U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 X  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

      For the transition period from…………to………………

Commission file number 0-18542

MID-WISCONSIN FINANCIAL SERVICES, INC.

 (Exact name of registrant as specified in its charter)

WISCONSIN      06-1169935

(State or other jurisdiction of incorporation or organization)           (IRS Employer Identification No.)

132 West State Street

Medford, WI  54451

(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code:  715-748-8300

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  T  No  £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date 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  T  No  £

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

     Large accelerated filer  £      

                                   Accelerated filer  £        

     Non-accelerated filer  £ (Do not check if a smaller reporting company) Smaller reporting company S

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

Yes  £  No  S

As of November 3, 2011 there were 1,655,362 shares of $0.10 par value common stock outstanding.  

1

MID-WISCONSIN FINANCIAL SERVICES, INC.

TABLE OF CONTENTS

2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements:

3

ITEM 1.  Financial Statements Continued:

4

.

ITEM 1.  Financial Statements Continued:

5

ITEM 1.  Financial Statements Continued:

6

ITEM 1.  Financial Statements Continued:

7

Mid-Wisconsin Financial Services, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

General

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly Mid-Wisconsin Financial Services, Inc.’s (the “Company”) and Mid-Wisconsin Bank’s (the “Bank”), its wholly owned banking subsidiary, consolidated financial position, results of operations, changes in stockholders’ equity and cash flows for the periods presented, and all such adjustments are of a normal recurring nature.  The consolidated financial position includes the accounts of all subsidiaries.  All material intercompany transactions and balances are eliminated.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year. We have reviewed and evaluated subsequent events through the date this Form 10-Q was filed.

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles have been omitted or abbreviated.  The information contained in the consolidated financial statements and footnotes in our Annual Report on Form 10-K for the year ended December 31, 2010 (“2010 Form 10-K”) should be referred to in connection with the reading of these unaudited interim financial statements.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the periods presented.  Actual results could differ significantly from those estimates.  Estimates that are susceptible to significant change include, but are not limited to, the determination of the allowance for loan and lease losses, the valuation of other real estate and repossessed assets, the valuations of investments and income taxes.

Recent Accounting Pronouncements

In April 2011, the FASB issued clarifying guidance regarding which loan modifications constitute troubled debt restructurings.  In evaluating whether a restructuring constitutes a troubled debt restructuring, the guidance maintains a creditor must separately conclude that the restructuring constitutes a concession and the debtor is experiencing financial difficulties.  The accounting standard provides further guidance with respect to whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties.  The measurement guidance is effective for interim and annual periods beginning on or after June 15, 2011, while the disclosure guidance is effective for interim and annual periods beginning on or after June 15, 2011 with retrospective application to restructurings occurring on or after the beginning of the fiscal year.  The Company adopted the accounting standard as of the beginning of the third quarter of 2011, as required, with no material impact on its results of operations, financial position, and liquidity.

In July 2010, the FASB issued guidance for improving disclosures about an entity’s allowance for loan losses and the credit quality of its loans.  The guidance requires additional disclosure to facilitate financial statement users’ evaluation of the following: (1) the nature of credit risk inherent in the entity’s loan portfolio, (2) how that risk is analyzed and assessed in arriving at the allowance for loan losses, and (3) the changes and reasons for those changes in the allowance for loan losses.  The increased disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010.  Increased disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 31, 2010.  The Company adopted the accounting standard as of December 31, 2010, with no material impact on its results of operations, financial position, and liquidity.

8

In January 2010, the FASB issued an accounting standard providing additional guidance relating to fair value measurement disclosures.  Specifically, companies are required to separately disclose significant transfers into and out of Level 1 and Level 2 measurements in the fair value hierarchy and the reasons for those transfers.  Significance should generally be based on earnings and total assets or liabilities, or when changes are recognized in other comprehensive income, based on total equity.  Companies may take different approaches in determining when to recognize such transfers, including using the actual date of the event or change in circumstances causing the transfer, or using the beginning or ending of a reporting period.  For Level 3 fair value measurements, the new guidance requires presentation of separate information about purchases, sales, issuances and settlements.  Additionally, the FASB also clarified existing fair value measurement disclosure requirements relating to the level of disaggregation, inputs, and valuation techniques.  This accounting standard was effective at the beginning of 2010, except for the detailed Level 3 disclosures which were effective at the beginning of 2011.  The Company adopted the accounting standard at the beginning of 2010 with no material impact on its results of operations, financial position, and liquidity.

