UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

 

Commission File Number 001-34955

 

ANCHOR BANCORP WISCONSIN INC.  

(Exact name of registrant as specified in its charter)

 

 

25 West Main Street

Madison, Wisconsin 53703

(Address of principal executive office)

 

 

Registrant’s telephone number, including area code (608) 252-8700

 

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

 

 

 

Securities registered pursuant to Section 12 (g) of the Act:
Not Applicable

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 or 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 the Form 10-K or any amendment to this Form 10-K.  þ

 

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

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

As of September 30, 2010, the aggregate market value of the 21,683,304 outstanding shares of the Registrant’s common stock deemed to be held by non-affiliates of the registrant was $13.7 million, based upon the closing price of $0.66 per share of common stock as reported by the Nasdaq Global Select Market on such date. Although directors and executive officers of the Registrant and certain of its employee benefit plans were assumed to be “affiliates” of the Registrant for purposes of this calculation, the classification is not to be interpreted as an admission of such status.

 

As of June 3, 2011, 21,677,594 shares of the Registrant’s common stock were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on August 4, 2011 (Part III, Items 10 to 14).

 

 

ANCHOR BANCORP WISCONSIN INC.

 

FISCAL 2011 FORM 10-K ANNUAL REPORT

 

TABLE OF CONTENTS

 

EXPLANATORY NOTE

 

We are restating our audited consolidated financial statements and related disclosures for the fiscal years ending March 31, 2010 and March 31, 2009 as well as our consolidated financial statements for the quarterly periods in the fiscal year ended March 31, 2010 and the first three quarters of the fiscal year ended March 31, 2011.

 

With this filing we are restating the consolidated balance sheets, statements of operations, statements of changes in stockholders’ equity and statements of cash flows for certain of the years ended March 31, 2007 through March 31, 2011, as well as the unaudited quarterly information for the quarterly periods in the fiscal year ended March 31, 2010 and the first three quarters of the fiscal year ended March 31, 2011.

 

We do not intend to file an amended Form 10-K or the Quarterly Reports on Form 10-Q for each of the quarterly periods for the fiscal years ended or the quarterly periods included in the years ended March 31, 2011, March 31, 2010, or March 31, 2009. As previously announced in our Current Report on Form 8-K filed with the SEC on June 10, 2011, we concluded that the consolidated financial statements and the related financial information contained in such previously filed reports should no longer be relied upon.

 

Footnote 23 of the March 31, 2011 financial statements presents the impact of the restatements on each quarter from the quarter ending June 30, 2009 to the quarter ending December 31, 2010.

 

Background of Restatement

 

On June 9, 2011, the Corporation announced that its Audit Committee had evaluated the financial reporting issues surrounding the accrual of dividends on Preferred Shares sold to the U.S. Treasury and two deferred compensation plans.

 

Management had accrued dividends on cumulative preferred stock prior to declaring a dividend on those shares. The declaration of the dividends was not allowed under the terms of a consent order with federal regulators. This dividend was accrued through August 15, 2010. The accrual of dividends resulted in an understatement of stockholders’ equity of the Corporation during the quarters that the undeclared dividend was accrued. The understatement was $8.479 million as of December 31, 2010.

 

The Corporation discontinued accruing the dividends on the cumulative preferred stock after August 15, 2010. The calculation for the net income available to common shareholders included only the dividends accrued versus the dividend in arrears. As a result, the loss per share available to common shareholders was understated by $0.04 for the quarter ended September 30, 2010 and $0.06 for the quarter ended December 31, 2010.

 

The Corporation also accrued interest at a rate of 5%, simple interest on the unpaid dividends. The agreement with the US Treasury requires a dividend of 5% on the unpaid dividends, compounded on the unpaid dividends. The accrual of interest expense impacted the net income for all quarters in 2010 and for the first three quarters of 2011. The detail of the quarterly impact can be found in Note 23 of the March 31, 2011 consolidated financial statements.

 

The accrual of interest on the unpaid dividends resulted in an overstatement of interest expense and net loss and an understatement in stockholders’ equity of the Corporation for all quarters in 2010 and for the first three quarters in 2011. The aggregate amount of the misstatement over all periods was approximately $447,000. Because of the nature of the misclassification, there was no impact on the net loss available to common shareholders.

 

Additionally, management identified and quantified the impact of an accounting error for two deferred compensation plans. The Corporation has two deferred compensation plans that require the payment to plan participants in the form of Corporation Common Stock. Grantor trusts were formed to hold Anchor BanCorp of Wisconsin Inc. common stock in the name of the plan participant for distribution under the terms of the plan. The measurement aspect of the plan obligations were accounted for correctly, but the liability for the plans was incorrectly included as “other liabilities” versus being recorded as an equity account. The grantor trusts were correctly accounted for and displayed as “deferred compensation obligation” in the equity section. The improper reporting of these plans resulted in an understatement of stockholders’ equity of the corporation of $5.247 million as of April 1, 2008, the earliest period reported in the consolidated financials included in this Form 10-K filing.

Internal Control Considerations

 

The Corporation had previously concluded that its internal controls over financial reporting were not effective for the years ended March 31, 2010 and 2009.

 

The Corporation’s management developed a remediation plan for the disclosed material weakness and significant deficiencies which was approved by the Audit Committee. Details of those remediation efforts are included in Item 9A of the March 31, 2011 Form 10-K.

 

The accounting errors noted above were the result of prior management’s decisions and the ineffective internal controls over financial reporting as noted above.

 

The accrued dividends were identified as an uncorrected misstatement by the independent auditors at March 31, 2010. This issue was part of the financial reporting weakness noted in the year ending March 31, 2010.

 

The accrual of “interest” on the unpaid dividends was identified as the review of the entire cumulative dividend accounting issue was being completed.

 

The deferred compensation issue was identified by management in the fourth fiscal quarter of the year ending March 31, 2011. The accounting for these plans has not changed since plan inception in the early 1990’s.

 

While evaluating the materiality of the deferred compensation issue identified during the fourth quarter of 2011, management considered the unusually low level of reported equity, and the impact of this misstatement aggregated with the misstatement related to the preferred stock dividends. Due to the combination of these two factors, management concluded that restatement of the prior periods was the most appropriate resolution.

 

The restatement related to the Excess Benefit Plan and Deferred Compensation Agreement resulted from the Corporation’s initiative to formalize the reconciliation process to substantiate general ledger accounts to remediate the 2010 material weakness and was not a result of a break down in controls identified in 2011.

 

In assessing materiality of the restatement, management notes that the impact represented an increase to Holding Company equity and that Bank capital was not impacted by the misstatement. The misstatement did not impact any financial covenants in the Amended and Restated Credit Agreement.

FORWARD-LOOKING STATEMENTS

 

In the normal course of business, we, in an effort to help keep our shareholders and the public informed about our operations, may from time to time issue or make certain statements, either in writing or orally, that are or contain forward-looking statements, as that term is defined in the U.S. federal securities laws. Generally, these statements relate to business plans or strategies, projected or anticipated benefits from acquisitions or dispositions made by or to be made by us, projections involving anticipated revenues, earnings, liquidity, profitability or other aspects of operating results or other future developments in our affairs or the industry in which we conduct business. Forward-looking statements may be identified by reference to a future period or periods or by the use of forward-looking terminology such as “anticipate,” “believe,” “project,” “continue,” “ongoing,” “expect,” “intend,” “plan,” “estimate” or similar expressions.

 

Although we believe that the anticipated results or other expectations reflected in our forward-looking statements are based on reasonable assumptions, we can give no assurance that those results or expectations will be attained. Forward-looking statements involve risks, uncertainties and assumptions (some of which are beyond our control), and as a result actual results may differ materially from those expressed in forward-looking statements due to several factors more fully described in Item 1A, “Risk Factors,” as well as elsewhere in this Annual Report on Form 10-K. Factors that could cause actual results to differ from forward-looking statements include, but are not limited to, the following, as well as those discussed elsewhere herein:

 

 

 

You should not put undue reliance on any forward-looking statements. Forward-looking statements speak only as of the date they are made and we undertake no obligation to update them in light of new information or future events, except to the extent required by federal securities laws.

 

 

We, Anchor BanCorp Wisconsin Inc. (the “Corporation” or the “Company”) are a registered savings and loan holding company incorporated under the laws of the State of Wisconsin. We are engaged in the savings and loan business through our wholly owned banking subsidiary, AnchorBank, fsb (the “Bank”).

 

The Bank was organized in 1919 as a Wisconsin chartered savings institution and converted to a federally chartered savings institution in 2000. AnchorBank, fsb is the third largest depository institution headquartered in the State of Wisconsin and its largest thrift in terms of assets. The Bank’s deposits are insured up to the maximum allowable amount by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Chicago, and is regulated by the Office of Thrift Supervision (“OTS”) and the FDIC. The Corporation is regulated by the OTS as a savings and loan holding company and is subject to the periodic reporting requirements of the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). See “Regulation and Supervision.”

 

Primarily through our branch network, we offer checking, savings, money market accounts, mortgages, home equity and other consumer loans, credit cards, annuities, investment products and related consumer financial services. The Bank also provides banking services to businesses, including checking accounts, lines of credit, secured loans and commercial real estate loans. AnchorBank’s branch network serves as the primary vehicle through which we cross sell additional products to existing customers and generate new customer relationships.

 

In addition to our branch network, we provide products and services online via our WebBranch^tm online banking system and our Speed e-App^tm online mortgage application tool. During the 2011 fiscal year we saw a substantial increase in mortgage applications received through Speed e-App, our online application service.

 

The Corporation also has a non-banking subsidiary, Investment Directions, Inc. (“IDI”), a Wisconsin corporation which has historically invested in real estate partnerships. During 2010, IDI sold substantially all of its assets and its investment activities have been substantially curtailed.

 

On June 25, 2010, the Corporation completed the sale of eleven branches located in Northwest Wisconsin to Royal Credit Union headquartered in Eau Claire, Wisconsin. Royal Credit Union assumed approximately $171.2 million in deposits and acquired $61.8 million in loans and $9.8 million in office properties and equipment. The net gain on the sale was $5.0 million. The net gain included a write off of the $3.9 million core deposit intangible that was required when designated core deposits were sold in this transaction. On July 23, 2010, the Corporation completed the sale of four branches located in Green Bay, Wisconsin and surrounding communities to Nicolet National Bank headquartered in Green Bay, Wisconsin. Nicolet National Bank assumed $105.1 million in deposits and acquired $24.8 million in loans and $0.4 million in office properties and equipment. The net gain on the sale was $2.3 million.

 

The Bank has two wholly-owned subsidiaries: ADPC Corporation (“ADPC”), a Wisconsin corporation, holds and develops certain of the Bank’s foreclosed properties. Anchor Investment Corporation (“AIC”), an operating subsidiary that is located in and formed under the laws of the State of Nevada, manages a portion of the Bank’s investment portfolio (primarily mortgage related securities).

 

As of March 31, 2011, the Corporation had 719 full-time and 98 part-time employees. The Corporation promotes equal employment opportunity and considers employee relations to be excellent. The average tenure of AnchorBank employees is 13 years. None of the AnchorBank employees are represented by a collective bargaining group.

 

The Corporation maintains a web site at www.anchorbank.com. All of the Corporation’s filings under the Exchange Act are available through our web site, free of charge, including copies of Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, on the date that the Corporation files those materials with, or furnishes them to, the SEC.

 

The Bank’s primary market area consists of south-central, east-central and southeastern Wisconsin, as well as contiguous counties in Iowa, Minnesota and Illinois. At March 31, 2011, the Bank conducted business from its headquarters and main office in Madison, Wisconsin, and from 55 other full-service offices and one loan origination office which services our more than 140,000 households and businesses. During the fiscal year ended March 31, 2011, 15 branches in the Northwest region of Wisconsin and the Green Bay area were sold. Additionally, in fiscal 2011, the Bank’s lending-only office in Hudson, Wisconsin was closed. One lending-only office in Lake Geneva, Wisconsin remains, while all other offices operate as full-service branches.

 

AnchorBank’s market area is concentrated in the greater Madison/Dane County, Suburban Milwaukee and Fox Valley areas. Together these areas account for nearly half of Wisconsin’s population and provide a strong platform for long term growth, both locally and regionally. Within its market footprint AnchorBank exhibits a strong retail franchise with the second highest market share of both deposits and mortgage origination in the Madison area and with the sixth largest deposit and mortgage origination share in the state overall.

 

Our home market of Madison provides a strong base in a highly attractive market. Madison is home to both state and county governments as well as the University of Wisconsin. Madison has enjoyed rapid population growth of 12.1 percent since 2000, a median household income 15 percent above the national average and relatively low unemployment at 5.7 percent (as of April 2011) versus the national average of 8.8 percent. Madison frequently ranks in the top 100 Places to Live in America by Money Magazine.

 

The Fox Valley, consisting primarily of the cities of Appleton and Oshkosh and their associated satellite communities is one of the state’s fastest growing areas and also benefits from significantly higher than median income levels at approximately $52,000, 5 percent higher than the national average. The Bank operates eight branches in the Fox Valley area.

 

In the Milwaukee area, AnchorBank operates eight branches, all located in suburban areas outside the City of Milwaukee. The largest city in Wisconsin, the Milwaukee Metropolitan area is home to roughly 1.6 million people with a median income of $51,279 and more than 70,000 businesses.

 

The Bank encounters strong competition in attracting both loan and deposit customers. Such competition includes banks, savings institutions, mortgage banking companies, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms. The Bank’s market area includes branches of several commercial banks that are substantially larger in terms of loans and deposits. Furthermore, tax exempt credit unions operate in most of the Bank’s market area and aggressively price their products and services to a large portion of the market. The Corporation’s profitability depends upon the Bank’s continued ability to successfully maintain market share and mitigate credit losses.

 

Customer demand for loans secured by real estate has been reduced by a weak economy, an increase in unemployment and a decrease in real estate values. Customer demand for real estate loans has decreased and the Bank’s income has been affected because alternative investments, such as securities, typically earn less income than real estate secured loans.

 

The principal factors that are used to attract deposit accounts and that distinguish one financial institution from another include rates of return, quality of service to the depositors, types of accounts, service fees, convenience of office locations and hours, and other services. We offer a full array of deposit, savings and investment products to meet the needs of our consumer and business customers with features, high service levels, convenience and rates/fees structured to provide a competitive value proposition for our customers and prospective customers. In return, our customers have rewarded us with high levels of satisfaction and loyalty as proven by our recent JD Powers Bank ratings which showed Anchor to be one of the highest rated banks in the upper Midwest.

