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, 2014

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)

 

 

 

Delaware		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

 

(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 by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  ¨

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 — $0.01 Par Value

Number of shares outstanding as of July 31, 2014: 9,050,000

 

 

 

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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, 2014 and Audited as of December 31, 2013			2
		Unaudited Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2014 and 2013			3
		Unaudited Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the Six Months Ended June 30, 2014 and Audited for the Nine Months Ended December 31, 2013			5
		Unaudited Consolidated Statements of Cash Flows for Six Months Ended June 30, 2014 and 2013			6
		Notes to Unaudited Consolidated Financial Statements			8
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations
		Executive Overview			53
		Results of Operations			57
		Financial Condition			67
		Risk Management			68
		Credit Risk Management			69
		Liquidity Risk Management			76
		Market Risk Management			78
		Compliance, Strategic and/or Reputational Risk Management			80
		Regulatory Developments			81
		Critical Accounting Estimates and Judgments			83
		Forward Looking Statements			86
Item 3		Quantitative and Qualitative Disclosures About Market Risk			87
Item 4		Controls and Procedures			87
Part II - Other Information
Item 1		Legal Proceedings			89
Item 1A		Risk Factors			89
Item 2		Unregistered Sales of Equity Securities and Use of Proceeds			89
Item 3		Defaults Upon Senior Securities			90
Item 4		Mine Safety Disclosures			90
Item 5		Other Information			90
Item 6		Exhibits			90
Signatures					91

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

										June 30, 2014				December 31, 2013
										(Unaudited)
										(In thousands, except share data)
Assets
Cash and due from banks										$	38,982			$	44,139
Interest-earning deposits											138,365				99,257
Cash and cash equivalents											177,347				143,396
Investment securities available for sale (AFS)											295,290				277,872
Loans held for sale											5,261				3,085
Loans held for investment											1,556,138				1,609,506
Less: Allowance for loan losses											(49,175	)			(65,182	)
Loans held for investment, net											1,506,963				1,544,324
Other real estate owned (OREO), net											56,170				63,460
Premises and equipment, net											25,459				24,800
Federal Home Loan Bank stock—at cost											11,940				11,940
Mortgage servicing rights, net											20,929				22,294
Accrued interest receivable											7,640				8,216
Other assets											14,250				13,087
Total assets										$	2,121,249			$	2,112,474
Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing										$	276,829			$	259,926
Interest bearing											1,596,411				1,615,367
Total deposits											1,873,240				1,875,293
Other borrowed funds											13,781				12,877
Accrued interest payable											393				415
Accrued taxes, insurance and employee related expenses											5,586				7,302
Other liabilities											16,742				14,389
Total liabilities											1,909,742				1,910,276
Commitments and contingent liabilities (Note 12)
		June 30, 2014				December 31, 2013
Preferred stock:
Par value		$	0.01			$	0.01
Authorized			100,000				100,000
Issued		$	—			$	—
Common stock:
Par value		$	0.01			$	0.01
Authorized			11,900,000				11,900,000
Issued			9,050,000				9,050,000				91				91
Additional paid-in capital											188,370				188,370
Retained earnings											24,896				20,359
Accumulated other comprehensive loss related to AFS securities											(1,738	)			(6,378	)
Accumulated other comprehensive loss related to other than temporary impairment (OTTI) securities - non-credit factors											(112	)			(244	)
Total accumulated other comprehensive loss											(1,850	)			(6,622	)
Total stockholders’ equity											211,507				202,198
Total liabilities and stockholders’ equity										$	2,121,249			$	2,112,474

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 (Loss)

(Unaudited)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands, except per share data)
Interest income
Loans		$	17,321			$	19,766			$	35,197			$	40,954
Investment securities and Federal Home Loan Bank stock			1,541				1,279				3,062				2,713
Interest-earning deposits			94				131				159				225
Total interest income			18,956				21,176				38,418				43,892
Interest expense
Deposits			1,033				1,504				2,121				3,214
Other borrowed funds			61				6,255				120				12,441
Total interest expense			1,094				7,759				2,241				15,655
Net interest income			17,862				13,417				36,177				28,237
Provision for loan losses			—				275				—				950
Net interest income after provision for loan losses			17,862				13,142				36,177				27,287
Non-interest income
Net impairment losses recognized in earnings			(13	)			—				(34	)			(83	)
Loan servicing income, net of amortization			740				55				1,514				110
Service charges on deposits			2,523				2,580				4,789				4,949
Investment and insurance commissions			1,131				1,063				1,987				2,015
Net gain on sale of loans			698				2,793				1,290				5,823
Net gain (loss) on sale of investment securities			—				—				301				(200	)
Net gain on sale of OREO			1,040				925				1,201				2,262
Other income			1,491				1,436				2,494				1,479
Total non-interest income			7,610				8,852				13,542				16,355

 

(Continued)

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Operations and Comprehensive Income (Loss)

(Unaudited)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands, except per share data)
Non-interest expense
Compensation and benefits		$	10,739			$	11,130			$	21,901			$	21,272
Occupancy			1,614				1,986				3,852				4,297
Furniture and equipment			791				850				1,557				1,612
Federal deposit insurance premiums			700				1,332				1,748				2,686
Data processing			1,315				1,420				2,686				3,282
Communications			463				536				1,036				948
Marketing			879				396				1,532				902
OREO expense, net			2,267				4,289				3,452				16,548
Investor loss reimbursement			(248	)			371				(86	)			3,181
Mortgage servicing rights impairment (recovery)			84				(1,258	)			95				(3,448	)
Provision for unfunded commitments			600				1,734				780				2,159
Loan processing and servicing expense			709				891				1,276				2,194
Legal services			602				1,271				955				2,371
Other professional fees			351				495				758				1,154
Insurance			206				376				516				794
Other expense			1,783				1,556				3,114				3,091
Total non-interest expense			22,855				27,375				45,172				63,043
Income (loss) before income taxes			2,617				(5,381	)			4,547				(19,401	)
Income tax expense (benefit)			10				—				10				—
Net income (loss)			2,607				(5,381	)			4,537				(19,401	)
Preferred stock dividends in arrears			—				(1,701	)			—				(3,363	)
Preferred stock discount accretion			—				(1,863	)			—				(3,706	)
Net income (loss) available to common equity		$	2,607			$	(8,945	)		$	4,537			$	(26,470	)
Net income (loss)		$	2,607			$	(5,381	)		$	4,537			$	(19,401	)
Reclassification adjustment for realized net (gains) losses recognized in Statements of Operations - Net gain (loss) on sale and call of investment securities			—				—				(301	)			200
Reclassification adjustments recognized in Statements of Operations - Net impairment losses recognized in earnings:
Net change in unrealized credit related other-than-temporary impairment			(36	)			(68	)			(78	)			(158	)
Realized credit losses			49				68				112				241
Change in net unrealized gains (losses) on available-for-sale securities			2,179				(6,144	)			5,039				(5,649	)
Total other comprehensive income (loss)			2,192				(6,144	)			4,772				(5,366	)
Comprehensive income (loss)		$	4,799			$	(11,525	)		$	9,309			$	(24,767	)
Income (loss) per common share:
Basic		$	0.29			$	(0.42	)		$	0.50				(1.25	)
Diluted			0.29				(0.42	)			0.50				(1.25	)
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)

 

		Preferred Stock				Common Stock				Additional Paid-in Capital				Retained Earnings (Deficit)				Treasury Stock				Deferred Compensation Obligation				Accumulated Other Comprehensive Income (Loss)				Total
		(In thousands)
Balance at March 31, 2013 (Audited)		$	103,833			$	2,536			$	110,034			$	(189,097	)		$	(89,848	)		$	(901	)		$	3,579			$	(59,864	)
Net income			—				—				—				111,623				—				—				—				111,623
Other comprehensive income, net of tax			—				—				—				—				—				—				(10,201	)			(10,201	)
Recapitalization transaction fees			—				—				(14,360	)			—				—				—				—				(14,360	)
Cancellation of common stock			—				(2,536	)			(88,213	)			—				89,848				901				—				—
Issuance of common stock			—				88				174,912				—				—				—				—				175,000
Preferred stock exchanged for common stock			(110,000	)			3				5,997				104,000				—				—				—				—
Accretion of preferred stock discount			6,167				—				—				(6,167	)			—				—				—				—
Balance at December 31, 2013 (Audited)		$	—			$	91			$	188,370			$	20,359			$	—			$	—			$	(6,622	)		$	202,198
Net income			—				—				—				4,537				—				—				—				4,537
Other comprehensive income, net of tax			—				—				—				—				—				—				4,772				4,772
Balance at June 30, 2014 (Unaudited)		$	—			$	91			$	188,370			$	24,896			$	—			$	—			$	(1,850	)		$	211,507

See accompanying Notes to Unaudited Consolidated Financial Statements

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

		Six Months Ended June 30,
		2014				2013
		(In thousands)
Operating Activities
Net income (loss)		$	4,537			$	(19,401	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Amortization and accretion of investment securities premium, net			676				689
Net (gain) loss on sale of investment securities			(301	)			200
Net impairment losses on investment securities			34				83
Origination of loans held for sale			(57,931	)			(295,227	)
Proceeds from sale of loans held for sale			57,045				312,828
Net gain on sale of loans			(1,290	)			(5,823	)
Provision for loan losses			—				950
Valuation adjustments for OREO			2,279				11,603
Provision for unfunded loan commitments			780				2,159
Gain on sale of OREO			(1,201	)			(2,262	)
Depreciation and amortization			1,212				1,248
Loss on disposal of premises and equipment, net			76				79
Mortgage servicing rights impairment (recovery)			95				(3,448	)
Decrease in accrued interest receivable			576				1,261
Decrease in other assets			107				2,757
Increase (decrease) in accrued interest payable			(22	)			9,127
Decrease in accrued taxes, insurance and employee related expenses			(1,716	)			(549	)
Increase (decrease) in other liabilities			1,573				(2,236	)
Net cash provided by operating activities			6,529				14,038
Investing Activities
Proceeds from sale of investment securities			388				6,420
Purchase of investment securities			(37,787	)			(68,009	)
Principal collected on investment securities			24,344				27,773
Decrease in loans held for investment			29,702				93,471
Purchases of premises and equipment			(1,947	)			(786	)
Proceeds from sale of OREO			13,899				29,193
Capitalized improvements of OREO			(28	)			(352	)
Net cash provided by investing activities			28,571				87,710

 

(Continued)

 

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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

		Six Months Ended June 30,
		2014				2013
		(In thousands)
Financing Activities
Decrease in deposits		$	(41,239	)		$	(92,817	)
Increase in advance payments by borrowers for taxes and insurance			39,186				39,681
Proceeds from borrowed funds			53,561				60,793
Repayment of borrowed funds			(52,657	)			(59,146	)
Net cash used in financing activities			(1,149	)			(51,489	)
Net increase in cash and cash equivalents			33,951				50,259
Cash and cash equivalents at beginning of period			143,396				191,280
Cash and cash equivalents at end of period		$	177,347			$	241,539
Supplemental disclosures of cash flow information:
Cash paid (received) or credited to accounts:
Interest on deposits and borrowings		$	2,263			$	7,277
Income tax payments (receipts)			22				(1,728	)
Non-cash transactions:
Transfer of loans to OREO			7,659				16,423

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” or the “Company”) and its wholly-owned subsidiaries, AnchorBank, fsb (the “Bank”) and Investment Directions, Inc. (“IDI”). The Bank has one subsidiary at June 30, 2014: 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 (including normal recurring accruals) necessary for a fair presentation of the unaudited interim 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 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- and six-month periods ended June 30, 2014 are not necessarily indicative of results that may be expected for the year ending December 31, 2014. 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/T for the transition period ended December 31, 2013.

Change in Fiscal Year End. On December 18, 2013, the Board approved the change of our fiscal year end from March 31 to December 31, beginning with December 31, 2013. References to any previous fiscal years mean the fiscal years ended on March 31. As a result of the change in fiscal year end, the consolidated financial statements include the Company’s financial results for the six month period from January 1, 2013 to June 30, 2013 of which January 1, 2013 to March 31, 2013 results were previously included in the fiscal year ended March 31, 2013 results.

Reclassifications. Certain prior period amounts are reclassified to conform to the current period presentations with no impact on net income (loss) or total stockholders’ equity when applicable.

Note 2 – Significant Transactions, Significant Risks and Uncertainties

Filing of Registration Statement on Form S-1

On May 12, 2014, the Company filed the fourth amendment to the registration statement on Form S-1 originally filed on December 20, 2013 in connection with a potential initial public offering of our common stock. Certain of our current stockholders may participate as selling stockholders in the offering but they are not legally obligated to do so. The offering is subject to market conditions and there can be no assurance as to whether or when the offering may be completed or as to the actual size or terms of the offering.

 

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Bankruptcy Proceedings and Emergence from Chapter 11

Background

Headquartered in Madison, Wisconsin, the Company is a savings and loan holding company that operates primarily through AnchorBank, its wholly owned banking subsidiary. The Bank is a $2.12 billion bank and Wisconsin’s largest thrift and offers personal and business banking services to more than 110,000 households and businesses.

As a result of the economic downturn, beginning in 2009, the Company experienced significant operating losses, significant levels of criticized assets and low levels of capital, all of which raised substantial doubt about the Company’s ability to continue as a going concern. As a result, in 2009 both the Company and the Bank became subject to Orders to Cease and Desist issued by the Office of Thrift Supervision. Further, the Company owed $116.3 million to various lenders led by U.S. Bank under a short-term line of credit (the “Credit Agreement”) which it was unable to repay. Additionally, the Company received $110 million in 2009 from the issuance of senior preferred shares under the Troubled Asset Relief Program (“TARP”). These funds were distributed down to the Bank. Despite the TARP funds, the Company’s financial condition did not improve. The Company continued to negotiate with U.S. Bank and was successful in negotiating amendments to the Credit Agreement to avoid a default thereunder. Also during that time, the Company diligently sought qualified sources of outside capital.

In 2013, the Company entered into a Plan of Reorganization. Under the Plan of Reorganization, a Chapter 11 Proceeding was filed in federal Bankruptcy Court to effect a reorganization of the Company. Pursuant to the Plan of Reorganization, the Company: (i) issued new common stock to a limited number of investors in consideration of $175 million of new equity capital; (ii) made a discounted cash payment of $49.0 million in full satisfaction of the amounts owed under the Credit Agreement (which included the principal amount of $116.3 million plus accrued interest and fees of approximately $67.2 million); (iii) exchanged the senior preferred shares issued pursuant to TARP for 60 million shares of common stock; and (iv) eliminated the previously existing shares of Company common stock that were outstanding (which we refer to in this report as “Legacy Common Stock”). The Plan of Reorganization is described in greater detail below.

Bankruptcy Proceedings

On August 12, 2013, the Company filed a voluntary petition for relief (the “Chapter 11 Case”) under the provisions of chapter 11 of title 11 of the United States Code, 11 U.S.C. §§ 101, et seq. (the “Bankruptcy Code”), Case No. 13-14003-rdm, in the United States Bankruptcy Court for the Western District of Wisconsin (the “Bankruptcy Court”) to implement the Plan of Reorganization in order to facilitate the restructuring of the Company and the recapitalization of the Bank. Prior to the petition date, U.S. Bank National Association and Bank of America, N.A., as senior secured creditors of the Company (the “Lenders”), and the Treasury, as sole preferred stockholder of the Company, voted to accept the Plan of Reorganization.

On August 30, 2013, the Bankruptcy Court entered the Confirmation Order, by which it confirmed the Plan of Reorganization. On September 27, 2013 (the “Effective Date”), the Plan of Reorganization became effective in accordance with its terms. During the period of bankruptcy, we incurred and expensed $1.9 million of reorganization costs, primarily comprised of professional fees.

Emergence Accounting

Upon emergence, we determined we did not meet the requirements to apply fresh start reporting under applicable accounting standards because we did not meet the solvency criteria of Accounting Standards Codification (ASC) 852-10-45-19. The reorganization value immediately before the date of confirmation was greater than the total of all post-petition liabilities and allowed claims and, therefore, indicative of not meeting the test to require fresh start accounting under ASC 852. As of the date of confirmation, we estimated our enterprise value (or reorganization value) to be approximately $2.2 billion. The Company utilized the equity value using the income and market approach to approximate fair value. Accordingly, our consolidated financial statements do not include fresh start reporting, whereby the Company would have to revalue all of its assets and liabilities. At the time of filing for the Chapter 11 Case, we identified liabilities subject to compromise of $188.3 million, which included the outstanding Credit Agreement of approximately $116.3 million, interest and fees due under the Credit Agreement of $67.2 million and $4.8 million in other liabilities.

 

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Plan of Reorganization. Below is a summary of the significant transactions affecting the Company as a result of the effectiveness of the Plan of Reorganization.

Delaware Conversion

Pursuant to the Plan of Reorganization, on September 25, 2013, we (i) converted from a Wisconsin corporation to a Delaware corporation in accordance with Section 265 of the Delaware General Corporation Law and (ii) filed a Certificate of Incorporation with the Secretary of State of the State of Delaware (the “Amended Charter”), to, among other things, declassify our Board, increase the number of authorized shares of our common stock and adopt certain restrictions on acquisitions and dispositions of our securities. The Amended Charter provides for (a) 2,000,000,000 shares of authorized common stock, par value $0.01 per share (the “Common Stock”), and (b) 1,000,000 shares of authorized preferred stock, par value $0.01 per share. A reverse stock split was effected and a subsequent amendment to the corporate charter was filed on October 2, 2013 providing for 11,900,000 shares of authorized common stock, par value $0.01 per share and 100,000 shares of authorized preferred stock, par value $0.01. There are 9,050,000 shares of Common Stock outstanding as of June 30, 2014.

Private Placements

In connection with the Plan of Reorganization, we entered into stock purchase agreements with certain institutional and other private investors and directors and officers of the Company (the “Investors”) for the purchase and sale of 1,750,000,000 (adjusted on October 2, 2013 as a result of a reverse stock split to 8,750,000 shares) shares of our Common Stock at a purchase price of $0.10 per share.

Pursuant to the stock purchase agreements, we issued and sold the Common Stock to (i) certain Investors such that, after giving effect to the transactions contemplated in the Plan of Reorganization, each such Investor owns up to 9.9% of the Common Stock pursuant to the Private Placements and the Treasury Issuance (as defined below), for an aggregate purchase price of $87.8 million, (ii) certain other Investors such that, after giving effect to the transactions contemplated in the Plan of Reorganization, each such Investor owns up to 4.9% of the Authorized Common Stock pursuant to the Private Placements and the Treasury Issuance, for an aggregate purchase price of $83.7 million, and (iii) certain directors and officers of the Company for an aggregate purchase price of $3.5 million. We received gross proceeds of $175.0 million as a result of the Private Placements and incurred $14.4 million of capital raise costs all of which have been recorded in the Consolidated Statement of Changes in Stockholders’ Equity (Deficit).

TARP Exchange

On January 30, 2009, pursuant to the Treasury’s Capital Purchase Program, we issued and sold to the Treasury 110,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series B of the Company with an aggregate liquidation preference of $110.0 million (the “TARP Preferred Stock”). In addition, we issued to the Treasury a warrant (the “TARP Warrant”) to purchase up to 7,399,103 shares of our common stock, par value $0.10 per share (the “Legacy Common Stock”), at an initial per share exercise price of $2.23. Pursuant to the Plan of Reorganization, we, on the Effective Date and immediately following the consummation of the Private Placements, (i) exchanged the TARP Preferred Stock for 60.0 million shares (adjusted to 300,000 shares as a result of the reverse stock split) of Common Stock (the “Treasury Issuance”) and (ii) cancelled the TARP Warrant in its entirety (collectively, the “TARP Exchange”). The difference between the Common Stock issued and the Preferred Stock redeemed of $104.0 million was recorded as an increase directly to retained earnings. The $104.0 million represents a return from the Preferred stockholder thereby increasing the amount available to common stockholders for purposes of earnings per share.