In April 2011, the FASB issued an accounting standard that modifies the criteria for determining when repurchase agreements would be accounted for as a secured borrowing rather than as a sale.  Currently, an entity that maintains effective control over transferred financial assets must account for the transfer as a secured borrowing rather than as a sale.  The provisions remove from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee.  The FASB believes that contractual rights and obligations determine effective control and that there does not need to be a requirement to assess the ability to exercise those rights.  The accounting standard does not change the

other existing criteria used in the assessment of effective control and is effective prospectively for transactions, or modifications of existing transactions, that occur on or after January 1, 2012.  As the Company accounts for all of its repurchase agreements as collateralized financing arrangements, the adoption of this accounting standard is not expected to have a material impact on the Company’s statements of income or condition.

In May 2011, the FASB issued an accounting standard that provides a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”).  The changes to U.S. GAAP as a result of the accounting standard are as follows:  (1) the concepts of highest and best use and valuation premise are only relevant when measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities); (2) U.S. GAAP currently prohibits application of a blockage factor in valuing financial instruments with quoted prices in active markets, while the new accounting standard extends that prohibition to all fair value measurements; (3) an exception is provided to the basic fair value measurement principles for an entity that holds a group of financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk that are managed on the basis of the entity’s net exposure to either of those risks, which such exception allows the entity, if certain criteria are met, to measure the fair value of the net asset or liability position in a manner consistent with how market participants would price the net risk position; (4) the fair value measurement of instruments classified within an entity’s shareholders’ equity have been aligned with the guidance for liabilities; and (5) disclosure requirements have been enhanced for recurring Level 3 fair value measurements to disclose quantitative information about unobservable inputs and assumptions used, to describe the valuation processes used by the entity, and to describe the sensitivity of fair value measurements to changes in unobservable inputs and interrelationships between those inputs.  In addition, entities must report the level in the fair value hierarchy of items that are not measured at fair value in the statement of condition but whose fair value must be disclosed.  The provisions of the accounting standard are effective for the Company’s interim reporting period beginning on or after December 15, 2011.  The adoption of this accounting standard is not expected to have a material impact on the Company’s statements of income or condition.

9

In June 2011, the FASB issued an accounting standard that allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  The statement(s) are required to be presented with equal prominence as the other primary financial statements.  The accounting pronouncement eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity but does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The provisions of this accounting standard are effective for the Company’s interim reporting period beginning on or after December 15, 2011, with retrospective application required.  The adoption of this accounting standard will have no impact on the Company’s statements of condition.

Note 2 – Earnings (Loss) per Common Share

Earnings (loss) per common share is calculated by dividing net income (loss) available to common equity by the weighted average number of common shares outstanding.  Diluted earnings (loss) per share is calculated by dividing net income (loss) available to common equity by the weighted average number of shares adjusted for the dilutive effect of common stock awards.  Presented below are the calculations for basic and diluted earnings (loss) per common share.

10

Note 3- Securities

The amortized cost and fair values of investment securities available-for-sale at September 30, 2011 and December 31, 2010 were as follows:

The amortized cost and fair values of investment debt securities available-for-sale at September 30, 2011, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities

because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Fair values of securities are estimated based on financial models or prices paid for similar securities.  It is possible interest rates could change considerably, resulting in a material change in estimated fair value.

11

The following table represents gross unrealized losses and the related fair value of investment securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2011 and December 31, 2010.

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment (“OTTI”) that may result due to the current adverse economic conditions.  A determination as to whether a security’s decline in market value is OTTI takes into consideration numerous factors.  Some factors the Company may consider in the OTTI analysis include:

 (1) the length of time and the extent to which fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) our intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  Based on the Company’s evaluation, a third party vendor reviews specific investment securities identified by management for OTTI.  To determine OTTI, a discounted cash flow model is utilized to estimate the fair value of the security.  The use of a discounted cash flow model involves judgment, particularly of interest rates, estimated default rates and prepayment speeds.  

During 2010, the Company determined that OTTI existed in one non-agency mortgage-backed security and two corporate securities since the unrealized losses on these securities appear to be related in part to expected credit losses that will not be recovered by the Company.  In the first quarter 2011, the Company sold the three OTTI securities, which resulted in net investment losses of $55.  As of September 30, 2011 the Company has determined that there are no remaining OTTI securities in the investment portfolio.