 

The primary factors in competing for loans are interest rates, loan fee charges, and timeliness and quality of service to the borrower. Similar to the market for deposit and investment products, we focus on offering the best overall value to our loan customers. During the 2011 fiscal year we originated $745 million in single family

“conforming” loans. While single family “conforming” loans are subsequently sold to investors, a key competitive difference is that AnchorBank retains servicing on our residential mortgages, thereby ensuring a high level of continuing customer service. AnchorBank currently has a servicing portfolio of approximately $3.40 billion.

 

General.  At March 31, 2011, the Bank’s net loans held for investment totaled $2.52 billion, representing approximately 74.2% of its $3.39 billion of total assets at that date. Loans held for investment consist of single-family residential loans of $652.2 million, multi-family residential loans of $499.6 million, commercial real estate loans of $645.7 million, construction and land loans of $225.2 million, commercial and industrial loans of $96.8 million and consumer loans of $563.3 million.

 

The Bank originates residential loans secured by properties located primarily in Wisconsin, with adjustable-rate loans generally being originated for inclusion in the Bank’s loan portfolio and fixed-rate loans generally being originated for sale into the secondary market.

 

Loan Portfolio Composition.  The following table presents the composition of the Bank’s consolidated loans held for investment at the dates indicated.

 

The following table shows, at March 31, 2011, the scheduled contractual maturities of the Bank’s consolidated gross loans held for investment, as well as the dollar amount of such loans which are scheduled to mature after one year which have fixed or adjustable interest rates.

 

 

Residential Loans.  At March 31, 2011, $652.2 million, or 24.3%, of the Bank’s total loans receivable consisted of residential loans, substantially all of which were 1 to 4 family dwellings. Residential loans have increased as a percentage of the Bank’s total loans receivable from 20.8% at March 31, 2007 to 24.3% at March 31, 2011.

 

The adjustable-rate loans currently in the Bank’s portfolio have up to 30-year maturities and terms which permit the Bank to annually increase or decrease the rate on the loans, based on a designated index. These loans are documented according to standard industry practices. This is generally subject to a limit of 2% per adjustment and an aggregate 6% adjustment over the life of the loan. The Bank makes a limited number of interest-only loans which tend to have a shorter term to maturity and does not originate negative amortization and option payment ARMS.

 

Adjustable-rate loans decrease the risks associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. The Bank believes that these risks, which have not had a material adverse effect on the Bank to date, generally are less than the risks associated with holding fixed-rate loans in an increasing interest rate environment. At March 31, 2011, approximately $445.5 million, or 68.7%, of the Bank’s permanent residential loans receivable consisted of loans with adjustable interest rates. Also, as interest rates decline, borrowers may refinance their mortgages into fixed-rate loans thereby prepaying the balance of the loan prior to maturity.

 

The Bank continues to originate long-term, fixed-rate conventional mortgage loans. The Bank generally sells current production of these loans with terms of 15 years or more to Fannie Mae, Freddie Mac and other institutional investors, while keeping some of the 10-year term loans in its portfolio. In order to provide a full range of products to its customers, the Bank also participates in the loan origination programs of Wisconsin Housing and Economic Development Authority (“WHEDA”), Wisconsin Department of Veterans Affairs (“WDVA”) and the USDA Rural Guarantee Program. The Bank retains the right to service substantially all loans that it sells.

 

At March 31, 2011, approximately $203.0 million, or 31.3%, of the Bank’s permanent residential loans receivable consisted of loans that provide for fixed rates of interest. Although these loans generally provide for repayments of principal over a fixed period of ten to 30 years, it is the Bank’s experience that, because of prepayments and due-on-sale clauses, such loans generally remain outstanding for a substantially shorter period of time.

 

Commercial and Industrial Loans.  The Bank originates loans for commercial, corporate and business purposes, including issuing letters of credit. At March 31, 2011, commercial and industrial loans amounted to $96.8 million, or 3.6%, of the Bank’s total loans receivable. The Bank’s commercial business loan portfolio is comprised of loans for a variety of purposes and generally is secured by equipment, machinery and other business

assets. Commercial business loans generally have terms of five years or less and interest rates that float in accordance with a designated published index. Substantially all of such loans are secured and backed by the personal guarantees of the owners of the business.

 

Commercial Real Estate Loans.  The Bank originates commercial real estate loans that it typically holds in its loan portfolio. Such loans generally have adjustable rates and shorter terms than single-family residential loans, thus increasing the sensitivity of the loan portfolio to changes in interest rates, as well as providing higher fees and rates than residential loans. At March 31, 2011, the Bank had $1.37 billion of loans secured by commercial real estate, which represented 51.1% of the Bank’s total loans receivable. The Bank generally limits the origination of such loans to its primary market area.

 

The Bank’s commercial real estate loans are primarily secured by apartment buildings, office and industrial buildings, warehouses, small retail shopping centers and various special purpose properties, including hotels, restaurants and nursing homes.

 

Although terms vary, commercial real estate loans generally have amortizations of 15 to 25 years, as well as balloon payments of two to five years, and terms which provide that the interest rates thereon may be adjusted annually at the Bank’s discretion, based on a designated index.

 

Consumer Loans.  The Bank offers consumer loans in order to provide a full range of financial services to its customers. At March 31, 2011, $563.3 million, or 21.0%, of the Bank’s consolidated total loans receivable consisted of consumer loans. Consumer loans generally have higher interest rates than mortgage loans but generally involve more risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral.

 

The largest component of the Bank’s other consumer loan portfolio is second mortgage and home equity loans. The primary home equity loan product has an adjustable interest rate that is linked to the prime interest rate and is secured by a mortgage, either a primary or a junior lien, on the borrower’s residence. New home equity lines do not exceed 85% of appraised value at the loan origination date. A fixed-rate home equity second mortgage term product is also offered.

 

Approximately $276.7 million, or 10.3%, of the Bank’s total loans receivable at March 31, 2011 consisted of education loans. These are generally made for a maximum of $3,500 per year for undergraduate studies and $8,500 per year for graduate studies and are placed in repayment on an installment basis within six months of graduation. Education loans generally have interest rates that adjust annually in accordance with a designated index. Both the principal amount of an education loan and interest thereon generally are guaranteed by the Great Lakes Higher Education Corporation up to 97% of the balance of the loan, which generally obtains reinsurance of its obligations from the U.S. Department of Education. Education loans may be sold to the U.S. Department of Education or to other investors. The Bank received $24.3 million from the sale of these education loans during fiscal 2011.

 

The remainder of the Bank’s consumer loan portfolio consists of vehicle loans and other secured and unsecured loans that have been made for a variety of consumer purposes. These include credit extended through credit cards issued by a third party, ELAN Financial Services, pursuant to an agency arrangement under which the Bank participates in outstanding balances, currently at 25% to 28%, with a third party, ELAN Financial Services. The Bank also shares 33% to 37% of annual fees paid to ELAN and 30% of late payment, over limit and cash advance fees paid to ELAN as well as 25% to 30% of interchange income paid to ELAN.

 

At March 31, 2011, the Bank’s approved credit card lines amounted to $42.3 million. The total outstanding amount at March 31, 2011 is $7.8 million.

 

Net Fee Income From Lending Activities.  Loan origination and commitment fees and certain direct loan origination costs are being deferred and the net amounts are amortized as an adjustment to the related loan’s yield.

 

The Bank also receives other fees and charges relating to existing mortgage loans, which include prepayment penalties, late charges and fees collected in connection with a change in borrower or other loan modifications. Other types of loans also generate fee income for the Bank. These include annual fees assessed on credit card accounts, transactional fees relating to credit card usage and late charges on consumer loans.

Origination, Purchase and Sale of Loans.  The Bank’s loan originations come from a number of sources. Residential mortgage loan originations are attributable primarily to depositors, branch customers, the Company’s website, referrals from real estate brokers, builders and direct solicitations. Commercial real estate loan originations are obtained by direct solicitations and referrals. Consumer loans are originated from branch customers, existing depositors and mortgagors and direct solicitation.

 

Applications for all types of loans are obtained at the Bank’s three lending regions, certain of its branch offices and one loan origination facility. Loan approval authority is designated to a Concurrence Authority Credit Officer to sign within their authority. Loans may also be approved by members of the Senior Loan Committee, within designated limits or by the Board of Directors.

 

The Bank’s general policy is to lend up to the lesser of 80% of the appraised value or purchase price of the property, whichever is less, securing a single-family residential loan (referred to as the loan-to-value ratio). The Bank will lend more than 80% of the appraised value of the property, but will require that the borrower obtain when possible, private mortgage insurance in an amount intended to reduce the Bank’s exposure to 80% or less of the appraised value of the underlying property. At March 31, 2011, the Bank had approximately $6.7 million of loans that had loan-to-value ratios of greater than 80% and did not have private mortgage insurance for the portion of the loans above such amount.

 

Property appraisals on the real estate and improvements securing the Bank’s single-family residential loans are made by the Bank’s staff or by independent appraisers, approved by the Bank’s Board of Directors, during the underwriting process. Appraisals are performed in accordance with federal regulations and policies.

 

The Bank’s underwriting criteria generally require that multi-family residential and commercial real estate loans have loan-to-value ratios which amount to 75 to 80% or less and debt coverage ratios of a minimum of 120%. The Bank also obtains personal guarantees on its multi-family residential and commercial real estate loans from the principals of the borrowers, as well as appraisals of the collateral from independent appraisal firms.

 

The portfolio of commercial real estate and commercial and industrial loans is reviewed on a continuing basis to identify any potential risks that exist in regard to the property management, financial criteria of the loan, operating performance, competitive marketplace and collateral valuation. The relationship manager’s function of the Bank is responsible for identifying and reporting credit risk quantified through a loan rating system and making recommendations to mitigate credit risk in the portfolio. The risk management function provides an independent review of this function. These and other underwriting standards are documented in written policy statements, which are periodically updated and approved by the Bank’s Board of Directors.

 

The Bank encounters certain environmental risks in its lending activities. Under federal and state environmental laws, lenders may become liable for costs of cleaning up hazardous materials found on secured properties. Certain states may also impose liens with higher priorities than first mortgages on properties to recover funds used in such efforts. Although the foregoing environmental risks are more usually associated with industrial and commercial loans, environmental risks may be substantial for residential lenders, like the Bank, since environmental contamination may render the secured property unsuitable for residential use. In addition, the value of residential properties may become substantially diminished by contamination of nearby properties. In accordance with the guidelines of Fannie Mae and Freddie Mac, appraisals for single-family homes on which the Bank lends include comments on environmental influences and conditions. The Bank attempts to control its exposure to environmental risks with respect to loans secured by larger properties by monitoring available information on hazardous waste disposal sites and requiring environmental inspections of such properties prior to closing the loan. No assurance can be given, however, that the value of properties securing loans in the Bank’s portfolio will not be adversely affected by the presence of hazardous materials or that future changes in federal or state laws will not increase the Bank’s exposure to liability for environmental cleanup.

 

The Bank has been actively involved in the secondary market since the mid-1980s and generally originates single-family residential loans under terms, conditions and documentation which permit sale to Freddie Mac, Fannie Mae, and other investors in the secondary market. The Bank sells substantially all of the fixed-rate, single-family residential loans with terms over 15 years it originates in order to decrease the amount of such loans in its loan portfolio. The volume of loans originated and sold is dependent on a number of factors, but is most influenced

by general interest rates. In periods of lower interest rates, demand for fixed-rate mortgages increases. In periods of higher interest rates, customer demand for fixed-rate mortgages declines. The Bank’s sales are usually made through forward sales commitments. The Bank attempts to limit any interest rate risk created by forward commitments by limiting the number of days between the commitment and closing, charging fees for commitments, and limiting the amounts of its uncovered commitments at any one time. Forward commitments to cover closed loans and loans with rate locks to customers range from 70% to 100% of committed amounts. The Bank also periodically has used its loans to securitize mortgage-backed securities.

 

The Bank generally services all originated loans that have been sold to other investors. This includes the collection of payments, the inspection of the secured property, and the disbursement of certain insurance and tax advances on behalf of borrowers. The Bank recognizes a servicing fee when the related loan payments are received. At March 31, 2011, the Bank was servicing $3.40 billion of loans for others.

 

The Bank is not an active purchaser of loans. At March 31, 2011, approximately $11.4 million of mortgage loans were being serviced for the Bank by others. Servicing of loans or loan participations purchased by the Bank is performed by the seller, with a portion of the interest being paid by the borrower retained by the seller to cover servicing costs.

 

During the fiscal year ended March 31, 2011, the Corporation began disaggregating its loans by portfolio segment, the level at which the Corporation has developed and documented its systematic method for determining its allowance for loan losses, and class of financing receivable, which is a disaggregation of portfolio segment in accordance with current accounting standards. Prior year activity is shown under the previous classifications.

 

The following table shows the Bank’s consolidated total loans on a gross basis originated, purchased, sold and repaid during the periods indicated.

 

 

 

 

Delinquency Procedures.  Delinquent and problem loans are a normal part of any lending business. When a borrower fails to make a required payment by the 15th day after which the payment is due, internal collection procedures are instituted. The borrower is contacted to determine the reason for the delinquency and attempts are made to cure the loan. The Bank regularly reviews the loan status, the condition of the property, and circumstances of the borrower. Based upon the results of its review, the Bank may negotiate and accept a repayment program with the borrower, accept a voluntary deed in lieu of foreclosure, agree to the terms of a short sale or initiate foreclosure proceedings.

 

A decision as to whether and when to initiate foreclosure proceedings is based upon such factors as the amount of the outstanding loan in relation to the original indebtedness, the extent of delinquency, the value of the collateral, and the borrower’s financial ability and willingness to cooperate in curing the deficiencies. If foreclosed on, the

property is sold at a public sale and the Bank will generally bid an amount reasonably equivalent to the fair value of the foreclosed property or the amount of judgment due the Bank.

 

Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as foreclosed property until it is sold. When property is acquired, it is recorded at the estimated fair value less cost to sell at the date of acquisition, with charge-offs, if any, charged to the allowance for loan losses prior to transfer to foreclosed property. Upon acquisition, all costs incurred in maintaining the property are expensed. In the case of a short sale, any remaining loan balance in excess of the net proceeds is charged to the allowance for loan losses.

 

For discussion of the Corporation’s asset quality, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition — Non-Performing Assets” in Item 7. See also Notes 1 and 5 to the Consolidated Financial Statements in Item 8.

