Table of Contents

 

 

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 June 30, 2012

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 001-34955

 

 

ANCHOR BANCORP WISCONSIN INC.

(Exact name of registrant as specified in its charter)

 

 

 

Wisconsin		39-1726871
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
25 West Main Street Madison, Wisconsin		53703
(Address of principal executive office)		(Zip Code)

(608) 252-8700

Registrant’s telephone number, including area code

Not Applicable

(Former name, former address, and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark 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  x    No  ¨

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

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class: Common stock — $.10 Par Value

Number of shares outstanding as of July 31, 2012: 21,247,725

 

 

 

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ANCHOR BANCORP WISCONSIN INC.

INDEX - FORM 10-Q

 

						Page #
Part I – Financial Information
Item 1       Financial Statements
				Unaudited Consolidated Balance Sheets as of June 30, 2012 and March 31, 2012		2
				Unaudited Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended June 30, 2012 and 2011		3
				Unaudited Consolidated Statements of Changes in Stockholders’ Deficit for the Three Months Ended June 30, 2012 and Year Ended March 31, 2012		5
				Unaudited Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2012 and 2011		6
				Notes to Unaudited Consolidated Financial Statements		8
Item 2        Management’s Discussion and Analysis of Financial Condition and Results of Operations						44
				Executive Overview		44
				Results of Operations		49
				Financial Condition		53
				Regulatory Developments		54
				Risk Management		57
				Credit Risk Management		58
				Liquidity Risk Management		66
				Market Risk Management		69
				Critical Accounting Estimates and Judgments		72
				Forward Looking Statements		75
Item 3        Quantitative and Qualitative Disclosures About Market Risk						76
Item 4       Controls and Procedures						76
Part II – Other Information
Item 1       Legal Proceedings						77
Item 1A    Risk Factors						77
Item 2        Unregistered Sales of Equity Securities and Use of Proceeds						77
Item 3       Defaults Upon Senior Securities						77
Item 4       Mine Safety Disclosures						77
Item 5       Other Information						77
Item 6       Exhibits						77
Signatures						79

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

 

		June 30, 2012				March 31, 2012
		(In thousands, except share data)
Assets
Cash and due from banks		$	55,995			$	51,584
Interest-bearing deposits			312,374				191,396
Cash and cash equivalents			368,369				242,980
Investment securities available for sale			231,644				242,299
Investment securities held to maturity (fair value of $0 and $20, respectively)			—				20
Loans
Held for sale			27,938				39,332
Held for investment, less allowance for loan losses of $100,477 at June 30, 2012 and $111,215 at March 31, 2012			1,959,551				2,058,008
Other real estate owned, net			83,955				88,841
Premises and equipment, net			27,422				25,453
Federal Home Loan Bank stock—at cost			30,522				35,792
Mortgage servicing rights, net			20,590				22,156
Accrued interest receivable			11,391				12,075
Other assets			22,694				22,496
Total assets		$	2,784,076			$	2,789,452
Liabilities and Stockholders’ Deficit
Deposits
Non-interest bearing		$	275,526			$	264,751
Interest bearing			1,977,647				2,000,164
Total deposits			2,253,173				2,264,915
Other borrowed funds			476,378				476,103
Accrued interest and fees payable			47,937				43,320
Accrued taxes, insurance and employee related expenses			6,502				6,385
Other liabilities			28,594				28,279
Total liabilities			2,812,584				2,819,002
Commitments and contingent liabilities (Note 13)
Preferred stock, $0.10 par value, 5,000,000 shares authorized, 110,000 shares issued and outstanding; dividends in arrears of $20,395 at June 30, 2012 and $18,785 at March 31, 2012			98,284				96,421
Common stock, $0.10 par value, 100,000,000 shares authorized, 25,363,339 shares issued, 21,247,725 shares outstanding			2,536				2,536
Additional paid-in capital			110,402				110,402
Retained deficit			(149,321	)			(147,513	)
Accumulated other comprehensive income related to AFS securities			4,444				3,628
Accumulated other comprehensive loss related to OTTI securities - non credit factors			(3,325	)			(3,496	)
Total accumulated other comprehensive income			1,119				132
Treasury stock (4,115,614 shares at June 30, 2012 and March 31, 2012), at cost			(90,259	)			(90,259	)
Deferred compensation obligation			(1,269	)			(1,269	)
Total stockholders’ deficit			(28,508	)			(29,550	)
Total liabilities and stockholders’ deficit		$	2,784,076			$	2,789,452

See accompanying Notes to Unaudited Consolidated Financial Statements.

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Operations and Comprehensive Income

(Unaudited)

 

		Three Months Ended June 30,
		2012				2011
		(In thousands, except per share data)
Interest income:
Loans		$	25,288			$	32,109
Investment securities and Federal Home Loan Bank stock			1,549				3,956
Interest-bearing deposits			154				52
Total interest income			26,991				36,117
Interest expense:
Deposits			3,591				7,319
Other borrowed funds			7,001				7,278
Total interest expense			10,592				14,597
Net interest income			16,399				21,520
Provision for credit losses			(1,716	)			3,482
Net interest income after provision for credit losses			18,115				18,038
Non-interest income:
Impairment on new OTTI securities			—				—
Non-credit related impairment on new OTTI securities recognized in other comprehensive income			—				—
Reclassification of credit related other-than-temporary impairment from other comprehensive income			(64	)			(59	)
Net impairment losses recognized in earnings			(64	)			(59	)
Loan servicing income (loss), net of amortization			(395	)			814
Service charges on deposits			2,866				2,794
Investment and insurance commissions			1,032				1,037
Net gain on sale of loans			5,823				1,173
Net gain on sale of investment securities			62				1,136
Net gain on sale of OREO			3,172				1,245
Revenue from real estate partnership operations			5				38
Other			997				994
Total non-interest income			13,498				9,172

(Continued)

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Operations and Comprehensive Income (Con’t.)

(Unaudited)

 

		Three Months Ended June 30,
		2012				2011
		(In thousands, except per share data)
Non-interest expense:
Compensation and benefits		$	10,560			$	10,194
Occupancy			1,833				1,980
Furniture and equipment			1,586				1,544
Federal deposit insurance premiums			1,564				1,933
Data processing			1,385				1,383
Marketing			239				305
Expenses from real estate partnership operations			571				42
OREO expense, net			7,012				8,870
Mortgage servicing rights impairment			1,257				221
Legal services			1,574				934
Other professional fees			643				1,018
Other			3,334				3,531
Total non-interest expense			31,558				31,955
Income (loss) before income taxes			55				(4,745	)
Income tax expense			—				10
Net income (loss)			55				(4,755	)
Preferred stock dividends in arrears			(1,610	)			(1,536	)
Preferred stock discount accretion			(1,863	)			(1,863	)
Net loss available to common equity		$	(3,418	)		$	(8,154	)
Net income (loss)		$	55			$	(4,755	)
Reclassification adjustment for realized net gains recognized in income			(62	)			(1,136	)
Reclassification adjustment for unrealized credit related other-than-temporary impairment losses recognized in income			68				59
Reclassification adjustment for credit related other-than-temporary impairment previously recognized on securities paid-off during the period			(4	)			—
Change in net unrealized gains on available-for-sale securities			985				14,013
Comprehensive income		$	1,042			$	8,181
Loss per common share:
Basic		$	(0.16	)		$	(0.38	)
Diluted			(0.16	)			(0.38	)
Dividends declared per common share			—				—

See accompanying Notes to Unaudited Consolidated Financial Statements.

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

(Unaudited)

 

		Preferred Stock				Common Stock				Additional Paid-in Capital				Retained Deficit				Treasury Stock				Deferred Compensation Obligation				Accu- mulated Other Compre- hensive Income (Loss)				Total
		(In thousands)
Balance at April 1, 2011		$	89,008			$	2,536			$	111,513			$	(103,362	)		$	(90,534	)		$	(2,380	)		$	(19,952	)		$	(13,171	)
Net loss			—				—				—				(36,738	)			—				—				—				(36,738	)
Reclassification adjustment for realized net gains recognized in income			—				—				—				—				—				—				(6,579	)			(6,579	)
Reclassification adjustment for unrealized credit related other-than-temporary impairment losses recognized in income			—				—				—				—				—				—				558				558
Change in net unrealized gains (losses) on available-for-sale securities			—				—				—				—				—				—				26,105				26,105
Vesting of restricted stock			—				—				—				—				275				—				—				275
Change in stock-based deferred compensation obligation			—				—				(1,111	)			—				—				1,111				—				—
Accretion of preferred stock discount			7,413				—				—				(7,413	)			—				—				—				—
Balance at March 31, 2012			96,421				2,536				110,402				(147,513	)			(90,259	)			(1,269	)			132				(29,550	)
Net income			—				—				—				55				—				—				—				55
Reclassification adjustment for realized net gains recognized in income			—				—				—				—				—				—				(62	)			(62	)
Reclassification adjustment for unrealized credit related other-than-temporary impairment losses recognized in income			—				—				—				—				—				—				68				68
Reclassification adjustment for credit related other-than-temporary impairment previously recognized on securities paid-off during the period			—				—				—				—				—				—				(4	)			(4	)
Change in net unrealized gains (losses) on available-for-sale securities			—				—				—				—				—				—				985				985
Accretion of preferred stock discount			1,863				—				—				(1,863	)			—				—				—				—
Balance at June 30, 2012		$	98,284			$	2,536			$	110,402			$	(149,321	)		$	(90,259	)		$	(1,269	)		$	1,119			$	(28,508	)

See accompanying Notes to Unaudited Consolidated Financial Statements

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

		Three Months Ended June 30,
		2012				2011
		(In thousands)
Operating Activities
Net income (loss)		$	55			$	(4,755	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for credit losses			(1,716	)			3,482
Provision for OREO losses			4,634				4,890
Depreciation and amortization			1,004				909
Amortization and accretion of investment securities premium/discount, net			206				371
Real estate held for development and sale impairment			245				—
Mortgage servicing rights impairment			1,257				221
Cash paid to originate loans held for sale			(242,340	)			(80,549	)
Cash received on sale of loans held for sale			259,557				72,927
Net gain on sales of loans			(5,823	)			(1,173	)
Net gain on sale of investment securities			(62	)			(1,136	)
Gain on sale of OREO			(3,172	)			(1,245	)
Net impairment losses recognized in earnings			64				59
Decrease in accrued interest receivable			684				730
Increase in prepaid expense and other assets			(134	)			(345	)
Increase in accrued interest and fees payable			4,617				2,962
Increase in other liabilities			432				3,193
Net cash provided by operating activities			19,508				541
Investing Activities
Proceeds from sale of investment securities			1,905				55,757
Principal collected on investment securities			9,549				10,405
FHLB stock redemption			5,270				—
Decrease in loans held for investment			81,355				102,646
Purchases of premises and equipment			(103	)			(156	)
Proceeds from sale of premises and equipment			—				9
Proceeds from sale of OREO			19,372				20,823
Net cash provided by investing activities			117,348				189,484

(Continued)

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Cont’d)

(Unaudited)

 

		Three Months Ended June 30,
		2012				2011
		(In thousands)
Financing Activities
Decrease in deposits		$	(16,401	)		$	(61,183	)
Increase in advance payments by borrowers for taxes and insurance			4,659				3,989
Proceeds from borrowed funds			19,700				1,550,000
Repayment of borrowed funds			(19,425	)			(1,661,100	)
Net cash used in financing activities			(11,467	)			(168,294	)
Net increase in cash and cash equivalents			125,389				21,731
Cash and cash equivalents at beginning of period			242,980				107,015
Cash and cash equivalents at end of period		$	368,369			$	128,746
Supplementary cash flow information:
Cash paid (received) or credited to accounts:
Interest on deposits and borrowings		$	5,975			$	11,635
Income taxes			10				—
Non-cash transactions:
Transfer of loans to OREO			18,818				23,252
Transfer of OREO to premises and equipment			2,870				—

See accompanying Notes to Unaudited Consolidated Financial Statements

 

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ANCHOR BANCORP WISCONSIN INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

The unaudited consolidated financial statements include the accounts and results of operations of Anchor BanCorp Wisconsin Inc. (the “Corporation”) and its wholly-owned subsidiaries, AnchorBank fsb (the “Bank”) and Investment Directions, Inc. (“IDI”). The Bank has one subsidiary at June 30, 2012: ADPC Corporation. Significant inter-company balances and transactions have been eliminated.

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the unaudited consolidated financial statements have been included.

In preparing the unaudited consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the amounts reported in the unaudited consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate, the net carrying value of mortgage servicing rights and deferred tax assets, and the fair value of investment securities, interest rate lock commitments, forward contracts to sell mortgage loans, and loans held for sale. The results of operations and other data for the three-month period ended June 30, 2012 is not necessarily indicative of results that may be expected for the fiscal year ending March 31, 2013. We have evaluated all subsequent events through the date of this filing. The interim unaudited consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012.

Certain prior period amounts have been reclassified to conform to the current period presentations with no impact on net income (loss) or total equity.

Note 2 – Significant Risks and Uncertainties

Regulatory Agreements

On June 26, 2009, the Corporation and the Bank each consented to the issuance of an Order to Cease and Desist (the “Corporation Order” and the “Bank Order,” respectively, and together, the “Orders”) by the Office of Thrift Supervision (the “OTS”). As of July 21, 2011, regulation of the Bank was assumed by the Office of the Comptroller of the Currency (“OCC”), and the Federal Reserve became the primary regulator for the Corporation.

The Corporation Order requires the Corporation to notify, and in certain cases to obtain the permission of, the Federal Reserve prior to: (i) declaring, making or paying any dividends or other capital distributions on its capital stock, including the repurchase or redemption of its capital stock; (ii) incurring, issuing, renewing or rolling over any debt, increasing any current lines of credit or guaranteeing the debt of any entity; (iii) making certain changes to its directors or senior executive officers; (iv) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; and (v) making any golden parachute payments or prohibited indemnification payments. The Corporation developed and submitted to the OTS a three-year cash flow plan, which must be reviewed at least quarterly by the Corporation’s management and board for material deviations between the cash flow plan’s projections and actual results (the “Variance Analysis Report”). Within 45 days following the end of each quarter, the Corporation is required to provide the Federal Reserve its Variance Analysis Report for that quarter.

 

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The Bank Order requires the Bank to notify, or in certain cases obtain the permission of, the OCC prior to (i) increasing its total assets in any quarter in excess of an amount equal to net interest credited on deposit liabilities during the quarter; (ii) accepting, rolling over or renewing any brokered deposits; (iii) making certain changes to its directors or senior executive officers; (iv) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; (v) making any golden parachute or prohibited indemnification payments; (vi) paying dividends or making other capital distributions on its capital stock; (vii) entering into certain transactions with affiliates; and (viii) entering into third-party contracts outside the normal course of business. The Bank also developed and submitted within the prescribed time periods, a written capital restoration plan, a problem asset plan, a revised business plan, and an implementation plan resulting from a review of commercial lending practices. The Orders also require the Bank to regularly review its current liquidity management policy and the adequacy of its allowance for loan and lease losses.

On August 31, 2010, the OTS approved the capital restoration plan submitted by the Bank, although the approval included a Prompt Corrective Action Directive (“PCA”). The only additional requirement included in the PCA was that the Bank must obtain prior written approval from the Regional Director before entering into any contract or lease for the purchase or sale of real estate or of any interest therein, except for contracts entered into in the ordinary course of business for the purchase or sale of other real estate owned due to foreclosure (“OREO”) where the contract does not exceed $3.5 million and the sales price of the OREO does not fall below 85% of the net carrying value of the OREO.

The Orders also required that, as of September 30, 2009, the Bank had to meet and maintain both a core capital ratio equal to or greater than 7 percent and a total risk-based capital ratio equal to or greater than 11 percent. Further, as of December 31, 2009, the Bank had to meet and maintain both a core capital ratio equal to or greater than 8 percent and a total risk-based capital ratio equal to or greater than 12 percent.

At June 30, 2012, the Bank had a tier 1 leverage (core) ratio of 4.56% and a total risk-based capital ratio of 8.98%, each below the required capital ratios set forth above. Without a waiver, amendment or modification of the Orders, the Bank could be subject to further regulatory action, although neither the Bank nor the Corporation has received notice of any regulatory action to be taken by the OCC or the Federal Reserve with regards to the Orders. That said, at June 30, 2012, the Bank’s risk-based capital is considered “adequately capitalized” for regulatory purposes. Under OCC requirements, a bank must have a total risk-based capital ratio of 8 percent or greater to be considered adequately capitalized. The Bank continues to work toward the requirements of the Bank Order which requires a total risk-based capital ratio of 12 percent, which exceeds traditional capital levels for a bank. All customer deposits remain fully insured to the limits set by the FDIC.

As referenced above, on July 21, 2011, the OTS, which was the Bank’s primary regulator, ceased operations as a result of changes implemented pursuant to the Dodd-Frank Act. As of July 21, 2011, regulation of the Bank was assumed by the OCC, and the Federal Reserve became the primary regulator for the Corporation. The Federal Reserve and the OCC are now responsible for the administration of the Orders.

Going Concern

The Corporation and the Bank continue to diligently work with their financial and professional advisors in seeking qualified sources of outside capital, and in achieving compliance with the requirements of the Orders. The Corporation and the Bank consult with the Federal Reserve, the OCC and FDIC on a regular basis concerning the Corporation’s and Bank’s proposals to obtain outside capital and to develop action plans that will be acceptable to federal regulatory authorities, but there can be no assurance that these actions will be successful, or that even if one or more of the Corporation’s and Bank’s proposals are accepted by the Federal regulators, that these proposals will be successfully implemented. While the Corporation’s management continues to exert maximum effort to attract new capital, significant operating losses in the past four fiscal years, significant levels of criticized assets at the Bank and negative equity raise substantial doubt as to the Corporation’s ability to continue as a going concern. If the Corporation and Bank are unable to achieve compliance with the requirements of the Orders, or implement an acceptable capital restoration plan, and if the Corporation and Bank cannot otherwise comply with such commitments and regulations, the OCC or FDIC could force a sale, liquidation or federal conservatorship or receivership of the Bank.

 

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As discussed in greater detail in the previous section, “Regulatory Agreements”, the Corporation and the Bank have submitted a capital restoration plan describing how the Corporation intends to restore the capital position of the Bank. On August 31, 2010, the OTS accepted this plan. The OCC and Federal Reserve now have oversight authority of this plan.

Further, the Corporation entered into an amendment dated November 29, 2011 (“Amendment No. 8”) to the Amended and Restated Credit Agreement (“Credit Agreement”) among the Corporation, the lenders from time to time a party thereto, and U.S. Bank National Association, as administrative agent for such lenders, or the “Agent” as described in Note 9, in which the existing interest rate remained the same and the financial covenants related to capital ratios and non-performing loans were moderately relaxed. Under the terms of the Credit Agreement, the Agent and the lenders have certain rights if all covenants are not complied with, including the right to accelerate the maturity of the borrowings. As of June 30, 2012, the Corporation was in compliance with the financial and non-financial covenants contained in the Credit Agreement, as amended, although there is no guarantee that the Corporation will remain in compliance with the covenants. As of the date of this filing, the Corporation does not have sufficient cash on hand to reduce outstanding borrowings to zero. There can be no assurance that the Corporation will be able to raise sufficient capital or have enough cash on hand to reduce outstanding borrowings to zero by November 30, 2012, which may, if unable to secure an extension at that time, limit the Corporation’s ability to fund ongoing operations.

Credit Risks

While the Corporation has devoted and will continue to devote substantial management resources toward the resolution of all delinquent and impaired loans, no assurance can be made that management’s efforts will be successful. These conditions create an uncertainty about material adverse consequences that may occur in the near term. The continuing recession and the decrease in valuations of real estate have had a significant adverse impact on the Corporation’s consolidated financial condition and results of operations.

Non-performing assets totaled $272.9 million at June 30, 2012, or 9.8% of total assets, which decreased the Corporation’s interest income. The Corporation’s results of operations will continue to be impacted by the level of non-performing assets and the Corporation expects continued downward pressure on interest income in the future. As reported in the accompanying unaudited interim consolidated financial statements, the Corporation has net income of $55,000 for the three months ended June 30, 2012. Stockholders’ equity improved from a deficit of $29.6 million or (1.06)% of total assets at March 31, 2012 to a deficit of $28.5 million or (1.02)% of total assets at June 30, 2012.

Note 3 – Recent Accounting Pronouncements

ASU No. 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU 2011-02 states that in evaluating whether a restructuring constitutes a troubled debt restructuring (TDR), a creditor must separately conclude that both of the following exist: (i) the restructuring constitutes a concession and (ii) the debtor is experiencing financial difficulties. In addition, the amendments to Topic 310 clarify that a creditor is precluded from using the effective interest rate test in the debtor’s guidance on restructuring of payables when evaluating whether a restructuring constitutes a troubled debt restructuring. The amendments to Topic 310 also required new disclosures regarding currently outstanding TDRs and TDR activity during the period. The Corporation adopted ASU 2011-02 in its second quarter of fiscal 2012.

As a result of adopting the amendments in ASU 2011-02, the Corporation reassessed all restructurings that occurred on or after April 1, 2011, the beginning of the prior fiscal year, for identification as TDRs. Certain receivables were identified as TDRs for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology. Upon identifying those receivables as TDRs, they were also deemed impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of impairment measured in accordance with the guidance of ASC 310-10-35 for the receivables that are newly identified as impaired. The adoption of the ASU resulted in an increase in the number of loans within its commercial real estate portfolios that are considered TDRs but did not have a material impact on the Company’s financial statements for the periods ended September 30, 2011. At September 30, 2011, the period of adoption, the recorded

 

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investment in receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under ASC 310-10-35 was $258,000, and the resulting allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss, was zero.

Note 4 – Investment Securities

The amortized cost and fair value of investment securities are as follows:

 

						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				(Losses)				Value
		(In thousands)
At June 30, 2012
Available-for-sale:
U.S. government sponsored and federal agency obligations		$	3,528			$	23			$	—			$	3,551
Corporate stock and bonds			652				77				(22	)			707
Non-agency CMOs (1)			21,784				32				(3,340	)			18,476
Government sponsored agency mortgage-backed securities (1)			3,797				248				—				4,045
GNMA mortgage-backed securities (1)			200,764				4,105				(4	)			204,865
		$	230,525			$	4,485			$	(3,366	)		$	231,644
At March 31, 2012
Available-for-sale:
U.S. government sponsored and federal agency obligations		$	3,556			$	—			$	(25	)		$	3,531
Corporate stock and bonds			652				50				(41	)			661
Non-agency CMOs (1)			25,067				163				(3,638	)			21,592
Government sponsored agency mortgage-backed securities (1)			3,944				251				—				4,195
GNMA mortgage-backed securities (1)			208,948				3,597				(225	)			212,320
		$	242,167			$	4,061			$	(3,929	)		$	242,299
Held-to-maturity:
Government sponsored agency mortgage-backed securities (1) (2)		$	20			$	—			$	—			$	20

 

(1)	Primarily collateralized by residential mortgages.

