgage loans, our loan servicing department is responsible for
collection procedures from the 15th day of delinquency through the completion of
foreclosure. Specific procedures include a late charge notice being sent at the
time a payment is over 15 days past due with a second notice (in the form of a
billing coupon) being sent before the payment becomes 30 days past due. Once the
account is 30 days past due, we attempt telephone contact with the borrower.
Letters are sent if contact has not been established by the 45th day of
delinquency. On the 60th day of delinquency, attempts at telephone contact
continue and stronger letters, including foreclosure notices, are sent. If
telephone contact cannot be made, we send our property inspector or a loan
officer to the property.
When contact is made with the borrower, we attempt to obtain full payment or
work out a repayment schedule to avoid foreclosure. All properties are inspected
prior to foreclosure approval. Most borrowers pay before the deadline given and
it is not necessary to start foreclosure action. If it is, action starts when
the loan is between the 90th and 120th day of delinquency. We normally seek the
shortest redemption period possible. If we obtain the property at the
foreclosure sale, we hold the property as real estate owned. It is marketed
after a market evaluation is obtained and any PMI claims are filed. The
collection procedures and guidelines as outlined by Fannie Mae, Freddie Mac,
Federal Housing Administration (FHA), Veterans Administration (VA), Department
of Veterans Affairs (DVA), Wisconsin Housing and Economic Development Authority
(WHEDA) and Guaranteed Rural Housing are followed.
The collection procedures for consumer loans, excluding student loans and
indirect consumer loans, include sending periodic late notices to a borrower
once a loan is 5 to 15 days past due depending upon the grace period associated
with
12
a loan. We attempt to make direct contact with a borrower once a loan becomes 30
days past due. Supervisory personnel review loans 60 days or more delinquent on
a regular basis. If collection activity is unsuccessful after 90 days, we may
pursue legal remedies ourselves or refer the matter to our legal counsel for
further collection effort or charge-off a loan. Loans we deem to be
uncollectible are proposed for charge off. Charge-offs of consumer loans require
the approval of our consumer loan manager, a senior officer or a management
committee. All student loans are serviced by the Great Lakes Higher Education
Servicing Corporation or Student Loan Marketing Association ("Sallie Mae") which
guarantees their servicing to comply with all Department of Education
Guidelines. Our student loan portfolio is guaranteed by the Great Lakes Higher
Education Guaranty Corporation, which is reinsured by the U.S. Department of
Education.
The collection procedures for multi-family, commercial real estate and
commercial business loans include sending periodic late notices to a borrower
once a loan is past due. We attempt to make direct contact with a borrower once
a loan becomes 15 days past due. A loan servicing manager or a manager of
multi-family and commercial real estate loans reviews loans 15 days or more
delinquent on a regular basis. The commercial banking manager reviews commercial
business loans 10 days or more delinquent on a regular basis. If collection
activity is unsuccessful, we may refer the matter to our legal counsel for
further collection effort. Within 90 days, loans we deem to be uncollectible are
proposed for repossession or foreclosure and charge-off. This action requires
the approval of our board of directors.
Our policies require that management continuously monitor the status of the loan
portfolio and report to the board of directors on a monthly basis. These reports
include information on delinquent loans and foreclosed real estate.
The following table presents information regarding non-accrual mortgage,
consumer and other loans, commercial business loans. accruing loans delinquent
90 days or more, and foreclosed properties and repossessed assets as of the
dates indicated.
AT DECEMBER 31,
-------------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ -------
(DOLLARS IN THOUSANDS)
Non-accrual mortgage loans .................. $1,399 $1,814 $ 730 $3,372 $ 2,793
Non-accrual consumer loans .................. 527 444 383 283 320
Non-accrual commercial business loans ....... 5,357 346 750 -- --
Accruing loans delinquent 90 days or more ... 1,108 936 1,258 1,152 3,617
------ ------ ------ ------ -------
Total non-performing loans ........ 8,391 3,540 3,121 4,807 6,730
Foreclosed properties and repossessed
assets, net .............................. 750 383 2,281 3,018 3,505
------ ------ ------ ------ -------
Total non-performing assets ....... $9,141 $3,923 $5,402 $7,825 $10,235
====== ====== ====== ====== =======
Non-performing loans to total loans ......... 0.50% 0.19% 0.16% 0.44% 0.65%
Non-performing assets to total asset ........ 0.32 0.14 0.19 0.44 0.55
Interest income that would have been
recognized if non-accrual loans
had been current ...................... $ 375 $ 139 $ 77 $ 245 $ 185
====== ====== ====== ====== =======
There was no specific reserve related to any loans for any date presented. There
are no significant loans, which were considered to be impaired as defined in
Statement of Financial Accounting Standards ("SFAS") No. 114 at December 31,
2002, 2001, 2000, 1999, or 1998.
There are no restructured loans at the dates presented.
Total non-performing loans increased as of December 31, 2002, as compared to
December 31, 2001, primarily as a result of an increase in non-accrual business
and non-accrual consumer loans. Even with the reported increase, we believe
non-performing loans and assets, expressed as a percentage of total loans and
assets, are still below national averages for financial institutions, due in
part to our loan underwriting standards. The increase relating to consumer and
commercial loans results from the general decline in economic conditions.
In view of the continuing weakness in the economy, we have been increasing the
amount of management time to monitor the commercial loan portfolio since that is
an area particularly sensitive to economic downturns.
13
In light of the economic downturn, there are two commercial borrowers that we
have on our watch list. One commercial borrower has loans that total $5.5
million and are current at December 31, 2002. We have provided $277,000 to the
loan loss allowance on one of these loans of $1.8 million. At present, we do not
anticipate any loss from the other commercial loans of $3.7 million but continue
to carefully monitor this borrower.
The other commercial borrower has three loans which total $4.6 million that we
are monitoring closely. This borrower is current at December 31, 2002, however,
its business is being affected by the general economic slowdown. If this
company's sales do not improve by the end of the first quarter of 2003, we may
place these loans in a substandard classification and create a loan loss
allowance for the loans.
The ultimate results with these, and other, commercial loans will depend on the
success of the related business or projects, economic performance and other
factors affecting loans and borrowers.
With the exception of mortgage loans insured or guaranteed by the FHA, VA or
Guaranteed Rural Housing, we stop accruing income on loans when interest or
principal payments are greater than 90 days in arrears or earlier when the
timely collectibility of such interest or principal is doubtful. We designate
loans on which we stop accruing income as non-accrual loans and we reverse
outstanding interest that we previously credited to income. We may recognize
income in the period that we collect it when the ultimate collectibility of
principal is no longer in doubt. We return a non-accrual loan to accrual status
when factors indicating doubtful collection no longer exist. We had $7.3 and
$2.6 million of non-accrual loans at December 31, 2002 and 2001, respectively.
Interest income that would have been recognized had such loans been performing
in accordance with their contractual terms totaled approximately $375,000 and
$139,000 for the years December 31, 2002 and 2001, respectively. A total of
approximately $557,000 and $85,000 of interest income was actually recorded on
such loans in 2002 and 2001, respectively.
All commercial real estate loans which are greater than 90 days past due are
considered to be potentially impaired. Impaired loans are individually assessed
to determine whether a loan's carrying value is in excess of the fair value of
the collateral or the present value of the loan's cash flows discounted at the
loan's effective interest rate and if the carrying value is in excess, a loan
loss allowance will be established.
Foreclosed real estate consists of property we acquired through foreclosure or
deed in lieu of foreclosure. Foreclosed real estate properties are initially
recorded at the lower of the recorded investment in the loan or fair value.
Thereafter, we carry foreclosed real estate at fair value less estimated selling
costs. Foreclosed real estate is inspected periodically. Additional outside
appraisals are obtained if we consider that appropriate. Additional write-downs
may occur if the property value deteriorates. These additional write-downs are
charged directly to current operations.
14
Allowance for Loan Losses. The following table presents the activity in our
allowance for loan losses at or for the periods indicated.
AT OR FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- ------- -------
(DOLLARS IN THOUSANDS)
Balance at beginning of period .... $ 12,245 $ 12,238 $ 6,948 $ 6,855 $ 7,195
Provision for loan losses ......... 760 723 423 350 637
Purchase of
First Northern ................ -- -- 5,028 -- --
Charge-offs:
Mortgage loans ................ (14) (65) (38) (152) (997
Consumer loans ................ (428) (337) (156) (189) (223)
Commercial business loans ..... (39) (415) -- -- --
-------- -------- -------- ------- -------
Total charge-offs ......... (481) (817) (194) (341) (1,220)
Recoveries:
Mortgage loans ................ 66 26 1 40 206
Consumer loans ................ 40 57 32 44 37
Commercial business loans ..... 113 18 -- -- --
-------- -------- -------- ------- -------
Total recoveries .......... 219 101 33 84 243
-------- -------- -------- ------- -------
Net charge-offs ............... (262) (716) (161) (257) (977)
-------- -------- -------- ------- -------
Balance at end of period .......... $ 12,743 $ 12,245 $ 12,238 $ 6,948 $ 6,855
======== ======== ======== ======= =======
Net charge-offs to average loans .. 0.01% 0.04% 0.01% 0.02% 0.08%
Allowance for loan losses
to total loans .................. 0.76% 0.67% 0.62% 0.64% 0.66%
Allowance for loan losses to
non-performing loans ............ 151.87% 345.90% 392.12% 144.54% 101.86%
The allowance for loan losses has been determined in accordance with generally
accepted accounting principles. We are responsible for the timely and periodic
determination of the amount of the allowance required. We believe that our
allowance for loan losses is adequate to cover specifically identifiable loan
losses, as well as estimated losses inherent in our portfolio for which certain
losses are probable but not specifically identifiable.
Loan loss allowances are reviewed monthly. General allowances are maintained by
the following categories for performing loans to provide for unidentified
inherent losses in the portfolios:
- One-to-four family
- Consumer
- Multi-family and commercial real estate
- Commercial business
Allowance goals have been established based on an internal risk evaluation by
loan category. Various factors are taken into consideration including:
historical loss experience, economic factors and other factors, that, in
management's judgement would affect the collectibility of the portfolio as of
the evaluation date. Adjustments to the allowance for loan losses are charged
against operations as provision for loan losses to maintain allowances at the
desired levels.
The appropriateness of the allowance is reviewed by senior management based upon
its evaluation of then-existing economic and business conditions affecting the
key lending areas of the Bank. Other outside factors such as credit quality
trends, collateral values, loan volumes and concentrations, specific industry
conditions within portfolio segments and recent loss experience in particular
segments of the portfolio that existed as of the balance sheet date and the
impact that such conditions were believed to have had on the collectibility of
the loan are also considered. Our board of directors also reviews the loan loss
allowances compared to the relative size of the portfolio on at least a
quarterly basis.
15
Delinquent and Non-performing loans. One-to four-family loans delinquent more
than 90 days, multi-family and commercial real estate loans delinquent more than
60 days, consumer loans delinquent more than 90 days and commercial business
loans more than 60 days are reviewed and analyzed by senior officers on an
individual basis. Any potential loss is charged against the allowance by
establishing a corresponding specific allowance for that loan from the general
allowance. In such an event, the loan is then reduced by the amount of the
specific allowance and a corresponding amount is charged off to the allowance
for losses on loans.
By following careful underwriting guidelines, we have historically maintained
low levels of non-performing loans to total loans. Our ratio of non-performing
loans to total loans at December 31, 1998 was 0.65% and continued to decrease
until December 31, 2002 at which time it increased to 0.50%. This increase was
the result of a couple of commercial loans where the economic slowdown has
impacted their businesses.
We believe the primary risks inherent in our portfolio are possible increases in
interest rates, a possible continued decline in the economy, generally, and a
possible decline in real estate market values. Any one or a combination of these
events may adversely affect our loan portfolio resulting in increased
delinquencies and loan losses. Accordingly, and because of the increased
concentration of consumer loans, we have taken steps to increase our level of
loan loss allowances over the last 5 years. At December 31, 2002, the allowance
for loan losses as a percentage of total loans was 0.76% compared with 0.66% at
December 31, 1998. Furthermore, the increase in the allowance for loan losses
each year from 1998 to 2002 reflects our strategy of resolving non-performing
loans while providing adequate allowances for inherent losses in the portfolio,
identifying potential losses in a timely manner, and providing an adequate
allowance to reflect changes in the components of the portfolio during that
period.
Although we believe that we have established and maintained the allowance for
loan losses at adequate levels, future additions may be necessary if economic
and other conditions in the future differ substantially from the current
operating environment. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review our loan and foreclosed
real estate portfolios and the related allowance for loan losses and valuation
allowance for foreclosed real estate. One or more of these agencies,
specifically the OTS or the Federal Deposit Insurance Corporation ("FDIC"), may
require us to increase the allowance for loan losses or the valuation allowance
for foreclosed real estate based on their judgements of information available to
them at the time of their examination, thereby adversely affecting our results
of operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Comparison of Operating Results for the years ended December 31,
2002 and 2001--Provision for Loan Losses." The following tables represent our
allocation of allowance for loan losses by loan category on the dates indicated:
AT DECEMBER 31,
---------------------------------------------------------------------
2002 2001 2000
--------------------- --------------------- ---------------------
PERCENTAGE PERCENTAGE PERCENTAGE
OF OF OF
LOANS IN LOANS IN LOANS IN
CATEGORY CATEGORY CATEGORY
TO TOTAL TO TOTAL TO TOTAL
LOAN CATEGORY AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
- ------------- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Mortgage loans
One-to four-family ........ $ 4,701 52.46% $ 5,608 52.46% $ 6,279 59.56%
Other ..................... 3,160 22.37 2,875 22.36 2,173 15.72
------- ------ ------- ------ ------- ------
Total mortgage loans ... 7,861 74.83 8,483 74.82 8,452 75.28
Home equity lines ............ 1,171 4.04 1,803 4.04 519 3.97
Consumer ..................... 1,705 17.91 1,007 17.92 2,483 17.80
Commercial business loans .... 1,507 3.22 952 3.22 784 2.95
Unallocated .................. 499 0.00 -- 0.00 -- 0.00
------- ------ ------- ------ ------- ------
Total allowance for
loan losses ........... $12,743 100.00% $12,245 100.00% $12,238 100.00%
======= ====== ======= ------ ======= ======
AT DECEMBER 31,
-------------------------------------------
1999 1998
-------------------- --------------------
PERCENTAGE PERCENTAGE
OF OF
LOANS IN LOANS IN
CATEGORY CATEGORY
TO TOTAL TO TOTAL
LOAN CATEGORY AMOUNT LOANS AMOUNT LOANS
------ ----- ------ -----
(Dollars in thousands)
Mortgage loans
One-to four-family ........ $4,736 67.37% $5,189 70.56%
Other ..................... 822 12.01 596 11.07
------ ------ ------ ------
Total mortgage loans ... 5,558 79.38 5,785 81.63
Home equity lines ............ 253 4.58 229 4.36
Consumer ..................... 617 12.47 439 11.27
Commercial business loans .... 520 3.57 402 2.74
Unallocated .................. -- 0.00 -- 0.00
------ ------ ------ ------
Total allowance for
loan losses ........... $6,948 100.00% $6,855 100.00%
====== ====== ====== ======
16
INVESTMENT ACTIVITIES
Investment Securities. The Bank's board of directors reviews and approves its
investment policy on an annual basis. Senior officers, as authorized by the
board of directors, implement this policy. The board of directors reviews
investment activity on a monthly basis.
Our investment objectives are to meet liquidity requirements, generate a
favorable return on investments without undue compromise to our other business
objectives and our levels of interest rate risk, credit risk and investment
portfolio concentrations. Federally chartered savings banks have authority to
invest in various types of assets, including U.S. Treasury obligations,
securities of various federal agencies, state and municipal obligations,
mortgage-related securities, mortgage derivative securities, certain time
deposits of insured banks and savings institutions, certain bankers'
acceptances, repurchase agreements, loans of federal funds, and, subject to
certain limits, corporate debt and equity securities, commercial paper and
mutual funds.
The Bank's investment policy allows participation in hedging strategies or the
use of financial futures, options or forward commitments or interest rate swaps
but only with prior approval of the board of directors. We did not have any such
hedging transactions in place at December 31, 2002. Our investment policy
prohibits the purchase of non-investment grade bonds. Our investment policy also
provides that we will not engage in any practice that the Federal Financial
Institutions Examination Council considers to be an unsuitable investment
practice. For information regarding the carrying values, yields and maturities
of our investment securities and mortgage-related securities, see "--Carrying
Values, Yields and Maturities."
We classify securities as trading, held-to-maturity, or available-for-sale at
the date of purchase. At December 31, 2002, all investment securities are
classified as available-for-sale. These securities are carried at fair value
with the change in fair value recorded as a component of shareholders' equity.
Mortgage-related Securities. Most of our mortgage-related securities are
directly or indirectly insured or guaranteed by the Government National Mortgage
Association ("GNMA"), Freddie Mac or Fannie Mae. The rest of the securities are
private placement collateralized mortgage obligations ("CMOs"). Private
placement CMOs carry higher credit risks and higher yields than CMOs insured or
guaranteed by agencies of the U.S. Government. We classify our entire
mortgage-related securities portfolio as available-for-sale.
At December 31, 2002, mortgage-related securities available-for-sale totaled
$618.1 million, or 21.7% of total assets. At December 31, 2002, the
mortgage-related securities portfolio had a weighted average yield of 5.39%. Of
the mortgage-related securities we held at December 31, 2002, $553.1 million, or
89.5%, had fixed rates and $65.1 million, or 10.5%, had adjustable-rates.
Mortgage-related securities at December 31, 2002 included real estate mortgage
investment conduits ("REMICs"), which are securities derived by reallocating
cash flows from mortgage pass-through securities or from pools of mortgage loans
held by a trust. REMICs are a form of, and are often referred to as CMOs.
Our CMOs have fixed and variable coupon rates ranging from 1.72% to 6.50% and a
weighted average yield of 4.99% at December 31, 2002. At December 31, 2002, CMOs
totaled $443.1 million, which constituted 71.7% of the mortgage-related
securities portfolio, or 15.6% of total assets. Our CMOs had an expected average
life of 2.0 years at December 31, 2002. For a further discussion of our
investment policies, including those for mortgage-related securities, see
"--Investment Securities." Purchases of mortgage-related securities may decline
in the future to offset any significant increase in demand for one- to
four-family mortgage loans and other loans.
Mortgage-related securities generally yield less than the loans that underlie
such securities because of the cost of payment guarantees or credit enhancements
that reduce credit risk. However, mortgage-related securities are more liquid
than individual mortgage loans. In general, mortgage-related securities issued
or guaranteed by GNMA, Freddie Mac and Fannie Mae are weighted at no more than
20% for risk-based capital purposes, compared to the 50% risk weighting assigned
to most non-securitized residential mortgage loans.
17
While mortgage-related securities carry a reduced credit risk as compared to
whole loans, they remain subject to the risk of a fluctuating interest rate
environment. Along with other factors, such as the geographic distribution of
the underlying mortgage loans, changes in interest rates may alter the
prepayment rate of those mortgage loans and affect both the prepayment rates and
value of mortgage-related securities.
The following table presents our investment securities and mortgage-related
securities activities for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
--------- --------- ---------
(IN THOUSANDS)
INVESTMENT SECURITIES AVAILABLE-FOR-SALE:
Carrying value at beginning of period .............. $ 93,059 $ 94,129 $ 57,763
--------- --------- ---------
Purchases .......................................... 36,390 174,938 47,509
Purchase of First Northern ......................... -- -- 39,320
Calls .............................................. (4,023) (14,000) --
Maturities ......................................... (50,960) (163,178) (52,160)
Principal payments ................................. (937) (563) (13)
Premium amortization and discount accretion, net ... 134 503 (15)
(Decrease) increase in unrealized gains ............ (437) 1,230 1,725
--------- --------- ---------
Net increase (decrease) in investment securities ... (19,833) (1,070) 36,366
--------- --------- ---------
Carrying value at end of period .................... $ 73,226 $ 93,059 $ 94,129
========= ========= =========
MORTGAGE-RELATED SECURITIES AVAILABLE-FOR-SALE:
Carrying value at beginning of period .............. $ 521,084 $ 464,873 $ 374,100
--------- --------- ---------
Purchases .......................................... 365,312 176,658 120,690
Purchase of First Northern ......................... -- -- 13,569
Principal payments ................................. (275,518) (128,256) (52,467)
Premium amortization and discount accretion, net ... (253) 723 501
Increase in unrealized gains ....................... 7,498 7,086 8,480
--------- --------- ---------
Net increase in mortgage-related securities ........ 97,039 56,211 90,773
--------- --------- ---------
Carrying value at end of period .................... $ 618,123 $ 521,084 $ 464,873
========= ========= =========
18
The following table presents the fair value of our money market investments,
investment securities and mortgage-related securities portfolios at the dates
indicated. It also presents the coupon type for the mortgage-related securities
portfolio. For all securities and for all periods presented, the carrying value
is equal to fair value.
AT DECEMBER 31,
--------------------------------------------
2002 2001 2000
---------- ---------- ----------
CARRYING/ CARRYING/ CARRYING/
FAIR VALUE FAIR VALUE FAIR VALUE
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
MONEY MARKET INVESTMENTS
Interest-earning deposits .................................. $ 36,462 $ 35,338 $ 15,097
Federal funds sold ......................................... 165,000 175,000 20,000
-------- -------- --------
Total money market investments ......................... $201,462 $210,338 $ 35,097
======== ======== ========
INVESTMENT SECURITIES AVAILABLE-FOR-SALE
Mutual funds ............................................... $ 34,034 $ 32,982 $ 31,080
United States government and federal agency obligations .... 28,212 41,319 60,397
Corporate issue securities ................................. 9,563 17,189 999
Freddie Mac stock .......................................... 1,417 1,569 1,653
-------- -------- --------
Total investment securities available-for-sale ......... $ 73,226 $ 93,059 $ 94,129
======== ======== ========
MORTGAGE-RELATED SECURITIES AVAILABLE-FOR-
SALE BY ISSUER:
Freddie Mac ................................................ $288,113 $161,895 $ 70,106
Fannie Mae ................................................. 296,604 328,630 377,027
Private placement CMO's .................................... 8,406 28,783 15,489
GNMA ....................................................... 25,000 1,776 2,251
-------- -------- --------
Total mortgage-related securities ...................... $618,123 $521,084 $464,873
======== ======== ========
TOTAL INVESTMENT PORTFOLIO ..................................... $892,811 $824,481 $594,099
======== ======== ========
Carrying Values, Yields and Maturities. The table below presents information
regarding the carrying values, weighted average yields and contractual
maturities of our investment securities and mortgage-related securities at
December 31, 2001. Mortgage-related securities are presented by issuer and by
coupon type.
AT DECEMBER 31, 2002
---------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE
ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS
-------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD
----- ----- ----- ----- ----- -----
(DOLLARS IN THOUSANDS)
INVESTMENT SECURITIES AVAILABLE-FOR-SALE:
Mutual funds ...................................... $34,034 2.97% $ -- --% $ -- --
United States government and agencies ............. 17,990 5.82 10,222 6.40 -- --
Corporate issues .................................. 1,540 6.42 8,023 6.11 -- --
Freddie Mac stock ................................. 1,417 1.47 -- -- -- --
------- ---- ------- ---- ------- ----
Total investment securities .................. $54,981 3.94 $18,245 6.27 $ -- --
======= ======= =======
MORTGAGE-RELATED SECURITIES AVAILABLE-FOR-SALE:
BY ISSUER:
GNMA pass-through certificates ................. $ -- $ -- $ 108 7.94 $ 81 8.50
Fannie Mae pass-through certificates ........... -- -- 10 7.70 24, 929 6.40
Freddie Mac pass- through certificates ......... -- -- -- -- -- --
Private CMO's .................................. 6 7.20 412 6.74 2,175 5.81
Freddie Mac, Fannie Mae and GNMA-REMICs ........ -- -- -- -- 38,521 4.60
------- ---- ------- ---- ------- ----
Total mortgage-related securities .......... $ 6 7.20 $ 530 7.00 $65,706 5.30
======= ======= =======
BY COUPON TYPE:
Adjustable rate ................................... $ -- -- $ -- -- $ 3,349 5.64
Fixed rate ........................................ 6 7.20 530 7.00 62,357 5.28
------- ---- ------- ---- ------- ----
Total mortgage-related securities .......... $ 6 7.20 $ 530 7.00 $65,706 5.30
======= ======= =======
Total investment and mortgage-related
securities portfolio ............................ $54,987 3.94% $18,775 6.29% $65,706 5.30%
======= ======= =======
AT DECEMBER 31, 2002
-------------------------------------------
MORE THAN TEN YEARS TOTAL
-------------------- --------------------
WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD
----- ----- ----- -----
(DOLLARS IN THOUSANDS)
INVESTMENT SECURITIES AVAILABLE-FOR-SALE:
Mutual funds ...................................... $ -- -- $ 34,034 2.97%
United States government and agencies ............. -- -- 28,212 6.02
Corporate issues .................................. -- -- 9,563 6.16
Freddie Mac stock ................................. -- -- 1,417 1.47
-------- ---- -------- ----
Total investment securities .................. $ -- -- $ 73,226 4.50
======== ========
MORTGAGE-RELATED SECURITIES AVAILABLE-FOR-SALE:
BY ISSUER:
GNMA pass-through certificates ................. $ 4,056 4.76 $ 4,245 4.91
Fannie Mae pass-through certificates ........... 137,406 6.51 162,345 6.49
Freddie Mac pass- through certificates ......... 8,406 6.36 8,406 6.36
Private CMO's .................................. 16,472 5.40 19,065 5.48
Freddie Mac, Fannie Mae and GNMA-REMICs ........ 385,541 5.00 424,062 4.97
-------- ---- -------- ----
Total mortgage-related securities .......... $551,881 5.39 $618,123 5.39
======== ========
BY COUPON TYPE:
Adjustable rate ................................... $ 61,707 4.64 $ 65,056 4.70
Fixed rate ........................................ 490,174 5.48 553,067 5.46
-------- ---- -------- ----
Total mortgage-related securities .......... $551,881 5.39 $618,123 5.39
======== ========
Total investment and mortgage-related
securities portfolio ............................ $551,881 5.39% $691,349 5.29%
======== ========
19
DEPOSITS
We offer a variety of deposit accounts having a range of interest rates and
terms. We currently offer regular savings accounts (consisting of passbook and
statement savings accounts), interest-bearing demand accounts,
non-interest-bearing demand accounts, money market accounts, and time deposits.
We also offer IRA time deposit accounts.
Deposit flows are influenced significantly by general and local economic
conditions, changes in prevailing interest rates, pricing of deposits and
competition. Our deposits are primarily obtained from areas surrounding our 70
bank offices and we rely primarily on paying competitive rates, service, and
long-standing relationships with customers to attract and retain these deposits.
We do use brokers to obtain wholesale deposits to a limited extent. At December
31, 2002, we had approximately $17.9 million of brokered wholesale deposits.
When we determine our deposit rates, we consider local competition, U.S.
Treasury securities offerings and the rates charged on other sources of funds.
Core deposits (defined as regular savings accounts, money market accounts and
demand accounts) represented 39.0% of total deposits on December 31, 2002. At
December 31, 2002, time deposits with remaining terms to maturity of less than
one year amounted to $681.3 million. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Analysis of Net Interest
Income."
The following table presents our deposit activity for the periods indicated:
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000
----------- ---------- -----------
(DOLLARS IN THOUSANDS)
Total deposits at beginning of period .. $ 2,090,440 $1,894,820 $ 1,343,007
Net deposits (withdrawals) ............. (26,619) 115,105 (85,790)
Acquisition of First Northern .......... -- -- 578,588
Interest credited, net of penalties .... 62,834 80,515 59,015
----------- ---------- -----------
Total deposits at end of period ........ $ 2,126,655 $2,090,440 $ 1,894,820
=========== ========== ===========
Net increase (decrease) ................ $ 36,215 $ 195,620 $ 551,813
=========== ========== ===========
Percentage increase (decrease) ......... 1.73% 10.32% 41.09%
At December 31, 2002, we had $166.9 million in time deposits with balances of
$100,000 and over maturing as follows:
MATURITY PERIOD AMOUNT
- --------------- ------
(IN THOUSANDS)
Three months or less .............................................. $ 48,979
Over three months through six months .............................. 12,845
Over six months through 12 months ................................. 27,175
Over 12 months through 24 months .................................. 20,130
Over 24 months through 36 months .................................. 26,204
Over 36 months .................................................... 31,531
--------
Total ............................................................. $166,864
========
20
The following table presents the distribution of our deposit accounts at the
dates indicated by dollar amount and percent of portfolio, and the weighted
average nominal interest rate on each category of deposits.