The following is a summary of the credit loss of OTTI recognized in earnings on investment securities during 2010.  The Company recognized OTTI write-downs of $412 during the third quarter 2010. The write-downs were to two unrelated private placement trust preferred securities.  One of the issues was completely written off with an OTTI write-down of $211.  The other issue was partially written-off with an OTTI write-down of $201, related in part to credit losses that were not expected to be recovered by the Company.

12

There were no credit losses of OTTI recognized in earnings during 2011.

Based on the Company’s evaluation, management believes that any remaining unrealized losses at September 30, 2011 are primarily attributable to changes in interest rates and the current market conditions, and not credit deterioration.  

Note 4 – Loans, Allowance for Loan Losses, and Credit Quality

The period end loan composition as of September 30, 2011 and December 31, 2010 is as follows:

13

A summary of the changes in the allowance for loan and lease losses by portfolio segment for the periods indicated:

The allocation methodology used by the Company includes allocation for specifically identified impaired loans and loss factor allocations, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors.  Management allocates the allowance for loan and lease losses by pools of risk within each loan portfolio.  While the methodology used at September 30, 2011 and December 31, 2010 was generally comparable, several refinements were incorporated into the historical loss factor allocation process during the first quarter 2011.  The refinements, which impacted individual portfolio allocation amounts, did not materially impact the overall level of the allowance for loan and lease losses.

At September 30, 2011, the allowance for loan loss allocations for the commercial business, real estate construction, agricultural, and residential mortgage portfolios increased, with all other loan portfolio allocations declining from December 31, 2010.  The increase in commercial business and real estate construction was primarily due to a decline in credit quality and higher loss rates.  The increase in agricultural allocation was due to a slight decline in credit quality and increased loan volume.  Residential mortgage increased primarily due to a decline in credit quality metrics.  The allocation of the allowance for loan losses by loan portfolio is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular category.  The total allowance for loan losses is available to absorb losses from any segment of the loan portfolio.

14

The following table presents nonaccrual loans by portfolio segment for the periods indicated as follows:

Loans are generally placed on nonaccrual status when contractually past due 90 days or more on interest or principal payments.  Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest payments on loans, it is management’s practice to place such loans on nonaccrual status immediately, rather than delaying such action until the loan becomes 90 days past due.  When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, amortization of related loan fees is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash.  If collectability of the principal is in doubt, payments received are applied to the loan principal balance.

A nonaccrual loan is returned to accrual status when all delinquent principal and interest payments become current in accordance with the terms of the loan agreement, the borrower has demonstrated a period of sustained performance, generally a minimum of nine months, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.  

A summary of loans by credit quality indicator based on internally assigned credit grade is as follows:

15

Loans risk rated acceptable or better are credits performing in accordance with the original terms, have adequate sources of repayment and little identifiable collectability risk.  Special mention credits have potential weaknesses that deserve management’s attention.  If left unremediated, these potential weaknesses may result in deterioration of the repayment of the credit.  Substandard loans typically have

weaknesses in the paying capability of the obligor and/or guarantor or in collateral coverage.  These loans have a well-defined weakness that jeopardizes the liquidation of the debt and are characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected.  Loans classified as doubtful have all the weaknesses of substandard loans with the added characteristic that the collection of all amounts due according to the original contractual terms is highly unlikely and the amount of the loss is reasonably estimable.  Loans classified as loss are considered uncollectible.  

The following table represents loans by past due status for the periods indicated:

16

The following table presents impaired loans for the periods indicated:

17

Troubled Debt Restructurings

Loans are considered restructured loans if concessions have been granted to borrowers that are experiencing financial difficulty to maximize the collection of amounts due.  Restructured loan modifications generally result in the Company working with borrowers on a case-by-case basis and may include payment schedule modifications, interest rate concession, maturity date extensions, modification of note structure, or some combination of these concessions.  

Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status.  Nonaccrual restructured loans are included with all other nonaccrual loans.  All accruing restructured loans are reported as troubled debt restructurings. Restructured loans remain on nonaccrual status until the customer has attained a sustained period of repayment performance under the modified loan terms, by internal policy usually a minimum of nine months.  Performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to, or maintained on, accrual status.  If

the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains on nonaccrual.  

All restructured loans are considered impaired for reporting and measurement purposes.  A loan that has been modified at a below market rate will return to performing status if it satisfies the nine-month performance requirement; however, it will remain classified as a restructured loan.  

The following table provides the number of loans modified and classified as trouble debt restructurings by loan category during the three and nine months ended September 30, 2011.