 

In addition to lending activities, the Corporation conducts other investment activities on an ongoing basis in order to diversify assets, limit interest rate risk and credit risk and meet regulatory liquidity requirements. The Corporation invests in mortgage-related securities which are insured or guaranteed by Freddie Mac, Fannie Mae, or Ginnie Mae backed by Freddie Mac, Fannie Mae and Ginnie Mae mortgage-backed securities and also invests in non-agency collateralized mortgage obligations (“CMOs”). Investment decisions are made by authorized officers in accordance with policies established by the Board of Directors.

 

Management determines the appropriate classification of securities at the time of purchase. Debt securities are classified as held-to-maturity when the Corporation has the intent and ability to hold the securities to maturity. Held-to-maturity securities are carried at amortized cost. Securities are classified as trading when the Corporation intends to actively buy and sell securities in order to make a profit. Trading securities are carried at fair value, with unrealized holding gains and losses included in earnings. There were no securities designated as trading during the three years ended March 31, 2011.

 

At March 31, 2011, the amortized cost of the Corporation’s investment securities held to maturity amounted to $27,000, all of which are 30-year securities. There were no five- and seven-year balloon securities. All of the held to maturity investment securities are insured or guaranteed by Fannie Mae and are adjustable-rate securities.

 

Securities not classified as held-to-maturity or trading are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders’ equity. For the years ended March 31, 2011 and 2010, stockholders’ equity decreased $14.6 million (net of deferred income tax receivable) and increased $938,000 (net of deferred income tax receivable), respectively, to reflect net unrealized gains and losses on holding securities classified as available-for-sale.

 

The Corporation’s policy does not permit investment in non-investment grade bonds and permits investment in various types of liquid assets permissible for the Bank under OTS regulations, which include U.S. Government obligations, municipal bonds, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Although the Corporation does not purchase non-investment grade securities, it does own $26.5 million, or 5.1% of the total investment security portfolio, of non-investment grade securities as a result of ratings downgrades. Subject to limitations on investment grade securities, the Corporation also invests in corporate stock and debt securities from time to time.

 

Agency-backed securities increase the quality of the Corporation’s assets by virtue of the insurance or guarantees of federal agencies that back them, require less capital under risk-based regulatory capital requirements than non-insured or guaranteed mortgage loans, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Corporation. At March 31, 2011, securities with a fair value of $481.9 million held by the Corporation are either AAA rated or are guaranteed by government sponsored agencies. At March 31, 2011, $420.8 million of the Corporation’s securities available-for-sale were pledged to secure various obligations of the Corporation. The Corporation had no securities held-to-maturity that were pledged to secure obligations of the Corporation at March 31, 2011.

The table below sets forth information regarding the amortized cost and fair values of the Corporation’s investment securities at the dates indicated.

 

 

The Corporation’s mortgage-backed securities are made up of CMOs, including CMOs which qualify as Real Estate Mortgage Investment Conduits (“REMICs”) under the Internal Revenue Code of 1986, as amended (“Code”). At March 31, 2011, the Corporation had $27,000 of mortgage-backed securities held to maturity. The fair value of the mortgage-backed securities available for sale held by the Corporation amounted to $475.5 million at the same date.

The following table sets forth the maturity and weighted average yield characteristics of the Corporation’s investment securities at March 31, 2011, classified by term to maturity. The balance is at amortized cost for held-to-maturity securities and at fair value for available-for-sale securities.

 

 

Due to repayments of the underlying loans, the actual maturities of certain investment securities are expected to be substantially sooner than the scheduled maturities.

 

For additional information regarding the Corporation’s investment securities, see the Corporation’s Consolidated Financial Statements, including Note 4 thereto included in Item 8.

 

General.  Deposits are a major source of the Bank’s funds for lending and other investment activities. In addition to deposits, the Bank derives funds from principal repayments and prepayments on loan and mortgage-related securities, maturities of investment securities, sales of loans and securities, interest payments on loans and securities, advances from the FHLB and, from time to time, repurchase agreements and other borrowings. Loan repayments and interest payments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates, economic conditions, the stock market and competition. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They also may be used on a longer term basis for general business purposes, including providing financing for lending and other investment activities and asset/liability management strategies.

 

Deposits.  The Bank’s deposit products include passbook and statement savings accounts, demand accounts (i.e. checking), interest bearing checking accounts, money market deposit accounts and certificates of deposit ranging in terms of 42 days to seven years. Included among these deposit products are Individual Retirement Account certificates and Keogh retirement certificates, as well as negotiable-rate certificates of deposit with balances of $100,000 or more (“jumbo certificates”).

 

The Bank’s deposits are obtained primarily from residents of Wisconsin. The Bank has entered into agreements with certain brokers that provide funds for a specified fee. While brokered deposits are a good source of funds, they are interest rate driven and thus inherently have more liquidity and interest rate risk. At March 31, 2011, the Bank had $48.1 million in brokered deposits, which accounted for 1.78% of its $2.71 billion of total deposits and accrued interest. At March 31, 2011, the Bank is precluded from obtaining new or renewing existing

brokered deposits. The Bank has $107.6 million in out of network certificates of deposit. These deposits are opened via internet listing services and the balances are kept within FDIC insured limits.

 

The Bank attracts deposits through a network of convenient office locations by utilizing a customer sales and service plan and by offering a wide variety of accounts and services, competitive interest rates and convenient customer hours. Deposit terms offered by the Bank vary according to the minimum balance required, the time period the funds must remain on deposit and the interest rate, among other factors. In determining the characteristics of its deposit accounts, consideration is given to the profitability and liquidity of the Bank, matching terms of the deposits with loan products, the attractiveness to customers and the rates offered by the Bank’s competitors.

 

The following table sets forth the amount and maturities of the Bank’s certificates of deposit at March 31, 2011.

 

 

At March 31, 2011, the Bank had $406.5 million of certificates greater than or equal to $100,000, of which $78.6 million are scheduled to mature in less than three months, $151.8 million in three to six months, $93.6 million in six to twelve months and $82.5 million in over twelve months.

 

Borrowings.  From time to time the Bank obtains advances from the FHLB, which generally are secured by capital stock of the FHLB and certain of the Bank’s mortgage loans and investment securities. See “Regulation.” Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The FHLB may prescribe the acceptable uses for these advances, as well as limitations on the size of the advances and repayment provisions.

 

From time to time the Bank enters into repurchase agreements with nationally recognized primary securities dealers. Repurchase agreements are accounted for as borrowings by the Bank and are secured by mortgage-backed securities. The Bank did not utilize this source of funds during the year ended March 31, 2011, but may do so in the future.

 

The Corporation used a short-term line of credit used in part to fund IDI’s partnership interests and investments in real estate held for development and sale. This line of credit also funded other Corporation needs. The final maturity of the line of credit was extended to November 30, 2011. At March 31, 2011 and 2010, the Corporation had drawn $116.3 million under this line of credit, respectively. The Corporation is currently in default and does not have credit remaining on this line of credit. See Note 11 to the Corporation’s Consolidated Financial Statements in Item 8 for more information on borrowings.

 

The following table sets forth the outstanding balances and weighted average interest rates for the Corporation’s borrowings at the dates indicated.

 

The following table sets forth information relating to the Corporation’s short-term (original maturities of one year or less) borrowings for the periods indicated.

 

 

Investment Directions, Inc.  IDI is a wholly-owned, non-banking subsidiary of the Corporation that has invested in various limited partnerships and subsidiaries funded by borrowings from the Corporation. Because the Corporation has made substantially all of the initial capital investment in these partnerships and as a result bears substantially all the risks of ownership of these partnerships, such partnerships have been deemed variable interest entities (“VIE’s”) subject to the consolidation requirements of ASC 810-10-15. The application of ASC-810-10-15 results in the consolidation of assets, liabilities, income and expense of the partnerships into the Corporation’s financial statements. During the year ended March 31, 2010, IDI sold its interest in Davsha LLC and its related interest in the limited partnerships as well as the golf course and resort at Indian Palms, which included some developed lots for $11.5 million.

 

The assets that remain at IDI include an equity interest in one commercial real estate property and one real estate development along with various notes receivable.

 

At March 31, 2011, the Corporation had extended $4.2 million to IDI to fund various partnership and subsidiary investments. This represents a decrease of $0.4 million from borrowings of $4.6 million at March 31, 2010. These amounts are eliminated in consolidation.

 

California Investment Directions, Inc.  CIDI was a wholly owned non-banking subsidiary of IDI formed in April 2000 to purchase and hold the general partnership interest in S&D Indian Palms, Ltd. and a minority interest in Davsha, LLC. CIDI was organized in the State of California. Davsha and its subsidiaries invested in VIE’s which were subject to consolidation pursuant to ASC 810-10-15. CIDI was dissolved during the year ended March 31, 2010 because its entire interest in the limited partnerships was eliminated. CIDI’s net income for the year ended March 31, 2010 was $765,000.

 

S&D Indian Palms, Ltd.  Indian Palms was a wholly owned non-banking subsidiary of IDI organized in the state of California which owned a golf resort and land for residential lot development in California. Indian Palms sold land to Davsha, LLC, which in turn sold land to its subsidiaries and subsequently to its real estate partnerships for lot development. Indian Palms’ net income for the year ended March 31, 2010 was $10.4 million.

 

Davsha, LLC.  Davsha was a wholly owned non-banking subsidiary of IDI (80% owned) and CIDI (20% owned). Davsha was organized in the state of California, where it purchased land from Indian Palms and developed residential housing for sale. Davsha had three wholly owned non-banking subsidiaries, Davsha III, Davsha V and Davsha VII. Each of these subsidiaries formed partnerships with developers and purchased lots from Davsha. Davsha’s net income for the year ended March 31, 2010 was $2.1 million.

ADPC Corporation.  ADPC is a wholly owned subsidiary of the Bank that holds certain of the Bank’s foreclosed properties. The Bank’s investment in ADPC at March 31, 2011 amounted to $8.9 million as compared to $2.7 million at March 31, 2010. ADPC had a net loss of $233,000 for the year ended March 31, 2011 as compared to $998,000 for the year ended March 31, 2010.

 

Anchor Investment Corporation.  AIC is an operating subsidiary of the Bank that was incorporated in March 1993. Located in the State of Nevada, AIC was formed for the purpose of managing a portion of the Bank’s investment portfolio (primarily mortgage-backed securities). As an operating subsidiary, AIC’s results of operations are combined with the Bank’s for financial and regulatory purposes. The Bank’s investment in AIC amounted to $219.7 million at March 31, 2011 as compared to $223.6 million at March 31, 2010. AIC had net income of $6.5 million for the year ended March 31, 2011 as compared to $7.8 million for the year ended March 31, 2010.

 

The business of the Corporation and the Bank is subject to extensive regulation and supervision under federal banking laws and other federal and state laws and regulations. In general, these laws and regulations are intended for the protection of depositors, the deposit insurance funds administered by the FDIC and the banking system as a whole, and not for the protection of stockholders or creditors of insured institutions.

 

Set forth below are brief descriptions of selected laws and regulations applicable to the Corporation and the Bank. These descriptions are not intended to be a comprehensive description of all laws and regulations to which the Corporation and the Bank are subject or to be complete descriptions of the laws and regulations discussed. The descriptions of statutory and regulatory provisions are qualified in their entirety by reference to the particular statutes and regulations. Changes in applicable statutes, regulations or regulatory policy may have a material effect on the Bank and our businesses.

 

General.  The Corporation is registered as a savings and loan holding company under Section 10 of the Home Owners’ Loan Act (“HOLA”). As a result, the Corporation is subject to the regulation, examination, supervision and reporting requirements of the OTS. The Corporation must file quarterly and annual reports with the OTS that describes its financial condition.

 

The Bank is a federal savings bank organized under the laws of the United States and subject to regulation and examination by the OTS. The OTS regulates all areas of the Bank’s banking operations, including investments, reserves, lending, mergers, payment of dividends, interest rates, transactions with affiliates (including the Corporation), establishment of branches and other aspects of the Bank’s operations. The Bank is subject to regular examinations by the OTS and is assessed amounts to cover the costs of such examinations.

 

Because the Bank’s deposits are insured by the FDIC to the maximum extent permitted by law, the Bank is also regulated by the FDIC. The major functions of the FDIC with respect to insured institutions include making assessments, if required, against insured institutions to fund the appropriate deposit insurance fund and preventing the continuance or development of unsound and unsafe banking practices.

 

Activities Restrictions.  There are generally no restrictions on the activities of a savings and loan holding company, such as the Corporation, which controlled only one subsidiary savings association on or before May 4, 1999 (a “grandfathered holding company”). However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings association, the Director may impose such restrictions as it deems necessary to address such risk, including limiting (i) payment of dividends by the savings association; (ii) transactions between the savings association and its affiliates; and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings association subsidiary of such a holding company fails to meet the qualified thrift lender (“QTL”) test, then such unitary holding company also shall become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings association requalifies as a QTL within one year thereafter, shall register as, and become subject to the restrictions applicable to, a bank holding company. Regulation as a bank holding company could be adverse to the Corporation’s operations

and impose additional and possibly more burdensome regulatory requirements on the Corporation. See “- The Bank — Qualified Thrift Lender Test” below.

 

If a savings and loan holding company acquires control of a second savings association and holds it as a separate institution, the holding company becomes a multiple savings and loan holding company. As a general rule, multiple savings and loan holding companies are subject to restrictions on their activities that are not imposed on a grandfathered holding company. They could not commence or continue any business activity other than: (i) those permitted for a bank holding company under section 4(c) of the Bank Holding Company Act (unless the Director of the OTS by regulation prohibits or limits such 4(c) activities); (ii) furnishing or performing management services for a subsidiary savings association; (iii) conducting an insurance agency or escrow business; (iv) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings association; (v) holding or managing properties used or occupied by a subsidiary savings association; (vi) acting as trustee under deeds of trust; or (vii) those activities authorized by regulation as of March 5, 1987, to be engaged in by multiple savings and loan holding companies.

 

Restrictions on Acquisitions.  Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the OTS:

 

 

In evaluating an application by a holding company to acquire a savings association, the OTS must consider the financial and managerial resources and future prospects of the holding company and savings association involved, the risk of the acquisition to the insurance funds, the convenience and needs of the community and the effect of the acquisition on competition. Acquisitions which result in a savings and loan holding company controlling savings associations in more than one state are generally prohibited, except in supervisory transactions involving failing savings associations or based on specific state authorization of such acquisitions. Except with the prior approval of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such Corporation’s voting stock, may acquire control of any savings institution, other than a subsidiary savings institution, or of any other savings and loan holding company.