Following the effectiveness of the Plan of Reorganization, the Treasury sold to certain institutional investors (the “Secondary Investors”) all of the shares of Common Stock delivered to the Treasury in connection with the Treasury Issuance at a purchase price equal to $0.10 per share (the “Secondary Treasury Sales”) under the securities purchase agreements, dated as of September 19, 2013, among the Treasury, the Secondary Investor and (with respect to certain provisions) the Company. In connection with the Secondary Treasury Sales, we entered into secondary sale purchaser agreements with the Secondary Investors pursuant to which we made certain representations and warranties to the Investor and provided rights to the Secondary Investors similar to the rights provided to Investors under the Stock Purchase Agreements. In connection with the Secondary Treasury Sales, the Treasury received gross proceeds of $6.0 million and ceased to be our stockholder.

 

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Cancellation of Legacy Common Stock

As of July 31, 2013, we had 21,247,225 shares of Legacy Common Stock issued and outstanding. On the Effective Date, immediately following the consummation of the TARP Exchange, all shares of the outstanding Legacy Common Stock including those shares held as treasury stock and in any stock incentive plans were cancelled for no consideration pursuant to the Plan of Reorganization. In connection with the cancellation of the Legacy Common Stock pursuant to the Plan of Reorganization, the Rights Agreement, dated as of November 5, 2010, by and between the Company and American Stock Transfer & Trust Company, LLC was terminated on the Effective Date in accordance with its terms.

Senior Debt Settlement

We were a party to the Amended and Restated Credit Agreement, dated as of June 9, 2008, among the Company, the lenders from time to time a party thereto, and U.S. Bank National Association, as administrative agent for the Lenders. As of June 30, 2013, the aggregate amount of obligations under the Credit Agreement was approximately $183.5 million (including with respect to unpaid principal balance, accrued but unpaid interest thereon and all administrative and other fees or penalties). On the Effective Date, pursuant to the Plan of Reorganization, we satisfied all of our obligations under the Credit Agreement by a cash payment to the Lenders of $49.0 million (plus expense reimbursement as contemplated by the Credit Agreement). As a result of the transaction, we recognized a gain on extinguishment of debt of $134.5 million.

All Other Claims Unaffected

All other claims were unaffected by, and were paid in full under, the Plan of Reorganization.

Termination of Orders to Cease and Desist

The Bank’s primary regulator is the Office of the Comptroller of the Currency (“OCC”). The Federal Reserve is the primary regulator of the Corporation. 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 “C&D Orders”). On August 31, 2010, a Prompt and Corrective Action Directive (“PCA Directive”) was issued for the Bank.

The Corporation Order required the Corporation to notify, and in certain cases to obtain the permission of, the Federal Reserve prior to making dividends or capital distributions, incurring debt, making changes to or entering into contracts with directors or executive officers.

The Bank Order required the Bank to notify, or in certain cases obtain the permission of, the OCC prior to increases above a certain threshold in total assets, entering into brokered deposits, making changes to or entering into contracts with directors or executives officers, entering into certain transactions with affiliates or entering into third-party contracts outside the normal course of business and to meet and maintain both a core capital ratio and a total risk-based capital ratio.

On April 2, 2014, the Bank was notified that the Bank Order and the PCA Directive were terminated. On July 31, 2014, the Corporation was notified that the Corporation Order was terminated.

 

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Note 3 – Recent Accounting Pronouncements

Accounting Standards Update (ASU) 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved After the Requisite Service Period.” The ASU clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense (measured as of the grant date without taking into account the effect of the performance target) related to an award for which transfer to the employee is contingent on the entity’s satisfaction of a performance target until it becomes probable that the performance target will be met. The ASU does not contain any new disclosure requirements and is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. This ASU currently has no impact on the Company.

ASU 2014-11, “Transfers and Servicing: Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures” makes limited amendments to the guidance in ASC 860 on accounting for certain repurchase agreements (“repos”). The ASU (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linking repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions and repurchase-to-maturity transactions) accounted for as secured borrowings. In addition, the ASU provides examples of repurchase and securities lending arrangements that illustrate whether a transferor has maintained effective control over the transferred financial assets. The accounting changes in the ASU are effective for public business entities for the first interim or annual period beginning after December 15, 2014. Early adoption is prohibited. This ASU will have no effect on the Company.

ASU 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40)—Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” These amendments are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property when collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. Further, this amendment clarifies that an in-substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. ASU 2014-04 is effective for public companies for annual periods and interim periods within those annual periods beginning after December 15, 2014. The Corporation has not yet evaluated the effect this ASU will have on its consolidated financial statements.

ASC Topic 740 “Income Taxes.” New authoritative accounting guidance under ASC Topic 740, “Income Taxes” amended prior guidance to include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit

 

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carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The authoritative guidance is effective for reporting periods after January 1, 2014. The Company is in compliance with these requirements and adoption did not have an impact on the consolidated financial statements.

Note 4 - Investment Securities

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

 

		Amortized Cost				Gross Unrealized								Fair Value
						Gains				Losses
		(In thousands)
June 30, 2014
Available for sale:
U.S. government sponsored and federal agency obligations		$	3,303			$	25			$	—			$	3,328
Corporate stock and bonds			1				5				—				6
Non-agency CMOs (1)			5,968				12				(124	)			5,856
GSA mortgage-backed securities (1)			83,879				476				(224	)			84,131
GNMA mortgage-backed securities (1)			203,989				1,152				(3,172	)			201,969
		$	297,140			$	1,670			$	(3,520	)		$	295,290
December 31, 2013
Available for sale:
U.S. government sponsored and federal agency obligations		$	3,359			$	17			$	—			$	3,376
Corporate stock and bonds			88				267				—				355
Non-agency CMOs (1)			6,452				9				(253	)			6,208
GSA mortgage-backed securities (1)			50,721				160				(723	)			50,158
GNMA mortgage-backed securities (1)			223,874				1,056				(7,155	)			217,775
		$	284,494			$	1,509			$	(8,131	)		$	277,872

 

(1)	CMOs (collateralized mortgage obligations), GSAs (government sponsored agencies) and GNMA (Ginnie Mae) mortgage-backed securities are primarily collateralized by residential mortgages.

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.

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 4.0% to 6.5%. 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.

 

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The table below presents the fair value and gross unrealized losses of securities in a loss position, aggregated by investment category and length of time that individual holdings have been in a continuous unrealized loss position.

 

		Unrealized Loss Position
		Less than 12 months								12 months or More								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
		(In thousands)
June 30, 2014
Non-agency CMOs		$	—			$	—			$	4,525			$	(124	)		$	4,525			$	(124	)
Government sponsored agency mortgage-backed securities (1)			21,227				(70	)			9,006				(154	)			30,233				(224	)
GNMA mortgage-backed securities			27,250				(39	)			106,696				(3,133	)			133,946				(3,172	)
		$	48,477			$	(109	)		$	120,227			$	(3,411	)		$	168,704			$	(3,520	)
December 31, 2013
Non-agency CMOs		$	1,219			$	(7	)		$	4,776			$	(246	)		$	5,995			$	(253	)
Government sponsored agency mortgage-backed securities (1)			47,480				(723	)			—				—				47,480				(723	)
GNMA mortgage-backed securities			140,824				(5,143	)			25,449				(2,012	)			166,273				(7,155	)
		$	189,523			$	(5,873	)		$	30,225			$	(2,258	)		$	219,748			$	(8,131	)

 

(1)	Includes mortgage-backed securities and CMOs.

In 2008, the Company received proceeds in connection with shares redeemed as part of the Visa, Inc. initial public offering. The Bank was a member of the former Visa, Inc. payments organization and was issued shares when Visa, Inc. was organized. Approximately 39% of those shares were redeemed in connection with the public offering. The remaining shares are restricted because of unsettled litigation pending against Visa, Inc. At its discretion, Visa, Inc. may redeem additional shares in order to resolve pending litigation. The restriction expires upon resolution of the pending litigation. Accordingly, the Company has recorded these shares at zero in the Consolidated Balance Sheets. Upon expiration of the restriction, the Company expects to record the fair value of the remaining shares.

Other-Than-Temporary Impairment

The number of individual securities in the tables above total 29 at June 30, 2014 and 35 at December 31, 2013. Although these securities have declined in value at some point, the 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.

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, an other-than-temporary impairment loss is recognized 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).

 

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An independent pricing service is utilized to run a discounted cash flow model in the calculation of other-than-temporary impairment losses on non-agency CMOs. This model determines 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 4.0% to 6.5%. These rates equate to the effective yield implicit in the security at the date of acquisition of the bonds for which OTTI has not been previously incurred. For bonds with 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 underlying loans as of June 30, 2014. 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 one to month 24 constant default rate in the model ranged from 5.57% to 12.18%.

At June 30, 2014, five non-agency CMOs with a fair value of $5.8 million and an adjusted cost basis of $5.9 million were other-than-temporarily impaired. At December 31, 2013, six non-agency CMOs with a fair value of $6.2 million and an adjusted cost basis of $6.4 million were other-than-temporarily impaired. Unrealized other-than-temporary impairment due to credit losses of $13,000 and $34,000 was included in earnings for the three and six months ended June 30, 2014 and zero and $83,000 for the three and six months ended June 30, 2013, respectively. For the three months ended June 30, 2014 and 2013, realized losses of $49,000 and $68,000, respectively, and $112,000 and $241,000 for the six month periods, respectively, 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 GNMA mortgage-backed securities as of June 30, 2014 and December 31, 2013 due to changes in interest rates and other non-credit related factors totaled $3.4 million and $7.9 million, respectively. 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 loss.

 

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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 loss for the periods presented:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands)
Beginning balance of unrealized OTTI related to credit losses		$	759			$	1,002			$	801			$	1,778
Additional unrealized OTTI related to credit losses for which OTTI was previously recognized			12				—				33				83
Debit related OTTI previously recognized for OTTI recovery during the period			2				3				3				3
Credit related OTTI previously recognized for securities sold during the period			—				—				—				(686	)
Decrease for realized amount of credit losses for which unrealized credit related OTTI was previously recognized			(51	)			(71	)			(115	)			(244	)
Ending balance of unrealized OTTI related to credit losses		$	722			$	934			$	722			$	934

On a cumulative basis, other-than-temporary impairment losses recognized in earnings by year of vintage were as follows:

 

Year of Vintage		June 30, 2014
		(In thousands)
Prior to 2005		$	7
2005			220
2007			495
		$	722

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,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands)
Proceeds from sales		$	—			$	—			$	388			$	6,420
Gross gains		$	—			$	—			$	301			$	1
Gross losses			—				—				—				(201	)
Net gain/(loss) on sales		$	—			$	—			$	301			$	(200	)

At June 30, 2014 and December 31, 2013, investment securities available for sale with a fair value of approximately $143.2 million and $162.8 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, 2014 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)
U.S. government sponsored and federal agency obligations		$	—			$	3,328			$	—			$	—			$	3,328
Corporate stock and bonds			—				—				—				6				6
Non-agency CMOs			—				—				2				5,854				5,856
Government sponsored agency mortgage-backed securities (1)			—				164				13,263				70,704				84,131
GNMA mortgage-backed securities			—				233				—				201,736				201,969
Total		$	—			$	3,725			$	13,265			$	278,300			$	295,290

 

(1)	Includes mortgage-backed securities and CMOs.

Note 5 - Loans Receivable

Loans receivable held for investment consist of the following:

 

		June 30, 2014				December 31, 2013
		(In thousands)
Residential		$	533,330			$	529,777
Commercial and industrial			16,002				21,591
Commercial real estate:
Land and construction			105,989				92,050
Multi-family			266,394				281,917
Retail/office			142,007				154,075
Other commercial real estate			156,246				174,313
Consumer:
Education			118,300				129,520
Other consumer			231,625				238,311
Total unpaid principal balance			1,569,893				1,621,554
Undisbursed loan proceeds(1)			(12,182	)			(10,322	)
Unamortized loan fees, net			(1,568	)			(1,722	)
Unearned interest			(5	)			(4	)
Total loan contra balances			(13,755	)			(12,048	)
Loans held for investment			1,556,138				1,609,506
Allowance for loan losses			(49,175	)			(65,182	)
Loans held for investment, net		$	1,506,963			$	1,544,324

 

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

 

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Residential Loans

At June 30, 2014, $533.3 million, or 34.0%, 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 were originated with up to 30-year maturities and terms which provide for annual increases or decreases of 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. 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, 2014, approximately $316.8 million, or 59.4%, 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 portion 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, Wisconsin Department of Veterans Affairs and the Federal Housing Administration. The right to service substantially all loans sold is retained.

At June 30, 2014, approximately $216.5 million, or 40.6%, 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, because of prepayments and due-on-sale clauses, such loans generally remain outstanding for a shorter period of time.

Commercial and Industrial Loans

The Corporation originates loans for commercial and business purposes, including issuing letters of credit. At June 30, 2014, the unpaid principal balance receivable of commercial and industrial loans amounted to $16.0 million, or 1.0%, of the total loans unpaid principal balance receivable. The commercial and industrial loan portfolio is comprised of loans for a variety of business purposes which are generally secured by equipment, machinery and other corporate assets. These loans generally have terms of seven years or less and interest rates that float in accordance with a designated published index. Substantially all 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 which include 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, 2014, $670.6 million of loans unpaid principal balance receivable were secured by commercial real estate, which represented 42.7% of the total loans unpaid principal balance. The origination of such loans is generally limited to the Corporation’s primary market area, concentrated in Wisconsin’s greater Madison, Fox Valley and Milwaukee regions. Loans are made in contiguous states when appropriate.

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 community-based residential facilities and senior housing. Although terms vary, commercial real estate loans generally have fixed interest rates, amortization periods of 15 to 30 years, as well as balloon payments of two to seven years.

 

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Consumer Loans

The Corporation offers consumer loans in order to provide a wider range of financial services to its customers. At June 30, 2014, $349.9 million, or 22.3%, of the total loans unpaid principal balance receivable consisted of consumer loans. Consumer loans consist of education loans, first and second mortgages, credit cards, vehicles and other unsecured personal loans. Consumer loans typically have higher interest rates than mortgage loans and 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 $118.3 million, or 7.5%, of the total loans unpaid principal balance receivable at June 30, 2014 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 nine 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. The origination of student loans was discontinued October 1, 2010 following the March 2010 law ending loan guarantees provided by the U.S. Department of Education. Although direct student loans, without a government guarantee, may be originated, risk-adjusted returns for these loans continue to be unattractive. Education loans may be sold to the U.S. Department of Education or to other investors. No education loans were sold during the three and six months ended June 30, 2014 or 2013.

The residential loans included in the consumer portfolio include both first and second mortgages and consist primarily of the Express loan product (the Bank’s expedited first mortgage refinance and home equity loan product). Express loans are available for owner occupied one- to two-family residential properties, with loan amounts up to $200,000, a fixed interest rate, up to 15 year amortization, low fees and rapid closing timeframes. 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 90% of appraised value of the property at the loan origination date. A fixed-rate home equity second mortgage term product is also offered.

Other consumer loans consist of credit cards, vehicle loans and other secured and unsecured loans made for a variety of consumer purposes. Credit is extended to Bank customers 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 net of our share of losses

Allowances for Loan Losses

The allowance for loan losses consists of general 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 general allowance component is based on historical loss experience adjusted for various qualitative factors. Loans graded substandard and below are individually examined to determine the appropriate loan loss reserve. In addition, reserves for unfunded commitments, letters of credit and repurchase of sold loans are maintained and classified in other liabilities.

For the quarter ended June 30, 2014, the Bank modified its general allowance methodology to increase the historical loss period from an eight to nine quarter historical look-back period with the intent to build to a 12 quarter look back period subsequent to June 30, 2014. The modification was done to reflect a more stable economic environment and

 

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to capture additional loss statistics considered reflective of the current portfolio. The impact to the allowance for loan losses at June 30, 2014 after implementing the above modification was a reduction of the required reserve of $381,000 as compared to the previous methodology. See the Company’s annual report on Form 10-K for the nine months ended December 31, 2013 for a full description of the allowance methodology.

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

 

		June 30, 2014				December 31, 2013
		(In thousands)
General reserve		$	33,633			$	35,844
Substandard reserve			10,040				6,225
Specific reserve			5,502				23,113
Total allowance for loan losses		$	49,175			$	65,182

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

 

		June 30, 2014				December 31, 2013
		(In thousands)
Pass		$	1,484,701			$	1,460,457
Special mention			2,693				24,203
Total pass and special mention rated loans			1,487,394				1,484,660
Substandard rated loans, excluding TDR accrual (1)			29,083				35,310
Troubled debt restructurings - accrual			11,249				33,087
Non-accrual			42,167				68,497
Total impaired loans			53,416				101,584
Total unpaid principal balance		$	1,569,893			$	1,621,554

 

(1)	Includes residential and consumer loans identified as substandard that are not necessarily on non-accrual.

 

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The following table presents activity in the allowance for loan losses by portfolio segment:

 

For the Three Months Ended:		Residential				Commercial and Industrial				Commercial Real Estate				Consumer				Total
		(In thousands)
June 30, 2014
Beginning balance		$	9,378			$	4,938			$	35,043			$	4,138			$	53,497
Provision			1,388				911				(3,383	)			1,084				—
Charge-offs			(566	)			(3,633	)			(1,141	)			(291	)			(5,631	)
Recoveries			125				380				651				153				1,309
Ending balance		$	10,325			$	2,596			$	31,170			$	5,084			$	49,175
June 30, 2013
Beginning balance		$	14,525			$	7,072			$	54,581			$	3,637			$	79,815
Provision			2,099				(974	)			(2,180	)			1,330				275
Charge-offs			(1,665	)			(411	)			(2,199	)			(907	)			(5,182	)
Recoveries			163				155				604				42				964
Ending balance		$	15,122			$	5,842			$	50,806			$	4,102			$	75,872

 

For the Six Months Ended:		Residential				Commercial and Industrial				Commercial Real Estate				Consumer				Total
		(In thousands)
June 30, 2014
Beginning balance		$	13,059			$	6,402			$	42,065			$	3,656			$	65,182
Provision			(1,428	)			373				(1,551	)			2,606				—
Charge-offs			(1,662	)			(4,955	)			(11,902	)			(1,435	)			(19,954	)
Recoveries			356				776				2,558				257				3,947
Ending balance		$	10,325			$	2,596			$	31,170			$	5,084			$	49,175
June 30, 2013
Beginning balance		$	12,174			$	6,591			$	62,269			$	2,727			$	83,761
Provision			6,296				99				(9,995	)			4,550				950
Charge-offs			(3,529	)			(1,135	)			(3,512	)			(3,320	)			(11,496	)
Recoveries			181				287				2,044				145				2,657
Ending balance		$	15,122			$	5,842			$	50,806			$	4,102			$	75,872

 

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The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method:

 

		Residential				Commercial and Industrial				Commercial Real Estate				Consumer				Total
		(In thousands)
June 30, 2014
Allowance for loan losses:
Associated with impaired loans		$	816			$	202			$	4,050			$	434			$	5,502
Associated with all other loans			9,509				2,394				27,120				4,650				43,673
Total		$	10,325			$	2,596			$	31,170			$	5,084			$	49,175
Loans:
Impaired loans individually evaluated		$	10,215			$	995			$	40,355			$	1,851			$	53,416
All other loans			523,115				15,007				630,281				348,074				1,516,477
Total		$	533,330			$	16,002			$	670,636			$	349,925			$	1,569,893
December 31, 2013
Allowance for loan losses:
Associated with impaired loans		$	2,375			$	1,745			$	18,516			$	477			$	23,113
Associated with all other loans			10,684				4,657				23,549				3,179				42,069
Total		$	13,059			$	6,402			$	42,065			$	3,656			$	65,182
Loans:
Impaired loans individually evaluated		$	19,060			$	2,314			$	77,047			$	3,163			$	101,584
All other loans			510,717				19,277				625,308				364,668				1,519,970
Total		$	529,777			$	21,591			$	702,355			$	367,831			$	1,621,554

At June 30, 2014, $53.4 million of unpaid principal balance of loans are deemed impaired which includes performing troubled debt restructurings. At December 31, 2013, impaired loans were $101.6 million. A loan is identified as impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement may not be collected and thus are placed on non-accrual status. Interest income on certain impaired loans is recognized on a cash basis.