AT DECEMBER 31,
------------------------------------------------------------------------
2002 2001
---- ----
WEIGHTED WEIGHTED
PERCENT AVERAGE PERCENT AVERAGE
OF TOTAL NOMINAL OF TOTAL NOMINAL
AMOUNT DEPOSITS RATE AMOUNT DEPOSITS RATE
------ -------- ---- ------ -------- ----
(DOLLARS IN THOUSANDS)
Savings ............................................. $ 230,170 10.82% 0.63% $ 214,859 10.28% 1.19%
Interest-bearing demand ............................. 149,008 7.01 0.37 137,317 6.57 0.64
Money market ........................................ 351,433 16.53 1.62 335,946 16.07 2.08
Non-interest bearing demand ......................... 98,941 4.65 0.00 96,362 4.61 0.00
---------- ------ ------ ---------- ------ ------
Total ....................................... 829,552 39.01 0.93 784,484 37.53 1.33
---------- ------ ------ ---------- ------ ------
Certificates:
Time deposits with
original maturities of:
Three months or less ........................... 125,771 5.91 2.06 95,946 4.59 2.68
Over three months to twelve months ............. 248,269 11.67 2.53 187,960 8.99 3.94
Over twelve months to twenty-four months ....... 336,919 15.84 3.83 713,413 34.12 5.43
Over twenty-four months to thirty-six months ... 167,574 7.88 5.12 208,859 9.99 5.79
Over thirty-six months to forty-eight months ... 188,180 8.85 4.34 29,998 1.44 5.50
Over forty-eight months to sixty months ........ 227,265 10.69 5.31 67,717 3.24 5.80
Over sixty months .............................. 3,125 0.15 5.90 2,063 0.10 6.41
---------- ------ ------ ---------- ------ ------
Total time deposits ......................... 1,297,103 60.99 3.91 1,305,956 62.47 5.09
---------- ------ ------ ---------- ------ ------
Total deposits .............................. $2,126,655 100.00% 2.75% $2,090,440 100.00% 3.68%
========== ====== ====== ========== ====== ======
AT DECEMBER 31,
-------------------------------------
2000
----
WEIGHTED
PERCENT AVERAGE
OF TOTAL NOMINAL
AMOUNT DEPOSITS RATE
------ -------- ----
(DOLLARS IN THOUSANDS)
Savings ............................................. $ 200,915 10.60% 2.40%
Interest-bearing demand ............................. 133,975 7.07 1.12
Money market ........................................ 290,947 15.35 5.41
Non-interest bearing demand ......................... 87,079 4.60 0.00
---------- ------ ------
Total ....................................... 712,916 37.62 3.09
---------- ------ ------
Certificates:
Time deposits with
original maturities of:
Three months or less ........................... 150,613 7.95 6.03
Over three months to twelve months ............. 260,978 13.78 5.87
Over twelve months to twenty-four months ....... 563,858 29.76 6.25
Over twenty-four months to thirty-six months ... 137,810 7.27 6.15
Over thirty-six months to forty-eight months ... 7,587 0.40 5.66
Over forty-eight months to sixty months ........ 58,909 3.11 6.01
Over sixty months .............................. 2,149 0.11 6.48
---------- ------ ------
Total time deposits ......................... 1,181,904 62.38 6.11
---------- ------ ------
Total deposits .............................. 1,894,820 100.00% 4.98%
========== ====== ======
BORROWINGS
We borrow funds to finance our lending and investing activities. Substantially
all of our borrowings take the form of advances from the FHLB of Chicago. At
December 31, 2002 we had borrowings totaling $83.6 million with maturities of
less than one year, and $271.4 million of borrowings with longer stated terms
but which are callable by the FHLB of Chicago. We have pledged certain loans as
blanket collateral for these advances and future advances. The FHLB of Chicago
offers a variety of borrowing options with fixed or variable rates, flexible
repayment options, and fixed or callable terms. We choose the rate, repayment
option, and term to fit the purpose of the borrowing. See "Notes to Consolidated
Financial Statements--Note 7. Borrowings."
The following table sets forth certain information regarding borrowings by Bank
Mutual at the end of and during the periods indicated:
AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
-------- -------- --------
(DOLLARS IN THOUSANDS)
Balance outstanding at end of year:
Notes payable to FHLB ........................ $332,299 $442,025 $546,489
Overnight borrowings from FHLB ............... -- -- 20,225
Other borrowings ............................. 22,679 23,335 910
Weighted average interest rate at end of year:
Notes payable to FHLB ........................ 5.57% 5.75% 6.31%
Overnight borrowings from FHLB ............... -- -- 6.85%
Other borrowings ............................. 0.99% 1.39% 5.74%
Maximum amount outstanding during the year:
Notes payable to FHLB ........................ $445,914 $547,653 $546,760
Overnight borrowings from FHLB ............... 5,480 39,275 120,900
Other borrowings ............................. 19,835 60,720 2,820
Average amount outstanding during the year:
Notes payable to FHLB ........................ $395,351 $491,248 $289,032
Overnight borrowings from FHLB ............... 25 6,348 20,145
Other borrowings ............................. 3,309 5,285 84
Weighted average interest rate during the year:
Fixed interest rate notes payable to FHLB .... 5.68% 5.91% 6.56%
Overnight borrowings from FHLB ............... 1.53% 5.74% 6.56%
Other borrowings ............................. 1.45% 3.38% 6.29%
21
Borrowings decreased to $355.0 million at December 31, 2002, as compared to
$465.4 million at December 31, 2001, primarily as a result of the proceeds of
loan sales and deposit growth. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Comparisons of Financial
Condition at December 31, 2002 and 2001."
AVERAGE BALANCE SHEET AND RATE YIELD ANALYSIS
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
AVERAGE EQUITY TO AVERAGE ASSETS
The ratio of average equity to average assets measures a financial institution's
financial strength. At December 31, 2002, 2001, 2000, 1999, and 1998 our average
equity to average assets ratio was 10.9%, 10.4%, 9.7%, 9.6%, and 9.2%,
respectively.
CASH DIVIDENDS
We paid cash dividends of $0.34 per share in 2002 and $0.28 per share in 2001.
We did not pay any cash dividends in 2000. We also increased the cash dividend
paid in the first quarter of 2003 to $0.10 per share or a 11.1% increase when
compared to the $0.09 per share paid in the first quarter of 2002. The MHC has
waived dividend payments for 2003, 2002 and 2001.
SUBSIDIARIES
Lake Financial and Insurance Service, Inc., a wholly owned subsidiary of the
Bank, provides investment and insurance services to the Bank's customers and the
general public. Investment services include tax deferred and tax free
investments, mutual funds, and government securities. Personal insurance,
business insurance, life and disability insurance and mortgage protection
products are also offered by Lake Financial.
Mutual Investment Corporation, a wholly owned subsidiary of the Bank, owns and
manages part of the Bank's Investment portfolio. First Northern Investment Inc.
("FNII"), a wholly owned subsidiary of the Bank, owns and manages part of the
Bank's investments and SFC's indirect automobile loans.
MC Development LTD, a wholly owned subsidiary of the Bank, is involved in land
development and sales. It owns two parcels of undeveloped land consisting of 15
acres in Brown Deer, Wisconsin and 318 acres in Oconomowoc, Wisconsin. See
"Properties."
Great Northern Financial Savings Corp. ("GNFSC"), a wholly owned subsidiary of
the Bank, engages in the sale of credit life and disability insurance, and
offers brokerage services to the public, including the sale of tax deferred
annuities and mutual funds. GNFSC will be consolidated into Lake Financial on
April 1, 2003.
SFC, 50% owned by the Bank and 50% owned by another financial institution,
originates, sells, and services the indirect automobile loans. SFC sells the
loans on a regular basis to FNII or the Bank, but retains the servicing rights
in the loans.
In addition, the Bank has five wholly owned subsidiaries that are inactive but
will continue to be wholly owned subsidiaries for possible future use in a
related or other area.
EMPLOYEES
At December 31, 2002, Bank Mutual employed 691 full time and 131 part time
associates. Management considers its relations with its associates to be good.
22
REGULATION
Set forth below is a brief description of certain laws and regulations that
relate to the regulation of the Bank, Bank Mutual, and the MHC.
GENERAL
The Bank is a federally chartered stock savings bank whose primary regulator is
the OTS. The FDIC under the SAIF insures its deposit accounts up to applicable
limits. The Bank is currently subject to extensive regulation, examination and
supervision by the OTS as its chartering agency, and by the FDIC as its deposit
insurer. The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, and must obtain regulatory approval prior to
entering into certain transactions, such as mergers with, or acquisitions of,
other depository institutions and opening or acquiring branch offices. In
addition, the Bank's relationship with its depositors and borrowers also is
regulated to a great extent by both federal and state laws, especially in such
matters as the ownership of deposit accounts and the form and content of the
Bank's mortgage documents.
The OTS currently conducts periodic examinations to assess the Bank's compliance
with various regulatory requirements. In addition, the FDIC has the right to
perform examinations of the Bank should the OTS or the FDIC determine the Bank
is in a weakened financial condition or a failure is foreseeable. This
regulation and supervision establishes a comprehensive framework of activities
in which a savings bank can engage and is intended primarily for the protection
of the deposit insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes.
Bank Mutual, as a federal stock corporation in a mutual holding company
structure, is deemed a federal stock holding company within the meaning of
Section 10(o) of the Home Owners' Loan Act. Bank Mutual is required to register
and file reports with the OTS and is subject to regulation and examination by
the OTS. Bank Mutual is also required to file certain reports with, and
otherwise comply with, the rules and regulations of the Securities and Exchange
Commission ("SEC") under the federal securities laws.
The MHC is a federal mutual holding company within the meaning of Section 10(o)
of the Home Owners' Loan Act. As such, the MHC has registered with the OTS and
is subject to OTS examination and supervision as well as certain reporting
requirements.
Any change in these laws and regulations, whether by the OTS, the FDIC, the SEC,
or through legislation, could have a material adverse impact on the Bank, Bank
Mutual, and the MHC and their operations and shareholders.
Certain of the laws and regulations applicable to the Bank, Bank Mutual, and the
MHC are summarized below. These summaries do not purport to be complete and are
qualified in their entirety by reference to such laws and regulations.
FEDERAL REGULATION OF THE BANK
General. As a federally chartered, SAIF-insured savings bank, the Bank is
subject to extensive regulation by the OTS and the FDIC. Lending activities and
other investments must comply with federal statutory and regulatory
requirements. This federal regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the SAIF, the FDIC and depositors. This
regulatory structure gives the regulatory authorities extensive discretion in
connection with their supervisory and enforcement activities and examination
policies, including policies regarding the classification of assets and the
establishment of adequate loan loss reserves.
The OTS regularly examines the Bank and issues a report on its examination
findings to the Bank's boards of directors. The Bank's relationships with its
depositors and borrowers is also regulated by federal law, especially in such
matters as the ownership of savings accounts and the form and content of the
Bank's mortgage documents.
23
The Bank must file reports with the OTS and the FDIC concerning its activities
and financial condition, and must obtain regulatory approvals prior to entering
into transactions such as mergers with or acquisitions of other financial
institutions. Any change in such regulations, whether by the OTS, the FDIC or
the United States Congress, could have a material adverse impact on the Bank and
its operations.
Regulatory Capital Requirements. OTS capital regulations require savings
institutions such as the Bank to meet three capital standards. The minimum
standards are tangible capital equal to at least 1.5% of adjusted total assets,
core capital equal to at least 3% of adjusted total assets, and risk-based
capital equal to at least 8% of total risk-weighted assets. These capital
standards are in addition to the capital standards promulgated by the FDIC under
its prompt corrective action regulations, as described below under the heading
"Prompt Corrective Action."
Tangible capital is defined as core capital less all intangible assets and
certain mortgage servicing rights. Core capital is defined as common
shareholders' equity, noncumulative perpetual preferred stock, related surplus
and minority interests in the equity accounts of fully consolidated
subsidiaries, nonwithdrawable accounts and pledged deposits of mutual savings
associations and qualifying supervisory goodwill, less nonqualifying intangible
assets, mortgage servicing rights and investments in certain non-includable
subsidiaries.
The risk-based capital standard for savings institutions requires the
maintenance of total risk-based capital of at least 8% of risk-weighted assets.
Risk-based capital is comprised of core and supplementary capital. The
components of supplementary capital include, among other items, cumulative
perpetual preferred stock, perpetual subordinated debt, mandatory convertible
subordinated debt, intermediate-term preferred stock, up to 45% of unrealized
gains on available-for-sale equity securities with readily determinable fair
values, and the portion of the allowance for loan losses not designated for
specific loan losses. The portion of the allowance for loan and lease losses
includible in supplementary capital is limited to a maximum of 1.25% of
risk-weighted assets. Overall, supplementary capital is limited to 100% of core
capital. A savings association must calculate its risk-weighted assets by
multiplying each asset and off-balance sheet item by various risk factors as
determined by the OTS, which range from 0% for cash to 100% for delinquent
loans, property acquired through foreclosure, commercial loans, and other
assets.
OTS rules require a deduction from capital for institutions that have
unacceptable levels of interest rate risk. The OTS calculates the sensitivity of
an institution's net portfolio value based on data submitted by the institution
in a schedule to its quarterly Thrift Financial Report and using the interest
rate risk measurement model adopted by the OTS. The amount of the interest rate
risk component, if any, is deducted from an institution's total capital in order
to determine if it meets its risk-based capital requirement.
Dividend and Other Capital Distribution Limitations. The OTS imposes various
restrictions or requirements on the ability of savings institutions to make
capital distributions, including dividend payments.
OTS regulations require the Bank to give the OTS 30 days' advance notice of any
proposed declaration of dividends, and the OTS has the authority under its
supervisory powers to prohibit the payment of dividends. OTS regulations impose
uniform limitations on the ability of all savings banks and associations to
engage in various distributions of capital such as dividends, stock repurchases
and cash-out mergers. In addition, the regulation utilizes a three-tiered
approach permitting various levels of distributions based primarily upon a
savings bank's capital level.
The Bank currently meets the criteria to be designated a Tier 1 association and,
consequently, could at its option (after prior notice to, and no objection made
by, the OTS) distribute up to 100% of its net income during the calendar year
plus 50% of its surplus capital at the beginning of the calendar year less any
distributions previously paid during the year. Additional dividends or
distributions would require further OTS approval.
See the section entitled "MHC Regulation - Waiver of Dividends" below for a
discussion of the specific regulatory requirements relating to the MHC's
determination to waive dividends from Bank Mutual in fiscal years 2001, 2002 and
2003.
Qualified Thrift Lender Test. Federal savings associations must meet a qualified
thrift lender test or they become subject to operating restrictions. Until
recently, the chief restriction was the elimination of borrowing rights from the
savings association's Federal Home Loan Bank. However, with passage of the
Gramm-Leach-Bliley Financial
24
Modernization Act of 1999 by Congress, the failure to maintain qualified thrift
lender status will not affect the Bank's borrowing rights with the FHLB of
Chicago. Notwithstanding these changes, the Bank anticipates that it will
maintain an appropriate level of investments consisting primarily of residential
mortgages, mortgage-backed securities and other mortgage-related investments,
and otherwise qualify as a qualified thrift lender. The required percentage of
these mortgage-related investments is 65% of portfolio assets. Portfolio assets
are all assets minus goodwill and other intangible assets, property used by the
institution in conducting its business and liquid assets equal to 20% of total
assets. Compliance with the qualified thrift lender test is determined on a
monthly basis in nine out of every twelve months.
Liquidity Standard. Each federal savings institution is required to maintain
sufficient liquidity to ensure its safe and sound operations.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Chicago,
which is one of 12 regional Federal Home Loan Banks. Each Federal Home Loan Bank
serves as a reserve or central bank for its members within its assigned region.
It is funded primarily from funds deposited by financial institutions and
proceeds derived from the sale of consolidated obligations of the Federal Home
Loan Bank System. It makes loans to members pursuant to policies and procedures
established by the board of directors of the Federal Home Loan Bank.
As a member, the Bank is required to purchase and maintain stock in the FHLB of
Chicago in an amount equal to the greatest of $500, 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year, or 5% of its outstanding advances. The Bank is
currently in compliance with this requirement. The FHLB of Chicago also imposes
various limitations on advances made to member banks, which limitations relate
to the amount and type of collateral, the amounts of advances, and other items.
Under the Gramm-Leach-Bliley Financial Services Modernization Act of 1999
(the"GLB Act"), the Bank is a voluntary member of the FHLB of Chicago. The Bank
could withdraw or reduce its stock ownership in the FHLB of Chicago, although it
has no current intention to do so. The FHLB of Chicago provides funds for
programs to resolve the problems created by troubled savings institutions. The
FHLB of Chicago also contributes to affordable housing programs through direct
loans, interest subsidies on advances, and grants targeted for community
investment and low- and moderate-income housing projects. These contributions
have adversely affected the level of dividends paid by the FHLB of Chicago and
could continue to do so in the future.
On June 12, 2002, the FHLB of Chicago adopted a plan to restructure its capital
stock in accordance with the GLB Act. The plan allows for the creation of a more
permanent capital base and offers members flexibility and choice through two
classes of stock. Implementation of the plan is expected in late 2003. At this
time, it is not possible to predict the impact the plan may have on the Bank.
Federal Reserve System. The Federal Reserve System requires all depository
institutions to maintain non-interest-bearing reserves at specified levels
against their checking, NOW, and Super NOW checking accounts and non-personal
time deposits. Savings institutions have authority to borrow from the Federal
Reserve System "discount window," but Federal Reserve System policy generally
requires savings institutions to exhaust all other sources before borrowing from
the Federal Reserve System.
Deposit Insurance. The deposit accounts held by customers of the Bank are
insured by the SAIF to a maximum of $100,000 as permitted by law. Insurance on
deposits may be terminated by the FDIC if it finds that the Bank has engaged in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC or the OTS as the Bank's primary regulator. The
management of the Bank does not know of any practice, condition, or violation
that might lead to termination of the Bank's deposit insurance.
Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), the FDIC established a system for setting deposit insurance premiums
based upon the risks a particular bank or savings association posed to its
deposit insurance funds. Under the risk-based deposit insurance assessment
system, the FDIC assigns an institution to one of three capital categories based
on the institution's financial information, as of the reporting period ending
six months before the assessment period. The three capital categories are (i)
well capitalized, (ii) adequately capitalized and (iii) undercapitalized. The
FDIC also assigns an institution to one of three supervisory subcategories
within each
25
capital group. With respect to the capital ratios, institutions are classified
as well capitalized, adequately capitalized or undercapitalized using ratios
that are substantially similar to the prompt corrective action capital ratios
discussed below. The FDIC also assigns an institution to a supervisory subgroup
based on a supervisory evaluation provided to the FDIC by the institution's
primary federal regulator and information that the FDIC determines to be
relevant to the institution's financial condition and the risk posed to the
deposit insurance funds (which may include, if applicable, information provided
by the institution's state supervisor).
An institution's assessment rate depends on the capital category and supervisory
category to which it is assigned. Under the final risk-based assessment system,
there are nine assessment risk classifications (i.e., combinations of capital
groups and supervisory subgroups) to which different assessment rates are
applied. Assessment rates for deposit insurance currently range from 0 basis
points to 27 basis points. The capital and supervisory subgroup to which an
institution is assigned by the FDIC is confidential and may not be disclosed. A
bank's rate of deposit insurance assessments will depend upon the category and
subcategory to which the bank is assigned by the FDIC. Any increase in insurance
assessments could have an adverse effect on the earnings of insured
institutions, including the Bank.
Transactions with Affiliates. Sections 23A and 23B of the Federal Reserve Act
govern transactions between an insured federal savings bank, such as the Bank,
and any of its affiliates. An affiliate of a bank is any company or entity that
controls, is controlled by or is under common control with the bank. A
subsidiary of a bank that is not also a depository institution or a "financial
subsidiary" under the GLB Act is not treated as an affiliate of the bank for the
purposes of Sections 23A and 23B; however, the OTS has the discretion to treat
subsidiaries of a savings institution as affiliates on a case-by-case basis.
Sections 23A and 23B limit the extent to which a bank or its subsidiaries may
engage in "covered transactions" with any one affiliate to an amount equal to
10% of such bank's capital stock and surplus, and limit all such transactions
with all affiliates to an amount equal to 20% of such capital stock and surplus.
The statutory sections also require that all such transactions be on terms that
are consistent with safe and sound banking practices. The term "covered
transaction" includes the making of loans, purchase of assets, issuance of
guarantees and other similar types of transactions. Further, most loans by a
bank to any of its affiliates must be secured by collateral in amounts ranging
from 100 to 130 percent of the loan amounts. In addition, any covered
transaction by a bank with an affiliate and any purchase of assets or services
by a bank from an affiliate must be on terms that are substantially the same, or
at least as favorable, to the bank as those that would be provided to a
non-affiliate.
In 2002, the Federal Reserve Board adopted proposed Regulation W, which becomes
effective in 2003. Regulation W comprehensively implements and interprets
Sections 23A and 23B, in part by codifying prior interpretations.
Acquisitions and Mergers. Under the federal Bank Merger Act, any merger of the
Bank with or into another institution would require the approval of the OTS, or
the primary federal regulator of the resulting entity if it is not an
OTS-regulated institution. Among other things, this meant that when the Banks
combined by a merger of one into the other, that transaction required the
approval of the OTS, which was obtained. See also "Acquisition of Bank Mutual"
below for a discussion of factors relating to acquisitions of Bank Mutual.
Prohibitions Against Tying Arrangements. Banks are subject to the prohibitions
of 12 U.S.C. Section 1972 on certain tying arrangements. A depository
institution is prohibited, subject to certain exceptions, from extending credit
to or offering any other service, or fixing or varying the consideration for
such extension of credit or service, on the condition that the customer obtain
some additional service from the institution or certain of its affiliates or not
obtain services of a competitor of the institution.
Customer Privacy. Under the GLB Act, financial institutions such as the Bank are
required to develop and maintain privacy policies relating to information on the
customers, restrict and establish procedure practices to protect customer data.
The GLB further restricts the sharing of non-public customer data with
non-affiliated parties if the customer requests.
Uniform Real Estate Lending Standards. Pursuant to FDICIA, the federal banking
agencies adopted uniform regulations prescribing standards for extensions of
credit that are secured by liens on interests in real estate or made for the
purpose of financing the construction of a building or other improvements to
real estate. Under the joint regulations adopted by the federal banking
agencies, all insured depository institutions must adopt and maintain written
policies that establish appropriate limits and standards for extensions of
credit that are secured by liens or interests in real estate or are made for the
purpose of financing permanent improvements to real estate. These policies must
establish loan
26
portfolio diversification standards, prudent underwriting standards (including
loan-to-value limits) that are clear and measurable, loan administration
procedures, and documentation, approval and reporting requirements. The real
estate lending policies must reflect consideration of the Interagency Guidelines
for Real Estate Lending Policies that have been adopted by the federal bank
regulators.
The Interagency Guidelines, among other things, require a depository institution
to establish internal loan-to-value limits for real estate loans that are not in
excess of the following supervisory limits:
- for loans secured by raw land, the supervisory loan-to-value limit
is 65% of the value of the collateral;
- for land development loans (i.e., loans for the purpose of improving
unimproved property prior to the erection of structures), the
supervisory limit is 75%;
- for loans for the construction of commercial, multi-family or other
non-residential property, the supervisory limit is 80%;
- for loans for the construction of one- to four-family properties,
the supervisory limit is 85%; and
- for loans secured by other improved property (e.g., farmland,
completed commercial property and other income-producing property,
including non-owner occupied, one- to four-family property), the
limit is 85%.
Although no supervisory loan-to-value limit has been established for
owner-occupied, one- to four-family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
Community Reinvestment Act. Under the Community Reinvestment Act ("CRA"), any
insured depository institution, including the Bank, has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community. The CRA requires the OTS, in connection
with its examination of a savings bank, to assess the depository institution's
record of meeting the credit needs of its community and to take such record into
account in its evaluation of certain applications by such institution, including
applications for additional branches and acquisitions.
Among other things, the CRA regulations contain an evaluation system that would
rate an institution based on its actual performance in meeting community needs.
In particular, the evaluation system focuses on three tests:
- a lending test, to evaluate the institution's record of making loans
in its service areas;
- an investment test, to evaluate the institution's record of
investing in community development projects, affordable housing, and
programs benefiting low or moderate income individuals and
businesses; and
- a service test, to evaluate the institution's delivery of services
through its branches, ATMs and other offices.
The CRA requires the OTS, in the case of the Bank, to provide a written
evaluation of a savings association's CRA performance utilizing a four-tiered
descriptive rating system and requires public disclosure of an association's CRA
rating. Mutual Savings Bank and First Northern Savings Bank each received at
least "satisfactory" overall ratings in their most recent CRA examinations.
Safety and Soundness Standards. Pursuant to the requirements of FDICIA, as
amended by the Riegle Community Development and Regulatory Improvement Act of
1994, each federal banking agency, including the OTS, has adopted guidelines
establishing general standards relating to internal controls, information and
internal audit systems, loan
27
documentation, credit underwriting, interest rate exposure, asset growth, asset
quality, earnings and compensation, fees and benefits. In general, the
guidelines require, among other things, appropriate systems and practices to
identify and manage the risks and exposures specified in the guidelines. The
guidelines prohibit excessive compensation as an unsafe and unsound practice and
describe compensation as excessive when the amounts paid are unreasonable or
disproportionate to the services performed by an executive officer, employee,
director, or principal shareholder.
Prompt Corrective Action. FDICIA also established a system of prompt corrective
action to resolve the problems of undercapitalized institutions. The OTS, as
well as the other federal banking regulators, adopted the FDIC's regulations
governing the supervisory actions that may be taken against undercapitalized
institutions. The FDIC's regulations establish and define five capital
categories, in the absence of a specific capital directive, as follows:
Total Capital to Tier 1 Capital to Tier 1 Capital
Category Risk Weighted Assets Risk Weighted Assets to Total Assets
-------- -------------------- -------------------- ---------------
Well capitalized (greater than or equal to) 10% (greater than or equal to) 6% (greater than or equal to) 5%
Adequately capitalized (greater than or equal to) 8% (greater than or equal to) 4% (greater than or equal to) 4%*
Under capitalized (less than) 8% (less than) 4% (less than) 4%*
Significantly undercapitalized (less than) 6% (less than) 3% (less than) 3%
Critically undercapitalized Tangible assets to capital of # 2%
- ----------
* 3% if the bank receives the highest rating under the uniform system
The severity of the action authorized or required to be taken under the prompt
corrective action regulations increases as a bank's capital decreases within the
three undercapitalized categories. All banks are prohibited from paying
dividends or other capital distributions or paying management fees to any
controlling person if, following such distribution, the bank would be
undercapitalized. The FDIC or the OTS, in the case of the Bank, is required to
monitor closely the condition of an undercapitalized bank and to restrict the
growth of its assets. An undercapitalized bank is required to file a capital
restoration plan within 45 days of the date the bank receives notice that it is
within any of the three undercapitalized categories, and the plan must be
guaranteed by any parent holding company. The aggregate liability of a parent
holding company is limited to the lesser of:
- an amount equal to five percent of the bank's total assets at the
time it became "undercapitalized"; and
- the amount that is necessary (or would have been necessary) to bring
the bank into compliance with all capital standards applicable with
respect to such bank as of the time it fails to comply with the
plan.
If a bank fails to submit an acceptable plan, it is treated as if it were
"significantly undercapitalized." Banks that are significantly or critically
undercapitalized are subject to a wider range of regulatory requirements and
restrictions.
The FDIC has a broad range of grounds under which it may appoint a receiver or
conservator for an insured depository bank. If one or more grounds exist for
appointing a conservator or receiver for a bank, the FDIC may require the bank
to issue additional debt or stock, sell assets, be acquired by a depository bank
holding company or combine with another depository bank. Under FDICIA, the FDIC
is required to appoint a receiver or a conservator for a critically
undercapitalized bank within 90 days after the bank becomes critically
undercapitalized or to take such other action that would better achieve the
purposes of the prompt corrective action provisions. Such alternative action can
be renewed for successive 90-day periods. However, if the bank continues to be
critically undercapitalized on average during the quarter that begins 270 days
after it first became critically undercapitalized, a receiver must be appointed,
unless the FDIC makes certain findings that the bank is viable.
Loans to a Bank's Insiders. A bank's loans to its executive officers, directors,
any owner of more than 10% of its stock (each, an insider) and any of certain
entities affiliated with any such person (an insider's related interest) are
subject to the conditions and limitations imposed by Section 22(h) of the
Federal Reserve Act and the Federal Reserve Board's Regulation O thereunder.
Under these restrictions, the aggregate amount of the loans to any insider and
the insider's related interests may not exceed the loans-to-one-borrower limit
applicable to national banks, which is comparable to the loans-to-one-borrower
limit applicable to the Bank's loans. All loans by a bank to all insiders and
insiders' related
28
interests in the aggregate may not exceed the bank's unimpaired capital and
unimpaired surplus. With certain exceptions, loans to an executive officer,
other than loans for the education of the officer's children and certain loans
secured by the officer's residence, may not exceed the greater of $25,000 or
2.5% of the bank's unimpaired capital and unimpaired surplus, but in no event
more than $100,000. Regulation O also requires that any proposed loan to an
insider or a related interest of that insider be approved in advance by a
majority of the board of directors of the bank, with any interested director not
participating in the voting, if such loan, when aggregated with any existing
loans to that insider and the insider's related interests, would exceed either
$500,000 or the greater of $25,000 or 5% of the bank's unimpaired capital and
surplus. Generally, such loans must be made on substantially the same terms as,
and follow credit underwriting procedures that are no less stringent than, those
that are prevailing at the time for comparable transactions with other persons
and must not present more than a normal risk of collectability.
An exception is made for extensions of credit made pursuant to a benefit or
compensation plan of a bank that is widely available to employees of the bank
and that does not give any preference to insiders of the bank over other
employees of the bank.
The USA Patriot Act. In response to the terrorist attacks of September 11, 2001,
Congress adopted the Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA
PATRIOT Act. The USA PATRIOT Act gives the federal government new powers to
address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing, and broadened anti-money
laundering requirements. By means of amendments to the Bank Secrecy Act, Title
III of the USA PATRIOT Act takes measures intended to encourage information
sharing among bank regulatory agencies and law enforcement bodies. Further,
certain provisions of Title III impose affirmative obligations on a broad range
of financial institutions, including banks, savings banks and thrifts.