(2)	Full principal payoff was received on this security in May, 2012.

Independent pricing services are used to value all investment securities. One pricing service is used to value all securities except the non-agency CMOs. A specialized pricing service is used for valuation of the non-agency CMO portfolio.

 

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To estimate the fair value of non-agency CMOs, the pricing service valuation model discounted estimated expected cash flows after credit losses at rates ranging from 4% to 12%. The rates utilized are based on the risk free rate equivalent to the remaining average life of the security, plus a spread for normal liquidity and a spread to reflect the uncertainty of the cash flow estimates. The pricing service benchmarks its fair value results to other pricing services and monitors the market for actual trades. The cash flow model includes these inputs in its derivation of the discount rates used to estimate fair value. There are no payments in kind allowed on these non-agency CMOs.

The tables below present the fair value and gross unrealized losses of all securities in an unrealized loss position, aggregated by investment category and length of time that individual investments have been in a continuous unrealized loss position at June 30, 2012 and March 31, 2012.

 

		At June 30, 2012
		Unrealized Loss Position Less than 12 months								Unrealized Loss Position 12 months or More								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
		(In thousands)
Corporate stock and bonds		$	66			$	(22	)		$	—			$	—			$	66			$	(22	)
Non-agency CMOs			73				—				16,392				(3,340	)			16,465				(3,340	)
GNMA mortgage-backed securities			10,176				(4	)			—				—				10,176				(4	)
		$	10,315			$	(26	)		$	16,392			$	(3,340	)		$	26,707			$	(3,366	)

 

		At March 31, 2012
		Unrealized Loss Position Less than 12 months								Unrealized Loss Position 12 months or More								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
		(In thousands)
U.S. government sponsored and federal agency obligations		$	3,531			$	(25	)		$	—			$	—			$	3,531			$	(25	)
Corporate stock and bonds			111				(41	)			—				—				111				(41	)
Non-agency CMOs			77				—				18,109				(3,638	)			18,186				(3,638	)
GNMA mortgage-backed securities			37,631				(225	)			—				—				37,631				(225	)
		$	41,350			$	(291	)		$	18,109			$	(3,638	)		$	59,459			$	(3,929	)

Other-Than-Temporary Impairment

The number of individual securities in the tables above total 15 at June 30, 2012 and 20 at March 31, 2012, respectively. Although these securities have declined in value these unrealized losses are considered temporary. Management evaluates securities for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. In estimating other-than-temporary impairment losses on investment securities, management considers many factors which include: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value.

 

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To determine if an other-than-temporary impairment exists on a debt security with an unrealized loss, the Corporation first determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Corporation will recognize an other-than-temporary impairment loss in earnings equal to the difference between the security’s fair value and its amortized cost basis. If neither condition is met, the Corporation determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present values of the cash flows expected to be collected, discounted at the purchase yield or current accounting yield of the security, and the amortized cost basis is the credit loss. The credit loss is the portion of the impairment that is deemed other-than-temporary and recognized in earnings and is a reduction in the cost basis of the security. The portion of impairment related to all other factors is deemed temporary and included in other comprehensive income (loss).

The Corporation utilizes an independent pricing service to run a discounted cash flow model in the calculation of other-than-temporary impairment losses on non-agency CMOs. This model is used to determine the portion of the impairment that is other-than-temporary due to credit losses, and the portion that is temporary due to all other factors.

The significant inputs used for calculating the credit loss portion of securities with other-than-temporary impairment (“OTTI”) include prepayment assumptions, loss severities, original FICO scores, historical rates of delinquency, percentage of loans with limited underwriting, historical rates of default, original loan-to-value ratio, aggregate property location by metropolitan statistical area, original credit support, current credit support, and weighted-average maturity.

The discount rates used to establish the net present value of expected cash flows for purposes of determining OTTI ranged from 4% to 12%. These rates equate to the effective yield implicit in the security at the date of acquisition for the bonds for which the Corporation has not in the past incurred OTTI. For the bonds for which the Corporation has previously recorded OTTI, the discount rate used equates to the accounting yield on the security as of the valuation date.

Default rates were calculated separately for each category of underlying borrower based on delinquency status (i.e. current, 30 to 59 days delinquent, 60 to 89 days delinquent, 90+ days delinquent, and foreclosure balances) of the loans as of June 1, 2012. This data is entered into a loss migration model to calculate projected default rates, which are benchmarked against results that have recently been experienced by other major servicers of non-agency CMOs with similar attributes. The month 1 to month 24 constant default rate in the model ranged from 3.25% to 11.49%.

At June 30, 2012, 11 non-agency CMOs with a fair value of $16.8 million and an adjusted cost basis of $20.2 million were other-than-temporarily impaired. At March 31, 2012, 14 non-agency CMOs with a fair value of $19.6 million and an adjusted cost basis of $23.1 million were other-than-temporarily impaired. Unrealized other-than-temporary impairment due to credit losses of $64,000 was included in earnings for the three months ended June 30, 2012. For the three months ended June 30, 2012, realized losses of $138,000 related to credit issues (i.e. – principal reduced without a receipt of cash) were incurred that were previously recognized in earnings as unrealized other-than-temporary impairment.

Unrealized losses on U.S. government sponsored and federal agency obligations, corporate stocks and bonds and Ginnie Mae (“GNMA”) mortgage-backed securities as of June 30, 2012 due to changes in interest rates and other non-credit related factors totaled $26,000. The Corporation has analyzed these securities for evidence of other-than-temporary impairment and concluded that no OTTI exists and that the unrealized losses are properly classified in accumulated other comprehensive income.

The following table is a roll forward of the amount of other-than-temporary impairment related to credit losses that have been recognized in earnings for which a portion of impairment was deemed temporary and recognized in other comprehensive income for the three months ended June 30, 2012 and 2011:

 

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		Three months ended June 30,
		2012				2011
		(In thousands)
Beginning balance of unrealized OTTI related to credit losses		$	2,391			$	2,197
Additional unrealized OTTI related to credit losses for which OTTI was previously recognized			68				59
Credit related OTTI previously recognized for securities sold or paid-off during the period			(164	)			—
Decrease for realized amount of credit losses for which unrealized credit related OTTI was previously recognized			(138	)			—
Ending balance of unrealized OTTI related to credit losses		$	2,157			$	2,256

All of the Corporation’s other-than-temporarily impaired debt securities are non-agency CMOs. On a cumulative basis, other-than-temporary impairment losses recognized in earnings by year of vintage were as follows:

 

Year of Vintage		At June 30, 2012
		(In thousands)
Prior to 2005		$	7
2005			471
2006			299
2007			1,380
		$	2,157

The cost of investment securities sold is determined using the specific identification method. Sales of investment securities available for sale are summarized below:

 

		Three Months Ended June 30,
		2012				2011
		(In thousands)
Proceeds from sales:		$	1,905			$	55,757
Gross gains on sales			62				1,141
Gross losses on sales			—				(5	)
Net gain on sales		$	62			$	1,136

At June 30, 2012 and March 31, 2012, investment securities available-for-sale with a fair value of approximately $208.2 million and $216.3 million, respectively, were pledged to secure deposits, borrowings and for other purposes as permitted or required by law.

 

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The fair values of investment securities by contractual maturity at June 30, 2012 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Within 1 Year				After 1 Year through 5 Years				After 5 Years through 10 Years				Over Ten Years				Total
		(In thousands)
Available-for-sale, at fair value:
U.S. government sponsored and federal agency obligations		$	—			$	3,551			$	—			$	—			$	3,551
Corporate stock and bonds			—				—				—				707				707
Non-agency CMOs			—				—				827				17,649				18,476
Government sponsored agency mortgage-backed securities			10				30				867				3,138				4,045
GNMA mortgage-backed securities			—				—				434				204,431				204,865
Total		$	10			$	3,581			$	2,128			$	225,925			$	231,644

Note 5 – Loans Receivable

Loans receivable held for investment consist of the following:

 

		June 30, 2012				March 31, 2012
		(In thousands)
Residential		$	551,464			$	564,691
Commercial and industrial			30,473				38,977
Commercial real estate:
Land and construction			163,435				186,048
Multi-family			324,481				342,216
Retail/office			275,759				298,277
Other commercial real estate			234,667				248,275
Consumer:
Education			227,125				240,331
Other consumer			271,975				269,532
Total unpaid principal balance			2,079,379				2,188,347
Allowance for loan losses			(100,477	)			(111,215	)
Undisbursed loan proceeds(1)			(16,526	)			(16,034	)
Unearned loan fees, net			(2,819	)			(3,086	)
Unearned interest			(6	)			(4	)
Total contras to loans			(119,828	)			(130,339	)
Loans held for investment		$	1,959,551			$	2,058,008

 

(1)	Undisbursed loan proceeds are funds to be disbursed upon a draw request approved by the Corporation.

 

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Residential Loans

At June 30, 2012, $551.5 million, or 26.5%, of the total loans unpaid principal balance receivable consisted of residential loans, substantially all of which were 1 to 4 family dwellings. Residential loans consist of both adjustable and fixed-rate loans. The adjustable-rate loans currently in the portfolio have up to 30-year maturities and terms which permit the Corporation to annually increase or decrease the rate on the loans, based on a designated index. These rate changes are generally subject to a limit of 2% per adjustment and an aggregate 6% adjustment over the life of the loan. These loans are documented according to standard industry practices. The Corporation 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 adjustable rate mortgages.

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 Corporation believes that these risks, which have not had a material adverse effect to date, generally are less than the risks associated with holding fixed-rate loans in an increasing interest rate environment. Also, as interest rates decline, borrowers may refinance their mortgages into fixed-rate loans thereby prepaying the balance of the loan prior to maturity. At June 30, 2012, approximately $380.8 million, or 69.0%, of the held for investment residential loans unpaid principal balance consisted of loans with adjustable interest rates.

The Corporation continues to originate long-term, fixed-rate conventional mortgage loans. Current production of these loans with terms of 15 years or more are generally sold to Fannie Mae, Freddie Mac and other institutional investors, while a small percentage of loan production is retained in the held for investment portfolio. In order to provide a full range of products to its customers, the Corporation also participates in the loan origination programs of Wisconsin Housing and Economic Development Authority (“WHEDA”), Wisconsin Department of Veterans Affairs (“WDVA”) and the Federal Housing Administration (“FHA”). The Corporation retains the right to service substantially all loans that it sells.

At June 30, 2012, approximately $170.7 million, or 31.0%, of the held for investment residential loans unpaid principal balance consisted of loans with fixed rates of interest. Although these loans generally provide for repayments of principal over a fixed period of 10 to 30 years, it is the Corporation’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 Corporation originates loans for commercial, corporate and business purposes, including issuing letters of credit. At June 30, 2012, the unpaid principal balance receivable of commercial and industrial loans amounted to $30.5 million, or 1.5%, of the total loans unpaid principal balance receivable. The commercial and industrial loan portfolio is comprised of loans for a variety of business purposes and generally are secured by equipment, machinery and other corporate assets. These 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 Corporation originates commercial real estate loans that it typically holds in its loan portfolio which includes land and construction, multi-family, retail/office and other commercial real estate. Such loans generally have adjustable rates and shorter terms than single-family residential loans, thus increasing the earnings sensitivity of the loan portfolio to changes in interest rates, as well as providing higher fees and rates than residential loans. At June 30, 2012, $998.3 million of loans unpaid principal balance receivable were secured by commercial real estate, which represented 48.0% of the total loans unpaid principal balance receivable. The Corporation generally limits the origination of such loans to its primary market area.

 

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The Corporation’s commercial real estate loans are primarily secured by apartment buildings, office and industrial buildings, land, warehouses, small retail shopping centers and various special purpose properties, including hotels, and nursing homes. Although terms vary, commercial real estate loans generally have amortization periods 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 based on a designated index.

Consumer Loans

The Corporation offers consumer loans in order to provide a wider range of financial services to its customers. At June 30, 2012, $499.1 million, or 24.0%, of the total loans unpaid principal balance receivable consisted of consumer loans. Consumer loans typically 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.

Approximately $227.1 million, or 10.9%, of the total loans unpaid principal balance receivable at June 30, 2012 consisted of education loans. These loans 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 status on an installment basis within six months following 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 are generally guaranteed by the Great Lakes Higher Education Corporation up to 97% of the balance of the loan, which typically obtains reinsurance of its obligations from the U.S. Department of Education. During the quarter ended September 30, 2010, the Corporation discontinued the origination of student loans. Education loans may be sold to the U.S. Department of Education or to other investors. No education loans were sold during the three months ended June 30, 2012.

The largest component of the other consumer loan portfolio is second mortgage and home equity loans. The primary home equity loan product has an adjustable 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 of the property at the loan origination date. A fixed-rate home equity second mortgage term product is also offered.

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

Allowances for Loan Losses

The allowance for loan losses consists of general, substandard and specific components even though the entire allowance is available to cover losses on any loan. The specific allowance component relates to impaired loans (i.e. – non-accrual) and all loans reported as troubled debt restructurings. For such loans, an allowance is established when the discounted cash flows (or collateral value if repayment relies solely on the operation or sale of the collateral) of the impaired loan are lower than the carrying value of that loan. The substandard loan component is primarily associated with loans rated in this category but not in non-accrual status. The general allowance component covers pass, watch and special mention rated loans and is based on historical loss experience adjusted for various qualitative and quantitative factors. Loans graded substandard and below are individually examined to determine the appropriate loan loss reserve. A reserve for unfunded commitments and letters of credit is also maintained which is classified in other liabilities.

 

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The following table presents the allowance for loan losses by component:

 

		At June 30, 2012				At March 31, 2012
		(In thousands)
General component		$	32,170			$	37,085
Substandard loan component			28,936				29,980
Specific component			39,371				44,150
Total allowance for loan losses		$	100,477			$	111,215

The following table presents the unpaid principal balance of loans by risk category:

 

		At June 30, 2012				At March 31, 2012
		(In thousands)
Pass		$	1,567,180			$	1,624,889
Watch			119,203				115,917
Special mention			42,194				56,762
Total pass, watch and special mention rated loans			1,728,577				1,797,568
Substandard, excluding TDR accrual			90,122				93,207
TDR accrual			71,693				72,648
Non-accrual			188,987				224,924
Total impaired loans			260,680				297,572
Total unpaid principal balance		$	2,079,379			$	2,188,347

The following table presents activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2012 and 2011:

 

		Residential				Commercial and Industrial				Commercial Real Estate				Consumer				Total
		(In thousands)
For the Quarter Ended June 30, 2012:
Beginning balance		$	13,027			$	10,568			$	85,153			$	2,467			$	111,215
Provision			1,673				(1,443	)			(3,760	)			727				(2,803	)
Charge-offs			(1,363	)			(1,651	)			(6,768	)			(791	)			(10,573	)
Recoveries			208				1,042				1,356				32				2,638
Ending balance		$	13,545			$	8,516			$	75,981			$	2,435			$	100,477
For the Quarter Ended June 30, 2011:
Beginning balance		$	20,487			$	19,541			$	106,445			$	3,649			$	150,122
Provision			390				(197	)			2,733				694				3,620
Charge-offs			(1,756	)			(2,522	)			(12,574	)			(858	)			(17,710	)
Recoveries			506				643				1,415				144				2,708
Ending balance		$	19,627			$	17,465			$	98,019			$	3,629			$	138,740

 

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The following table presents the balance in the allowance for loan losses and the unpaid principal balance of loans by portfolio segment and based on impairment method as of June 30, 2012 and March 31, 2012:

 

		Residential				Commercial and Industrial				Commercial Real Estate				Consumer				Total
		(In thousands)
At June 30, 2012:
Allowance for loan losses:
Individually evaluated for impairment		$	4,900			$	4,726			$	29,363			$	382			$	39,371
Collectively evaluated for impairment			8,645				3,790				46,618				2,053				61,106
Total		$	13,545			$	8,516			$	75,981			$	2,435			$	100,477
Loans:
Loans individually evaluated		$	46,172			$	9,230			$	197,350			$	7,928			$	260,680
Loans collectively evaluated			505,292				21,243				800,992				491,172				1,818,699
Total		$	551,464			$	30,473			$	998,342			$	499,100			$	2,079,379
At March 31, 2012:
Allowance for loan losses:
Individually evaluated for impairment		$	5,080			$	5,548			$	33,137			$	385			$	44,150
Collectively evaluated for impairment			7,947				5,020				52,016				2,082				67,065
Total		$	13,027			$	10,568			$	85,153			$	2,467			$	111,215
Loans:
Loans individually evaluated		$	49,411			$	10,774			$	228,873			$	8,514			$	297,572
Loans collectively evaluated			515,280				28,203				845,943				501,349				1,890,775
Total		$	564,691			$	38,977			$	1,074,816			$	509,863			$	2,188,347

The provision for credit losses reflected in the consolidated statements of operations includes the provision for loan losses and the provision for unfunded commitment losses as follows:

 

		Three months ended June 30,
		2012				2011
		(In thousands)
Provision for loan losses		$	(2,803	)		$	3,620
Provision for unfunded commitment losses			1,087				(138	)
Provision for credit losses		$	(1,716	)		$	3,482

The provision for unfunded commitment losses in the three months ending June 30, 2012 totaled $1.1 million, up from $(0.1) million during the same period in 2011. This increase reflects the implementation in June 2012 of a more refined process of estimating probable losses inherent in the unfunded loan commitment and letter of credit portfolios. The reserve for unfunded commitments and letters of credit at June 30, 2012 totaled $1.7 million, classified in other liabilities on the consolidated balance sheet.

At June 30, 2012, $260.7 million of unpaid principal balance of loans were identified as impaired which includes performing troubled debt restructurings. At March 31, 2012, impaired loans were $297.6 million. A loan is identified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement and thus are placed on non-accrual status. Interest income on certain impaired loans is recognized on a cash basis.

 

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A substantial portion of the Corporation’s loans are collateralized by real estate in Wisconsin and adjacent states. Accordingly, the ultimate collectability of the loan portfolio is susceptible to changes in real estate market conditions in that area.

The following table presents impaired loans segregated by loans with no specific allowance and loans with an allowance, by class of loans, as of June 30, 2012:

 

		Unpaid Principal Balance				Associated Allowance				Carrying Amount				Average Carrying Amount				Fiscal Year to Date Interest Income Recognized
		(In thousands)
With no specific allowance recorded:
Residential		$	16,389			$	—			$	16,389			$	17,311			$	113
Commercial and industrial			111				—				111				1,501				46
Land and construction			40,290				—				40,290				43,451				103
Multi-family			15,174				—				15,174				15,678				127
Retail/office			12,444				—				12,444				12,581				133
Other commercial real estate			20,988				—				20,988				22,004				195
Education			—				—				—				—				—
Other consumer			452				—				452				455				14
Subtotal			105,848				—				105,848				112,981				731
With an allowance recorded (1):
Residential			29,783				4,900				24,883				25,599				94
Commercial and industrial			9,119				4,726				4,393				5,468				98
Land and construction			23,242				13,061				10,181				15,108				107
Multi-family			31,017				7,795				23,222				24,184				288
Retail/office			29,455				6,609				22,846				22,370				317
Other commercial real estate			24,740				1,898				22,842				23,370				157
Education (2)			721				1				720				769				—
Other consumer			6,755				381				6,374				6,340				111
Subtotal			154,832				39,371				115,461				123,208				1,172
Total
Residential			46,172				4,900				41,272				42,910				207
Commercial and industrial			9,230				4,726				4,504				6,969				144
Land and construction			63,532				13,061				50,471				58,559				210
Multi-family			46,191				7,795				38,396				39,862				415
Retail/office			41,899				6,609				35,290				34,951				450
Other commercial real estate			45,728				1,898				43,830				45,374				352
Education (2)			721				1				720				769				—
Other consumer			7,207				381				6,826				6,795				125
		$	260,680			$	39,371			$	221,309			$	236,189			$	1,903

 

(1)

Includes ratio-based allowance for loan losses of $2.8 million associated with loans totaling $23.9 million for which individual reviews have not been completed but an allowance established based on the ratio of allowance for loan losses to unpaid principal balance for the loans individually reviewed, by class of loan.

(2)	Excludes the guaranteed portion of education loans 90+ days past due with unpaid principal balance and average carrying amounts totaling $23,296 and $25,453 that are not considered impaired based on a guarantee provided by government agencies.

 

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The carrying amounts above and below include the unpaid principal balance less the associated allowance. The average carrying amount is a trailing twelve month average calculated based on the ending quarterly balances. The interest income recognized is the fiscal year to date interest income recognized on a cash basis.

The following table presents impaired loans segregated by loans with no specific allowance and loans with an allowance, by class of loans, as of March 31, 2012:

 

		Unpaid Principal Balance				Associated Allowance				Carrying Amount				Average Carrying Amount				Fiscal Year to Date Interest Income Recognized
		(In thousands)
With no specific allowance recorded:
Residential		$	19,845			$	—			$	19,845			$	22,224			$	208
Commercial and industrial			3,389				—				3,389				6,771				61
Land and construction			34,446				—				34,446				39,601				581
Multi-family			19,822				—				19,822				21,624				264
Retail/office			21,787				—				21,787				23,577				816
Other commercial real estate			24,213				—				24,213				23,812				571
Education			—				—				—				—				—
Other consumer			474				—				474				507				62
Subtotal			123,976				—				123,976				138,116				2,563
With an allowance recorded (1):
Residential			29,566				5,080				24,486				28,070				520
Commercial and industrial			7,385				5,548				1,837				6,285				260
Land and construction			47,545				14,543				33,002				47,499				886
Multi-family			27,307				7,896				19,411				25,803				927
Retail/office			28,954				6,672				22,282				27,417				858
Other commercial real estate			24,799				4,026				20,773				22,891				737
Education (2)			762				1				761				789				—
Other consumer			7,278				384				6,894				7,190				480
Subtotal			173,596				44,150				129,446				165,944				4,668
Total
Residential			49,411				5,080				44,331				50,294				728
Commercial and industrial			10,774				5,548				5,226				13,056				321
Land and construction			81,991				14,543				67,448				87,100				1,467
Multi-family			47,129				7,896				39,233				47,427				1,191
Retail/office			50,741				6,672				44,069				50,994				1,674
Other commercial real estate			49,012				4,026				44,986				46,703				1,308
Education (2)			762				1				761				789				—
Other consumer			7,752				384				7,368				7,697				542
		$	297,572			$	44,150			$	253,422			$	304,060			$	7,231

 

(1)

Includes ratio-based allowance for loan losses of $2.8 million associated with loans totaling $24.6 million for which individual reviews have not been completed but an allowance established based on the ratio of allowance for loan losses to unpaid principal balance for the loans individually reviewed, by class of loan.