 

Change of Control.  Federal law requires, with few exceptions, OTS approval (or, in some cases, notice and effective clearance) prior to any acquisition of control of the Corporation. Among other criteria, under OTS regulations, “control” is conclusively presumed to exist if a person or Corporation acquires, directly or indirectly, more than 25% of any class of voting stock of the savings association or holding company. Control is also presumed to exist, subject to rebuttal, if an acquiror acquires more than 10% of any class of voting stock (or more than 25% of any class of stock) and is subject to any of several “control factors,” including, among other matters, the relative ownership position of a person, the existence of control agreements and board composition. The Dodd-Frank Act amends the Bank Holding Company Act in regard to bank holding company acquisitions of control of out-of-state banks, replacing the prior “adequately-capitalized” and “adequately-managed” standards by now requiring the acquiring bank holding company to be well-capitalized and well-managed. The Federal Deposit Insurance Act is similarly amended with respect to interstate merger transactions, now requiring that the resulting bank be well-capitalized and well-managed following the transaction.

 

Change in Management.  If a savings and loan holding company is in a “troubled condition,” as defined in the OTS regulations, it is required to give 30 days’ prior written notice to the OTS before adding or replacing a director, employing any person as a senior executive officer or changing the responsibility of any senior executive officer so that such person would assume a different senior executive position. The OTS then has the opportunity to disapprove any such appointment.

 

Limitations on Dividends.  The Corporation is a legal entity separate and distinct from the Bank and its other subsidiaries. The Corporation’s principal source of revenue consists of dividends from the Bank. The payment of dividends by the Bank is subject to various regulatory requirements, including a minimum of 30 days’ advance

notice to the OTS of any proposed dividend to the Corporation. The Corporation is currently precluded from paying dividends under provisions of TARP and the OTS Order to Cease and Desist.

 

Other limitations may apply depending on the size of the proposed dividend and the condition of the Bank. See “— The Bank — Restrictions on Capital Distributions” below.

 

Capital Requirements.  OTS regulations require that federal savings banks maintain: (i) “tangible capital” in an amount of not less than 1.5% of adjusted total assets, (ii) “core (Tier 1) capital” in an amount not less than 3.0% of adjusted total assets and (iii) a level of risk-based capital equal to 8.0% of total risk-weighted assets. Most banks are required to maintain a “minimum leverage” ratio of core (Tier 1) capital of at least 4.0% to 5.0% of adjusted total assets.

 

“Core capital” includes common stockholders’ equity (including common stock, additional paid in capital and retained earnings, but excluding any net unrealized gains or losses, net of related taxes, on certain securities available for sale), noncumulative perpetual preferred stock and any related surplus and noncontrolling interests in the equity accounts of full consolidated subsidiaries. Intangible assets generally must be deducted from core capital, other than certain servicing assets and purchased credit card relationships, subject to limitations. “Tangible capital” means core capital less any intangible assets (except for mortgage servicing assets includable in core capital) and investments in subsidiaries engaged in activities not permissible for a national bank. “Total capital,” for purposes of the risk-based capital requirement, equals the sum of core capital plus supplementary (Tier 2) capital (which, as defined, includes the sum of, among other items, perpetual preferred stock not counted as core capital, limited life preferred stock, subordinated debt and general loan and lease loss allowances up to 1.25% of risk-weighted assets) less certain deductions. The amount of supplementary (Tier 2) capital that may be counted towards satisfaction of the total capital requirement may not exceed 100% of core capital, and OTS regulations require the maintenance of a minimum ratio of core capital to total risk-weighted assets of 4.0%. Risk-weighted assets are determined by multiplying certain categories of a savings association’s assets, including off-balance sheet equivalents, by an assigned risk weight of 0% to 100% based on the credit risk associated with those assets as specified in OTS regulations.

 

As of March 31, 2011, the Bank was not in compliance with all minimum regulatory capital requirements, with tangible, core and risk-based capital ratios of 4.26%, 4.26% and 8.04%, respectively. Capital requirements higher than the generally applicable minimum requirement may be established for a particular savings association if the OTS determines that the institution’s capital was or may become inadequate in view of its particular circumstances. In June, 2009, the Bank consented to the issuance of a Cease and Desist Agreement with the OTS which requires, among other things, capital requirements in excess of the generally applicable minimum requirements. See Note 2 to the Consolidated Financial Statements included in Item 8.

 

Prompt Corrective Action.  Under Section 38 of the Federal Deposit Insurance Act (“FDIA”), each federal banking agency is required to take prompt corrective action to deal with depository institutions subject to their jurisdiction that fail to meet their minimum capital requirements or are otherwise in a troubled condition. The prompt corrective action provisions require undercapitalized institutions to become subject to an increasingly stringent array of restrictions, requirements and prohibitions as their capital levels deteriorate and supervisory problems mount. Should these corrective measures prove unsuccessful in recapitalizing the institution and correcting its problems, the FDIA mandates that the institution be placed in receivership.

 

Pursuant to regulations promulgated under Section 38 of the FDIA, the corrective actions that the banking agencies either must or may take are tied primarily to an institution’s capital levels. In accordance with the framework set forth in the FDIA, the federal banking agencies have developed a classification system, pursuant to which all banks and savings associations are placed into one of five categories: well capitalized, adequately

capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The capital thresholds established for each of the categories are as follows:

 

 

 

 

The applicable federal banking agency also has authority, after providing an opportunity for a hearing, to downgrade an institution from “well capitalized” to “adequately capitalized” or to subject an “adequately capitalized” or “undercapitalized” institution to the supervisory actions applicable to the next lower category, for supervisory concerns.

 

Applicable laws and regulations also generally provide that no insured institution may make a capital distribution if it would cause the institution to become “undercapitalized.” Capital distributions include cash (but not stock) dividends, stock purchases, redemptions and other distributions of capital to the owners of an institution. Moreover, only a “well capitalized” depository institution may accept brokered deposits without prior regulatory approval.

 

“Undercapitalized” depository institutions are subject to growth limitations and other restrictions and are required to submit a capital restoration plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5% of the depository institution’s total assets at the time it became “undercapitalized,” and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”

 

“Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets and cessation of receipt of deposits from correspondent banks.

 

“Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.

 

As of March 31, 2011, the Bank was “adequately capitalized” under PCA guidelines. Under OTS requirements, a bank must have a total Risk-Based Capital Ratio of 8.0 percent or greater to be considered “adequately capitalized.” The Bank continues to work toward the requirements of the previously issued Cease and Desist Order which requires a total Risk-Based Capital Ratio of 12.0 percent, which exceeds traditional capital levels for a bank. At March 31, 2011, the Bank had not met the elevated capital levels. See Note 12 to the Consolidated Financial Statements included in Item 8.

 

Restrictions on Capital Distributions.  OTS regulations govern capital distributions by savings institutions, which include cash dividends, stock repurchases and other transactions charged to the capital account of a savings institution to make capital distributions. Under applicable regulations, a savings institution must file an application for OTS approval of the capital distribution if:

 

 

 

If an application is not required to be filed, savings institutions such as the Bank which are a subsidiary of a holding company (as well as certain other institutions) must still file a notice with the OTS at least 30 days before the board of directors declares a dividend or approves a capital distribution.

 

An institution that either before or after a proposed capital distribution fails to meet its then applicable minimum capital requirement or that has been notified that it needs more than normal supervision may not make any capital distributions without the prior written approval of the OTS. In addition, the OTS may prohibit a proposed capital distribution, which would otherwise be permitted by OTS regulations, if the OTS determines that such distribution would constitute an unsafe or unsound practice.

 

The FDIC prohibits an insured depository institution from paying dividends on its capital stock or interest on its capital notes or debentures (if such interest is required to be paid only out of net profits) or distributing any of its capital assets while it remains in default in the payment of any assessment due the FDIC. The Bank is currently not in default in any assessment payment to the FDIC.

 

Qualified Thrift Lender Test.  A savings association can comply with the qualified thrift lender, or QTL, test set forth in the HOLA and implementing regulations of the OTS by either meeting the QTL test set forth therein or qualifying as a domestic building and loan association as defined in Section 7701(a)(19) of the Internal Revenue Code of 1986. The QTL test set forth in the HOLA requires a savings association to maintain 65% of portfolio assets in qualified thrift investments, or QTLs. Portfolio assets are defined as total assets less intangibles, property used by a savings association in its business and liquidity investments in an amount not exceeding 20% of assets. Generally, QTLs are residential housing related assets. At March 31, 2011, the amount of the Bank’s assets which were invested in QTLs exceeded the percentage required to qualify the Bank under the QTL test.

 

Applicable laws and regulations provide that any savings association that fails to meet the definition of a QTL must either convert to a national bank charter or limit its future investments and activities (including branching and payments of dividends) to those permitted for both savings associations and national banks. Further, within one year of the loss of QTL status, a holding company of a savings association that does not convert to a bank charter must register as a bank holding company and be subject to all statutes applicable to bank holding companies. In order to exercise the powers granted to federally-chartered savings associations and maintain full access to FHLB advances, the Bank must continue to meet the definition of a QTL.

 

Safety and Soundness Standards.  The OTS and the other federal bank regulatory agencies have established guidelines for safety and soundness, addressing operational and managerial standards, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards are required to submit compliance plans to their appropriate federal regulators. The OTS and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. The Bank believes that it is in compliance with these guidelines and standards.

 

Community Investment and Consumer Protection Laws.  In connection with the Bank’s lending activities, the Bank is subject to a variety of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population. Included among these are the federal Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act, Truth-in-Savings Act, Fair Housing Act, Equal Credit Opportunity Act, Fair Credit Reporting Act, Bank Secrecy Act, Money Laundering Prosecution Improvements Act and Community Reinvestment Act.

 

The Community Reinvestment Act requires insured institutions to define the communities that they serve, identify the credit needs of those communities and adopt and implement a “Community Reinvestment Act Statement” pursuant to which they offer credit products and take other actions that respond to the credit needs of the community. The responsible federal banking regulator (the OTS in the case of the Bank) must conduct regular Community Reinvestment Act examinations of insured financial institutions and assign to them a Community Reinvestment Act rating of “outstanding,” “satisfactory,” “needs improvement” or “unsatisfactory.” The record of a depository institution under the Community Reinvestment Act will be taken into account when applying for the

establishment of new branches or mergers with other institutions. The Bank’s current Community Reinvestment Act rating is “satisfactory.”

 

The Bank attempts in good faith to ensure compliance with the requirements of the consumer protection statutes to which it is subject, as well as the regulations that implement the statutory provisions. The requirements are complex, however, and even inadvertent non-compliance could result in civil and, in some cases, criminal liability.

 

Federal Deposit Insurance.  Deposits held by the Bank are insured by the Deposit Insurance Fund (the “DIF”) as administered by the FDIC. The Dodd-Frank Act raised the standard maximum deposit insurance amount to $250,000 per depositor, per insured depository institution for each account ownership category. The change makes permanent the temporary coverage limit increase from $100,000 to $250,000 that had been in effect since October 2008.

 

In November 2008, the FDIC adopted a final rule relating to its Temporary Liquidity Guarantee Program (“TLGP”). The TLGP was first announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the Secretary of the Treasury (after consultation with the President), as an initiative to counter the system-wide crisis in the nation’s financial sector. Under the TLGP, the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30, 2009 and (ii) provide full FDIC deposit insurance coverage through December 31, 2009 for non-interest bearing transaction deposit accounts paying less than 0.5% interest per annum and held at participating FDIC-insured institutions. Coverage under the TLGP was available for the first 30 days without charge. The Company and the Bank elected to continue to participate in the TLGP account insurance program, through payment of a fee assessment of 10 basis points per quarter on amounts in excess of $250,000 in covered accounts. At March 31, 2011 and 2010, neither the Company nor the Bank had issued any senior unsecured debt under the TLGP.

 

The FDIC maintains the DIF by assessing each depository institution an insurance premium. The amount of the FDIC assessments paid by a DIF member institution is based on its relative risk of default as measured by the company’s FDIC supervisory rating, and other various measures, such as the level of brokered deposits, secured debt and debt issuer ratings.

 

The DIF assessment base rate currently ranges from 12 to 45 basis points for institutions that do not trigger factors for brokered deposits and unsecured debt, and higher rates for those that do trigger those risk factors. In February 2011, the FDIC redefined the deposit insurance assessment base, and updated the assessment rates. Absent any changes in the FDIC risk category due to other factors, including potential declines in the capital level of the Bank, the change in DIF assessment rate is expected to decrease FDIC insurance expense.

 

The Dodd-Frank Act effects further changes to the law governing deposit insurance assessments. There is no longer an upper limit for the reserve ratio designated by the FDIC each year, and the maximum reserve ratio may not be less than 1.35% of insured deposits, or the comparable percentage of the assessment base. Under prior law the maximum reserve ratio was 1.15%. The Dodd-Frank Act permits the FDIC until September 30, 2020 to raise the reserve ratio, which is currently negative, to 1.35%. The FDIC is required to offset the effect of increased assessments necessitated by the Dodd-Frank Act on insured depository institutions with total consolidated assets of less than $10 billion, but we cannot currently predict how this offset will affect us, and implementing rules are not expected until mid-2011. See “Risk Factors — Recent changes have created regulatory uncertainty” and “Risk Factors — Current and future increases in FDIC insurance premiums, including FDIC special assessments imposed on all FDIC-insured institutions, will decrease our earnings.” The Dodd-Frank Act also eliminates requirements under prior law that the FDIC pay dividends to member institutions if the reserve ratio exceeds certain thresholds, and the FDIC has proposed that in lieu of dividends, it will adopt lower rate schedules when the reserve ratio exceeds certain thresholds.

 

All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, which are referred to as FICO bonds, were issued to capitalize the

Federal Savings and Loan Insurance Corporation. FDIC-insured depository institutions paid between 1.02 cents to 1.14 cents per $100 of DIF-assessable deposits in 2009, and between 1.04 to 1.06 cents during 2010.

 

Brokered Deposits.  The FDIC restricts the use of brokered deposits by certain depository institutions. Under the FDIC and applicable regulations, (i) a “well capitalized insured depository institution” may solicit and accept, renew or roll over any brokered deposit without restriction, (ii) an “adequately capitalized insured depository institution” may not accept, renew or roll over any brokered deposit unless it has applied for and been granted a waiver of this prohibition by the OTS and (iii) an “undercapitalized insured depository institution” may not (x) accept, renew or roll over any brokered deposit or (y) solicit deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in such institution’s normal market area or in the market area in which such deposits are being solicited. The term “undercapitalized insured depository institution” is defined to mean any insured depository institution that fails to meet the minimum regulatory capital requirement prescribed by its appropriate federal banking agency. The OTS may, on a case-by-case basis and upon application by an adequately capitalized insured depository institution, waive the restriction on brokered deposits upon a finding that the acceptance of brokered deposits does not constitute an unsafe or unsound practice with respect to such institution. The Corporation had $48.1 million of outstanding brokered deposits at March 31, 2011. At March 31, 2011, the Bank is adequately capitalized under PCA guidelines although it is precluded from accepting, renewing or rolling over brokered deposits without prior approval of the OTS. Under OTS requirements, a bank must have a total Risk-Based Capital Ratio of 8.0 percent or greater to be considered “adequately capitalized.” The Bank continues to work toward the requirements of the previously issued Cease and Desist Order which requires a total Risk-Based Capital Ratio of 12.0 percent, which exceeds traditional capital levels for a bank. At March 31, 2011, the Bank had not met the elevated capital levels. See Note 2 to the Consolidated Financial Statements included in Item 8.