Among other requirements, Title III of the USA PATRIOT Act imposes the following
requirements with respect to financial institutions:
- All financial institutions must establish anti-money laundering
programs that include, at minimum; (a) internal policies,
procedures, and controls; (b) specific designation of an anti-money
laundering compliance officer; (c) ongoing employee training
programs, and (d) an independent audit function to test the
anti-money laundering program.
- The Secretary of the Treasury, in conjunction with other bank
regulators, may issue regulations that provide for minimum standards
with respect to customer identification at the time new accounts are
opened.
- Financial institutions that establish, maintain, or manage private
banking accounts or correspondent accounts in the United States for
non-United States persons or their representatives (including
foreign individuals visiting the United States) must establish
appropriate, specific, and, where necessary, enhanced due diligence
policies, procedures, and controls designed to detect and report
money laundering.
- Financial institutions are prohibited from establishing,
maintaining, administering or managing correspondent accounts for
foreign shell banks (foreign banks that do not have a physical
presence in any country), and will be subject to certain
recordkeeping obligations with respect to correspondent accounts of
foreign banks.
- Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal
Reserve Act and Bank Merger applications.
MHC REGULATION
General. The MHC, which owns a majority of Bank Mutual's stock, is a federal
mutual holding company within the meaning of Section 10(o) of the Home Owners'
Loan Act. As such, the MHC has registered with the OTS and is subject to OTS
examination and supervision as well as reporting requirements. In addition, the
OTS has enforcement authority over the MHC and its non-savings institution
subsidiaries. Thus, the regulation of the MHC affects Bank Mutual. Among other
things, this authority permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the financial safety, soundness or
stability of a subsidiary savings bank.
29
Permitted Activities. A mutual holding company (directly or, under certain
circumstances, through a subsidiary such as Bank Mutual) is permitted to, among
other things:
- invest in the stock of a savings institution;
- acquire a mutual institution through the merger of such institution
into a savings institution subsidiary of such mutual holding company
or an interim savings institution of such mutual holding company;
- merge with or acquire another mutual holding company, one of whose
subsidiaries is a savings institution;
- acquire non-controlling amounts of the stock of savings institutions
and savings institution holding companies, subject to various
restrictions;
- invest in a corporation the capital stock of which is available for
purchase by a savings institution under federal law or under the law
of any state where the subsidiary savings institution or
institutions have their home offices;
- furnish or perform management services for a savings institution
subsidiary;
- hold, manage or liquidate assets owned or acquired from a savings
institution subsidiary;
- hold or manage properties used or occupied by a savings institution
subsidiary; and
- act as a trustee under deed or trust.
As a result of the GLB Act, the activities of a mutual holding company were
expanded, but are generally limited to those of a financial nature, permitting
securities and insurance activities as well as affiliations with financial
companies such as insurance and securities firms. To engage in these expanded
financial activities, a holding company must meet certain eligibility
requirements and, in certain instances, elect to be treated as a "financial
holding company." Neither the MHC nor Bank Mutual has elected to be treated as a
financial holding company.
Waiver of Dividends. It has been the policy of a number of mutual holding
companies to waive the receipt of dividends declared by their savings
institution subsidiaries or mid-tier stock holding companies. Under OTS
regulations, the MHC may waive dividends from Bank Mutual only if the MHC
provides the OTS with written notice of its intent to waive its rights to
receive dividends 30 days prior to the proposed date of payment of the dividend
and the OTS does not object to such waiver. The OTS will not object to the
waiver if the following two determinations are made:
- the waiver would not be detrimental to the safe and sound operation
of the savings association; and
- the board of directors of the MHC expressly determines that waiver
of the dividend by the MHC is consistent with the directors'
fiduciary duties to the mutual members of the MHC.
Pursuant to these procedures, the MHC has waived dividends declared by Bank
Mutual for fiscal years 2003, 2002 and 2001. The management of the MHC believes
that this is consistent with fiduciary duties owed to members of the MHC based
on, among other reasons, certain adverse tax consequences that would result from
payment of the dividend to the MHC. In addition, management believes that
capital held in Bank Mutual will be as productive, if not more productive, than
capital held at the MHC level.
BANK MUTUAL REGULATION
Bank Mutual, as a federal stock corporation in a mutual holding company
structure, is deemed, and must register as, a federal mutual holding company
within the meaning of Section 10(o) of the Home Owners' Loan Act. Bank Mutual
has so registered, files reports with the OTS and is subject to regulation and
examination by the OTS. In addition, the OTS has enforcement authority over Bank
Mutual and any nonsavings institution subsidiary. The OTS can restrict or
prohibit activities that it determines to be a serious risk to Bank Mutual. This
OTS regulation is intended primarily for the protection of the Bank's depositors
and not for the benefit of Bank Mutual's shareholders.
Under the GLB Act, the permissible scope of activities of a holding company were
significantly expanded. See "MHC Regulation-Permitted Activities" above.
Bank Mutual is also subject to the regulation and supervision of the SEC and is
required to file certain reports with, and otherwise comply with, the rules and
regulations of the SEC.
30
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 was adopted in
response to public concerns regarding corporate accountability in connection
with the accounting and corporate governance scandals at companies such as Enron
and WorldCom. The stated goals of the Sarbanes-Oxley Act are to increase
corporate responsibility, to provide for enhanced penalties for accounting and
auditing improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate disclosures pursuant to the
securities laws.
The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation
enacted in some time. The Sarbanes-Oxley Act generally applies to all public
companies, including Bank Mutual, that file periodic reports with the Securities
and Exchange Commission, under the Securities Exchange Act of 1934.
The Sarbanes-Oxley Act includes very specific additional disclosure requirements
and new corporate governance rules, requires the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules and mandates further studies of certain issues by the SEC, and increases
penalties for violation. The Sarbanes-Oxley Act represents significant federal
involvement in matters traditionally left to state regulatory systems, such as
the regulation of the accounting profession, and to state corporate law, such as
the relationship between a board of directors and management and between a board
of directors and its committees.
The Sarbanes-Oxley Act addresses, among other matters:
- audit committees and auditor independence;
- certification of financial statements by the chief executive officer
and the chief financial officer;
- the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's statements that later require
restatement;
- a prohibition on insider trading during retirement plan black out
periods;
- further disclosure of off-balance sheet transactions;
- a prohibition on many personal loans to directors and officers (with
exceptions for financial institutions);
- expedited filing requirements for reporting of insiders'
transactions; and
- disclosure of a code of ethics and disclosure of a change or waiver
of such code.
The SEC has been delegated the task of enacting rules to implement various of
the provisions with respect to, among other matters, disclosure in filings
pursuant to the Exchange Act. This rule making is ongoing, and many of the
related rules have not yet become effective.
ACQUISITION OF BANK MUTUAL
Under federal law, no person may acquire control of the MHC, Bank Mutual or the
Bank without first obtaining, as summarized below, the approval of such
acquisition of control by the OTS (or another federal banking regulator). Bank
Mutual is majority-owned by the MHC; the MHC is a mutual institution in which
proxies have generally been given to its board of directors. This ownership and
regulatory structure would make a change in control of these entities difficult
without the concurrence of the board of directors of the MHC.
Under the federal Change in Bank Control Act and the Savings and Loan Holding
Company Act, any person, including a company, or group acting in concert,
seeking to acquire 10% or more of the outstanding shares of Bank Mutual must
file a notice with the OTS. In addition, any person or group acting in concert
seeking to acquire more than 25% of the outstanding shares of Bank Mutual's
common stock will be required to obtain the prior approval of the OTS. Under
regulations, the OTS generally has 60 days within which to act on such
applications, taking into consideration certain factors, including the financial
and managerial resources of the acquiror, the convenience and needs of the
communities served by Bank Mutual and the Bank, and the antitrust effects of the
acquisition.
FEDERAL AND STATE TAXATION
Federal Taxation. Bank Mutual and its subsidiaries file a calendar year
consolidated federal income tax return, reporting income and expenses using the
accrual method of accounting,
31
Bad Debt Reserves. The Small Business Job Protection Act of 1996 (the "Job
Protection Act") repealed the "reserve method" of accounting for bad debts by
most thrift institutions effective for the taxable years beginning after 1995.
Larger thrift institutions such as the Bank is now required to use the "specific
charge-off method." The Job Protection Act also granted partial relief from
reserve recapture provisions, which are triggered by the change in method. This
legislation did not have a material impact on Bank Mutual's financial condition
or results of operations.
The federal income tax returns for Bank Mutual's subsidiaries have been examined
and audited or closed without audit by the IRS for tax years through 1999.
Depending on the composition of its items of income and expense Bank Mutual may
be subject to alternative minimum tax ("AMT") to the extent AMT exceeds the
regular tax liability. AMT is calculated at 20% of alternative minimum taxable
income ("AMTI"). AMTI equals regular taxable income increased by certain tax
preferences, including depreciation deductions in excess of allowable AMT
amounts, certain tax-exempt interest income and 75% of the excess of adjusted
current earnings ("ACE") over AMTI. ACE equals AMTI adjusted for certain items,
primarily accelerated depreciation and tax-exempt interest. The payment of AMT
would create a tax credit, which can be carried forward indefinitely to reduce
the regular tax liability in future years.
State Taxation. Under current law, the state of Wisconsin imposes a corporate
franchise tax of 7.9% on the separate taxable incomes of the members of Bank
Mutual's consolidated income tax group except its Nevada subsidiaries.
Presently, the income of the Nevada subsidiaries is only subject to taxation in
Nevada, which currently does not impose a corporate income or franchise tax.
32
ITEM 2. PROPERTIES
Bank Mutual and its subsidiaries conducts its business through its executive
office and 70 banking offices, which had an aggregate net book value of $39.3
million as of December 31, 2002. The following table shows the location of Bank
Mutual's offices, whether they are owned or leased, and the expiration date of
the leases for the leased offices.
ORIGINAL DATE LEASED
LEASED OR OR DATE OF LEASE
LOCATION ACQUIRED OWNED EXPIRATION
- -------- -------- ----- ----------
EXECUTIVE OFFICE:
4949 West Brown Deer Road.................. 1991 Owned
Brown Deer, WI 53223
MILWAUKEE METRO AREA:
Bayshore Mall.............................. 1971 Leased 2009
5900 N. Port Washington Road
Glendale, WI 53217
Brookfield................................. 1973* Owned
17100 W. Capitol Drive
Brookfield, WI 53005
Brookfield Square.......................... 1975 Leased 2006
400 N. Moorland Road
Brookfield, WI 53005
Brown Deer................................. 1979 Owned
4801 W. Brown Deer Road
Brown Deer, WI 53223
Capitol Drive.............................. 1976 Owned
8050 W. Capitol Drive
Milwaukee, WI 53222
Cedarburg.................................. 1978* Leased 2006
W62 N248 Washington Avenue
Cedarburg, WI 53012
Downtown................................... 1955 Owned
510 E. Wisconsin Avenue
Milwaukee, WI 53202
Grafton.................................... 1978 Owned
2030 Wisconsin Avenue
Grafton, WI 53024
Howell Avenue.............................. 1977 Owned
3847 S. Howell Avenue
Milwaukee, WI 53207
Mayfair Mall............................... 2001 Leased 2011
2600 N. Mayfair Road
Wauwatosa, WI 53226
Mequon..................................... 1970* Owned
11249 N. Port Washington Road
Mequon, WI 53092
Oak Creek.................................. 1972 Owned
8780 S. Howell Avenue
Oak Creek, WI 53154
Oklahoma Avenue............................ 1982 Owned
6801 W. Oklahoma Avenue
Milwaukee, WI 53219
33
ORIGINAL DATE LEASED
LEASED OR OR DATE OF LEASE
LOCATION ACQUIRED OWNED EXPIRATION
- -------- -------- ----- ----------
Sherman Park............................... 1950* Owned
4812 W. Burleigh Street
Milwaukee, WI 53210
Southgate.................................. 1967 Owned
3340 S. 27th Street
Milwaukee, WI 53215
Southridge Mall............................ 1978 Leased 2004
5300 S. 76th Street
Greendale, WI 53129
Thiensville................................ 1960* Owned
208 N. Main Street
Thiensville, WI 53092
West Allis................................. 1976 Owned
10296 W. National Avenue
West Allis, WI 53227
MADISON AREA:
Downtown................................... 1980 Leased 2008
23 S. Pinckney Street
Madison, WI 53703
West....................................... 1982 Leased 2011
5521 Odana Road
Madison, WI 53719
Middleton.................................. 1978 Owned
6209 Century Avenue
Middleton, WI 53562
Monona..................................... 1981 Owned
5320 Monona Drive
Monona, WI 53716
JANESVILLE:.................................... 1973 Owned
2111 Holiday Drive
Janesville, WI 53545
SHEBOYGAN AREA:
Sheboygan.................................. 1973 Owned
801 N. 8th Street
Sheboygan, WI 53081
Sheboygan Motor Bank....................... 1984 Owned
730 N. 9th Street
Sheboygan, WI 53081
BEAVER DAM:.................................... 1975 Owned
130 W. Maple Avenue
Beaver Dam, WI 53916
BELOIT: ....................................... 1971 Leased 2012
3 Beloit Mall Shopping Center
Beloit, WI 53511
BERLIN: ....................................... 1973 Owned
103 E. Huron Street
Berlin, WI 54923
34
ORIGINAL DATE LEASED
LEASED OR OR DATE OF LEASE
LOCATION ACQUIRED OWNED EXPIRATION
- -------- -------- ----- ----------
FOND DU LAC:................................... 2000 Owned
W6606A Highway 23
Fond du Lac, WI 54937
PORTAGE:....................................... 1976 Owned
145 E. Cook Street
Portage, WI 53901
EAU CLAIRE:
Downtown................................... 1968* Owned
319 E. Grand Avenue
Eau Claire, WI 54701
Mall....................................... 1972* Owned
2812 Mall Drive
Eau Claire, WI 54701
Cub Foods.................................. 1996* Leased 2005
2717 Birch Street
Eau Claire, WI 54703
Pinehurst.................................. 1986* Owned
2722 Eddy Lane
Eau Claire, WI 54703
CHIPPEWA FALLS AREA:
Downtown................................... 1975* Owned
35 W. Columbia
Chippewa Falls, WI 54729
Falls Pick'N Save.......................... 1995* Leased 2005
303 Prairie View Road
Chippewa Falls, WI 54729
MENOMONIE AREA:
Downtown................................... 1967* Owned
717 Main Street
Menomonie, WI 54751
North...................................... 1978* Owned
2409 Hils Ct. N.E
Menomonie, WI 54751
RICE LAKE:..................................... 1979* Owned
2850 Pioneer Avenue
Rice Lake, WI 54868
BARRON: ....................................... 1995* Owned
1512 E. Division Ave. (Hwy. 8)
Barron, WI 54812
BLOOMER:....................................... 1995* Owned
1203 17th Avenue
Bloomer, WI 54724
CORNELL:....................................... 1980* Leased month to month
422 Main Street
Cornell, WI 54732
ELLSWORTH:..................................... 1975* Owned
385 W. Main Street
Ellsworth, WI 54011
35
ORIGINAL DATE LEASED
LEASED OR OR DATE OF LEASE
LOCATION ACQUIRED OWNED EXPIRATION
- -------- -------- ----- ----------
HAYWARD:....................................... 1984* Owned
10562 Kansas Avenue
Hayward, WI 54843
HUDSON: ....................................... 1979* Owned
2000 Crestview Drive
Hudson, WI 54016
SPOONER:....................................... 1995* Owned
500 Front Street
Spooner, WI 54801
ST. CROIX FALLS:............................... 1980* Owned
144 Washington Street N
St. Croix Falls, WI 54024
STANLEY:....................................... 1978* Owned
118 N. Broadway
Stanley, WI 54768
GREATER GREEN BAY AREA:
201 N. Monroe Avenue....................... 1975* Owned
Green Bay, WI 54301-4995
2255 University Avenue..................... 1970* Owned
Green Bay, WI 54308-8046
2357 S. Oneida Street...................... 1971* Owned
Green Bay, WI 54304-5286
2603 Glendale Avenue....................... 1986* Owned
Green Bay, WI 54313-6823
2370 East Mason Street..................... 1985* Owned
Green Bay, WI 54302-3347
2424 West Mason Street..................... 1992* Owned
Green Bay, WI 54303-4711
201 West Walnut St. (Operations Center).... 1999* Leased 2004
Green Bay, WI 54303
330 North Broadway......................... 1979* Owned
De Pere, WI 54115-5250
749 Main Avenue............................ 1972* Owned
De Pere, WI 54115-5190
FOX VALLEY AREA:
Appleton................................... 1985 Leased 2004
4323 W. Wisconsin Avenue
Fox River Mall
Appleton, WI 54915
Neenah..................................... 1974 Owned
101 W. Wisconsin Avenue
Neenah, WI 54956
36
ORIGINAL DATE LEASED
LEASED OR OR DATE OF LEASE
LOCATION ACQUIRED OWNED EXPIRATION
- -------- -------- ----- ----------
MARINETTE AREA:
830 Pierce Avenue.......................... 1972* Owned
Marinette, WI 54143-0318
Pine Tree Mall............................. 1978* Leased 2003
2314 Roosevelt Road
Marinette, WI 54143-0345
PESHTIGO:
616 French Street.......................... 1975* Owned
Peshtigo, WI 54157-0193
CRIVITZ:
315 Highway 141............................ 1985* Owned
Crivitz, WI 54114-0340
SHAWANO:
835 E. Green Bay Avenue.................... 1981* Owned
Shawano, WI 54166-0396
NEW LONDON:
101 Park Street............................ 1969* Owned
New London, WI 54961
HORTONVILLE:
209 South Nash Street...................... 1979* Owned
Hortonville, WI 54944
BRILLION:
314 N. Main Street......................... 1973* Owned
Brillion, WI 54110-1198
NEW HOLSTEIN:
2205 Wisconsin Avenue...................... 1976* Owned
New Holstein, WI 53061-1291
KIEL:
622 Fremont Street......................... 1970* Owned
Kiel, WI 53042-1321
STURGEON BAY:
1227 Egg Harbor Road....................... 1978* Owned
Sturgeon Bay, WI 54235-0068
WOODBURY, MINNESOTA:........................... 1995* Owned
8420 City Centre Drive
Woodbury, MN 55125
- ----------
* Date originally opened by an acquired institution
In addition, the Bank owns two parcels of undeveloped land through its MC
Development subsidiary. The 15 acre Brown Deer parcel is comprised of four lots
consisting of 2.9 to 4.3 acres and was part of a larger property that was
acquired in 1988 to accommodate the construction of a new corporate headquarters
building. Each of the lots is available for sale and is designed to accommodate
60,000 to 75,000 square foot office buildings. The net book value of the four
lots is $1.6 million. The 318 acre Oconomowoc parcel was held by an acquired
institution that obtained it through a foreclosure. It is located in an area of
the City of Oconomowoc that has seen considerable residential development. All
of the necessary utilities are available to the property and it will be marketed
for residential development in a manner that will attempt to maximize its
potential value. The parcel has a net book value of $345,000.
37
ITEM 3. LEGAL PROCEEDINGS
Bank Mutual is not involved in any pending legal proceedings other than routine
legal proceedings occurring in the ordinary course of business. We believe that
these routine legal proceedings, in the aggregate, are immaterial to our
financial condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table contains certain information regarding those persons who
have been determined, by Bank Mutual's board of directors, to be Bank Mutual
executive officers.
OFFICES AND POSITIONS
WITH BANK MUTUAL CORPORATION PRESENT OFFICE
NAME AGE AND ITS SUBSIDIARIES HELD SINCE(1)
- ---- --- -------------------- -------------
Michael T. Crowley, Jr. 60 Director, Chairman and Chief 1983(2)
Executive Officer of Bank Mutual;
Director, President and Chief
Executive Officer the Bank.
Michael D. Meeuwsen 49 Director, President and Chief 1989(3)
Operating Officer of Bank
Mutual; Director, Executive Vice
President and Chief Operating Officer
of the Bank.
Eugene H. Maurer, Jr. 57 Senior Vice President and Secretary of 1982(4)
Bank Mutual; Senior Vice President,
Chief Financial Officer, Treasurer and
Secretary of the Bank.
Rick B. Colberg 50 Chief Financial Officer of Bank Mutual; 1980(5)
Vice President of the Bank.
Marlene M. Scholz 57 Senior Vice President of Bank Mutual; 1981(6)
Senior Vice President and Controller of
the Bank.
- ----------
(1) Indicates date when individual first held office with Mutual Savings Bank
or First Northern Savings Bank. Each of these persons became a Bank Mutual
executive officer in 2000.
(2) Michael T. Crowley, Jr. is the chairman and chief executive officer of
Bank Mutual. He also is president and chief executive officer of the Bank;
he has served in those capacities since 1983 and 1985, respectively. He
also serves as a director of various Bank subsidiaries. Mr. Crowley, Jr.
also is a director of PULSE EFT Association, an ATM network of which the
Bank is a member.
(3) Michael D. Meeuwsen is the president and chief operating officer of Bank
Mutual He also has been executive vice president and chief operating
officer of the Bank since 2003, when First Northern Savings Bank merged
into it. Previously, he was president and chief executive officer of First
Northern Savings Bank: he had served as president since 1989 and chief
executive officer since 1990.
38
(4) Eugene H. Maurer, Jr. is the senior vice president of Bank Mutual. He is
also the senior vice president, secretary-treasurer and chief financial
officer of the Bank. He has held those positions since 1982. Mr. Maurer
also serves as an officer of several of the Bank's subsidiaries.
(5) Rick B. Colberg is the chief financial officer of Bank Mutual. He is also
Vice President of the Bank since 2003, when First Northern Savings Bank
merged into it. Previously he was senior vice president, chief financial
officer, and treasurer of First Northern Savings Bank; he had served as
chief financial officer since 1980, treasurer since 1982 and senior vice
president since 1997. He serves as as an officer and director of some of
the Bank's subsidiaries.
(6) Marlene M. Scholz is a senior vice president of Bank Mutual. She is senior
vice president and controller of the Bank. She has served in that position
since 1981 and serves as the Bank's principal accounting officer. Ms.
Scholz also serves as an officer of several Bank subsidiaries.
39
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of Bank Mutual Corporation is traded on The Nasdaq Stock
Market(R) under the symbol "BKMU."
As of March 10, 2003, there were 21,411,971 shares of common stock outstanding
and approximately 4,204 shareholders of record of the common stock. Bank Mutual
became a publicly held corporation on November 1, 2000 and we did not pay a cash
dividend in 2000. We paid a cash dividend of $0.34 per share in 2002 except for
shares owned by MHC, which waived dividends for 2002. We increased our cash
dividend to $0.10 per share to shareholders of record on February 19, 2003 and
paid March 4, 2003.
We anticipate that we will continue to pay quarterly cash dividends on our
common stock, although there can be no assurance that payment of such dividends
will continue or that they will not be reduced. The payment of dividends in the
future is discretionary with our board of directors and will depend on our
operating results and financial condition, regulatory limitations, tax
considerations and other factors. For 2002 and 2003, the MHC has waived
dividends from Bank Mutual.
Interest on deposits will be paid prior to payment of dividends on Bank Mutual's
common stock. Earnings appropriated to bad debt reserves and deducted for
federal income tax purposes cannot be used to pay cash dividends without the
payment of federal income taxes on the amounts removed from the reserves for
such purpose at the then current income tax rate.
Our common stock trades on The Nasdaq Stock Market(R). The high and low trading
prices since November 2, 2000 through December 31, 2002, by quarter, and the
dividends paid in each quarter, were as follows:
COMMON STOCK TRADING PRICE RANGE
(High and Low Sales Price)
2002 2001 2000
------------------- ------------------- --------------------
High Low High Low High Low
------- ------- ------- ------- ------- -------
1st Quarter $ 17.50 $ 15.23 $ 11.72 $ 9.44 n/a n/a
2nd Quarter $ 20.84 $ 17.00 $ 14.31 $ 10.25 n/a n/a
3rd Quarter $ 21.78 $ 17.55 $ 18.00 $ 13.60 n/a n/a
4th Quarter $ 25.50 $ 20.06 $ 17.04 $ 14.85 $ 10.25* $ 7.75*
------- ------- ------- ------- ------- -------
* The price is the high and low sales price from November 1, 2000 (date of
restructuring) to December 31, 2000.
CASH DIVIDENDS PAID
2002 2001
-------- --------
1st Quarter $ 0.08 $ 0.07
2nd Quarter 0.08 0.07
3rd Quarter 0.09 0.07
4th Quarter 0.09 0.07
-------- --------
$ 0.34 $ 0.28
======== ========
* A cash dividend of $0.10 per share, an 11.1% increase over the fourth
quarter of 2002 cash dividend of $0.09 per share, was paid on March 4,
2003 to shareholders of record on February 19, 2003.
During the first two months of 2003, Bank Mutual's common stock sales price
ranged between $24.15 to $21.53 per share, and closed on February 28, 2003 at
$22.96 per share.
40
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL HIGHLIGHTS
The following table provides selected financial data for Bank Mutual for its
past five fiscal years. The data is derived from Bank Mutual's (and Mutual
Savings') audited financial statements, although the table itself is not
audited. The following data should be read together with Bank Mutual's
consolidated financial statements and related notes and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" later in this
report.
On November 1, 2000, Mutual Savings Bank converted from a mutual to stock form
of organization, completing a restructuring that resulted in the creation of
Bank Mutual as its publicly-held holding company. The transactions included Bank
Mutual's stock offering and Bank Mutual's related acquisition of First Northern.
Under the purchase accounting method, First Northern's results are included from
the date of acquisition and results prior to those dates are those of Mutual
Savings Bank.
AT DECEMBER 31,
-----------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- ----------
(IN THOUSANDS EXCEPT NUMBER OF SHARES AND PER SHARE AMOUNTS)
SELECTED FINANCIAL CONDITION DATA:
Total assets ..................................... $ 2,843,328 $ 2,905,790 $ 2,789,532 $ 1,769,506 $1,872,862
Loans receivable, net ............................ 1,685,662 1,831,155 1,972,636 1,082,795 1,037,589
Loans held for sale .............................. 46,971 32,321 7,469 541 27,723
Securities available-for-sale, at fair value:
Investment securities ......................... 73,226 93,059 94,129 57,763 116,534
Mortgage-related securities ................... 618,123 521,084 464,873 374,100 270,897
Foreclosed properties and repossessed assets ..... 750 382 2,281 3,018 3,505
Goodwill ......................................... 52,570 52,570 55,967 8,254(2) 21,162
Other intangible assets .......................... 5,734 6,396 7,057 3,242(2) 8,624
Mortgage servicing rights ........................ 3,060 4,251 3,442 1,430 1,520
Deposits ......................................... 2,126,655 2,090,440 1,894,820 1,343,007 1,398,858
Borrowings ....................................... 354,978 465,360 567,624 242,699 270,822
Shareholders' equity ............................. 323,075 304,098 284,397 163,820 175,743
Tangible shareholders' equity .................... 264,011 243,486 220,757 152,194 147,895
Number of shares outstanding - net of treasury
stock .......................................... 21,752,971 22,337,165 22,341,665 n/a n/a
Book value per share ............................. 14.85 13.61 12.73 n/a n/a
Tangible book value per share .................... 12.14 10.90 9.88 n/a n/a
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2002 2001 2000 1999(2) 1998
----------- ----------- ----------- ----------- ----------
(IN THOUSANDS EXCEPT PER SHARE AMOUNT)
SELECTED OPERATING DATA:
Total interest income ............................ $ 165,432 $ 190,986 $ 135,711 $ 118,302 $ 125,470
Total interest expense ........................... 87,678 119,372 84,980 75,337 80,017
----------- ----------- ----------- ----------- ----------
Net interest income ........................... 77,754 71,614 50,731 42,965 45,453
Provision for loan losses ........................ 760 723 423 350 637
----------- ----------- ----------- ----------- ----------
Net interest income after provision for loan
losses ...................................... 76,994 70,891 50,308 42,615 44,816
----------- ----------- ----------- ----------- ----------
Total noninterest income ......................... 16,676 16,480 9,250 7,984 8,440
----------- ----------- ----------- ----------- ----------
Noninterest expense:
Amortization of goodwill ...................... -- 3,098 1,066 12,908(2) 1,749
Amortization of other intangible assets ....... 662 662 331 5,382 989
Total noninterest expense ........................ 54,169 55,004 36,144 51,279 35,521
----------- ----------- ----------- ----------- ----------
Income (loss) before income taxes ................ 39,501 32,367 23,414 (680) 17,735
Income tax expense ............................... 12,956 12,084 8,709 3,803 6,584
----------- ----------- ----------- ----------- ----------
Net income (loss) ................................ $ 26,545 $ 20,283 $ 14,705 $ (4,483) $ 11,151
=========== =========== =========== =========== ==========
Earnings per share-basic ......................... $ 1.26 $ 0.95 $ 0.15(1) n/a n/a
Earnings per share-diluted ....................... $ 1.23 $ 0.94 $ 0.15(1) n/a n/a
Cash dividends paid per share .................... $ 0.34 $ 0.28 n/a n/a n/a
41
AT OR FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
SELECTED FINANCIAL RATIOS:
Net interest margin (3) ........................................ 2.88% 2.67% 2.76% 2.44% 2.58%
Net interest rate spread ....................................... 2.52 2.22 2.26 2.03 2.16
Return on average assets ....................................... 0.92 0.71 0.76 (0.24)(2) 0.60
Return on assets, excluding goodwill(4) ........................ 0.92 0.82 0.82 0.46 0.70
Return on average shareholders' equity ......................... 8.44 6.85 7.86 (2.55)(2) 6.57
Return on average shareholders' equity, excluding goodwill(4) .. 8.44 7.89 8.43 4.79 7.60
Efficiency ratio, excluding amortization of goodwill (4)(5) .... 57.36 58.92 58.48 75.31 62.66
Noninterest expense (excluding amortization of
goodwill) as a percent of adjusted average assets(4) ........ 1.88 1.82 1.82 2.09 1.83
Shareholders' equity to total assets ........................... 11.36 10.47 10.20 9.26 9.38
Tangible shareholders' equity to adjusted total assets (6) ..... 9.48 8.57 8.11 8.66 8.02
SELECTED ASSET QUALITY RATIOS:
Non-performing loans to loans receivable, net .................. 0.50% 0.19% 0.16% 0.44% 0.65%
Non-performing assets to total assets .......................... 0.32 0.14 0.19 0.44 0.55
Allowance for loan losses to non-performing loans .............. 151.87 345.90 392.12 144.54 101.86
Allowance for loan losses to non-performing assets ............. 139.40 312.13 226.55 88.79 66.98
Allowance for loan losses to total loans receivable, net ....... 0.76 0.67 0.62 0.64 0.66
Charge-offs to average loans ................................... 0.01 0.04 0.01 0.02 0.08
(1) From date of restructuring (November 1, 2000) to December 31, 2000 based
upon 21,570,803 weighted-average shares outstanding. No shares were
outstanding prior to November 1, 2000.