During the three and nine months ended September 30, 2011, restructured loan modifications made in the commercial lending segment (commercial business, commercial real estate, and real estate construction loans) primarily included maturity date extensions, and payment schedule modifications.  In addition, the Company may work with the borrower in identifying other changes that will mitigate loss to the Company, which may include additional collateral or guarantees to support the loan.

Restructured loan modifications made in the consumer lending segment (real estate residential and installment loans) included maturity date extensions, interest rate concessions, deferrals of payments, and payment schedule modifications for the three months and nine months ended September 30, 2011.

The following table provides the number of loans modified in a trouble debt restructuring during the previous nine months which subsequently defaulted during the three and nine months ended September 30, 2011.

18

All loans modified in a trouble debt restructuring are evaluated for impairment.  The nature and extent of impairment of restructured loans, including those which have experienced a subsequent payment default, are considered in the determination of an appropriate level of the ALLL.

Note 5 – Other Real Estate Owned (“OREO”)

A summary of OREO, which is included in other assets, is as follows:

Changes in the valuation reserve for losses on OREO were as follows:

OREO was $5,108 at September 30, 2011, compared to $4,230 at December 31, 2010.  The properties held as OREO at September 30, 2011 consisted of $4,157 of commercial real estate (the largest being $1,744 related to a hotel/water park project), $654 real estate construction loans, $50 agricultural loans and $247 residential real estate.  OREO as of year-end 2010 consisted of $3,451of commercial real estate, $82 real estate construction, $150 agricultural loans and $547 residential real estate.  Management generally seeks to ensure properties held are monitored to minimize the Company’s risk of loss. Evaluations of the fair market value of the OREO properties are done quarterly and valuation adjustments, if necessary, are recorded in our consolidated financial statements.

In the first nine months of 2011, we sold 21 OREO properties resulting in a net gain from the sale of OREO of $135.  In November 2011, we sold the former car dealership property held in OREO since 2007.  During 2010 we sold 35 OREO properties resulting in a net gain from the sale of OREO of $187.  

19

Note 6- Short-term Borrowings

Short-term borrowings consisted of $11,227 and $9,512 of securities sold under repurchase agreements at September 30, 2011 and December 31, 2010, respectively.

The Company pledges U.S. agency securities available-for-sale as collateral for repurchase agreements.  The fair value of securities pledged for short-term borrowings totaled $20,648 at September 30, 2011 and $14,032 at December 31, 2010.

The following information relates to federal funds purchased, securities sold under repurchase agreements, and Federal Home Loan Bank open line of credit for the following periods.

Note 7- Long-term Borrowings

Long-term borrowings were as follows:

Federal Home Loan Bank Advances – Long-term advances from the Federal Home Loan Bank (“FHLB”) have maturities through 2015 and had a weighted-average interest rate of 3.90% and 4.24% at September 30, 2011 and December 31, 2010, respectively.  FHLB advances decreased $2,500 from year-end 2010 to September 30, 2011, due to the maturity of an advance that was not renewed due to the liquidity position of the Company.

In April 2010, FHLB advances of $22,061 were restructured.  The present value of the cash flows before and after the restructuring were reviewed and it was determined the restructuring was closely related to the original contract within accounting guidance that allows the prepayment penalty to be incorporated into the new borrowing agreements.

Structured repurchase agreements – Fixed rate structured repurchase agreements, which mature in 2014 and 2015 and are callable in 2013, had weighted-average interest rates of 4.24% at September 30, 2011 and December 31, 2010.

20

Note 8 - Fair Value Measurements

The FASB issued accounting guidance which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  This guidance emphasized that fair value (i.e., the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, and is a market-based measurement, not an entity-specific measurement.  When considering the assumption that market participants would use in pricing the asset or liability, the guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of hierarchy).  The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.  

Level 1 – Fair value measurement is based on quoted prices for identical assets or liabilities in active markets.

Level 2 – Fair value measurement is based on:  1) quoted prices for similar assets or liabilities in active markets; 2) quoted prices for similar assets or liabilities in markets that are not active; or 3) valuation models and methodologies for which all significant assumptions are or can be corroborated by observable market data.

Level 3 – Fair value measurement is based on valuation models and methodologies that incorporate unobservable inputs, which are typically based on an entity’s own assumptions, as there is little related market activity.

Some assets and liabilities, such as securities available-for-sale, are measured at fair values on a recurring basis under accounting principles generally accepted in the United States.  Other assets and liabilities, such as loans held for sale and impaired loans, are measured at fair values on a nonrecurring basis.