 

Federal Home Loan Bank System.  The FHLB System consists of twelve regional FHLBs, each subject to supervision and regulation by the Federal Housing Finance Board, or FHFB. The FHLBs provide a central credit facility for member savings associations. Collateral is required. The Bank is a member of the FHLB of Chicago. The maximum amount that the FHLB of Chicago will advance fluctuates from time to time in accordance with changes in policies of the FHFB and the FHLB of Chicago, and the maximum amount generally is reduced by borrowings from any other source. In addition, the amount of FHLB advances that a savings association may obtain is restricted in the event the institution fails to maintain its status as a QTL.

 

Federal Reserve System.  The Federal Reserve Board has adopted regulations that require savings associations to maintain non-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). These reserves may be used to satisfy liquidity requirements imposed by the OTS. Because required reserves must be maintained in the form of cash or a non-interest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce the amount of the Bank’s interest-earning assets.

 

Transactions With Affiliates Restrictions.  Transactions between savings associations and any affiliate are governed by Section 11 of the HOLA and Sections 23A and 23B of the Federal Reserve Act and regulations thereunder. An affiliate of a savings association generally is any company or entity which controls, is controlled by or is under common control with the savings association. In a holding company context, the parent holding company of a savings association (such as the Corporation) and any companies which are controlled by such parent holding company are affiliates of the savings association. Generally, Section 23A limits the extent to which the savings association or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such association’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. Section 23B applies to “covered transactions” as well as certain other transactions and requires that all transactions be on terms substantially the same, or at least as favorable, to the savings association as those provided to a non-affiliate. The term “covered transaction” includes the making of loans to, purchase of assets from and issuance of a guarantee to an affiliate and similar transactions. Section 23B transactions also apply to the provision of services and the sale of assets by a savings association to an affiliate. In addition to the restrictions imposed by Sections 23A and 23B, Section 11 of the HOLA prohibits a savings association from (i) making a loan or other extension of credit to an affiliate, except for any affiliate which engages only in certain activities which are permissible for bank holding companies, or (ii) purchasing or investing

in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings association.

 

In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on extensions of credit to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of a savings association (“a principal stockholder”), and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the savings association’s loans to one borrower limit (generally equal to 15% of the institution’s unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that (i) is widely available to employees of the institution and (ii) does not give preference to any director, executive officer or principal stockholder, or certain affiliated interests of either, over other employees of the savings institution. Section 22(h) also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a savings institution to all insiders cannot exceed the institution’s unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers.

 

The Dodd-Frank Act expands the 23A and 23B affiliate transaction rules. Among other things, upon the statutory changes’ effective date, which will likely be mid- to late- 2012, the scope of the definition of “covered transaction” under 23A will expand, collateral requirements will increase and certain exemptions will be eliminated. At March 31, 2011, the Bank was in compliance with the above restrictions.

 

Anti-Money Laundering.  Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. We are prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence in dealings with foreign financial institutions and foreign customers. We also must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions. Recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”), enacted in 2001, renewed in 2006 and extended, in part, in 2011. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

The USA Patriot Act amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. The statute also creates enhanced information collection tools and enforcement mechanics for the U.S. government, including: (1) requiring standards for verifying customer identification at account opening; (2) promulgating rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (3) requiring reports by nonfinancial trades and businesses filed with the Treasury’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (4) mandating the filing of suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations. The statute also requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

 

The Federal Bureau of Investigation may send bank regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. We may be subject to a request for a search of its records for any relationships or transactions with persons on those lists and may be required to report any identified relationships or transactions. Furthermore, the Office of Foreign Assets Control (“OFAC”) is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, bank regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked

Persons. If we find a name on any transaction, account or wire transfer that is on an OFAC list, we must freeze such account, file a suspicious activity report and notify the appropriate authorities.

 

Privacy Regulation.  The Corporation and the Bank are subject to numerous privacy-related laws and their implementing regulations, including but not limited to Title V of the Gramm-Leach-Bliley Act, the Fair Credit Reporting Act, the Electronic Funds Transfer Act, the Right to Financial Privacy Act, the Children’s Online Privacy Protection Act and other federal and state privacy and consumer protection laws. Those laws and the regulations promulgated under their authority can limit, under certain circumstances, the extent to which financial institutions may disclose nonpublic personal information that is specific to a particular individual to affiliated companies and nonaffiliated third parties. Moreover, the Bank is required to establish and maintain a comprehensive Information Security Program in accordance with the Interagency Guidelines Establishing Standards for Safeguarding Customer Information. The program must be designed to:

 

 

In addition, the Federal Trade Commission has implemented a nationwide “do not call” registry that allows consumers to prevent unsolicited telemarketing calls. Millions of households already have placed their telephone numbers on this registry.

 

Regulatory Enforcement Authority.  The enforcement powers available to federal banking agencies are substantial and include, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against insured institutions and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

 

Sarbanes-Oxley Act of 2002.  The Sarbanes-Oxley Act of 2002 (i) created a public company accounting oversight board; (ii) strengthened auditor independence from corporate management; (iii) heightened the responsibility of public company directors and senior managers for the quality of the financial reporting and disclosure made by their companies; (iv) adopted a number of provisions to deter wrongdoing by corporate management; (v) imposed a number of new corporate disclosure requirements; (vi) adopted provisions which generally seek to limit and expose to public view possible conflicts of interest affecting securities analysts; and (vii) imposed a range of new criminal penalties for fraud and other wrongful acts, as well as extended the period during which certain types of lawsuits can be brought against a company or its insiders.

 

Overdraft Fees.  In November 2009, the Federal Reserve Board adopted amendments under its Regulation E that impose new restrictions on banks’ abilities to charge overdraft fees. The final rule prohibits financial institutions from charging fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. Should the Bank be required to comply with Regulation E or if it becomes subject to a future regulation promulgated by the Office of the Comptroller of the Currency, as a result of changes relating to expected dissolution of the OTS in July 2011, the Bank may experience decreased revenues and additional compliance costs.

 

Interchange Fee.  The Dodd-Frank Act, through a provision known as the Durbin Amendment, requires the Federal Reserve Board to establish standards for interchange fees that are “reasonable and proportional” to the cost of processing the debit card transaction and imposes other requirements on card networks. On December 16, 2010, the Federal Reserve Board proposed an interchange fee cap of twelve cents per transaction, although institutions like the Bank with less than 10 billion in assets would be exempt. Notwithstanding the exemption, it is widely expected that retailers may require smaller institutions to accept the same limitation as a condition of acceptance of their debit cards. Consequently if the interchange fee cap is implemented, we expect it could result in decreased revenues and increased compliance costs for the banking industry and the Bank.

Source of Strength Doctrine.  Federal Reserve policy requires bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act requires this Federal Reserve policy to be made law. Under this policy, the holding company is expected to commit resources to support its bank subsidiary, including at times when the holding company may not be in a financial position to provide it. Any capital loans by a bank holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Temporary Liquidity Guarantee Program.  In October 2008, the Secretary of the United States Department of the Treasury (“Treasury”) invoked the systemic risk exception of the FDIC Improvement Act of 1991 and the FDIC announced the Temporary Liquidity Guarantee Program (the “TLGP”). The TLGP provides a guarantee, through the earlier of maturity or June 30, 2012, of certain senior unsecured debt issued by participating Eligible Entities (including the Corporation) between October 14, 2008 and October 31, 2009. The maximum amount of FDIC-guaranteed debt a participating Eligible Entity (including the Corporation) may have outstanding is 125% of the entity’s senior unsecured debt that was outstanding as of September 30, 2008 that was scheduled to mature on or before October 31, 2009. The ability of Eligible Entities (including the Corporation) to issue guaranteed debt under the TLGP expired on October 31, 2009. As of October 31, 2009, the Corporation had no senior unsecured debt outstanding under the TLGP. The Corporation and the Bank signed a master agreement with the FDIC on December 5, 2008 for issuance of bonds under the program. The Corporation did not have any unsecured debt, thus had to file for an exemption to be able to issue bonds under this program. The Bank is eligible to issue up to $88 million as of March 31, 2011. As of March 31, 2011, the Bank had $60.0 million of bonds issued.

 

Another aspect of the TLGP, also established by the FDIC in October 2008, is the transaction account guarantee program (“TAG Program”) under which the FDIC fully guaranteed all non-interest-bearing transaction accounts until December 31, 2009, for FDIC-insured institutions that agreed to participate in the program. The TAG Program applies to all personal and business checking deposit accounts that do not earn interest at participating institutions. The TAG Program was subsequently extended, until December 31, 2010, with an assessment of between 15 and 25 basis points after January 1, 2010. The assessment depends upon an institution’s risk profile and is assessed quarterly on balances in noninterest-bearing transaction accounts that exceed the existing deposit insurance limit of $250,000 for insured depository institutions that have not opted out of this component of the TLGP. The Corporation opted to participate in this component of the TLPG. The Dodd-Frank Act has extended unlimited deposit insurance to non-interest-bearing transaction accounts until December 31, 2012.

 

Emergency Economic Stabilization Act of 2008.  On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (“EESA”), giving the United States Department of the Treasury (“Treasury”) authority to take certain actions to restore liquidity and stability to the U.S. banking markets. Based upon its authority in the EESA, a number of programs to implement EESA have been announced. Those programs include the following:

 

 

 

The American Recovery and Reinvestment Act of 2009.  On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law. Included among the many provisions in ARRA are restrictions affecting financial institutions who are participants in TARP, which are set forth in the form of amendments to EESA. These amendments provide that during the period in which any obligation under TARP remains outstanding (other than obligations relating to outstanding warrants), TARP recipients are subject to appropriate standards for executive compensation and corporate governance which were set forth in an interim final rule regarding TARP standards for Compensation and Corporate Governance, issued by Treasury and effective on June 15, 2009 (the “Interim Final Rule”). Among the executive compensation and corporate governance provisions included in ARRA and the Interim Final Rule are the following:

 

 

The Special Inspector General for the Troubled Asset Relief Program (“SIGTARP”) was established pursuant to Section 121 of EESA and has the duty, among other things, to conduct, supervise, and coordinate audits and investigations of the purchase, management and sale of assets by the Treasury under TARP and the CPP, including the shares of non-voting preferred shares purchased from the Corporation. Thus, the Corporation is now also subject to supervision, regulation and investigation by SIGTARP by virtue of its participation in the TARP CPP.

 

In addition, companies who have issued preferred stock to Treasury under TARP are now permitted to redeem such investments at any time, subject to consultation with banking regulators. Upon such redemption, the warrants may be immediately liquidated by Treasury.

Homeowners Affordability and Stability Plan

 

In February 2009, the Administration also announced its Financial Stability Plan and Homeowners Affordability and Stability Plan (“HASP”). The Financial Stability Plan is the second phase of TARP, to be administrated by the Treasury. Its four key elements include:

 

 

The HASP is a program aimed to help seven to nine million families restructure their mortgages to avoid foreclosure. The plan also develops guidance for loan modifications nationwide. HASP provides programs and funding for eligible refinancing of loans owned or guaranteed by Fannie Mae or Freddie Mac, along with incentives to lenders, mortgage servicers, and borrowers to modify mortgages of “responsible” homeowners who are at risk of defaulting on their mortgage. The goals of HASP are to assist in the prevention of home foreclosures and to help stabilize falling home prices.

 

Beyond the Company’s participation in certain programs, such as TARP, the Company will benefit from these programs if they help stabilize the national banking system and aid in the recovery of the housing market.

 

Dodd-Frank Act

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and smaller bank and thrift holding companies, such as the Corporation, will be regulated in the future. Among other things, these provisions abolish the OTS and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards, and pre-payments. The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of the Corporation in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is likely to affect our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within the financial services industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time. The Corporation’s management is actively reviewing the provisions of the Dodd-Frank Act, many of which are phased-in over the next several months and years, and assessing its probable impact on the business, financial condition, and results of operations of the Corporation. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Corporation in particular, is uncertain at this time.

Federal Housing Finance Agency

 

In January 2011, the Federal Housing Finance Agency (FHFA) announced that it directed Fannie Mae and Freddie Mac to work on a joint initiative, in coordination with FHFA and HUD, to consider alternatives for future mortgage servicing structures and servicing compensation for their single-family mortgage loans. Alternatives that may be considered include a fee for service compensation structure for nonperforming loans, as well as the possibility of reducing or eliminating the minimum mortgage servicing fee for performing loans, or other structures. In its announcement, FHFA stated that any implementation of a new servicing compensation structure would not be expected to occur before summer 2012.

 

Legislative and Regulatory Proposals

 

Proposals to change the laws and regulations governing the operations and taxation of, and federal insurance premiums paid by, savings banks and other financial institutions and companies that control such institutions are frequently raised in the U.S. Congress, state legislatures and before the FDIC, the OTS and other bank regulatory authorities. The likelihood of any major changes in the future and the impact such changes might have on us or our subsidiaries are impossible to determine. Similarly, proposals to change the accounting treatment applicable to savings banks and other depository institutions are frequently raised by the SEC, the federal banking agencies, the IRS and other appropriate authorities, including, among others, proposals relating to fair market value accounting for certain classes of assets and liabilities. The likelihood and impact of any additional future accounting rule changes and the impact such changes might have on us or our subsidiaries are impossible to determine at this time.

 

Federal

 

The Corporation files a consolidated federal income tax return on behalf of itself, the Bank and its subsidiaries on a fiscal tax year basis.

 

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 are 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 the Bank’s financial condition or results of operations.

 

State

 

Under current law, the state of Wisconsin imposes a corporate franchise tax of 7.9% on the separate taxable incomes of the members of the Corporation’s consolidated income tax group, including, pursuant to an agreement between the Corporation and the Wisconsin Department of Revenue, AIC commencing in the fourth quarter of fiscal 2004.

 

 

Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K. The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition, results of operations or prospects could be materially and adversely affected by any of these risks. The trading price of, and market for, shares of our common stock could decline due to any of these risks. This report, including the documents incorporated by reference herein, also contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks described below and in the documents incorporated by reference herein.