(2) Mutual Savings Bank acquired First Federal on March 31, 1997. In 1999,
Bank Mutual's non-interest expense included a special write-off of
intangible assets of $15.6 million, resulting from the acquisition of
First Federal, which Mutual Savings Bank deemed to be impaired.
(3) Net interest margin is calculated by dividing net interest income by
average earnings assets.
(4) In 2002, accounting rules concerning the amortization of goodwill changed.
These ratios are being presented "excluding goodwill" so as to make them
comparable amongst the years presented and to eliminate the unusual effect
of the goodwill impairment in 1999 which distorts year-to-year
comparisons.
(5) Efficiency ratio is calculated by dividing noninterest expense by the sum
of net interest income and noninterest income.
(6) The ratio is calculated by dividing total shareholders' equity minus
goodwill, other intangible assets net of deferred taxes and mortgage
servicing rights by the sum of total assets minus goodwill, other
intangible assets net of deferred taxes and mortgage servicing rights.
42
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Bank Mutual is a United States corporation chartered by the OTS. It was
chartered on November 1, 2000, to become the mid-tier holding company in the
regulatory restructuring of Mutual Savings Bank into mutual holding company
form. To accomplish the transaction, Mutual Savings Bank adopted a plan of
restructuring and as of November 1, 2000, converted from a mutual savings bank
to a mutual holding company. Bank Mutual became a holder of all of the shares of
Mutual Savings Bank, which was rechartered as a federal stock savings bank.
Mutual Savings Bancorp, MHC, a U.S.-chartered mutual holding company of which
Mutual Savings Bank's depositors hold all of the voting and membership rights,
owns 11,193,174 shares, or 51.5% of Bank Mutual's outstanding common stock.
Bank Mutual issued 6,141,006 shares of common stock to public shareholders in
the subscription stock offering conducted in connection with the restructuring.
Net proceeds to Bank Mutual were $58.3 million. Expenses related to the offering
totaled $3.1 million and $0.6 million was loaned by Bank Mutual to Bank Mutual's
Employee Stock Ownership Plan ("ESOP") to purchase 60,910 shares of common
stock.
On November 1, 2000, Bank Mutual acquired First Northern Capital Corp. ("First
Northern"), the parent of First Northern Savings Bank. In the First Northern
Acquisition, Bank Mutual issued to former First Northern shareholders 5,007,485
shares of Bank Mutual common stock and paid $75.1 million in cash. The First
Northern Acquisition was accounted for using the purchase method of accounting;
therefore, First Northern results and financial data are included in Bank Mutual
results and financial data only from and after the November 1, 2000 acquisition
date. Prior to that date, the data are those of Mutual Savings Bank. The First
Northern Acquisition substantially affects the comparison of the financial
condition of Bank Mutual at December 31, 2000, and the comparison of results of
operations for 2000.
On March 16, 2003, Mutual Savings Bank and First Northern Savings Bank combined
to form a single subsidiary bank of Bank Mutual. There are no expected office
closings or sales, and no employees are expected to be severed as a result of
the combination.
In connection with the following discussion, see "Cautionary Statements" in Item
1 of this document regarding forward-looking statements and factors that could
impact the business and financial prospects of Bank Mutual.
SIGNIFICANT ACCOUNTING POLICIES
There are a number of accounting policies that we established which require us
to use our judgement. Some of the more significant policies are as follows:
- Establishing the amount of the allowance for loan losses requires
the use of our judgement. We evaluate our assets at least quarterly,
and review their risk components as a part of that evaluation. See
"Notes to Consolidated Financial Statements--Note 1. Summary of
Significant Accounting Policies--Allowance for Loan Losses" for a
discussion of the risk components. If we misjudge a major component
and experience a loss, it will likely affect our earnings. We
consistently challenge ourselves in the review of the risk
components to identify any changes in trends and their cause.
- Another valuation that requires our judgement relates to mortgage
servicing rights. Essentially, mortgage servicing rights are
established on loans (primarily mortgage loans) that we originate
and sell. We allocate a portion of a loan's book basis to mortgage
servicing rights when a loan is sold, based upon its relative fair
value. The fair value of mortgage servicing rights is the present
value of estimated future net cash flows from the servicing
relationship using current market assumptions for prepayments,
servicing costs and other factors. As the loans are repaid and net
servicing revenue is earned, mortgage servicing rights are amortized
into expense. Net servicing revenues are expected to exceed this
amortization expense. However, if our actual prepayment experience
exceeds what we originally anticipated, net servicing revenues may
be less than expected and mortgage servicing rights may be impaired.
This impairment would be recorded as a charge to earnings as
experienced in 2002.
43
- We also use our judgement in the valuation of other intangible
assets (core deposit based intangibles). Core deposit based
intangible assets have been recorded for core deposits (defined as
checking, money market and savings deposits) that have been acquired
in acquisitions that were accounted for as purchase business
combinations. The core deposit based intangible assets have been
recorded using the assumption that they provide a more favorable
source of funding than more expensive wholesale borrowings. An
intangible asset has been recorded for the present value of the
difference between the expected interest to be incurred on these
deposits and interest expense that would be expected if these
deposits were replaced by wholesale borrowings, over the expected
lives of the core deposits. We currently estimate the underlying
core deposits have lives of seven to fifteen years. If we find these
deposits have a shorter life, we will have to write down the asset
by expensing the amount that is impaired.
- We review goodwill at least annually for impairment, which requires
the use of our judgement. Goodwill has been recorded as a result of
two acquisitions in which purchase price exceeded the fair value of
net assets acquired. We analyze the price paid for those
acquisitions and compare those to a number of current indices. In
particular, we look at the price paid as a percent of assets; price
paid to deposits; premium paid to core deposits; and other
indicators. If the current indices are such that would indicate that
the existing goodwill is more than the goodwill that would be
developed by doing the same transaction today, impairment would
occur and as such, would be charged to current earnings.
COMPARISONS OF FINANCIAL CONDITION AT DECEMBER 31, 2002 AND 2001
Bank Mutual's total assets decreased $62.5 million, or 2.1%, to $2.84 billion at
December 31, 2002 as compared to $2.91 billion at December 31, 2001. The
decrease in assets was the result of loan sales, the proceeds of which reduced
the mortgage loan portfolio, and were used to pay off borrowings. These and
other factors affecting the total assets are discussed in more detail below.
Federal funds sold decreased by $10.0 million to $165.0 million at December 31,
2002 as compared to $175.0 million at December 31, 2001. The decrease was
primarily the result of using the federal funds sold to purchase
mortgage-related securities.
Investment securities available-for-sale decreased $19.8 million as a result of
maturing investments which were primarily reinvested into mortgage-related
securities.
Mortgage-related securities increased $97.0 million to $618.1 million at
December 31, 2002 as compared to $521.1 million at December 31, 2001. Throughout
2002, mortgage-related securities experienced continued historically high rates
of repayments due to the prepayments of the underlying mortgage loans which in
turn resulted from the high level of refinancing activity. The majority of cash
from these prepayments were reinvested into mortgage-related securities. The
effect of these purchases was to reduce the average yield on mortgage-related
investment portfolio to 5.60% during December 31, 2002 as compared to 6.46%
during December 31, 2001. See Item 1 hereof for further information as to our
investment portfolio; the caption "Investment Activities" is incorporated herein
by reference.
The following table sets forth our mortgage, consumer and commercial loan
originations and purchases:
DURING THE YEAR ENDED DECEMBER 31,
----------------------------------
2002 2001
---------- --------
(In thousands)
Originations:
Mortgage loans ............................... $ 752,771 $691,466
Consumer loans ............................... 293,320 242,580
Commercial business loans .................... 27,141 30,202
---------- --------
Total loans originated ................... 1,073,232 964,248
Purchases:
Mortgage loans ............................... 4,042 8,885
---------- --------
Total loans purchased .................... 4,042 8,885
---------- --------
Total loans originated and purchased ............. $1,077,274 $973,133
========== ========
44
Loan originations increased $109.0 million in 2002 primarily as a result of
historically low interest rates which prompted consumers to refinance their
existing loans. Existing higher interest rate fixed rate mortgage loans and
adjustable rate mortgage loans were refinanced primarily into lower interest
rate fixed rate mortgage loans. These fixed rate mortgage loans were sold in the
secondary market which resulted in a net reduction in our mortgage loan
portfolio. Consumer loan originations also increased substantially as a result
of special product offerings (such as a 10 year fixed rate fully amortizing
second mortgage loan) and consumers refinancing their existing debt. A majority
of the consumer loan originations were second mortgage loans. Commercial
business loan originations decreased in 2002 as a result of the slowdown of the
economy and the resulting hesitation by businesses to expand or increase
production. We anticipate that we will continue our emphasis on consumer and
commercial loan originations as it aids in our interest rate risk management and
provides for higher yields, although at somewhat more risk than traditional
mortgage products.
Total loans receivable-net decreased $145.5 million as a result of our sale of
$368.6 million of fixed rate single family mortgage loans which was not fully
offset by the origination or purchases of new loans added to the portfolio. We
sell a majority of our fixed rate mortgage loan originations to reduce our
interest rate risk. Within the total loan portfolio, our commercial real estate
portfolio increased $21.4 million, our construction and development loans
increased $1.6 million, our consumer loan portfolio grew $16.6 million and our
commercial business portfolio grew $128,000. We continued to emphasize growth in
these portfolios to meet the needs in our market area. Our one-to-four family
portfolio decreased $164.5 million and our multi-family decreased $19.7 million
as a result of customer refinancings and, in the case of our one-to-four family
mortgage loans, the decrease was also due to the sales of fixed rate mortgage
loans. For further information on our loans, see "Asset Quality" in Item 1
hereof, which is incorporated herein by reference.
Goodwill resulted from the acquisition of First Northern in 2000 and First
Federal Bancshares of Eau Claire ("First Federal") in 1997. Under the Financial
Accounting Standards Board ("FASB") No. 142 "Goodwill and Other Intangible
Assets" goodwill is tested at least annually for impairment. If goodwill is
determined to be impaired, it would be expensed in the period in which it became
impaired. An impairment occurred in 1999 with respect to $15.6 million of
intangible assets resulting from the 1997 acquisition of First Federal.
Other intangible assets are composed of core deposit based intangibles which
were also the result of the First Northern and First Federal acquisitions. Other
intangible assets are amortized over its expected life and tested for impairment
at least annually.
Mortgage servicing rights are established on loans (primarily mortgage loans)
that we originate and sell. See "Significant Accounting Policies" above and
within "Comparisons of Operating Results for Years Ended December 31, 2002 and
2001--Noninterest Income" below for a further discussion of mortgage servicing
rights.
Other assets are comprised of the following:
AT DECEMBER 31,
---------------------
2002 2001
-------- --------
(IN THOUSANDS)
Accrued Interest:
Mortgage-related securities ...................... $ 2,481 $ 2,431
Investment securities ............................ 1,516 1,721
Loans receivable ................................. 7,399 9,436
-------- --------
Total accrued interest ................... 11,396 13,588
Foreclosed properties and repossessed assets ......... 750 382
Premises and equipment ............................... 44,034 43,187
Federal Home Loan Bank stock, at cost ................ 32,885 31,233
Life insurance policies .............................. 17,141 15,938
Other ................................................ 10,017 8,714
-------- --------
$116,223 $113,042
======== ========
45
Our foreclosed properties and repossessed assets increased $368,000 to $750,000
at December 31, 2002 as a result of foreclosures on a few single family homes.
We believe that we continue to have good quality assets and the homes, boats,
recreational vehicles and other items that have been repossessed, are small in
dollar amount in comparison to the size of our loan portfolio.
Premises and equipment increased $847,000 in 2002 as a result of purchasing new
computer equipment and software for both subsidiary banks in anticipation of our
March 2003 combination. We also have purchased a new loan origination system
which is being integrated into our operations. The effect of these two events
was to increase our equipment depreciation expense. In addition, we are
establishing a new office in Menomonee Falls, WI (a suburb of Milwaukee, WI) and
a replacement office for our Ashwaubenon office ( a village adjacent to Green
Bay, WI). It is anticipated the Menomonee Falls office will cost approximately
$1.5 million and the Ashwaubenon office will cost approximately $1.2 million.
Both offices are expected to be operational in the third or fourth quarter of
2003.
FHLB of Chicago stock increased $1.7 million primarily as a result of stock
dividends paid by the FHLB of Chicago. The FHLB of Chicago requires the
ownership of FHLB of Chicago stock to borrow. The FHLB of Chicago has targeted a
rate of return for their stock of 1% over the 1 year constant maturity Treasury
note yield. Historically, the FHLB of Chicago stock has met or exceeded its
targeted returns but we cannot assure that will continue. See "Notes to
Consolidated Financial Statements--Note 7. Borrowings."
Life insurance policies or bank owned life insurance ("BOLI") is an asset that
is used to partially offset the future cost of employee benefits. BOLI is
long-term life insurance on the lives of certain current and past employees
where the insurance policy benefits and ownership are retained by us. The cash
value accumulation on BOLI is permanently tax deferred if the policy is held to
the participant's death.
Deposits increased $36.2 million in the year 2002. We believe the stock market
decline in 2001 and 2002, coupled with world events throughout this period, have
made some consumers re-evaluate their investment objectives and, hence, their
investment portfolios. As a result of this re-evaluation, more investors have
included a greater percentage of insured deposits within their investment mix.
We also believe that deposit growth (or shrinkage) in 2003 and future periods
will depend, in significant part, on the performance of other investment
alternatives and world events.
Our borrowings decreased $110.4 million in 2002 as a result of the cash received
from loan sales and the increase in deposits. We anticipate that we will
continue to pay off maturing borrowings in 2003 as a result of our cash
position, although our ability to make those payments will depend upon our
actual future results and our future financial needs.
Most of our borrowings are from the Federal Home Loan Bank of Chicago. Of these
amounts, approximately $205.0 million are callable by the FHLB. We reflect them
in our financial statements as due in 2004, which is their stated maturity date,
because we have received indications from the FHLB that other borrowings would
be available if the borrowings are called earlier.
Shareholders' equity increased $19.0 million as a result of net income,
increased comprehensive income and stock option exercises offset by the
repurchase of our common stock and the payment of cash dividends. Our
shareholders' equity to total asset ratio at December 31, 2002 was 11.4% as
compared to 10.5% at December 31, 2001. We began a stock repurchase program in
2001 and as of December 31, 2002, we had repurchased 956,000 shares at an
average cost of $18.14 per share. We used 329,000 of the 956,000 shares
repurchased to institute a restricted stock awards program under the Bank Mutual
Corporation 2001 Stock Incentive Plan, which shareholders approved in May 2001.
See "Notes to Consolidated Financial Statements--Note 10. Stock-Based Benefit
Plans." After December 31, 2002, through February 28, 2003, we purchased an
additional 342,000 shares at an average cost of $23.42 per share.
We increased our quarterly cash dividend to $0.08 per share for the first two
quarters of 2002 and again increased the cash dividend to $0.09 per share for
the last two quarters of 2002 for a total cash dividend paid in 2002 of $0.34
per share. The 2002 dividend payout was 12.8% since Mutual Savings Bancorp, MHC
elected to waive cash dividends in 2002 on its 11,193,174 shares of Bank Mutual.
46
AVERAGE BALANCE SHEET AND YIELD/RATE ANALYSIS
The following table presents, for the periods indicated, the total dollar amount
of interest income from average interest-earning assets, the resultant yields,
and the interest expense on average interest-bearing liabilities, expressed both
in dollars and rates. No tax equivalent adjustments were made since we do not
have any tax exempt investments. Average balances are derived from average daily
balances. The yield on securities available-for-sale is included in investment
securities and mortgage-related securities and yields are calculated on the
historical basis. The yields and rates are established by dividing income or
expense dollars by the average balance of the asset or liability.
AVERAGE BALANCE SHEET, INTEREST AND RATE PAID
-----------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
2002 2001
---------------------------------- ---------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID COST BALANCE PAID COST
------- ---- ---- ------- ---- ----
(DOLLARS IN THOUSANDS)
ASSETS:
INTEREST-EARNING ASSETS (1):
Loans receivable, net ............... $1,808,861 $124,490 6.88% $1,932,281 $147,558 7.64%
Mortgage-related securities ......... 576,259 32,256 5.60 480,856 31,042 6.46
Investment securities ............... 120,015 5,580 4.65 145,889 8,212 5.63
Interest-earning deposits ........... 27,991 431 1.54 29,485 994 3.37
Federal funds ....................... 162,137 2,675 1.65 96,142 3,180 3.31
---------- -------- ---- ---------- -------- ----
Total interest-earning assets ..... 2,695,263 165,432 6.14 2,684,653 190,986 7.11
Noninterest-earning assets ............. 179,081 174,909
---------- ----------
Total average assets .............. $2,874,344 $2,859,562
========== ==========
LIABILITIES AND EQUITY:
INTEREST-BEARING LIABILITIES:
Savings deposits .................... $ 229,303 2,402 1.05 $ 209,020 3,902 1.87
Money market accounts ............... 349,868 6,673 1.91 318,211 12,200 3.83
Interest-bearing
demand accounts ................... 141,328 833 0.59 128,435 1,208 0.94
Time deposits ....................... 1,281,258 54,983 4.29 1,262,584 71,974 5.70
---------- -------- ---- ---------- -------- ----
Total deposits .................... 2,001,757 64,891 3.24 1,918,250 89,284 4.65
Advance payment by borrowers
for taxes and insurance ........... 21,401 243 1.14 22,307 399 1.79
Borrowings .......................... 398,684 22,544 5.65 502,881 29,689 5.90
---------- -------- ---- ---------- -------- ----
Total interest-
bearing liabilities ........... 2,421,842 87,678 3.62 2,443,438 119,372 4.89
---------- -------- ---- ---------- -------- ----
NONINTEREST-BEARING LIABILITIES
Noninterest-bearing
deposits .......................... 92,988 82,368
Other noninterest-
bearing liabilities ............... 44,836 37,362
---------- ----------
Total noninterest-
bearing liabilities ............... 137,824 119,730
---------- ----------
Total liabilities ................. 2,559,666 2,563,168
Equity .............................. 314,678 296,394
---------- ----------
Total average liabilities
and equity .................... $2,874,344 $2,859,562
========== ==========
Net interest income and net
interest rate spread (2) .......... $ 77,754 2.52 $ 71,614 2.22
======== ========
Net interest-earning
assets and net interest
margin (3) ................... $ 273,421 2.88% $ 241,215 2.67%
========== ==== ========== ====
Average interest-earnings
assets to average interest-
bearing liabilities ................. 1.11x 1.10x
AVERAGE BALANCE SHEET, INTEREST AND RATE PAID
---------------------------------------------
YEARS ENDED DECEMBER 31,
---------------------------------
2000
---------------------------------
INTEREST AVERAGE
AVERAGE EARNED YIELD
BALANCE PAID COST
------- ---- ----
(DOLLARS IN THOUSANDS)
ASSETS:
INTEREST-EARNING ASSETS (1):
Loans receivable, net ............... $1,263,100 $ 96,511 7.64%
Mortgage-related securities ......... 466,924 31,725 6.79
Investment securities ............... 74,396 5,412 7.27
Interest-earning deposits ........... 12,735 791 6.21
Federal funds ....................... 20,708 1,272 6.14
---------- -------- ----
Total interest-earning assets ..... 1,837,863 135,711 7.38
--------
Noninterest-earning assets ............. 91,401
----------
Total average assets .............. $1,929,264
==========
LIABILITIES AND EQUITY:
INTEREST-BEARING LIABILITIES:
Savings deposits .................... $ 157,516 3,837 2.44
Money market accounts ............... 233,549 12,208 5.23
Interest-bearing
demand accounts ................... 96,432 992 1.03
Time deposits ....................... 849,328 48,750 5.74
---------- -------- ----
Total deposits .................... 1,336,825 65,787 4.92
Advance payment by borrowers
for taxes and insurance ........... 14,047 332 2.36
Borrowings .......................... 309,746 18,861 6.09
---------- -------- ----
Total interest-
bearing liabilities ........... 1,660,618 84,980 5.12
---------- -------- ----
NONINTEREST-BEARING LIABILITIES
Noninterest-bearing
deposits .......................... 50,959
Other noninterest-
bearing liabilities ............... 30,706
----------
Total noninterest-
bearing liabilities ............... 81,655
----------
Total liabilities ................. 1,742,283
Equity .............................. 186,981
----------
Total average liabilities
and equity .................... $1,929,264
==========
Net interest income and net
interest rate spread (2) .......... $ 50,731 2.26
========
Net interest-earning
assets and net interest
margin (3) ................... $ 177,245 2.76%
========== ====
Average interest-earnings
assets to average interest-
bearing liabilities ................. 1.11x
(1) For the purposes of these computations, non-accruing loans and loans held
for sale are included in the average loans outstanding.
47
(2) Interest rate spread is the difference between the average yield on
interest-earning assets and the average cost on interest-bearing
liabilities.
(3) Net interest margin is determined by dividing net interest income by total
interest-earning assets.
Rate/Volume Analysis. The following table presents the extent to which changes
in interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected our interest income and interest
expense during the periods indicated. Information is provided in each category
with respect to:
(1) changes attributable to changes in volume (change in volume
multiplied by prior rate);
(2) changes attributable to change in rate (changes in rate multiplied
by prior volume); and
(3) the net change.
The changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
YEAR ENDED DECEMBER 31,
2002 COMPARED TO 2001
INCREASE (DECREASE) DUE TO
--------------------------
VOLUME RATE NET
-------- -------- --------
(IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans receivable ..................... $ (9,062) $(14,006) $(23,068)
Mortgage-related securities .......... 5,678 (4,464) 1,214
Investment securities ................ (1,328) (1,304) (2,632)
Interest-earning deposits ............ (48) (515) (563)
Federal funds ........................ 1,551 (2,056) (505)
-------- -------- --------
Total ........................ (3,209) (22,345) (25,554)
-------- -------- --------
INTEREST-BEARING LIABILITIES:
Savings deposits ..................... 349 (1,849) (1,500)
Money market deposits ................ 1,111 (6,638) (5,527)
Interest-bearing demand deposits ..... 111 (486) (375)
Time deposits ........................ 1,049 (18,040) (16,991)
Advance payment by borrowers for
taxes and insurance ............... (15) (141) (156)
Borrowings ........................... (5,932) (1,213) (7,145)
-------- -------- --------
Total ................... (3,327) (28,367) (31,694)
-------- -------- --------
Net change in net interest income .... $ 118 $ 6,022 $ 6,140
======== ======== ========
YEAR ENDED DECEMBER 31,
2001 COMPARED TO 2000
INCREASE (DECREASE) DUE TO
--------------------------
VOLUME RATE NET
-------- -------- --------
(IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans receivable ..................... $ 51,047 $ -- $ 51,047
Mortgage-related securities .......... 886 (1,569) (683)
Investment securities ................ 4,243 (1,443) 2,800
Interest-earning deposits ............ 687 (484) 203
Federal funds ........................ 2,734 (826) 1,908
-------- -------- --------
Total ........................ 59,597 (4,322) 55,275
-------- -------- --------
INTEREST-BEARING LIABILITIES:
Savings deposits ..................... 1,085 (1,020) 65
Money market deposits ................ 3,765 (3,773) (8)
Interest-bearing demand deposits ..... 309 (93) 216
Time deposits ........................ 23,566 (342) 23,224
Advance payment by borrowers for
taxes and insurance ............... 161 (94) 67
Borrowings ........................... 11,434 (606) 10,828
-------- -------- --------
Total ................... 40,320 (5,928) 34,392
-------- -------- --------
Net change in net interest income .... $ 19,277 $ 1,606 $ 20,883
======== ======== ========
48
COMPARISONS OF OPERATING RESULTS FOR YEARS ENDED DECEMBER 31, 2002 AND 2001
GENERAL
Net income for the year ended December 31, 2002 was $26.5 million as compared to
$20.3 million for the year ended December 31, 2001. The increase is primarily a
result of historically low interest rates (which produced record mortgage loan
originations and sales), the elimination of goodwill amortization, gains on the
sales of loans and increased net interest margin, partially offset by the
impairment of mortgage servicing rights.
NET INTEREST INCOME
Net interest income for 2002 increased $6.1 million, or 8.6%, to $77.8 million
for 2002 as compared to $71.6 million for 2001. Net interest income increased
primarily as a result of the increase in the net interest margin. The net
interest margin for 2002 was 2.88%, as compared to 2.67% in 2001. The Federal
Reserve reduced interest rates which helped to improve the net interest margin
for the Banks. Historically, reduced interest rates have improved the net
interest margin, as the Banks were generally able to reduce the interest rates
paid on interest-bearing liabilities more quickly than interest rates charged on
interest-earning assets. That effect benefited results in 2002; however, the
high level of mortgage refinancing activity in which higher interest rate
mortgage loans were paid off and the sales of fixed rate mortgage loans
partially offset the effects of the reduced cost of interest-bearing
liabilities.
NET INTEREST INCOME OUTLOOK
Because of the length of time in which interest rates have been declining and
the unprecedented levels of refinancing activity, we expect that we will
experience, at least in early 2003, a somewhat different effect than we have
recently experienced. The loan refinancing has reduced yields on loans going
forward more quickly than we are able to reduce the already substantially
lowered interest rates on deposits and other liabilities. Further, a significant
portion of the proceeds of loan refinancings have been reinvested in relatively
lower-yielding investment securities, as we generally sell fixed rate mortgages.
If interest rates continue to remain stable or move lower in 2003, we anticipate
that our net interest margin would be compressed (reduced) as a result of the
continued reductions to the yields on interest-earning assets as compared to a
more modest decrease to rates on our interest-bearing liabilities. As a result
of that compression, we would expect that our net income would be reduced in
2003 as compared to 2002, which we expect would reduce net interest income. If,
however, interest rates begin to rise during 2003, there could be a positive
effect on the loan portfolio, resulting from increased originations of
adjustable rate loans, which in turn may offset the reductions in yields and net
interest income.
TOTAL INTEREST INCOME
Total interest income decreased $25.6 million or 13.4% to $165.4 million as
compared to $191.0 million for 2001. The decrease was primarily the result of
existing mortgage loans refinancing to a lower interest rate; sales of fixed
rate mortgage loans and using the proceeds from the sales to invest in
mortgage-related securities (purchased at a lower yield than the yields on the
loans sold); and prepayments on higher yielding mortgage-related securities.
Interest income on loans decreased $23.1 million or 15.6% primarily as a result
of the refinancing of existing loans to lower interest rate loans, originations
at interest rates that were below the existing yield on the portfolio and to a
lesser extent, downward interest rate modifications on certain existing loans.
Although we had record loan originations, a majority of those originations were
fixed rate. We sell the majority of our fixed rate single family mortgage loans
to the secondary market which helps us to manage our interest rate risk. These
actions reduced our average yield to 6.88% in 2002 as compared to 7.64% in 2001.
Interest on investments decreased $2.6 million in 2002 as compared to 2001 as a
result of maturing investments being reinvested at a lower yield and some of the
maturing dollars being invested into mortgage-related securities.
Interest on mortgage-related securities increased $1.2 million in 2002 as a
result of additional mortgage-related securities outstanding offset by the
reduced yield on the portfolio. The average mortgage-related securities
49
outstanding for 2002 was $576.3 million as compared to $480.9 million in 2001.
The average yield on this portfolio was 5.60% for 2002 as compared to 6.46% in
2001. The decrease in yield was the result of prepayments of higher yielding
mortgage-related securities and the reinvestment of those dollars and additional
funds into lower yielding mortgage-related securities.