(2)	Excludes the guaranteed portion of education loans 90+ days past due with unpaid principal balance and average carrying amounts totaling $24,641 and $25,520 that are not considered impaired based on a guarantee provided by government agencies.

 

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The following is additional information regarding impaired loans:

 

		At June 30,				At March 31,
		2012				2012
		(In thousands)
Unpaid principal balance of impaired loans:
With specific reserve required		$	154,832			$	173,596
Without a specific reserve			105,848				123,976
Total impaired loans			260,680				297,572
Less:
Specific valuation allowance for impaired loans			(39,371	)			(44,150	)
Carrying amount of impaired loans		$	221,309			$	253,422
Average carrying amount of impaired loans		$	236,189			$	304,060
Loans and troubled debt restructurings on non-accrual status			188,987				224,924
Troubled debt restructurings – accrual			71,693				72,648
Troubled debt restructurings – non-accrual (1)			61,520				76,378
Loans past due ninety days or more and still accruing (2)			23,296				30,697

 

(1)	Troubled debt restructurings – non-accrual are included in the loans and troubled debt restructurings on non-accrual status line item above.

(2)	Includes the guaranteed portion of education loans of $23,296 and $24,641 at June 30, 2012, and March 31, 2012, respectively, that were 90+ days past due which continue to accrue interest due to a guarantee provided by government agencies covering approximately 97% of the outstanding balance.

 

		For the Three Months Ended
		June 30,
		2012				2011
		(In thousands)
Interest income recognized on impaired loans on a cash basis		$	1,903			$	1,263

All TDRs are classified as impaired loans, subject to performance conditions noted below. TDRs may be on either accrual or non-accrual status based upon the repayment performance of the borrower and management’s assessment of collectability. Loans deemed non-accrual may return to accrual status after six consecutive months of performance in accordance with the terms of the restructuring. Additionally, they may be considered not a TDR after twelve consecutive months of performance in accordance with the terms of the restructuring agreement, if the interest rate was a market rate for a borrower with similar credit risk at the date of restructuring.

The Corporation is currently committed to lend approximately $6.0 million in additional funds on impaired loans in accordance with the original terms of these loans; however, is not legally obligated to, and will not, disburse additional funds on any loans while in nonaccrual status or if the borrower is in default.

The Corporation experienced declines in the valuations for real estate collateral supporting portions of its loan portfolio throughout fiscal years 2010, 2011 and 2012, as reflected in recently received appraisals. Currently, $348.2 million or approximately 92% of the unpaid principal balance of classified loans (i.e. loans risk rated as substandard or loss) have recent appraisals (i.e. within one year) or have been determined to not need an appraisal. Loans that do not require an appraisal under Corporation policy include situations in which the loan (i) is fully reserved; (ii) has a

 

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small balance (less than $250,000) and rather than being individually evaluated for impairment, is included in a homogenous pool of loans; (iii) uses a net present value of future cash flows to measure impairment; or (iv) is not secured by real estate. Appraised values greater than one year old are discounted by an additional 10% for improved land or commercial real estate and 20% for unimproved land, in determination of the allowance for loan losses.

While Corporation policy may not require updated appraisals for these loans, new appraisals may still be obtained. For example, 56% of the loans which do not require an updated appraisal do have either an appraisal within the last year or an appraisal on order. If real estate values decline, the Corporation may have to increase its allowance for loan losses as updated appraisals or other indications of a decrease in the value of collateral are received.

The following table presents the aging of the recorded investment in past due loans as of June 30, 2012 by class of loans:

 

		Days Past Due
		30-59				60-89				90 or More				Total
		(In thousands)
Residential		$	2,305			$	1,242			$	34,442			$	37,989
Commercial and industrial			1,045				936				2,595				4,576
Land and construction			5,227				110				24,004				29,341
Multi-family			2,087				539				25,850				28,476
Retail/office			1,190				6,501				10,352				18,043
Other commercial real estate			—				496				13,450				13,946
Education			9,113				7,155				24,017				40,285
Other consumer			1,045				852				6,384				8,281
		$	22,012			$	17,831			$	141,094			$	180,937

The following table presents the aging of the recorded investment in past due loans as of March 31, 2012 by class of loans:

 

		Days Past Due
		30-59				60-89				90 or More				Total
		(In thousands)
Residential		$	2,414			$	1,071			$	37,791			$	41,276
Commercial and industrial			976				539				3,183				4,698
Land and construction			37				—				60,680				60,717
Multi-family			360				541				26,371				27,272
Retail/office			2,627				2,634				14,033				19,294
Other commercial real estate			1,884				191				16,323				18,398
Education			8,370				6,562				25,403				40,335
Other consumer			1,664				692				6,879				9,235
		$	18,332			$	12,230			$	190,663			$	221,225

Total delinquencies (loans past due 30 days or more) at June 30, 2012 were $180.9 million. The Corporation has experienced a reduction in delinquencies in each quarter-end since December 31, 2010 due to improving credit conditions and loans moving to OREO. The Corporation has $23.3 million of education loans past due 90 days or more that are still accruing interest due to the approximate 97% guarantee provided by governmental agencies. Loans less than 90 days delinquent may be placed on non-accrual status when the probability of collection of principal and interest is deemed to be insufficient to warrant further accrual.

 

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Credit Quality Indicators:

The Corporation groups commercial and industrial and commercial real estate loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. This analysis is updated on a monthly basis. The Corporation uses the following definitions for risk ratings:

Pass. Loans classified as pass represent assets that are evaluated and are performing under the stated terms. Pass rated assets are analyzed by the pay capacity of the obligor, current net worth of the obligor and/or by the value of the loan collateral.

Watch. Loans classified as watch possess potential weaknesses that require management attention, but do not yet warrant adverse classification. While the status of an asset put on this list does not technically trigger their classification as substandard or non-accrual, it is considered a proactive way to identify potential issues and address them before the situation deteriorates further and results in a loss for the Corporation.

Special Mention. Loans classified as special mention exhibit material negative financial trends due to company specific or industry conditions which, if not corrected or mitigated, threaten their capacity to meet current or continuing debt obligations. These borrowers still demonstrate the financial flexibility to address and cure the root cause of these adverse financial trends without significant deviations from their current business plan. Their potential weakness deserves close attention and warrant enhanced monitoring on the part of management. The expectation is these borrowers will return to a pass rating given reasonable time; or will be further downgraded.

Substandard. Loans classified as substandard are inadequately protected by the current net worth, paying capacity of the obligor, or by the collateral pledged. Substandard assets must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Corporation will sustain a loss if the deficiencies are not corrected.

Non-Accrual. Loans classified as non-accrual have the weaknesses of those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that fall into this category are deemed collateral dependent and an individual impairment evaluation is performed on all relationships greater than $500,000. Loans in this category are allocated a specific reserve if the collateral does not support the outstanding loan balance or charged off if deemed uncollectible.

As of June 30, 2012, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

		Pass				Watch				Special Mention				Substandard				Non-Accrual				Total  Unpaid Principal Balance
		(In thousands)
Commercial and industrial		$	10,438			$	5,132			$	244			$	7,446			$	7,213			$	30,473
Commercial real estate:
Land and construction			47,596				18,667				6,236				44,587				46,349				163,435
Multi-family			240,725				22,415				1,921				22,534				36,886				324,481
Retail/office			144,885				53,769				8,877				43,576				24,652				275,759
Other			122,107				19,220				24,916				43,672				24,752				234,667
		$	565,751			$	119,203			$	42,194			$	161,815			$	139,852			$	1,028,815
Percent of total unpaid principal balance			55.0	%			11.6	%			4.1	%			15.7	%			13.6	%			100.0	%

 

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As of March 31, 2012, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

																						Total Unpaid
										Special												Principal
		Pass				Watch				Mention				Substandard				Non-Accrual				Balance
		(In thousands)
Commercial and industrial		$	15,187			$	5,506			$	255			$	9,812			$	8,217			$	38,977
Commercial real estate:
Land and construction			63,643				4,532				6,344				47,300				64,229				186,048
Multi-family			252,107				26,829				2,728				22,790				37,762				342,216
Retail/office			149,907				58,252				13,080				43,221				33,817				298,277
Other			122,427				20,798				34,355				42,732				27,963				248,275
		$	603,271			$	115,917			$	56,762			$	165,855			$	171,988			$	1,113,793
Percent of total unpaid principal balance			54.2	%			10.4	%			5.1	%			14.9	%			15.4	%			100.0	%

Residential and consumer loans are managed on a pool basis due to their homogeneous nature. Loans that are delinquent 90 days or more are considered non-accrual. The following table presents the unpaid principal balance of residential and consumer loans based on accrual status as of June 30, 2012 and March 31, 2012:

 

		At June 30, 2012												At March 31, 2012
		Accrual				Non-Accrual				Total Unpaid Principal Balance				Accrual				Non-Accrual				Total Unpaid Principal Balance
		(In thousands)
Residential		$	510,129			$	41,335			$	551,464			$	520,141			$	44,550			$	564,691
Consumer:
Education (1)			226,404				721				227,125				239,569				762				240,331
Other consumer			264,896				7,079				271,975				261,908				7,624				269,532
		$	1,001,429			$	49,135			$	1,050,564			$	1,021,618			$	52,936			$	1,074,554

 

(1)	Non – accrual education loans represent the portion of these loans 90+ days past due that are not covered by a guarantee provided by government agencies that is limited to approximately 97% of the outstanding balance.

Troubled Debt Restructurings

Modification of loan terms in a troubled debt restructuring are generally in the form of an extension of payment terms or lowering of the interest rate, although occasionally the Corporation has reduced the outstanding principal balance.

Loans modified in a troubled debt restructuring that are currently on non-accrual status will remain on non-accrual status for a period of at least six months. If after six months, or a longer period sufficient to demonstrate the willingness and ability of the borrower to perform under the modified terms, the borrower has made payments in accordance with the modified terms, the loan is returned to accrual status but retains its designation as a troubled debt restructuring. The designation as a troubled debt restructuring is removed in years after the restructuring if both of the following conditions exist: (a) the restructuring agreement specifies an interest rate equal to or greater than the rate that the creditor was willing to accept at the time of restructuring for a new loan with comparable risk and (b) the loan is not impaired based on the terms specified by the restructuring agreement.

 

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The following table presents information related to loans modified in a troubled debt restructuring, by class, during the three months ended June 30, 2012:

 

		Three Months Ended June 30, 2012
		Number of Modifications				Unpaid Principal Balance (2) (at period end)
										Balance in the ALLL (3)
Troubled Debt Restructurings (1)										Prior to Modification				At Period End
		(Dollars in thousands)
Residential			0			$	—			$	—			$	—
Commercial and industrial			2				163				206				156
Land and construction			2				962				96				—
Multi-family			0				—				—				—
Retail/office			3				1,719				596				631
Other commercial real estate			0				—				—				—
Education			0				—				—				—
Other consumer			2				37				—				—
			9			$	2,881			$	898			$	787

 

(1)	Loans modified in a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported in this table.

(2)	The unpaid principal balance is inclusive of all partial paydowns and charge-offs since the modification date.

(3)	The balance in the ALLL represents any specific component of the allowance for loan losses associated with these loans.

The following table presents loans modified in a troubled debt restructuring from July 1, 2011 to June 30, 2012, by class, that subsequently defaulted (i.e., 90 days or more past due following a modification) during the three months ended June 30, 2012:

 

		Three Months Ended
		June 30, 2012
						Unpaid
		Number of				Principal
		Modified				Balance (2)
Troubled Debt Restructurings (1)		Loans				(at period end)
		(Dollars in thousands)
Residential			0			$	—
Commercial and industrial			2				523
Land and construction			0				—
Multi-family			0				—
Retail/office			1				161
Other commercial real estate			0				—
Education			0				—
Other consumer			0				—
			3			$	684

 

(1)	Loans modified in a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported in this table.

(2)	The unpaid principal balance is inclusive of all partial paydowns and charge-offs since the modification date.

 

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The following table presents the unpaid principal balance of loans modified in a TDR during the three months ended June 30, 2012, by class and by type of modification:

 

		Principal and  Interest to Interest Only
						Interest Rate Reduction
Troubled Debt Restructurings (1)(2)						To Below Market Rate				To Interest Only (3)				Below Market Rate (4)				Other (5)				Total
		(In thousands)
Residential		$	—			$	—			$	—			$	—			$	—			$	—
Commercial and industrial			—				—				—				—				163				163
Land and construction			—				—				—				210				752				962
Multi-family			—				—				—				—				—				—
Retail/office			—				161				—				546				1,012				1,719
Other commercial real estate			—				—				—				—				—				—
Education			—				—				—				—				—				—
Other consumer			—				—				18				—				19				37
		$	—			$	161			$	18			$	756			$	1,946			$	2,881

 

(1)	Loans modified in a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported in this table.

(2)	The unpaid principal balance is inclusive of all partial paydowns and charge-offs since the modification date.

(3)	Includes modifications of loan repayment terms from principal and interest to interest only, along with a reduction in the contractual interest rate.

(4)	Includes loans modified at below market rates for borrowers with similar risk profiles and having comparable loan terms and conditions. Market rates are determined by reference to internal new loan pricing grids that specify credit spreads based on loan risk rating and term to maturity.

(5)	Other modifications primarily include providing for the deferral of interest currently due to the new maturity date of the loan.

As time passes and borrowers continue to perform in accordance with the restructured loan terms, a portion of the troubled debt restructurings – non-accrual balance may be returned to accrual status.

Pledged Loans

At June 30, 2012 and March 31, 2012, residential, multi-family, education and other consumer loans receivable with unpaid principal of approximately $822.5 million and $792.7 million were pledged to secure borrowings and for other purposes as permitted or required by law. Certain of the real-estate related loans are pledged as collateral for FHLB borrowings. See Note 9.

In the ordinary course of business, the Bank has granted loans to principal officers and directors and their affiliates amounting to $454,000 and $515,000 at June 30, 2012 and March 31, 2012, respectively. During the three months ended June 30, 2012, there were no principal additions and principal payments totaled $61,000.

Note 6 – Other Real Estate Owned

Real estate acquired by foreclosure, real estate acquired by deed in lieu of foreclosure and other repossessed assets (OREO) are held for sale and are initially recorded at fair value less a discount for estimated selling expenses at the date of foreclosure. At the date of foreclosure, any write down to fair value less estimated selling costs is charged to the allowance for loan losses. If the discounted fair value exceeds the net carrying value of the loans, recoveries to the allowance for loan losses are recorded to the extent of previous charge-offs, with any excess, which is infrequent, recognized as a gain in non-interest income. Subsequent to foreclosure, valuations are periodically performed and a valuation allowance is established if fair value less estimated selling costs exceeds the carrying value. Costs relating to the development and improvement of the property may be capitalized; holding period costs and subsequent changes to the valuation allowance are charged to expense.

 

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A summary of the activity in other real estate owned is as follows:

 

		For the Three Months Ended June 30,
		2012				2011
		(In thousands)
Balance at beginning of period		$	88,841			$	90,707
Additions			18,818				23,252
Valuations/write-offs			(4,634	)			(4,890	)
Transfer to premises and equipment			(2,870	)			—
Sales			(16,200	)			(19,578	)
Balance at end of period		$	83,955			$	89,491

The balances at end of period above are net of a valuation allowance of $24.5 million and $20.9 million at June 30, 2012 and 2011, respectively, recognized during the holding period for declines in fair value subsequent to foreclosure or acceptance of deed in lieu of foreclosure. A summary of activity in the OREO valuation allowance is as follows:

 

		For the Three Months Ended June 30,
		2012				2011
		(In thousands)
Balance at beginning of period		$	22,521			$	19,975
Provision			4,634				4,890
Sales			(2,623	)			(4,000	)
Balance at end of period		$	24,532			$	20,865

During the three months ended June 30, 2012 and 2011, OREO expense, net was $7.0 million and $8.9 million, consisting of $4.6 million and $4.9 million of valuation adjustments, $411,000 and $1.1 million of foreclosure cost expense and $2.0 million and $2.9 million of net expenses from operations, respectively.

Note 7 – Mortgage Servicing Rights

The Corporation records mortgage servicing rights (MSRs) when loans are sold to third parties with servicing of those loans retained. In addition, MSRs are recorded when acquiring or assuming an obligation to service a financial (loan) asset that does not relate to an asset that is owned. Servicing assets are initially measured at fair value determined using a discounted cash flow model based on market assumptions at the time of origination. Subsequently, the MSR asset is carried at the lower of amortized cost or fair value. The Corporation assesses MSRs for impairment using a discounted cash flow model provided by a third party that is based on current market assumptions at each reporting period. For purposes of measuring fair value, the servicing rights are stratified into relatively homogeneous pools based on characteristics such as product type and interest rate bands. Impairment is recognized, if necessary, at the pool level rather than for each individual servicing right asset.

The fair value of the Corporation’s MSRs is highly sensitive to changes in market interest rates, and will generally decrease in value in a falling rate environment, while generally increasing in value as rates rise. The Corporation’s MSRs are fairly highly correlated to changes in the U.S. Treasury 10-year note rate which fell considerably from 1.67% at June 30, 2012 to 1.51% at July 31, 2012. Impairment losses are expected in future periods if market interest rates remain at these historically low levels or continue to decline.

The Corporation has chosen to use the amortization method to measure servicing assets. Under the amortization method, servicing assets are amortized in proportion to and over the period of net servicing income. Income generated as the result of the capitalization of new servicing assets is reported as net gain on sale of loans and the amortization of servicing assets is reported as a reduction to loan servicing income in the consolidated statements of operations. Ancillary income is recorded in other non-interest income.

 

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Information regarding mortgage servicing rights for the three months ended June 30, 2012 and 2011 is as follows:

 

		For the Three Months Ended June 30,
		2012				2011
		(In thousands)
Balance at beginning of period		$	24,970			$	25,366
Additions			2,027				670
Amortization			(2,336	)			(1,305	)
Balance at end of period – before valuation allowance			24,661				24,731
Valuation allowance			(4,071	)			(626	)
Balance at end of period		$	20,590			$	24,105
Fair value at the end of the period		$	20,848			$	25,210
Key assumptions:
Weighted average discount rate			10.97	%			11.30	%
Weighted average prepayment speed			15.95	%			9.90	%

The projections of amortization expense for mortgage servicing rights set forth below are based on asset balances as of June 30, 2012 and an assumed amortization rate of 20% per year. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.

 

		MSR Amortization
		(In thousands)
Three months ended June 30, 2012		$	2,336
Estimate for the year ended March 31,
2013 (nine remaining months)		$	3,699
2014			4,192
2015			3,354
2016			2,683
2017			2,146
Thereafter			8,586
		$	24,661

Mortgage loans serviced for others are not included on the consolidated balance sheets. The unpaid principal balance of mortgage loans serviced for others was approximately $3.1 billion at June 30, 2012 and March 31, 2012.

 

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Note 8 – Deposits

Deposits are summarized as follows:

 

		June 30, 2012								March 31, 2012
		Carrying				Weighted				Carrying				Weighted
		Amount				Average Rate				Amount				Average Rate
		(Dollars in thousands)
Non-interest-bearing checking		$	275,526				0.00	%		$	264,751				0.00	%
Interest-bearing checking
Fixed rate			237,961				0.07				235,459				0.07
Variable rate			29,308				0.10				30,639				0.10
Total checking accounts			542,795				0.04				530,849				0.04
Money market accounts			496,042				0.25				492,787				0.28
Regular savings			271,202				0.10				265,238				0.10
Advance payments by borrowers for taxes and insurance			10,793				0.10				6,134				0.10
Certificates of deposit:
0.00% to 1.99%			728,914				0.82				751,326				0.86
2.00% to 3.99%			171,491				2.38				179,455				2.42
4.00% and above			31,936				4.54				39,126				4.51
Total certificates of deposit			932,341				1.23				969,907				1.30
Total deposits		$	2,253,173				0.59	%		$	2,264,915				0.64	%

Maturities of certificates of deposit outstanding at June 30, 2012 are summarized as follows:

 

Matures During Year Ended March 31,		Amount
		(In thousands)
2013 (nine remaining months)		$	653,971
2014			198,798
2015			29,441
2016			11,620
2017			38,511
Thereafter			—
		$	932,341

At June 30, 2012 and March 31, 2012, certificates of deposit with balances greater than or equal to $100,000 totaled $190.3 million and $195.2 million, respectively.

The Bank has entered into agreements with certain brokers that provided deposits obtained from their customers at specified interest rates for an identified fee, or so called “brokered deposits.” At June 30, 2012 and March 31, 2012, the Bank had $274,000 and $2.1 million in brokered deposits. Due to existing capital levels, the Bank is currently prohibited from obtaining or renewing any brokered deposits. The Bank has $24.9 million in out-of-network certificates of deposit at June 30, 2012. These deposits, which are not considered brokered deposits, are opened via internet listing services and are kept within FDIC insured balance limits.

 

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Note 9 – Other Borrowed Funds

Other borrowed funds consist of the following:

 

				June 30, 2012								March 31, 2012
		Matures During						Weighted								Weighted
		Year Ended						Average								Average
		March 31,		Amount				Rate				Amount				Rate
				(Dollars in thousands)
FHLB advances:		2013 (nine remaining months)		$	10,000				4.12	%		$	10,000				4.12	%
		2014			11,500				1.93				11,500				1.93
		2015			150,000				1.52				150,000				1.62
		2018			100,000				3.36				100,000				3.36
		2019			86,000				2.87				86,000				2.87
Total FHLB advances					357,500								357,500
Line of credit					116,300				15.00				116,300				15.00
Repurchase agreements					2,578				0.14				2,303				0.21
				$	476,378				5.41	%		$	476,103				5.53	%

The Bank selects loans that meet underwriting criteria established by the FHLB as collateral for outstanding advances. FHLB advances are limited to 65% of single-family loans, 60% of multi-family loans and 20% of eligible home equity and home equity line of credit loans meeting such criteria. FHLB borrowings of $191.0 million have call features that may be exercised quarterly by the FHLB. The FHLB borrowings are also collateralized by mortgage-related securities with a fair value of $179.3 million and $184.6 million at June 30, 2012 and March 31, 2012, respectively.