A substantial portion of 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.

 

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The following table presents impaired loans segregated by loans with no specific allowance and loans with an allowance by class of loans. The carrying amounts represent the unpaid principal balance less the associated allowance. The interest income recognized column represents all interest income recorded either on a cash or accrual basis after the loan became impaired.

 

		Unpaid Principal Balance				Associated Allowance				Carrying Amount				Average Carrying Amount (1)				Year-to-Date Interest Income Recognized
		(In thousands)
June 30, 2014
With no specific allowance recorded:
Residential		$	5,555			$	—			$	5,555			$	6,114			$	63
Commercial and industrial			688				—				688				2,167				53
Land and construction			11,531				—				11,531				15,391				339
Multi-family			6,446				—				6,446				5,892				305
Retail/office			3,385				—				3,385				4,794				96
Other commercial real estate			8,425				—				8,425				9,110				347
Education			209				—				209				274				—
Other consumer			1,049				—				1,049				1,446				25
Subtotal			37,288				—				37,288				45,188				1,228
With an allowance recorded (2):
Residential		$	4,660			$	816			$	3,844			$	4,028			$	111
Commercial and industrial			307				202				105				775				26
Land and construction			7,875				3,585				4,290				5,199				114
Multi-family			451				95				356				350				7
Retail/office			1,339				250				1,089				1,284				6
Other commercial real estate			903				120				783				783				44
Education (3)			—				—				—				—				—
Other consumer			593				434				159				410				13
Subtotal			16,128				5,502				10,626				12,829				321
Total
Residential		$	10,215			$	816			$	9,399			$	10,142			$	174
Commercial and industrial			995				202				793				2,942				79
Land and construction			19,406				3,585				15,821				20,590				453
Multi-family			6,897				95				6,802				6,242				312
Retail/office			4,724				250				4,474				6,078				102
Other commercial real estate			9,328				120				9,208				9,893				391
Education (3)			209				—				209				274				—
Other consumer			1,642				434				1,208				1,856				38
		$	53,416			$	5,502			$	47,914			$	58,017			$	1,549

 

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		Unpaid Principal Balance				Associated Allowance				Carrying Amount				Average Carrying Amount (1)				Nine Months Ended December 31, 2013 Interest Income Recognized
		(In thousands)
December 31, 2013
With no specific allowance recorded:
Residential		$	3,751			$	—			$	3,751			$	4,032			$	43
Commercial and industrial			60				—				60				79				39
Land and construction			4,311				—				4,311				4,707				91
Multi-family			9,848				—				9,848				5,845				221
Retail/office			6,896				—				6,896				7,659				210
Other commercial real estate			9,216				—				9,216				9,737				456
Education			0				—				—				—				—
Other consumer			343				—				343				631				87
Subtotal			34,425				—				34,425				32,690				1,147
With an allowance recorded (2):
Residential		$	15,309			$	2,375			$	12,934			$	13,140			$	422
Commercial and industrial			2,254				1,745				509				658				44
Land and construction			20,418				7,512				12,906				15,193				252
Multi-family			14,312				3,693				10,619				6,286				228
Retail/office			9,347				6,925				2,422				4,948				128
Other commercial real estate			2,699				386				2,313				2,270				99
Education (3)			276				—				276				338				—
Other consumer			2,544				477				2,067				2,211				105
Subtotal			67,159				23,113				44,046				45,044				1,278
Total
Residential		$	19,060			$	2,375			$	16,685			$	17,172			$	465
Commercial and industrial			2,314				1,745				569				737				83
Land and construction			24,729				7,512				17,217				19,900				343
Multi-family			24,160				3,693				20,467				12,131				449
Retail/office			16,243				6,925				9,318				12,607				338
Other commercial real estate			11,915				386				11,529				12,007				555
Education (3)			276				—				276				338				—
Other consumer			2,887				477				2,410				2,842				192
		$	101,584			$	23,113			$	78,471			$	77,734			$	2,425

 

(1)	Calculated on a trailing 12 month basis for June 30, 2014, and a trailing 9 month basis for December 31, 2013.

(2)

Includes ratio-based allowance for loan losses of $0.7 million and $2.1 million associated with loans totaling $2.1 million and $12.5 million at June 30, 2014, and December 31, 2013, respectively, 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.

(3)

Excludes the guaranteed portion of education loans 90+ days past due with unpaid principal balance of $6,767 and $8,930 and average carrying amounts totaling $9,787 and $13,730 at June 30, 2014, and December 31, 2013, respectively, that are not considered impaired based on a guarantee provided by government agencies.

 

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The average recorded investment in impaired loans and interest income recognized on impaired loans follows:

 

						Interest Income Recognized												Interest Income Recognized
		Average Carrying Amount(1)				Three Months Ended				Six Months Ended				Average Carrying Amount(1)				Three Months Ended				Six Months Ended
						June 30, 2014												June 30, 2013
		(In Thousands)
Residential		$	10,142			$	65			$	174			$	26,643			$	250			$	604
Commercial and industrial			2,942				53				79				1,043				47				(11	)
Land and construction			20,590				260				453				26,820				128				71
Multi-family			6,242				2				312				22,297				305				433
Retail/office			6,078				37				102				16,775				13				(305	)
Other commercial real estate			9,893				185				391				29,188				321				472
Education			274				—				—				538				—				—
Other consumer			1,856				7				38				3,285				73				83
		$	58,017			$	609			$	1,549			$	126,589			$	1,137			$	1,347

 

(1)	The average carry amount was calculated on a trailing 12 month basis.

 

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The following is additional information regarding impaired loans:

 

		June 30, 2014				December 31, 2013
		(In thousands)
Carrying amount of impaired loans		$	47,914			$	78,471
Average carrying amount of impaired loans			58,017				77,734
Loans and troubled debt restructurings on non-accrual status			42,167				68,497
Troubled debt restructurings - accrual			11,249				33,087
Troubled debt restructurings - non-accrual (1)			21,405				29,346
Troubled debt restructurings valuation allowance			5,500				12,216
Loans past due ninety days or more and still accruing (2)			6,767				8,930

 

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

(2)	Representes the guaranteed portion of education loans 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.

Although the Corporation is currently not committed to lend any additional funds on impaired loans in accordance with the original terms of these loans, it is not legally obligated to, and will cautiously 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 2012 and 2013 and the three and six months ended June 30, 2014, as reflected in recently received appraisals. Currently, $80.2 million or approximately 97.2% of the unpaid principal balance of classified loans (i.e. loans risk rated as substandard, doubtful 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 corporate policy include situations in which the loan (i) is fully reserved; (ii) has a 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 corporate policy may not require updated appraisals for these loans, new appraisals may still be obtained. For example, 46% of the loans which do not require an updated appraisal either have had an appraisal within the last year or an appraisal is on order. If real estate values decline, the allowance for loan losses may increase as updated appraisals or other indications of a decrease in the value of collateral are received.

 

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The following table presents the aging of the recorded investment in past due loans by class of loans:

 

		Days Past Due
		30-59				60-89				90 or More				Total
		(In thousands)
June 30, 2014
Residential		$	1,691			$	328			$	3,315			$	5,334
Commercial and industrial			220				48				2,755				3,023
Land and construction			170				—				3,917				4,087
Multi-family			2,064				228				2,842				5,134
Retail/office			2,734				1,214				2,169				6,117
Other commercial real estate			262				2,020				1,352				3,634
Education			3,500				2,682				6,976				13,158
Other consumer			616				231				1,230				2,077
		$	11,257			$	6,751			$	24,556			$	42,564
December 31, 2013
Residential		$	1,287			$	564			$	8,897			$	10,748
Commercial and industrial			1,609				—				1,461				3,070
Land and construction			105				—				11,307				11,412
Multi-family			1,612				—				1,079				2,691
Retail/office			968				83				10,887				11,938
Other commercial real estate			184				506				3,785				4,475
Education			5,210				2,914				9,206				17,330
Other consumer			910				213				2,395				3,518
		$	11,885			$	4,280			$	49,017			$	65,182

Total delinquencies (loans past due 30 days or more) at June 30, 2014 were $42.6 million. The Corporation has experienced a significant reduction in delinquencies since December 31, 2013 primarily due to improving credit conditions and $7.7 million of loans moving to OREO. The Corporation has $6.8 million of education loans past due 90 days or more at June 30, 2014 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.

Credit Quality Indicators:

The Corporation groups commercial and industrial loans 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 following definitions are used 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. A subcategory of loans classified as pass are watch loans.

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.

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 warrants 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.

 

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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 a loss will be sustained 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 for 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.

The risk category of loans by class of loans, and based on the most recent analysis performed, is as follows:

 

		Pass				Special Mention				Substandard				Non-Accrual				Total Unpaid Principal Balance
		(In thousands)
June 30, 2014
Commercial and industrial		$	11,676			$	—			$	3,332			$	994			$	16,002
Commercial real estate:
Land and construction			83,101				70				3,972				18,846				105,989
Multi-family			258,307				—				1,838				6,249				266,394
Retail/office			131,315				1,019				5,679				3,994				142,007
Other			137,557				1,228				13,175				4,286				156,246
		$	621,956			$	2,317			$	27,996			$	34,369			$	686,638
Percent of total unpaid principal balance			90.6	%			0.3	%			4.1	%			5.0	%			100.0	%
December 31, 2013
Commercial and industrial		$	16,542			$	—			$	3,540			$	1,509			$	21,591
Commercial real estate:
Land and construction			57,221				75				10,025				24,729				92,050
Multi-family			255,741				465				22,053				3,658				281,917
Retail/office			130,966				2,967				5,777				14,365				154,075
Other			135,045				20,696				11,770				6,802				174,313
		$	595,515			$	24,203			$	53,165			$	51,063			$	723,946
Percent of total unpaid principal balance			82.3	%			3.3	%			7.3	%			7.1	%			100.0	%

 

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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:

 

		June 30, 2014												December 31, 2013
		Accrual (1)				Non-Accrual				Total Unpaid Principal Balance				Accrual				Non-Accrual				Total Unpaid Principal Balance
		(In thousands)
Residential		$	527,283			$	6,047			$	533,330			$	515,373			$	14,404			$	529,777
Consumer
Education (2)			118,091				209				118,300				129,244				276				129,520
Other consumer			230,083				1,542				231,625				235,557				2,754				238,311
		$	875,457			$	7,798			$	883,255			$	880,174			$	17,434			$	897,608

 

(1)	Accrual residential and consumer loans includes substandard rated loans including TDR-accrual.

(2)	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

Modifications of loan terms in a troubled debt restructuring (“TDR”) 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 at year end after the time in which 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:

 

		Three Months Ended June 30,
		2014												2013
Troubled Debt Restructurings (1)		Number of Modifications				Unpaid Principal Balance (at beginning of period)				Unpaid Principal Balance (2) (at period end)				Number of Modifications				Unpaid Principal Balance (at beginning of period)				Unpaid Principal Balance (2) (at period end)
		(Dollars in thousands)
Residential			5			$	775			$	546			$	—			$	—			$	—
Commercial and industrial			—				—				—				—				—				—
Land and construction			2				372				357				—				—				—
Multi-family			1				315				273				—				—				—
Retail/office			—				—				—				1				47				47
Other commercial real estate			—				—				—				1				98				98
Education			—				—				—				—				—				—
Other consumer			10				287				280				—				—				—
			18			$	1,749			$	1,456				2			$	145			$	145
		Six Months Ended June 30,
		2014												2013
Troubled Debt Restructurings (1)		Number of Modifications				Unpaid Principal Balance (at beginning of period)				Unpaid Principal Balance (2) (at period end)				Number of Modifications				Unpaid Principal Balance (at beginning of period)				Unpaid Principal Balance (2) (at period end)
		(Dollars in thousands)
Residential			10			$	1,294			$	1,284			$	—			$	—			$	—
Commercial and industrial			1				48				48				—				—				—
Land and construction			2				372				357				1				438				425
Multi-family			3				1,283				1,198				—				—				—
Retail/office			—				—				—				2				264				261
Other commercial real estate			2				251				257				3				681				679
Education			—				—				—				—				—				—
Other consumer			11				353				346				—				—				—
			29			$	3,601			$	3,490				6			$	1,383			$	1,365

 

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The following tables present the unpaid principal balance of loans modified in a troubled debt restructuring by class and by type of modification:

 

		Three Months Ended June 30, 2014
		Principal and Interest to Interest Only												Below Market Rate (4)
						Interest Rate Reduction
Troubled Debt Restructurings (1)(2)						To Below Market Rate				To Interest Only (3)								Other (5)				Total
		(In thousands)
Residential		$	176			$	163			$	—			$	—			$	207			$	546
Commercial and industrial			—				—				—				—				—				—
Land and construction			—				—				—				—				357				357
Multi-family			—				—				—				—				273				273
Retail/office			—				—				—				—				—				—
Other commercial real estate			—				—				—				—				—				—
Education			—				—				—				—				—				—
Other consumer			—				188				—				—				92				280
		$	176			$	351			$	—			$	—			$	929			$	1,456
		Three Months Ended June 30, 2013
		Principal and Interest to Interest Only
						Interest Rate Reduction								Below Market Rate (4)
Troubled Debt Restructurings (1)(2)						To Below Market Rate				To Interest Only (3)								Other (5)				Total
		(In thousands)
Residential		$	—			$	—			$	—			$	—			$	—			$	—
Commercial and industrial			—				—				—				—				—				—
Land and construction			—				—				—				—				—				—
Multi-family			—				—				—				—				—				—
Retail/office			—				47				—				—				—				47
Other commercial real estate			—				98				—				—				—				98
Education			—				—				—				—				—				—
Other consumer			—				—				—				—				—				—
		$	0			$	145			$	—			$	—			$	0			$	145

 

(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.

 

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		Six Months Ended June 30, 2014
		Principal and Interest to Interest Only												Below Market Rate (4)
						Interest Rate Reduction
Troubled Debt Restructurings (1)(2)						To Below Market Rate				To Interest Only (3)								Other (5)				Total
		(In thousands)
Residential		$	176			$	448			$	—			$	120			$	540			$	1,284
Commercial and industrial			—				—				—				—				48				48
Land and construction			—				—				—				—				357				357
Multi-family			—				—				—				925				273				1,198
Retail/office			—				—				—				—				—				—
Other commercial real estate			—				—				—				215				42				257
Education			—				—				—				—				—				—
Other consumer			—				254				—				—				92				346
		$	176			$	702			$	—			$	1,260			$	1,352			$	3,490
		Six Months Ended June 30, 2013
		Principal and Interest to Interest Only												Below Market Rate (4)
						Interest Rate Reduction
Troubled Debt Restructurings (1)(2)						To Below Market Rate				To Interest Only (3)								Other (5)				Total
		(In thousands)
Residential		$	—			$	—			$	—			$	—			$	—			$	—
Commercial and industrial			—				—				—				—				—				—
Land and construction			—				—				—				425				—				425
Multi-family			—				—				—				—				—				—
Retail/office			—				261				—				—				—				261
Other commercial real estate			540				139				—				—				—				679
Education			—				—				—				—				—				—
Other consumer			—				—				—				—				—				—
		$	540			$	400			$	—			$	425.00			$	0			$	1,365

 

(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.

 

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The following table presents loans modified in a troubled debt restructuring during the twelve months prior to the dates indicated, by portfolio segment, that subsequently defaulted (i.e.: 90 days or more past due following a modification) during the three and six months ended June 30, 2014 and June 30, 2013:

 

		Three Months Ended June 30,																Six Months Ended June 30,
		2014								2013								2014								2013
Troubled Debt Restructurings (1)		Number of Modified Loans				Unpaid Principal Balance (2) (at period end)				Number of Modified Loans				Unpaid Principal Balance (2) (at period end)				Number of Modified Loans				Unpaid Principal Balance (2) (at period end)				Number of Modified Loans				Unpaid Principal Balance (2) (at period end)
		(Dollars in thousands)																(Dollars in thousands)
Residential			—			$	—				—			$	—				—			$	—				—			$	—
Commercial and industrial			—				—				2				34				—				—				2				34
Land and construction			—				—				2				369				—				—				2				369
Multi-family			—				—				—				—				—				—				—				—
Retail/office			—				—				2				261				—				—				2				261
Other commercial real estate			—				—				5				1,029				—				—				5				1,029
Education			—				—				—				—				—				—				—				—
Other consumer			—				—				1				13				—				—				1				13
			—			$	—				12			$	1,706				—			$	—				12			$	1,706

 

(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.

Unfunded Commitments and Repurchase Loan Reserve

In addition to the allowance for loan losses reflected on the Consolidated Balance Sheets, a reserve is also provided for unfunded loan commitments and for the repurchase of previously sold loans. The reserve for unfunded loan commitments includes unfunded commitments to lend and commercial letters of credit. These reserves are classified in other liabilities on the Consolidated Balance Sheets. The balances of these reserves for the periods presented is as follows:

 

		Three months ended June 30,								Six months ended June 30,
		2014				2013				2014				2013
		(In thousands)
Reserve for unfunded commitment losses beginning balance		$	4,844			$	1,956			$	4,664			$	1,531
Provision for unfunded commitments			600				1,734				780				2,159
Ending reserve for unfunded commitment losses		$	5,444			$	3,690			$	5,444			$	3,690
Reserve for repurchased loans beginning balance		$	2,600			$	2,600			$	2,600			$	570
Provision for repurchased loans			(249	)			—				(249	)			2,030
Ending reserve for repurchased loans		$	2,351			$	2,600			$	2,351			$	2,600

The amount of the allowance for unfunded loan commitments is determined using the average reserve rate by risk rating that applies to the associated funded loan category multiplied by the unfunded commitment amount multiplied by an estimated utilization factor. The reserve also covers potential loss on letters of credit outstanding for which the Bank may be unable to recover the amount outstanding. At June 30, 2014, a liability of $5.4 million was required and reflects an increase due to increased balances of outstanding commitments most of which are construction related credits. In addition, $2.4 million is a specific reserve related to one outstanding letter of credit currently in litigation.

 

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The amount of the reserve for repurchased loans is determined using the serviced portfolio balances multiplied by historical and expected loss rates to provide for the probable losses related to sold mortgage loans. The reserve declined $249,000 during both the three and six month periods ended June 30, 2014 compared to zero and $2.0 million during the three and six months ended June 30, 2013, respectively. Total expense incurred for investor loss reimbursements including any provision recorded or reserve released was ($248,000) and ($86,000) for the three and six months ended June 30, 2014, respectively and $371,000 and $3.2 million for the three and six months ended June 30, 2013, respectively. Losses may result from the repurchase of loans or indemnification of loss incurred upon foreclosure and disposition of related collateral. The analysis of the reserve at June 30, 2014 required a liability of $2.4 million.

Pledged Loans

At June 30, 2014 and December 31, 2013, residential, multi-family, education and other consumer loans receivable with unpaid principal of approximately $724.4 million and $744.1 million were pledged to secure borrowings and for other purposes as permitted or required by law. Certain real-estate related loans are pledged as collateral for FHLB of Chicago borrowings. See Note 9.