Interest income on interest-earning deposits (which includes investments in
Federal Funds) decreased $1.1 million to $3.1 million in 2002 as compared to
$4.2 million in 2001. Although the average balance for 2002 increased $64.5
million as compared to the 2001 average balance, the primary reason for the
decrease in interest income was the reduced average yield earned on those
deposits. The yield on interest-earning deposits was substantially impacted by
the Federal Reserve's interest rate reductions throughout 2001 and the one
Federal Reserve interest rate reduction in 2002 which affected market interest
rates.
TOTAL INTEREST EXPENSE
Interest expense on deposits decreased substantially in 2002. The decrease of
$24.4 million, or 27.3%, was the result of the decreased cost of those deposits
partially offset by the growth in deposits. We believe the growth in deposits
was the result of continued uncertainties in the stock market and world events.
At the same time, market interest rates were being decreased thereby reducing
the cost of new and renewing deposits. The average cost of deposits for 2002 was
3.24% as compared to 4.65% in 2001. If the stock market value would rise or
world events stabilized, we believe some of the deposits we acquired in 2002 and
2001 may be withdrawn to fund customer investments in the stock market. In
addition, market interest rates may rise and increase the cost of our deposits.
Interest expense on borrowings decreased $7.1 million to $22.5 million in 2002
as compared to $29.7 million in 2001. The decrease was the result of maturing
borrowings being paid-off.
PROVISIONS FOR LOAN LOSSES
We provided $760,000 for loan losses in 2002 as compared to $723,000 in 2001.
The provision in 2002 was in response to increased commercial loan
delinquencies, charge-offs, changes in the loan portfolio mix (reduction in
one-to-four family loans and an increase in comparatively riskier commercial
real estate, development and commercial loans) and a weakening economy,
partially offset by the decrease in the dollar amount of the loan portfolio.
The allowance for loan losses at December 31, 2002 was $12.7 million or 151.9%
of non-performing loans and 139.4% of non-performing assets as compared to $12.2
million or 345.9% of non-performing loans and 312.1% of non-performing assets at
December 31, 2001. The loan loss allowance to total loans was 0.76% at December
31, 2002 as compared to 0.67% at December 31, 2001.
Future provisions for loan losses will continue to be based upon our assessment
of the overall loan portfolio and the underlying collateral, trends in
non-performing loans, current economic conditions and other relevant factors in
order to maintain the allowance for loan losses at adequate levels to provide
for probable and estimatable future losses. The establishment of the amount of
the loan loss allowance inherently involves judgements by management as to the
adequacy of the allowance, which ultimately may or may not be correct. Higher
rates of loan defaults than anticipated would likely result in a need to
increase provisions in future years. Also, as multi-family and commercial loan
portfolios increase, additional provisions would likely be added to the loan
loss allowances as they carry a higher risk of loss. See also "Asset Quality" in
Item 1, which is incorporated by reference, for certain other factors that may
affect our provisions for loan losses on a go forward basis.
NONINTEREST INCOME
Total noninterest income increased $196,000 to $16.7 million in 2002 as compared
to $16.5 million in 2001. This increase was primarily a result of increased
gains on the sales of loans partially offset by the impairment of mortgage
servicing rights.
50
Service charges on deposits increased $199,000 in 2002 as a result of increased
usage of debit cards and fees from checking accounts. We emphasize checking
accounts as we believe it is the primary account which enables us to develop
other business with the customer.
Brokerage and insurance commissions increased $477,000 to $3.2 million in 2002
as compared to $2.7 million in 2001. The increase was primarily the result of
increased sales of tax-deferred annuity products.
Loan related fees were substantially affected by the impairment of mortgage
servicing rights in 2002. A total of $2.6 million of mortgage servicing rights
were determined to be impaired in 2002 and in accordance with generally accepted
accounting principles, a valuation allowance was established with an offsetting
charge against loan related fees. Offsetting the mortgage servicing rights
impairment was the collection of fees on mortgage loans that had their interest
rates reduced before their initial lock-in period had expired or before their
next interest adjustment date; and fees collected from our fixed rate
modification program which allowed fixed rate mortgage loan consumers to
negotiate a lower fixed rate without the cost of a complete refinance of their
existing mortgage loan.
Gains on the sales of loans increased $2.0 million to $6.0 million in 2002 as
compared to $4.0 million in 2001. This increase was the result of low market
interest rates, which spurred significant refinancings and a large number of
fixed rate mortgage loan originations. We sell most of these fixed rate mortgage
loans to the secondary market to reduce our interest rate risk. We anticipate
that loan sales, and related fee income, will be substantially less in 2003 as
compared to 2002 if interest rates stabilize or rise from December 31, 2002
levels.
Other noninterest income decreased $390,000 to $3.9 million in 2002 as compared
to $4.3 million in 2001. The decrease is primarily the result of a settlement of
a life insurance policy in 2001 and the sale of real estate owned in 2001.
NONINTEREST EXPENSE
Total noninterest expense decreased $835,000 to $54.2 million in 2002 as
compared to $55.0 million in 2001. The decrease was the result of changes in
accounting rules relating to the amortization of goodwill resulting from prior
acquisitions offset by an increase in compensation expense. As a result of those
accounting rule changes, we no longer amortize goodwill.
Compensation expense increased $2.6 million or 9.2% to $31.4 million in 2002 as
compared to $28.7 million in 2001. The increase was primarily the result of:
increased health care costs; increased expense associated with the employee
stock ownership plan; normal pay increases to existing employees; and incentive
payouts to loan originators for the high volume of loan originations. Based on
contracts in place and market conditions, we expect our health insurance costs
to continue to increase significantly in 2003.
Occupancy and equipment expense increased $276,000 primarily from increased
depreciation expense of computer equipment and software related to
implementation of a new teller platform and a new loan origination/documentation
system. In addition, we anticipate that in 2003, we will be opening a new branch
office (cost estimated to be $1.5 million), a replacement office for an existing
office (cost estimated to be $1.2 million) and as a result of the merger of the
two subsidiary Banks, replacing signage (cost estimated to be $350,000). The
effect of both of these new offices and signage replacement will be to increase
our occupancy expense.
The amortization of goodwill was significantly changed in 2002 as a result of
the adoption of SFAS No. 142. As a result, other intangibles continue to be
amortized, goodwill is no longer amortized over a stated period of time but
rather it remains on the statement of financial condition and periodically
tested for impairment. That change increased pre-tax earnings and after-tax
earnings by $3.1 million in 2002 as compared to 2001. If goodwill is found to be
impaired, the impaired amount is expensed to current operations, which would
negatively affect the results in any period in which such an impairment was
determined. See "Notes to Consolidated Financial Statements -- Note 1. Summary
of Significant Accounting Policies -- Recent Accounting Changes."
Other expenses decreased $653,000 or 5.3% to $11.6 million in 2002 as compared
to $12.3 million in 2001. The decrease was the result of the reduction in real
estate owned expense and the reduction in loan expenses in 2002.
51
Also, in 2003, we anticipate we will increase our marketing budget by
approximately $1.3 million to aid in the consolidation of the two subsidiary
Banks.
INCOME TAXES
Income tax expense increased $872,000 to $13.0 million in 2002 as compared to
$12.1 million in 2001. The increase was the result of increased taxable income.
However, the effective income tax rate decreased to 32.8% in 2002 as compared to
37.3% in 2001 primarily as a result of the elimination of the goodwill
amortization expense. Goodwill amortization is a nondeductible tax expense and
therefore resulted in the 2001 effective tax rate being higher than 2002.
COMPARISONS OF OPERATING RESULTS FOR YEARS ENDED DECEMBER 31, 2001 AND 2000
GENERAL
Net income for the year ended December 31, 2001 was $20.3 million as compared to
$14.7 million of the year ended December 31. 2000. The increase is primarily a
result of including a full year of operations of First Northern Savings Bank in
2001 and historically low interest rates, which produced record mortgage loan
originations and sales.
NET INTEREST INCOME
Net interest income for 2001 increased $20.9 million, or 41.2%, to $71.6 million
for 2001 as compared to $50.7 million for 2000. Net interest income increased
primarily as a result of the First Northern Acquisition and growth in interest
earning assets. The net interest margin for 2001 was 2.67%, as compared to 2.76%
in 2000. Interest rates were substantially affected by Federal Reserve actions
during 2001. The net interest margin was compressed throughout 2000 as a result
of market interest rates moving upward as the Federal Reserve moved to increase
interest rates early in the year to slow the pace of the economic expansion.
However, the Federal Reserve quickly reversed its restrictive growth mode,
beginning in early 2001, by reducing interest rates throughout 2001. Reduced
interests rates have historically improved the Banks' net interest margin, as
the Banks are generally able to reduce the interest rates paid on
interest-bearing liabilities more quickly than interest rates charged on
interest-earning assets. That was mitigated somewhat during 2001 by the high
level of mortgage refinancing activity in which higher interest rate loans were
paid off.
TOTAL INTEREST INCOME
Total interest income increased $55.3 million, or 40.7%, to $191.0 million for
2001 as compared to $135.7 million for 2000. The increase in total interest
income was primarily the result of the First Northern Acquisition and growth in
federal funds sold and securities.
Interest income on loans rose substantially in 2001 primarily from the First
Northern Acquisition. Our loan originations were strong in 2001, especially
fixed interest rate mortgage loans; however, we sold the majority of our fixed
rate mortgage loans to the secondary market. In addition to respond to the lower
interest rate environment, we allowed some customers with our adjustable
interest rate mortgage loans to reduce their interest rate for a fee, before the
expiration of their initial lock-in period or next adjustment date. These
actions, along with our continued emphasis on multi-family and commercial loan
originations, stabilized our average yield at 7.64% for 2001.
Interest on investments increased $2.8 million as a result of the full years
results from the First Northern Acquisition and the increase in securities in
2001.
Interest on mortgage-related securities decreased $0.7 million in 2001 although
the average balances of mortgage-related securities for 2001 increased $13.9
million. The average yield on mortgage-related securities in 2001 decreased to
6.46% from 6.79% in 2000. This decrease in yield was the result of prepayments
of higher yielding
52
mortgage-related securities and the reinvestment of those dollars and additional
money into lower-yielding mortgage-related securities.
Interest income on interest-earning deposits increased $2.1 million in 2001 as a
result of additional dollars invested throughout 2001. As deposits and loan
sales increased, the additional cash was invested in short-term investments.
However, as market interest rates decreased (as a result of the Federal
Reserve's actions) the yield on these investments also decreased.
TOTAL INTEREST EXPENSE
Interest expense on deposits increased $23.5 million, or 35.7%, to $89.3 million
in 2001 compared to $65.8 million in 2000. This increase was the result of the
effect of the First Northern Acquisition over the full year and growth in
deposits. We believe the growth in deposits was the result of the uncertainties
in the stock market and world events. At the same time, market interest rates
were being decreased as a result of Federal Reserve actions thereby reducing the
average cost of deposits to 4.65% for 2001 as compared to 4.92% for 2000.
Borrowing expense increased $10.8 million, or 57.4%, to $29.7 million in 2001 as
compared to $18.9 million in 2000. This increase is a result of the full year
affect of the First Northern Acquisition partially offset by the reduction in
borrowings. Most of the borrowings are with FHLB of Chicago and have fixed
interest rates and terms.
PROVISION FOR LOAN LOSSES
We provided $723,000 for loan losses in 2001 as compared to $423,000 in 2000.
The provision was increased in 2001 as a result of the change in the loan
portfolio mix (reduction in one-to-four family loans and an increase in
comparatively riskier multi-family and commercial loans) and charge-offs, as
well as the weakening of the economy. The allowance for loan losses at December
31, 2001 was $12.2 million or 345.9% of non-performing loans and 312.1% of
non-performing assets. The loan loss allowance to total loans is 0.67% as
compared to 0.62% at December 31, 2000.
NONINTEREST INCOME
Total noninterest income increased $7.2 million, or 78.2%, to $16.5 million in
2001 as compared to $9.3 million in 2000. The increase is primarily the result
of the First Northern Acquisition and a significant increase in gains on the
sales of loans.
Service charges on deposits and brokerage and insurance commissions increased
$1.6 million and $0.7 million, respectively, as a result of the First Northern
Acquisition and increased sales of tax-deferred annuity products.
Loan related fees increased $0.1 million primarily as a result of two factors.
First, fees collected on adjustable rate mortgage loans that had their interest
rates reduced before their initial lock-in period had expired or before their
next interest adjustment date. The fee varied with the option the customer
chose. Second, fees collected from our fixed rate modification program which
allowed fixed rate mortgage loan customers to negotiate a lower fixed rate
without the cost of a complete refinance of their existing mortgage loan.
Gains on the sales of loans increased $3.7 million to $4.0 million in 2001 as
compared to $0.3 million in 2000. This substantial increase was the result of
low market interest rates, which spurred significant refinancings and a large
number of fixed rate mortgage loans to be originated. We sell most of these
fixed rate mortgage loans to the secondary market to reduce our interest rate
risk.
Other noninterest income increased $1.1 million or 35.2% to $4.3 million in 2001
as compared to $3.2 million in 2000. The increase is primarily the result of the
First Northern Acquisition, a settlement of a life insurance policy and other
miscellaneous fees.
53
NONINTEREST EXPENSE
Total noninterest expense increased $18.9 million to $55.0 million in 2001 as
compared to $36.1 million in 2000. The increase was primarily the result of the
acquisition of First Northern and its first full year of operations, the
implementation of stock-based benefit plans and normal increased cost of
operations.
Compensation expense increased $9.5 million or 49.6% to $28.7 million in 2001 as
compared to $19.2 million in 2000. The increase was the result of: the
acquisition of First Northern and its first full year of operations; the $1.5
million in expense associated with the employee stock ownership plan; the
implementation of a restricted stock awards plan resulting in $387,000 of
expense in 2001; increased health care costs; and incentive payouts to loan
originators for the high volume of loan originations.
Occupancy and equipment expense increased $3.0 million primarily from the
acquisition of First Northern and its first full year of operations with Bank
Mutual.
The amortization of goodwill and the amortization of other intangible assets
increased substantially in 2001 as compared to 2000. The $2.0 million increase
in the amortization of goodwill and the $331,000 increase in the amortization of
other intangibles were the result of the increased amortization from the
goodwill and other intangible assets created from the acquisition of First
Northern in November 2000.
Our efficiency ratio excluding the amortization of goodwill and other intangible
assets was 58.7% in 2001 as compared to 58.3% in 2000.
INCOME TAXES
Income tax expense increased $3.4 million to $12.1 million in 2001 as compared
to $8.7 million in 2000. The increase was the result of increased taxable
income. The effective income tax rate in 2001 was 37.3% as compared to 37.2% in
2000.
LIQUIDITY AND CAPITAL RESOURCES
The term "liquidity" refers to our ability to generate adequate amounts of cash
to fund loan originations, loan purchases, deposit withdrawals, and operating
expenses. Our primary sources of funds are deposits, scheduled amortization, and
prepayments of loan principal and mortgage-related securities, maturities and
calls of investment securities, borrowings from the FHLB of Chicago and funds
provided by our operations. Historically, these sources of funds have been
adequate to maintain liquidity, with the Banks borrowing correspondingly more in
periods in which their operations generate less cash. In the event these sources
of liquidity would become inadequate, Bank Mutual believes that it could access
the wholesale deposit market, although there can be no assurances that wholesale
deposits would be available if needed.
Loan repayments and maturing investment securities are a relatively predictable
source of funds. However, deposit flows, calls of investment securities and
prepayments of loans and mortgage-related securities are strongly influenced by
interest rates, general and local economic conditions and competition in the
marketplace. For example, during 2002, loan prepayments increased significantly
because of the reduced interest rate environment; another very different
interest rate environment could lead to a significantly different result. These
factors reduce the predictability of the timing of these sources of funds.
Our primary investing activities are the origination and purchase of one-to
four-family real estate loans, multi-family and commercial real estate loans,
home equity loans, other consumer loans, commercial business loans, the purchase
of mortgage-related securities, and to a lesser extent, the purchase of
investment securities.
These investing activities were funded by principal payments on mortgage loans
and mortgage-related securities, calls and maturities on investment securities,
borrowings, deposit growth, and funds provided by our operating activities.
At December 31, 2002, Bank Mutual had:
- outstanding loan commitments to borrowers of approximately $49.0
million;
54
- unused commercial lines of credit of approximately $29.1 million;
and
- available home equity, overdraft lines of credit and unused credit
card lines of credit of approximately $145.3 million.
There were no outstanding commitments to purchase securities at December 31,
2002. We are committed to maintaining a strong liquidity position; therefore, we
monitor our liquidity position on a daily basis. Based upon our historical
experience and available sources of liquidity, we anticipate that we will have
sufficient funds from operations and/or borrowing capacity to meet current
funding commitments. See also "Management of Interest Rate Risk - Gap Analysis"
in Item 7A hereof, which is incorporated herein by reference, which discusses
maturities, and "Notes to Consolidated Financial Statements-Note 5. Other
Assets," which includes a summary of future lease obligations.
At December 31, 2002, we exceeded each of the applicable regulatory capital
requirements for both savings bank subsidiaries. In order to be classified as
"well-capitalized" by the FDIC we are required to have leverage (tier 1) capital
of at least 5.00%. To be classified as a well-capitalized bank by the FDIC, we
must also have a risk-based total capital ratio of at least 10.00%. At December
31, 2002, Mutual Savings Bank had a risk-based total capital ratio of 17.42% and
a leverage ratio of 7.77%; First Northern Savings Bank had a risked-based total
capital ratio of 14.80% and a leverage ratio of 9.62%. See "Notes to
Consolidated Financial Statements---Note 8. Shareholders' Equity."
Because OTS regulations require that the MHC own at least a majority of the
outstanding shares of Bank Mutual, and currently 48.5% of Bank Mutual's common
shares are owned by persons other than the MHC, the future issuance of Bank
Mutual common stock is not expected to be a significant source of capital
resources for Bank Mutual as long as the mutual holding company structure
remains in place.
Shareholders' equity is decreased by unearned ESOP shares, which represents
shares in the Bank Mutual Employee Stock Ownership Plan which had not yet been
earned by participating employees, and unearned deferred compensation, which
represents stock grants under the management recognition plan ("MRP") component
of its 2001 Stock Incentive Plan. See "Notes to Consolidated Financial
Statements--Note 1. Summary of Significant Accounting Policies." Shareholders'
equity is increased by $10.5 million of accumulated other comprehensive income,
consisting primarily of increased market-value of securities available-for-sale.
Bank Mutual repurchased 956,000 shares under its stock repurchase program; of
these amounts, 330,000 shares were used for restricted stock awards (of which
2,800 shares were forfeited) and 40,106 shares were used for exercised stock
options, leaving 588,694 shares held as treasury shares at fiscal year end.
Cash and cash equivalents decreased $10.2 million during 2002; however, we still
maintained $241.8 million of cash and cash equivalents at December 31, 2002.
Bank Mutual provided $68.8 million in investing activities, primarily as a
result of the decrease in the loan portfolio caused by the sale of fixed rate
mortgage loans, offset by purchases of investment securities and principal
repayments on mortgage related securities. The cash provided by investing
activities was combined with the cash provided by operating activities and
netted against cash used by financing activities. The cash from operating
activities is primarily a result of Bank Mutual's net income for the year, and
non-cash expenses, offset by net change in loans originated for sale. Cash used
by financing activities resulted primarily from repayments of long-term
borrowings and treasury stock purchases, offset by deposit growth.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and accompanying notes of Bank Mutual have been
prepared in accordance with accounting principles generally accepted in the
United States ("GAAP"). GAAP generally requires the measurement of financial
position and operating results in terms of historical dollars without
consideration for changes in the relative purchasing power of money over time
due to inflation. The impact of inflation is reflected in the increased cost of
our operations. Unlike industrial companies, our assets and liabilities are
primarily monetary in nature. As a result, changes in market interest rates have
a greater impact on performance than do the effects of inflation.
RISK FACTORS
In addition to the various factors discussed above, you should consider
carefully the following risk factors when evaluating Bank Mutual's performance
and outlook.
55
Changing Interest Rates May Hurt Our Profits. To be profitable, we have to earn
more money in interest and fees than we pay as interest and other expenses. Of
our first mortgage loans maturing after one year, a majority have interest rates
that are fixed for the term of the loan. While most of our deposit accounts
consist of checking accounts, money market accounts, savings accounts and time
deposit accounts with remaining terms to maturity of less than one year, most of
our loans have longer remaining terms. It is unlikely that interest rates will
continue to decline in the near future in the dramatic way in which they did
during 2002. Although we have a positive GAP at December 31, 2002, if interest
rates rise substantially, the amount of interest we pay on deposits is likely to
increase more quickly than the amount of interest we receive on our loans,
mortgage-related securities and investment securities. This would cause our
profits to decrease. Rising interest rates would likely reduce the value of our
mortgage-related securities and investment securities and may decrease demand
for loans and make it more difficult for borrowers to repay their loans. If
interest rates remain stable or fall, our net interest income is also likely to
be reduced because the heavy refinancing activity, which already has occurred,
will likely continue to increase the portion of our assets in relatively
lower-yielding investments and also lower average yields on loans more quickly
than we can lower rates on deposits and other interest-bearing liabilities. For
additional information on our exposure to interest rates, see "Quantitative and
Qualitative Disclosures about Market Risk--Management of Interest Rate Risk."
Increases in Market Interest Rates are Likely to Adversely Affect Equity. As of
December 31, 2002, we owned $691.3 million of securities available-for-sale.
Generally accepted accounting principles require that we carry these securities
at fair value on our balance sheet. Unrealized gains or losses on these
securities, reflecting the difference between the fair market value and the
amortized cost, net of its tax effect, are carried as a component of
shareholders' equity. When market rates of interest increase, the fair value of
our securities available-for-sale generally decreases and equity correspondingly
decreases. When rates decrease, fair value generally increases and shareholders'
equity correspondingly increases. As of December 31, 2002, Bank Mutual's
available-for-sale portfolio had an unrealized gain of $16.3 million, because
fair value was $691.3 million and amortized cost was $675.1 million. While Bank
Mutual has benefited from the decrease in interest rates during 2002, continuing
decreases of this magnitude are unlikely to occur in the near future.
The Economic Recession and World Events Could Affect Our Earnings. The United
States economy, which was softening during 2000, entered into a recession during
early 2001 and has continued through 2002 according to economists. The
recession, or at least a soft economy, is generally believed to have continued
into early 2003, and it is not yet clear whether a recovery has begun or when
one will begin. When a recovery begins, we do not know how swift or strong it
will be or how long it would continue. The effects of a recession, or a weak
economy, can significantly affect our operations and profitability. For example,
higher unemployment and reduced business sales or profits can make it more
difficult for borrowers to repay their loans. Similarly, reduced income or
confidence can lead consumers to reduce their purchases, and thus reduce loan
demand.
The weakness in the national and local economies have been exacerbated by the
attacks of September 11, 2001 and their aftermath and other world events such as
the possibility of an armed conflict. Bank Mutual, and the economy as a whole,
may be affected by future world events, such as acts of terrorism or
developments in the war on terrorism.
Low Demand for Real Estate Loans May Lower Our Profitability. Making loans
secured by real estate is our primary business and primary source of profits. If
customer demand for real estate loans decreases, our profits may decrease
because our alternative investments, primarily securities, earn less income for
us than real estate loans. Customer demand for loans secured by real estate
could be reduced by a weaker economy, an increase in unemployment, a decrease in
real estate values or an increase in interest rates.
Strong Competition Within Our Market Area May Reduce Our Customer Base. We
encounter strong competition both in attracting deposits and originating real
estate and other loans. We compete with commercial banks, savings institutions,
mortgage banking firms, credit unions, finance companies, mutual funds,
insurance companies, and brokerage and investment banking firms. Our market area
includes branches of several commercial banks that are substantially larger than
us in terms of deposits and loans. In addition, tax exempt credit unions operate
in most of our market area and aggressively price their products and services to
a large part of the population. Our profitability depends upon our continued
ability to successfully maintain or increase our market share.
56
We Are Expanding Our Lending Activities in Riskier Areas. We have identified
commercial real estate, commercial business and consumer loans as areas for
increased lending emphasis, and our loans of these types increased both in
absolute dollars and as a percentage of our portfolio during 2002. While
increased lending diversification is expected to increase interest income,
non-residential loans carry greater risk of payment default than residential
real estate loans. As the volume of these loans increase, credit risk increases.
In the event of substantial borrower defaults, our provision for loan losses
would increase and therefore, earnings would be reduced.
Our consumer loan portfolio included $58.1 million of indirect auto loans at
December 31, 2002. Indirect auto lending was not a business line for Mutual
Savings prior to the First Northern Acquisition, but was begun with a portfolio
then acquired. Although First Northern has experienced minimal delinquencies in
its automobile loan portfolio historically, borrowers may be more likely to
become delinquent on an automobile loan than on a residential real estate loan.
Moreover, unlike the collateral for real estate loans, automobiles depreciate
rapidly and, in the event of default, principal loss as a percent of the loan
balance depends upon the mileage and condition of the vehicle at the time of
repossession, over which Bank Mutual has no control. Similarly, any non-real
estate collateral securing commercial business loans may depreciate over time
and fluctuate in value.
Mutual Savings and First Northern Savings Bank May Not Integrate as We Hope.
Mutual Savings and First Northern Savings Bank combined as of March 16, 2003,
changing the Bank's name to "Bank Mutual" in the process. We have not
experienced any significant problems, such as customer loss or difficulties from
our systems conversions; however, we may find that the operations and management
philosophies will not combine as well as we expect, which could lead to
operating inefficiencies and complications going forward. We also may experience
customer resistance to, or confusion from, the change in the name of our Banks.
We Have Significant Intangible Assets Which We May Need to Write Off (Expense)
in the Future. Bank Mutual has approximately $52.6 million in goodwill, $5.7
million in other intangible assets and $3.1 million of mortgage servicing rights
as of December 31, 2002. As a result of SFAS No. 142, Bank Mutual no longer
amortizes goodwill but will continue to amortize the other intangible assets
over seven to fifteen years and will evaluate the mortgage servicing rights for
impairment on a monthly basis. We will periodically check goodwill, and the
other intangible assets for impairment. At some point in the future, our
intangible assets may become impaired, and we would need to write them off as a
reduction to earnings in the period in which they became impaired. For example,
in 1999 Mutual Savings Bank wrote off $15.6 million of "impaired" goodwill and
intangible assets from the 1997 acquisition of First Federal. Even though this
special write-off did not affect our cash position, our 1999 results were
reduced by this action. Future periods could be similarly affected.
Stock-Based and Other Benefits Affect Our Results. We have adopted a stock
incentive plan which provided for the granting of options to purchase common
stock and for awards of common stock to our eligible officers, employees and
directors. We also have an employee stock ownership plan, and have adopted a
restoration plan that will supplement the benefits to selected executive
officers under the employee stock ownership plan and our 401(k) plan. The cost
of the employee stock ownership plan will vary based on our stock price at
specific points in the future. Additionally, we experienced a significant
increase in employee health care costs in 2002, and expect further significant
increases in 2003. These expenses will continue to affect our future earnings,
as may other factors, such as government mandates, which would further increase
the cost of compensation and/or benefits that are provided to employees.
The MHC's Control Over Bank Mutual May Prevent Transactions You Would Like. The
MHC is managed by generally the same directors and officers who manage Bank
Mutual. Because the MHC owns a majority of Bank Mutual's common stock, the board
of directors of the MHC controls the outcome of most matters put to a vote of
shareholders of Bank Mutual. We cannot assure you that the votes cast by the MHC
will be in your best interest as a shareholder.
57
QUARTERLY FINANCIAL INFORMATION
The following table sets forth certain unaudited quarterly data for the periods
indicated:
QUARTER ENDED
-----------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(In thousands, except per share amounts)
2002 (unaudited)
Interest income ................... $42,967 $42,138 $41,245 $ 39,082
Interest expense .................. 23,578 21,937 21,964 20,199
------- ------- ------- --------
Net interest income .......... 19,389 20,201 19,281 18,883
Provision for loan losses ......... 15 40 940 (235)
------- ------- ------- --------
Net income after provision
for loan losses .......... 19,374 20,161 18,341 19,118
Total noninterest income .......... 3,843 3,857 3,959 5,017
Total noninterest expense ......... 13,611 13,510 12,998 14,050
------- ------- ------- --------
Income before income taxes ........ 9,606 10,508 9,302 10,085
Income taxes ...................... 3,275 3,537 2,938 3,206
------- ------- ------- --------
Net income ........................ $ 6,331 $ 6,971 $ 6,364 $ 6,879
======= ======= ======= ========
Earnings per share - Basic ........ $ 0.30 $ 0.33 $ 0.30 $ 0.33
======= ======= ======= ========
Earnings per share - Diluted ...... $ 0.29 $ 0.32 $ 0.30 $ 0.32
======= ======= ======= ========
Cash dividend paid per share ...... $ 0.08 $ 0.08 $ 0.09 $ 0.09
======= ======= ======= ========
2001 (unaudited)
Interest income ................... $49,294 $48,053 $47,590 $ 46,049
Interest expense .................. 31,640 30,632 29,709 27,391
------- ------- ------- --------
Net interest income .......... 17,654 17,421 17,881 18,658
Provision for loan losses ......... 101 109 333 180
------- ------- ------- --------
Net income after provision
for loan losses .......... 17,553 17,312 17,548 18,478
Total noninterest income .......... 3,349 4,160 4,025 4,946
Total noninterest expense ......... 13,192 13,362 13,789 14,661
------- ------- ------- --------
Income before income taxes ........ 7,710 8,110 7,784 8,763
Income taxes (benefit) ............ 2,907 3,032 2,860 3,285
------- ------- ------- --------
Net income (loss) ................. $ 4,803 $ 5,078 $ 4,924 $ 5,478
======= ======= ======= ========
Earnings per share - Basic ........ $ 0.22 $ 0.24 $ 0.23 $ 0.26
======= ======= ======= ========
Earnings per share - Diluted ...... $ 0.22 $ 0.24 $ 0.23 $ 0.26
======= ======= ======= ========
Cash dividend paid per share ...... $ 0.07 $ 0.07 $ 0.07 $ 0.07
======= ======= ======= ========
RECENT ACCOUNTING DEVELOPMENTS
We discuss recent accounting changes in the "Notes to Consolidated Financial
Statement--Note 1. Summary of Significant Accounting Policies--Recent Accounting
Changes." We also discussed the effect of changes in accounting rules relating
to the amortization of goodwill above in "Comparisons Of Operating Results For
Years Ended December 31, 2002 and 2001 - Noninterest Expense."