In instances where the determination of the fair value measurements is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considerations specific to the asset or liability.

Following is a description of the valuation methodologies used for the Company’s more significant instruments measured on a recurring and nonrecurring basis at fair value, as well as the classification of the asset or liability within the fair value hierarchy:

Investment securities available-for-sale – Securities available-for-sale may be classified as Level 1, Level 2, or Level 3 measurements within the fair value hierarchy.  Level 1 investment securities include equity securities traded on a national exchange.  The fair value measurement of a Level 1 security is based on the quoted price of the security.  The fair value measurement of a Level 2 security is obtained from an independent pricing service and is based on recent sales of similar securities and other observable market data.  Examples of these investment securities include U.S. government and agency securities, obligations of states and political subdivisions, corporate debt securities, and mortgage related securities.  In certain cases where there is limited activity or less transparency around inputs to the estimated fair value, securities are classified within Level 3 of the fair value hierarchy.  The fair value measurement of a Level 3 security is based on a discounted cash flow model that incorporates assumptions market participants would use to measure the fair value of the security.  

21

Loans held for sale – Loans held for sale, which consist generally of current production of certain fixed-rate, first-lien residential mortgage loans, are carried at the lower of cost or estimated fair value.  The estimated fair value is based on current secondary market prices for similar loans, which is considered a Level 2 nonrecurring fair value measurement.  

The fair value of loans held for sale is based on observable current prices in the secondary market in which loans trade. All loans held for sale are categorized based on commitments received from secondary sources that the loans qualify for placement at the time of underwriting and at an agreed upon price. A gain or loss is recognized at the time of sale reflecting the present value of the difference between the contractual interest rate of the loan and the yield to investors.

Loans – Loans are not measured at fair value on a recurring basis.

Impaired loans – The Company considers a loan impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement, including principal and interest.   Loans considered to be impaired are measured at fair value on a nonrecurring basis.  The fair value measurement of an impaired loan is based on the fair value of the underlying collateral.  Fair value measurements of underlying collateral that utilize observable market data such as independent appraisals reflecting recent comparable sales are considered Level 2 measurements.  Other fair value measurements that incorporate estimated assumptions market participants would use to measure fair value are considered Level 3 measurements.

OREO – Real estate acquired through or in lieu of loan foreclosure is not measured at fair value on a recurring basis.  However, OREO is initially measured at fair value, less estimated costs to sell, when it is acquired and is also measured at fair value, less estimated costs to sell, if it becomes subsequently impaired.  

The fair value measurement for each property may be obtained from an independent appraiser or prepared internally.  Fair value measurements obtained from independent appraisers are generally based on sales of comparable assets and other observable market data and are considered Level 2 measurements.  Fair value measurements prepared internally are based on observable market data but include significant unobservable data and are therefore considered Level 3 measurements.

22

Information regarding the fair value of assets measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010, is as follows:

The table below presents a roll forward of the balance sheet amounts for the nine months ended September 30, 2011 and for the year ended December 31, 2010, for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).

23

Information regarding the fair values of assets measured at fair value on a nonrecurring basis as of September 30, 2011 and December 31, 2010, is as follows:

At September 30, 2011 loans with a carrying amount of $14,155 were considered impaired and were written down to their estimated fair value of $12,214.  As a result, the Company recognized a specific valuation allowance against these impaired loans totaling $1,941.  At year end December 31, 2010 loans with a carrying amount of $9,749 were considered impaired and were written down to their estimated fair value of $7,808.  As a result, the Company recognized a specific valuation allowance against these impaired loans totaling $1,941.  

The Company is required to disclose estimated fair values for its financial instruments.  Fair value estimates, methods, and assumptions are set forth below for the Company’s financial instruments.

The estimated fair values of the Company’s financial instruments on the balance sheet at September 30, 2011 and December 31, 2010 were as follows:

The Company estimates fair value of all financial instruments regardless of whether such instruments are measured at fair value.  The following methods and assumptions were used by the Company to estimate fair value of financial instruments not previously discussed.

Cash and short-term investments – The carrying amounts reported in the consolidated balance sheets for cash and due from banks, interest-bearing deposits in other financial institutions, and federal funds sold approximate the fair value of these assets.

24

Securities and other investments – The fair value of investment securities available-for-sale is based on quoted prices in active markets, or if quoted prices are not available for a specific security, the fair values are estimated by using pricing models, quoted price with similar characteristics, or discounted cash flows.