Credit Agreement

As of June 30, 2012 and March 31, 2012, the Corporation had drawn a total of $116.3 million at a weighted average interest rate of 15.00%, on a short term line of credit to various lenders led by U.S. Bank. The total line of credit available is $116.3 million. At June 30, 2012 and March 31, 2012, the base rate was 0.00% and the deferred rate was 15.00% for a weighted average interest rate of 15.00%.

On November 29, 2011, the Corporation entered into Amendment No. 8 (the “Amendment”) to the Amended and Restated Credit Agreement, dated as of June 9, 2008, (the “Credit Agreement”), among the Corporation, the lenders from time to time a party thereto, and U.S. Bank National Association, as administrative agent for such lenders, or the “Agent.” The Corporation is currently in default on the Credit Agreement as a result of failure to make a principal payment on March 2, 2009. Under the Amendment, the Agent and the Lenders agreed to forbear from exercising their rights and remedies against the Corporation until the earliest to occur of the following: (i) the occurrence of any Event of Default (other than a failure to make principal payments on the outstanding balance under the Credit Agreement or other Existing Defaults); or (ii) November 30, 2012. Notwithstanding the agreement to forbear, the Agent may at any time, in its sole discretion, take any action reasonably necessary to preserve or protect its interest in the stock of the Bank, IDI, or any other collateral securing any of the obligations against the actions of the Corporation or any third party without notice to or the consent of any party.

The Amendment also provides that the outstanding balance under the Credit Agreement shall bear interest at 15% per annum. Interest accruing under the Credit Agreement is due on the earlier of (i) the date the Credit Agreement is paid in full or (ii) November 30, 2012. At June 30, 2012, the Corporation had accrued interest and amendment fees payable related to the Credit Agreement of $40.2 million and $5.7 million, respectively.

Within two business days after the Corporation has knowledge of an “event,” the CFO is required to submit a statement of the event to the Agent, together with a statement of the actions which the Corporation proposes to take in response to the event. An event may include: (i) any event which, either of itself or with the lapse of time or the giving of notice or both, would constitute a Default under the Credit Agreement; (ii) a default or an event of default under any other material agreement to which the Corporation or Bank is a party; or (iii) any pending or threatened litigation or certain administrative proceedings.

 

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The Amendment requires the Bank to maintain the following financial covenants:

 

•

Tier 1 leverage ratio of not less than 3.70% at all times.

 

•

Total risk based capital ratio of not less than 7.50% at all times.

 

•

Ratio of non-performing loans to gross loans not to exceed 15.00% at any time.

The Credit Agreement and the Amendment also contain customary representations, warranties, conditions and events of default for agreements of such type. At June 30, 2012, the Corporation was in compliance with all covenants contained in the Credit Agreement and the Amendment. Under the terms of the Credit Agreement and Amendment, the Agent and the lenders have certain rights, including the right to accelerate the maturity of the borrowings if the Corporation is not in compliance with all covenants. Currently, no such action has been taken by the Agent or the Lenders. However, the default creates significant uncertainty related to the Corporation’s operations.

Temporary Liquidity Guarantee Program

In October 2008, the Secretary of the United States Department of the 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 June 30, 2009. The Bank signed a master agreement with the FDIC on December 5, 2008 for issuance of bonds under the program and subsequently issued $60.0 million of bonds in February 2009 bearing interest at a fixed rate of 2.74%. The bonds matured on February 11, 2012 and were paid in full.

Note 10 – Capital Purchase Program

Pursuant to the Capital Purchase Program (“CPP”) in January 2009, Treasury, on behalf of the U.S. government, purchased the Corporation’s preferred stock, along with warrants to purchase approximately 7.4 million shares of the Corporation’s common stock at an exercise price of $2.23 per share. The preferred stock has a dividend rate of 5% per year, until the fifth anniversary of Treasury’s investment and a dividend of 9% thereafter. During the time Treasury holds securities issued pursuant to this program, the Corporation is required to comply with certain provisions regarding executive compensation and corporate governance. Participation in the CPP also imposes certain restrictions upon the payment of dividends to common shareholders and stock repurchase activities. The Corporation elected to participate in the CPP and received $110 million. The Corporation has deferred 13 dividend payments on the Series B Preferred Stock held by the U.S. Treasury. On September 30, 2011, the Treasury exercised its right to appoint two directors to the Board of Directors of the Corporation as a result of the nonpayment of dividends. At June 30, 2012 and March 31, 2012, the cumulative amount of dividends in arrears not declared, including interest on unpaid dividends at 5% per annum, was $20.4 million and $18.8 million, respectively.

Note 11 – Regulatory Capital

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

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Qualitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of core, tangible, and risk-based capital. Management believes, as of June 30, 2012, that the Bank was adequately capitalized under PCA guidelines. Under these OCC 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. The Bank does not currently meet these elevated capital levels. See Note 2.

The following table summarizes the Bank’s capital ratios and the ratios required by its federal regulators to be considered adequately or well-capitalized under standard PCA guidelines at June 30, 2012 and March 31, 2012:

 

										Minimum Required
		Actual								To be Adequately Capitalized								To be Well Capitalized								Under Order to Cease and Desist
		Amount				Ratio				Amount				Ratio				Amount				Ratio				Amount				Ratio
		(Dollars in thousands)
At June 30, 2012
Tier 1 leverage (core)		$	127,026				4.56	%		$	111,333				4.00	%		$	139,166				5.00	%		$	222,666				8.00	%
Total risk-based capital			148,738				8.98				132,460				8.00				165,574				10.00				198,689				12.00
At March 31, 2012
Tier 1 leverage (core)		$	125,894				4.51	%		$	111,685				4.00	%		$	139,606				5.00	%		$	223,370				8.00	%
Total risk-based capital			149,141				8.42				141,701				8.00				177,126				10.00				212,551				12.00

The following table reconciles the Bank’s stockholders’ equity to federal regulatory capital at June 30, 2012 and March 31, 2012:

 

		June 30, 2012				March 31, 2012
		(In thousands)
Stockholders’ equity of the Bank		$	129,972			$	128,071
Less: Disallowed servicing assets			(1,827	)			(2,045	)
Accumulated other comprehensive (income) loss			(1,119	)			(132	)
Tier 1 capital			127,026				125,894
Plus: Allowable general valuation allowances			21,712				23,247
Total risk-based capital		$	148,738			$	149,141

Note 12 – Income Taxes

The Corporation accounts for income taxes based on the asset and liability method. Deferred tax assets and liabilities are recorded based on the difference between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes, computed using enacted tax rates. Significant net deferred tax assets have been created for deductible temporary differences, the largest of which relates to our allowance for loan losses. For

 

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income tax return purposes, only net charge-offs on uncollectible loan balances are deductible, not the provision for credit losses. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon management’s evaluation and judgment of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of the current and future economic and business conditions. The Corporation considers both positive and negative evidence regarding the ultimate realizability of deferred tax assets. Positive evidence includes the existence of taxes paid in available carry back years as well as the probability that taxable income will be generated in future periods while negative evidence includes significant losses in the current year or cumulative losses in the current and prior two years as well as general business and economic trends.

At June 30, 2012 and March 31, 2012, the Corporation determined that a valuation allowance relating to the deferred tax asset was necessary. This determination was based largely on the negative evidence represented by the losses in the current and prior fiscal years caused by the significant loan loss provisions associated with the loan portfolio. In addition, general uncertainty surrounding future economic and business conditions have increased the potential volatility and uncertainty of projected earnings. Therefore, a valuation allowance of $150.4 million and $149.8 million at June 30, 2012 and March 31, 2012, respectively, was recorded to offset net deferred tax assets that exceed the Corporation’s carry back potential.

The significant components of the Corporation’s deferred tax assets (liabilities) are as follows:

 

		At June 30,				At March 31,
		2012				2012
		(In thousands)
Deferred tax assets:
Allowance for loan losses		$	50,998			$	54,063
Other loss reserves			2,206				2,635
Federal NOL carryforwards			86,141				82,885
State NOL carryforwards			18,656				18,178
Purchase accounting			223				216
Other			3,586				3,635
Total deferred tax assets			161,810				161,612
Valuation allowance			(150,447	)			(149,831	)
Adjusted deferred tax assets			11,363				11,781
Deferred tax liabilities:
FHLB stock dividends			(2,269	)			(2,636	)
Mortgage servicing rights			(8,258	)			(8,825	)
Unrealized gains (losses)			(449	)			(53	)
Other			(387	)			(267	)
Total deferred tax liabilities			(11,363	)			(11,781	)
Net deferred tax assets		$	—			$	—

The Corporation is subject to U.S. federal income tax as well as income tax of state jurisdictions. The tax years 2009-2011 remain open to examination by the Internal Revenue Service and certain state jurisdictions while the years 2008-2011 remain open to examination by certain other state jurisdictions.

The Corporation recognizes interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2012 and March 31, 2012, the Corporation has not recognized any accrued interest and penalties related to uncertain tax positions.

 

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Note 13 – Commitments and Contingent Liabilities

The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and financial guarantees which involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement and exposure to credit loss the Corporation has in particular classes of financial instruments. The same credit policies are used in making commitments and conditional obligations as for on-balance-sheet instruments. Since many of the commitments are expected to expire without being drawn upon, the total committed amounts do not necessarily represent future cash requirements.

Financial instruments whose contract amounts represent credit risk are as follows:

 

		June 30, 2012				March 31, 2012
		(In thousands)
Commitments to extend credit:		$	11,627			$	15,022
Unused lines of credit:
Home equity			112,619				112,760
Credit cards			28,888				31,658
Commercial			10,974				9,446
Letters of credit			17,709				17,349
Credit enhancement under the Federal Home Loan Bank of Chicago Mortgage Partnership Finance Program			20,442				20,442

Commitments to extend credit are in the form of a loan in the near future. Unused lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and may be drawn upon at the borrowers’ discretion. Letters of credit commit the Corporation to make payments on behalf of customers when certain specified future events occur. Commitments and letters of credit primarily have fixed expiration dates or other termination clauses and may require payment of a fee. As some such commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. With the exception of credit card lines of credit, the Corporation primarily extends credit on a secured basis. Collateral obtained consists primarily of single-family residences and income-producing commercial properties.

At June 30, 2012, the Corporation has $1.7 million of reserves on unfunded commitments, unused lines of credit and letters of credit classified in other liabilities. The Corporation intends to fund commitments through current liquidity.

Pursuant to a credit enhancement feature of the MPF program, the Corporation has retained secondary credit loss exposure in the amount of $20.4 million at June 30, 2012 related to approximately $351.4 million of residential mortgage loans that the Bank has originated as agent for the FHLB. Under the credit enhancement, the FHLB is liable for losses on loans up to one percent of the original delivered loan balances in each pool. The Bank is then liable for losses over and above the first position up to a contractually agreed-upon maximum amount in each pool that was delivered to the Program. The Corporation receives a monthly fee for this credit enhancement obligation based on the outstanding loan balances. The Corporation has recorded net credit enhancement fee income from this program totaling $4,000 and $46,000 for the three months ending June 30, 2012 and June 30, 2011, respectively. Based on historical experience, the Corporation does not anticipate that any credit losses will be incurred under the credit enhancement obligation.

 

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In the ordinary course of business, there are legal proceedings against the Corporation and its subsidiaries. Management considers that the aggregate liabilities, if any, resulting from such actions would not have a material, adverse effect on the consolidated financial position of the Corporation.

One pending lawsuit against the Corporation currently in the discovery stage involves a Bank-issued letter of credit in support of a residential real estate development. Although no specific reserve for loss has been established at June 30, 2012, possible losses due to an unfavorable outcome have been estimated in the range of zero to $2.4 million due to a shortfall in collateral value.

Note 14 – Derivative Financial Instruments

The Corporation enters into contracts that meet the definition of derivative financial instruments in accordance with ASC 815—Derivative and Hedging. Derivatives are used as part of a risk management strategy to address exposure to changes in interest rates inherent in the Corporation’s origination and sale of certain residential mortgages into the secondary market. These derivative contracts used for risk management purposes include: (1) interest rate lock commitments provided to customers to fund mortgage loans intended to be sold; and (2) forward sale contracts for the future delivery of funded residential mortgages.

Forward sale contracts are entered into when interest rate lock commitments are granted to customers in an effort to economically hedge the effect of future changes in interest rates on the commitments to fund mortgage loans intended to be sold, as well as on the portfolio of funded mortgages not yet sold. For accounting purposes, these derivatives are not designated as being in a hedging relationship. The contracts are carried at fair value on the consolidated balance sheets, with changes in fair value recorded in the consolidated statements of operations.

Derivative financial instruments are summarized as follows:

 

				At June 30, 2012								At March 31, 2012
		Balance Sheet Location		Notional Amount				Estimated Fair Value				Notional Amount				Estimated Fair Value
				(In thousands)
Derivative assets:
Interest rate lock commitments (1)		Other assets		$	146,842			$	3,151			$	115,032			$	943
Forward contracts to sell mortgage loans (2)		Other liabilities			—				—				50,000				98
Derivative liabilities:
Interest rate lock commitments (1)		Other liabilities			259				1				27,689				72
Forward contracts to sell mortgage loans (2)		Other liabilities			155,000				1,516				105,000				557

 

(1)	Interest rate lock commitments include $120.6 million and $118.3 million of commitments not yet approved in the credit underwriting process, yet represent potential interest rate risk exposure to the extent of those mortgage loan applications eventually approved for funding.

(2)	The Corporation has elected to offset the fair value of individual forward sale contracts and present a net amount in accordance with ASC 815-45, Derivatives and Hedging.

Net gains (losses) included in the consolidated statements of operations related to derivative financial instruments during the three months ended June 30, 2012 and 2011 were ($3.8) million and ($0.5) million, respectively, recognized in net gain on sale of loans.

 

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Note 15 – Fair Value of Financial Instruments

ASC Topic 820 establishes a framework for measuring fair value and disclosures about fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

In determining fair value, the Corporation uses various valuation methods including market, income and cost approaches. Based on these approaches, assumptions are utilized that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable inputs. Valuation methodologies are employed that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on observability of the inputs used in the valuation methodologies, financial assets and liabilities measured at fair value on a recurring and nonrecurring basis are categorized according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities that are adjusted to fair value are classified in one of the following three categories:

 

•

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

•

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

•

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Fair Value on a Recurring Basis

The table below presents the financial instruments carried at fair value as of June 30, 2012 and March 31, 2012, by the valuation hierarchy (as described above):

 

		Total
		June 30, 2012				Level 1				Level 2				Level 3
		(In thousands)
Financial assets
Investment securities availble for sale:
U.S. government sponsored and federal agency obligations		$	3,551			$	—			$	3,551			$	—
Corporate stock and bonds			707				707				—				—
Non-agency CMOs			18,476				—				—				18,476
Government sponsored agency mortgage-backed securities			4,045				—				4,045				—
GNMA mortgage-backed securities			204,865				—				204,865				—
Other assets:
Interest rate lock commitments			3,151				—				3,151				—
Total		$	234,795			$	707			$	215,612			$	18,476
Financial liabilities
Other liabilities:
Interest rate lock commitments		$	1			$	—			$	1			$	—
Forward contracts to sell mortgage loans			1,516				—				1,516				—
Total		$	1,517			$	—			$	1,517			$	—

 

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		Total
		March 31, 2012				Level 1				Level 2				Level 3
		(In thousands)
Financial assets
Investment securities availble for sale:
U.S. government sponsored and federal agency obligations		$	3,531			$	—			$	3,531			$	—
Corporate stock and bonds			661				661				—				—
Non-agency CMOs			21,592				—				—				21,592
Government sponsored agency mortgage-backed securities			4,195				—				4,195				—
GNMA mortgage-backed securities			212,320				—				212,320				—
Other assets:
Interest rate lock commitments			943				—				943				—
Total		$	243,242			$	661			$	220,989			$	21,592
Financial liabilities
Other liabilities:
Interest rate lock commitments		$	72			$	—			$	72			$	—
Forward contracts to sell mortgage loans			459				—				459				—
Total		$	531			$	—			$	531			$	—

An independent service is used to price available-for-sale U.S. government sponsored and federal agency obligations, corporate bonds, government sponsored agency mortgage-backed securities, and GNMA mortgage-backed securities using a market data model under Level 2. The significant inputs used at June 30, 2012 and March 31, 2012 to price Ginnie Mae mortgage-backed securities are as follows:

 

		June 30, 2012								March 31, 2012
		From				To				From				To
Coupon rate			1.6	%			5.5	%			1.6	%			5.5	%
Duration (in years)			0.3				6.1				0.1				6.1
PSA prepayment speed			283				457				201				495

The Corporation had 99.7% of its non-agency CMOs valued by another independent pricing service that used a discounted cash flow model that incorporates inputs considered Level 3 by the accounting guidance. The significant inputs used by the model at June 30, 2012 and March 31, 2012 include observable and unobservable inputs as follows:

 

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		June 30, 2012								March 31, 2012
		From				To				From				To
Observable inputs:
30 to 59 day delinquency rate			2.3	%			5.1	%			1.2	%			4.8	%
60 to 89 day delinquency rate			0.4				2.7				0.6				2.5
90 plus day delinquency rate			0.9				5.2				1.1				6.0
Loss severity			39.7				73.3				39.5				71.7
Coupon rate			5.0				7.5				5.0				7.5
Current credit support			—				28.3				—				25.3
Unobservable inputs:
Month 1 to month 24 constant default rate			3.3				11.5				3.4				11.3
Discount rate			4.0				12.0				4.0				12.0

Other assets and other liabilities include interest rate lock commitments provided to customers to fund mortgage loans intended to be sold and forward sale contracts for future delivery of funded residential mortgages to investors. The Corporation relies on an internal valuation model to estimate the fair value of its interest rate lock commitments, which includes applying an estimated pull-through rate (the percentage of commitments expected to result in a closed loan) based on historical experience; multiplied by quoted investor prices on closed loans for future delivery determined to be reasonably applicable to the loan commitment based on interest rate, terms and rate lock expiration.

The Corporation also relies on an internal valuation model to estimate the fair value of its forward contracts to sell residential mortgage loans (i.e., an estimate of what the Corporation would receive or pay to terminate the forward delivery contract) based on market prices for similar financial instruments, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available.

The following is a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (level 3):

 

		Three Months  Ended June 30, 2012				Year Ended March  31, 2012
		Non-agency CMOs				Non-agency CMOs
		(In thousands)
Balance at beginning of period		$	21,592			$	46,637
Total gains (losses) (realized/unrealized)
Included in earnings			129				334
Included in other comprehensive income			168				(192	)
Included in earnings as unrealized other-than-temporary impairment			(68	)			(558	)
Included in earnings upon payoff of securities for which other-than-temporary impairment was previously recognized			4				—
Included in earnings as realized other-than-temporary impairment			138				363
Principal repayments			(1,582	)			( 8,596	)
Sales			(1,905	)			(16,396	)
Balance at end of period		$	18,476			$	21,592

There were no transfers in or out of Levels 1, 2 or 3 during the three months ended June 30, 2012 and twelve months ended March 31, 2012.

 

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Fair Value on a Nonrecurring Basis

Certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Loans held for sale and mortgage servicing rights includes only those items that were adjusted to fair value as of the dates indicated. The following table presents such assets carried on the consolidated balance sheet by caption and by level within the fair value hierarchy as of June 30, 2012 and March 31, 2012:

 

		Total June 30,  2012				Level 1				Level 2				Level 3
		(In thousands)
Impaired loans, with an allowance recorded, net		$	115,461			$	—			$	—			$	115,461
Mortgage servicing rights			19,357				—				—				19,357
Other real estate owned			83,955				—				—				83,955
Total assets at fair value		$	218,773			$	—			$	—			$	218,773

 

		Total March 31,  2012				Level 1				Level 2				Level 3
		(In thousands)
Impaired loans, with an allowance recorded, net		$	129,446			$	—			$	—			$	129,446
Loans held for sale			145				—				145				—
Mortgage servicing rights			20,671				—				—				20,671
Other real estate owned			88,841				—				—				88,841
Total assets at fair value		$	239,103			$	—			$	145			$	238,958

The Corporation does not adjust loans held for investment to fair value on a recurring basis. However, some loans are considered impaired and an allowance for loan losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of the underlying collateral less estimated costs to sell. The fair value of collateral is usually determined based on appraisals. In some cases, adjustments are made to appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. Since adjustments to appraised values are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement.

Loans held for sale primarily consist of the current origination of certain fixed- and adjustable-rate residential mortgage loans and are carried at lower of cost or fair value, determined on a loan level basis. These loans are valued individually based upon quoted market prices and the amount of any gross loss is recorded as a valuation allowance in loans held for sale. Fees received from the borrower and direct costs to originate the loan are deferred and recorded as an adjustment to the loan carrying value.

Mortgage servicing rights are recorded as an asset when loans are sold to third parties with servicing rights retained. The cost allocated to the mortgage servicing rights retained has been recognized as a separate asset and is initially recorded at fair value and subsequently amortized in proportion to, and over the period of, estimated net servicing revenues. The carrying value of these assets is reviewed for impairment on a monthly basis using a lower of carrying value or fair value methodology. The fair value of servicing rights is determined by estimating the present value of future net cash flows using a discounted cash flow model, taking into consideration market loan prepayment speeds, discount rates, servicing costs and other economic factors. For purposes of measuring impairment, the rights are stratified based on predominant risk characteristics of the underlying loans which include product type (i.e., fixed, adjustable or balloon) and interest rate bands. If the aggregate carrying value of the capitalized mortgage servicing rights for a stratum exceeds its fair value, the difference is recognized in earnings as an impairment loss.

 

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Critical assumptions used in the discounted cash flow model include mortgage prepayment speeds, discount rates, costs to service, ancillary and late fee income. Variations in the assumptions could materially affect the estimated fair values. Changes to the assumptions are made when market data indicate that new trends have developed. Current market participant assumptions based on loan product types – fixed rate, adjustable rate and balloon loans–include discount rates in the range of 10.0 to 16.5 percent as well as total portfolio lifetime weighted average prepayment speeds of 5.9 to 42.3 percent annual CPR. Many of these assumptions are subjective and require a high level of management judgment. MSR valuation assumptions are reviewed and approved by management on a quarterly basis.