58
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MANAGEMENT OF INTEREST RATE RISK
Bank Mutual's ability to maintain net interest income depends upon earning a
higher yield on assets than the rates we pay on deposits and borrowings.
Fluctuations in interest rates will ultimately impact both our level of income
and expense recorded on a large portion of our assets and liabilities.
Fluctuations in interest rates will also affect the market value of all
interest-earning assets, other than those which possess a short term to
maturity.
Interest rate sensitivity is a measure of the difference between amounts of
interest-earning assets and interest-bearing liabilities which either reprice or
mature during a given period of time. The difference, or the interest rate
sensitivity "gap," provides an indication of the extent to which our interest
rate spread will be affected by changes in interest rates. See "Gap Analysis"
below.
Due to the nature of our operations, we are not directly subject to foreign
currency exchange or commodity price risk. Instead, our real estate loan
portfolio, concentrated in Wisconsin, is subject to risks associated with the
local economy. We did not engage in any hedging transactions that use derivative
instruments (such as interest rate swaps and caps) during 2002, 2001 and 2000.
In the future, we may, with approval of our board of directors, engage in
hedging transactions utilizing derivative instruments.
We seek to coordinate asset and liability decisions so that, under changing
interest rate scenarios, earnings will remain within an acceptable range.
The primary objectives of our interest rate management strategy are to:
- maintain earnings and capital within self-imposed parameters over a
range of possible interest rate environments;
- coordinate interest rate risk policies and procedures with other
elements of our business plan, all within the context of the current
business environment and our capital and liquidity requirements; and
- manage interest rate risk in a manner consistent with the approved
guidelines and policies set by our board of directors.
To achieve the objectives of managing interest rate risk, our Asset/Liability
committees meet periodically to discuss and monitor the market interest rate
environment and provide reports to the board of directors. These committees (one
at each bank) are comprised of members of their respective senior management.
Historically, our lending activities have emphasized one- to four-family first
and second mortgage loans. Our primary source of funds has been deposits and
borrowings, consisting primarily of time deposits and borrowings which have
substantially shorter terms to maturity than the loan portfolio. We have
employed certain strategies to manage the interest rate risk inherent in the
asset/liability mix, including:
- emphasizing the origination of adjustable-rate and certain 15-year
fixed rate mortgage loans for portfolio, and selling certain 15 and
20 year fixed rate mortgage loans and all 30-year fixed rate
mortgage loans;
- maintaining a significant level of investment securities and
mortgage-related securities with a weighted average life of less
than eight years or with interest rates that reprice in less than
five years; and
- managing deposits and borrowings to provide stable funding.
59
We believe that the frequent repricing of our adjustable-rate mortgage loans,
the cash flows from our 15-year fixed rate real estate loans, the shorter
duration of our consumer loans, and adjustable rate features and shorter
durations of our investment securities, reduce our exposure to interest rate
fluctuations.
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-bearing assets maturing or repricing within a
specific time period and the amount of interest-bearing liabilities maturing or
repricing within that same time period.
A gap is considered positive when the amount of interest-earning assets maturing
or repricing within a specific time period exceeds the amount of
interest-bearing liabilities maturing or repricing within that specific time
period. A gap is considered negative when the amount of interest-bearing
liabilities maturing or repricing within a specific time period exceeds the
amount of interest-earning assets maturing or repricing within the same period.
During a period of rising interest rates, a financial institution with a
negative gap position would be expected, absent the effects of other factors, to
experience a greater increase in the costs of its liabilities relative to the
yields of its assets and thus a decrease in the institution's net interest
income. An institution with a positive gap position would be expected, absent
the effect of other factors, to experience the opposite result. Conversely,
during a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income while a positive gap would tend to reduce
net interest income.
At December 31, 2002, based on the assumptions below, our interest-earning
assets maturing or repricing within one year exceeded our interest-bearing
liabilities maturing or repricing within the same period by $228.7 million. This
represented a positive cumulative one-year interest rate sensitivity gap of
8.0%, and a ratio of interest-earning assets maturing or repricing within one
year to interest-bearing liabilities maturing or repricing within one year of
119.7%.
The following table presents the amounts of our interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2002, which we
anticipate to reprice or mature in each of the future time periods shown. The
information presented in the following table is based on the following
assumptions:
i) Investment securities - based upon contractual maturities and if
applicable, call dates.
ii) Mortgage-related securities - based upon an independent outside
source for determining cash flows (prepayment speeds).
iii) Loans - based upon contractual maturities, repricing date, if
applicable, scheduled repayments of principal and projected
prepayments of principal based upon our historical experience or
anticipated prepayments.
iv) Deposits - based upon contractual maturities and our historical
decay rates.
v) Borrowings - based upon the earlier of call date or final maturity;
however, as a result of the above-market interest rate floor on
$200.0 million of FHLB of Chicago borrowings, these borrowings have
been reclassified to their final maturity date in 2004. We have
received indications from FHLB of Chicago that they would replace
the borrowings even if the borrowings were called.
60
AT DECEMBER 31, 2002
-----------------------------------------------------------------------------------
THREE TO MORE THAN ONE MORE THAN
WITHIN THREE TWELVE YEAR TO THREE THREE YEARS TO OVER
MONTHS MONTHS YEARS FIVE YEARS FIVE YEARS TOTAL
------------ -------- ------------- -------------- ---------- ----------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable:
Mortgage loans:
Fixed .................................. $ 41,507 $ 92,073 $162,328 $ 93,787 $ 113,746 $ 503,441
Adjustable ............................. 172,449 237,889 244,637 93,135 3,345 751,455
Consumer loans ............................ 131,315 129,109 143,332 21,803 6,388 431,947
Commercial and industrial loans ........... 25,447 17,180 17,427 1,006 -- 61,060
Interest-earning deposits .................... 209,838 -- -- -- -- 209,838
Investment securities ........................ 38,337 16,292 9,415 8,084 -- 72,128
Mortgage-related securities:
Fixed .................................. 86,356 125,991 239,405 95,903 20,417 568,072
Adjustable ............................. 31,873 3,013 -- -- -- 34,886
Other interest-earning assets ................ 32,885 -- -- -- -- 32,885
-------- -------- -------- -------- --------- ----------
Total interest-earning assets ....... 770,007 621,547 816,544 313,718 143,896 2,665,712
-------- -------- -------- -------- --------- ----------
Interest-bearing liabilities:
Deposits:
Interest-bearing demand accounts ....... 772 2,315 5,635 4,993 135,275 148,990
Savings accounts ....................... 3,913 11,632 27,256 22,951 164,416 230,168
Money market accounts .................. 340,232 1,004 2,221 1,727 6,030 351,214
Time deposits .......................... 366,733 349,582 364,135 214,352 -- 1,294,802
Advance payments by borrowers for
taxes and insurance ....................... 704 2,356 -- -- -- 3,060
Borrowings ................................... 25,154 58,447 249,810 7,955 13,711 355,077
-------- -------- -------- -------- --------- ----------
Total interest-bearing liabilities .. 737,508 425,336 649,057 251,978 319,432 2,383,311
-------- -------- -------- -------- --------- ----------
Interest rate sensitivity gap ................ $ 32,499 $196,211 $167,487 $ 61,740 $(175,536) $ 282,401
======== ======== ======== ======== ========= ==========
Cumulative interest rate sensitivity gap ..... $ 32,499 $228,710 $396,197 $457,937 $ 282,401
Cumulative interest rate sensitivity
gap as a percentage total assets .......... 1.14% 8.04% 13.93% 16.11% 9.93%
Cumulative interest-earning assets
as a percentage of interest
bearing liabilities ....................... 104.41% 119.67% 121.87% 122.19% 111.85%
The methods used in the previous table have some inherent shortcomings. For
example, although certain assets and liabilities may have similar maturities or
periods to repricing, they may react in different degrees to changes in market
interest rates. Interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Certain assets, such as
adjustable-rate loans, have features which limit changes in interest rates on a
short-term basis and over the life of the loan. If interest rates change,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Finally, the ability of borrowers to
make payments on their adjustable-rate loans may decrease if interest rates
increase.
PRESENT VALUE OF EQUITY
In addition to the gap analysis table, we also use simulation models to monitor
interest rate risk. The models report the present value of equity in different
interest rate environments, assuming an instantaneous and permanent interest
rate shock to all interest rate-sensitive assets and liabilities. The present
value of equity is the difference between the present value of expected cash
flows of interest rate-sensitive assets and liabilities. The changes in market
value of assets and liabilities due to changes in interest rates reflect the
interest rate sensitivity of those assets and liabilities as their values are
derived from the characteristics of the asset or liability (i.e., fixed rate,
adjustable-rate, caps, floors) relative to the current interest rate
environment. For example, in a rising interest rate environment the fair market
value of a fixed rate asset will decline, whereas the fair market value of an
adjustable-rate asset, depending on its repricing characteristics, may not
decline. Increases in the market value of assets will increase the present value
of equity whereas decreases in market value of assets will decrease the present
value of equity. Conversely, increases in the market value of liabilities will
decrease the present value of equity whereas decreases in the market value of
liabilities will increase the present value of equity.
61
The following table presents the estimated present value of equity over a range
of interest rate change scenarios at December 31, 2002. The present value ratio
shown in the table is the present value of equity as a percent of the present
value of total assets in each of the different rate environments. For purposes
of this table, we have made assumptions such as prepayment rates and decay rates
similar to those used for the gap analysis table.
PRESENT VALUE OF EQUITY
AS PERCENT OF
PRESENT VALUE OF EQUITY PRESENT VALUE OF ASSETS
-------------------------------------------------- ------------------------------
CHANGE IN DOLLAR DOLLAR PERCENT PRESENT VALUE PERCENT
INTEREST RATES AMOUNT CHANGE CHANGE RATIO CHANGE
-------------- ------ ------ ------ ----- ------
(BASIS POINTS) (DOLLARS IN THOUSANDS)
+300 $333,132 (18,845) (5.35)% 11.83% (1.66)%
+200 342,380 (9,597) (2.73) 12.01 (0.17)
+100 349,574 (2,403) (0.68) 12.11 0.67
0 351,977 -- -- 12.03 --
-100 349,309 (2,668) (0.76) 11.77 (2.16)
-200 358,094 6,117 1.74 11.93 (0.83)
-300 391,048 39,071 11.10 12.86 6.90
As in the case of the gap analysis table, the methods we used in the previous
table have some inherent shortcomings. This type of modeling requires that we
make assumptions which may not reflect the manner in which actual yields and
costs respond to changes in market interest rates. For example, we make
assumptions regarding the acceleration rate of the prepayment speeds of higher
yielding mortgage loans. Prepayments will accelerate in a falling rate
environment and the reverse will occur in a rising rate environment. We also
assume that decay rates on core deposits will accelerate in a rising rate
environment and the reverse in a falling rate environment. The table assumes
that we will take no action in response to the changes in interest rates, when
in practice rate changes on certain products, such as savings deposits, may lag
market changes. In addition, prepayment estimates and other assumptions within
the model are subjective in nature, involve uncertainties, and therefore cannot
be determined with precision. Accordingly, although the present value of equity
model may provide an estimate of our interest rate risk at a particular point in
time, such measurements are not intended to and do not provide a precise
forecast of the effect of changes in interest rates on our present value of
equity.
62
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Auditors
Board of Directors
Bank Mutual Corporation and Subsidiaries
We have audited the accompanying consolidated statements of financial condition
of Bank Mutual Corporation (the Company) and Subsidiaries as of December 31,
2002 and 2001, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for the three years ended December 31, 2002.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company and
Subsidiaries at December 31, 2002 and 2001 and the consolidated results of their
income and their cash flows for the three years ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States.
As discussed in Note 1, in 2002 the Company changed its method for accounting
for goodwill.
Ernst & Young LLP
Milwaukee, Wisconsin
January 31, 2003 except for
Note 14 as to which date
is March 16, 2003.
63
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Financial Condition
DECEMBER 31
2002 2001
----------- -----------
(In Thousands)
ASSETS
Cash and due from banks $ 40,297 $ 41,574
Federal funds sold 165,000 175,000
Interest-earning deposits 36,462 35,338
----------- -----------
Cash and cash equivalents 241,759 251,912
Securities available-for-sale, at fair value:
Investment securities 73,226 93,059
Mortgage-related securities 618,123 521,084
Loans held for sale 46,971 32,321
Loans receivable, net 1,685,662 1,831,155
Goodwill 52,570 52,570
Other intangible assets 5,734 6,396
Mortgage servicing rights 3,060 4,251
Other assets 116,223 113,042
----------- -----------
$ 2,843,328 $ 2,905,790
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 2,126,655 $ 2,090,440
Borrowings 354,978 465,360
Advance payments by borrowers for taxes and insurance 3,060 3,499
Other liabilities 35,560 42,393
----------- -----------
2,520,253 2,601,692
Guarantees and Commitments(Notes 1 and 12)
Shareholders' equity:
Preferred stock - $.01 par value:
Authorized- 10,000,000 shares in 2002 and 2001
Issued and outstanding - none in 2002 and 2001 -- --
Common stock - $.01 par value:
Authorized- 100,000,000 shares in 2002 and 2001
Issued - 22,341,665 shares in 2002 and 2001
Outstanding - 21,752,971 shares in 2002; 22,337,165 in 2001 223 223
Additional paid-in capital 109,074 108,043
Retained earnings 224,932 201,777
Unearned ESOP shares (6,647) (7,850)
Accumulated other comprehensive income 10,487 6,018
Unearned deferred compensation (3,133) (4,047)
Treasury stock - 588,694 shares in 2002; 4,500 in 2001 (11,861) (66)
----------- -----------
Total shareholders' equity 323,075 304,098
----------- -----------
$ 2,843,328 $ 2,905,790
=========== ===========
See accompanying notes to consolidated financial statements.
64
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Income
YEAR ENDED DECEMBER 31
2002 2001 2000
--------- --------- ---------
(In Thousands, Except Per Share Amounts)
Interest income:
Loans $ 124,490 $ 147,558 $ 96,511
Investment securities 5,580 8,212 5,412
Mortgage-related securities 32,256 31,042 31,725
Interest-earning deposits 3,106 4,174 2,063
--------- --------- ---------
Total interest income 165,432 190,986 135,711
Interest expense:
Deposits 64,891 89,284 65,787
Borrowings 22,544 29,689 18,861
Advance payments by borrowers for taxes and insurance
243 399 332
--------- --------- ---------
Total interest expense 87,678 119,372 84,980
--------- --------- ---------
Net interest income 77,754 71,614 50,731
Provision for loan losses 760 723 423
--------- --------- ---------
Net interest income after provision for loan losses 76,994 70,891 50,308
Noninterest income:
Service charges on deposits 4,634 4,435 2,855
Brokerage and insurance commissions 3,157 2,680 1,937
Loan related fees (1,056) 1,081 954
Gain on sales of loans 5,993 3,955 301
Gain on sales of securities 9 -- --
Other 3,939 4,329 3,203
--------- --------- ---------
Total noninterest income 16,676 16,480 9,250
Noninterest expenses:
Compensation, payroll taxes and other employee benefits
31,350 28,710 19,186
Occupancy and equipment 10,533 10,257 7,208
Amortization of goodwill -- 3,098 1,066
Amortization of other intangible assets 662 662 331
Other 11,624 12,277 8,353
--------- --------- ---------
Total noninterest expenses 54,169 55,004 36,144
--------- --------- ---------
Income before income taxes 39,501 32,367 23,414
Income taxes 12,956 12,084 8,709
--------- --------- ---------
Net income (loss) $ 26,545 $ 20,283 $ 14,705
========= ========= =========
Per share data:
Earnings per share - basic $ 1.26 $ 0.95 See Note 1
========= =========
Earnings per share - diluted $ 1.23 $ 0.94 See Note 1
========= =========
Cash dividends per share paid $ 0.34 $ 0.28 N/A
========= =========
See accompanying notes to consolidated financial statements.
65
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholder's Equity
Additional Unearned
Common Paid-In Retained ESOP
Stock Capital Earnings Shares
--------- ---------- --------- ---------
(In Thousands)
Balances at January 1, 2000 $ -- $ -- $ 169,746 $ --
Comprehensive income:
Net income -- -- 14,705 --
Other comprehensive income
Change in net unrealized gain (loss) on securities
available-for-sale, net of deferred income tax
benefit of $3,636 -- -- -- --
Total comprehensive income
Sale of common stock 61 58,238 -- (609)
Issuance of common stock in acquisition 50 50,025 -- --
Purchase of shares for the ESOP -- -- -- (8,362)
Capitalization of Mutual Holding Company 112 (112) (100) --
--------- --------- --------- ---------
Balances at December 31, 2000 223 108,151 184,351 (8,971)
Comprehensive income:
Net income -- -- 20,283 --
Other comprehensive income
Change in net unrealized gain (loss) on
securities available-for-sale, net of
deferred income tax liability of $2,940 -- -- -- --
Total comprehensive income
Purchase of treasury stock -- -- -- --
Issuance of management recognition plan shares -- (419) -- --
Committed ESOP shares -- 311 -- 1,150
Cash dividends ($0.28 per share) -- (2,857) --
Purchase of shares for the ESOP -- -- -- (29)
--------- --------- --------- ---------
Balances at December 31, 2001 223 108,043 201,777 (7,850)
Comprehensive income:
Net income -- -- 26,545 --
Other comprehensive income
Change in net unrealized gain (loss) on
securities available-for-sale, net of
deferred income tax benefit of $2,593 -- -- -- --
Total comprehensive income -- -- -- --
Purchase of treasury stock -- -- -- --
Committed ESOP shares -- 1,207 -- 1,203
Exercise of stock options -- (176) -- --
Amortization of deferred compensation -- -- -- --
Cash dividends ($0.34 per share) -- -- (3,390) --
--------- --------- --------- ---------
Balances at December 31, 2002 $ 223 $ 109,074 $ 224,932 $ (6,647)
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
66
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholder's Equity
Accumulated Other Unearned
Comprehensive Deferred Treasury
Income (Loss) Compensation Stock Total
----------------- ------------ -------- ---------
(In Thousands)
Balances at January 1, 2000 $ (5,926) $ -- $ -- $ 163,820
Comprehensive income:
Net income -- -- -- 14,705
Other comprehensive income
Change in net unrealized gain (loss) on
securities available-for-sale, net of
deferred income tax benefit of $3,636 6,569 -- -- 6,569
---------
Total comprehensive income -- -- -- 21,274
Sale of common stock -- -- -- 57,690
Issuance of common stock in acquisition -- -- -- 50,075
Purchase of shares for the ESOP -- -- -- (8,362)
Capitalization of Mutual Holding Company -- -- -- (100)
--------- --------- --------- ---------
Balances at December 31, 2000 643 -- -- 284,397
Comprehensive income:
Net income -- -- -- 20,283
Other comprehensive income
Change in net unrealized gain (loss) on
securities available-for-sale, net of
deferred income tax liability of $2,940 5,375 -- -- 5,375
---------
Total comprehensive income -- -- -- 25,658
Purchase of shares for the ESOP -- (4,920) (4,920)
Issuance of management recognition plan shares -- (4,047) 4,854 388
Committed ESOP shares -- -- -- 1,461
Cash dividends ($0.28 per share) -- -- -- (2,857)
Purchase of ESOP shares -- -- -- (29)
--------- --------- --------- ---------
Balances at December 31, 2001 6,018 (4,047) (66) 304,098
Comprehensive income:
Net income -- -- -- 26,545
Other comprehensive income
Change in net unrealized gain (loss) on
securities available-for-sale, net of
deferred income tax benefit of $2,593 4,469 -- -- 4,469
---------
Total comprehensive income -- -- -- 31,014
Purchase of treasury stock -- -- (12,417) (12,417)
Committed ESOP shares -- -- -- 2,410
Exercise of stock options -- -- 622 446
Amortization of deferred compensation -- 914 -- 914
Cash dividends ($0.34 per share) -- -- -- (3,390)
--------- --------- --------- ---------
Balance at December 31, 2002 $ 10,487 $ (3,133) $ (11,861) $ 323,075
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
67
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31
2002 2001 2000
--------- --------- ---------
(In Thousands)
OPERATING ACTIVITIES:
Net income $ 26,545 $ 20,283 $ 14,705
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 760 723 423
Provision for depreciation 2,811 2,621 1,719
Amortization of intangibles 662 3,760 1,397
Amortization of cost of stock benefit plans 3,298 1,849 --
Net premium (discount) amortization on securities 119 (1,225) (538)
Net change in loans originated for sale (8,657) (20,897) (6,627)
Net gain on sale of available-for-sale securities (9) -- --
Gain on sales of loans (5,993) (3,955) (301)
Gain on sale of real estate owned (184) (618) (845)
Increase (decrease) in other liabilities (9,971) 147 7,441
(Increase) decrease in other assets (1,140) 1,723 2,263
(Increase) decrease in accrued interest receivable 2,192 2,247 (2,043)
Other -- -- 1,734
--------- --------- ---------
Net cash provided by operating activities 10,433 6,658 19,328
INVESTING ACTIVITIES:
Net purchases of investments in mutual funds (1,030) (1,652) (1,827)
Proceeds from maturities of investment securities 55,929 177,742 52,173
Purchases of investment securities (35,360) (173,288) (166,372)
Purchases of mortgage-related securities (365,312) (176,658) --
Principal repayments on mortgage-related securities 275,518 128,257 52,467
Net (increase) decrease in loans receivable 143,192 140,348 (70,589)
Proceeds from sale of foreclosed properties 1,182 3,391 4,387
Net increase in Federal Home Loan Bank stock (1,652) (2,307) (1,639)
Net purchases of premises and equipment (3,658) (1,963) (1,597)
Business acquisition, net of cash and cash equivalents -- -- (71,143)
--------- --------- ---------
Net cash provided (used) by investing activities 68,809 93,870 (204,140)
See accompanying notes to consolidated financial statements.
68
Bank Mutual Corporation and Subsidiaries
Consolidated Statements of Cash Flows (continued)
YEAR ENDED DECEMBER 31
2002 2001 2000
--------- --------- ---------
(In Thousands)
FINANCING ACTIVITIES:
Net increase (decrease) in deposits $ 36,761 $ 196,545 $ (21,794)
Net increase (decrease) in short-term borrowings (656) 2,200 (46,792)
Proceeds from long-term borrowings 8,245 79,806 145,126
Repayments on long-term borrowings (117,971) (184,270) (44,305)
Net decrease in advance payments by borrowers for taxes
and insurance (439) (813) (9,888)
Proceeds from sale of stock -- -- 58,299
Proceeds from exercise of stock options 472 -- --
Increase in unearned ESOP shares -- (29) (8,971)
Cash dividends (3,390) (2,857) --
Purchase of treasury stock (12,417) (4,920) --
Capitalization of Mutual Savings Bancorp, MHC -- -- (100)
--------- --------- ---------
Net cash provided (used) by financing activities (89,395) 85,662 71,575
--------- --------- ---------
Increase (decrease) in cash and cash equivalents (10,153) 186,190 (113,237)
Cash and cash equivalents at beginning of year 251,912 65,722 178,959
--------- --------- ---------
Cash and cash equivalents at end of year $ 241,759 $ 251,912 $ 65,722
========= ========= =========
Supplemental information:
Interest paid on deposits $ 65,438 $ 90,209 $ 61,045
Income taxes paid 13,684 12,639 9,087
Loans transferred to foreclosed properties and
repossessed assets 1,406 410 2,697
Loans transferred from loans held for sale to portfolio -- -- 5,162
Issuance of management recognition plan shares -- 4,435 --
See accompanying notes to consolidated financial statements.
69
Bank Mutual Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
(Dollars in Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Bank Mutual Corporation (the Company) is a United States corporation chartered
by the Office of Thrift Supervision. It was chartered on November 1, 2000, to
become the mid-tier holding company in the regulatory restructuring of Mutual
Savings Bank into mutual holding company form. To accomplish the transaction,
Mutual Savings Bank adopted a plan of restructuring and, as of November 1, 2000,
converted from a mutual savings bank to a mutual holding company. The Company
became a holder of all of the shares of Mutual Savings Bank, which was
rechartered as a federal stock savings bank. Mutual Savings Bancorp, MHC, a
U.S.-chartered mutual holding company of which Mutual Savings Bank's depositors
hold all of the voting and membership rights, owns 11,193,174 shares of common
stock, or 51.5% of the Company's stock at December 31, 2002.
The Company issued 6,141,006 shares of common stock to public shareholders in
the subscription stock offering conducted in connection with the restructuring.
Net proceeds to the Company were $58,299. Expenses related to the offering
totaled $3,111, and $609 was loaned by the Company to the Company's Employee
Stock Ownership Plan (ESOP) to purchase 60,910 shares of common stock. See Note
9 for further discussion of the ESOP.
Concurrent with the restructuring, the Company issued 5,007,485 shares of common
stock and cash of $75,112 for all the issued and outstanding common stock of
First Northern Capital Corp. (First Northern), the parent company of First
Northern Savings Bank.
As a result of the restructuring and the First Northern Acquisition, Mutual
Savings Bank and First Northern Savings Bank (together the Banks) became wholly
owned subsidiaries of the Company. See Note 14 for discussion on the combination
of the two wholly owned subsidiaries.
BUSINESS
The Banks are federal savings banks offering a full range of financial services
to customers who are primarily located in the state of Wisconsin. The Banks are
principally engaged in the business of attracting deposits from the general
public and using such deposits to originate residential and commercial real
estate loans, consumer loans, and commercial and industrial loans.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts and transactions of
the Company and its wholly owned subsidiaries, the Banks. Mutual Savings Bank
has the following wholly owned subsidiaries: Lake Financial and Insurance
Services, Mutual Investment Corporation and MC Development Ltd. First Northern
Savings Bank has the following wholly owned subsidiaries: First Northern
Investments Inc. and Great Northern Financial Services Corporation. Significant
intercompany accounts and transactions have been eliminated in consolidation.
First Northern Savings Bank also has a 50% owned subsidiary, Savings Financial
Corporation, which is accounted for using the equity method.
70
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the statement of financial condition and revenues
and expenses for the period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers federal funds sold and interest-bearing deposits that have
original maturities of three months or less to be cash equivalents.
FEDERAL HOME LOAN BANK STOCK
Stock of the Federal Home Loan Bank (FHLB) is owned due to regulatory
requirements and carried at cost which is its redeemable value.
INVESTMENT AND MORTGAGE-RELATED SECURITIES AVAILABLE-FOR-SALE
Available-for-sale securities are stated at fair value, with the unrealized
gains and losses, net of tax, reported as a separate component of equity.
The amortized cost of securities classified as available-for-sale is adjusted
for amortization of premiums and accretion of discounts to maturity, or in the
case of mortgage-related securities, over the estimated life of the security.
Such amortization is included in interest income from investments. Interest and
dividends are included in interest income from investments. Realized gains and
losses and declines in value judged to be other-than-temporary are included in
net gain or loss on sales of securities and are based on the specific
identification method.
LOANS HELD FOR SALE
Loans held for sale, which generally consist of current production of certain
fixed-rate mortgage loans, are recorded at the lower of aggregate cost or market
value. Fees received from the borrower are deferred and recorded as an
adjustment of the carrying value.
LOANS RECEIVABLE AND RELATED INTEREST INCOME
Interest on loans is accrued and credited to income as earned. Accrual of
interest is generally discontinued either when reasonable doubt exists as to the
full, timely collection of interest or principal or when a loan becomes
contractually past due by more than 90 days with respect to interest or
principal. At that time, any accrued but uncollected interest is reversed and
additional income is recorded only to the extent that payments are received and
the collection of principal is reasonably assured. Loans are restored to accrual
status when the obligation is brought current, has performed in accordance with
the contractual terms for a reasonable period of time and the ultimate
collectibility of the total contractual principal and interest is reasonably
assured.
LOAN FEES AND RELATED COSTS
Loan origination and commitment fees and certain direct loan origination costs
are deferred and amortized as an adjustment of the related loans' yield. The
Company amortizes these amounts using the level-yield method over the
contractual life of the related loans.
71
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ALLOWANCE FOR LOAN LOSSES
The Company evaluates impairment of loans when they warrant such review. A loan
is considered impaired when the carrying amount of the loan exceeds the present
value of the expected future cash flows, discounted at the loan's original
effective interest rate or the fair value of the underlying collateral. The
allowance is charged for an amount equal to the impairment. General valuation
allowances are based on an evaluation of the various risk components that are
inherent in the credit portfolio. The risk components that are evaluated include
past loan loss experience; the level of nonperforming and classified assets;
current economic conditions; volume, growth and composition of the loan
portfolio; adverse situations that may affect borrowers' ability to repay; the
estimated value of any underlying collateral; peer group comparisons; regulatory
guidance; and other relevant factors.