Risks Related to Our Industry

 

Our business may be adversely affected by current conditions in the financial markets, the real estate market and economic conditions generally.

 

Beginning in the latter half of 2007 and continuing into 2011, negative developments in the capital markets resulted in uncertainty and instability in the financial markets, and an economic downturn. The housing market declined, resulting in decreasing home prices and increasing delinquencies and foreclosures. The credit performance of residential and commercial real estate, construction and land loans resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. The declines in the performance and value of mortgage assets encompassed all mortgage and real estate asset types, leveraged bank loans and nearly all other asset classes, including equity securities. These write-downs have caused many financial institutions to seek additional capital or to merge with larger and stronger institutions. Some financial institutions have failed. Continued, and potentially increased, volatility, instability and weakness could affect our ability to sell investment securities and other financial assets, which in turn could adversely affect our liquidity and financial position. This instability also could affect the prices at which we could make any such sales, which could adversely affect our earnings and financial condition.

 

Concerns over the stability of the financial markets and the economy have resulted in decreased lending by some financial institutions to their customers and to each other. This tightening of credit has led to increased loan delinquencies, lack of customer confidence, increased market volatility and a widespread reduction in general business activity. Competition among depository institutions for deposits has increased significantly, and access to deposits or borrowed funds has decreased for many institutions. It has also become more difficult to assess the creditworthiness of customers and to estimate the losses inherent in our loan portfolio.

 

Current conditions, including high unemployment, weak corporate performance, soft real estate markets, and the decline of home sales and property values, could negatively affect the volume of loan originations and prepayments, the value of the real estate securing our mortgage loans, and borrowers’ ability to repay loan obligations, all of which could adversely impact our earnings and financial condition. Business activity across a wide range of industries and regions is greatly reduced, and local governments and many companies are in serious difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. A worsening of current conditions would likely adversely affect our business and results of operations, as well as those of our customers. As a result, we may experience increased foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds.

 

The soundness of other financial institutions could negatively affect us.

 

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.

 

Regulation by federal and state agencies could adversely affect our business, revenue, and profit margins.

 

We are heavily regulated by federal and state agencies. This regulation is to protect depositors, the federal deposit insurance fund and the banking system as a whole. Congress and state legislatures and federal and state regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including interpretation or implementation of statutes, regulations, or policies, could affect us adversely, including limiting the types of financial services and products we may offer and/or increasing the ability of non-banks to offer competing financial services and products. Also, if we do not comply with laws, regulations, or policies, we could receive regulatory sanctions and damage to our reputation.

Competition in the financial services industry is intense and could result in losing business or reducing margins.

 

We operate in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes, and continued consolidation. We face aggressive competition from other domestic and foreign lending institutions and from numerous other providers of financial services. The ability of non-banking financial institutions to provide services previously limited to commercial banks has intensified competition. Because non-banking financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures. Securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This may significantly change the competitive environment in which we conduct business. Some of our competitors have greater financial resources and/or face fewer regulatory constraints. As a result of these various sources of competition, we could lose business to competitors or be forced to price products and services on less advantageous terms to retain or attract clients, either of which would adversely affect our profitability.

 

We continually encounter technological change.

 

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition, results of operations and cash flows.

 

Risks Related to Our Business

 

We experienced a net loss in fiscal 2011 directly attributable to a substantial deterioration in our commercial real estate, land and construction loan portfolio and the resulting increase in our provision for credit losses.

 

We realized a net loss of $41.2 million in fiscal 2011. The net loss is primarily the result of a $51.2 million provision to our credit loss reserve. The credit loss reserve is the amount required to maintain the allowance for loan losses at an adequate level to absorb probable loan losses. The provision for credit losses is primarily attributable to our residential construction and residential land loan portfolios, which continue to experience deterioration in estimated collateral values and repayment abilities of some of our customers. Other reasons for the level of the provision for credit losses are attributable to the continued weak economic conditions and decline in real estate values in the markets served by the Corporation.

 

At March 31, 2011, our non-performing loans (consisting of loans past due more than 90 days, loans less than 90 days delinquent but placed on non-accrual status due to anticipated probable loss and non-accrual troubled debt restructurings) were $306.3 million compared to $399.9 million at March 31, 2010. For the year ended March 31, 2011, net charge-offs as a percentage of average loans were 2.76% compared to 3.30% for the corresponding period in 2010.

 

Despite the improvement in the State of Wisconsin unemployment rate from 9.8% at March 31, 2010 to 8.1% at March 31, 2011, the economy remains fragile. The deterioration in our commercial real estate, construction and land loan portfolios has been caused primarily by the weakening economy and the slowdown in sales of the housing market. With many real estate projects requiring an extended time to market, some of our borrowers have exhausted their liquidity which may require us to place their loans into non-accrual status.

Our independent registered public accounting firm has expressed substantial doubt about our ability to continue as a going concern.

 

Our independent registered public accounting firm in its audit report for the fiscal year ending March 31, 2011 has expressed substantial doubt about our ability to continue as a going concern. Continued operations depend on our ability to meet our existing debt obligations and the financing or other capital required to do so may not be available or may not be available on reasonable terms. The Bank has low levels of capital, significant operating losses and significant deterioration in the quality of its assets. Further, we have become subject to enhanced regulatory scrutiny. The potential lack of sources of liquidity raises substantial doubt about our ability to continue as a going concern for the foreseeable future. Our Consolidated Financial Statements were prepared under the assumption that we will continue our operations on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. Our Consolidated Financial Statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. If we cannot continue as a going concern, our shareholders will lose some or all of their investment.

 

We are actively pursuing a broad range of strategic alternatives in order to address any doubt related to the Corporation’s ability to continue as a going concern. There can be no assurance that the pursuit of strategic alternatives will result in any transaction, or that any such transaction, if consummated, will allow the Corporation’s shareholders to avoid a loss of all or substantially all of their investment in the Corporation. In addition, a transaction, which would likely involve equity financing, would result in substantial dilution to our current shareholders and could adversely affect the price of our common stock. The pursuit of strategic alternatives may also involve significant expenses and management time and attention.

 

We have reported material weaknesses in our internal control over financial reporting and if additional material weaknesses are discovered in the future, our stock price and investor confidence in us may be adversely affected.

 

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected. In connection with management’s assessments of our internal control over financial reporting over the prior two fiscal years and interim quarterly periods in the current fiscal year, we identified material weakness in our internal control over financial reporting.

 

As disclosed in Item 9A “Controls and Procedures,” we believe we have taken the steps necessary to remediate certain material weaknesses identified during these periods. The controls implemented to remediate these material weaknesses were determined to be operating effectively as of March 31, 2011.

 

We may, in the future, identify additional internal control deficiencies that could rise to the level of a material weakness or uncover errors in financial reporting. Material weaknesses in our internal control over financial reporting may cause investors to lose confidence in us, which could have an adverse effect on our business and stock price.

 

The Bank may be subject to a federal conservatorship or receivership if it cannot comply with the Cease and Desist Order, the Capital Restoration Plan, the Memorandum of Understanding, or if its condition continues to deteriorate.

 

In June 2009, the Bank voluntarily entered into a Cease and Desist Order with the OTS which required, among other things, capital requirements in excess of the generally applicable minimum requirements. The Bank was also required to create and implement a Capital Restoration Plan. The condition of the Bank’s loan portfolio may continue to deteriorate in the current economic environment and thus continue to deplete the Bank’s capital and other financial resources. Therefore, should the Bank fail to comply with the Cease and Desist Order or the Memorandum of Understanding, fail to fulfill the terms of its Capital Restoration Plan, fail to comply with capital and liquidity funding requirements, or suffer a continued deterioration in its financial condition, the Bank may be subject to being placed into a federal conservatorship or receivership by the OTS, with the FDIC appointed as conservator or receiver. If these events occur, the Corporation probably would suffer a complete loss of the value of its ownership interest in the Bank, and the Corporation subsequently may be exposed to significant claims by the FDIC and the OTS.

Our business is subject to liquidity risk, and changes in our source of funds may adversely affect our performance and financial condition by increasing our cost of funds.

 

Our ability to make loans is directly related to our ability to secure funding. Retail deposits and core deposits are our primary source of liquidity. We also rely on advances from the FHLB of Chicago as a funding source. We have also been granted access to Federal Reserve Bank of Chicago’s discount window, but as of March 31, 2011 we had no borrowings outstanding from this source. In addition, as of March 31, 2011, the Corporation had outstanding borrowings from the FHLB of $478.5 million, out of our maximum borrowing capacity from the FHLB at this time, based on collateral currently pledged, of $769.5 million.

 

Primary uses of funds include withdrawal of and interest payments on deposits, originations of loans and payment of operating expenses. Core deposits represent a significant source of low-cost funds. Alternative funding sources such as large balance time deposits or borrowings are a comparatively higher-cost source of funds. Liquidity risk arises from the inability to meet obligations when they come due or to manage unplanned decreases or changes in funding sources. Although we believe we can continue to pursue our core deposit funding strategy successfully, significant fluctuations in core deposit balances may adversely affect our financial condition and results of operations.

 

Concern of our customers over deposit insurance may cause a decrease in deposits.

 

With recent increased concerns about bank failures, customers increasingly are concerned about the extent to which their deposits are insured by the FDIC. Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with their bank is fully insured. The Dodd-Frank Provision, which became effective on December 31, 2010, provides unlimited FDIC insurance coverage for all noninterest-bearing transaction accounts, as well as IOLTA accounts. This full deposit insurance coverage is in effect until December 31, 2012. We have elected to participate in the program. If this program is not extended beyond December 31, 2012, we may experience a decrease in deposits. Decreases in deposits may adversely affect our funding costs, net income, and liquidity.

 

Our liquidity is largely dependent upon our ability to receive dividends from our subsidiary bank, which accounts for most of our revenue and could affect our ability to pay dividends, and we may be unable to enhance liquidity from other sources.

 

We are a separate and distinct legal entity from our subsidiaries, including the Bank. We receive substantially all of our revenue from dividends from the Bank. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank and certain of our non-bank subsidiaries may pay us. Additionally, if our subsidiaries’ earnings are not sufficient to make dividend payments to us while maintaining adequate capital levels, our ability to make dividend payments to our preferred and common shareholders will be negatively impacted. The Bank is currently precluded from paying dividends to us.

 

Additional increases in our level of non-performing assets would have an adverse effect on our financial condition and results of operations.

 

Weakening conditions in the real estate sector have adversely affected, and may continue to adversely affect, our loan portfolio. Non-performing assets decreased by $58.4 million to $397.0 million, or 11.7% of total assets, at March 31, 2011 from $455.4 million, or 10.3% of total assets, at March 31, 2010. If loans that are currently non-performing further deteriorate, we may need to increase our allowance to cover additional charge-offs. If loans that are currently performing become non-performing, we may need to continue to increase our allowance for loan losses if additional losses are anticipated which would have an adverse impact on our financial condition and results of operations. The increased time and expense associated with the work out of non-performing assets and potential non-performing assets also could adversely affect our operations.

 

Future sales or other dilution of the Corporation’s equity may adversely affect the market price of the Corporation’s common stock.

 

In connection with our participation in TARP CPP the Corporation has, or under other circumstances, may, issue additional common stock or preferred securities, including securities convertible or exchangeable for, or that represent

the right to receive, common stock. Further, pursuant to the Cease and Desist order with the OTS, the Bank must meet certain capital ratios which may require the issuance of additional equity capital, which would significantly dilute the current shareholders. The market price of the Corporation’s common stock could decline as a result of sales of a large number of shares of common stock, preferred stock or similar securities in the market. The issuance of additional capital stock would dilute the ownership interest of the Corporation’s existing shareholders.

 

Holders of our common stock have no preemptive rights and are subject to potential dilution.

 

Our articles of incorporation do not provide any shareholder with a preemptive right to subscribe for additional shares of common stock upon any increase thereof. Thus, upon the issuance of any additional shares of common stock or other voting securities of the Company or securities convertible into common stock or other voting securities, shareholders may be unable to maintain their pro rata voting or ownership interest in us.

 

On June 26, 2009, the Corporation and the Bank each consented to the issuance of an Order to Cease and Desist by the Office of Thrift Supervision. If we do not raise additional capital, we may not be in compliance with the capital requirements of the Bank’s Cease and Desist Order, which could have a material adverse effect upon us.

 

The Cease and Desist Orders required that, no later than December 31, 2009, the Bank had to meet and maintain both a core capital ratio equal to or greater than eight percent and a total risk-based capital ratio equal to or greater than twelve percent. At March 31, 2011, the Bank and Corporation had complied with all aspects of the Cease and Desist Orders, except that the Bank, based upon presently available unaudited financial information, had core capital and total risk-based capital ratios of 4.26 percent and 8.04 percent, respectively, each below the required capital ratios set in the Cease and Desist Orders. Without a waiver by the OTS or an amendment or modification of the Orders, the Bank could be subject to further regulatory action.

 

All customer deposits remain fully insured to the highest limits set by the FDIC.

 

If the Bank is placed in conservatorship or receivership, it is highly likely that such action would lead to a complete loss of all value of the Company’s ownership interest in the Bank. In addition, further restrictions could be placed on the Bank if it were determined that the Bank was significantly undercapitalized, or critically undercapitalized, with increasingly greater restrictions being imposed as any level of undercapitalization increased.

 

Although the Bank is considered “adequately capitalized” under PCA guidelines for regulatory purposes, we will incur increased premiums for deposit insurance and will trigger acceleration of certain of our brokered deposits if we fall below the “adequately capitalized” threshold.

 

In April 2011, the FDIC issued new base assessment rates dependent upon the risk category assigned to an institution. These rates range between twelve and 45 basis points. The revised assessment criteria is a risk-based determination, rather than solely based on capital levels. Higher insurance premiums may be assessed to institutions that fall in the higher risk categories, which would impact earnings.

 

Future Federal Deposit Insurance Corporation assessments will hurt our earnings.

 

In November 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. Any additional emergency special assessment imposed by the FDIC will likely negatively impact the Company’s earnings.

 

Our allowance for losses on loans and leases may not be adequate to cover probable losses.