Related Party Loans

In the ordinary course of business, the Bank has granted loans to principal officers and directors and their affiliates with outstanding balances amounting to $73,000 and $83,000 at June 30, 2014 and December 31, 2013, respectively. During the six months ended June 30, 2014, principal additions were $3,000 and principal payments totaled $13,000.

Note 6 – Other Real Estate Owned

Real estate acquired by foreclosure or by deed in lieu of foreclosure as well as other repossessed assets (OREO) are held for sale and are initially recorded at fair value less a discount for estimated selling costs 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 the carrying value exceeds the fair value less estimated selling costs. Costs relating to the development and improvement of the property may be capitalized, generally those greater than $10,000; holding period costs and subsequent changes to the valuation allowance are charged to OREO expense, net included in non-interest expense. Incremental valuation adjustments may be recognized in the Statements of Operations if, in the opinion of management, such additional losses are deemed probable.

 

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

 

		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands)
Balance at beginning of period		$	62,140			$	84,342			$	63,460			$	90,000
Additions			3,321				3,261				7,659				16,423
Capitalized improvements			0				52				28				352
OREO valuation adjustments, net (1)			(1,824	)			(2,368	)			(2,279	)			(11,603	)
Sales			(7,467	)			(17,046	)			(12,698	)			(26,931	)
Balance at end of period		$	56,170			$	68,241			$	56,170			$	68,241

 

(1)	Includes adjustments to the OREO reserve for probable losses and property writedowns.

The balances at end of period above are net of a valuation allowance of $24.5 million at June 30, 2014 and $35.4 million at June 30, 2013, 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								For the Six Months Ended June 30
		2014				2013				2014				2013
		(In thousands)
Balance at beginning of period		$	29,653			$	36,009			$	30,842			$	31,128
Valuation adjustments (1)			1,824				2,368				2,279				11,603
Sales			(6,962	)			(2,929	)			(8,606	)			(7,283	)
Balance at end of period		$	24,515			$	35,448			$	24,515			$	35,448

 

(1)	Includes adjustments to the OREO reserve for probable losses and property writedowns.

Net OREO expense consisted of the following components:

 

		Three Months Ended June 30								Six Months Ended June 30
		2014				2013				2014				2013
		(In thousands)
Valuation adjustments		$	1,824			$	2,368			$	2,279			$	11,603
Foreclosure cost expense			187				557				331				1,067
Expenses from operations, net			256				1,364				842				3,878
OREO expense, net		$	2,267			$	4,289			$	3,452			$	16,548

Note 7 - Mortgage Servicing Rights

Mortgage servicing rights (MSRs) are recorded 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. MSRs are assessed for impairment using a discounted cash flow model provided by a third party that is based on current market assumptions at the end of each reporting period. For purposes of measuring impairment, 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.

 

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Accounting for MSRs is based on the amortization method. Under this 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.

Information regarding the Corporation’s mortgage servicing rights is as follows:

 

		Three Months Ended June 30								Six Months Ended June 30
		2014				2013				2014				2013
		(In thousands)
Balance at beginning of period		$	22,341			$	24,235			$	23,041			$	24,348
Additions			353				1,383				599				3,036
Amortization			(922	)			(1,747	)			(1,868	)			(3,513	)
Balance at end of period - before valuation allowance			21,772				23,871				21,772				23,871
Valuation allowance			(843	)			(1,153	)			(843	)			(1,153	)
Balance at end of period		$	20,929			$	22,718			$	20,929			$	22,718

 

		As of June 30,
		2014				2013
Fair value at the end of the period		$	21,588			$	23,372
Key assumptions:
Weighted average discount rate			11.98	%			12.17	%
Weighted average prepayment speed			8.63	%			9.08	%

The projections of amortization expense for mortgage servicing rights set forth below are based on asset balances as of June 30, 2014 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)
Six months ended June 30, 2014		$	1,868
Estimate for the year ended December 31,
2014		$	2,177
2015			3,919
2016			3,135
2017			2,508
2018			2,007
Thereafter			8,026
Total			21,772

The unpaid principal balance of mortgage loans serviced for others is not included in the Consolidated Balance Sheets. The unpaid principal of mortgage loans serviced for others was approximately $2.59 billion at June 30, 2014 and $2.71 billion at December 31, 2013.

 

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Loans intended to be sold are originated in accordance with specific criteria established by the investor agencies – these are known as “conforming loans”. During the sale of these loans, certain representations and warranties are made that the loans conform to these previously established underwriting standards. In the event that any of these representations and warranties or standards are found to be out of compliance, the Corporation may be responsible for repurchasing the loan at the unpaid principal balance or indemnifying the buyer against loss related to that loan.

Note 8 – Deposits

Deposits are summarized as follows:

 

		June 30, 2014								December 31, 2013
		Carrying Amount				Weighted Average Rate				Carrying Amount				Weighted Average Rate
		(Dollars in thousands)
Non-interest-bearing checking		$	276,829				—	%		$	259,926				—	%
Interest-bearing checking			286,268				0.05				301,956				0.07
Total checking accounts			563,097				0.03				561,882				0.04
Money market accounts			461,114				0.19				468,461				0.19
Regular savings			316,196				0.10				293,159				0.10
Advance payments by borrowers for taxes and insurance			40,008				0.19				822				0.21
Certificates of deposit:
0.00% to 0.99%			405,937				0.32				457,407				0.33
1.00% to 1.99%			71,293				1.27				67,762				1.28
2.00% to 2.99%			15,595				2.37				16,116				2.37
3.00% to 3.99%			—				—				7,310				3.59
4.00% and above			—				—				2,374				4.24
Total certificates of deposit			492,825				0.52				550,969				0.57
Total deposits		$	1,873,240				0.21	%		$	1,875,293				0.24	%

Annual maturities of certificates of deposit outstanding at June 30, 2014 are summarized as follows:

 

		Amount
		(In thousands)
Matures During Year Ending December 31:
2014		$	174,569
2015			196,475
2016			64,571
2017			28,442
2018			21,207
2019			7,561
Total		$	492,825

 

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At June 30, 2014 and December 31, 2013, certificates of deposit with balances greater than or equal to $100,000 totaled $78.2 million and $88.7 million, respectively.

The Bank has entered into agreements with certain brokers that will provide deposits obtained from their customers at specified interest rates for an identified fee, or so called “brokered deposits.” The Bank had no brokered deposits at June 30, 2014 and December 31, 2013. There were no out of network certificates of deposit at June 30, 2014 and December 31, 2013. These deposits, which are not considered brokered deposits, are opened via internet listing services and are kept within FDIC insured balance limits.

Note 9 – Other Borrowed Funds

Other borrowed funds consist of the following:

 

				June 30, 2014								December 31, 2013
		Matures During Year Ending December 31,		Amount				Weighted Average Rate				Amount				Weighted Average Rate
		(Dollars in thousands)
FHLB advances		2018		$	10,000				2.33	%		$	10,000				2.33	%
Repurchase agreements					3,540				0.10				2,636				0.10
Long term lease obligation					241				2.46				241				2.46
				$	13,781				1.76	%		$	12,877				1.88	%

FHLB of Chicago Advances

The Bank pledges certain loans that meet underwriting criteria established by the Federal Home Loan Bank of Chicago (“FHLB of Chicago”) as collateral for outstanding advances. The unpaid principal balance of loans pledged to secure FHLB of Chicago borrowings totaled $644.5 million and $659.4 million at June 30, 2014 and December 31, 2013, respectively. The FHLB of Chicago borrowings are also collateralized by mortgage-related securities totaling $110.2 million and $122.2 million at June 30, 2014 and December 31, 2013, respectively. At June 30, 2014, there were no FHLB of Chicago borrowings with call features that may be exercised by the FHLB of Chicago.

Credit Agreement

On September 27, 2013, pursuant to the Plan of Reorganization, we satisfied all of our obligations under the Credit Agreement through a cash payment to the Lenders of $49.0 million (plus expense reimbursement as contemplated by the Credit Agreement) and the Credit Agreement was terminated.

Note 10 – 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 bank 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 tier 1 leverage, tier 1 risk-based and total risk-based capital. Under standard regulatory guidelines, a bank must have a total risk-based capital ratio of 8% or greater to be considered “adequately capitalized.”

The following table summarizes the Bank’s capital ratios to be considered adequately or well capitalized under standard regulatory guidelines:

 

										Minimum Required
		Actual								To be Adequately Capitalized								To be Well Capitalized
		Capital				Ratio				Capital				Ratio				Capital				Ratio
		(Dollars in thousands)
June 30, 2014
Tier 1 leverage (1)		$	206,272				9.75	%		$	84,658				4.00	%		$	105,823				5.00	%
Tier 1 risk-based capital (2)			206,272				16.12				51,194				4.00				76,792				6.00
Total risk-based capital (3)			222,747				17.40				102,389				8.00				127,986				10.00
December 31, 2013
Tier 1 leverage (1)		$	201,995				9.60	%		$	84,170				4.00	%		$	105,212				5.00	%
Tier 1 risk-based capital (2)			201,995				15.77				51,226				4.00				76,839				6.00
Total risk-based capital (3)			218,668				17.07				102,452				8.00				128,065				10.00

 

(1)	Tier 1 capital divided by adjusted total assets.

(2)	Tier 1 capital divided by total risk-weighted assets.

(3)	Total risk-based capital divided by total risk-weighted assets.

The following table presents the components of the Bank’s regulatory capital:

 

		June 30, 2014				December 31, 2013
		(In thousands)
Stockholders’ equity of the Bank		$	205,922			$	196,469
Less: Disallowed servicing assets			(1,500	)			(1,096	)
Accumulated other comprehensive loss			1,850				6,622
Tier 1 capital			206,272				201,995
Plus: Allowable allowance for loan losses			16,475				16,673
Total risk-based capital		$	222,747			$	218,668

The Bank may not declare or pay a cash dividend if such declaration and payment would violate regulatory requirements.

Note 11 – Offsetting Assets and Liabilities

ASC 210-20-50 – Disclosures of Offsetting Assets and Liabilities, requires entities to provide disclosures of both gross information and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement.

 

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The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards (IFRS).

Offsetting, otherwise known as netting, takes place when entities present their rights and obligations to each other as a net amount in their statement of financial condition. The Company has certain assets and liabilities on the Consolidated Balance Sheets which could be subject to the right of setoff and related arrangements associated with financial instruments and derivatives. Derivative instruments reported are used as part of a risk management strategy to address exposure to changes in interest rates inherent in the Company’s origination and sale of certain residential mortgages into the secondary market, as presented in Note 13 – Derivative Financial Instruments. A repurchase agreement is a transaction that involves the “sale” of financial assets by one party to another, subject to an agreement by the “seller” to repurchase the assets at a specified date or in specified circumstances.

The following table reflects the gross and net amounts of such assets and liabilities:

 

		Gross Amounts of Recognized Assets or Liabilities				Gross Amounts Offset in the Consolidated Balance Sheets				Net Amount of Assets Presented in the Consolidated Balance Sheets
As of June 30, 2014
Assets
Interest rate commitments		$	179			$	—			$	179
Forward sale contracts			23				(23	)			—
Liabilities
Interest rate commitments			9				—				9
Forward sale contracts			130				(23	)			107
Repurchase Agreements			3,540				—				3,540
As of December 31, 2013
Assets
Interest rate commitments		$	40			$	—			$	40
Forward sale contracts			33				(1	)			32
Liabilities
Interest rate commitments			16				—				16
Forward sale contracts			1				(1	)			—
Repurchase Agreements			2,636				—				2,636

Note 12 – 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.

 

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

 

		June 30, 2014				December 31, 2013
		(In thousands)
Commitments to extend credit		$	82,532			$	26,054
Unused commitments			786				657
Unused lines of credit:
Home equity			113,941				109,414
Credit cards			22,711				22,751
Commercial			104,052				54,840
Letters of credit			17,857				17,131
Credit enhancement under the Federal Home Loan Bank of Chicago Mortgage Partnership Finance Program			15,877				15,877

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, 2014, the Corporation has $5.4 million of reserves on unfunded commitments, unused lines of credit, letters of credit and $2.4 million of reserves for repurchase of sold loans classified in other liabilities. The Corporation intends to fund commitments through current liquidity.

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 retained a secondary credit loss exposure in the amount of $15.9 million at June 30, 2014 related to approximately $191.9 million of residential mortgage loans that the Corporation has originated and is still outstanding as agent for the FHLB of Chicago. Under the credit enhancement, the FHLB of Chicago is liable for losses on loans up to one percent of the original delivered loan balances in each pool up to the point the credit enhancement is reset. After the credit enhancement resets, the FHLB of Chicago loss contingency could be reduced depending upon losses experienced and loan balances. The Corporation is then liable for losses over and above the FHLB of Chicago first loss 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.

Other loans sold to investors with recourse to the Corporation met the underwriting standards of the investor and the Corporation at the time of origination. In the event of default by the borrower, the investor may resell the loans to the Corporation at par value. As the Corporation expects relatively few such loans to become delinquent, the total amount of loans sold with recourse does not necessarily represent future cash requirements. Collateral obtained on such loans consists primarily of single-family residences. The unpaid principal balance of loans repurchased from investors totaled $469,000 and $648,000 for the three and six months ended June 30, 2014 and $228,000 for each of the three and six month periods ended June 30, 2013. Alternatively, investors make requests to be made whole on a loan whereby the property has been disposed of at a loss. The related expense excluding the reserves for repurchased loans was $1,000 and $163,000 for the three and six months ended June 30, 2014 and $371,000 and $1.2 million for the three and six months ended June 30, 2013.

 

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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.

We are a defendant in a pending lawsuit captioned Village of Kronenwetter v. AnchorBank, fsb, Marathon County, Wisconsin, Case No. 11-CV-1370, which is an action brought by the Village of Kronenwetter on November 14, 2011 to enforce and collect on a $4.4 million letter of credit issued by the Bank in support of the development of a mixed use TIF development in the Village of Kronenwetter, Wisconsin. The complaint alleges that the Bank wrongfully refused to honor a full draw on the letter of credit and that the developer failed to notify the plaintiff of the renewal of the letter of credit or to renew the letter of credit within the time limitations set forth in the development agreement. A specific reserve for loss on unfunded loan commitments was established at June 30, 2013 in the amount of $2.4 million due to a shortfall in the value of the residential real estate development supporting the letter of credit, $1.7 million of which was recorded during the quarter ended June 30, 2013. The specific reserve balance at June 30, 2014 remained at $2.4 million.

We are the plaintiff/counterclaim defendant in a pending lawsuit captioned AnchorBank, fsb v. Henriette McLean et al., Dane County, Wisconsin, Case No. 13-CV-811. The Bank is seeking to enforce personal guarantees executed by McLean related to amounts borrowed by Mineral Point Road Holdings, LLC (“MPRH”). At the time of the commencement of the lawsuit, March 7, 2013, McLean owed the Bank $363,302 under the guarantees. As a result of the recent sale of real estate owned by MPRH, the amount of the debt is now $300,127. The Bank has the right to obtain its attorneys’ fees incurred in collecting on the guarantees if it prevails in the lawsuit. On January 27, 2014, McLean filed a 196-paragraph Counterclaim against the Bank. McLean alleges various misconduct by the Bank related to its loans to MPRH and the procurement of her guarantees. Most of the counterclaims are based upon alleged misrepresentations and/or misrepresentations by omission. McLean is seeking the return of the $182,629 she paid to the Bank in 2012 under her guarantees, treble damages, and punitive damages. McLean has also filed a third-party complaint seeking contribution/indemnity from Joseph Gallina (the managing member of MPRH) and various entities controlled by Gallina.

Note 13 – 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 (the “pipeline”), as well as on the portfolio of funded mortgages not yet sold (the “warehouse”). 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.

 

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Derivative financial instruments are summarized as follows:

 

				June 30, 2014								December 31, 2013
		Balance Sheet Location		Notional Amount				Estimated Fair Value				Notional Amount				Estimated Fair Value
				(In thousands)
Derivative assets:
Interest rate lock commitments (1)		Other assets		$	16,142			$	164			$	3,863			$	37
Unused commitments (2)		Other assets			786				15				369				3
Forward contracts to sell mortgage loans (3)		Other assets			8,000				23				8,000				33
Derivative liabilities:
Interest rate lock commitments (1)		Other liabilities			3,901				9				2,172				12
Unused commitments (2)		Other liabilities			—				—				288				4
Forward contracts to sell mortgage loans (3)		Other assets			16,000				130				1,000				1

 

(1)

Interest rate lock commitments include $8.8 million and $1.5 million of commitments not yet approved in the credit underwriting process at June 30, 2014 and December 31, 2013, respectively, yet represent potential interest rate risk exposure to the extent of those mortgage loan applications eventually approved for funding.

(2)	The Corporation recognizes fair value of unused commitments held for trading which consists of closed residential real estate loans in recission at period end.

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

Net gains (losses) included in the Consolidated Statements of Operations related to derivative financial instruments, recognized in net gain on sale of loans, are summarized as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands)
Interest rate lock commitments		$	36			$	(1,123	)		$	156			$	(1,564	)
Unused commitments		$	15			$	(226	)		$	(11	)		$	(226	)
Forward contracts to sell mortgage loans			(304	)			2,529				(330	)			2,396
Total		$	(253	)		$	1,180			$	(185	)		$	606

Note 14 - 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, various valuation methods are used including market, income and cost approaches. Assumptions that market participants would use in pricing the asset or liability are utilized in these valuation methods, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs may 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.

 

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•

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 by the valuation hierarchy (as described above):

 

		Level 1				Level 2				Level 3				Total
		(In Thousands)
June 30, 2014
Financial assets
Investment securities available for sale:
U.S. government sponsored and federal agency obligations		$	—			$	3,328			$	—			$	3,328
Corporate stock and bonds			6				—				—				6
Non-agency CMOs			—				—				5,856				5,856
Government sponsored agency mortgage-backed securities			—				84,131				—				84,131
GNMA mortgage-backed securities			—				201,969				—				201,969
Loans held for sale			—				5,261				—				5,261
Other assets:
Interest rate lock commitments			—				164				—				164
Unused commitments			—				15				—				15
Forward contracts to sell mortgage loans			—				23				—				23
Total		$	6			$	294,891			$	5,856			$	300,753
Financial liabilities
Other liabilities:
Interest rate lock commitments		$	—			$	9			$	—			$	9
Unused commitments			—				—				—				—
Forward contracts to sell mortgage loans			—				130				—				130
Total		$	—			$	139			$	—			$	139

 

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		Level 1				Level 2				Level 3				Total
		(In Thousands)
December 31, 2013
Financial assets
Investment securities available for sale:
U.S. government sponsored and federal agency obligations		$	—			$	3,376			$	—			$	3,376
Corporate stock and bonds			355				—				—				355
Non-agency CMOs			—				—				6,208				6,208
Government sponsored agency mortgage-backed securities			—				50,158				—				50,158
GNMA mortgage-backed securities			—				217,775				—				217,775
Loans held for sale (1)			—				3,085				—				3,085
Other assets:
Interest rate lock commitments			—				37				—				37
Unused commitments			—				3				—				3
Forward contracts to sell mortgage loans			—				33				—				33
Total		$	355			$	274,467			$	6,208			$	281,030
Financial liabilities
Other liabilities:
Interest rate lock commitments		$	—			$	12			$	—			$	12
Unused commitments			—				4				—				4
Forward contracts to sell mortgage loans			—				1				—				1
Total		$	—			$	17			$	—			$	17

 

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

 

		June 30, 2014								Weighted Average				December 31, 2013								Weighted Average
		From				To								From				To
Coupon rate			1.6	%			4.6	%			2.4	%			1.6	%			4.6	%			2.4	%
Duration (in years)			1.0				6.4				3.9				1.1				5.7				3.6
PSA prepayment speed			147				374				214				128				458				346

The Corporation had 99.1% of its non-agency CMOs valued by an independent pricing service that used a discounted cash flow model that incorporates inputs considered Level 3 by the accounting guidance.