The allowance is increased by provisions charged to earnings and reduced by
charge-offs, net of recoveries. The allowance reflects management's best
estimate of the amount necessary to provide for probable and estimatable losses
on loans. The allowance is based on a risk model developed and implemented by
management and approved by the Banks' Boards of Directors.
MORTGAGE SERVICING RIGHTS
Mortgage servicing rights are recorded as an asset when loans are sold with
servicing rights retained. The cost of mortgage service rights is amortized in
proportion to, and over the period of, estimated net servicing revenues.
Impairment of mortgage servicing rights is assessed based on the fair value of
those rights. Fair values are estimated using discounted cash flows based on
current market assumptions.
FORECLOSED PROPERTIES AND REPOSSESSED ASSETS
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. Costs
related to the development and improvement of property are capitalized, whereas
costs related to holding the property are expensed. Gains and losses on sales
are recognized based on the carrying value upon closing of the sale.
PREMISES AND EQUIPMENT
Land, buildings, leasehold improvements and equipment are carried at amortized
cost. Buildings and equipment are depreciated over their estimated useful lives
using the straight-line method. Leasehold improvements are amortized over the
shorter of their useful lives or lease terms. The Company reviews buildings,
leasehold improvements and equipment for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Impairment exists when the estimated undiscounted cash flows for
the property are less than its carrying value. If identified, an impairment loss
is recognized through a charge to earnings based on the fair value of the
property.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill, representing the excess of purchase price over the fair value of net
assets acquired, results from acquisitions made by the Company. Goodwill is
reviewed at least annually for impairment based upon guidelines specified by
Statement of Financial Accounting Standards (SFAS) No. 142 - "Goodwill and Other
Intangible Assets." Other intangible assets, primarily attributed to the
customer relationships acquired, are amortized over their estimated useful
lives, generally seven - fifteen years. Other intangible assets are reviewed if
facts and circumstances indicate that they may be impaired. Prior to January 1,
2002, the Company amortized goodwill on a straight-line basis over periods of
ten to twenty years and periodically assessed whether events or changes in
circumstances indicated that the carrying amount of goodwill might be impaired.
72
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LIFE INSURANCE POLICIES
Investments in life insurance policies owned by the Company are carried at the
amount that could be realized under the insurance contract.
INCOME TAXES
The Company files a consolidated federal income tax return and separate, or
combined, state income tax returns, depending on the state. A deferred tax asset
or liability is determined based on the enacted tax rates that will be in effect
when the differences between the financial statement carrying amounts and tax
bases of existing assets and liabilities are expected to be reported in the
Company's income tax returns. The effect on deferred taxes of a change in tax
rates is recognized in income in the period that includes the enactment date of
the change. A valuation allowance is provided for any deferred tax asset for
which it is more likely than not that the asset will not be realized. Changes in
valuation allowances are recorded as a component of income taxes.
EARNINGS PER SHARE
Basic and diluted earnings per share (EPS) are computed by dividing net income
by the weighted-average number of common shares outstanding for the period. ESOP
shares committed to be released are considered outstanding. Shares of restricted
stock which have been awarded under the management recognition plan (MRP)
provisions of the Company's 2001 Stock Incentive Plan, whether or not vested,
are considered common stock equivalents and are included in the weighted-average
number of shares outstanding for basic EPS. If dilutive, nonvested MRP shares
are considered common stock equivalents and are included in the weighted-average
number of shares outstanding for diluted EPS. The calculation of EPS for the
period subsequent to the Mutual Savings Bank restructuring and First Northern
Savings Bank merger reflects the actual weighted-average shares outstanding for
the period November 1, 2000 to December 31, 2000, including both shares issued
in the stock offering conducted in connection with the restructuring as well as
shares issued in conjunction with the First Northern Acquisition. The
calculation of EPS for the two-month period November 1, 2000 to December 31,
2000, was $0.15 per share and is calculated based on net income for the
two-month period of $3,182 and the weighted-average shares outstanding of
21,570,803. No earnings per share are reflected for periods prior to November 1,
2000, because there were no shares outstanding prior to the restructuring.
PENSION COSTS
The Company has both defined-benefit and defined-contribution plans. The
Company's net periodic pension cost of the defined-benefit plan consists of the
expected cost of benefits earned by employees during the current period and an
interest cost on the projected benefit obligation, reduced by the expected
earnings on assets held by the retirement plan, amortization of transitional
assets over a period of 15 years, amortization of prior service cost and
amortization of recognized actuarial gains and losses over the estimated future
service period of existing plan participants. The costs associated with the
defined-contribution plans consist of a predetermined percentage of
compensation, which is determined by the Banks' Board of Directors.
SEGMENT INFORMATION
The Company has determined that it has one reportable segment - community
banking. The Banks offer a range of financial products and services to external
customers, including: accepting deposits from the general public; originating
residential, consumer and commercial loans; and marketing annuities and other
insurance products. Revenues for each of these products are disclosed in the
consolidated statements of income.
73
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GUARANTEES
In November 2002, the FASB issued Interpretation No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" (the Interpretation). The Interpretation will
significantly change (in 2003) current practice in the accounting for, and
disclosure of, guarantees. The Interpretation requires certain guarantees to be
recorded at fair value, which is different from current practice, which is
generally to record a liability only when a loss is probable and reasonably
estimatable, as those terms are defined in FASB Statement No. 5, "Accounting for
Contingencies." The recording of the liability will not significantly affect the
Company's financial condition. The Interpretation also requires a guarantor to
make significant new disclosures (see below) even when the likelihood of making
any payments under the guarantee is remote, which is another change from current
practice.
The Company has entered into an agreement whereby, for an initial fee and annual
fee, certain of its United States Treasury notes are pledged as collateral for
an Industrial Development Revenue Bond which was issued by a local municipality
to finance commercial real estate owned by a third party, unrelated to the
Company. Under the terms of the agreement, Mutual Savings Bank must maintain
with a trustee collateral with a fair market value, as defined, aggregating 108%
or more of the sum of the outstanding principal balance of the bonds plus
accrued interest on the outstanding principal. The Company continues to receive
interest payments on the collateral.
At December 31, 2002 and 2001, United States Treasury notes with outstanding
principal balances aggregating approximately $10,000 were held by the trustee as
collateral for these bonds which had an outstanding principal balance of $4,305
and $4,615 at December 31, 2002 and 2001, respectively. The third-party borrower
is current on all scheduled payments due under the bond issue, which has a
scheduled maturity of December 15, 2009.
RECENT ACCOUNTING CHANGES
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" and No. 142, "Goodwill and Other Intangible Assets,"
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill and certain intangible assets are no longer amortized but are
reviewed at least annually for impairment. Separable intangible assets that are
not deemed to have indefinite lives will no longer be amortized but will be
subject to annual impairment tests in accordance with the SFAS. Other intangible
assets will continue to be amortized over their useful lives. See Note 4.
Goodwill, Other Intangible Assets and Mortgage Servicing Rights.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which supercedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
and the provisions for the disposal of a segment of a business in APB Opinion
No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." This statement requires that long-lived
assets to be disposed of by sale be measured at the lower of their carrying
amount or fair value less cost to sell, and recognition of impairment losses on
long-lived assets to be held if the carrying amount of the long-lived asset is
not recoverable from its undiscounted cash flows and exceeds its fair value.
Additionally, SFAS No. 144 resolved various implementation issues related to
SFAS No. 121. The provisions of SFAS No. 144 were adopted on January 1, 2002 and
had no effect on the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This statement nullifies Emerging Issues Task
Force Issue No. 94-3 "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" and requires that a liability for costs associated with an
exit or disposal activity be recognized when the liability is probable and
represents obligations to transfer assets or provide services as a result of
past transactions. The provisions of this statement are effective for exit or
disposal activities that are initiated after December 31, 2002 and are not
expected to have a material impact on the Company's consolidated financial
statements.
74
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
On December 31, 2002, FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation" to provide alternative methods of
transition to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure provisions of SFAS
No. 123 to require disclosure in the summary of significant accounting policies
of the effect of the Company's accounting policy with respect to stock-based
employee compensation on reported net income and earnings per share in annual
and interim financial statements. SFAS No. 148's amendment of the transition and
annual disclosure provisions of SFAS No. 123 are effective for fiscal years
ending after December 15, 2002. Bank Mutual will continue to account for
stock-based compensation in accordance with APB Opinion 25 as allowed under FASB
No. 123.
In May 2001, Bank Mutual shareholders approved the 2001 Stock Incentive Plan,
providing for the grant of stock options up to 1,114,849 shares and restricted
stock ("MRP") awards up to 334,454 shares. Of these, 330,000 MRP shares were
granted during the year ended December 31, 2001 to employees in management
positions and 2,800 shares were subsequently forfeited. No shares were granted
during the year ended December 31, 2002. The outstanding MRP grants had a fair
value of $7,568 at December 31, 2002. The grants under the MRP are being
amortized to compensation expense as the Company's employees become vested in
the awarded shares.
The amount amortized to expense was $885 for the year ended December 31, 2002
and $388 for the year ended December 31, 2001. The remaining unamortized cost of
the MRP is reflected as a reduction of shareholders' equity as unearned deferred
compensation.
Options for 1,104,000 shares were granted on May 8, 2001 at an exercise price of
$11.76. Options for 1,045,894 shares remain outstanding at December 31, 2002, of
which options for 218,800 shares were vested. In addition, options for 40,106
shares were exercised in 2002 and options for 18,000 shares have been forfeited.
As a result of OTS regulatory requirements resulting from the mutual holding
company structure, Bank Mutual will need to purchase up to approximately 1.45
million shares of its common stock for issuance pursuant to awards which have
been or are made under the Stock Incentive Plan. Bank Mutual has repurchased
956,000 shares through December 31, 2002 with no specific schedule announced for
the completion of these purchases. Because of the options' vesting schedules
under the Stock Incentive Plan, Bank Mutual would not be required to repurchase
in the near future all of the shares which the Stock Incentive Plan will
ultimately require.
The estimated fair value of each option granted is calculated using the
Black-Scholes option-pricing model. The following summarizes the weighted
average assumptions used in the model:
2002 2001
----- -----
Risk-free interest rate 5.30% 5.30%
Dividend yield 2.00% 2.00%
Expected stock volatility 26.30% 26.30%
Expected years until exercise 7.0 8.0
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. Option valuation models such as the Black-Scholes require the
input of highly subjective assumptions including the expected stock price
volatility. Bank Mutual's stock options have characteristics significantly
different from traded options and inasmuch, changes in the subjective input
assumptions can materially affect the fair value estimate. In management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock options.
Bank Mutual accounts for the stock options in accordance with APB Opinion 25, as
allowed under FASB No. 123, and, therefore, no compensation cost has been
recognized in connection with stock options granted in any year. Pursuant to
FASB No. 123 disclosure requirements, pro forma net income and earnings per
share are presented below as if compensation cost for stock options was
determined under the fair value method and amortized to expense over the
options' vesting periods.
75
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
YEAR ENDED DECEMBER 31
2002 2001
---------- ----------
Net income:
As reported $ 26,545 $ 20,283
Pro forma $ 25,826 $ 19,819
Basic earnings per share:
As reported $ 1.26 $ 0.95
Pro forma $ 1.22 $ 0.92
Diluted earnings per share:
As reported $ 1.23 $ 0.94
Pro forma $ 1.20 $ 0.92
The pro forma amounts may not be indicative of the effect on reported net income
and earnings per share for future years as current options vest over five years.
RECLASSIFICATIONS
Certain 2001 and 2000 amounts have been reclassified to conform to the 2002
presentation.
76
2. SECURITIES, AVAILABLE-FOR-SALE
The amortized cost and fair value of investment securities available-for-sale
are as follows:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
At December 31, 2002:
Investment securities:
U.S. government and federal agency obligations $ 26,955 $ 1,257 $ -- $ 28,212
Corporate issue obligations 9,586 59 (82) 9,563
Mutual funds 34,148 26 (140) 34,034
Federal Home Loan Mortgage Corporation stock 1,440 -- (23) 1,417
-------- ------- ------- --------
Total investment securities 72,129 1,342 (245) 73,226
Mortgage-related securities:
Federal Home Loan Mortgage Corporation 284,647 3,610 (144) 288,113
Federal National Mortgage Association 285,817 10,856 (69) 296,604
Private Placement CMOs 8,208 198 -- 8,406
Government National Mortgage Association 24,286 714 -- 25,000
-------- ------- ------- --------
Total mortgage-related securities 602,958 15,378 (213) 618,123
======== ======= ======= ========
Total $675,087 $16,720 $ (458) $691,349
======== ======= ======= ========
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
At December 31, 2001:
Investment securities:
U.S. government and federal agency obligations $ 39,667 $ 1,652 $ -- $ 41,319
Corporate issue obligations 17,300 55 (166) 17,189
Mutual funds 33,120 19 (157) 32,982
Federal Home Loan Mortgage Corporation stock 1,440 129 -- 1,569
-------- ------- ------- --------
Total investment securities 91,527 1,855 (323) 93,059
Mortgage-related securities:
Federal Home Loan Mortgage Corporation 162,365 948 (1,418) 161,895
Federal National Mortgage Association 321,198 8,214 (782) 328,630
Private Placement CMOs 28,137 662 (16) 28,783
Government National Mortgage Association 1,716 60 -- 1,776
-------- ------- ------- --------
Total mortgage-related securities 513,416 9,884 (2,216) 521,084
======== ======= ======= ========
Total $604,943 $11,739 $(2,539) $614,143
======== ======= ======= ========
The amortized cost and fair values of securities by contractual maturity at
December 31, 2002, are shown below. Actual maturities may differ from
contractual maturities because issuers have the right to call or prepay
obligations with or without call or prepayment penalties.
77
2. SECURITIES, AVAILABLE-FOR-SALE (CONTINUED)
AMORTIZED FAIR
COST VALUE
--------- --------
Due in one year or less $ 19,041 $ 19,530
Due after one year through five years 17,500 18,245
Due after five years through ten years -- --
Mutual funds 34,148 34,034
Federal Home Loan Mortgage Corporation stock 1,440 1,417
Mortgage-related securities 602,958 618,123
-------- --------
$675,087 $691,349
======== ========
The following table summarizes the adjustment to other comprehensive income and
the related tax effect for each of the three years ended December 31:
2002 2001 2000
------- ------- --------
Unrealized holding gain (loss) on available-for-
sale securities arising during the period $ 7,062 $ 8,315 $ 10,205
Related tax (expense) benefit (2,593) (2,940) (3,636)
------- ------- --------
Change in other comprehensive income $ 4,469 $ 5,375 $ 6,569
======= ======= ========
Investment securities with a fair value of approximately $29,161 and $21,712 at
December 31, 2002 and 2001, were pledged to secure deposits and for other
purposes as permitted or required by law. See also Notes 6 and 11 for additional
information regarding security pledges.
3. LOANS RECEIVABLE
Loans receivable consist of the following:
DECEMBER 31
2002 2001
---------- ----------
Mortgage loans:
One-to-four family $ 827,648 $ 992,126
Multifamily 112,189 131,925
Commercial real estate 186,960 165,556
Construction and development 127,174 125,611
---------- ----------
Total mortgage real estate loans 1,253,971 1,415,218
Consumer and other loans:
Fixed equity 234,049 200,500
Home equity lines of credit 77,697 76,472
Student 22,636 25,410
Home improvement 6,993 9,439
Automobile 68,140 77,621
Other 22,434 25,886
---------- ----------
Total consumer and other loans 431,949 415,328
Total commercial business loans 61,060 60,932
---------- ----------
Total loans receivable 1,746,980 1,891,478
Less:
Undisbursed loan proceeds 46,048 44,467
Allowance for loan losses 12,743 12,245
Unearned loan fees and discounts 2,527 3,611
---------- ----------
61,318 60,323
---------- ----------
Total loans receivable - net $1,685,662 $1,831,155
========== ==========
78
3. LOANS RECEIVABLE (CONTINUED)
The Company's first mortgage loans and home equity lines of credit are primarily
secured by properties housing one-to-four families which are generally located
in the Company's local lending areas in Wisconsin, Michigan and Minnesota. There
are no significant loans which are considered to be impaired at December 31,
2002 or 2001. Non-accrual loans at December 31, 2002 were $7,283 and at December
31, 2001, were $2,654.
A summary of the activity in the allowance for loan losses follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
-------- -------- --------
Balance at beginning of year $ 12,245 $ 12,238 $ 6,948
Provisions 760 723 423
Allowance of acquired business -- -- 5,028
Charge-offs (481) (817) (194)
Recoveries 219 101 33
-------- -------- --------
Balance at end of year $ 12,743 $ 12,245 $ 12,238
======== ======== ========
The unpaid principal balance of loans serviced for others was $638,801,
$583,057, and $440,207 at December 31, 2002, 2001 and 2000, respectively. These
loans are not reflected in the consolidated financial statements.
4. GOODWILL, OTHER INTANGIBLE ASSETS AND MORTGAGE SERVICING RIGHTS
The following is a reconciliation of reported net income and earnings per share
to net income and earnings per share adjusted as if SFAS No. 142 had been
adopted on January 1, 2000 (in thousands except per share amounts):
YEAR ENDED DECEMBER 31
2002 2001 2000
---------- ---------- ----------
Net income:
As reported $ 26,545 $ 20,283 $ 14,705
Add back: Goodwill amortization -- 3,098 1,066
---------- ---------- ----------
Adjusted net income $ 26,545 $ 23,381 $ 15,771
========== ========== ==========
Basic earnings per share:
As reported $ 1.26 $ 0.95 See Note 1
Add back: Goodwill amortization -- .14 --
---------- ---------- ----------
Adjusted basic earnings per share $ 1.26 $ 1.09 See Note 1
========== ========== ==========
Diluted earnings per share:
As reported $ 1.23 $ 0.94 See Note 1
Add back: Goodwill amortization -- .14 --
---------- ---------- ----------
Adjusted diluted earnings per share $ 1.23 $ 1.08 See Note 1
========== ========== ==========
79
4. GOODWILL, OTHER INTANGIBLE ASSETS AND MORTGAGE SERVICING RIGHTS (CONTINUED)
The carrying amount of mortgage servicing rights net of accumulated amortization
and the associated valuation allowance at December 31, 2002 is presented in the
following table.
2002 2001 2000
------- ------- -------
Mortgage servicing rights at beginning of year $ 4,738 $ 3,442 $ 3,711
Servicing rights 3,251 2,397 232
Amortized servicing rights (1,840) (1,101) (501)
------- ------- -------
Mortgage servicing rights at end of year 6,149 4,738 3,442
Valuation allowance (3,089) (487) --
------- ------- -------
Balance $ 3,060 $ 4,251 $ 3,442
======= ======= =======
Deposit based intangible had a carrying amount and a value net of accumulated
amortization of $5,734 at December 31, 2002.
The projections of amortization expense shown below for mortgage servicing
rights are based on existing asset balances and the existing interest rate
environment as of December 31, 2002. Future amortization expense may be
significantly different depending upon changes in the mortgage servicing
portfolio, mortgage interest rates and market conditions.
The following table shows the current period and estimated future amortization
expense for amortized intangible assets:
MORTGAGE
SERVICING DEPOSIT BASE
RIGHTS INTANGIBLES TOTAL
--------- ------------ ------
Twelve months ended December 31, 2002 (actual) $2,999 $ 662 $3,660
====== ====== ======
Estimate for year ending December 31,
2003 $1,784 $ 662 $2,445
2004 1,242 662 1,903
2005 34 662 695
2006 -- 662 661
2007 -- 662 661
Thereafter -- 2,424 2,429
------ ------ ------
$3,060 $5,734 $8,794
====== ====== ======
80
5. OTHER ASSETS
Other Assets are summarized as follows:
DECEMBER 31
2002 2001
-------- --------
Accrued interest:
Mortgage-related securities $ 2,481 $ 2,431
Investment securities 1,516 1,721
Loans receivable 7,399 9,436
-------- --------
Total accrued interest 11,396 13,588
Foreclosed properties and repossessed assets 750 382
Premises and equipment 44,034 43,187
Federal Home Loan Bank stock, at cost 32,885 31,233
Life insurance policies 17,141 15,938
Other 10,017 8,714
-------- --------
$116,223 $113,042
======== ========
Foreclosed properties and repossessed assets are summarized as follows:
DECEMBER 31
2002 2001
-------- --------
Acquired by foreclosure or in lieu of foreclosure $ 733 $ 346
Repossessed collateral 17 36
-------- --------
$ 750 $ 382
======== ========
Premises and equipment are summarized as follows:
DECEMBER 31
2002 2001
-------- --------
Land and land improvements $ 11,297 $ 11,098
Office buildings 39,074 38,128
Furniture and equipment 15,642 15,205
Leasehold improvements 1,092 1,227
-------- --------
67,105 65,658
Less allowances for depreciation and amortization 23,071 22,471
-------- --------
$ 44,034 $ 43,187
======== ========
Depreciation expense for 2002, 2001 and 2000 was $2,811, $2,621, and $1,719,
respectively.
The Banks lease various branch offices, office facilities and equipment under
noncancelable operating leases which expire on various dates through 2012.
Future minimum payments under noncancelable operating leases with initial or
remaining terms of one year or more for the years indicated are as follows at
December 31, 2002:
2003 $1,121
2004 775
2005 572
2006 508
2007 420
Thereafter 1,154
------
Total $4,550
======
Rental expenses totaled $1,022, $923, and $628 for 2002, 2001 and 2000,
respectively.
81
6. DEPOSITS
Deposits are summarized as follows:
DECEMBER 31
2002 2001
---------- ----------
Checking accounts:
Noninterest-bearing $ 98,941 $ 96,362
Interest-bearing 149,008 137,317
---------- ----------
247,949 233,679
Money market accounts 351,433 335,946
Savings accounts 230,170 214,859
Certificate accounts:
Due within one year 681,339 934,378
After one but within two years 185,125 262,910
After two but within three years 216,002 57,514
After three but within four years 58,768 31,406
After four but within five years 155,869 19,748
After five years -- --
---------- ----------
1,297,103 1,305,956
---------- ----------
$2,126,655 $2,090,440
========== ==========
The aggregate amount of certificate accounts with balances of one hundred
thousand dollars or more is approximately $166,864, and $144,955 at December 31,
2002 and 2001, respectively.
Interest expense on deposits was as follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
------- ------- -------
Interest-bearing checking accounts $ 833 $ 1,208 $ 992
Money market accounts 6,673 12,200 12,208
Savings accounts 2,402 3,902 3,682
Certificate accounts 54,983 71,974 48,905
------- ------- -------
$64,891 $89,284 $65,787
======= ======= =======
82
7. BORROWINGS
Borrowings consist of the following:
DECEMBER 31
2002 2001
----------------------- ------------------------
Weighted- Weighted-
Average Average
Balance Rate Balance Rate
-------- --------- -------- ---------
Federal Home Loan Bank
advances maturing:
2002 -- -- $116,339 6.21%
2003 $ 60,888 5.50% 60,905 5.50
2004 231,765 5.61 231,773 5.61
2005 17,990 5.21 17,995 5.20
2006 7,946 4.86 7,947 4.85
Thereafter 13,710 5.65 7,066 5.71
Other borrowings 22,679 0.99 23,335 1.39
-------- --------
$354,978 $465,360
======== ========
Advances that mature in the year 2004 consist of borrowings that are redeemable
at the option of the FHLB.
The Banks are required to maintain unencumbered mortgage loans in their
portfolios aggregating at least 167% of the amount of outstanding advances from
the FHLB as collateral. The Banks' borrowings at the FHLB are limited to the
lesser of 35% of total assets or 60% of the book value of certain mortgage
loans. In addition, these notes are collateralized by FHLB stock of $32,885 and
$31,233 at December 31, 2002 and 2001, respectively.
The Banks are a Treasury Tax & Loan (TT&L) depository for the Federal Reserve
Bank (FRB), and as such, they accept TT&L deposits. The Banks are allowed to
borrow these deposits from the FRB until they are called. The interest rate is
the federal funds rate less 25 basis points. U.S. Treasury Securities with a
face value greater than or equal to the amount borrowed are pledged as a
condition of borrowing TT&L deposits. As of December 31, 2002 and 2001, the TT&L
deposits were $22,679 and $23,335, respectively.
First Northern Savings Bank has a line of credit with two financial institutions
which totals $10.0 million. At December 31, 2002 and 2001, no draws were
outstanding.
8. SHAREHOLDERS' EQUITY
The Banks are subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possible additional discretionary, actions by
regulators, that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Banks must meet specific
capital guidelines that involve quantitative measures of the Banks' assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Banks' capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by federal regulation to ensure adequacy
require the Banks to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier I capital (as these terms are defined in
regulations) to risk-weighted assets (as these terms are defined in
regulations), and of Tier I capital (as these terms are defined in regulations)
to average assets (as these terms are defined in regulations). Management
believes, as of December 31, 2002, that the Banks meet all capital adequacy
requirements to which they are subject.
83
8. SHAREHOLDERS' EQUITY (CONTINUED)
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------ ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- ------- ----- ------- -----
Mutual Savings Bank
As of December 31, 2002:
Total capital $152,715 17.42% $70,129 8.00% $87,661 10.00%
(to risk-weighted assets)
Tier 1 capital 146,111 16.67% 35,064 4.00% 52,596 6.00%
(to risk-weighted assets)
Tier 1 capital 146,111 7.77% 75,214 4.00% 94,017 5.00%
(to average assets)
First Northern Savings Bank
As of December 31, 2002:
Total capital $ 94,324 14.80% $50,995 8.00% $63,743 10.00%
(to risk-weighted assets)
Tier 1 capital 89,851 14.10% 25,497 4.00% 38,246 6.00%
(to risk-weighted assets)
Tier 1 capital 89,851 9.62% 37,360 4.00% 46,700 5.00%
(to average assets)
Mutual Savings Bank
As of December 31, 2001:
Total capital $145,141 15.46% $75,085 8.00% $93,856 10.00%
(to risk-weighted assets)
Tier 1 capital 138,300 14.74% 37,542 4.00% 56,314 6.00%
(to risk-weighted assets)
Tier 1 capital 138,300 7.19% 76,955 4.00% 96,193 5.00%
(to average assets)
First Northern Savings Bank
As of December 31, 2001:
Total capital $ 85,851 13.50% $50,805 8.00% $63,507 10.00%
(to risk-weighted assets)
Tier 1 capital 80,677 12.70% 25,403 4.00% 38,104 6.00%
(to risk-weighted assets)
Tier 1 capital 80,677 8.55% 37,748 4.00% 47,185 5.00%
(to average assets)
84
8. SHAREHOLDERS' EQUITY (CONTINUED)
The Company is not aware of any conditions or events, which would change the
Banks' status as well capitalized. There are no conditions or events since that
notification that management believes have changed the Banks' category.
Following are reconciliations of the Banks' equity under generally accepted
accounting principles to capital as determined by regulators:
MUTUAL SAVINGS BANK FIRST NORTHERN SAVINGS BANK
------------------------ ---------------------------
RISK- TIER I RISK- TIER I
BASED (CORE) BASED (CORE)
CAPITAL CAPITAL CAPITAL CAPITAL
--------- --------- --------- ---------
As of December 31, 2002:
Equity per bank records $ 166,399 $ 166,399 $ 138,758 $ 138,758
Unrealized gains on investments (9,625) (9,625) (1,002) (1,002)
Goodwill and intangibles (8,372) (8,372) (47,635) (47,635)
Investment in "nonincludable"
subsidiaries (2,089) (2,089) (208) (208)
Disallowed servicing assets (202) (202) (62) (62)
Equity investments required to be
deducted (21) -- (1,645) --
Allowance for loan losses 6,625 -- 6,118 --
--------- --------- --------- ---------
Regulatory capital $ 152,715 $ 146,111 $ 94,324 $ 89,851
========= ========= ========= =========
RISK- TIER I RISK- TIER I
BASED (CORE) BASED (CORE)
CAPITAL CAPITAL CAPITAL CAPITAL
--------- --------- --------- ---------
As of December 31, 2001:
Equity per bank records $ 154,430 $ 154,430 $ 129,928 $ 129,928
Unrealized gains on investments (5,281) (5,281) (894) (894)
Goodwill and intangibles (8,726) (8,726) (47,873) (47,873)
Investment in "nonincludable"
subsidiaries (2,123) (2,123) (354) (354)
Disallowed servicing assets -- -- (130) (130)
Equity investments required to be
deducted -- -- (230) --
Allowance for loan losses 6,841 -- 5,404 --
--------- --------- --------- ---------
Regulatory capital $ 145,141 $ 138,300 $ 85,851 $ 80,677
========= ========= ========= =========
85
8. SHAREHOLDERS' EQUITY (CONTINUED)
The compensation of basic and diluted earnings per share is presented in the
following table.