Prepayment speeds may be affected by economic factors such as changes in home prices, market interest rates, the availability of other credit products to borrowers and customer payment patterns. Prepayment speeds include the impact of all borrower prepayments, including full payoffs, additional principal payments and the impact of loans paid off due to foreclosure liquidations. As market interest rates decline, prepayment speeds will generally increase as customers refinance existing mortgages to more favorable interest rate terms. As prepayment speeds increase, anticipated cash flows will generally decline resulting in a potential reduction, or impairment, of the fair value of the capitalized MSRs. Alternatively, an increase in market interest rates may cause a decrease in prepayment speeds and therefore an increase in fair value of MSRs. Annually, external data is obtained to test the values and assumptions that are used for the initial valuations in the discounted cash flow model.

Real estate acquired by foreclosure, real estate acquired by deed in lieu of foreclosure and other repossessed assets (OREO) are held for sale and are initially recorded at fair value less estimated selling expenses at the date of foreclosure. OREO is re-measured at the lower of cost or fair value after initial recognition and reported using a valuation allowance on foreclosed assets. Fair value is generally based on third party appraisals and is therefore considered a Level 3 measurement.

ASC Topic 825 requires disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, whether or not recognized in the consolidated balance sheets, including those financial assets and liabilities that are not measured and reported at fair value on a recurring or nonrecurring basis. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instruments. Certain financial instruments with a fair value that is not practicable to estimate and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented in the table below do not necessarily represent the underlying value of the Corporation.

The following methods and assumptions were used in estimating the fair value of financial instruments that were not previously disclosed:

Cash and cash equivalents and accrued interest: The carrying amounts reported in the balance sheets approximate the fair values for those assets and liabilities. In accordance with ASC Topic 820, cash and cash equivalents and accrued interest have been categorized as a Level 2 fair value measurement.

Loans receivable: The fair value of residential mortgage loans held for investment, commercial real estate loans, commercial and industrial loans, and consumer and other loans held for investment are estimated using observable inputs including estimated cash flows, and discount rates based on interest rates currently being offered for loans with similar terms, to borrowers of similar credit quality. In accordance with ASC Topic 820, loans held for investment have been categorized as a Level 2 fair value measurement.

Federal Home Loan Bank stock: The carrying amount of FHLB stock approximates its fair value as it can only be redeemed with the FHLB at par value. In accordance with ASC Topic 820, Federal Home Loan Bank stock has been categorized as a Level 2 fair value measurement.

Deposits: The fair value of checking, savings and money market accounts are estimated using a discounted cash flow analysis, with run-off rate based on published bank regulatory decay rate tables. The fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates being offered on certificates of deposit to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. In accordance with ASC Topic 820, deposits have been categorized as a Level 2 fair value measurement.

 

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Other borrowed funds: The fair value of other borrowed funds are estimated using discounted cash flow analysis, based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements. In accordance with ASC Topic 820, other borrowed funds have been categorized as a Level 2 fair value measurement.

Off-balance-sheet instruments: The fair value of off-balance-sheet instruments (held for investment lending commitments and unused lines of credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparties’ credit standing and discounted cash flow analyses. The fair value of these off-balance-sheet items approximates the recorded amounts of the related fees and is not material at June 30, 2012 and March 31, 2012.

The carrying amount and fair value of the Corporation’s financial instruments consist of the following:

 

		June 30, 2012								March 31, 2012
		Carrying Amount				Fair Value				Carrying Amount				Fair Value
		(In thousands)
Financial assets:
Cash and cash equivalents		$	368,369			$	368,369			$	242,980			$	242,980
Investment securities available for sale			231,644				231,644				242,229				242,299
Investment securities held to maturity			—				—				20				20
Loans held for sale			27,938				28,807				39,332				39,742
Loans held for investment			1,959,551				1,921,794				2,058,008				2,008,278
Mortgage servicing rights			20,590				20,848				22,156				22,346
Federal Home Loan Bank stock			30,522				30,522				35,792				35,792
Accrued interest receivable			11,391				11,391				12,075				12,075
Interest rate lock commitments			3,151				3,151				943				943
Financial liabilities:
Deposits			2,253,173				2,236,365				2,264,915				2,232,691
Other borrowed funds			476,378				503,798				476,103				502,846
Accrued interest payable-borrowings			40,880				40,880				36,568				36,568
Accrued interest payable-deposits			1,385				1,385				1,513				1,513
Interest rate lock commitments			1				1				72				72
Forward contracts to sell mortgage loans			1,516				1,516				459				459

Note 16 – Earnings Per Share

Basic earnings per share for the three months ended June 30, 2012 and 2011 has been determined by dividing net income available to common stockholders for the respective periods by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding plus the effect of dilutive securities. The effects of dilutive securities are computed using the treasury stock method.

 

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		Three Months Ended June 30,
		2012				2011
		(In thousands, except share and per share data)
Numerator:
Numerator for basic and diluted earnings per share – loss available to common stockholders		$	(3,418	)		$	(8,154	)
Denominator:
Denominator for basic earnings per share – weighted average shares			21,248				21,248
Effect of dilutive securities:
Employee stock options			—				—
Denominator for diluted earnings per share – adjusted weighted average shares and assumed conversions			21,248				21,248
Basic loss per common share		$	(0.16	)		$	(0.38	)
Diluted loss per common share		$	(0.16	)		$	(0.38	)

At June 30, 2012, approximately 144,000 stock options were excluded from the calculation of diluted earnings per share because they were anti-dilutive, representing all stock options currently outstanding. Treasury’s warrants (see Note 10) to purchase approximately 7.4 million shares at an exercise price of $2.23 were also not included in the computation of diluted earnings per share because the warrants’ exercise price was greater than the average market price of common stock and, therefore, anti-dilutive. Because of their anti-dilutive effect, the shares that would be issued if Treasury’s Senior Preferred Stock were converted into common stock are not included in the computation of diluted earnings per share for the three months ended June 30, 2012 and 2011.

 

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ANCHOR BANCORP WISCONSIN INC.

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Set forth below is management’s discussion and analysis of the consolidated results of operations and financial condition of Anchor Bancorp Wisconsin Inc. (the “Corporation”) and its wholly-owned subsidiaries, AnchorBank fsb (the “Bank”) and Investment Directions Inc. (“IDI”), for the three months ended June 30, 2012, which includes information regarding significant regulatory developments and the Corporation’s risk management activities, including asset/liability management strategies, sources of liquidity and capital resources. This discussion should be read in conjunction with the unaudited consolidated financial statements and supplemental data contained elsewhere in this quarterly report filed on Form 10-Q for the three-month period ending June  30, 2012.

EXECUTIVE OVERVIEW

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. The Cease and Desist Order required, that, no later than December 31, 2009, the Bank meet and maintain both a tier 1 (core) capital ratio equal to or greater than 8 percent and a total risk-based capital ratio equal to or greater than 12 percent.

The Cease and Desist Order also required that the Bank submit a Capital Restoration Plan along with a revised business plan to the OTS. The Bank complied with that directive on July 23, 2010 with the submission of its Revised Capital Restoration Plan (the “Plan”). On August 31, 2010, the OTS approved the Plan submitted by the Bank, although the approval included a Prompt Corrective Action Directive (“PCA”).

At June 30, 2012, the Bank and the Corporation had complied with all aspects of the Cease and Desist and the PCA, except the Bank had a tier 1 leverage ratio and a total risk-based capital ratio of 4.56 percent and 8.98 percent, respectively, each below the required capital ratios set forth above.

The Corporation remains diligent in its efforts to raise outside capital to bring it in compliance with the Cease and Desist Order. The Corporation continues to make strides to improve the financial performance and efficiency of the Bank to increase the likelihood that it will be able to attract outside capital.

But the organization continues to face significant challenges. The Corporation, as the holding company of the Bank, continues to be burdened with significant senior debt and preferred stock obligations. The Corporation currently owes $116.3 million to various lenders led by U.S. Bank under the Credit Agreement that matures November 30, 2012. The Corporation also has accrued but unpaid interest and fees totaling $45.8 million associated with this obligation that is due and payable at maturity.

In addition, the Corporation issued $110 million in preferred stock in January 2009 to the United States Treasury pursuant to the Treasury’s Capital Purchase Program (“CPP”). While the Bank has substantial liquidity, it is currently precluded by its regulators from paying dividends to the Corporation. As a result, and as permitted under the CPP program, the Corporation has deferred 13 quarterly preferred stock dividend payments to the Treasury totaling $20.4 million, including interest. As a result of those deferrals, Treasury had the right to appoint two additional persons to the Corporation’s Board of Directors and as announced on September 30, 2011, appointed Messrs. Duane Morse and Leonard Rush to the Corporation’s Board.

The Corporation has engaged and continues to work with Sandler O’Neill & Partners, L.P. as its financial advisor to assist in capital raising efforts to address its capital needs.

Credit Highlights

The Corporation has continued to see improvement in early stage and overall delinquencies during the past year. This, coupled with the Bank’s ongoing efforts to aggressively work out of troubled credits, has led to a decline in the level of non-performing loans. At June 30, 2012, 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) totaled $189.0 million, $35.9 million below the $224.9 million at March 31,

 

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2012. In addition, the Bank experienced a moderate decrease in the level of foreclosed properties on the consolidated balance sheet. At June 30, 2012, other real estate owned was $84.0 million, compared to $88.8 million at March 31, 2012, a 5.5 percent decrease. As a result, the decline in the levels of non-performing assets was just slightly greater than the decline in non-performing loans. An elevated level of non-performing assets has, and will continue to have, a negative impact on net interest income and expenses related to managing the troubled loan portfolio.

The allowance for loan losses declined to $100.5 million at June 30, 2012 from $111.2 million at March 31, 2012, a 9.7 percent decrease. Net charge-offs during the three months ended June 30, 2012 were $7.9 million compared to $15.0 million for the same period in 2012. The provision for credit losses was $(1.7) million for the three months ended June 30, 2012, compared to $3.5 million for the three months ended June 30, 2011. While the balance in the allowance for loan losses declined 9.7 percent during the first quarter of fiscal 2013, the allowance compared to total non-performing loans of 53.17 percent at June 30, 2012 compared favorably to the 49.45 percent at March 31, 2012.

Market and Industry Developments

The economic turmoil that began in the middle of 2007 and continued into 2010 has appeared to have settled into a slow economic recovery in 2011 and 2012. At this time the recovery has somewhat uncertain prospects. This has been accompanied by dramatic changes in the competitive landscape of the financial services industry and a wholesale reformation of the legislative and regulatory landscape with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which was signed into law by President Obama on July 21, 2010.

Dodd-Frank is extensive, complex and comprehensive legislation that impacts many aspects of banking organizations. Dodd-Frank is likely to negatively impact the Corporation’s revenue and increase both the direct and indirect costs of doing business, as it includes provisions that could increase regulatory fees and deposit insurance assessments and impose heightened capital standards, while at the same time impacting the nature and costs of the Corporation’s businesses. As a result of Dodd-Frank, the OTS ceased to be our primary regulator with the OCC now regulating the Bank and the Federal Reserve regulating the Corporation. It is unclear at this time what effect this change will have on our results of operations.

Until such time as the regulatory agencies issue proposed and final regulations implementing the numerous provisions of Dodd-Frank, a process that will extend at least over the next twelve months and may last several years, management will not be able to fully assess the impact the legislation will have on its business.

Financial Results

Results for the first quarter ended June 30, 2012 include:

 

•

Basic and diluted (loss) per common share improved to $(0.16) for the quarter ended June 30, 2012 compared to $(0.38) per share for the quarter ended June 30, 2011, primarily due to a decrease of $5.2 million in the provision for credit losses;

 

•

The net interest margin decreased to 2.57% for the quarter ended June 30, 2012 from 2.77% for the quarter ended June 30, 2011 primarily due to a decline in the average yield on mortgage and consumer loans as new loans and renewals are funded in today’s lower rate environment, and the maturity of lower rate FHLB advances during the first quarter of 2011;

 

•

Loans held for sale decreased $11.4 million, or 29.0% since March 31, 2012 primarily due to lower residential mortgage origination volume and retention of a significantly higher percentage of originated mortgage loans in the held for investment portfolio;

 

•

Loans held for investment (net of the allowance for loan losses) decreased $98.5 million, or 4.8%, since March 31, 2012 primarily due to scheduled pay-offs and amortization and the transfer of $18.8 million to other real estate owned;

 

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•

Deposits decreased $11.7 million, or 0.5%, since March 31, 2012 primarily due to runoff of time deposits;

 

•

Total risk-based capital ratio for the Bank was 8.98% as of June 30, 2012, compared to 8.42% at March 31, 2012. Under regulatory requirements, a bank must have a total risk-based capital ratio of 8% or greater to be considered adequately capitalized; however, the Bank’s total risk based capital ratio remains below the 12% level required under the terms of the Cease and Desist Order issued by the Office of Thrift Supervision (“OTS”) on June 26, 2009. (Now administered by the Federal Reserve with respect to the Corporation and the Office of the Comptroller of the Currency (“OCC”) with respect to the Bank).

 

•

Total non-performing loans decreased $35.9 million, or 16.0% to $189.0 million at June 30, 2012 from $224.9 million at March 31, 2012;

 

•

Total non-performing assets (total non-performing loans and other real estate owned) decreased $40.9 million, or 13.0%, to $272.9 million at June 30, 2012 from $313.8 million at March 31, 2012;

 

•

The provision for credit losses decreased $5.2 million, to a recapture of $(1.7) million for the three months ended June 30, 2012 from $3.5 million for the three months ended June 30, 2011; and

 

•

Delinquencies (loans past due 30 days or more) decreased $40.3 million or 18.2%, to $180.9 million at June 30, 2012 from $221.2 million at March 31, 2012.

 

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Selected quarterly data are set forth in the following tables.

 

		Three Months Ended
		6/30/2012				3/31/2012				12/31/2011				9/30/2011
		(Dollars in thousands – except per share amounts)
Operations Data:
Net interest income		$	16,399			$	15,888			$	16,014			$	18,500
Provision for credit losses			(1,716	)			4,601				8,380				17,115
Net gain on sale of loans			5,823				6,406				6,018				3,994
Net gain on sale of investment securities			62				217				20				5,206
Net gain on sale of branches			—				—				—				—
Other non-interest income			7,613				6,357				3,456				5,579
Non-interest expense			31,558				28,220				28,997				32,325
Income (loss) before income tax expense (benefit)			55				(3,953	)			(11,869	)			(16,161	)
Income tax expense			—				—				—				—
Net income (loss)			55				(3,953	)			(11,869	)			(16,161	)
Preferred stock dividends in arrears			(1,610	)			(1,591	)			(1,572	)			(1,579	)
Preferred stock discount accretion			(1,863	)			(1,844	)			(1,853	)			(1,853	)
Net loss available to common equity			(3,418	)			(7,388	)			(15,294	)			(19,593	)
Selected Financial Ratios (1) :
Yield on interest-earning assets			4.22	%			4.17	%			4.09	%			4.42	%
Cost of funds			1.56				1.72				1.81				1.84
Interest rate spread			2.66				2.45				2.28				2.58
Net interest margin			2.57				2.35				2.19				2.48
Return on average assets			0.01				(0.54	)			(1.51	)			(2.02	)
Average equity to average assets			(1.03	)			(0.94	)			(0.53	)			(0.20	)
Non-interest expense to average assets			4.56				3.89				3.69				4.04
Per Share:
Basic loss per common share		$	(0.16	)		$	(0.35	)		$	(0.72	)		$	(0.92	)
Diluted loss per common share			(0.16	)			(0.35	)			(0.72	)			(0.92	)
Dividends per common share			—				—				—				—
Book value per common share			(6.52	)			(6.57	)			(6.37	)			(5.81	)
Financial Condition:
Total assets		$	2,784,076			$	2,789,452			$	3,061,573			$	3,197,441
Loans receivable, net
Held for sale			27,938				39,332				36,962				45,199
Held for investment			1,959,551				2,058,008				2,166,351				2,257,905
Deposits			2,253,173				2,264,915				2,472,697				2,593,670
Other borrowed funds			476,378				476,103				538,091				537,194
Stockholders’ deficit			(28,508	)			(29,550	)			(25,327	)			(13,391	)
Allowance for loan losses			100,477				111,215				130,926				138,347
Non-performing assets(2)			272,942				313,765				348,077				349,472

 

(1)	Annualized when appropriate.

(2)	Non-performing assets consist of loans past due more than ninety days and on non-accrual status, loans past due due less than ninety days but placed on non-accrual status due to anticipated probable loss, non-accrual troubled debt restructurings and OREO.

 

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		Three Months Ended
		6/30/2011				3/31/2011				12/31/2010				9/30/2010
		(Dollars in thousands – except per share amounts)
Operations Data:
Net interest income		$	21,520			$	21,460			$	22,314			$	22,418
Provision for credit losses			3,482				10,178				21,412				10,674
Net gain on sale of loans			1,173				1,600				5,601				9,216
Net gain on sale of investment securities			1,136				709				1,187				6,653
Net gain on sale of branches			—				2				100				2,318
Other non-interest income			5,618				4,479				4,798				5,533
Non-interest expense			30,710				36,305				24,647				34,112
Income (loss) before income tax expense (benefit)			(4,745	)			(18,233	)			(12,059	)			1,352
Income tax expense (benefit)			10				150				—				14
Net income (loss)			(4,755	)			(18,383	)			(12,059	)			1,338
Preferred stock dividends in arrears			(1,536	)			(1,503	)			(1,494	)			(1,352	)
Preferred stock discount accretion			(1,863	)			(1,843	)			(1,853	)			(1,853	)
Net loss available to common equity			(8,154	)			(21,729	)			(15,406	)			(1,867	)
Selected Financial Ratios (1):
Yield on interest-earning assets			4.66	%			4.57	%			4.66	%			4.80	%
Cost of funds			1.77				1.84				2.07				2.24
Interest rate spread			2.89				2.73				2.59				2.56
Net interest margin			2.77				2.63				2.51				2.45
Return on average assets			(0.39	)			(2.12	)			(1.31	)			0.13
Return on average equity			N/M				N/M				N/M				20.30
Average equity to average assets			(0.32	)			(0.15	)			0.41				0.63
Non-interest expense to average assets			3.69				4.18				2.64				3.51
Per Share:
Basic loss per common share		$	(0.38	)		$	(1.02	)		$	(0.72	)		$	(0.09	)
Diluted loss per common share			(0.38	)			(1.02	)			(0.72	)			(0.09	)
Dividends per common share			—				—				—				—
Book value per common share			(5.41	)			(5.80	)			(4.94	)			(3.31	)
Financial Condition:
Total assets		$	3,240,867			$	3,394,825			$	3,580,752			$	3,803,853
Loans receivable, net
Held for sale			16,333				7,538				37,196				28,744
Held for investment			2,390,987				2,520,367				2,661,991				2,839,217
Deposits			2,643,099				2,699,433				2,835,245				3,017,498
Other borrowed funds			547,045				659,005				682,090				700,539
Stockholders’ (deficit) equity			(4,990	)			(13,171	)			4,939				39,611
Allowance for loan losses			138,740				150,122				157,438				156,186
Non-performing assets(2)			375,201				396,981				403,364				410,347

 

(1)	Annualized when appropriate.

(2)	Non-performing assets consist of loans past due more than ninety days and on non-accrual status, loans past due due less than ninety days but placed on non-accrual status due to anticipated probable loss, non-accrual troubled debt restructurings and OREO.

 

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RESULTS OF OPERATIONS

Overview

Net results from operations for the three months ended June 30, 2012 improved $4.7 million to net income of $0.1 million from a net loss of $4.8 million in the prior year period. The swing to modest net income from the net loss reported for the three-month period last year was largely due to a decrease in provision for credit losses of $5.2 million and higher non-interest income of $4.3 million. These favorable variances were partially offset by a decrease in net interest income of $5.1 million. The discussion that follows in this section provides additional details regarding these results.

Average Interest-Earning Assets, Average Interest-Bearing Liabilities and Interest Rate Spread

The tables on the following page show the Corporation’s average balances, interest, average rates, net interest margin and interest rate spread for the periods indicated. The average balances are derived from average daily balances.

 

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		Three Months Ended June 30,
		2012												2011
		Average Balance				Interest				Average Yield/ Cost(1)				Average Balance				Interest				Average Yield/ Cost(1)
		(Dollars In thousands)
Interest-Earning Assets
Mortgage loans		$	1,519,198			$	18,795				4.95	%		$	1,849,237			$	23,658				5.12	%
Consumer loans			501,032				6,065				4.84				548,617				6,956				5.07
Commercial business loans			19,727				428				8.68				69,098				1,495				8.65
Total loans receivable (2) (3)			2,039,957				25,288				4.96				2,466,952				32,109				5.21
Investment securities (4)			238,427				1,521				2.55				498,615				3,942				3.16
Interest-bearing deposits			245,474				154				0.25				82,284				52				0.25
Federal Home Loan Bank stock			33,128				28				0.34				54,829				14				0.10
Total interest-earning assets			2,556,986				26,991				4.22				3,102,680				36,117				4.66
Non-interest-earning assets			208,817												225,150
Total assets		$	2,765,803											$	3,327,830
Interest-Bearing Liabilities
Demand deposits		$	1,011,400				549				0.22			$	908,274				604				0.27
Regular savings			275,380				84				0.12				251,892				112				0.18
Certificates of deposit			950,943				2,958				1.24				1,521,360				6,603				1.74
Total deposits			2,237,723				3,591				0.64				2,681,526				7,319				1.09
Other borrowed funds			477,866				7,001				5.86				605,312				7,278				4.81
Total interest-bearing liabilities			2,715,589				10,592				1.56				3,286,838				14,597				1.78
Non-interest-bearing liabilities			78,830												51,804
Total liabilities			2,794,419												3,338,642
Stockholders’ deficit			(28,616	)											(10,812	)
Total liabilities and stockholders’ deficit		$	2,765,803											$	3,327,830
Net interest income/interest rate spread (5)						$	16,399				2.66	%						$	21,520				2.88	%
Net interest-earning assets		$	(158,603	)										$	(184,158	)
Net interest margin (6)											2.57	%											2.77	%
Ratio of average interest-earning assets to average interest-bearing liabilities			0.94												0.94

 

(1)	Annualized

(2)	For the purpose of these computations, non-accrual loans are included in the daily average loan amounts outstanding.

(3)	Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from non-accrual status during the period indicated.

(4)	Average balances of securities available-for-sale are based on amortized cost.