 

		June 30, 2014								Weighted Average				December 31, 2013								Weighted Average
		From				To								From				To
Observable inputs:
30 to 59 day delinquency rate			2.0	%			4.9	%			3.1	%			1.6	%			5.8	%			4.0	%
60 to 89 day delinquency rate			0.3				2.1				1.2				0.8				2.5				1.9
90 plus day delinquency rate			3.9				8.1				6.1				4.6				9.9				6.5
Loss severity			52.6				64.0				57.9				52.0				68.5				57.1
Coupon rate			5.0				6.0				5.5				5.0				6.0				5.5
Current credit support			—				3.9				—				—				4.3				—
Unobservable inputs:
Month 1 to month 24 constant default rate			5.6				12.2				8.5				5.3				11.6				8.2
Discount rate			4.0				6.5				6.1				4.0				7.0				6.6

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.

 

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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,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands)
Non-agency CMOs
Beginning balance		$	6,041			$	7,549			$	6,208			$	14,158
Total realized/unrealized gains (losses):
Included in earnings			—				1				—				(198	)
Included in other comprehensive income			76				114				132				972
Included in earnings as unrealized other-than-temporary impairment			(12	)			—				(33	)			(83	)
Included in earnings upon payoff of securities for which other-than-temporary impairment was previously recognized			—				—				—				—
Included in earnings as realized other-than-temporary impairment			49				68				112				241
Principal repayments			(298	)			(551	)			(563	)			(1,489	)
Sales							—				—				(6,420	)
Ending balance		$	5,856			$	7,181			$	5,856			$	7,181

There were no transfers in or out of Levels 1, 2 or 3 during the three and six months ended June 30, 2014 or 2013. The Corporation’s policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria changes and result in transfers between levels.

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 Sheets by caption and by level within the fair value hierarchy:

 

		Level 1				Level 2				Level 3				Total
		(In thousands)
June 30, 2014
Impaired loans, with an allowance recorded, net		$	—			$	—			$	10,626			$	10,626
Mortgage servicing rights			—				—				7,766				7,766
Other real estate owned			—				—				56,170				56,170
Total assets at fair value		$	—			$	—			$	74,562			$	74,562
December 31, 2013
Impaired loans, with an allowance recorded, net		$	—			$	—			$	44,046			$	44,046
Mortgage servicing rights			—				—				6,448				6,448
Other real estate owned			—				—				63,460				63,460
Total assets at fair value		$	—			$	—			$	113,954			$	113,954

 

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The significant inputs for those assets measured at fair value on a nonrecurring basis are as follows:

 

		June 30, 2014
		Method		Inputs
Impaired loans, with an allowance recorded, net		Appraised Values		External appraised values-adjustments made to values due to management factors including age of appraisal, age of comparables, known changes in the market and in the collateral and selling and commission cost of 15% to 35%.
Mortgage servicing rights		Discounted Cash Flow		Weighted average prepayment speed 8.63%; weighted average discount rate 11.98%.
Other real estate owned		Appraised Values		External appraised values less selling and commission cost of 15% to 35%.

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.

Mortgage servicing rights (MSR) are recorded as an asset when loans are sold to third parties with servicing rights retained. Mortgage servicing rights are 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 non-interest expense as an impairment loss.

Critical assumptions used in the MSR 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 11.5% to 25.0% as well as portfolio weighted average prepayment speeds of 2.9% to 59.9% annual CPR. Many of these assumptions are subjective and involve a high degree 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 subject to discounting and is therefore considered a Level 3 measurement.

 

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Fair Value Summary

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. Results from these 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 held for investment: 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 that are not included with impaired loans in the preceding section titled Fair Value on a Nonrecurring Basis 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 rates 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.

Other borrowed funds: The fair value of FHLB advances and repurchase agreements 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, 2014 and December 31, 2013.

 

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

 

		June 30, 2014								December 31, 2013
		Carrying Amount				Fair Value				Carrying Amount				Fair Value
		(In thousands)
Financial assets:
Cash and cash equivalents		$	177,347			$	177,347			$	143,396			$	143,396
Investment securities available for sale			295,290				295,290				277,872				277,872
Loans held for sale			5,261				5,261				3,085				3,085
Loans held for investment			1,506,963				1,463,279				1,544,324				1,488,677
Mortgage servicing rights			20,929				21,588				22,294				23,553
Federal Home Loan Bank stock			11,940				11,940				11,940				11,940
Accrued interest receivable			7,640				7,640				8,216				8,216
Interest rate lock commitments			164				164				37				37
Unused commitments			15				15				3				3
Forward contracts to sell mortgage loans (1)			23				23				33				33
Financial liabilities:
Non-maturity deposits			1,380,415				1,380,415				1,324,324				1,324,324
Deposits with stated maturities			492,825				492,263				550,969				549,668
Other borrowed funds			13,781				14,076				12,877				13,121
Accrued interest payable—borrowings			19				19				22				22
Accrued interest payable—deposits			374				374				393				393
Interest rate lock commitments			9				9				12				12
Unused commitments			—				—				4				4
Forward contracts to sell mortgage loans (1)			130				130				1				1

Note 15 – 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 net operating loss (NOL) carryforwards and deductible temporary differences, the largest of which relates to our allowance for loan losses. For income tax purposes, only net charge-offs on uncollectible loans 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 cumulative losses in the past several years as well as general business and economic trends.

At June 30, 2014 and December 31, 2013, 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 prior fiscal years caused by the significant loss provisions associated with the loan portfolio. Therefore, a valuation allowance of $116.1 million and $119.8 million at June 30, 2014 and December 31, 2013, respectively, was recorded to offset net deferred tax assets.

 

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The significant components of deferred tax assets (liabilities) are as follows:

 

		June 30, 2014				December 31, 2013
		(In thousands)
Deferred tax assets:
Allowance for loan losses		$	19,728			$	27,193
OREO valuation allowance and other loss reserves			13,598				15,026
Federal NOL carryforwards			72,312				66,359
State NOL carryforwards			16,793				15,710
Unrealized securities losses, net			742				2,657
Other			2,670				3,154
Total deferred tax assets			125,843				130,099
Valuation allowance			(116,071	)			(119,780	)
Adjusted deferred tax assets			9,772				10,319
Deferred tax liabilities:
FHLB stock dividends			(833	)			(833	)
Mortgage servicing rights			(8,397	)			(8,944	)
Other			(542	)			(542	)
Total deferred tax liabilities			(9,772	)			(10,319	)
Net deferred tax assets		$	—			$	—

The Corporation is subject to U.S. federal income tax as well as income tax of various state jurisdictions. The tax years 2010-2013 remain open to examination by the Internal Revenue Service and certain state jurisdictions while the years 2009-2013 remain open to examination by certain other state jurisdictions.

The Corporation recognizes any interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2014 and December 31, 2013, the Corporation has not recognized any accrued interest and penalties related to uncertain tax positions.

Note 16 – Earnings Per Share

Basic earnings per share for the three and six months ended June 30, 2014 and 2013 have been determined by dividing net income (loss) available to common equity for the respective periods by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net loss available to common equity 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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The computation of earnings per share is as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands, except per share data)
Numerator:
Numerator for basic and diluted earnings per share - income (loss) available to common stockholders		$	2,607			$	(8,945	)		$	4,537			$	(26,470	)
Denominator:
Denominator for basic earnings per share - weighted average shares			9,050				21,247				9,050				21,247
Effect of dilutive securities:
Employee stock options			—				—				—				—
Denominator for diluted earnings per share - weighted average shares			9,050				21,247				9,050				21,247
Basic earnings (loss) per common share		$	0.29			$	(0.42	)		$	0.50			$	(1.25	)
Diluted earnings (loss) per common share		$	0.29			$	(0.42	)		$	0.50			$	(1.25	)

 

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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” or the “Company”) and its wholly-owned subsidiaries, AnchorBank fsb (the “Bank”) and Investment Directions Inc. (“IDI”), 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.

On December 18, 2013, the Board approved the change of the Company’s fiscal year end from March 31 to December 31, beginning with December 31, 2013. References to any of the Company’s previous fiscal years mean the fiscal years ended on March 31. This quarterly report on Form 10-Q includes results for the year to date period beginning on January 1, 2013 through June 30, 2013 which have not been previously disclosed.

EXECUTIVE OVERVIEW

Financial Results

Results as of and for the quarter ending June 30, 2014 include:

 

•

Basic and diluted earnings per share and earnings per share were $0.29 for the three months ended June 30, 2014, compared to basic and diluted loss per share available to common equity of ($0.42) for the same period in 2013;

 

•

Net income and net income available to common equity was $2.6 million for the three months ended June 30, 2014 compared to a net loss of $5.4 million or $8.9 million net loss available to common equity for the prior year period;

 

•

The net interest margin increased 1.18% to 3.51% for the quarter ended June 30, 2014 from 2.33% in the prior year period largely due to lower average balances and rates paid on borrowings. Average balances declined due to the settlement of the credit agreement (credit agreement with U.S. Bank) and prepayments of Federal Home Loan Bank of Chicago (“FHLB of Chicago”) borrowings;

 

•

Loans held for investment (net of the allowance for loan losses) declined $53.4 million, or 3.3%, since December 31, 2013 primarily due to repayments outpacing loan originations for a net decline of $54.1 million. The allowance for loan losses (ALLL) declined $16.0 million since December 31, 2013 and $7.7 million of loans were transferred to other real estate owned;

 

•

Total non-performing loans decreased $26.3 million, or 38.4%, to $42.2 million at June 30, 2014 from $68.5 million at December 31, 2013;

 

•

Total non-performing assets (total non-performing loans and other real estate owned) decreased $33.6 million, or 25.5%, to $98.3 million at June 30, 2014 from $132.0 million at December 31, 2013, as the Bank continues its efforts to reduce problem asset levels.

 

•

Deposits decreased $2.1 million, less than one percent, since December 31, 2013 primarily due to runoff of time deposits of $58.1 million partially offset by increases in regular savings balances of $23.0 million and seasonal increases in advance payments of $39.2 million;

 

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•

The Bank was well capitalized as of June 30, 2014. Total risk-based capital ratio was 17.40% as of June 30, 2014, compared to 17.07% at December 31, 2013. Tier 1 capital was 9.75% as of June 30, 2014, compared to 9.60% at December 31, 2013.

 

•

No provision for loan losses was recorded for the three months ended June 30, 2014, a decrease from the $275,000 for the three months ended June 30, 2013; and

 

•

Delinquencies (loans past due 30 days or more) decreased $22.6 million, or 34.7%, to $42.6 million at June 30, 2014 from $65.2 million at December 31, 2013.

Termination of Orders to Cease and Desist

The Bank’s primary regulator is the Office of the Comptroller of the Currency (“OCC”). The Federal Reserve is the primary regulator of the Corporation. 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 “C&D Orders”). On August 31, 2010, a Prompt and Corrective Action Directive (“PCA Directive”) was issued for the Bank.

The Corporation Order required the Corporation to notify, and in certain cases to obtain the permission of, the Federal Reserve prior to making dividends or capital distributions, incurring debt, making changes to or entering into contracts with directors or executive officers.

The Bank Order required the Bank to notify, or in certain cases obtain the permission of, the OCC prior to increases above a certain threshold in total assets, entering into brokered deposits, making changes to or entering into contracts with directors or executives officers, entering into certain transactions with affiliates or entering into third-party contracts outside the normal course of business and to meet and maintain both a core capital ratio and a total risk-based capital ratio.

On April 2, 2014, the Bank was notified that the Bank Order and the PCA Directive were terminated. On July 31, 2014, the Corporation was notified that the Corporation Order was terminated.

 

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Credit Highlights

The Corporation has continued to see improvement in early stage and overall delinquencies during the past two years. 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, 2014, 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 (“TDRs”)) were $42.2 million, a decline of $26.3 million from the $68.5 million at December 31, 2013. Foreclosed properties declined $7.3 million to $56.2 million at June 30, 2014 from $63.5 million at December 31, 2013, an 11.5% decrease. Non-performing assets have had, and are expected to continue to have, a negative impact on net interest income and expenses related to managing the troubled loan portfolio and foreclosed properties.

The ALLL declined to $49.2 million at June 30, 2014 from $65.2 million at December 31, 2013, a 24.6% decrease. Net charge-offs during the three and six months ended June 30, 2014 were $4.3 million and $16.0 million, respectively, compared to $4.2 million and $8.8 million during the same periods in 2013, respectively. There was no provision for loan losses for the three and six month periods ended June 30, 2014 compared to $275,000 and $950,000 for the three and six months ended June 30, 2013, respectively. While the balance of the ALLL declined 24.6% during the six months ended June 30, 2014, the allowance compared to total non-performing loans was 116.6% at June 30, an increase from 95.2% at December 31, 2013 as a result of a larger decrease in non-performing loans. At June 30, 2014, the ratio of the allowance to total loans was 3.16% compared to 4.05% at December 31, 2013.

Recent Market and Industry Developments

The economic turmoil that began in the middle of 2007 and continued through 2012 appears to have settled into a slow economic recovery. 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 Dodd-Frank and other legislation.

Dodd-Frank is an extensive, complex and comprehensive piece of legislation that impacts many aspects of banking organizations. Dodd-Frank is likely to negatively impact our 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 our businesses.

Until such time as the regulatory agencies issue proposed and final regulations implementing the numerous provisions of Dodd-Frank, a process that may last several years, management will not be able to fully assess the impact the legislation will have on its business and, accordingly, results of operations may vary from period to period.

 

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Selected quarterly data are set forth in the following tables.

 

		Three Months Ended
		6/30/2014				3/31/2014				12/31/2013				9/30/2013				6/30/2013
		(Dollars in thousands - except per share amounts)
Operations Data:
Net interest income		$	17,862			$	18,315			$	18,877			$	15,812			$	13,417
Provision for loan losses			—				—				—				—				275
Non-interest income			7,610				5,932				8,002				142,679				8,852
Non-interest expense			22,855				22,317				23,125				45,232				27,375
Income (loss) before income tax expense			2,617				1,930				3,754				113,259				(5,381	)
Income tax expense			10				—				—				9				—
Net income (loss)			2,607				1,930				3,754				113,250				(5,381	)
Preferred stock dividends in arrears(1)			—				—				—				103,163				(1,701	)
Preferred stock discount accretion			—				—				—				(4,304	)			(1,863	)
Net income (loss) available to common equity			2,607				1,930				3,754				212,109				(8,945	)
Selected Financial Ratios (2):
Yield on interest-earning assets			3.72	%			3.89	%			3.86	%			3.80	%			3.71	%
Cost of funds			0.23				0.25				0.27				0.89				1.34
Interest rate spread			3.49				3.64				3.59				2.91				2.37
Net interest margin			3.51				3.66				3.61				2.88				2.33
Return on average assets			0.49				0.37				0.69				19.76				(0.92	)
Average equity to average assets			9.88				9.81				9.32				(2.67	)			(2.64	)
Non-interest expense to average assets			4.33				4.32				4.24				7.89				4.67
Per Share:
Basic earnings (loss) per common share		$	0.29			$	0.21			$	0.41			$	10.24			$	(0.42	)
Diluted earnings (loss) per common share			0.29				0.21				0.41				10.24				(0.42	)
Dividends per common share			—				—				—				—				—
Book value per common share			23.37				22.84				22.34				22.21				(8.33	)
Financial Condition:
Total assets		$	2,121,249			$	2,109,824			$	2,112,474			$	2,191,001			$	2,344,469
Loans receivable
Held for sale			5,261				2,944				3,085				4,571				19,705
Held for investment, net			1,506,963				1,513,720				1,544,324				1,582,554				1,627,243
Deposits			1,873,240				1,868,751				1,875,293				1,943,144				2,001,913
Other borrowed funds			13,781				13,210				12,877				19,748				318,749
Stockholders’ equity (deficit)			211,507				206,708				202,198				201,037				(71,389	)
Allowance for loan losses			49,175				53,497				65,182				71,853				75,872
Non-performing assets(3)			98,337				102,118				131,957				162,899				175,029

 

(1)	Including compounding, and $104,000 in quarter ended 9/30/2013 for retirement of preferred shares.

(2)	Annualized when appropriate.

(3)	Non-performing assets consist of loans past due ninety days or more and on non-accrual status, loans past 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 – Three months Ended June 30, 2014

Net results from operations for the three months ended June 30, 2014 improved $8.0 million to net income of $2.6 million from a net loss of $5.4 million in the prior year period. The improvement in results was primarily the result of a $4.4 million increase in net interest income and a decline of $4.5 million in non-interest expense. These were slightly offset by a decline of $1.2 million in non-interest income compared to the prior year period. The discussion that follows in this section provides additional details regarding these results for the three month periods.

 

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Net Interest Income

The following table shows the Corporation’s average balances, interest, average rates, the spread between the combined average rates earned on interest-earning assets and average cost of interest-bearing liabilities, net interest margin, which represents net interest income as a percentage of average interest-earning assets, and the ratio of average interest-earning assets to average interest-bearing liabilities for the years indicated. The average balances are derived from daily balances.

 

		Three Months Ended June 30,
		2014												2013
		Average Balance				Interest				Average Yield/ Cost(1)				Average Balance				Interest				Average Yield/ Cost(1)
		(Dollars in thousands)
Interest-Earning Assets
Mortgage loans		$	1,185,347			$	12,922				4.31	%		$	1,320,460			$	14,477				4.34	%
Consumer loans			351,332				4,185				4.78				402,009				4,880				4.87
Commercial business loans			21,454				214				3.95				25,594				409				6.32
Total loans receivable (2) (3)			1,558,133				17,321				4.40				1,748,063				19,766				4.47
Investment securities (4)			290,578				1,520				2.07				269,194				1,260				1.85
Interest-earning deposits			153,033				94				0.25				212,980				131				0.25
Federal Home Loan Bank stock			11,940				21				0.71				25,630				19				0.30
Total interest-earning assets			2,013,684				18,956				3.72				2,255,867				21,176				3.71
Non-interest-earning assets			102,264												96,925
Total assets		$	2,115,948											$	2,352,792
Interest-Bearing Liabilities
Demand deposits		$	1,020,155				296				0.12			$	1,037,506				319				0.12
Regular savings			346,070				94				0.11				329,354				90				0.11
Certificates of deposit			503,916				643				0.51				638,212				1,095				0.69
Total deposits			1,870,141				1,033				0.22				2,005,072				1,504				0.30
Other borrowed funds			15,434				61				1.56				319,530				6,255				7.83
Total interest-bearing liabilities			1,885,575				1,094				0.23				2,324,602				7,759				1.34
Non-interest-bearing liabilities			21,290												90,289
Total liabilities			1,906,865												2,414,891
Stockholders’ equity (deficit)			209,083												(62,099	)
Total liabilities and stockholders’ equity (deficit)		$	2,115,948											$	2,352,792
Net interest income/interest rate spread (5)						$	17,862				3.49	%						$	13,417				2.37	%
Net interest-earning assets		$	128,109											$	(68,735	)
Net interest margin (6)											3.51	%											2.33	%
Ratio of average interest-earning assets to average interest-bearing liabilities			1.07												0.97

 

(1)	Annualized

(2)	For the purpose of these computations, non-accrual loans are included in the 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 fair value.