YEAR ENDED DECEMBER 31
-------------------------------------------
2002 2001 2000
----------- ----------- -----------
BASIC EARNINGS PER SHARE
Net income $ 26,545 $ 20,283 $ 14,705
=========== =========== ===========
Weighted average shares outstanding 20,995,707 21,320,080 21,570,803
Allocated ESOP shares for the period 89,188 89,188 --
Vested MRP shares for the period 65,580 31,366 --
----------- ----------- -----------
21,150,475 21,440,634 21,570,803
=========== =========== ===========
Basic earnings per share $ 1.26 $ 0.95 See Note 1
=========== ===========
DILUTED EARNINGS PER SHARE
Net income $26,545,000 $20,283,000 $14,705,000
=========== =========== ===========
Weighted average shares outstanding used
in basic earnings per share 21,150,475 21,150,475 21,570,803
Net dilutive effect of:
Stock option shares 352,985 129,471 --
Unvested MRP shares 75,934 25,385 --
----------- ----------- -----------
21,579,394 21,595,490 21,570,803
=========== =========== ===========
Diluted earnings per share $ 1.23 $ 0.94 See Note 1
=========== ===========
86
9. EMPLOYEE BENEFIT PLANS
Bank Mutual Corporation
Bank Mutual Corporation has a discretionary, defined-contribution savings plan
(the Savings Plan). The Savings Plan is qualified under Sections 401 and 401(k)
of the Internal Revenue Code and provides employees meeting certain minimum age
and service requirements the ability to make contributions to the Savings Plan
on a pretax basis. The Company then matches a percentage of the employee's
contributions. Matching contributions made by the Company or Mutual Savings Bank
were $103 in 2002, $89 in 2001 and $76 in 2000. Effective December 31, 2001,
First Northern Savings Bank's 401(k) Plan, described below, was combined with
the Savings Plan which was formerly maintained by Mutual Savings Bank. Effective
January 1, 2002, the Savings Plan became a defined contribution 401(k) plan for
employees of Bank Mutual and its subsidiaries.
Bank Mutual Corporation also has a defined-benefit pension plan covering
employees meeting certain minimum age and service requirements and a
supplemental pension plan for certain qualifying employees. The supplemental
pension plan is funded through a "rabbi trust" arrangement. The benefits are
generally based on years of service and the employee's average annual
compensation for five consecutive calendar years in the last ten calendar years
which produces the highest average. The Company's funding policy is to
contribute annually the amount necessary to satisfy the requirements of the
Employee Retirement Income Security Act of 1974. Prior to January 1, 2002, this
plan was maintained by Mutual Savings Bank. As of January 1, 2002, First
Northern Savings Bank employees meeting certain minimum age and service
requirements entered the defined benefit plan; for those First Northern Savings
Bank employees, only years of service after that date are counted for funding.
However, for vesting purposes, First Northern Savings Bank employees received
credit under the defined benefit plan for their years of service since joining
First Northern
The following tables set forth the defined benefit pension plan's funded status
and net periodic benefit cost:
2002 2001
-------- --------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year $ 16,435 $ 15,024
Service cost 1,251 803
Interest cost 1,163 1,096
Amendment -- 34
Actuarial loss (gain) 497 (209)
Benefits paid (364) (313)
-------- --------
Benefit obligation at end of year $ 18,982 $ 16,435
======== ========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 18,435 $ 16,221
Actual return on plan assets 1,266 2,417
Employer contributions 1,733 110
Benefits paid (364) (313)
-------- --------
Fair value of plan assets at end of year $ 21,070 $ 18,435
======== ========
FUNDED STATUS
Funded status at end of year $ 2,088 $ 2,000
Unrecognized net actuarial loss (1,511) (2,079)
Unrecognized prior service cost 591 720
Unrecognized net transition asset -- --
-------- --------
Prepaid benefit cost $ 1,168 $ 641
======== ========
Weighted-average assumptions used in cost calculations:
Discount rate 7.00% 7.50%
Rate of increase in compensation levels 5.00% 5.00%
Expected long-term rate of return on plan assets 7.00% 7.50%
87
9. EMPLOYEE BENEFIT PLANS (CONTINUED)
2002 2001 2000
------- ------- -------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 1,251 $ 803 $ 819
Interest cost 1,163 1,096 1,032
Expected return on plan assets (1,266) (1,196) (1,049)
Amortization of transition asset -- (50) (51)
Amortization of prior service cost 129 146 195
Recognized actuarial loss (gain) (4) 16 18
Amortization of gain from prior periods (68) -- --
------- ------- -------
Total net periodic benefit cost $ 1,205 $ 815 $ 964
======= ======= =======
Pension plan assets which consist primarily of immediate participation guarantee
contracts with an insurance company are actively managed by investment
professionals.
Mutual Savings Bank
Mutual Savings Bank has a deferred retirement plan for non-officer directors who
have provided at least five years of service. Four of the six existing eligible
directors' benefits have vested. In the event a director dies prior to
completion of these payments, payments will go to the director's heirs. Mutual
Savings Bank has funded these arrangements through "rabbi trust" arrangements,
and based on actuarial analyses believes these obligations are adequately
funded.
First Northern Savings Bank
Prior to January 1, 2002, First Northern Savings Bank had a participatory
defined-contribution 401(k) plan. The plan covered all employees with at least
one year of service and who attained age 21. First Northern Savings Bank
annually contributed 3% of an employee's gross earnings and had funded an
additional discretionary dollar amount to the plan. First Northern Savings Bank
also matched 50% of the first 4% of the amount of each employee's contribution.
In addition, each employee may contribute amounts in excess of 4%, up to the
lesser of 15% of compensation or federal tax limits, with no First Northern
Savings Bank participation. Total expense relating to this plan for the year
ended December 31, 2001 was $498 and for the two months ended December 31, 2000,
was $53. Effective December 31, 2001, the First Northern Savings Bank's
participatory defined-contribution 401(k) plan was combined with Mutual Savings
Bank's defined contribution 401(k) plan and as of January 1, 2002, a new
combined Bank Mutual defined contribution 401(k) plan was established, as
discussed above.
First Northern Savings Bank also has an unfunded deferred retirement plan for
the Bank's non-employee directors. All members of First Northern Savings Bank's
Board of Directors are eligible under the plan. Directors of predecessor
institutions who are members of an advisory board are eligible at the discretion
of First Northern Savings Bank. Currently there are four retired advisory board
members in the plan. First Northern Savings Bank also has supplemental
retirement plans for several executives. Total expense relating to these plans
for the year ended December 31, 2002 and 2001 was $191 and $225. For the two
months ended December 31, 2000 the expense was $17.
88
10. STOCK-BASED BENEFIT PLANS
In conjunction with the reorganization, the Company established an ESOP for the
employees of the Company and the Banks. The ESOP is a qualifying plan under
Internal Revenue Service guidelines. It covers all full-time employees who have
attained at least 21 years of age and completed one year of service. At November
1, 2000, the ESOP borrowed $609 from the Company and purchased 60,910 shares of
common stock issued in the public offering. Subsequent to this initial purchase,
through December 31, 2000, the ESOP borrowed an additional $8,362 and purchased
an additional 828,000 shares. In January 2001, the ESOP bought an additional
2,969 shares. Expense is recognized based on the fair value (average stock
price) of shares scheduled to be released from the ESOP trust. One-tenth of the
shares are scheduled to be released each year which started in 2001. Also,
additional shares may be released as the ESOP Trust receives cash dividends from
the unallocated shares held in the Trust. In 2002 and 2001, such additional
shares were released. ESOP expense for the year ended December 31, 2002 was
$2,414; for the year ended December 31, 2001 was $1,461; there was no ESOP
expense during the year ended December 31, 2000. ESOP shares not committed to be
released are not considered outstanding for the purposes of computing EPS.
The following table summarizes shares of Company common stock held by the ESOP
at December 31.
2002 2001 2000
-------- -------- --------
Shares allocated to participants 233,175 113,936 --
Unallocated and unearned shares 658,704 777,943 888,910
Fair value of unearned ESOP shares $ 15,236 $ 11,887 $ 8,445
11. INCOME TAXES
The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31
2002 2001 2000
-------- -------- -------
Current:
Federal $ 13,703 $ 10,768 $ 8,732
State (43) (113) (230)
-------- -------- -------
13,660 10,655 8,502
Deferred expense (benefit):
Federal (895) 1,125 (129)
State 191 304 335
-------- -------- -------
(704) 1,429 206
-------- -------- -------
$ 12,956 $ 12,084 $ 8,708
======== ======== =======
For state income tax purposes, certain subsidiaries have net operatings loss
carryovers of $13,251 available to offset against future income. The carryovers
expire in the years 2003 through 2018 if unused.
89
11. INCOME TAXES (CONTINUED)
The income tax provision differs from the provision computed at the federal
statutory corporate rate as follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
-------- -------- --------
Income before provision for income taxes $ 39,501 $ 32,367 $ 23,414
======== ======== ========
Tax expense at federal statutory rate $ 13,825 $ 11,328 $ 8,195
Increase (decrease) in taxes resulting from:
State income taxes - net of federal tax benefit (521) 124 70
Nondeductible intangible amortization -- 1,177 466
Bank Owned Life Insurance (317) (381) --
Other (31) (164) (23)
-------- -------- --------
Provision for income taxes $ 12,956 $ 12,084 $ 8,708
======== ======== ========
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
The significant components of the Company's deferred tax assets and liabilities
are summarized as follows:
DECEMBER 31
2002 2001
-------- --------
Deferred tax assets:
State net operating losses $ 693 $ 829
Loan loss reserves 4,938 4,386
Pension 2,336 2,140
Deferred compensation 1,283 1,350
Other 322 97
-------- --------
Total deferred tax assets 9,572 8,802
Valuation allowance (784) (769)
-------- --------
Net Deferred tax assets 8,788 8,033
Deferred tax liabilities:
Property and equipment depreciation 1,204 1,189
FHLB stock dividends 2,884 2,077
Deferred loan fees 172 520
Purchase accounting adjustments 5,866 6,289
Unrealized gain on investment securities 5,859 3,183
-------- --------
Total deferred tax liabilities 15,985 13,258
-------- --------
Net deferred tax asset (liability) $ (7,197) $ (5,225)
======== ========
The Banks and certain predecessor banks qualified under provisions of the
Internal Revenue Code that permitted it to deduct from taxable income an
allowance for bad debts that differed from the provision for such losses charged
to income for financial reporting purposes. Accordingly, no provision for
federal income taxes has been made for approximately $64,475 of retained income
as of December 31, 2002. If, in the future, either of the Banks no longer
qualifies as a bank for tax purposes, income taxes of approximately $25,874
would be imposed.
90
12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments consist of commitments to extend credit and involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amounts recognized in the consolidated statements of financial condition. The
contract amounts reflect the extent of involvement the Company has in particular
classes of financial instruments and also represents the Company's maximum
exposure to credit loss.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and generally
require payment of a fee. As some commitments expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates the collateral needed and creditworthiness
of each customer on a case by case basis. The Company generally extends credit
only on a secured basis. Collateral obtained varies, but consists principally of
one-to-four family residences.
Financial instruments whose contract amounts represent credit risk are as
follows:
DECEMBER 31
2002 2001
-------- --------
Unused consumer lines of credit $145,306 $130,269
Unused commercial lines of credit 29,106 21,376
Commitments to extend credit:
Fixed rate 40,920 14,979
Adjustable rate 8,055 26,164
Credit enhancement under the Federal Home Loan Bank
of Chicago Mortgage Partnership Finance program 16 34
Forward commitments to sell mortgage loans of $73,792 at December 31, 2002,
represent commitments obtained by the Company from a secondary market agency to
purchase mortgages from the Company. Commitments to sell loans expose the Banks
to interest rate risk if market rates of interest decrease during the commitment
period. Commitments to sell loans are made to mitigate interest rate risk on
commitments to originate loans and loans held for sale. Forward commitments at
December 31, 2001 were $41,314.
The Company participates in the FHLB Mortgage Partnership Finance Program (the
Program). In addition to entering into forward commitments to sell mortgage
loans to a secondary market agency, the Company enters into firm commitments to
deliver loans to the FHLB through the Program. Under the Program, loans are
funded by the FHLB and the Company receives an agency fee reported as a
component of gain on sale of loans. The Company had no firm commitments
outstanding to deliver loans through the Program at December 31, 2002. Once
delivered to the Program, the Company provides a contractually agreed-upon
credit enhancement and performs servicing of the loans. Under the credit
enhancement, the Company is liable for losses on loans delivered to the Program
after application of any mortgage insurance and a contractually agreed-upon
credit enhancement provided by the Program subject to an agreed-upon maximum.
The Company received a fee for this credit enhancement. The Company does not
anticipate that any credit losses will be incurred in excess of anticipated
credit enhancement fees.
91
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
Disclosure of fair value information about certain financial instruments,
whether or not recognized in the consolidated financial statements, for which it
is practicable to estimate the value, is summarized below. In cases where quoted
market prices are not available, fair values are based on estimates using
present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument.
Certain financial instruments and all nonfinancial instruments are excluded from
this disclosure. Accordingly, the aggregate fair value of amounts presented does
not represent the underlying value of the Company and is not particularly
relevant to predicting the Company's future earnings or cash flows.
The following methods and assumptions are used by the Company in estimating its
fair value disclosures of financial instruments:
Cash and Cash Equivalents: The carrying amounts reported in the statements of
financial condition for cash and cash equivalents approximate those assets' fair
values.
Investment and Mortgage-Related Securities: Fair values for these securities are
based on quoted market prices or such prices of comparable instruments.
Loans Receivable and Loans Held-for-Sale: The fair value of one-to-four family
fixed-rate mortgage loans was determined based on the current market price for
securities collateralized by similar loans. For variable rate one-to-four family
mortgage, consumer and other loans that reprice frequently and with no
significant change in credit risk, carrying values approximate fair values. The
fair value for fixed-rate commercial real estate, rental property mortgage,
consumer and other loans was estimated by projecting cash flows at market
interest rates.
Mortgage Servicing Rights: The Company has calculated the fair market value of
mortgage servicing rights for those loans that are sold with servicing rights
retained. For valuation purposes, loans are stratified by product type and,
within product type, by interest rates. The fair value of mortgage servicing
rights is based upon the present value of estimated future cash flows using
current market assumptions for prepayments, servicing cost and other factors.
Federal Home Loan Bank Stock: Federal Home Loan Bank stock is carried at cost,
which is its redeemable (fair) value, since the market for this stock is
restricted.
Accrued Interest Receivable: The carrying value of accrued interest receivable
approximates fair value.
Deposits and Advance Payments by Borrowers for Taxes and Insurance: Fair values
for 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 advance payments by borrowers for taxes and
insurance are equal to their carrying amounts at the reporting date.
92
13. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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.
DECEMBER 31 DECEMBER 31
2002 2001
-------------------------- --------------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------- --------- --------- ---------
Cash and cash equivalents $ 241,759 $ 241,759 $ 251,912 $ 251,912
Investment and mortgage-related securities 691,349 691,349 614,143 614,143
Loans receivable, net 1,685,662 1,743,105 1,831,155 1,870,581
Loans held for sale 46,971 46,971 32,321 32,321
Mortgage servicing rights 3,060 3,060 4,251 4,251
Federal Home Loan Bank stock 32,885 32,885 31,233 31,233
Accrued interest receivable 11,396 11,396 13,588 13,588
Deposits and accrued interest 2,126,655 2,168,534 2,090,440 2,107,022
Advance payments by borrowers 3,060 3,060 3,499 3,499
Borrowings 354,978 374,533 465,360 489,484
The above table does not include any amount for the value of any
off-balance-sheet items (see Note 12) since the fair value of these items is not
significant.
14. SUBSEQUENT EVENT
On March 16, 2003, Bank Mutual's two savings bank subsidiaries combined under
Mutual Savings Bank's charter and formed one savings bank named "Bank Mutual."
Estimated costs incurred with the combination are as follows: Marketing costs of
$1.3 million of which $900,000 is anticipated to be expensed in the first six
months of 2003 and $350,000 of signage which will be capitalized and then
amortized over its useful life. In addition, systems upgrades of approximately
$1.8 million of which the majority was capitalized in late 2002 and will be
amortized over five years.
93
15. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
STATEMENT OF FINANCIAL CONDITION
DECEMBER 31
2002 2001
--------- ---------
ASSETS
Cash and cash equivalents $ 15,576 $ 20,241
Investment in subsidiaries 305,157 284,358
Receivable from ESOP 6,647 7,850
Other assets 17 1
--------- ---------
$ 327,397 $ 312,450
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Due to subsidiaries $ 3,455 $ 6,948
Other liabilities 867 1,404
--------- ---------
4,322 8,352
Shareholders' equity
Common stock - $.01 par value:
Authorized - 100,000,000 shares
Issued - 22,341,665 shares in 2002 and 2001
Outstanding - 21,752,971 shares in 2002 and
22,337,165 in 2001 223 223
Additional paid-in capital 109,074 108,043
Retained earnings 224,932 201,777
Unearned ESOP shares (6,647) (7,850)
Accumulated other comprehensive income 10,487 6,018
Unearned deferred compensation (3,133) (4,047)
Treasury stock - 588,694 shares in 2002, 4,500 in 2001 (11,861) (66)
--------- ---------
323,075 304,098
--------- ---------
$ 327,397 $ 312,450
========= =========
STATEMENT OF INCOME
YEAR ENDED DECEMBER 31
2002 2001
--------- ---------
Interest income $ 989 $ 1,560
Equity in earnings of subsidiaries 26,330 19,668
Other 3 139
--------- ---------
Total income 27,322 21,367
Total expenses 634 667
--------- ---------
Income before provision for income taxes 20,700
Provision for income taxes 143 417
--------- ---------
Net income $ 26,545 $ 20,283
========= =========
94
15. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31
2002 2001
-------- --------
Cash flows from operating activities
Net income $ 26,545 $ 20,283
Adjustment to reconcile net income to net cash provided by
(used in) operating activities:
Equity in earnings of subsidiaries (26,330) (19,668)
Amortization of cost of stock benefit plans 3,770 1,849
Decrease in due to subsidiaries (3,493) (2,011)
Change in other operating activities and liabilities (553) 1,758
-------- --------
Net cash used in operating activities (61) 2,211
Cash flows from investing activities:
Transfer from subsidiary resulting from restructuring -- --
Business acquisition, net of cash and cash equivalents -- --
Dividends from Company subsidiaries 10,000 3,120
-------- --------
Net cash provided by investing activities 10,000 3,120
Cash flows from financing activities:
Sale of stock -- --
Purchase of ESOP shares -- (29)
Cash dividends (3,390) (2,857)
Purchase of treasury stock (12,417) (4,920)
Payments received on ESOP 1,203 1,150
-------- --------
Net cash provided by financing activities (14,604) (6,656)
-------- --------
Increase (decrease) in cash and cash equivalents (4,665) (1,325)
Cash and cash equivalents at beginning of year 20,241 21,566
-------- --------
Cash and cash equivalents at end of year $ 15,576 $ 20,241
======== ========
95
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to this item is incorporated herein by reference to
"Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in Bank Mutual's definitive Proxy Statement for its Annual Meeting
of Shareholders on May 5, 2003 (the "2003 Annual Meeting Proxy Statement"). See
also "Executive Officers of the Registrant" in Part I hereof, which is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to this item is incorporated by reference to "Directors'
Compensation", "Executive Compensation" and "Compensation Committee Interlocks
and Insider Participation" in the 2003 Annual Meeting Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to this item is incorporated by reference to "Security
Ownership of Certain Beneficial Owners" in the 2003 Annual Meeting Proxy
Statement.
EQUITY COMPENSATION PLAN INFORMATION
The following chart gives aggregate information regarding grants under all
equity compensation plans of Bank Mutual through December 31, 2002.
Number of securities
remaining available
Number of securities for future issuance under
to be issued upon Weighted-average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected
Plan category warrants and rights (1) warrants and rights in 1st column) (2)
------------- ----------------------- ------------------- ------------------
Equity compensation plans 1,045,896 $11.76 37,103
approved by securityholders
Equity compensation plans not -0- n/a -0-
approved by securityholders
Total 1,045,896 $11.76 37,103
- ----------
(1) Represents options granted under the Bank Mutual Corporation 2001 Stock
Incentive Plan ("2001 Plan"), which was approved by shareholders in May
2001, as amended with shareholder approval in May 2002.
(2) Represents 28,849 shares as to which options may be granted under the 2001
Plan, and 8,254 shares which remained available under the 2001 Plan for
grant as restricted shares. In addition, there are 658,704 shares that are
held in the Employee Stock Ownership Plan, subject to release and
allocation.
96
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to this item is incorporated by reference to
"Compensation Committee Interlocks and Insider Participation" and "Certain
Transactions with Bank Mutual" in the 2003 Annual Meeting Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. In response to the
adoption of the Sarbanes-Oxley Act of 2002, Bank Mutual and the
certifying officers of this report have implemented disclosure
controls and procedures to ensure that material information relating
to Bank Mutual is made known to the signing officers, and
consequently reflected in periodic SEC reports. These controls and
procedures are built upon Bank Mutual's pre-existing practices. Bank
Mutual and those officers have evaluated for this report, the
effectiveness of those disclosures controls and procedures within 90
days prior to its filing. Bank Mutual and the certifying officers
believe that these disclosure controls and procedures are effective,
based upon this evaluation.
(b) Changes in internal controls. During the period covered by this
report, there were not any significant changes in Bank Mutual's
internal controls or in other factors that could significantly
effect these controls subsequent to the date of their evaluation,
including any corrective actions with respect to material weaknesses
and significant deficiencies.
97
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of the Report:
1. and 2. Financial Statements and Financial Statement
Schedules.
The following consolidated financial statements of Bank Mutual Corporation and
subsidiaries are filed as part of this report under Item 8, "Financial
Statements and Supplementary Data":
Consolidated Statements of Financial Condition - December 31, 2002 and
2001.
Consolidated Statements of Operations - Years Ended December 31, 2002,
2001 and 2000.
Consolidated Statements of Changes In Shareholders' Equity - Years Ended
December 31, 2002, 2001 and 2000.
Consolidated Statements of Cash Flows - Years Ended December 31, 2002,
2001 and 2000.
Notes to Consolidated Financial Statements.
Report of Ernst & Young LLP, Independent Auditors.
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
3. Exhibits. See Exhibit Index following the signature page of this
report, which is incorporated herein by reference. Each management
contract or compensatory plan or arrangement required to be filed as
an exhibit to this report is identified in the Exhibit
Index by an asterisk following its exhibit number.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed in the fourth quarter of
2002.
98
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
BANK MUTUAL CORPORATION
March 20, 2003
By: /s/ Michael T. Crowley, Jr.
------------------------------------
Michael T. Crowley, Jr.
Chairman and Chief Executive Officer
----------
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes Michael T.
Crowley, Jr., Michael D. Meeuwsen, and Rick B. Colberg, or any of them, as
attorneys-in-fact with full power of substitution, to execute in the name and on
behalf of such person, individually, and in each capacity stated below or
otherwise, and to file, any and all amendments to this report.
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated.*
SIGNATURE AND TITLE
/s/ Michael T. Crowley, Jr. /s/ Raymond W. Dwyer, Jr.
- ---------------------------------------- -------------------------------
Michael T. Crowley, Jr., Chairman, Raymond W. Dwyer, Jr., Director
Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Michael D. Meeuwsen /s/ Thomas J. Lopina, Sr.
- ---------------------------------------- -------------------------------
Michael D. Meeuwsen, President, Thomas J. Lopina, Sr., Director
Chief Operating Officer and Director
/s/ Rick B. Colberg /s/ William J. Mielke
- ---------------------------------------- -------------------------------
Rick B. Colberg, Chief Financial Officer William J. Mielke, Director
(Principal Financial Officer)
/s/ Marlene M. Scholz /s/ Robert B. Olson
- ---------------------------------------- -------------------------------
Marlene M. Scholz, Senior Vice President Robert B. Olson, Director
(Principal Accounting Officer)
/s/ Michael T. Crowley, Sr. /s/ David J. Rolfs
- ---------------------------------------- -------------------------------
Michael T. Crowley, Sr., Director David J. Rolfs, Director
/s/ Thomas H. Buestrin /s/ Jelmer G. Swoboda
- ---------------------------------------- -------------------------------
Thomas H. Buestrin, Director Jelmer G. Swoboda, Director
/s/ Mark C. Herr
- ----------------------------------------
Mark C. Herr, Director
- ----------
* Each of the above signatures is affixed as of March 20, 2003.
99
CERTIFICATIONS
I, Michael T. Crowley, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Bank Mutual Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
/s/ Michael T. Crowley, Jr.
----------------------------------------
Michael T. Crowley, Jr.
Chairman and CEO
100
I, Rick B. Colberg, certify that:
1. I have reviewed this annual report on Form 10-K of Bank Mutual Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
/s/ Rick B. Colberg
----------------------------------------
Rick B. Colberg
Chief Financial Officer
101
BANK MUTUAL
("Bank Mutual" or the "Registrant")
Commission File No. 000-32107
EXHIBIT INDEX
TO
2002 REPORT ON FORM 10-K
The following exhibits are filed with, or incorporated by reference in, this
Report on Form 10-K for the year ended December 31, 2002:
INCORPORATED HEREIN FILED
EXHIBIT DESCRIPTION BY REFERENCE TO HEREWITH
- ------- ----------- --------------- --------
2.1 Plan of Restructuring from Mutual Savings Bank Exhibit 2.1 to Bank Mutual's
to Mutual Holding Company of Mutual Savings Registration Statement on Form
Bank, as amended and restated July 31, 2000** S-1, Registration No. 333-
39362 (the "2000 S-1")
3(i) Charter of Bank Mutual Exhibit 3(i) to 2000 S-1
3(ii) Bylaws of Bank Mutual Exhibit 3(ii) to 2000 S-1
4.1 Charter of Bank Mutual Exhibit 3(i) to 2000 S-1
4.2 Stock Issuance Plan of Mutual Savings, as Exhibit 4.2 to Post-Effective
amended and restated July 31, 2000 Amendment No. 1 to 2000 S-1
4.3 Plan of Restructuring Exhibit 2.1 above
10.1* Mutual Savings Bank Benefit Restoration Plan Exhibit 10.1 to 2000 S-1
10.2* Mutual Savings Bank Outside Directors' Exhibit 10.2 to 2000 S-1
Retirement Plan
10.3* Mutual Savings Bank Executive Excess Benefit Exhibit 10.3 to 2000 S-1
Plan
10.4* Agreement regarding deferred compensation Exhibit 10.4 to 2000 S-1
Agreement dated May 16, 1988 between Mutual
Savings Bank and Michael T. Crowley, Jr.
10.5(a)* Employment Agreement between Mutual Exhibit 10.5(a) to 2000 S-1
Savings Bank and Michael T. Crowley Jr.
10.5(b)* Amendment thereto dated February 17, 1998 Exhibit 10.5(b) to 2000 S-1
10.6(a)* Employment Agreement between Mutual Exhibit 10.6(a) to 2000 S-1
Savings Bank and Michael T. Crowley, Sr. dated
December 31, 1993
10.6(b)* Amendment thereto dated February 17, 1998 Exhibit 10.6(b) to 2000 S-1
10.7* Form of Employment Agreements of Mr. Exhibit 10.7 to 2000 S-1
Maurer and Ms. Scholz with Mutual Savings
Bank, each dated as of January 1, 2001
10.8(a)* Employment Agreement between First Northern Exhibit 10.8(a) to Bank
Savings Bank and Michael D. Meeuwsen dated Mutual's Annual Report on
as of January 2, 1990 Form 10-K for the year ended
December 31, 2000 ("2000
10-K")
E-1
INCORPORATED HEREIN FILED
EXHIBIT DESCRIPTION BY REFERENCE TO HEREWITH
- ------- ----------- --------------- --------
10.8(b)* Amendments No. 1 thereto, dated as of Exhibit 10.8(b) to 2000 10-K
September 20, 1995
10.9* Employment Agreement between First Northern Exhibit 10.9 to 2000 10-K
Savings Bank and Rick B. Colberg dated as of
November 1, 2000
10.10(a)* Non-Qualified Deferred Retirement Plan for Exhibit 10.10(a) to 2000 10-K
Directors of First Northern Savings Bank
10.10(b)* Amendment No. 1 thereto Exhibit 10.3.2 to First Northern
Capital Corp.'s Annual Report
on Form 10-K for the fiscal year
ended December 31, 1998
("FNCC 1998 10-K")
10.11(a)* Form of Supplemental Retirement Agreements Exhibit 10.11(a) to 2000 10-K
dated as of January 1, 1994 between First
Northern Savings Bank and each of Michael D.
Meeuwsen and Rick B. Colberg
10.11(b)* Form of Amendment No. 1 thereto dated as of Exhibit 10.11(b) to 2000 10-K
September 20, 1995
10.11(c)* Form of Amendment No. 2 thereto, dated as of Exhibit 10.6.4 to FNCC 1998
October 15, 1998 10-K
10.12* Mutual Savings Bank Management Incentive Exhibit 10.12(b) to 2000 10-K
Compensation Plan (MIP)
10.13* First Northern Savings Bank Management Exhibit 10.13 to 2000 10-K
Incentive Compensation Plan
10.14 Bank Mutual 2001 Stock Incentive Plan, as Exhibit 10.1 to Bank Mutual's
amended May 7, 2002 Quarterly Report on Form 10-Q
for the quarter ended March 31,
2002
21.1 List of Subsidiaries X
23.1 Consent of Ernst & Young LLP X
24.1 Powers of Attorney Signature Page
99.1 Certification of the CEO pursuant to 18 U.S.C. X
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of the CFO pursuant to 18 U.S.C. X
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
- ----------
* Designates management or compensatory agreements, plans or arrangements
required to be filed as exhibits pursuant to Item 14(c) of Form 10-K
** Without exhibit or schedules, which will be furnished to the Commission
upon request
E-2