Net loans – Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, residential mortgage, and other consumer. The fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company’s repayment schedules for each loan classification. In addition, for impaired loans, marketability and appraisal values for collateral were considered in the fair value determination.

Deposits – The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW accounts, and money market accounts, is equal to the amount payable on demand at the reporting date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows.  The discount rate reflects the credit quality and operating expense factors of the Company.

Short-term borrowings – The carrying amount reported in the consolidated balance sheets for short-term borrowings approximates the liability’s fair value.

Long-term borrowings – The fair values are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Subordinated debentures – The fair value is estimated by discounting future cash flows using the current interest rates at which similar borrowings would be made.

Accrued interest – The carrying amount of accrued interest approximates its fair value.

Off-balance sheet instruments – The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the present creditworthiness of the counter parties. Since this amount is immaterial, no amounts for fair value are presented.

Limitations – Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of particular financial instruments. Fair value estimates are based on judgments regarding future expected loss

experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include premises and equipment, goodwill and intangibles, and other assets and other liabilities. In addition, the income tax ramifications related to the realization of the unrealized gains or losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Because of the wide range of valuation techniques and the numerous assumptions which must be made, it may be difficult to compare our Company’s fair value to that of other financial institutions. It is important that the many assumptions discussed above be considered when using the estimated fair value disclosures and to realize that because of the uncertainties, the aggregate fair value should in no way be construed as representative of the underlying value of the Company.  

25

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

We operate as a one-bank holding company and own all of the outstanding capital stock of Mid-Wisconsin Bank (the “Bank”), chartered as a state bank in Wisconsin.  The Bank is engaged in general commercial and retail banking services, including wealth management services.  

The following management’s discussion and analysis is presented to assist in the understanding and evaluation of our consolidated financial condition as of September 30, 2011 and December 31, 2010 and results of operations for the three-month and nine-month periods ended September 30, 2011 and 2010.  It is intended to supplement the unaudited financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith.  Quarterly comparisons reflect continued consistency of operations and do not reflect any significant trends or events other than those noted in the comments.

Special Note Regarding Forward-Looking Statements

Statements made in this document and in documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Stockholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, could affect the future financial results of the Company and could cause those results to differ materially from those expressed in forward-looking statements contained or incorporated by reference in this document. These factors, many of which are beyond the Company’s control, include the following:

·

operating, legal and regulatory risks, including the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations promulgated thereunder;

·

economic, political and competitive forces affecting our banking and wealth management businesses;

·

changes in monetary policy and general economic conditions, which may impact our net interest income;

·

the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful; and

·

other factors discussed under Item 1A, “Risk Factors” in our 2010 Form 10-K and elsewhere therein and herein, and from time to time in our other filings with the Securities and Exchange Commission after the date of this report.

These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. We specifically disclaim any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.

Critical Accounting Policies

Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industry in which we operate.  This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes.  These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements.  Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.  We believe the following policies are important to the portrayal of our financial condition and require subjective or complex judgments and, therefore, are critical accounting policies.

26

Investment Securities:  The fair value of our investment securities is important to the presentation of the consolidated financial statements since the investment securities are carried on the consolidated balance sheet at fair value.   We utilize a third party vendor to assist in the determination of the fair value of our investment portfolio. Adjustments to the fair value of the investment portfolio impact our consolidated financial condition by increasing or decreasing assets and stockholders’ equity, and possibly earnings.  Declines in the fair value of investment securities below their cost that are deemed to be OTTI are reflected in earnings as realized losses and such securities are assigned a new cost basis. In estimating OTTI, we consider many factors which include: (1) the length of time and the extent to which fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) our intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  To determine OTTI, we utilize a discounted cash flow model to estimate the fair value of the security.  The use of a discounted cash flow model involves judgment, particularly of interest rates, estimated default rates and prepayment speeds.

Allowance for Loan and Lease Losses (“ALLL”):   Management’s evaluation process used to determine the adequacy of the allowance for loan and lease losses is subject to the use of estimates, assumptions, and judgments. The evaluation process combines several factors: (1) evaluation of facts and issues related to specific loans; (2) management’s ongoing review and grading of the loan portfolio; (3) consideration of historical loan loss and delinquency experience on each portfolio category; (4) trends in past due and nonperforming loans; (5) the risk characteristics of the various classifications of loans; (6) changes in the size and character of the loan portfolio; (7) concentrations of loans to specific borrowers or industries; (8) existing and forecasted economic conditions; (9) the fair value of underlying collateral; and (10) other qualitative and quantitative factors which could affect potential credit losses.  Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance for loan and lease losses, could change significantly.  As an integral part of their examination process, various regulatory agencies also review the allowance for loan and lease losses. Such agencies may require that certain loan balances be classified differently or charged-off when their credit evaluations differ from those of management, based on their

judgments about information available to them at the time of their examination. The Company believes the allowance for loan and lease losses as recorded in the consolidated financial statements is adequate.