(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 increased $4.4 million, or 33.1%, for the three months ended June 30, 2014, as compared to the same period in the prior year. Interest income decreased $2.2 million, or 10.5%, for the three months ended June 30, 2014, compared to the same period in the prior year, due to a decline in average balances and yields in all loan categories with the largest impact to income from the residential and commercial real estate loan portfolios. Investment securities balances and yields increased from the prior year period. Interest expense decreased $6.7 million, or 85.9%, for the three months ended June 30, 2014, as compared to the same period in the prior year due to the settlement of the credit agreement with U.S. Bank and prepayment of FHLB of Chicago borrowings resulting in lower borrowed funds balances and a reduction in certificate of deposit average balances and the rate paid on these accounts. The net interest margin increased to 3.51% for the three month period ended June 30, 2014 from 2.33% for the respective period in the prior year.

Loan portfolio average balances declined $189.9 million from June 30, 2013 largely due to principal and interest payments net of new loan originations. New loan originations had been limited as part of our capital improvement strategy to reduce risk-weighted assets by shrinking the overall size of the balance sheet. However, we have recently developed and are implementing strategies to increase profitability by slowing asset runoff and generating new loan volume to improve the net interest margin. Investment securities average balances increased $21.4 million primarily due to the purchase of securities totaling $37.8 million since June 30, 2013, partially offset by sales, maturities and principal collections of $24.4 million. The average balance of interest-earning deposits declined $59.9 million as the flow of funds from the loan and investment securities portfolios were used to reinvest in higher yielding investment securities and fund deposit run off.

Other borrowed funds average balances declined by $304.1 million for the three months ended June 30, 2014 when compared to the same period in the prior year primarily due to the payoff and settlement of $116.3 million under the Credit Agreement and prepayment of $187.5 million of FHLB of Chicago borrowings during the quarter ended September 30, 2013. The average balance of certificates of deposit decreased $134.3 million for the three months ended June 30, 2014 compared to the same period in the previous year. Likewise, the average rate paid on certificates of deposit fell by 18 basis points year over year. The decline in certificates of deposit average balances and interest rates was largely the result of lower rates offered in the market and pricing discipline as a result of reduced funding needs.

Provision for Loan Losses

Provision for loan losses was zero, a decrease of $275,000 for the three month period ended June 30, 2014, as compared to the same period in the previous year. Non-performing loans totaled $42.2 million at June 30, 2014, down from $68.5 million at December 31, 2013.

The decrease in provision for loan losses for the three months ended June 30, 2014 was due to reduced loan balances compared to the same period in the prior year, particularly non-performing loans which carry a greater loan provision. In addition, reduced net charge-offs resulted in no additional provision being required for the quarter ending June 30, 2014.

Future provisions for loan losses will continue to be based upon management’s assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors in order to maintain the ALLL 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 would decline should credit metrics such as net charge-offs and the amount of non-performing loans continue to 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)
		2014				2013				Amount				Percent
		(Dollars in thousands)
Net impairment losses recognized in earnings		$	(13	)		$	—			$	(13	)			N/M
Loan servicing income (loss), net of amortization			740				55				685				N/M
Service charges on deposits			2,523				2,580				(57	)			(2.2	)
Investment and insurance commissions			1,131				1,063				68				6.4
Net gain on sale of loans			698				2,793				(2,095	)			(75.0	)
Net gain on sale of OREO			1,040				925				115				12.4
Other income			1,491				1,436				55				3.8
Total non-interest income		$	7,610			$	8,852			$	(1,242	)			(14.0	)%

N/M = Not Meaningful

Non-interest income decreased $1.2 million, or 14%, to $7.6 million for the three months ended June 30, 2014, compared to $8.9 million for the same period in 2013. The decrease was primarily due to a decline in gain on sale of loans of $2.1 million partially offset by an increase in loan servicing income of $685,000.

The decrease in net gain on sale of loans of $2.1 million was primarily attributable to a significantly lower volume of residential mortgage loan sales in the current year period of $34.1 million compared to $150.2 million in the same three month period a year ago. Market mortgage rates reached historic lows during the fourth calendar quarter of 2012 into the first quarter of 2013 and have increased significantly since March 31, 2013, which caused a reduction in financing activity resulting in decreased sales volume.

Loan servicing income increased $685,000 in the current period compared to the respective period a year ago primarily due to lower amortization charges related to the mortgage servicing right (“MSR”) asset.

 

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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)
		2014				2013				Amount				Percent
		(Dollars in thousands)
Compensation and benefits		$	10,739			$	11,130			$	(391	)			(3.5	)%
Occupancy			1,614				1,986				(372	)			(18.7	)
Furniture and equipment			791				850				(59	)			(6.9	)
Federal deposit insurance premiums			700				1,332				(632	)			(47.4	)
Data processing			1,315				1,420				(105	)			(7.4	)
Communications			463				536				(73	)			(13.6	)
Marketing			879				396				483				N/M
OREO expense, net			2,267				4,289				(2,022	)			(47.1	)
Investor loss reimbursement			(248	)			371				(619	)			N/M
Mortgage servicing rights impairment (recovery)			84				(1,258	)			1,342				N/M
Provision for unfunded loan commitments			600				1,734				(1,134	)			(65.4	)
Loan processing and servicing expense			709				891				(182	)			(20.4	)
Legal services			602				1,271				(669	)			(52.6	)
Other professional fees			351				495				(144	)			(29.1	)
Insurance			206				376				(170	)			(45.2	)
Other expense			1,783				1,556				227				14.6
Total non-interest expense		$	22,855			$	27,375			$	(4,520	)			(16.5	)%

N/M = Not Meaningful

Non-interest expense decreased $4.5 million, or 16.5%, to $22.9 million for the three months ended June 30, 2014, as compared to $27.4 million for the respective period in 2013. Most categories of expense experienced a decline when compared to the prior year period. The largest decreases were due to lower OREO expense, net, provision for unfunded loan commitments, legal services, deposit insurance premiums and investor loss reimbursement. The decreases were partly offset by an increase in MSRs impairment.

The significant decline in OREO expense of $2.0 million during the three months ended June 30, 2014 was primarily the result of lower valuation adjustments on repossessed property. The provision for unfunded loan commitments declined by $1.1 million when compared with the prior year as the result of a specific reserve made during the period ended June 30, 2013 related to a loan commitment litigation. Legal services declined during the period due to lower expense related to commercial loan workouts as non-performing loans continue to decline. Deposit insurance premiums have declined due to a reduced rate being charged to the Bank beginning in December 2013. Investor loss reimbursement declined as a portion of the reserve for repurchased loans was reversed during the current year quarter compared to repurchases of $371,000 made in the prior year quarter. Most other categories of expense reflected declines over the prior year period in part due to ongoing expense control efforts.

MSR impairment expense was $84,000 in the three months ended June 30, 2014 as rates have increased and prepayment has slowed. An MSR impairment recovery of $1.3 million was recorded in the prior year comparable period.

Income Taxes

Income tax expense of $10,000 was recorded for the three month periods ended June 30, 2014 compared to no expense for the same period in 2013. While previously unrecognized net operating loss carryforwards were used to substantially offset taxable income, some states in which we operate have a minimum tax requirement which resulted in $10,000 of tax expense in the current period. A full valuation allowance has been recorded on the remaining net deferred tax asset due to the uncertainty of our ability to create sufficient taxable income to utilize the tax asset.

 

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Overview – Six months Ended June 30, 2014

Net results from operations for the six months ended June 30, 2014 improved $23.9 million to net income of $4.5 million from a net loss of $19.4 million in the prior year period. The improvement in results was primarily the result of a $17.9 million decline in non-interest expense and an increase in net interest income of $7.9 million compared to the six months ended June 30, 2013. Non-interest income was lower than the prior year period by $2.8 million. The discussion that follows in this section provides additional details regarding these results for the three month periods.

 

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Net Interest Income

The following table shows the Corporation’s average balances, interest, average rates, the spread between the combined average rates earned on interest-earning assets and average cost of interest-bearing liabilities, net interest margin, which represents net interest income as a percentage of average interest-earning assets, and the ratio of average interest-earning assets to average interest-bearing liabilities for the years indicated. The average balances are derived from daily balances.

 

		Six Months Ended June 30,
		2014												2013
		Average Balance				Interest				Average Yield/ Cost(1)				Average Balance				Interest				Average Yield/ Cost(1)
		(Dollars in thousands)
Interest-Earning Assets
Mortgage loans		$	1,199,339			$	26,116				4.33	%		$	1,340,668			$	30,113				4.47	%
Consumer loans			356,456				8,502				4.81				414,500				10,004				4.87
Commercial business loans			21,624				579				5.33				25,426				837				6.55
Total loans receivable (2) (3)			1,577,419				35,197				4.44				1,780,594				40,954				4.57
Investment securities (4)			286,865				3,027				2.10				267,250				2,675				1.99
Interest-earning deposits			130,488				159				0.25				184,105				225				0.25
Federal Home Loan Bank stock			11,940				35				0.59				25,630				38				0.30
Total interest-earning assets			2,006,712				38,418				3.81				2,257,579				43,892				3.87
Non-interest-earning assets			98,688												104,109
Total assets		$	2,105,400											$	2,361,688
Interest-Bearing Liabilities
Demand deposits		$	1,013,413				602				0.12			$	1,031,260				667				0.13
Regular savings			328,487				173				0.11				310,148				165				0.11
Certificates of deposit			519,577				1,346				0.52				667,744				2,382				0.72
Total deposits			1,861,477				2,121				0.23				2,009,152				3,214				0.32
Other borrowed funds			14,968				120				1.59				318,894				12,441				7.87
Total interest-bearing liabilities			1,876,445				2,241				0.24				2,328,046				15,655				1.36
Non-interest-bearing liabilities			21,650												88,793
Total liabilities			1,898,095												2,416,839
Stockholders’ equity (deficit)			207,305												(55,151	)
Total liabilities and stockholders’ equity (deficit)		$	2,105,400											$	2,361,688
Net interest income/interest rate spread (5)						$	36,177				3.57	%						$	28,237				2.51	%
Net interest-earning assets		$	130,267											$	(70,467	)
Net interest margin (6)											3.58	%											2.47	%
Ratio of average interest-earning assets to average interest-bearing liabilities			1.07												0.97

 

(1)	Annualized

(2)	For the purpose of these computations, non-accrual loans are included in the 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 fair value.

(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.

Net interest income increased $7.9 million, or 28.1%, for the six months ended June 30, 2014, as compared to the same period in the prior year. Interest income decreased $5.5 million, or 12.5%, for the six months ended June 30, 2014, compared to the same period in the prior year, due to declines in average balances and yields in all loan

 

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categories but primarily declines in the residential and commercial real estate loan portfolios. Investment securities average balance and yield increased modestly over the prior year period. Interest expense declined $13.4 million, or 85.7%, for the six months ended June 30, 2014, as compared to the same period in the prior year due to the settlement of the credit agreement with U.S. Bank and prepayment of FHLB of Chicago borrowings resulting in lower borrowed funds balances and a reduction in certificate of deposit average balances and the rate paid on these accounts. The net interest margin increased to 3.58% for the six month period ended June 30, 2014 from 2.47% for the respective period in the prior year.

Loan portfolio average balances declined $203.2 million from June 30, 2013 largely due to principal and interest payments net of new loan originations and loan sales. New loan originations had been limited as part of our capital improvement strategy to reduce risk-weighted assets by shrinking the overall size of the balance sheet. However, as problem loans have been steadily rolling off, we are now replacing them but at a slower rate with the intent of generating new loan volume to improve the net interest margin. Investment securities average balances increased $19.6 million primarily due to the purchase of securities totaling $37.8 million since June 30, 2013, partially offset by sales, maturities and principal collections of $24.4 million. The average balance of interest-earning deposits declined $53.6 million as the flow of funds from the loan and investment securities portfolios were used to reinvest in higher yielding investment securities and fund deposit run off.

Other borrowed funds average balances declined by $303.9 million for the six months ended June 30, 2014 when compared to the same period in the prior year primarily due to the payoff and settlement of $116.3 million under the Credit Agreement and prepayment of $187.5 million of FHLB of Chicago borrowings during the quarter ended September 30, 2013. The average balance of certificates of deposit decreased $148.2 million for the six months ended June 30, 2014 compared to the same period in the previous year. Likewise, the average rate paid on certificates of deposit fell by 20 basis points year over year. The decline in certificates of deposit average balances and interest rates was largely the result of lower rates offered in the market and pricing discipline as a result of reduced funding needs.

Provision for Loan Losses

Provision for loan losses was zero, a decrease of $950,000 for the six month period ended June 30, 2014, as compared to the same period in the previous year. Non-performing loans totaled $42.2 million at June 30, 2014, down from $68.5 million at December 31, 2013.

The decrease in provision for loan losses for the six months ended June 30, 2014 was due to reduced loan balances compared to the same period in the prior year, particularly non-performing loans which carry a greater loan provision. In addition, reduced net charge-offs resulted in no additional provision being required for the six months ending June 30, 2014.

Future provisions for loan losses will continue to be based upon management’s assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors in order to maintain the ALLL 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 would decline should credit metrics such as net charge-offs and the amount of non-performing loans continue to 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:

 

		Six Months Ended June 30,								Increase (Decrease)
		2014				2013				Amount				Percent
		(Dollars in thousands)
Net impairment losses recognized in earnings		$	(34	)		$	(83	)		$	49				59.0	%
Loan servicing income (loss), net of amortization			1,514				110				1,404				N/M
Service charges on deposits			4,789				4,949				(160	)			(3.2	)
Investment and insurance commissions			1,987				2,015				(28	)			(1.4	)
Net gain on sale of loans			1,290				5,823				(4,533	)			(77.8	)
Net gain on sale of investment securities			301				(200	)			501				N/M
Net gain on sale of OREO			1,201				2,262				(1,061	)			(46.9	)
Other income			2,494				1,479				1,015				68.6
Total non-interest income		$	13,542			$	16,355			$	(2,813	)			(17.2	)%

N/M = Not Meaningful

Non-interest income decreased $2.8 million, or 17.2%, to $13.5 million for the six months ended June 30, 2014, compared to $16.4 million for the same period in 2013. The decrease was primarily due to declines in gain on sale of loans of $4.5 million and net gain on sale of OREO of $1.1 million. These unfavorable items were partially offset by increases in loan servicing income of $1.4 million, other income of $1.0 million, and gain on sale of securities of $501,000.

The decrease in net gain on sale of loans of $4.5 million was primarily attributable to a significantly lower volume of residential mortgage loan sales in the current year period of $57.0 million compared to $312.8 million in the same six month period a year ago. Market mortgage rates reached historic lows during the fourth calendar quarter of 2012 into the first quarter of 2013 and have increased significantly since March 31, 2013, which caused a reduction in financing activity resulting in decreased sales volume. Net gain on sale of OREO decreased by $1.1 million in the six months ended June 30, 2014 from $2.3 million in the year ago period largely due to the impact of lower sales volume with smaller gains per property as the OREO portfolio balances continue to decline and we realize smaller margins per property.

Loan servicing income increased $1.4 million in the current period compared to the respective period a year ago primarily due to lower amortization charges related to the MSR asset. Other income increased by $1.0 million over the prior year due to income from real estate partnerships, increased rental income of bank property and increased credit card income. Sales of investment securities reflect a $301,000 gain during the six months ended June 30, 2014 compared to a loss of $200,000 in the same period in 2013.

 

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Non-Interest Expense

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

 

		Six Months Ended June 30,								Increase (Decrease)
		2014				2013				Amount				Percent
		(Dollars in thousands)
Compensation and benefits		$	21,901			$	21,272			$	629				3.0	%
Occupancy			3,852				4,297				(445	)			(10.4	)
Furniture and equipment			1,557				1,612				(55	)			(3.4	)
Federal deposit insurance premiums			1,748				2,686				(938	)			(34.9	)
Data processing			2,686				3,282				(596	)			(18.2	)
Communications			1,036				948				88				9.3
Marketing			1,532				902				630				69.8
OREO expense, net			3,452				16,548				(13,096	)			(79.1	)
Investor loss reimbursement			(86	)			3,181				(3,267	)			N/M
Mortgage servicing rights impairment (recovery)			95				(3,448	)			3,543				N/M
Provision for unfunded loan commitments			780				2,159				(1,379	)			(63.9	)
Loan processing and servicing expense			1,276				2,194				(918	)			(41.8	)
Legal services			955				2,371				(1,416	)			(59.7	)
Other professional fees			758				1,154				(396	)			(34.3	)
Insurance			516				794				(278	)			(35.0	)
Other expense			3,114				3,091				23				0.7
Total non-interest expense		$	45,172			$	63,043			$	(17,871	)			(28.3	)%

N/M = Not Meaningful

Non-interest expense decreased $17.9 million, or 28.3%, to $45.2 million for the six months ended June 30, 2014, as compared to $63.0 million for the respective period in 2013. The decrease was primarily due to lower OREO expense, net, investor loss reimbursement, legal services and provision for unfunded loan commitments. These decreases were partly offset by an increase in mortgage servicing rights impairment of $3.5 million due to a recovery recorded in the current year period.

The significant decline in OREO expense of $13.1 million during the six months ended June 30, 2014 was primarily the result of a decline of $9.3 million in valuation adjustments on repossessed property. OREO real estate taxes also declined by $2.5 million over the prior year period. Investor loss reimbursement declined due to a $1.7 million reserve was recorded in the prior year period. Legal fees declined $1.4 million due to lower expense related to commercial loan workouts as non-performing loans continue to decline. The prior year provision for unfunded loan commitments included a specific reserve of $1.7 million related to one credit. Most other categories of expense reflected declines over the prior year period in part due to ongoing expense control efforts.

MSR impairment expense was $95,000 in the six months ended June 30, 2014 as rates have increased and prepayment has slowed versus a recovery of $3.4 million in the prior year period. Other increases include marketing expense of $630,000 which has been ramped up to support the growth objectives of the bank and compensation and benefits have increased $629,000 as new commercial lending staff has been added to support commercial banking growth initiatives.

Income Taxes

Income tax expense of $10,000 was recorded for the six month periods ended June 30, 2014 compared to no expense for the same period in 2013. While previously unrecognized net operating loss carryforwards were used to substantially offset taxable income, some states in which we operate have a minimum tax requirement which resulted in $10,000 of tax expense in the current period. A full valuation allowance has been recorded on the remaining net deferred tax asset due to the uncertainty of our ability to create sufficient taxable income to utilize the tax asset.

 

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FINANCIAL CONDITION

General

Total assets of the Corporation decreased $8.8 million, or less than one percent, to $2.12 billion at June 30, 2014. This decrease was primarily attributable to lower balances in net loans held for investment and OREO which were mostly offset by higher cash and cash equivalents and investment securities balances.

Investment Securities

Investment securities available-for-sale increased $17.4 million during the six months ended June 30, 2014, or 6.3%, primarily due to purchases of $37.8 million and a decrease in fair market value net loss adjustments of $4.8 million. The increase was partially offset by principal repayments and sales of $24.4 million and $115,000 of other-than-temporary impairment losses that were recognized in earnings. See Note 4 to the Consolidated Financial Statements.

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 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 the extent dependent upon the level of interest rate increases, the time period to the next interest rate repricing date for individual loans within the security and the applicable periodic (annual and/or lifetime) cap which could limit the degree to which an individual loan could 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 that need to be recognized in earnings as other-than-temporary impairment.

Loans Held for Investment

Loans held for investment decreased $53.4 million during the six months ended June 30, 2014 from $1.61 billion at December 31, 2013 to $1.56 billion at June 30, 2014. The activity included principal repayments and other adjustments (the majority of which are undisbursed loan proceeds) of $209.4 million and transfers to other real estate owned of $7.7 million, partially offset by originations and refinances. During the three months ended June 30, 2014, the Corporation originated $97.9 million of loans for investment, as compared to $57.4 million during the three months ended March 31, 2014.

Loans Held for Sale

Residential mortgage loans originated for sale amounted to $57.9 million for the six months ended June 30, 2014 compared to $295.2 million for the same period ended June 30, 2013. At December 31, 2013, loans held for sale, which consisted solely of single-family residential mortgage loans, amounted to $3.1 million, and increased $2.2 million to $5.3 million at June 30, 2014.