 

Our level of non-performing loans decreased significantly in the fiscal year ended March 31, 2011, relative to the preceding year. Our provision for credit losses decreased by $110.7 million to $51.2 million for the fiscal year ended March 31, 2011 from $161.9 million for the fiscal year ended March 31, 2010. Our allowance for loan losses decreased by $29.5 million to $150.1 million, or 5.6% of total loans, at March 31, 2011 from $179.6 million, or 5.2% of total loans at March 31, 2010. Our allowance for loan and foreclosure losses was 42.9% at March 31, 2011,

43.1% at March 31, 2010 and 52.1% at March 31, 2009, respectively, of non-performing assets. There can be no assurance that any future declines in real estate market conditions and values, general economic conditions or changes in regulatory policies will not require us to increase our allowance for loan and lease losses, which would adversely affect our results of operations.

 

If our investment in the common stock of the Federal Home Loan Bank of Chicago is other than temporarily impaired, our financial condition and results of operations could be materially impaired.

 

The Bank owns common stock of the Federal Home Loan Bank of Chicago (“FHLBC”). The common stock is held to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBC’s advance program. The aggregate cost and fair value of our FHLBC common stock as of March 31, 2011 was $54.8 million, based on its par value. There is no market for the FHLBC common stock and while redemptions may be requested they are at the discretion of the FHLBC.

 

The Bank evaluates the FHLBC stock for impairment on a regular basis. The determination of whether FHLB stock is impaired depends on a number of factors and is based on an assessment of the ultimate recoverability of cost rather than changes in the book value of the shares. If our investment in the common stock of the Federal Home Loan Bank of Chicago were to become other than temporarily impaired, our financial condition and results of operations could be materially affected.

 

We are not paying dividends on our common stock and are deferring distributions on our preferred stock, and are otherwise restricted from paying cash dividends on our common stock. The failure to resume paying dividends may adversely affect us.

 

We historically paid cash dividends before suspending dividend payments on our common stock. The Federal Reserve, as a matter of policy, has indicated that bank holding companies should not pay dividends using funds from TARP CPP. There is no assurance that we will resume paying cash dividends. Even if we resume paying dividends, future payment of cash dividends on our common stock, if any, will be subject to the prior payment of all unpaid dividends and deferred distributions on our Series B Preferred Stock held by the U.S. Treasury. Further, we need prior Treasury approval to increase our quarterly cash dividends prior to January 30, 2012, or until the date we redeem all shares of Series B Preferred Stock or the Treasury has transferred all shares of Series B Preferred Stock to third parties. All dividends are declared and paid at the discretion of our board of directors and are dependent upon our liquidity, financial condition, results of operations, capital requirements and such other factors as our board of directors may deem relevant.

 

Further, dividend payments on our Series B Preferred Stock are cumulative and therefore unpaid dividends and distributions will accrue and compound on each subsequent dividend payment date. In the event of any liquidation, dissolution or winding up of the affairs of our company, holders of the Series B Preferred Stock shall be entitled to receive for each share of Series B Preferred Stock the liquidation amount plus the amount of any accrued and unpaid dividends. Upon deferring six quarterly dividend payments, whether or not consecutive, the Treasury obtained the right to appoint two directors to our board of directors until all accrued but unpaid dividends have been paid. We have deferred eight dividend payments on the Series B Preferred Stock held by the Treasury as of March 31, 2011. As of the date of this filing, we are working with Treasury on the selection and appointment of two directors. Treasury currently has an observer present at quarterly board meetings.

 

Maintaining or increasing market share depends on market acceptance and regulatory approval of new products and services.

 

Our success depends, in part, on the ability to adapt products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. This can reduce net interest income and noninterest income from fee-based products and services. In addition, the widespread adoption of new technologies could require us to make substantial capital expenditures to modify or adapt existing products and services or develop new products and services. We may not be successful in introducing new products and services in response to industry trends or development in technology or those new products may not achieve market acceptance. As a

result, we could lose business, be forced to price products and services on less advantageous terms to retain or attract clients, or be subject to cost increases.

 

We may fail to meet continued listing requirements with NASDAQ.

 

Our common stock is listed on the NASDAQ Global Select Market. As a NASDAQ listed company, we are required to comply with the continued listing requirements of the NASDAQ Market Place Rules to maintain our listing status which includes maintaining a minimum closing bid price of at least $1.00 per share for our common stock. We were notified by NASDAQ on May 13, 2011 of our non-compliance with listing standards because the bid price of our common stock closed below the required minimum $1.00 per share for the previous 30 consecutive business days. We will regain compliance if our common stock trades above $1.00 per share for ten consecutive business days during the 180 days following May 13, 2011. If we are unable to regain compliance, our common stock will be delisted by NASDAQ. Delisting could reduce the ability of investors to purchase or sell our common stock as quickly and as inexpensively as they have done historically.

 

Continued deterioration in the real estate markets or other segments of our loan portfolio could lead to additional losses, which could have a material negative effect on our financial condition and results of operations.

 

The commercial real estate market continues to experience a variety of difficulties. As a result of increased levels of commercial and consumer delinquencies and declining real estate values, which reduce the customer’s borrowing power and the value of the collateral securing the loan, we have experienced increasing levels of charge-offs and provisions for credit losses. Continued increases in delinquency levels or continued declines in real estate values, which cause our borrowers’ loan-to-value ratios to increase, could result in additional charge-offs and provisions for credit losses. This could have a material negative effect on our business and results of operations.

 

Significant legal actions could subject us to substantial uninsured liabilities.

 

We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. Substantial legal liability or significant regulatory action against us could have material adverse financial effects or cause significant reputational harm to us, which in turn could seriously harm our business prospects. We may be exposed to substantial uninsured liabilities, which could adversely affect our results of operations and financial condition.

 

While we attempt to manage the risk from changes in market interest rates, interest rate risk management techniques are not exact. In addition, we may not be able to economically hedge our interest rate risk. A rapid or substantial increase or decrease in interest rates could adversely affect our net interest income and results of operations.

 

Our net income depends primarily upon our net interest income. Net interest income is income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans, investment securities and short-term investments. The amount of interest income is dependent on many factors, including the volume of earning assets, the general level of interest rates, the dynamics of changes in interest rates and the level of nonperforming loans. The cost of funds varies with the amount of funds required to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds and the levels of non-interest-bearing demand deposits and equity capital.

 

Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest earning assets, or vice versa. When interest-bearing liabilities mature or reprice more quickly than interest earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. We are unable to predict changes in market interest rates which are affected by many factors beyond

our control including inflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets. Based on our net interest income simulation model, if market interest rates were to increase immediately by 100 or 200 basis points (a parallel and immediate shift of the yield curve) net interest income would be expected to increase by 5.01% and 8.83%, respectively, from what it would be if rates were to remain at March 31, 2011 levels. The actual amount of any increase or decrease may be higher or lower than that predicted by our simulation model. The amounts and assumptions used in the simulation model should not be viewed as indicative of expected actual results. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies. Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, credit spreads, relationships between interest sensitive instruments and key driver rates, balance sheet growth, client loan and deposit preferences and the timing of changes in these variables.

 

An interruption in or breach in security of our information systems may result in a loss of customer business.

 

We rely heavily on communications and information systems to conduct our business. Any failure or interruptions or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposits, servicing, or loan origination systems. The occurrence of any failures, interruptions or security breaches of information systems used to process customer transactions could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition, results of operations and cash flows.

 

Additionally, we outsource a portion of our data processing to a third party. If our third party provider encounters difficulties or if we have difficulty in communicating with such third party, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations. Furthermore, breaches of such third party’s technology may also cause reimbursable loss to our consumer and business customers, through no fault of our own.

 

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

 

Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our business.

 

Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base; impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures and is insured for these situations, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition, results of operations and cash flows.

 

The Corporation is exposed to risk of environmental liabilities with respect to properties to which it takes title.

 

In the course of our business, we may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities

could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, cash flows, liquidity and results of operations could be materially and adversely affected.

 

Our regional concentration makes us particularly at risk for changes in economic conditions in our primary market.

 

Our business is primary located in Wisconsin. Thus, we are particularly vulnerable to adverse changes in economic conditions in Wisconsin and the Midwest more generally.

 

Our asset valuations include observable inputs and may include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect our results of operations or financial condition.

 

We must use estimates, assumptions and judgments when financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, we estimate fair value primarily by using cash flows and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying inputs, factors, assumptions or estimates in any of the areas underlying our estimates could materially impact our future financial condition and results of operations.

 

During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be more difficult to value certain of our assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions and interest rates could materially impact the valuation of assets as reported within our consolidated financial statements, and the period-to-period changes in value could vary significantly.

 

Lenders may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud, or certain borrower defaults, which could harm our liquidity, results of operations and financial condition.

 

When we sell mortgage loans, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with our securitizations. While we have taken steps to enhance our underwriting policies and procedures, there can be no assurance that these steps will be effective or reduce risk associated with loans sold in the past. To date, the volume of repurchases has been insignificant. If the level of repurchase and indemnity activity becomes material, our liquidity, results of operations and financial condition will be adversely affected.

 

The infusion of outside capital may dilute the Corporation’s equity and may adversely affect the market price of the Corporation’s common stock.

 

In connection with our effort to raise qualified sources of outside capital, strengthen our balance sheet and improve our financial performance, the Corporation may issue additional common stock or preferred securities, including securities convertible or exchangeable for, or that represent the right to receive, common stock. The market price of the Corporation’s common stock could decline as a result of sales of a large number of shares of

common stock, preferred stock or similar securities in the market. The issuance of additional capital stock would dilute the ownership interest of the Corporation’s existing shareholders.

 

Our Shareholder Rights Plan limits our likelihood of being acquired in a manner not approved by our Board.

 

On November 5, 2010 we entered into a shareholder rights plan designed to reduce the likelihood that we will experience an “ownership change” under U.S. federal income tax laws. The existence of the rights plan may make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control that is not approved by our Board, which in turn could prevent our shareholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.

 

Risks Related to Our Credit Agreement

 

We are party to a credit agreement that requires us to observe certain covenants that limit our flexibility in operating our business.

 

We are party to a credit agreement, dated as of June 9, 2008, by and among the Corporation, the financial institutions from time to time party to the agreement and U.S. Bank National Association, as administrative agent for the lenders, as amended (the “Credit Agreement”). The most recent amendment, Amendment No. 7 to the Amended and Restated Credit Agreement is dated May 25, 2011, though it was executed May 31, 2011. The Credit Agreement requires us to comply with affirmative and negative covenants customary for restricted indebtedness. These covenants limit our ability to, among other things:

 

 

The Credit Agreement provides that the Bank must attain and maintain certain capital ratios and requires us to retain a financial consultant, as well as other customary representations, warranties, conditions and events of default for agreements of such type. The Agent and the lenders have certain rights, including the right to accelerate the maturity of the borrowings if all covenants are not complied with. Further, the Agent or the lenders have agreed to forbear from exercising their rights and remedies until the earlier of (i) the occurrence of an event of default, as that term is defined in the Amendment, other than failure to make principal payments, or (ii) November 30, 2011.

 

If the lenders under the secured credit facilities accelerate the repayment of borrowings, we may not have sufficient assets to make the payments when due.

 

Accordingly, this creates significant uncertainty related to the Corporation’s operations.

 

We must pay in full the outstanding balance under the Credit Agreement by the earlier of November 30, 2011 or the receipt of net proceeds of a financing transaction from the sale of equity securities.

 

As of March 31, 2011, the total revolving loan commitment under the Credit Agreement was $116.3 million and aggregate borrowings under the Credit Agreement were $116.3 million. We must pay in full the outstanding balance under the Credit Agreement by the earlier of November 30, 2011 or the receipt of net proceeds of a financing transaction from the sale of equity securities of not less than $116.3 million. If the net proceeds are received from the U.S. Department of the Treasury and the terms of such investment prohibit the use of the investment proceeds to repay senior debt, then no payment is required from the Treasury investment. As of the date of this filing, we do not have sufficient cash on hand to reduce our outstanding borrowings to zero. There can be no assurance that we will be able to raise sufficient capital or have sufficient cash on hand to reduce our outstanding borrowings to zero by November 30, 2011, which may limit our ability to fund ongoing operations.

Unless the maturity date is extended, our outstanding borrowings under our Credit Agreement are due on November 30, 2011. The Credit Agreement does not include a commitment to refinance the remaining outstanding balance of the loans when they mature and there is no guarantee that our lenders will renew their loans at that time. Refusal to provide us with renewals or refinancing opportunities would cause our indebtedness to become immediately due and payable upon the contractual maturity of such indebtedness, which could result in our insolvency if we are unable to repay the debt.

 

If the Agent or the lenders decided not to refinance the remaining outstanding balance of the loans then at the earlier of (i) the occurrence of an event of default under the Amendment (other than a failure to make principal payments), or (ii) November 30 2011, the agent, on behalf of the lenders may, among other remedies, seize the outstanding shares of the Bank’s capital stock held by the Corporation or other securities or assets of the Corporation’s subsidiaries which have been pledged as collateral for borrowings under the Credit Agreement. If the Agent were to take one or more of these actions, it could have a material adverse affect on our reputation, operations and ability to continue as a going concern, and the common shareholders could lose all of their investment.

 

If we are unable to renew, replace or expand our sources of financing on acceptable terms, it may have an adverse effect on our business and results of operations and our ability to make distributions to shareholders. Upon liquidation, holders of our debt securities and lenders with respect to other borrowings will receive, and any holders of preferred stock that is currently outstanding and that we may issue in the future may receive, a distribution of our available assets prior to holders of our common stock. The decisions by investors and lenders to enter into equity and financing transactions with us will depend upon a number of factors, including our historical and projected financial performance, compliance with the terms of our current credit arrangements, industry and market trends, the availability of capital and our investors’ and lenders’ policies and rates applicable thereto, and the relative attractiveness of alternative investment or lending opportunities.

 

Risks Related to Recent Market, Legislative and Regulatory Events

 

We are highly dependent upon programs administered by Fannie Mae, Freddie Mac and Ginnie Mae. Changes in existing U.S. government-sponsored mortgage programs or servicing eligibility standards could materially and adversely affect our business, financial position, results of operations or cash flows.

 

Our ability to generate revenues through mortgage loan sales to institutional investors in the form of mortgage-backed securities depends to a significant degree on programs administered by Fannie Mae, Freddie Mac, Ginnie Mae and others that facilitate the issuance of mortgage-backed securities in the secondary market. These entities play a powerful role in the residential mortgage industry, and we have significant business relationships with them. Our status as a Fannie Mae and Freddie Mac approved seller/servicer is subject to compliance with each entity’s respective selling and servicing guides.