OREO:   Real estate acquired through, or in lieu of, loan foreclosure is held for sale and initially recorded at fair value at the date of foreclosure, establishing a new cost basis.  The fair value is based on appraised or estimated values obtained, less estimated costs to sell, and adjusted based on the highest and best use of the properties, or other changes.  There are uncertainties as to the price we may ultimately receive on the sale of the properties, potential property valuation allowances due to declines in the fair values, and the carrying costs of properties for expenses such as utilities, real estate taxes, and other ongoing expenses may affect future earnings.   

Income taxes:  The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings. The Company believes the tax assets and liabilities are properly recorded in the consolidated financial statements.

All remaining information included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations is shown in thousands of dollars, except per share data.

27

RESULTS OF OPERATIONS

Performance Summary

The Company reported net loss to common shareholders $346, or $0.21 per common share, for the quarter ended September 30, 2011, compared to net income to common shareholders of $2, or $0.00 per common share, in the comparable 2010 period.    For the nine months ended September 30, 2011, net loss to common shareholders was $1,228, or $0.74 per common share.  This compares to net income to common shareholders of $22, or $0.01 per common share, for the nine months ended September 30, 2010.

Management believes that the weak economy has resulted in borrowers being very cautious with business expansion, hiring additional employees, and adding additional debt. This environment, combined with historically low interest rates, has created intense competition for high quality credits while other investment alternatives offer little return.  In addition, we expect that the level of provision for loan and lease losses, along with credit-related expenses, will continue to put pressure on our earnings.

Key factors behind these results are discussed below:

·

Net interest income of $11,514 for the nine months ended September 30, 2011, decreased by 6.3% from the same period in 2010.  On a fully tax-equivalent basis, the net interest margin at September 30, 2011 decreased to 3.33% from 3.48% for the same period in 2010.  The decrease in net interest margin was primarily due to an elevated level of liquidity that was invested in lower-yielding assets, weak loan demand, high levels of nonaccrual loans, and the sale of higher yielding investment securities during the latter half of 2010.  Average loans outstanding decreased by $17,805 to $339,460 and the average balance of federal funds sold and securities purchased under agreements to resell increased $4,249 to $22,274 at September 30, 2011, compared to a year earlier.  The average yield on earning assets was 4.76% at September 30, 2011 compared to 5.37% at September 30, 2010.

·

Loans of $338,150 at September 30, 2011, decreased $1,020 from December 31, 2010. Loan growth has been impacted by the current credit environment, economic conditions, loan payoffs,

and charge-offs.  Although competition among local and regional banks for creditworthy borrowers and core deposit customers remains high, we remain committed to supporting our markets through lending to creditworthy borrowers despite the increasing regulatory burden and current economic challenges.

·

Total deposits were $385,973 at September 30, 2011, down $14,637 from the year ended December 31, 2010, primarily due to normal customer inflows and outflows and the maturity of brokered certificates of deposit.   

·

Net charge-offs were $4,039 in the first nine months of 2011, and $2,439 for the comparable period in 2010. The provision for loan and lease losses was $3,850 for the first nine months of 2011, compared with $3,255 for the first nine months of 2010.  The provision for loan and lease losses was $900 for the third quarter 2011 and 2010, respectively.  The year-to-date 2011 provision has increased over the 2010 provision due to economic factors that include: the high unemployment rate in our market areas, increased delinquencies in existing commercial real estate and construction credits resulting from weakness in the local economies, depressed collateral values, and internal assessments of currently performing loans with increased risk for future delinquencies.  The Bank’s coverage ratio of the allowance for loan and lease losses to total loans at September 30, 2011 was 2.74% compared to 2.79% at December 31, 2010 and 2.55% at September 30, 2010.