(5)	Interest rate spread represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities and is represented on a fully tax equivalent basis if applicable.

(6)	Net interest margin represents net interest income as a percentage of average interest-earning assets.

 

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Net Interest Income

Net interest income decreased $5.1 million or 23.8% for the three months ended June 30, 2012, as compared to the respective periods in the prior year. Interest income decreased $9.1 million or 25.3% for the three months ended June 30, 2012, as compared to the same period in the prior year primarily due to a decline in average balances in the loan and investment security portfolios. Interest expense decreased $4.0 million or 27.4% for the three months ended June 30, 2012, as compared to the same period in the prior year due to a reduction in certificate of deposit (“CD”) average balances and the rate paid on these accounts. The net interest margin decreased to 2.57% for the three-month period ended June 30, 2012 from 2.77% for the three-month period in the prior year.

Loan portfolio average balances declined $427.0 million in the quarter ending June 30, 2012 compared to the same period a year ago largely due to scheduled principal payments, prepayments of principal, charge-offs and transfers to OREO. New loan origination has been limited as part the Corporation’s capital improvement strategy to reduce risk-weighted assets by shrinking the overall size of the balance sheet. Investment security average balances decreased $260.2 million primarily due to the sale of higher yielding holdings in fiscal 2012 for capital management purposes.

The average balance of CDs decreased $570.4 million for the three months ended June 30, 2012 as compared to the respective period a year ago. Likewise, the average rate paid on CDs fell by 50 basis points quarter over quarter. The decline in CD average balances and interest rates was largely the result of lower rates offered in the market due to reduced funding needs and improved deposit pricing disciplines.

Provision for Credit Losses

Provision for credit losses decreased $5.2 million for the three-month period ended June 30, 2012, as compared to the respective period last year. The decrease in provision for credit losses was partly due to the approximately $2.5 million impact of lower net charge-offs in the quarter ending June 30, 2012 of $7.9 million that replaced net charge-offs of $20.4 million in the quarter ending December 31, 2010 in the trailing six quarter net charge-off history used in the determination of the general component of the allowance for loan losses. In addition, the provision for credit losses attributable to substandard and impaired loans was favorably impacted by the steady quarter-over-quarter decrease in non-performing loans since March 2010. Non-performing loans totaled $189.0 million at June 30, 2012 down from $260.9 million at June 30, 2011.

Future provisions for credit losses will continue to be based upon management’s assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors in order to maintain the allowance for loan losses at adequate levels to provide for probable and estimable future losses. The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the adequacy of the allowance, which ultimately may change. Higher rates of loan defaults than anticipated would likely result in a need to increase provisions in future periods. Conversely, the provision for loan losses may decline should credit metrics such as net-charge offs and the amount of non-performing loans improve in the future.

 

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Non-Interest Income

The following table presents non-interest income by major category for the periods indicated:

 

		Three Months Ended June 30,								Increase (Decrease)
		2012				2011				Amount				Percent
		(Dollars in thousands)
Net impairment losses recognized in earnings		$	(64	)		$	(59	)		$	(5	)			(8.5	)%
Loan servicing income (loss), net of amortization			(395	)			814				(1,209	)			(148.5	)
Service charges on deposits			2,866				2,794				72				2.6
Investment and insurance commissions			1,032				1,037				(5	)			(0.5	)
Net gain on sale of loans			5,823				1,173				4,650				396.4
Net gain on sale of investment securities			62				1,136				(1,074	)			(94.5	)
Net gain on sale of OREO			3,172				1,245				1,927				154.8
Revenue from real estate partnership operations			5				38				(33	)			(86.8	)
Other			997				994				3				0.3
Total non-interest income		$	13,498			$	9,172			$	4,326				47.2	%

Non-interest income increased $4.3 million or 47.2% to $13.5 million for the three months ended June 30, 2012, compared to $9.2 million for the respective period in 2011. The increase was primarily due to higher gains on the sale of loans and OREO, partially offset by lower loan servicing income and gain on sale of investment securities. The increase in net gain on sale of loans of $4.7 million was primarily attributable to a significantly higher volume of residential mortgage loan sales in the current year period, as well as higher margins on sale. The loan servicing decrease of $1.2 million in the current quarter compared to the respective period a year ago was primarily due to higher amortization charges related to the mortgage servicing right asset reflecting lower market interest rates at the end of June 2012. Net gain on sale of investment securities also fell, by $1.1 million, to $0.1 million in the three months ended June 30, 2012, primarily due to a significant decrease in the level of investment security sale activity, as proceeds from sale totaled $1.9 million in the current quarter compared to $55.8 million in the same quarter a year ago. Net gain on OREO increased to $3.2 million in the quarter ending June 30, 2012 from $1.2 million in the year ago quarter largely due to the impact of improved market conditions on prices at which property is being sold from the inventory of repossessed property.

 

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Non-Interest Expense

The following table presents non-interest expense by major category for the periods indicated:

 

		Three Months Ended June 30,								Increase (Decrease)
		2012				2011				Amount				Percent
		(Dollars in thousands)
Compensation and benefits		$	10,560			$	10,194			$	366				3.6	%
Occupancy			1,833				1,980				(147	)			(7.4	)
Furniture and equipment			1,586				1,544				42				2.7
Federal deposit insurance premiums			1,564				1,933				(369	)			(19.1	)
Data processing			1,385				1,383				2				0.1
Marketing			239				305				(66	)			(21.6	)
Expenses from real estate partnership operations			571				42				529				1,259.5
OREO expense, net			7,012				8,870				(1,858	)			(20.9	)
Mortgage servicing rights impairment			1,257				221				1,036				468.8
Legal services			1,574				934				640				68.5
Other professional fees			643				1,018				(375	)			(36.8	)
Other			3,334				3,531				(197	)			(5.6	)
Total non-interest expense		$	31,558			$	31,955			$	(397	)			(1.2	)%

Non-interest expense decreased $0.4 million or 1.2% to $31.6 million for the three months ended June 30, 2012, as compared to $32.0 million for the respective period in 2011. The decrease was primarily due to lower OREO expenses to maintain, operate and sell OREO property; partially offset by higher MSR impairment due to the impact of lower interest rates and the resultant mortgage refinance activity.

Income Taxes

Income tax expense the three months ended June 30, 2012 was zero compared to $10 thousand for the same period a year ago. A full valuation allowance has been recorded on the net deferred tax asset due to the uncertainty of the Corporation’s ability to create sufficient taxable income to utilize it.

FINANCIAL CONDITION

During the three months ended June 30, 2012, total assets decreased by $5.4 million from $2.79 billion at March 31, 2012 to $2.78 billion at June 30, 2012. The majority of this decrease was attributable to a decrease of $98.5 million in loans held for investment, offset by a $125.4 million increase in cash and cash equivalents.

Interest-bearing deposits totaled $312.4 million at June 30, 2012, up $121.0 million or 63.2% from $191.4 million at March 31, 2012. The build-up of cash liquidity in the period resulted primarily from cash flow generated by the loan portfolio, and the unfavorable investment security reinvestment environment in the quarter caused by historically low market interest rates.

Investment securities available for sale decreased $10.7 million during the three months ended June 30, 2012 as a result of sales of $1.8 million, principal repayments of $9.5 million, a net increase in fair value of $0.9 million, premium amortization net of discount accretion of $0.2 and net realized and unrealized impairment losses of $0.1 million in the period.

Investment securities are subject to inherent risks based upon the future performance of the underlying collateral (i.e., mortgage loans) for these securities. Among these risks are prepayment risk, interest rate risk and credit risk. Should general interest rate levels decline, the mortgage-related securities portfolio

 

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would be subject to (i) prepayments as borrowers typically would seek to obtain financing at lower rates, (ii) a decline in interest income received on adjustable-rate mortgage-related securities, and (iii) an increase in fair value of fixed-rate mortgage-related securities. Conversely, should general interest rate levels increase, the mortgage-related securities portfolio would be subject to (i) a longer term to maturity as borrowers would be less likely to prepay their loans, (ii) an increase in interest income received on adjustable-rate mortgage-related securities, (iii) a decline in fair value of fixed-rate mortgage-related securities, (iv) a decline in fair value of adjustable-rate mortgage-related securities to an extent dependent upon the level of interest rate increases, the time period to the next interest rate repricing date for the individual security and the applicable periodic (annual and/or lifetime) cap which could limit the degree to which the individual security may reprice within a given time period, and (v) should default rates and loss severities increase on the underlying collateral of mortgage-related securities, the Corporation may experience credit losses recognized in earnings as other-than-temporary impairment.

Loans held for investment decreased $98.5 million during the three months ended June 30, 2012. Activity for the period consisted of principal repayments of $143.0 million and transfers to other real estate owned of $18.8 million; partially offset by originations and refinances of $52.9 million and other miscellaneous activity of $10.4 million.

Other real estate owned decreased $4.9 million to $84.0 million at June 30, 2012 from $88.8 million at March 31, 2012 due to sales of $19.1 million and additional write downs of various properties of $4.6 million. These decreases were partially offset by transfers in from the loan portfolio of $18.8 million.

Net deferred tax assets were zero at June 30, 2012 and March 31, 2012 due to a valuation allowance on the entire balance. The valuation allowance is necessary as the recovery of the net deferred asset is not more likely than not as it is uncertain if the Corporation can generate sufficient taxable income in the near future.

Total liabilities decreased $6.4 million during the three months ended June 30, 2012 largely due to an $11.7 million decrease in deposits, partially offset by a $4.6 million increase in accrued interest and fees payable. The decrease in deposits was largely due to lower CD balances attributable to more disciplined pricing of these products to reduce excess liquidity, partially offset by an increase in checking, savings and money market deposit product balances. Brokered deposits totaled $274,000 or approximately 0.01% of total deposits at June 30, 2012 and $2.1 million or approximately 0.09% of total deposits at March 31, 2012.

Stockholders’ equity increased $1.0 million during the three months ended June 30, 2012 primarily due improved fair value of the available for sale investment securities portfolio of $0.8 million attributable to falling market interest rates during the quarter.

REGULATORY DEVELOPMENTS

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:

 

•

Capital Purchase Program (“CPP”). Pursuant to this program, Treasury, on behalf of the US government, purchased preferred stock, along with warrants to purchase common stock, from certain financial institutions, including bank holding companies, savings and loan holding companies and banks or savings associations not controlled by a holding company. The investment has a dividend rate of 5% per year, until the fifth anniversary of Treasury’s investment and a dividend of 9% thereafter. During the time Treasury holds securities issued pursuant to this program, participating financial institutions will be required to comply with certain provisions regarding executive compensation and corporate governance. Participation in this program also imposed certain restrictions upon a participating institution’s dividends to common shareholders and stock repurchase activities. As described further herein, we elected to participate in the CPP and received $110 million pursuant to the program.

 

•

Temporary Liquidity Guarantee Program. This program contained both (i) a debt guarantee component, whereby the FDIC will guarantee until June 30, 2012, the senior unsecured debt issued by eligible financial institutions between October 14, 2008 and June 30, 2009; and (ii) an account transaction guarantee

 

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component, whereby the FDIC will insure 100% of non-interest bearing deposit transaction accounts held at eligible financial institutions, such as payment processing accounts, payroll accounts and working capital accounts through December 31, 2009. The Corporation and the Bank signed a master agreement with the FDIC on December 5, 2008 for issuance of bonds under the program. As of June 30, 2012, the Bank had no bonds outstanding as all matured in February, 2012.

 

•

Permanent increase in deposit insurance coverage. Dodd-Frank permanently raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor.

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 CPP. ARRA provides that during the period in which any obligation under CPP remains outstanding (other than obligations relating to outstanding warrants), CPP recipients are subject to appropriate standards for executive compensation and corporate governance which were set forth in an interim final rule regarding 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:

 

•

an incentive compensation “clawback” provision to cover “senior executive officers” (defined in this instance and below to mean the “named executive officers” for whom compensation disclosure is provided in the Corporation’s proxy statement) and the next twenty most highly compensated employees;

 

•

a prohibition on certain golden parachute payments to cover any payment related to a departure for any reason (with limited exceptions) made to any senior executive officer (as defined above) and the next five most highly compensated employees;

 

•

a limitation on incentive compensation paid or accrued to the five most highly compensated employees of the financial institution, subject to limited exceptions for pre-existing arrangements set forth in written employment contracts executed on or prior to February 11, 2009, and certain awards of restricted stock which may not exceed 1/3 of annual compensation, are subject to a two year holding period and cannot be transferred until Treasury’s preferred stock is redeemed in full;

 

•

a requirement that the Corporation’s chief executive officer and chief financial officer provide in annual securities filings, a written certification of compliance with the executive compensation and corporate governance provisions of the Interim Final Rule;

 

•

an obligation for the compensation committee of the board of directors to evaluate with the Corporation’s chief risk officer certain compensation plans to ensure that such plans do not encourage unnecessary or excessive risks or the manipulation of reported earnings;

 

•

a requirement that companies adopt a Corporation-wide policy regarding excessive or luxury expenditures; and

 

•

a requirement that companies permit a separate, non-binding shareholder vote to approve the compensation of executives.

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.

 

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In addition, companies who have issued preferred stock to Treasury under CPP 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.

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.

Order to Cease and Desist

On June 26, 2009, the Corporation and the Bank each consented to the issuance of an Order to Cease and Desist (the “Corporation Order” and the “Bank Order,” respectively, and together, the “Orders”) by the OTS. As of July 21, 2011, the Cease and Desist Order is now administered by the OCC with respect to the Bank and the Federal Reserve with respect to the Corporation.

The Corporation Order requires the Corporation to notify, and in certain cases to obtain the permission of, the Federal Reserve prior to: (i) declaring, making or paying any dividends or other capital distributions on its capital stock, including the repurchase or redemption of its capital stock; (ii) incurring, issuing, renewing or rolling over any debt, increasing any current lines of credit or guaranteeing the debt of any entity; (iii) making certain changes to its directors or senior executive officers; (iv) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; and (v) making any golden parachute payments or prohibited indemnification payments. The Corporation developed and submitted to the OTS a three-year cash flow plan, which must be reviewed at least quarterly by the Corporation’s management and board for material deviations between the cash flow plan’s projections and actual results (the “Variance Analysis Report”). Within 45 days following the end of each quarter, the Corporation is required to provide the Federal Reserve its Variance Analysis Report for that quarter.

The Bank Order requires that the Bank notify, or in certain cases receive the permission of, the OTS prior to (i) increasing its total assets in any quarter in excess of an amount equal to net interest credited on deposit liabilities during the quarter; (ii) accepting, rolling over or renewing any brokered deposits; (iii) making certain changes to its directors or senior executive officers; (iv) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; (v) making any golden parachute or prohibited indemnification payments; (vi) paying dividends or making other capital distributions on its capital stock; (vii) entering into certain transactions with affiliates; and (viii) entering into third-party contracts outside the normal course of business.

 

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The Orders also required that the Bank meet and maintain both a core capital ratio equal to or greater than 8 percent and a total risk-based capital ratio equal to or greater than 12 percent. The Bank submitted to the OTS, a written capital contingency plan, a problem asset plan, a revised business plan, and an implementation plan resulting from a review of commercial lending practices. The Orders also required the Bank to review its current liquidity management policy and the adequacy of its allowance for loan and lease losses.

At June 30, 2012 and March 31, 2012 the Bank had a tier 1 leverage ratio of 4.56% and 4.51%, respectively, and a total risk-based capital ratio of 8.98% and 8.42%, respectively, each below the required capital ratios set forth above. All customer deposits remain fully insured to the highest limits set by the FDIC. As a result, the bank regulatory agencies may take additional significant regulatory action against the Bank and Corporation which could, among other things, materially adversely affect the Corporation’s shareholders. The bank regulatory agencies may grant extensions to the timelines established by the Orders.

The description of each of the Orders and the corresponding Stipulation and Consent to Issuance of Order to Cease and Desist were previously filed attached as Exhibits to the Corporation’s Annual Report on Form 10-K for the fiscal year ended March 31, 2009.

Capital Restoration Plan

In August, 2010, the Bank received conditional approval of its Capital Restoration Plan (the “Plan”) from the OTS. In conjunction with this approval, the Board of Directors of the Corporation executed a Stipulation and Consent to a Prompt Corrective Action Directive (the “Directive”) dated August 31, 2010, with the OTS. The Plan included two sets of assumptions for continuing to improve the Bank’s capital levels, one based on obtaining capital from an outside source and one which reflects the results of the Bank’s ongoing initiatives in the absence of an external capital infusion. An essential element for the conditional approval of the Plan was the Bank’s ability to attain “adequately capitalized” (8.0% or greater total risk based capital) status as of July 31, 2010. Based on the Bank’s internal financial reporting, a total risk based capital level of 8.05% was achieved as of July 31, 2010. As of June 30, 2012, total risk-based capital was 8.98%.

In addition to requiring compliance with the Plan, the Directive imposes certain other operating requirements and restrictions, most of which were also part of the voluntary Orders entered into with the OTS in June 2009. The Plan will now be administered by OCC.

RISK MANAGEMENT

The Bank encounters risk as part of the normal course of business and designs risk management processes to help manage these risks. This Risk Management section describes the Bank’s risk management philosophy, principles, governance and various aspects of its risk management program.

Risk Management Philosophy

The Bank’s risk management philosophy is to manage to an acceptable level of overall risk while still allowing it to capture opportunities and optimize shareholder value. However, due to the general state of the economy and the elevated risk in the loan portfolio, the Bank’s risk profile does not currently meet our desired risk level. The Bank is working toward reducing the overall risk level to a more desired risk profile.

Risk Management Principles

The Bank views risk management as not about eliminating risks, but about identifying and accepting risks and then working to effectively manage them so as to optimize shareholder value. Risk management includes, but is not limited to the following:

 

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•

Taking only risks consistent with the Bank’s strategy and within its capability to manage,

 

•

Ensuring strong underwriting and credit risk management practices,

 

•

Practicing disciplined capital and liquidity management,

 

•

Helping ensure that risks and earnings volatility are appropriately understood and measured,

 

•

Avoiding excessive concentrations, and

 

•

Helping support external stakeholder confidence.

Although the Board as a whole is primarily responsible for oversight of risk management, committees of the Board may provide oversight to specific areas of risk with respect to the level of risk and risk management structure. The Bank uses management level risk committees to help ensure that business decisions are executed within our desired risk profile. Management provides oversight for the establishment and implementation of new risk management initiatives, review of risk profiles and discussion of key risk issues. The Bank hired a new Chief Risk Officer in charge of overseeing credit risk management several years ago. Our internal audit department performs an independent assessment of the internal control environment and plays a critical role in risk management, testing the operation of the internal control system and reporting findings to management and to the Audit Committee of the Board.

CREDIT RISK MANAGEMENT

Credit risk represents the possibility that a customer, counterparty or issuer may not perform in accordance with contractual terms. Credit risk is inherent in the financial services business and results from extending credit to customers, purchasing investment securities and entering into certain guarantee contracts. Credit risk is one of the most significant risks facing the Bank.

In addition to credit policies and procedures and setting portfolio objectives for the level of credit risk, the Bank has established guidelines for problem loans, acceptable levels of total borrower exposure and other credit measures. In 2011, 2012 and fiscal year-to-date 2013, management has continued to focus on loss mitigation and maximization of recoveries in the Bank’s non-performing asset portfolios. Over time, the Bank will return to management of portfolio returns through discrete investments within approved risk tolerances.

The Bank seeks to achieve credit portfolio objectives by maintaining a customer base that is diverse in borrower exposure and industry types. Corporate credit personnel are responsible for loan underwriting and approval processes to help ensure that newly approved loans meet policy and portfolio objectives.

The Risk Management group is responsible for monitoring credit risk. Internal Audit also provides an independent assessment of the effectiveness of the credit risk management process. The Bank also manages credit risk in accordance with regulatory guidance.

 

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Non-Performing Loans

The composition of non-performing loans is summarized as follows for the dates indicated:

 

		June 30, 2012												March 31, 2012
		Non- Performing Loans				Percent of Non- Performing Loans				Percent of Total Gross Loans(1)				Non- Performing Loans				Percent of Non- Performing Loans				Percent of Total Gross Loans(1)
		(Dollars in thousands)
Residential		$	41,335				21.9	%			1.99	%		$	44,550				19.8	%			2.04	%
Commercial and industrial			7,213				3.8				0.35				8,217				3.7				0.38
Land and construction			46,349				24.5				2.23				64,229				28.6				2.94
Multi-family			36,886				19.5				1.77				37,762				16.8				1.73
Retail/office			24,652				13.0				1.19				33,817				15.0				1.55
Other commercial real estate			24,752				13.1				1.19				27,963				12.4				1.28
Education (2)			721				0.4				0.03				762				0.3				0.03
Other consumer			7,079				3.7				0.34				7,624				3.4				0.35
Total non-performing loans		$	188,987				100.0	%			9.09	%		$	224,924				100.0	%			10.28	%

 

(1)	Gross loans are the unpaid principal balance before the reduction for loans in process, unearned interest and loan fees and the allowance for loans losses.

(2)	Excludes the guaranteed portion of education loans 90+ days past due with an unpaid principal balance totaling $23,296 and $24,641 at June 30, 2012 and March 31, 2012, respectively, that are not considered impaired based on a guarantee provided by government agencies.

 

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The following is a summary of non-performing loan activity for the three months ended June 30, 2012:

 

Loan Class		Non- performing loan  balance April 1, 2012				Additions				Transferred to Accrual Status				Transferred to OREO				Paid Down				Charged Off				Non- performing loan balance June 30, 2012				Remaining balance of loans				Associated ALLL
		(In thousands)
Residential		$	44,550			$	2,222			$	(665	)		$	(2,934	)		$	(697	)		$	(1,141	)		$	41,335			$	510,129			$	13,545
Commercial and industrial			8,217				899				(70	)			—				(910	)			(923	)			7,213				23,260				8,516
Land and construction			64,229				—				(38	)			(11,415	)			(4,570	)			(1,857	)			46,349				117,086				25,926
Multi-family			37,762				360				—				(101	)			(433	)			(702	)			36,886				287,595				15,816
Retail/office			33,817				—				(53	)			(3,800	)			(4,887	)			(425	)			24,652				251,107				19,283
Other commercial real estate			27,963				580				(75	)			(514	)			(498	)			(2,704	)			24,752				209,915				14,956
Education			762				6				—				—				(47	)			—				721				226,404				351
Other consumer			7,624				1,069				(674	)			(54	)			(268	)			(618	)			7,079				264,896				2,084
Total		$	224,924			$	5,136			$	(1,575	)		$	(18,818	)		$	(12,310	)		$	(8,370	)		$	188,987			$	1,890,392			$	100,477

Non-performing loans (consisting of loans past due more than 90 days and on non-accrual status, loans less than 90 days delinquent but placed on non-accrual status due to anticipated probable loss and non-accrual troubled debt restructurings) decreased $35.9 million during the three months ended June 30, 2012. The loan categories with the largest decline in non-performing loans during the three months ended June 30, 2012 were land and construction loans of $17.9 million and retail/office loans of $9.2 million.