 

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Other Real Estate Owned

OREO, net decreased $7.3 million to $56.2 million at June 30, 2014 from $63.5 million at December 31, 2013 due to sales of $12.7 million offset by additions during the quarter of $7.7 million, net of $2.3 million in valuation adjustments.

Deposits

Deposits decreased $2.1 million during the six months ended June 30, 2014 to $1.87 billion, due to declines of $58.1 million in certificates of deposit (“CDs”) and $7.4 million in money market accounts which was mostly offset by increases in advance payments of $39.2 million and regular savings of $23.0 million. A significant portion of the CD decreases were due to planned reductions in deposits from single service special rate households. Deposits obtained from brokerage firms which solicit deposits from their customers amounted to zero at June 30, 2014 and December 31, 2013. The weighted average rate of certificate of deposits decreased to 0.52% at June 30, 2014 compared to 0.57% at December 31, 2013.

Other Liabilities

Total liabilities declined $534,000 from December 31, 2013 to June 30, 2014 due to declines in deposits of $2.1 million and accrued taxes, insurance and employee related expenses of $1.7 million since December 31, 2013. These declines were partially offset by an increase in other liabilities of $2.4 million during the six months ended June 30, 2014. Other borrowed funds increased slightly to $13.8 million at June 30, 2014 from $12.9 million at December 31, 2013. Other borrowed funds as of June 30, 2014 consist primarily of FHLB of Chicago borrowings of $10.0 million and retail repurchase agreements of $3.5 million. At June 30, 2014 and December 31, 2013, FHLB of Chicago advances totaled $10.0 million and had a weighted average interest rate of 2.33%.

Stockholders’ Equity (Deficit)

Stockholders’ equity increased $9.3 million to $211.5 million at June 30, 2014 compared to $202.2 million at December 31, 2013. The increase during the six months ended June 30, 2014 was primarily the result of net income during the period of $4.5 million and a decline in accumulated other comprehensive income (loss) (AOCI) related to AFS securities. AOCI declined by $4.8 million during the six months ended June 30, 2014.

RISK MANAGEMENT

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

Risk Management Philosophy

The Bank’s risk management philosophy is to manage to an overall level of 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. While improvements have occurred, the Bank continues to work toward reducing the overall risk level to a more desired risk profile.

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:

 

•

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.

 

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Although the Board of Directors (the “Board”) 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, reviews risk profiles and discusses key risk issues. The Chief Risk Officer is in charge of overseeing credit risk management. Our internal audit and compliance departments perform an independent assessment of the internal control environment and plays a critical role in risk and compliance management, testing the operation of the internal control system and reporting findings to the Risk Committee 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. Management continues to focus on loss mitigation and maximization of recoveries in the Bank’s non-performing assets portfolio. Over time, the Bank intends to return to management of portfolio returns through discrete portfolio 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, while Internal Audit provides an independent assessment of the effectiveness of the credit risk management process. An external credit risk management group also provides loan review services. Credit risk is managed taking into account regulatory guidance.

 

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Non-Performing Loans

The composition of non-performing loans is summarized as follows:

 

		June 30, 2014												December 31, 2013
		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		$	6,046				14.3	%			0.39	%		$	14,404				21.0	%			0.89	%
Commercial and industrial			995				2.4				0.06				1,509				2.2				0.09
Land and construction			18,846				44.7				1.20				24,729				36.1				1.52
Multi-family			6,249				14.8				0.40				3,658				5.4				0.22
Retail/office			3,994				9.4				0.25				14,365				21.0				0.89
Other commercial real estate			4,286				10.2				0.27				6,802				9.9				0.42
Education (2)			209				0.5				0.01				276				0.4				0.02
Other consumer			1,542				3.7				0.10				2,754				4.0				0.17
Total		$	42,167				100.0	%			2.68	%		$	68,497				100.0	%			4.22	%

 

(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 $6,767 and $8,930 at June 30, 2014, and December 31, 2013, respectively, that are not considered impaired based on a guarantee provided by government agencies.

The following is a summary of non-performing loan activity:

 

		Non- Performing Loans December 31, 2013				Additions				Transfer to Accrual Status				Transfer to OREO				Paid Down				Charged Off				Non- Performing Loans June 30, 2014				Remaining Balance of Loans				Associated ALLL
		(In thousands)
Residential		$	14,404			$	1,971			$	(4,013	)		$	(4,105	)		$	(740	)		$	(1,471	)		$	6,046			$	527,284			$	10,325
Commercial and industrial			1,509				4,845				(401	)			(57	)			(518	)			(4,383	)			995				15,007				2,596
Land and construction			24,729				5,242				(219	)			(852	)			(6,308	)			(3,746	)			18,846				87,143				9,633
Multi-family			3,658				4,592				(791	)			0				(422	)			(788	)			6,249				260,145				6,169
Retail/office			14,365				1,613				(1,359	)			(2,349	)			(1,737	)			(6,539	)			3,994				138,013				8,824
Other commercial real estate			6,802				2,661				(1,474	)			(140	)			(3,808	)			245				4,286				151,960				6,544
Education			276				—				—				—				(67	)			—				209				118,091				428
Other consumer			2,754				850				(569	)			(156	)			(353	)			(984	)			1,542				230,083				4,656
Total		$	68,497			$	21,774			$	(8,826	)		$	(7,659	)		$	(13,953	)		$	(17,666	)		$	42,167			$	1,527,726			$	49,175

Non-performing loans decreased $26.3 million during the six months ended June 30, 2014. The loan categories with the largest decline in non-performing loans were retail/office of $10.4 million, residential loans of $8.4 million, land and construction of $5.9 million and other commercial real estate of $2.5 million.

The interest income that would have been recorded during the three and six months ended June 30, 2014 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 $0.7 million and $1.9 million, respectively.

 

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Non-Performing Assets

The composition of non-performing assets and related credit metrics are summarized as follows:

 

		June 30, 2014				December 31, 2013
		(Dollars in thousands)
Non-accrual loans - excluding troubled debt restructurings		$	20,762			$	39,151
Troubled debt restructurings - non-accrual (1)			21,405				29,346
Other real estate owned (OREO)			56,170				63,460
Total non-performing assets		$	98,337			$	131,957
Non-performing loans to gross loans (2)			2.69	%			4.22	%
Non-performing assets to total assets			4.64				6.25
Allowance for loan losses to gross loans (2)			3.13				4.02
Allowance for loan losses to non-performing loans			116.62				95.16
Allowance for loan losses plus OREO valuation allowance to non-performing assets			74.94				72.77

 

(1)	Troubled debt restructurings – non-accrual represent non-accrual loans that have been modified in a troubled debt restructuring.

(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 TDR 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 enough 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 TDR. The designation as a TDR 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.

The following is a summary of non-performing asset activity for the three months ended June 30, 2014:

 

		Non-Performing Loans (1)				Other Real Estate Owned (OREO)				Total Non- Performing Assets
		(In thousands)
Balance at December 31, 2013		$	68,497			$	63,460			$	131,957
Additions			21,774				7,659				29,433
Transfer of loans to OREO			(7,659	)			—				(7,659	)
Returned to accrual status			(8,826	)			—				(8,826	)
Sales			—				(12,698	)			(12,698	)
Loan charge-offs/OREO valuations adjustments, net			(17,666	)			(2,279	)			(19,945	)
Capitalized improvements			—				28				28
Payments			(13,953	)			—				(13,953	)
Balance at June 30, 2014		$	42,167			$	56,170			$	98,337

 

(1)	Total non-performing loans exclude the guaranteed portion of education loans of $6,767 and $8,930 that are 90 days or more past due but still accruing interest at June 30, 2014, and December 31, 2013, respectively.

 

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Loan Delinquencies 30 Days and Over

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

 

		June 30, 2014								December 31, 2013
						% of Total								% of Total
Days Past Due		Balance				Gross Loans				Balance				Gross Loans
		(Dollars in thousands)
30 to 59 days		$	11,257				0.72	%		$	11,885				0.73	%
60 to 89 days			6,751				0.43				4,280				0.26
90 days and over			24,556				1.56				49,017				3.02
Total		$	42,564				2.71	%		$	65,182				4.02	%

Loans delinquent 30 to 89 days increased $1.8 million to $18.0 million at June 30, 2014 from $16.2 million at December 31, 2013 as a result of more substandard loans in these past due categories.

Impaired Loans

At June 30, 2014, the Corporation identified $53.4 million of loans as impaired, which includes $11.2 million of performing TDRs. At December 31, 2013, impaired loans were $101.6 million, which included $33.1 million of performing TDRs. 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.

The following is additional information regarding impaired loans.

 

		June 30,				December 31,
		2014				2013
		(In thousands)
Carrying amount of impaired loans		$	47,914			$	78,471
Average carrying amount of impaired loans			58,017				77,734
Loans and troubled debt restructurings on non-accrual status			42,167				68,497
Troubled debt restructurings - accrual			11,249				33,087
Troubled debt restructurings - non-accrual (1)			21,405				29,346
Troubled debt restructurings valuation allowance			5,500				12,216
Loans past due ninety days or more and still accruing (2)			6,767				8,930

 

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

(2)	Representes the guaranteed portion of education loans 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.

Interest income recognized on impaired loans on a cash basis was $1.5 million and $1.3 million for the six months ended June 30, 2014 and 2013.

 

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Allowance for Loan Losses

Like all financial institutions, we must maintain an adequate ALLL. The ALLL is established through a provision for loan losses charged to expense. Loans are charged-off against the ALLL when we believe that repayment of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. The balance in the ALLL 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 “Critical Accounting Estimates and Judgments.”

The ALLL consists of general 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 loans reported as troubled debt restructurings. For such loans, an ALLL 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 general allowance component is based on historical net loss experience for the past nine quarters, adjusted for qualitative factors. A reserve for unfunded commitments, letters of credit and repurchase of sold loans is also maintained which is classified in other liabilities.

For the quarter ended June 30, 2014, the Bank modified its general allowance methodology to increase the historical loss period from an eight to nine quarter historical look-back period with the intent to build to a 12 quarter look back period subsequent to June 30, 2014. The modification was done to reflect a more stable economic environment and to capture additional loss statistics considered reflective of the current portfolio. The impact to the allowance for loan losses at June 30, 2014 after implementing the above modifications was a reduction of the required reserve of $381,000 as compared to the previous methodology. See the Company’s annual report on Form 10-K for the nine months ended December 31, 2013 for a full description of the allowance methodology.

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

Qualitative factors include:

 

•

Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;

 

•

Changes in international, national, regional and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;

 

•

Changes in the nature and volume of the portfolio and in the terms of loans;

 

•

Changes in the experience, ability and depth of lending management and other relevant staff;

 

•

Changes in the volume and severity of past due loans, the volume of non-accrual loans, and volume and severity of adversely classified or graded loans;

 

•

Changes in the quality of AnchorBank’s loan review system;

 

•

Changes in the value of underlying collateral for collateral-dependent loans;

 

•

The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and

 

•

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in AnchorBank’s current portfolio.

Any 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 nine 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 qualitative factor related to 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 ALLL 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’ ALLL , and may recommend adjustments based on their assessment of the adequacy of the ALLL. Management periodically reviews the assumptions and formula used in determining the ALLL and makes adjustments if required to reflect the current risk profile of the portfolio.

 

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The following table presents the ALLL by component:

 

		June 30,				December 31,
		2014				2013
		(In thousands)
General reserve		$	33,633			$	35,844
Substandard reserve			10,040				6,225
Specific reserve			5,502				23,113
Total allowance for loan losses		$	49,175			$	65,182

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

 

		June 30,				December 31,
		2014				2013
		(In thousands)
Pass		$	1,484,701			$	1,460,457
Special mention			2,693				24,203
Total pass and special mention rated loans			1,487,394				1,484,660
Substandard rated loans, excluding TDR accrual (1)			29,083				35,310
Troubled debt restructurings - accrual			11,249				33,087
Non-accrual			42,167				68,497
Total impaired loans			53,417				101,584
Total unpaid principal balance		$	1,569,893			$	1,621,554

 

(1)	Includes residential and consumer loans identified as substandard that are not necessarily on non-accrual.

The following table presents credit risk metrics related to the ALLL:

 

		June 30,				December 31,
		2014				2013
		(Dollars in thousands)
General ALLL / pass and special mention loans			2.3	%			2.4	%
Substandard ALLL / substandard loans			34.5	%			17.6	%
Specific ALLL / impaired loans			33.9	%			31.2	%
Loans 30 to 89 days past due		$	18,008			$	16,165

The ratio of the general ALLL to pass and special mention loans remained relatively stable while the substandard ALLL to substandard loans and specific ALLL to impaired loans increased from December 31, 2013 to reflect management’s assessment of risk and related potential for loss.

 

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The following table summarizes the activity in the ALLL for the periods indicated.

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2014				2013				2014				2013
		(Dollars in thousands)
Allowance at beginning of period		$	53,497			$	79,815			$	65,182			$	83,761
Charge-offs:
Residential			(566	)			(1,665	)			(1,662	)			(3,529	)
Multi-family			(506	)			(170	)			(883	)			(354	)
Commercial real estate			(589	)			(374	)			(7,391	)			(781	)
Land and construction			(46	)			(1,655	)			(3,628	)			(2,377	)
Consumer			(291	)			(907	)			(1,435	)			(3,320	)
Commercial and industrial			(3,633	)			(411	)			(4,955	)			(1,135	)
Total charge-offs			(5,631	)			(5,182	)			(19,954	)			(11,496	)
Recoveries:
Residential			125				163				356				181
Multi-family			73				74				131				108
Commercial real estate			489				177				2,294				1,063
Land and construction			89				353				133				873
Consumer			153				42				257				145
Commercial and industrial			380				155				776				287
Total recoveries			1,309				964				3,947				2,657
Net charge-offs			(4,322	)			(4,218	)			(16,007	)			(8,839	)
Provision for loan losses			—				275				—				950
Allowance at end of period		$	49,175			$	75,872			$	49,175			$	75,872
Net charge-offs to average loans held for sale and for investment (1)			(1.11	)%			(0.97	)%			(2.03	)%			(0.99	)%

 

(1)	Annualized.

Total charge-offs and recoveries of $5.6 million and $1.3 million, respectively, for the three months ended June 30, 2014 increased $449,000 and $345,000, respectively, from the three months ended June 30, 2013. Total charge-offs and recoveries of $20.0 million and $3.9 million, respectively, for the six months ended June 30, 2014 increased $8.5 million and $1.3 million, respectively, from the six months ended June 30, 2013.

The provision for loan losses decreased $275,000 and $950,000 to zero for the three and six months ended June 30, 2014, respectively compared to the same periods in the prior year. The improvement was largely due to a lower required allowance for losses on impaired loans, reflecting the relatively steady quarter-over-quarter decrease in non-performing loans since June 2010. Management monitors and evaluates the portfolio on an ongoing basis and also considered the decrease in non-performing loans to total loans to 2.69% at June 30, 2014 from 4.22% at December 31, 2013 to be a factor that warranted the decrease in provision for loan losses.

 

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Other Real Estate Owned

OREO, net decreased $7.3 million during the six months ended June 30, 2014. Individual properties included in OREO at June 30, 2014 with a recorded balance in excess of $1 million are listed below:

 

Description		Location		Carrying Value
				(in thousands)
Raw Land		Northeast Wisconsin		$	3,266
Commercial Building		Northwest Wisconsin			2,355
Commercial Building		Northwest Wisconsin			1,140
Commercial Building		South Central Wisconsin			3,825
Raw Land		South Central Wisconsin			2,231
Commercial Building		South Central Wisconsin			1,790
Commercial Building		South Central Wisconsin			1,403
Raw Land		South Central Wisconsin			1,352
Raw Land		South Central Wisconsin			1,238
Condo Lot		South Central Wisconsin			1,161
Raw Land		South Central Wisconsin			1,105
Commercial Lot		South Central Wisconsin			1,071
Raw Land		Southeast Wisconsin			3,680
Commercial Building		Southeast Wisconsin			3,036
Commercial Building		Southeast Wisconsin			2,054
Raw Land		Southeast Wisconsin			1,162
Other properties individually less than $1 million					24,302
				$	56,170

Foreclosed properties are recorded at fair value less cost to sell upon transfer to OREO with shortfalls, if any, charged to the ALLL. 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 carrying values of OREO properties are reviewed and appropriate adjustments made based upon updated appraisals, broker opinions or signed sales contracts. For appraisals received over one year ago, management considers broker and market analysis to update the estimated fair value. Incremental valuation adjustments may be recognized in the Statement of Operations if, in the opinion of management, additional losses are deemed probable.

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

Operating Activities

Net cash provided by operations of $6.5 million for the six months ended June 30, 2014 decreased $7.5 million when compared to the same period in 2013 primarily due to lower valuation adjustments for OREO losses and lower gains on the sale of residential first mortgage loans.

Investing Activities

Net cash from investing activities decreased $59.1 million for the six months ended June 30, 2014 as compared to the same period in 2013 due to a decline in the origination of loans held for investment and lower proceeds from sales of OREO and investments.

Financing Activities

Net cash used for financing activities decreased $50.3 million for the six months ended June 30, 2014 as compared to the same period in 2013 primarily due to a decline in the level of run off on deposit balances during the period.

Liquidity and Capital Resources

On an unconsolidated basis, the Corporation’s typical sources of funds could include dividends from its subsidiaries, including the Bank, interest on its investments and returns on its real estate held for sale. The Corporation currently finances its operations through cash on hand and, to a lesser extent, interest on investments and dividends from its non-Bank subsidiary. A significant amount of our consolidated operating expenses are incurred and paid directly by the Corporation’s subsidiaries.

The Bank’s primary sources of funds are payments on loans and securities, deposits from retail and corporate banking businesses and wholesale funding sources (FHLB of Chicago advances, other borrowings and broker/internet CDs). As of June 30, 2014, the Corporation had outstanding borrowings from the FHLB of Chicago of $10.0 million. The total maximum credit capacity at the FHLB of Chicago based on the existing stock holding as of June 30, 2014 was $238.8 million, subject to collateral availability. Total credit capacity based on the value of the existing collateral pledged was $470.6 million as of June 30, 2014 after considering other collateral requirements for letters of credit and our participation in the Mortgage Partnership Finance Program of the FHLB of Chicago (“MPF Program”). The Bank has also been granted access to the Federal Reserve Bank of Chicago’s discount window but as of June 30, 2014, the Bank had no borrowings outstanding from this source.

Loan Commitments

At June 30, 2014, the Bank had outstanding commitments to originate loans of $82.5 million, $786,000 of unused commitments and commitments to extend funds to, or on behalf of, customers pursuant to lines, and unused letters of credit of $240.7 million. Scheduled maturities of certificates of deposits during the six months following June 30, 2014 amounted to $174.6 million. Scheduled maturities of borrowings during the same period totaled $3.5 million. Management believes adequate resources are available to fund all Bank commitments to the extent required.

Investment Securities

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 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

 

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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, credit losses may be experienced, which are recognized in earnings as net impairment losses.

MPF Program

The Corporation previously participated in the MPF Program of the FHLB of Chicago. Pursuant to the credit enhancement feature of the MPF Program, the Corporation retained a secondary credit loss exposure in the amount of $15.9 million at June 30, 2014 related to approximately $191.9 million of residential mortgage loans that the Corporation has originated and is still outstanding as agent for the FHLB of Chicago. Under the credit enhancement, the FHLB of Chicago is liable for losses on loans up to one percent of the original delivered loan balances in each pool up to the point the credit enhancement is reset. After the credit enhancement resets, the FHLB of Chicago and the Corporation’s loss contingency could be reduced depending upon losses experienced and loan balances. The Corporation is then liable for losses over and above the FHLB of Chicago first loss 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 Corporation discontinued funding loans through the MPF Program in 2008.