28

·

Despite a legal settlement of $500 received in the first quarter 2011, noninterest income for the nine months ended September 30, 2011 was $3,324, a $350 decrease from the same nine-month period in 2010.  Noninterest income continued to decline from declining service fees due to regulatory changes and decreased mortgage banking income from the sales of residential real estate loans into the secondary market.  Mortgage banking income did increase in the third quarter 2011 compared to the first six months of 2011 due to declines in interest rates; however, even with this recent uptick the activity is not as high as 2010 levels.  Total noninterest income for the quarter ended September 30, 2011 was $915 compared to $1,467 during the September 2010 quarter mainly due to a $330 gain on sale of securities available for sale in the third quarter 2010, while no such gains were recognized in the 2011 time period.  

·

Noninterest expense for the nine months ended September 30, 2011 was $12,495, an increase of $775 over the first nine months of 2010, due primarily to increased foreclosure/OREO expenses, collection expenses, FDIC costs, marketing and product expenses associated with a new deposit product, loan servicing costs, and loss on sale of investment securities.  Noninterest expense for the third quarter 2011 increased $191 to $4,184, or 4.8%, compared to the third quarter 2010 primarily due to OREO write-downs taken in the third quarter 2011 and increased legal and professional fees.

·

In September 2010, the Company recognized other-than-temporary impairment (“OTTI”) write-downs of $412 from two private placement trust preferred securities as the unrealized losses appeared to be related to expected credit losses that will not be recovered by the Company.  No OTTI credit losses were recognized in earnings during 2011.

·

As of September 30, 2011, the Company’s tier 1 risk-based capital ratio and total risk-based capital ratios were 9.8 % and 15.4%, respectively.  Both ratios are in excess of regulatory minimum requirements.

Net Interest Income

Comparison of nine months ended September 30, 2011 versus September 30, 2010

Our earnings are substantially dependent on net interest income, which is the difference between interest earned on loans, securities and other interest-earning assets, and the interest paid on deposits and borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.

Taxable-equivalent net interest income for the nine months ended September 30, 2011, was $11,712, down from $12,468 in the related 2010 period. The decrease in taxable-equivalent net interest income was primarily attributable to unfavorable rates variances (as the impact of changes in the interest rate environment and product pricing reduced taxable-equivalent net interest income by $624) and to a lesser extent to unfavorable volume variances (as changes in the balances and mix of earning assets and interest-bearing liabilities lowered taxable-equivalent net interest income by $132).

The taxable-equivalent net interest margin for the first nine months of 2011 was 3.33%, down from 3.48% in the related 2010 period.  For 2011, the yield on earning assets of 4.76% was 61 bps lower than the comparable period last year.  Loan yields decreased 46 bps, to 5.57%, impacted by increased levels of nonaccrual loans, lower loan yields given the repricing of adjustable rate loans, soft loan demand, and competitive pricing pressures to retain and/or obtain creditworthy borrowers.  The yield on investment securities and other short-term investments decreased 81 bps to 2.67%, impacted by the Company’s excess liquidity position invested in lower-yielding assets resulting from soft loan demand during 2011 and the sale of investment securities during the latter half of 2010.

29

The cost of interest-bearing liabilities of 1.72% for the first nine months of 2011 was 50 bps lower than the related 2010 period.  The average cost of interest-bearing deposits was 1.46%, down 47 basis points, while the cost of wholesale funding (comprised of short-term borrowings and long-term borrowings) decreased 7 bps to 3.29% for the nine months ended September 30, 2011.  The Company’s outstanding $10,310 of subordinated debentures had a fixed rate of 5.98% through December 15, 2010, after which they have had a floating rate equal to the three-month LIBOR plus 1.43%, adjusted quarterly.  The interest rate at September 30, 2011 was 1.78%.  

Average earning assets of $470,340 for the first nine months of 2011 were $8,238 lower than the comparable period last year.   Average federal funds sold and securities purchased under agreements to resell grew $4,249 to $22,274, reflecting the Company’s increased liquidity position.  Average loans decreased $17,805 to $339,460 as a result of soft loan demand, pay-offs and charge-offs.   Taxable-equivalent interest income in 2011 decreased $2,498 to $16,730 due to $626 unfavorable earning asset volume changes and $1,872 unfavorable rate variances.

Average interest-bearing liabilities of $390,104 for the first nine months of 2011 were down $16,845 compared to the related 2010 period. Average interest-bearing deposits decreased $17,326 while noninterest-bearing deposits increased $9,236.  For the first nine months of 2011, interest expense decreased $1,742 of which $1,248 was due to favorable rate changes and $494 was due to favorable volume changes.

30

Table 1:  Year-To-Date Net Interest Income Analysis – Taxable-Equivalent Basis

31

Table 2:  Volume/Rate Variance – Taxable-Equivalent Basis