The interest income that would have been recorded during the three months ended June 30, 2012 and 2011 if the Bank’s non-performing loans at the end of the period had been current in accordance with their terms during the period was $1.1 million and $465,000, respectively.

 

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Non-Performing Assets

The composition of non-performing assets is summarized as follows for the dates indicated:

 

		At June 30,				At March 31,
		2012				2012
		(Dollars in thousands)
Non-accrual loans – excluding troubled debt restructurings		$	127,467			$	148,546
Troubled debt restructurings – non-accrual (1)			61,520				76,378
Other real estate owned (OREO)			83,955				88,841
Total non-performing assets		$	272,942			$	313,765
Total non-performing loans to total gross loans (2)			9.09	%			10.28	%
Total non-performing assets to total assets			9.80				11.25
Allowance for loan losses to total gross loans (2)			4.83				5.08
Allowance for loan losses to total non-performing loans			53.17				49.45
Allowance for loan losses plus OREO valuation allowance to total non-performing assets			45.80				42.62

 

(1)	Troubled debt restructurings – non-accrual represent non-accrual loans that were modified in a troubled debt restructuring less than six months prior to the period end date or have not performed in accordance with the modified terms for at least six months.

(2)	Gross loans are the unpaid principal balance before the reduction for loans in process, unearned interest and loan fees and the allowance for loans losses.

Loans modified in a troubled debt restructuring due to rate or term concessions that are currently on non-accrual status will remain on non-accrual status for a period of at least six months. If after six months, or a longer period sufficient to demonstrate the willingness and ability of the borrower to perform under the modified terms, the borrower has made payments in accordance with the modified terms, the loan is returned to accrual status but retains its status as a troubled debt restructuring. The designation as a troubled debt restructuring is removed in years after the restructuring if both of the following conditions are met: (a) the restructuring agreement specifies an interest rate equal to or greater than the rate that the creditor was willing to accept at the time of restructuring for a new loan with comparable risk and (b) the loan is not impaired based on the terms specified by the restructuring agreement. As time passes and borrowers continue to perform in accordance with the restructured loan terms, a portion of the troubled debt restructurings – non-accrual balance may be returned to accrual status.

 

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The following is a summary of non-performing asset activity for the three months ended June 30, 2012:

 

		Total Non- performing Loans (1)				Other Real Estate Owned (OREO)				Total  Non- performing Assets
		(In thousands)
Balance at April 1, 2012		$	224,924			$	88,841			$	313,765
Additions			5,136				—				5,136
Transfers:
Nonaccrual to OREO			(18,818	)			18,818				—
OREO to premises and equipment			—				(2,870	)			(2,870	)
Returned to accrual status			(1,575	)			—				(1,575	)
Sales			—				(16,200	)			(16,200	)
Loan charge-offs/OREO net additional write-downs			(8,370	)			(4,634	)			(13,004	)
Payments			(12,310	)			—				(12,310	)
Balance at June 30, 2012		$	188,987			$	83,955			$	272,942

 

(1)	Total non-performing loans exclude $24,641 and $23,296 of education loans that are 90 days or more past due but still accruing interest at April 1, 2012 and June 30, 2012, respectively.

Loan Delinquencies 30 Days and Over

The following table sets forth information relating to the Corporation’s past due loans that were delinquent 30 days and over at the dates indicated.

 

		June 30, 2012								March 31, 2012
Days Past Due		Balance				% of Total Gross Loans				Balance				% of Total Gross Loans
		(Dollars in thousands)
30 to 59 days		$	22,012				1.06	%		$	18,332				0.84	%
60 to 89 days			17,831				0.86				12,230				0.56
90 days and over			141,094				6.79				190,663				8.71
Total		$	180,937				8.71	%		$	221,225				10.11	%

Loans delinquent 90 days and over decreased $49.6 million to $141.1 million at June 30, 2012 from $190.7 million at March 31, 2012 as a result of increased monitoring and loss mitigation efforts.

Impaired Loans

At June 30, 2012, the Corporation has identified $260.7 million of loans as impaired which includes non-accrual loans plus performing troubled debt restructurings. At March 31, 2012, impaired loans were $297.6 million. A loan is identified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement and thus are placed on non-accrual status.

Allowance for Loan and Lease Losses

Like all financial institutions, we must maintain an adequate allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance for loan losses when we believe that repayment of principal is unlikely. Subsequent recoveries, if any, are

 

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credited to the allowance. The allowance is an amount that we believe will be adequate to absorb probable losses on existing loans that may become uncollectible, based on evaluation of the collectability of loans and prior credit loss experience, together with the other factors discussed in the critical accounting policies.

The allowance for loan losses consists of general, substandard loan and specific components even though the entire allowance is available to cover losses on any loan. The specific allowance component relates to impaired loans (i.e. – non-accrual) and all loans reported as troubled debt restructurings. For such loans, an allowance is established when the discounted cash flows (or collateral value if repayment relies solely on the operation or sale of the collateral) of the impaired loan are lower than the carrying value of that loan. The substandard loan component is primarily associated with loans rated in this category but not in non-accrual status. The general allowance component covers pass, watch and special mention rated loans and is based on historical net loss experience for the past six quarters, adjusted for various qualitative and quantitative factors. Loans graded substandard and below are individually examined to determine the appropriate loan loss reserve. A reserve for unfunded commitments and letters of credit is also maintained which is classified in other liabilities.

The general component allowance for loan loss methodology incorporates the following quantitative and qualitative risk factors to establish the appropriate general allowance for loan loss at each reporting date.

Quantitative factors include:

 

•

loan volume and terms

 

•

delinquency and charge-off trends

 

•

collateral values

 

•

credit concentrations

 

•

external factors such as competition and legal and regulatory requirements,

 

•

portfolio size

Qualitative factors include:

 

•

lending policies, procedures and practices

 

•

national and local economic conditions

 

•

experience, ability and depth of lending management and other relevant staff

 

•

loan review system

Specific changes in the risk factors are based on perceived risk of similar groups of loans classified by collateral type, purpose and terms. Statistics on local trends, peers, and an internal six quarter net loss history are also incorporated into the allowance methodology. Due to the credit concentration of our loan portfolio in real estate secured loans, the value of collateral is heavily dependent on real estate values in Wisconsin and surrounding states. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic or other conditions. In addition, the OCC, as an integral part of their examination processes, periodically reviews the Banks’ allowance for loan losses, and may recommend adjustments to the allowance. Management periodically reviews the assumptions and formula used in determining the allowance and makes adjustments if required to reflect the current risk profile of the portfolio.

During the quarter ending December 31, 2011, the values assigned to quantitative factors regarding loan volume and terms, delinquency and charge-off trends, and collateral values; and the qualitative factor regarding economic conditions, were adjusted lower to reflect the results of an analysis based on various publications, market research, economic reports, Corporation portfolio credit metrics, management’s expertise and knowledge of the immediate lending market, as well as analysis of peer institutions and similar markets. The factor value changes resulted in a lower required allowance for loan losses as of December 31, 2011 totaling $6.1 million. The lower required allowances by portfolio segment were $2.4 million for the residential segment, $0.1 million for the commercial and industrial segment, and $3.6 million for the commercial real estate segment. No changes to the values assigned to quantitative and qualitative factors were made in the three months ending June 30, 2012.

 

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The following table presents the allowance for loan losses by component:

 

		At June 30, 2012				At March 31, 2012
		(In thousands)
General component		$	32,170			$	37,085
Substandard loan component			28,936				29,980
Specific component			39,371				44,150
Total allowance for loan losses		$	100,477			$	111,215

The following table presents the unpaid principal balance of loans by risk category:

 

		At June 30, 2012				At March 31, 2012
		(In thousands)
Pass		$	1,567,180			$	1,624,889
Watch			119,203				115,917
Special mention			42,194				56,762
Total pass, watch and special mention rated loans			1,728,577				1,797,568
Substandard, excluding TDR accrual			90,122				93,207
TDR accrual			71,693				72,648
Non-accrual			188,987				224,924
Total impaired loans			260,680				297,572
Total unpaid principal balance		$	2,079,379			$	2,188,347

The following table presents credit risk metrics related to the allowance for loan losses:

 

		At June 30, 2012				At March 31, 2012
		(Dollars in thousands)
General ALLL / pass, watch and special mention loans			1.9	%			2.1	%
Substandard ALLL / substandard loans, excluding TDR accrual			32.1	%			32.2	%
Specific ALLL / impaired loans			15.1	%			14.8	%
Loans 30 to 89 days past due		$	39,843			$	30,562

 

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The following table summarizes activity in the allowance for loan losses for the period indicated.

 

		Three Months Ended June 30,
		2012				2011
		(Dollars in thousands)
Allowance at beginning of period		$	111,215			$	150,122
Charge-offs:
Residential			(1,363	)			(1,756	)
Multi-family			(752	)			(548	)
Commercial real estate			(3,904	)			(6,147	)
Land and construction			(2,112	)			(5,879	)
Consumer			(791	)			(858	)
Commercial and industrial			(1,651	)			(2,522	)
Total charge-offs			(10,573	)			(17,710	)
Recoveries:
Residential			208				506
Multi-family			51				212
Commercial real estate			1,059				915
Land and construction			246				289
Consumer			32				144
Commercial and industrial			1,042				642
Total recoveries			2,638				2,708
Net charge-offs			(7,935	)			(15,002	)
Provision			(2,803	)			3,620
Allowance at end of period		$	100,477			$	138,740
Net charge-offs to average loans held for sale and for investment			(1.56	)%			(2.43	)%

Total loan charge-offs were $10.6 million and $17.7 million for the three months ending June 30, 2012 and 2011, respectively. Total loan charge-offs for the three months ended June 30, 2012 decreased $7.1 million from the same period in the prior fiscal year. Recoveries decreased $70,000 during the three months ended June 30, 2012 from the same period in the prior fiscal year.

A recapture of the provision for loan losses totaling $2.8 million for the three months ending June 30, 2012 represented an improvement of $6.4 million compared to $3.6 million of provision expense for the three months ended June 30, 2011. The improvement in the provision for loan losses is the result of management’s ongoing evaluation of the loan portfolio. Management considered the allowance for loan losses to total non-performing loans of 53.17% in determining the provision for loan losses and the adequacy of the allowance for loan losses.

The allowance process is analyzed regularly, with modifications made if needed, and those results are reported four times per year to the Bank’s Board of Directors. Although management believes that the June 30, 2012 allowance for loan losses is adequate based upon the current evaluation of loan delinquencies, non-performing assets, charge-off trends, economic conditions and other factors, there can be no assurance that future adjustments to the allowance will be unnecessary. Management also continues to pursue all practical and legal methods of collection, repossession and disposal, and adheres to high underwriting standards in the origination process in order to continue to improve asset quality. Determination as to the classification of assets and the amount of valuation allowances is subject to review by the bank regulatory agencies which can recommend the establishment of additional general or specific loss allowances.

 

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Other Real Estate Owned

Other real estate owned (OREO) decreased $4.9 million during the three months ended June 30, 2012. Individual properties included in OREO at June 30, 2012 with a recorded balance in excess of $1 million are listed below:

 

Description		Location		Carrying Value
				(In thousands)
Condo units with additional land		Central Wisconsin		$	5,726
Retail/office building		Central Wisconsin			2,567
Multi-family and vacant land		Northwest Wisconsin			1,578
Vacant land		Northwest Wisconsin			1,052
Vacant land		South Central Wisconsin			8,533
Retail/office building		South Central Wisconsin			2,762
Single family and vacant land		South Central Wisconsin			1,950
Commercial building		South Central Wisconsin			1,294
Vacant land		South Central Wisconsin			1,445
Retail/office building		South Central Wisconsin			1,076
Vacant land		Southeast Wisconsin			5,100
Commercial building		Southeast Wisconsin			3,035
Commercial building and vacant land		Southeast Wisconsin			1,581
Vacant land		Southeast Wisconsin			1,190
Office/warehouse building		Southeast Wisconsin			1,190
Vacant land		Southeast Wisconsin			1,162
Other properties individually less than $1 million					42,714
				$	83,955

Foreclosed properties are recorded at fair value less cost to sell upon transfer to OREO with shortfalls, if any, charged to the allowance for loan losses. Subsequent decreases in the valuation of OREO are recorded in a valuation account for the foreclosed property with a corresponding charge to OREO expense, net. The fair value is primarily based on appraisals. On a quarterly basis, the Corporation reviews the carrying values of its OREO properties and makes appropriate adjustments based upon updated appraisals or market analysis including recent sales or broker opinion. For appraisals received over one year ago, management considers broker and market analysis to update the estimated fair value.

LIQUIDITY RISK MANAGEMENT

Liquidity risk is the risk of potential loss if the Corporation were unable to meet its funding requirements at a reasonable cost. The Corporation manages liquidity risk at the bank and holding company to help ensure that it can obtain cost-effective funding to meet current and future obligations.

The largest source of liquidity on a consolidated basis is the deposit base that originates from retail and corporate banking businesses. Other borrowed funds are available from a diverse mix of short and long-term funding sources. Liquid assets and unused borrowing capacity from a number of sources are also available to maintain an adequate liquidity position.

 

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Liquidity and Capital Resources

On an unconsolidated basis, the Corporation’s sources of funds include dividends from its subsidiaries, including the Bank, interest on its investments and returns on its real estate held for sale. As a condition of the Cease and Desist Order with the OTS (now administered by the OCC), the Bank is currently prohibited from paying dividends to the Corporation. Due to a lack of liquidity and resultant failure to make a principal payment on March 2, 2009, the Corporation continued to be unable to meet its obligations under the credit agreement during the three months ended June 30, 2012.

The Bank’s primary sources of funds are principal and interest payments on loans and securities, deposits from retail and wholesale sources, FHLB advances and other borrowings. The Bank is currently prohibited from obtaining new brokered deposits due to its current capital levels. As of June 30, 2012, the Corporation had outstanding borrowings from the FHLB of $357.5 million. The total maximum borrowing capacity at the FHLB based on the existing stock holding as of June 30, 2012 was $610.4 million, subject to collateral availability. Total borrowing capacity based on the value of the existing collateral pledged was $493.5 million.

Capital Purchase Program

On January 30, 2009, as part of Treasury’s CPP, the Corporation entered into a Letter Agreement with Treasury. Pursuant to the Securities Purchase Agreement – Standard Terms (the “Securities Purchase Agreement”) the Corporation issued to the Treasury 110,000 shares of the Corporation’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Preferred Stock”), having a liquidation amount per share of $1,000, for a total purchase price of $110,000,000. The Preferred Stock will pay cumulative compounding dividends at a rate of 5% per year for the first five years following issuance and 9% per year thereafter. The Securities Purchase Agreement provides for redemption of shares of the Preferred Stock for the per share liquidation amount of $1,000 plus any accrued and unpaid dividends. The Corporation has deferred the payment of dividends during each of the 13 quarters ended June 30, 2012 due to a lack of liquidity. As a result of such deferrals, on September 30, 2011, the Treasury exercised its right to appoint two directors to the Board of Directors of the Corporation.

As long as any Preferred Stock is outstanding, the Corporation may not pay dividends on its Common Stock, $.10 par value per share, and redeem or repurchase its Common Stock, unless all accrued and unpaid dividends for all past periods on the Preferred Stock are fully paid. The Preferred Stock is non-voting except for class voting rights on matters that would adversely affect the rights of the holders of the Preferred Stock.

As a condition to participating in the CPP, the Corporation issued and sold to the Treasury warrants to purchase up to 7,399,103 shares of the Corporation’s Common Stock, at an initial per share exercise price of $2.23, for an aggregate purchase price of approximately $16.5 million. The term of the warrants is ten years. Issuance of the warrants was subject to the receipt by the Corporation of shareholder approval which was received at the 2009 annual meeting of shareholders. The warrants provide for the adjustment of the exercise price should the Corporation not have received shareholder approval, as well as customary anti-dilution provisions. Pursuant to the Securities Purchase Agreement, the Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the warrants.

The terms of the Treasury’s purchase of the preferred securities include restrictions on certain forms of executive compensation and limits on the tax deductibility of compensation paid to executive management. The Corporation invested the proceeds of the sale of Preferred Stock and warrants into the Bank as Tier 1 capital.

Loan Commitments

At June 30, 2012, the Bank had outstanding commitments to originate loans of $11.6 million and commitments to extend funds to, or on behalf of, customers pursuant to lines and letters of credit of $170.2 million. Scheduled maturities of certificates of deposit for the Bank during the twelve months following June 30, 2012 amounted to $744.0 million. Scheduled maturities of borrowings during the same period totaled $10.0 million for the Bank and $116.3 million for the Corporation. Management believes adequate resources are available to fund all Bank commitments to the extent required. For more information regarding the Corporation’s borrowings, see “Credit Agreement” section below.

 

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Other

The Corporation previously participated in the Mortgage Partnership Finance Program of the FHLB of Chicago (“MPF Program”). Pursuant to the credit enhancement feature of the MPF Program, the Corporation has retained a secondary credit loss exposure in the amount of $20.4 million at June 30, 2012 related to approximately $351.4 million of residential mortgage loans that the Corporation has originated as agent for the FHLB. Under the credit enhancement, the FHLB is liable for losses on loans up to one percent of the original delivered loan balances in each pool. The Corporation is then liable for losses over and above the first position up to a contractually agreed-upon maximum amount in each pool that was delivered to the Program. The Corporation receives a monthly fee for this credit enhancement obligation based on the outstanding loan balances. The monthly fee received is net of losses under the MPF Program. The MPF Program was discontinued in 2008 in its present format and the Corporation no longer funds loans through the MPF Program.

The Bank has entered into agreements with certain brokers that provided deposits obtained from their customers at specified interest rates for an identified fee, or so called “brokered deposits.” At June 30, 2012, the Bank had $274,000 of brokered deposits. At June 30, 2012, the Bank was under a Cease and Desist Order with the OCC which limits the Bank’s ability to accept, renew or roll over brokered deposits without prior approval of the OCC.

In January 2012, the Bank exchanged four of its Federal Home Loan Bank advances totaling $150.0 million for an equal number and principal amount of advances with extended maturity dates and different interest rate terms to reduce interest rate risk and lower the current cost of funds. The advances exchanged carried fixed rates of interest ranging from 2.53% to 3.25% and maturity dates from January through March 2013. The new advances all mature in January 2015 and require monthly interest payments based on 3 month LIBOR plus a spread ranging from 0.98% to 1.15%. Prepayment fees due upon exchange of the instruments totaling $4.3 million were embedded in the spread over LIBOR on the new advances. No gain or loss was recorded for these transactions as the criteria in Accounting Standards Codification 470-50, “Debt – Modifications and Extinguishments” requiring accounting as an extinguishment of debt were not met.

Under federal law and regulation, the Bank is required to meet tier 1 leverage, tier 1 risk-based and total risk-based capital requirements. Tier 1 capital primarily consists of stockholders’ equity minus certain intangible assets and unrealized gains/losses on available-for-sale securities. Total risk-based capital primarily consists of tier 1 capital plus a qualifying portion of the allowance for loan losses. The risk-based capital requirements presently address credit risk related to both recorded and off-balance sheet commitments and obligations.

The Cease and Desist Orders also required that by no later than December 31, 2009, the Bank meet and maintain both a tier 1 leverage (core) ratio equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%. The Bank was required to submit to the OTS, and has submitted, a written capital contingency plan, a problem asset plan, a revised business plan, and an implementation plan resulting from a review of commercial lending practices.

At June 30, 2012, the Bank had a tier 1 leverage ratio of 4.56% and a total risk-based capital ratio of 8.98%, each below the required capital ratios set forth above. As a result, the OCC may take additional significant regulatory action against the Bank and Corporation which could, among other things, materially adversely affect the Corporation’s shareholders. All customer deposits remain fully insured to the highest limits set by the FDIC. The OCC may grant extensions to the timelines established by the Orders.

Our ability to meet short-term liquidity and capital resource requirements may be subject to our ability to obtain additional debt financing and equity capital. We may increase capital resources through offerings of equity securities (possibly including common shares and one or more classes of preferred shares), commercial paper, medium-term notes, securitization transactions structured as secured financings, and senior or subordinated notes.

 

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Credit Agreement

On November 29, 2011, the Corporation entered into Amendment No. 8 (the “Amendment”) to the Amended and Restated Credit Agreement, dated as of June 9, 2008, (the “Credit Agreement”) among the Corporation, the Lenders from time to time a party thereto, and U.S. Bank National Association, as administrative agent for such Lenders (the “Agent”). The Corporation owes $116.3 million principal amount under the Credit Agreement.

Under the Amendment, the Agent and the Lenders agreed to forbear from exercising their rights and remedies against the Corporation until the earliest to occur of the following: (i) the occurrence of any Event of Default (other than a failure to make principal payments on the outstanding balance under the Credit Agreement or other Existing Defaults, as defined in the Credit Agreement); or (ii) November 30, 2012. Notwithstanding the agreement to forbear, the Agent may at any time, in its sole discretion, take any action reasonably necessary to preserve or protect its interest in the stock of the Bank, IDI or any other collateral securing any of the obligations against the actions of the Corporation or any third party without notice to or the consent of any party.

The Amendment also provides that the outstanding balance under the Credit Agreement shall bear interest at a rate equal to 15% per annum. Interest accruing under the Credit Agreement is due on the earlier of (i) the date the loans are paid in full or (ii) November 30, 2012. At June 30, 2012, the Corporation had accrued interest payable related to the Credit Agreement of $40.2 million and an amendment fee payable of $5.7 million.

Within two business days after the Corporation obtains knowledge of an event, the Chief Financial Officer of the Bank shall submit a statement of the event together with a statement of the actions which the Corporation proposes to take to the Agent as a result of the occurrence of such event. An event may include: (i) any event which, either of itself or with the lapse of time or the giving of notice or both, would constitute a Default under the Credit Agreement; (ii) a default or an event of default under any other material agreement to which the Corporation or Bank is a party; or (iii) any pending or threatened litigation or certain administrative proceedings.