 

During 2011, 95% of our mortgage loan sales were sold to, or were sold pursuant to programs sponsored by, Fannie Mae or Freddie Mac. We also derive other material financial benefits from our relationships with Fannie Mae and Freddie Mac, including the assumption of credit risk by these entities on loans included in mortgage-backed securities in exchange for our payment of guarantee fees and the ability to avoid certain loan inventory finance costs through streamlined loan funding and sale procedures. Any discontinuation of, or significant reduction or material change in, the operation of these entities or any significant adverse change in the level of activity in the secondary mortgage market or the underwriting criteria of these entities would likely prevent us from originating and selling most, if not all, of our mortgage loan originations.

 

In addition, we service loans on behalf of Fannie Mae and Freddie Mac, as well as loans that have been securitized pursuant to securitization programs sponsored by Fannie Mae and Freddie Mac in connection with the issuance of agency guaranteed mortgage-backed securities and a majority of our mortgage servicing rights relate to these servicing activities. These entities establish the base service fee in which to compensate us for servicing loans. In January 2011, the Federal Housing Finance Agency directed Fannie Mae and Freddie Mac to develop a joint initiative to consider alternatives for future mortgage servicing structures and compensation. Under this proposal, the GSEs are considering potential structures in which the minimum service fee would be reduced or eliminated altogether. The GSEs are also considering different pricing options for non-performing loans to better align servicer incentives with MBS investors and provide the loan guarantor the ability to transfer non-performing servicing.

These proposals, if adopted, could cause significant changes that impact the entire mortgage industry. The lower capital requirements could increase competition by lowering barriers to entry on mortgage originations and could increase the concentration of performing loans with larger servicers that have a cost-advantage through economies of scale that would no longer be limited by capital constraints.

 

In February 2011, the Obama administration issued a report to Congress, outlining various options for long-term reform of Fannie Mae and Freddie Mac. These options involve reducing the role of Fannie Mae and Freddie Mac in the mortgage market and to ultimately wind down both institutions such that the private sector provides the majority of mortgage credit. The report states that any potential reform efforts will make credit less easily available and that any such changes should occur at a measured pace that supports the nation’s economic recovery. Any of these options are likely to result in higher mortgage rates in the future, which could have a negative impact on our Mortgage production business. Additionally, it is unclear what impact these changes will have on the secondary mortgage markets, mortgage-backed securities pricing, and competition in the industry.

 

The potential changes to the government-sponsored mortgage programs, and related servicing compensation structures, could require us to fundamentally change our business model in order to effectively compete in the market. Our inability to make the necessary changes to respond to these changing market conditions or loss of our approved seller/servicer status with any of these entities, would have a material adverse effect on our overall business and our consolidated financial position, results of operations and cash flows.

 

The TARP CPP and the ARRA impose certain executive compensation and corporate governance requirements that may adversely affect us and our business, including our ability to recruit and retain qualified employees.

 

The purchase agreement we entered into in connection with our participation in the TARP CPP required us to adopt the Treasury’s standards for executive compensation and corporate governance while the Treasury holds the equity issued pursuant to the TARP CPP, including the common stock which may be issued pursuant to the warrant to purchase 7,399,103 shares of common stock. These standards generally apply to our chief executive officer, chief financial officer and the three next most highly compensated senior executive officers. The standards include:

 

 

In particular, the change to the deductibility limit on executive compensation may increase the overall cost of our compensation programs in future periods.

 

ARRA imposed further limitations on compensation during the TARP assistance period including:

 

 

The prohibition may expand to other employees based on increases in the aggregate value of financial assistance that we receive in the future.

The Treasury released an interim final rule on TARP standards for compensation and corporate governance on June 10, 2009, which implemented and further expanded the limitations and restrictions imposed on executive compensation and corporate governance by the TARP CPP and ARRA. The new Treasury interim final rules, which became effective on June 15, 2009, also prohibit any tax gross-up payments to senior executive officers and the next 20 highest paid executives. The rule further authorizes the Treasury to establish the Office of the Special Master for TARP Executive Compensation with broad powers to review compensation plans and corporate governance matters of TARP CPP recipients.

 

These provisions and any future rules issued by the Treasury could adversely affect our ability to attract and retain management capable and motivated sufficiently to manage and operate our business through difficult economic and market conditions. If we are unable to attract and retain qualified employees to manage and operate our business, we may not be able to successfully execute our business strategy.

 

TARP lending goals may not be attainable.

 

Congress and the bank regulators have encouraged recipients of TARP CPP capital to use such capital to make loans and it may not be possible to safely, soundly and profitably make sufficient loans to creditworthy persons in the current economy to satisfy such goals. Congressional demands for additional lending by TARP CPP recipients, and regulatory demands for demonstrating and reporting such lending are increasing. On November 12, 2008, the bank regulatory agencies issued a statement encouraging banks to, among other things, “lend prudently and responsibly to creditworthy borrowers” and to “work with borrowers to preserve homeownership and avoid preventable foreclosures.” We continue to lend and have expanded our mortgage loan originations, and to report our lending to the Treasury. The future demands for additional lending are unclear and uncertain, and we could be forced to make loans that involve risks or terms that we would not otherwise find acceptable or in our shareholders’ best interest. Such loans could adversely affect our results of operation and financial condition, and may be in conflict with bank regulations and requirements as to liquidity and capital. The profitability of funding such loans using deposits may be adversely affected by increased FDIC insurance premiums.

 

The Company and the Bank are subject to extensive regulation, supervision and examination by federal banking authorities.

 

Changes in applicable regulations or legislation could have a substantial impact on our operations. Additional legislation and regulations that could significantly affect our powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations. In that regard, proposals for legislation restructuring the regulation of the financial services industry are currently under consideration. Adoption of such proposals could, among other things, increase the overall costs of regulatory compliance. Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties. These powers recently have been utilized more frequently due to the serious national, regional and local economic conditions that we and other financial institutions are facing. The exercise of regulatory authority may have a negative impact on our financial condition and results of operations. We cannot predict the actual effects of various governmental, regulatory, monetary and fiscal initiatives, which have been and may be enacted on the financial markets. The terms and costs of these activities, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity, and a continuation or worsening of current financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations, and the trading price of our common stock. In addition, failure or the inability to comply with these various requirements can lead to diminished reputation and investor confidence, reduced franchise value, loss of business, curtailment of expansion opportunities, fines and penalties, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems.

 

There can be no assurance that enacted legislation or any proposed federal programs will stabilize the U.S. financial system and such legislation and programs may adversely affect us.

 

There has been much legislative and regulatory action in response to the financial crises affecting the banking system and financial markets and threats to investment banks and other financial institutions. There can be no

assurance, however, as to the actual impact that the legislation and its implementing regulations or any other governmental program will have on the financial markets. The failure of the actions by the legislators, the regulatory bodies or the U.S. government to stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, and access to credit or the trading price of our common shares.

 

Contemplated and proposed legislation, state and federal programs, and increased government control or influence may adversely affect us by increasing the uncertainty in our lending operations and expose us to increased losses, including legislation that would allow bankruptcy courts to permit modifications to mortgage loans on a debtor’s primary residence, moratoriums on a mortgagor’s right to foreclose on property, and requirements that fees be paid to register other real estate owned property. Statutes and regulations may be altered that may potentially increase our costs to service and underwrite mortgage loans. Additionally, federal intervention and operation of formerly private institutions may adversely affect our rights under contracts with such institutions and the way in which we conduct business in certain markets.

 

The fiscal and monetary policies of the federal government and its agencies could have a material adverse effect on our earnings.

 

The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect the net interest margin. The resultant changes in interest rates can also materially decrease the value of certain financial assets we hold, such as debt securities. Its policies can also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve Board policies are beyond our control and difficult to predict; consequently, the impact of these changes on our activities and results of operations is difficult to predict.

 

Management’s ability to retain key officers and employees may change.

 

Our future operating results depend substantially upon the continued service of its executive officers and key personnel. Our future operating results also depend in significant part upon its ability to attract and retain qualified management, financial, technical, marketing, sales and support personnel. Competition for qualified personnel is intense, and we cannot ensure success in attracting or retaining qualified personnel. There may be only a limited number of persons with the requisite skills to serve in these positions, and it may be increasingly difficult for us to hire personnel over time.

 

Our ability to retain key officers and employees may be further impacted by legislation and regulation affecting the financial services industry. For example, Section 7001 of the ARRA which amended Section 111 of the EESA in its entirety, as well as the final interim regulations issued by the U.S. Treasury, significantly expanded the executive compensation restrictions. Such restrictions applied to us as a participant in the TARP CPP and generally continued to apply for as long as any Treasury owned shares were outstanding. These ARRA restrictions shall not apply to us during such time when the federal government only holds warrants to purchase common shares. Such restrictions and standards may further impact management’s ability to compete with financial institutions that are not subject to the ARRA limitations on executive compensation.

 

Our business, financial condition, or results of operations could be materially adversely affected by the loss of any of its key employees, or our inability to attract and retain skilled employees.

 

We are subject to various reporting requirements that increase compliance costs, and failure to comply timely could adversely affect our reputation and the value of our common stock.

 

We are required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by the Securities and Exchange Commission, the Public Corporation Accounting Oversight Board and Nasdaq. In particular, we are required to include management and independent auditor reports on internal controls as part of our Annual Report on Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act. We expect to continue to spend significant amounts of time and money on compliance with these rules. In addition, pursuant to our Cease and Desist Order with OTS, we must

prepare and submit various reports and may face further reporting obligations in the future depending upon our financial condition. Compliance with various regulatory reporting requires significant commitments of time from management and our directors, which reduces the time available for the performance of their other responsibilities. Our failure to track and comply with the various rules may materially adversely affect our reputation, ability to obtain the necessary certifications to financial statements, lead to additional regulatory enforcement actions, and could adversely affect the value of our common stock.

 

Non-compliance with USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions, and curtail expansion opportunities

 

Financial institutions are required under the USA PATRIOT and Bank Secrecy Acts to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the U.S. Treasury’s office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, curtailment of expansion opportunities, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations. We have developed policies and continues to augment procedures and systems designed to assist in compliance with these laws and regulations.

 

The impact of the Dodd-Frank Act is still uncertain, but it may increase our costs of doing business and could result in restrictions on certain products and services we offer.

 

Regulation of the financial services industry is undergoing major changes. The Dodd-Frank Act significantly revises and expands the rulemaking, supervisory and enforcement authority of federal bank regulators. Although the statute will have a greater impact on larger institutions than regional bank holding companies such as the Bank, many of its provisions will apply to us. Among other things, the Dodd-Frank Act:

 

 

 

Some of these changes are effective immediately, though most will be phased in gradually. In addition, the statute in many instances calls for future rulemaking to implement its provisions, so the precise contours of the law and its effects on us cannot yet be fully understood. The provisions of the Dodd-Frank Act and the subsequent exercise by regulators of their revised and expanded powers thereunder could materially impact the profitability of our business, the value of assets we hold or the collateral available for our loans, require changes to business practices or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk. Legislators and regulators are also considering a wide range of proposals beyond the Dodd-Frank Act that, if enacted, could result in major changes to the way banking operations are regulated.

 

We may be subject to more stringent capital requirements.

 

As discussed above, the Dodd-Frank Act would require the federal banking agencies to establish stricter risk-based capital requirements and leverage limits to apply to banks and bank holding companies. In addition, the “Basel III” standards recently announced by the Basel Committee on Banking Supervision (the “Basel Committee”), if adopted, could lead to significantly higher capital requirements, higher capital charges and more restrictive leverage and liquidity ratios. The standards would, among other things, impose more restrictive eligibility requirements for Tier 1 and Tier 2 capital; increase the minimum Tier 1 common equity ratio to 4.5%, net of regulatory deductions, and introduce a capital conservation buffer of an additional 2.5% of common equity to risk-weighted assets, raising the target minimum common equity ratio to 7%; increase the minimum Tier 1 capital ratio to 8.5% inclusive of the capital conservation buffer; increase the minimum total capital ratio to 10.5% inclusive of the capital buffer; and introduce a countercyclical capital buffer of up to 2.5% of common equity or other fully loss absorbing capital for periods of excess credit growth. Basel III also introduces a non-risk adjusted Tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity standards.

 

The new Basel III capital standards will be phased in from January 1, 2013 until January 1, 2019, and it is not yet known how these standards will be implemented by U.S. regulators generally or how they will be applied to financial institutions of our size. Implementation of these standards, or any other new regulations, may adversely affect our ability to pay dividends, or require us to restrict growth or raise capital, including in ways that may adversely affect our results of operations or financial condition.

 

 

None

 

 

At March 31, 2011, the Bank conducted its business from its headquarters and main office at 25 West Main Street, Madison, Wisconsin and 55 other full-service offices and one loan origination office. The Bank owns 36 of its full-service offices, leases the land on which four such offices are located, and leases the remaining 17 full-service offices. The Bank also owns a building at its headquarters which hosts its support center as well as four land sites for future development. In addition, the Bank leases its one loan-origination facility. The leases expire between 2011 and 2030. The aggregate net book value at March 31, 2011 of the properties owned or leased, including headquarters, properties and leasehold improvements, was $21.0 million. See Note 9 to the Corporation’s

Consolidated Financial Statements included in Item 8, for information regarding premises and equipment. We believe that our current facilities are adequate to meet our present needs.

 

 

The Corporation is involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management of the Corporation to be immaterial to the financial condition and results of operations of the Corporation.

 

 

This item is not in use.

 

 

Common Stock

 

The Corporation’s Common Stock is traded on the Nasdaq Global Select Market under the symbol “ABCW”. At June 3, 2011, there were approximately 2,500 stockholders of record. That number does not include stockholders holding their stock in street name or nominee’s name.

 

Quarterly Stock Price and Dividend Information

 

The table below shows the reported high and low sale prices of Common Stock and cash dividends paid per share of Common Stock during the periods indicated in fiscal 2011 and 2010.

 

 

For information regarding restrictions on the payments of dividends by the Bank to the Corporation, see “Item 1. Business — Regulation and Supervision — The Bank — Restrictions on Capital Distributions,” “Item 1A. Risk Factors — Risks Related to Our Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” of this Form 10-K.

 

Repurchases of Common Stock

 

As of March 31, 2011, the Corporation does not have a stock repurchase plan in place.

Performance Graph

 

The following graph compares the yearly cumulative total return on the Common Stock over a five-year measurement period since March 31, 2006 with (i) the yearly cumulative total return on the stocks included in the Nasdaq Stock Market Index (for United States companies) and (ii) the yearly cumulative total return on the stocks included in the Morningstar, Inc. index (formally known as the Hemscott Group) Index. All of these cumulative returns are computed assuming the reinvestment of dividends at the frequency with which dividends were paid during the applicable years.

 

 

The following information at and for the years ended March 31, 2011, 2010, 2009, 2008 and 2007 has been derived from the Corporation’s historical audited consolidated financial statements for those years.