FHLB of Chicago Advances

The Bank pledges certain loans that meet underwriting criteria established by the FHLB of Chicago as collateral for outstanding advances. The unpaid principal balance of loans pledged to secure FHLB of Chicago borrowings totaled $644.5 million and $659.4 million at June 30, 2014 and December 31, 2013, respectively. The FHLB of Chicago borrowings are also collateralized by mortgage-related securities totaling $110.2 million and $122.2 million at June 30, 2014 and December 31, 2013, respectively. At June 30, 2014, there were no FHLB of Chicago borrowings with call features that may be exercised by the FHLB of Chicago.

Other

The Bank has, in the past, 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, 2014, the Bank had no brokered deposits. The Bank Orders previously prohibited the Bank’s ability to accept, renew or roll over brokered deposits without prior approval of the OCC.

Regulatory Capital

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. At June 30, 2014, the Bank met the requirements to be considered well capitalized under these regulations.

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.

While the Corporation attempts to manage its balance sheet to minimize the effect that a change in interest rates has on its net interest margin it may utilize derivative financial instruments as part of its interest rate risk management strategy. The Corporation’s Board of Directors recently approved developing a program for the prudent use of interest rate swap transactions to manage the interest rate risk of commercial loans and to manage other balance sheet interest rate risk. The Corporation intends to enter into interest rate-related transactions to facilitate the interest rate risk management strategies of commercial customers. The Corporation would then mitigate this risk by entering

 

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into equal and offsetting interest rate-related transactions with highly rated third party financial institutions. The Corporation’s objectives with the use of derivatives is to add stability to its net interest margin and to manage its exposure to movements in interest rates. There are currently no outstanding interest rate transactions or any activity during the six months ended June 30, 2014.

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, mortgage-backed securities, and other securities) that are largely funded by interest-bearing liabilities (deposits and borrowings). All of the financial instruments of the Corporation as of June 30, 2014 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 and mix 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 the 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 the net earnings generated from these instruments. The Corporation’s exposure to interest rate risk is managed primarily through the 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 the Corporation operates. Deposit pricing is competitive with promotional rates frequently offered by competitors. Borrowings, which include FHLB of Chicago 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 the Corporation’s exposure to interest rate risk. The rates, terms, and interest rate indices of the 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 uses 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 assets and liabilities. In addition, the model computes a theoretical market value of equity by estimating the market values of its assets and liabilities using present value methodology. The model also projects the effect on earnings and theoretical value under various interest rate change scenarios. The Corporation’s exposure to interest rates is reviewed on a monthly basis by senior management and the Board of Directors.

 

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Net Interest Income Sensitivity Analysis

The Corporation performs a net interest income sensitivity analysis as part of its asset/liability management processes. Net interest income sensitivity 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. The table below presents the projected changes in twelve-month cumulative net interest income for the various rate shock levels at June 30, 2014 and December 31, 2013, respectively.

 

		200 Basis Point Rate Increase				100 Basis Point Rate Increase
June 30, 2014			3.7	%			1.8	%
December 31, 2013			3.5	%			1.4	%

As a result of current market conditions, 100 and 200 basis point decreases in market interest rates are not applicable for the periods presented as those decreases would result in some deposit interest rate assumptions falling below zero. Nonetheless, the Corporation’s net interest income may decline in declining rate environments as yields on earning assets could continue to adjust downward.

As shown above, at June 30, 2014, the effect of an immediate 200 basis point increase in interest rates would decrease the Corporation’s net interest income by 3.7%. The net interest income sensitivity was changed at December 31, 2013 to reflect a change in methodology that has been implemented to segregate nonaccrual loans in the model. Overall net interest income sensitivity remains within the Corporation’s guidelines.

The changes in the Corporation’s net interest income reflected above were due, in large part, to the optionality on both sides of the balance sheet. The changes in net interest income over the one year horizon for June 30, 2014 under the 100 basis point and 200 basis point increases in market interest rates scenarios are reflective of this optionality. In general, in a rising rate environment, yields on loans and investment securities are expected to re-price upwards more quickly than the cost of funds.

Mortgage-backed securities, including adjustable rate mortgage pools, are modeled in the above analysis based on their estimated repricing or principal paydowns obtained from outside analytical sources. Loans are modeled in the above analysis based on contractual maturity or contractual repricing dates, coupled with principal prepayment assumptions. Deposits are modeled based on management’s analysis of industry trends and customer behavior.

The Corporation also uses these assumptions to estimate the market value of equity and the market risk to this value due to changes in interest rates. This focus helps model risks embedded in the balance sheet over a longer time horizon than the net interest income simulation. The calculation is based on the present value of projected future cash flows. As of June 30, 2014, the projected changes for the market value of equity were within the Corporation’s policy limits.

Computations of the prospective effects of hypothetical interest rate changes are dependent 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 Company may undertake in response to changes in interest rates. Because such assumptions can be no more than estimates, certain assets and liabilities modeled 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 rate sensitivity results included above do not and cannot necessarily indicate the actual future impact of general interest rate movements on the Company’s net interest income.

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. The Corporation has a separate department with individuals having specialized training and experience tasked with ensuring compliance with state and federal public interest, consumer, and civil rights oriented banking laws and regulations.

 

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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.

REGULATORY DEVELOPMENTS

The Dodd-Frank Act

On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act is having a broad impact on the financial services industry, and imposes significant regulatory and compliance requirements, including the imposition of increased capital, leverage, and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector. The Dodd-Frank Act also created the Consumer Financial Protection Bureau (the “CFPB”). The CFPB is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. Additionally, the Dodd-Frank Act established a new framework of authority to conduct systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the OCC, and the FDIC.

As a result of the Dodd-Frank Act, primary jurisdiction for the supervision and regulation of federal thrifts, including the Bank, was transferred to the OCC, while supervision and regulation of SLHCs, including the Company, was transferred to the Federal Reserve. Although the Dodd-Frank Act maintained the federal thrift charter, it eliminated certain benefits of the charter and imposed new penalties for failure to comply with the qualified thrift investment (“QTL”) test. Under the Dodd-Frank Act, the risk-based and leverage capital standards currently applicable to U.S. insured depository institutions will be imposed on U.S. bank holding companies and SLHCs, and depository institutions and their holding companies will be subject to minimum risk-based and leverage capital requirements on a consolidated basis. In addition, the Dodd-Frank Act requires that SLHCs be well capitalized and well managed in the same manner as bank holding companies in order to engage in the expanded financial activities permissible only for a financial holding company.

Many of the requirements of the Dodd-Frank Act are in the process of being implemented and most will be subject to regulations implemented over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements.

Basel III Capital Rules

In July 2013, the federal banking agencies published final rules (the “Basel III Capital Rules”) that revised their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to implement, in part, agreements reached by the Basel Committee on Banking Supervision (“Basel Committee”) and certain provisions of the Dodd-Frank Act. The Basel III Capital Rules will apply to banking organizations, including the Company and the Bank.

The Basel III Capital Rules are intended to increase both the amount and quality of regulatory capital. Among other things, the Basel III Capital Rules: (i) introduce a new capital measure entitled “Common Equity Tier 1” (“CET1”); (ii) specify that tier 1 capital consist of CET1 and additional financial instruments satisfying specified requirements

 

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that permit inclusion in tier 1 capital; (iii) define CET1 narrowly by requiring that most deductions or adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions or adjustments from capital as compared to the existing regulations. The Basel III Capital Rules also provide a permanent exemption from the proposed phase out of existing trust preferred securities and cumulative perpetual preferred stock from regulatory capital for banking organizations with less than $15 billion in total consolidated assets as of December 31, 2009.

The Basel III Capital Rules provide for the following minimum capital to risk-weighted assets ratios: (i) 4.5% based upon CET1; (ii) 6.0% based upon tier 1 capital; and (iii) 8.0% based upon total regulatory capital.

A minimum leverage ratio (tier 1 capital as a percentage of total assets) of 4.0% is also required under the Basel III Capital Rules (even for highly rated institutions). The Basel III Capital Rules additionally require institutions to retain a capital conservation buffer of 2.5% above these required minimum capital ratio levels. Banking organizations that fail to maintain the minimum 2.5% capital conservation buffer could face restrictions on capital distributions or discretionary bonus payments to executive officers.

The Basel III Capital Rules did not address the proposed liquidity coverage ratio (“LCR”) called for by the Basel Committee’s Basel III framework. On October 24, 2013, the Federal Reserve issued a proposed rule implementing a LCR requirement in the United States for larger banking organizations. Neither the Company nor the Bank would be subject to the LCR requirement as proposed.

Finally, the Basel III Capital Rules amend the thresholds under the “prompt corrective action” framework enforced with respect to the Bank by the OCC to reflect both (i) the generally heightened requirements for regulatory capital ratios as well as (ii) the introduction of the CET1 capital measure.

The enactment of the Basel III Capital Rules could increase the required capital levels of the Bank, and the Holding Company will become subject to consolidated capital rules. The Basel III Capital Rules become effective as applied to us and the Bank on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019. The ultimate impact of the new capital and liquidity standards on the Company and Bank is currently being reviewed and will depend on a number of factors, including additional developments in the implementation of the Basel III Capital Rules and any additional related rulemaking by the U.S. banking agencies.

The Volcker Rule

On December 10, 2013, five U.S. financial regulators, including the Federal Reserve and the OCC, adopted a final rule implementing the so-called “Volcker Rule.” The Volcker Rule was created by Section 619 of the Dodd-Frank Act and generally prohibits “banking entities” from engaging in “proprietary trading” and making investments and conducting certain other activities with “private equity funds” and “hedge funds.”

Although the final rule provides some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company and the Bank. The final regulations were published in the Federal Register on January 31, 2014, and became effective April 1, 2014; however, at the time the agencies released the final Volcker Rule, the Federal Reserve announced an extension of the conformance period for all banking entities until July 21, 2015.

In response to industry questions regarding the final Volcker Rule, the OCC, Federal Reserve, the FDIC, the SEC, and the CFTC issued a clarifying interim final rule on January 14, 2014, permitting banking entities to retain interests in certain collateralized debt obligations (“CDOs”) backed by trust preferred securities if the CDO meets certain requirements.

We are currently reviewing the scope of the regulations implementing the Volcker Rule to determine the impact of the rule on our operations.

 

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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, assumptions, judgments 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. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be its critical accounting policies. Management has reviewed the application of these polices with the Audit Committee of our Board of Directors. Management’s discussion and analysis should be read in conjunction with the consolidated financial statements and supplemental data contained elsewhere in this report. 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 generally accepted accounting principles. 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 MSRs. 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, loans held for sale, 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 MSRs, certain impaired loans and OREO. 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 ownership in a security 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).

 

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Allowance for Loan Losses

The allowance for loan losses is a valuation account for probable and inherent losses incurred in the loan portfolio. Management maintains an allowance for loan losses - and separately a reserve for unfunded loan commitments, letters of credit and repurchase of sold loans 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 portfolios and other relevant factors. The ALLL is comprised of general 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 qualitative factors. At least quarterly, management reviews the assumptions and methodology related to the general and specific allowances in an effort to update and refine the estimate.

In determining the general allowance, the loan portfolio is segregated by purpose and collateral type. By doing so, trends in borrower behavior and loss severity are more easily identified. For each class of loan, a historical loss factor is computed. 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 or other factors. Given the changes in the credit market that have occurred since 2008, management reviews each class’ historical losses by quarter for any trends that would indicate a different look back period would be more representative of current experience.

Historical loss rates used to calculate the general allowance are adjusted by values assigned to nine qualitative factors which are listed in the section titled “Allowance for Loan Losses” within “Credit Risk Management”. In determining the appropriate value to assign to a particular factor, if any, management compares the current underlying facts and circumstances with respect to that factor with those in the historical periods. Values assigned to factors are modified when changes in the environment relative to that quantitative or qualitative factor are deemed to be significant. Management will continue to analyze the factors on a quarterly basis, adjusting the historical loss rates as necessary, to a rate believed to be appropriate for the probable and inherent risk of loss in the portfolio.

For the quarter ended June 30, 2014, the Bank modified its general allowance methodology to increase the historical loss period from an eight to nine quarter historical look-back period with the intent to build to a 12 quarter look back period subsequent to June 30, 2014. The modification was done to reflect a more stable economic environment and to capture additional loss statistics considered reflective of the current portfolio. The impact to the allowance for loan losses at June 30, 2014 after implementing the above modifications was a reduction of the required reserve of $381,000 as compared to the previous methodology. See the Company’s annual report on Form 10-K for the nine months ended December 31, 2013 for a full description of the allowance methodology. Specific allowances are determined as a result of an 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 expected cash flows method. If the present value of expected cash flows or the fair value of collateral exceeds the Bank’s carrying value of a loan no loss is anticipated and no specific reserve is established. However, if the carrying value of a 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 allowance.

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 $500,000 or less in a homogenous pool of assets do not require an impairment analysis. 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. In those cases, evaluations are being utilized for smaller properties when an appraisal has been done within five years and no market deterioration is evident.

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 (less than one year old), 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 years beginning 2011 through the current period. These percentages are supported by the Bank’s analysis of appraisal activity over the past 12 months.

 

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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 impaired 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.

Management considers the ALLL at June 30, 2014 to be at an adequate 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 loan 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 are held for sale and are initially recorded at fair value less estimated selling costs at the date of foreclosure, establishing a new cost basis. Any write down to fair value less estimated selling costs is charged to the allowance for loan losses. If the 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 estimated selling expenses. 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 OREO expense, net included in non-interest expense. Incremental valuation adjustments may be recognized in the Statement of Operations if, in the opinion of management, additional losses are deemed probable.

Mortgage Servicing Rights

MSRs 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 underlying loans are stratified into relatively homogeneous pools based on predominant risk characteristics which include product type (i.e., fixed, adjustable or balloon) and interest rate bands. If the aggregate carrying value of the capitalized MSRs for a stratum exceeds its fair value, MSR impairment is recognized in earnings for the difference. As the loans are repaid and net servicing revenue is earned, the MSR asset is amortized as an offset in loan servicing income. 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 MSRs may be impaired.

Income Taxes

The Corporation’s provision for federal income taxes results 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 income or deductible expenses in future periods. The Corporation regularly reviews the carrying amount of its net deferred tax assets (net of deferred tax liabilities) 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 net 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 net deferred tax assets.

 

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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.

As a result this evaluation, a full valuation allowance has been established against the net deferred tax asset.

FORWARD-LOOKING STATEMENTS

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

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

 

•

our ability to successfully transform our business and implement our new business strategy;

 

•

our ability to fully realize our deferred tax assets;

 

•

on-going impact of the Recapitalization;

 

•

changes in the quality or composition of our loan and investment portfolios, other real estate owned values and allowance for loan losses;

 

•

impact of potential impairment of other intangibles in a challenging economy;

 

•

our ability to pay dividends;

 

•

our ability to address our liquidity needs;

 

•

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

 

•

our ability to recruit and retain key employees;

 

•

uncertainties about market interest rates;

 

•

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

 

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•

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;

 

•

security breaches of our information systems;

 

•

changes in the conditions of the securities markets, which could adversely affect, among other things, the value or credit quality of our assets, the availability and terms of funding necessary to meet our liquidity needs and our ability to originate loans;

 

•

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

 

•

the performance of third party investment products we offer;

 

•

environmental liability for properties to which we take title;

 

•

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

 

•

changes in accounting principles, policies or guidelines;

 

•

the impact of dilution of existing stockholders as a result of possible future capital raising transactions;

 

•

uncertainties relating to the Emergency Economic Stabilization Act of 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

 

•

other risk factors included under Part II, Item 1A Risk Factors in this report.

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

 

Item 3

Quantitative and Qualitative Disclosures About Market Risk.

The Corporation’s market risk has not materially changed from December 31, 2013. See Item 7A in the Corporation’s Annual Report on Form 10-K/T for the nine months ended December 31, 2013. 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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On May 14, 2013 the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) issued an updated version of its Internal Control - Integrated Framework (“2013 Framework”). Originally issued in 1992, (“1992 Framework”), the framework helps organizations design, implement, and evaluate the effectiveness of internal control concepts and simplify their use and application. The 1992 Framework will remain effective during the transition, which extends to December 15, 2014, after which time COSO will consider it as superseded by the 2013 Framework. As of June 30, 2014, the Company is using the 1992 Framework.

 

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Part II - Other Information

 

Item 1

Legal Proceedings.

We are a defendant in a pending lawsuit captioned Village of Kronenwetter v. AnchorBank, fsb, Marathon County, Wisconsin, Case No. 11-CV-1370, which is an action brought by the Village of Kronenwetter on November 14, 2011 to enforce and collect on a $4.4 million letter of credit issued by the Bank in support of the development of a mixed use TIF development in the Village of Kronenwetter, Wisconsin. The complaint alleges that the Bank wrongfully refused to honor a full draw on the letter of credit and that the developer failed to notify the plaintiff of the renewal of the letter of credit or to renew the letter of credit within the time limitations set forth in the development agreement. A specific reserve for loss on unfunded loan commitments was established at June 30, 2013 in the amount of $2.4 million due to a shortfall in the value of the residential real estate development supporting the letter of credit. The specific reserve balance at June 30, 2014 remained at $2.4 million.

We are the plaintiff/counterclaim defendant in a pending lawsuit captioned AnchorBank, fsb v. Henriette McLean et al., Dane County, Wisconsin, Case No. 13-CV-811. The Bank is seeking to enforce personal guarantees executed by McLean related to amounts borrowed by Mineral Point Road Holdings, LLC (“MPRH”). At the time of the commencement of the lawsuit, March 7, 2013, McLean owed the Bank $363,302 under the guarantees. As a result of the recent sale of real estate owned by MPRH, the amount of the debt is now $300,127. The Bank has the right to obtain its attorneys’ fees incurred in collecting on the guarantees if it prevails in the lawsuit. On January 27, 2014, McLean filed a 196-paragraph Counterclaim against the Bank. McLean alleges various misconduct by the Bank related to its loans to MPRH and the procurement of her guarantees. Most of the counterclaims are based upon alleged misrepresentations and/or misrepresentations by omission. McLean is seeking the return of the $182,629 she paid to the Bank in 2012 under her guarantees, treble damages, and punitive damages. McLean has also filed a third-party complaint seeking contribution/indemnity from Joseph Gallina (the managing member of MPRH) and various entities controlled by Gallina.

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

 

Item 1A

Risk Factors.

In addition to the risk factors and other information discussed elsewhere in this Quarterly Report on Form 10-Q, you should carefully consider the factors described in Part I, Item 1A of our Annual Report on Form 10-K/T for the nine months ended December 31, 2013, filed with the Securities and Exchange Commission (“SEC”) on or about March 20, 2014. Those risks and uncertainties could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in our Annual Report on Form 10–K/T, this Quarterly Report on Form 10-Q and in other documents we file with the SEC. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition, results of operations or prospects could be materially and adversely affected by any of these risks. This report, including the documents incorporated by reference herein, also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors.

 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

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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.
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.
Exhibit 101		The following financial statements from the Anchor Bancorp Wisconsin Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in Extensive Business Reporting Language (XBRL); (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations and Comprehensive Income (Loss), (iii) Consolidated Statements of Changes in Stockholders’ Equity (Deficit), (iv) Consolidated Statements of Cash Flows, and (v) the Notes to Unaudited Consolidated Financial Statements are included herein as an exhibit to this report.

 

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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 7, 2014				By:		/s/ Chris Bauer
								Chris Bauer, President and Chief Executive Officer
Date:		August 7, 2014				By:		/s/ Thomas G. Dolan
								Thomas G. Dolan, Executive Vice President, Treasurer and Chief Financial Officer

 

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