The Amendment requires the Bank to maintain the following financial covenants:

 

•

A Tier 1 Leverage Ratio of not less than 3.70% at all times.

 

•

A Total Risk Based Capital ratio of not less than 7.50% at all times.

 

•

Ratio of non-performing loans to gross loans not to exceed 15.00% at any time.

The total outstanding principal balance under the Credit Agreement as of June 30, 2012 was $116.3 million. These borrowings are shown in the Corporation’s consolidated financial statements as other borrowed funds. The Amendment provides that the Corporation must pay in full the outstanding balance under the Credit Agreement on the earlier of the Corporation’s receipt of net proceeds of a financing transaction from the sale of equity securities in an amount not less than $116.3 million, or November 30, 2012.

The Credit Agreement and the Amendment also contain customary representations, warranties, conditions and events of default for agreements of such type. At June 30, 2012, the Corporation was in compliance with all covenants contained in the Credit Agreement and the Amendment. Under the terms of the Credit Agreement, as amended on November 29, 2011, 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. Currently, no such action has been taken by the Agent or the Lenders. However, the default creates significant uncertainty related to the Corporation’s operations.

For additional information about the Credit Agreement, see Part II, Item 1A – Risk Factors – Risks Related to Our Credit Agreement in the Corporation’s Annual Report on Form 10-K for the year ended March 31, 2012.

MARKET RISK MANAGEMENT

Market risk is the risk of a loss in earnings or economic value due to adverse movements in market factors such as interest rates, credit spreads, foreign exchange rates, and equity prices. We are exposed to market risk primarily by our involvement in, among others, traditional banking activities of taking deposits and extending loans.

 

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Asset/Liability Management

The business of the Corporation and the composition of its consolidated balance sheet consist of investments in interest-earning assets (primarily loans and investment securities) that are largely funded by interest-bearing liabilities (deposits and borrowings). All of the financial instruments of the Corporation as of June 30, 2012 were held for other-than-trading purposes. Such financial instruments have varying levels of sensitivity to changes in market rates of interest. The Corporation’s net interest income is dependent on the amounts of and yields on its interest-earning assets as compared to the amounts of and rates on its interest-bearing liabilities. Net interest income is therefore sensitive to changes in market rates of interest.

The Corporation’s asset/liability management strategy is to maximize net interest income while limiting exposure to risks associated with changes in interest rates. This strategy is implemented by the Corporation’s ongoing analysis and management of its interest rate risk. A principal function of asset/liability management is to coordinate the levels of interest-sensitive assets and liabilities to manage net interest income changes within limits in times of fluctuating market interest rates.

Interest rate risk results when the maturity or repricing intervals and interest rate indices of interest-earning assets, interest-bearing liabilities, and off-balance-sheet financial instruments are different, thus creating a risk that will result in disproportionate changes in the value of, and net earnings generated from, interest-earning assets, interest-bearing liabilities, and off-balance-sheet financial instruments. The Corporation’s exposure to interest rate risk is managed primarily through a strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. Because the primary source of interest-bearing liabilities is customer deposits, the Corporation’s ability to manage the types and terms of such deposits may be somewhat limited by customer maturity preferences in the market areas in which we operate. Deposit pricing is competitive with promotional rates frequently offered by competitors. Borrowings, which include FHLB advances, short-term borrowings, and long-term borrowings, are generally structured with specific terms which, in management’s judgment, when aggregated with the terms for outstanding deposits and matched with interest-earning assets, reduce exposure to interest rate risk. The rates, terms, and interest rate indices of interest-earning assets result primarily from the Corporation’s strategy of investing in securities and loans (a portion of which have adjustable rates). This permits the Corporation to limit its exposure to interest rate risk, together with credit risk, while at the same time achieving a positive interest rate spread from the difference between the income earned on interest-earning assets and the cost of interest-bearing liabilities.

Management uses a simulation model for internal asset/liability management. The model incorporates maturity and repricing information for securities, loans, deposits, and borrowings plus repricing assumptions on products without specific repricing dates (e.g., savings and interest-bearing demand deposits), to calculate the cash flows, income, and expense of the Corporation’s assets and liabilities. In addition, the model computes a theoretical market value of equity by estimating the market values of assets and liabilities. The model also projects the effect on the Corporation’s earnings and theoretical value for a change in interest rates. The Corporation’s exposure to interest rates is reviewed on a monthly basis by senior management and the Board of Directors.

The Corporation performs a net interest income analysis as part of its asset/liability management processes. Net interest income analysis measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of change in net interest income in the event of sudden and sustained 100 and 200 basis point increases in market interest rates. As a result of current market conditions, 100 and 200 basis point decreases in market interest rates are not applicable for 2012 and 2011 as those decreases would result in some deposit interest rate assumptions falling below zero. Nonetheless, the Corporation’s net interest income could decline in those scenarios as yields on earning assets could continue to adjust downward.

 

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The following table presents the estimated percentage change in net interest income assuming hypothetical interest rate shocks:

 

		200 Basis Point Rate Increase				100 Basis Point Rate Increase
June 30, 2012			13.0	%			6.3	%
March 31, 2012			13.2	%			6.4	%

“Gap” analysis is used to determine the repricing characteristics of the Corporation’s assets and liabilities. The Corporation had a positive net Gap position at June 30, 2012 for Year 1 of 28.1% compared to 24.5% at March 31, 2012, meaning a greater amount of interest-earning assets are repricing or maturing than the amount of interest-bearing liabilities during the same time period. A positive gap generally indicates the Corporation is positioned to benefit from a rising interest rate environment. The Gap position does not necessarily indicate the level of the Corporation’s interest rate sensitivity or the impact to net interest income because the interest-earning assets and interest-bearing liabilities are repricing based on different indices.

Computations of the prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay rates. These computations should not be relied upon as indicative of actual results. Actual values may differ from those projections set forth above, should market conditions vary from assumptions used in preparing the analyses. Further, the computations do not contemplate any actions the Corporation may undertake in response to changes in interest rates.

The “Gap” analysis is based upon assumptions as to when assets and liabilities will reprice in a changing interest rate environment. Because such assumptions can be no more than estimates, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may, in fact, mature or reprice at different times and at different volumes than those estimated. Also, the renewal or repricing of certain assets and liabilities can be discretionary and subject to competitive and other pressures. Therefore, the gap information above does not and cannot necessarily indicate the actual future impact of general interest rate movements on the Corporation’s net interest income.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management” in the Corporation’s Annual Report on Form 10-K for the year ended March 31, 2012.

COMPLIANCE RISK MANAGEMENT

Compliance risk represents the risk of regulatory sanctions, reputational impact or financial loss resulting from the Corporation’s failure to comply with regulations and standards of good banking practice. Activities which may expose the Corporation to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, community reinvestment initiatives, fair lending challenges and employment and tax matters.

STRATEGIC AND/OR REPUTATION RISK MANAGEMENT

Strategic and/or reputation risk represents the risk of loss due to damage to reputation, failure to fully develop and execute business plans, failure to assess current and new opportunities in business, markets and products and any other event not identified in the defined risk types mentioned previously. Mitigation of the various risk elements that represent strategic and/or reputation risk is achieved through initiatives to help the Corporation better understand, monitor and report on the various risks.

 

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CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS

The consolidated financial statements are prepared by applying certain accounting policies. Certain of these policies require management to make estimates and strategic or economic assumptions that may prove inaccurate or are subject to variations that may significantly affect the reported results and financial position for the period or in future periods. Some of the more significant policies are as follows:

Fair Value Measurements

Management must use estimates, assumptions, and judgments when assets and liabilities are required to be recorded at, or adjusted to reflect, fair value under GAAP. This includes the initial measurement at fair value of the assets acquired and liabilities assumed in acquisitions qualifying as business combinations, foreclosed properties and repossessed assets and the capitalization of mortgage servicing rights. The valuation of both financial and nonfinancial assets and liabilities in these transactions requires numerous assumptions and estimates and the use of third-party sources including appraisers and valuation specialists.

Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Assets and liabilities measured at fair value on a recurring basis include available for sale securities, interest rate lock commitments and forward contracts to sell mortgage loans. Assets and liabilities measured at fair value on a non-recurring basis may include loans held for sale, mortgage servicing rights, certain impaired loans and foreclosed assets. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact future financial condition and results of operations.

Available-for-Sale Securities

Declines in the fair value of available-for-sale securities below their amortized cost that are deemed to be other-than- temporary are reflected in earnings as unrealized losses. In estimating other-than-temporary impairment losses on debt securities, management considers many factors which include: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. To determine if other-than-temporary impairment exists on a debt security, the Corporation first determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Corporation will recognize an other-than-temporary impairment loss in earnings equal to the difference between the fair value of the security and its amortized cost. If neither of the conditions is met, the Corporation determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present values of the cash flows expected to be collected, discounted at the purchase yield or current accounting yield of the security, and the amortized cost basis is the credit loss. The credit loss is the amount of impairment deemed other-than-temporary and recognized in earnings and is a reduction to the cost basis of the security. The amount of impairment related to all other factors (i.e. non-credit) is deemed temporary and included in accumulated other comprehensive income (loss).

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable and inherent losses incurred in the loan portfolio. Management maintains an allowance for loan and lease losses (ALLL)–and separately a reserve for unfunded loan commitments and letters of credit in other liabilities–at levels that we believe to be adequate to absorb estimated probable credit losses incurred in the loan portfolio. The adequacy of the ALLL is determined based on periodic evaluations of the loan and lease portfolios and other relevant factors. The ALLL is comprised of general, substandard loan and specific components. Even though the entire allowance is available to cover losses on any loan, specific allowances are provided on impaired loans pursuant to accounting standards. The general allowance is based on historical loss experience, adjusted for quantitative and qualitative factors. At least quarterly, management reviews the assumptions and methodology related to the general allowance in an effort to update and refine the estimate.

 

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In determining the general allowance, management has segregated the loan portfolio by purpose and collateral type. By doing so we are better able to identify trends in borrower behavior and loss severity. For each class of loan, we compute a historical loss factor. In determining the appropriate period of activity to use in computing the historical loss factor we look at trends in quarterly net charge-off rates. It is management’s intention to utilize a period of activity that is most reflective of current experience. Changes in the historical period are made when there is a distinct change in the trend of net charge-off experience. Given the changes in the credit market that have occurred since 2008, management reviewed each class’ historical losses by quarter for any trends that would indicate a different look back period would be more representative of current experience.

Management adjusts historical loss rates based on six quantitative factors and four qualitative factors which are listed in the preceding section titled Allowance for Loan and Lease Losses within Credit Risk Management. In determining the impact, if any, of an individual factor, management compares the current underlying facts and circumstances surrounding that particular factor with those in the historical periods, adjusting the historical loss factor based on changes in the quantitative or qualitative factor. Management will continue to analyze the factors on a quarterly basis, adjusting the historical loss factor as necessary, to a factor believed to be appropriate for the probable and inherent risk of loss in the portfolio.

Specific allowances are determined as a result of our impairment review process. When a loan is identified as impaired it is evaluated for loss using either the fair value of collateral method or the present value of cash flows method. If the present value of expected cash flows or the fair value of collateral exceeds the Bank’s carrying value of the loan no loss is anticipated and no specific reserve is established. However, if the Bank’s carrying value of the loan is greater than the present value of expected cash flows or fair value of collateral a specific reserve is established. In either situation, loans identified as impaired are excluded from the calculation of the general reserve.

The determination of the substandard loan ALLL component is consistent with the specific ALLL process, however is applicable to substandard rated loans that are not considered impaired.

The Corporation regularly obtains updated appraisals for real estate collateral dependent loans for which it calculates impairment based on the fair value of collateral. Loans having an unpaid principal balance of $250,000 or less in a homogenous pool of assets do not require an impairment analysis and, therefore, updated appraisals may not be obtained until the foreclosure or sheriff sale occurs. Due to certain limitations, including, but not limited to, the availability of qualified appraisers, the time necessary to complete acceptable appraisals, the availability of comparable market data and information, and other considerations, in certain instances current appraisals are not readily available.

The determination of value on an individually reviewed loan is estimated using an appraisal discounted by 15%, 25% or 35% depending on whether the appraisal is a) current, b) improved land or commercial real estate (CRE) greater than a year old, or c) unimproved land greater than a year old, respectively. The 15% discount represents an estimate of selling costs and potential taxes and other expenses the Bank may need to incur to dispose of a property. The additional discounts on appraisals greater than a year old of 10% and 20% on improved land/CRE and unimproved land, respectively reflect the decrease in collateral values during fiscal years 2010, 2011 and 2012. These percentages are supported by the Bank’s analysis of appraisal activity over the past 12 months.

Loans are considered to be non-performing at such time that they become ninety days past due or earlier if a loss is deemed probable. At the time a loan is determined to be non-performing it is downgraded per the Corporation’s loan rating system, it is placed on non-accrual, and an allowance consistent with the Corporation’s historical experience for similar “substandard” loans is established. Within ninety days of this determination a comprehensive analysis of the loans is completed, including ordering new appraisals, where necessary, and an adjustment to the estimated allowance is recognized to reflect the fair value of the loan based on the underlying collateral or the discounted cash flows. Until such date at which an updated appraisal is obtained, when deemed necessary, the Corporation applies discounts to the existing appraisals in estimating the fair value of collateral as described above.

 

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Management considers the ALLL at June 30, 2012 to be at an acceptable level, although changes may be necessary if future economic and other conditions differ substantially from the current environment. Although the best information available is used, the level of the ALLL remains an estimate that is subject to significant judgment and short-term change. To the extent actual outcomes differ from our estimates, additional provision for credit losses may be required that would reduce future earnings.

Foreclosure

Real estate acquired by foreclosure or by deed in lieu of foreclosure and other repossessed assets is held for sale and initially recorded at fair value less a 15% discount for estimated selling costs at the date of foreclosure, establishing a new cost basis. At the date of foreclosure any write down to fair value less estimated selling costs is charged to the allowance for loan losses. If the discounted fair value exceeds the net carrying value of the loans, recoveries to the allowance for loan losses are recorded to the extent of previous charge-offs, with any excess, which is infrequent, recognized as a gain in non-interest income. Subsequent to foreclosure, updated appraisals are generally obtained on an annual basis and the assets are adjusted to the lower of cost or fair value, less 15% for estimated selling expenses. An additional 10% discount is generally applied to all asset values that are based on appraisals greater than one year old. Costs relating to the development and improvement of the property are capitalized; holding period costs and subsequent changes to the valuation allowance are charged to non-interest expense.

Mortgage Servicing Rights

Mortgage servicing rights (MSR) are initially recorded as an asset, measured at fair value, when loans are sold to third parties with servicing rights retained. MSR assets are amortized in proportion to, and over the period of, estimated net servicing revenues. The carrying value of these assets is periodically reviewed for impairment using a lower of amortized cost or fair value methodology. The fair value of the servicing rights is determined by estimating the present value of future net cash flows, taking into consideration market loan prepayment speeds, discount rates, servicing costs and other economic factors. For purposes of measuring impairment, the rights are stratified into relatively homogeneous pools based on predominant risk characteristics of the underlying loans which include product type (i.e., fixed, adjustable or balloon) and interest rate bands. If the aggregate carrying value of the capitalized mortgage servicing rights for a stratum exceeds its fair value, a mortgage servicing right impairment is recognized in earnings for the difference. As the loans are repaid and net servicing revenue is earned, mortgage servicing rights are amortized into expense. Net servicing revenues are expected to exceed this amortization expense. However, if actual prepayment experience or defaults exceed what was originally anticipated, net servicing revenues may be less than expected and mortgage servicing rights may be impaired.

The interest rate bands used to stratify the serviced loans were changed in the quarter ending December 31, 2011 in response to the significantly lower interest rate environment over the past several years and the resultant “bunching’ of a substantial portion of serviced loans into two of the nine historical strata. The restratification of serviced loans did not have a material impact on the impairment measurement of the mortgage servicing right asset during that period.

Income Taxes

The Corporation’s provision for federal income taxes has resulted in the recognition of a deferred tax liability or deferred tax asset computed by applying the current statutory tax rates to net taxable or deductible differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements that will produce taxable or deductible amounts in future periods. The Corporation regularly reviews the carrying amount of its deferred tax assets to determine if the establishment of a valuation allowance is necessary. If based on the available evidence, it is more likely than not that all or a portion of the Corporation’s deferred tax assets will not be realized in future periods, a deferred tax valuation allowance would be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred tax assets.

In evaluating this available evidence, management considers, among other things, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences. The Corporation’s evaluation is based on current tax laws as well as management’s expectations of future performance.

 

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As a result of its evaluation, the Corporation has recorded a full valuation allowance on its net deferred tax asset.

Revenue Recognition

The Corporation derives net interest and non-interest income from various sources, including:

 

•

Lending,

 

•

Securities portfolio,

 

•

Customer deposits,

 

•

Loan servicing, and

 

•

Sale of loans and securities.

The Corporation also earns fees and commissions from issuing loan commitments, standby letters of credit and financial guarantees and selling various insurance products. Revenue earned on interest-earning assets, including the accretion of fair value adjustments on discounts for purchased loans, is recognized based on the effective yield of the financial instrument.

FORWARD-LOOKING STATEMENTS

This report contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the “Exchange Act,” and Section 27A of the Securities Act. Any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” and similar words or phrases. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Our actual results could differ materially from those anticipated in such forward-looking statements as a result of several factors more fully described under the caption “Risk Factors” and elsewhere in this report as well as in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012. Factors that could affect actual results include but are not limited to;

 

(i)

general economic or industry conditions could be less favorable than expected, resulting in a deterioration in credit quality, a change in the allowance for loan and lease losses or a reduced demand for credit or fee-based products and services;

 

(ii)

soundness of other financial institutions with which the Corporation and the Bank engage in transactions;

 

(iii)

competitive pressures could intensify and affect our profitability, including as a result of continued industry consolidation, the increased availability of financial services from non-banks, technological developments or bank regulatory reform;

 

(iv)

changes in technology;

 

(v)

deterioration in commercial real estate, land and construction loan portfolios resulting in increased loan losses;

 

(vi)

uncertainties regarding our ability to continue as a going concern;

 

(vii)

our ability to address our own liquidity problems;

 

(viii)

demand for financial services, loss of customer confidence, and customer deposit account withdrawals;

 

(ix)

our ability to pay dividends;

 

(x)

changes in the quality or composition of the Bank’s loan and investment portfolios and allowances for loan loss;

 

(xi)

dilution of existing shareholders as a result of possible future transaction;

 

(xii)

uncertainties about the Corporation and the Bank’s Cease and Desist Orders;

 

(xiii)

uncertainties about our ability to meet the Bank’s 12 percent capital requirement of our Cease and Desist Order;

 

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(xiv)

increases in Federal Deposit Insurance Corporation premiums due to market developments and regulatory changes;

 

(xv)

changes in accounting principles, policies or guidelines;

 

(xvi)

significant unforeseen legal expenses;

 

(xvii)

uncertainties about market interest rates;

 

(xviii)

security breaches of our information systems;

 

(xix)

environmental liability for properties to which we take title;

 

(xx)

expiration of our Amended and Restated Credit Agreement;

 

(xxi)

the effects of any changes to the servicing compensation structure for mortgage servicers pursuant to the programs of government sponsored entities;

 

(xxii)

uncertainties relating to the Emergency Economic Stabilization Act or 2008, the American Recovery and Reinvestment Act of 2009, the Dodd-Frank Act, the implementation by the U.S. Department of the Treasury and federal banking regulators of a number of programs to address capital and liquidity issues in the banking system and additional programs that will apply to us in the future, all of which may have significant effects on us and the financial services industry; and

 

(xxiii)

challenges relating to recruiting and retaining key employees.

In addition, to the extent that we engage in acquisition transactions, such transactions may result in large one-time charges to income, may not produce revenue enhancements or cost savings at levels or within time frames originally anticipated and may result in unforeseen integration difficulties. These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. All forward-looking statements are necessarily only estimates of future results, and there can be no assurance that actual results will not differ materially from expectations, and, therefore, you are cautioned not to place undue reliance on such statements. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this report. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

The Corporation does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

 

Item 3		Quantitative and Qualitative Disclosures About Market Risk.
		The Corporation’s market risk has not materially changed from March 31, 2012. See Item 7A in the Corporation’s Annual Report on Form 10-K for the year ended March 31, 2012. See also “Asset/Liability Management” in Part I, Item 2 of this report.
Item 4		Controls and Procedures.
		The Corporation’s management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report and, based on this evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are operating in an effective manner.
		Changes in Internal Control Over Financial Reporting
		There has been no change in the Corporation’s internal control over financial reporting ((as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the Corporation’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

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Part II – Other Information

 

Item 1		Legal Proceedings.
		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.
Item 1A		Risk Factors.
		We are subject to a number of risks which may potentially impact our business, financial condition, results of operations and liquidity. As a financial services institution, certain elements of risk are inherent in all of our transactions and are present in every business decision we make. Thus, we encounter risk as part of the normal course of our business, and we design risk management processes to help manage these risks.
		Refer to “Risk Factors” in the Corporation’s Annual Report on Form 10-K for the year ended March 31, 2012, for discussion of these risks.
Item 2		Unregistered Sales of Equity Securities and Use of Proceeds.
		There were no unregistered sales of equity securities or repurchases of equity securities by the registrant for the three months ended June 30, 2012.
Item 3		Defaults Upon Senior Securities.
		None.
Item 4		Mine Safety Disclosures.
		Not applicable.
Item 5		Other Information.
		None.
Item 6		Exhibits. *
		The following exhibits are filed with this report:
		Exhibit 31.1		Certification of Principal Executive Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002 is included herein as an exhibit to this Report.
		Exhibit 31.2		Certification of Principal Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002 is included herein as an exhibit to this Report.

 

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		Exhibit 32.1		Certification of the Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) is included herein as an exhibit to this Report.
		Exhibit 32.2		Certification of the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) is included herein as an exhibit to this Report.

 

*	XBRL Interactive Data File will be filed by amendment to this Form 10-Q within 30 days of the filing date of this Form 10-Q, as permitted by Rule 405(a)(2)(ii) of Regulation S-T.

 

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SIGNATURES

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

 

				ANCHOR BANCORP WISCONSIN INC.
Date: August 9, 2012				By:		/s/ Chris Bauer
						Chris Bauer, President and Chief Executive Office
Date: August 9, 2012				By:		/s/ Thomas G. Dolan
						Thomas G. Dolan, Executive Vice President, Treasurer and Chief Financial Officer

 

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